Document of The World Bank

FOR OFFICIAL USE ONLY

Report No. 45085-MX

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

PROGRAM DOCUMENT

FOR A PROPOSED ENVIRONMENTAL SUSTAINABILITY DEVELOPMENT POLICY LOAN

IN THE AMOUNT OF US$300.75 MILLION

TO

THE UNITED MEXICAN STATES

September 5,2008

Sustainable Development Department Colombia and Mexico Country Management Unit Latin America and the Caribbean Region

This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. I t s contents may not otherwise be disclosed without World Bank authorization.

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

UNITED MEXICAN STATES - FISCAL YEAR January 1 - December 31

CDM

CFE

CURRENCY EQUIVALENTS (Exchange Rate Effective as o f September 1,2008)

Clean Development Mechanism

Federal Electricity Commission or Comisidn Federal de Electricidad

Currency Unit = Mexican Peso (MXN) U S $ l

MXN 1 - 10.14 MXN -

US$O. 10 - -

CONAFOR

CONAGUA

CONAVI

WEIGHTS AND MEASURES Metr ic System

National Forestry Commission or Comisidn Nacional Forestal National Water Commission or Comisidn Nacional de Agua

National Housing Commission or Comisibn Nacional de Vivienda

ABBREVIATIONS AND ACRONYMS

DPL

EIA

EMBI+

1 AAA 1 Analytical and Advisory Activities I

Development Policy Loan

Environmental Impact Assessment

Emerging Markets Bond Index Plus

I ARD I Agriculture and Rural Development I

ENS0 ENVDPL ENVSAL

I BANSEF1

E l Nii lo Southern Oscillation

Environment Development Policy Loan Environment Structural Adjustment Loan

National Bank for Savings and Financial Services or Banco de Ahorro Nacional de Sewicios Financieros, Institucion de Banca de Desarrollo, S.N.C.,

FONATUR

I CBMM I Mesoamerican Mexican Biological Corridor or Corredor Bioldgico Mesoamericano-Mkxico I

National Tourism Fund or Fundo Nacional de Turismo

I clcc Intersecretarial Commission on Climate Change or Comisidn Intersecretarial de Cambio Climatic0

I co2 I Carbon dioxide I I COINBIO I Comission of Indigenous Biodiversity or Comisidn Indigena de la Biodiversidad I

I CPS 1 Country Partnership Strategy I

I EMS I Environmental Management Systems I I ENRP I Environment and Natural Resources Program I

I F A 0 I United Nations Food and Agriculture Organization I I FIDE I Investment Fund for Electricity Savings or Fideicomisso para el Ahorro de Energia Electrica I I FIRCO I Sharing Risk Investment Fund or Fideicomiso de Riesgo Compartido I

i

FOR OFFICIAL USE ONLY

ITWG

LyFC

Inter-Sectoral Technical Working Group

Central Power and Electricity Utility or Luz Y Fuerza del Centro

I MICs I Middle Income Countries

PDIA

PEMEX

PFM

PHRD

P M

PPm PROCYMAF

I MPN I Most Probable Number

Environmental Institutional Development Program or Programa de Desarrollo Institucional Ambiental

Mexico Petroleum Company or Petrdleos Mexicanos Public Financial Management

Policy and Human Resources Development

Public Information Notice

Parts Per Mil l ion

Forest Resources Conservation and Sustainable Management Project or Proyecto de Conservacidn y Manejo Sustentable de Recursos Forestales en MPxico

I Metrictons I

PRODEPLAN

PROFEP A

I Minimum wages I

Program for the Development o f Commercial Forest Plantations or Programa para el Desarrollo de Plantaciones Forestales Comerciales Federal Attorney General for Environmental Regulation or Procuraduria Federal de Proteccidn al Ambiente

1 NAFTA I North American Free Trade Agreement I I NHP I National Housing Program I 1 NDP I National Development Plan (2007-2012) I I NPT I National Program for Tourism or Programa Nacional de Turismo I 1 NSCC I National Strategy on Climate Change or Estrategia Nacional de Carnbio Climbtico I I NWP 1 National Water Plan I

I PRODDER I Rights Restitution Program or Programa de Devolucidn de Derechos I

I PROSENER I Energy Sector Program or Programa Sectorial de Energia I

This document has a restricted distribution and may be used by recipients only in the performance o f their off icial duties. I t s contents may not be otherwise disclosed without Wor ld Bank authorization.

PSA PSBR

I PSIA I Poverty and Social Impact Analysis I

Payment for Environmental Services or Pago por Servicios Ambientales

Public Sector Borrowing Requirements

RBCS SAGARPA

SHF

I SAL I Structural Adjustment Loan I

River Basin Councils or Consejos de Cuenca Ministry of Agriculture Secretaria de Agricultura or Ganaderia, Desarrollo Rural, Pesca y Alimentacidn

Federal Mortgage Company or Sociedad Hipotecaria Federal

I SEA I Strategic Environmental Assessment I SECTUR SEDESOL

Ministry o f Tourism or Secretaria de Turismo Ministrv of Social DeveloDment or Secretaria de Desarrollo Social I SEMARNAT Ministry of Environment and Natural Resources or Secretaria de Medio Ambiente y Recursos 1 Naturales

sox TESOFE

I SENER I Ministry of Energy, or Secretaria de Energia I

~~ ~ ~~ ~

Sulfur oxides

National Treasurv or Tesoreria de la Federacidn -

I SFA I Water Financing System or Sistema Financier0 de Agua I

wss

I SHCP 1 Ministry of Finance or Secretaria de Hacienda y Cre'dito Pliblico I

Water Supply and Sanitation

I TFP I Total Factory Productivity I I UNFCCC I United Nations Framework Convention on Climate Change I

Vice President: Pamela Cox

Sector Director: Laura Tuck Sector Manager: Laura Tlaiye

Task Team Leader: Adriana Moreira

Country Director: Axel van Trotsenburg

... 111

L

I .

MEXICO ENVIRONMENTAL SUSTAINABILITY DEVELOPMENT POLICY LOAN

CONTENTS

an and Program Summary .......................................................................................................... r i

INTRODUCTION ..................................................................................................................... 1

I1 . COUNTRY CONTEXT ............................................................................................................ 3

A . Recent Economic Developments in Mexico ........................................................................... 3 B . Macroeconomic Outlook and Debt Sustainability .................................................................. 4

I11 . THE GOVERNMENT'S PROGRAM .................................................................. 7

A . Government's Overall Program ........................................................................ 7 B . Environmental Challenges in the Tourism Sector, Government Strategy and Actions

Supported by this Operation .................................................................................................. 8 C . Environmental Challenges in the Energy Sector, Government Strategy and Actions

D . Environmental Challenges in the Forestry Sector, Government Strategy and Actions

E . Environmental Challenges in the Water Sector, Government Strategy and Actions

F . Environmental Challenges in the Agriculture Sector, Government Strategy and Actions

G . Environmental Challenges in the Housing Sector, Government Strategy and Actions

Supported by this Operation ................................................................................................. 12

Supported by this Operation ................................................................................................. 16

Supported by this Operation ................................................................................................. 19

Supported by this Operation ................................................................................................ -23

Supported by this Operation ................................................................................................. 26

IV BANK SUPPORT TO THE GOVERNMENT STRATEGY ................................................. 32

A . Link to Country Partnership Strategy ................................................................................... 32 B . Collaboration with the IMF and Other Donors ..................................................................... 32 C . Relationship to other Bank Operations ................................................................................. 32 D . Lessons Learned ................................................................................................................... 34 E . Analytical Underpinnings ..................................................................................................... 36

V . THE PROPOSED DEVELOPMENT POLICY L O A N ......................................................... 40

A . Operation Description ........................................................................................................... 40 B . Policy Areas .......................................................................................................................... 41 C . Loan Amount and Tranching ................................................................................................ 41

i v

VI. OPERATION IMPLEMENTATION., .................................................................................... 42

A . Poverty and Social Impacts .................................................................................................. 42 B . Implementation, Monitoring and Evaluation ........................................................................ 45 C . Fiduciary Aspects .................................................................................................................. 47 D . Disbursement and Auditing .................................................................................................. 47 E . Environmental Aspects ........................................................................................................ 48 F . Risks and Risk Mitigation ..................................................................................................... 48

ANNEXES

ANNEX 1 : Letter o f Development Policy .................................................................................... 50

ANNEX 2: Achievements under previous DPL Operations ......................................................... 61

ANNEX 3: Development Policy Matrix ...................................................................................... -71

ANNEX 4: Potential Poverty and Social Impacts ......................................................................... 73

ANNEX 5: Country at a Glance .................................................................................................... 77

ANNEX 6: Mexico Operations Porfolio (IBRDADA) and Grants ............................................... 80

ANNEX 7: Statement o f IFC’s Held and Disbursed Portfolio ...................................................... 81

ANNEX 8: Map (IBRD 33447) ..................................................................................................... 82

The Environment Sustainability Development Policy Loan was prepared by an IBRD team consisting of Adriana Moreira (Task Team Leader). Angela Armstrong. Rita Cestti. Ricardo Hernandez . Anjali Acharya. Benoit Bosquet. Douglas Olson (LCSEN); Yewande Awe (ENV); Angelica Nunez (LCSUW); Gabriela Elizondo Azuela (LCSEG); Gustavo Saltiel (LCSSD); Maria Elena Castro. William Reuben (LCSSO); Jozef Draaisma (LCSPE); Juan Carlos Alvarez (LEGLA); and Victor Ordonez (LCSFM) . This operation was prepared under the general guidance o f Axel van Trotsenburg (Country Director. LCC 1 C). Laura Tuck (Sector Director. LCSSD). Laura Tlaiye (Sector Manager. LCSEN). and Todd Crawford (Operations Adviser. LCSDE) . Peer reviewers were Aziz Bouzaher (AFTEN). Richard Damania (SASDI). Kirk Hamilton (ENV). and John Nash (LCSSD) . Karina Kashiwamoto (LCCIC) provided valuable administrative support .

V

LOAN AND PROGRAM SUMMARY

MEXICO

ENVIRONMENTAL SUSTAINABILITY DEVELOPMENT POLICY LOAN

Borrower: Implementing Agencies:

Amount and Terms:

Tranching :

Description:

The United Mexican States Secretaria de Medio Ambiente y Recursos Naturales (SEMARNAT), Secretaria de Hacienda y Cre‘dito Publico (SHCP), Secretaria de Turismo (SECTUR), Comisibn Nacional Forestal (CONAFOR), Comisidn Nacional de Agua (CONAGUA), Secretaria de Energia (SENER), Secretaria de Agricultura, Ganaderia, Desarrollo Rural, Pesca y Alimentacibn (SAGARPA), and Comisibn Nacional de Vivienda (CONAVI) . US$300.75 million fixed spread, U.S. dollar-denominated loan, 15 years o f grace and total repayment period o f 15 years. Front-end fee: 0.25 percent o f the loan amount, capitalized. The full amount o f the loan will be disbursed in a single tranche upon effectiveness. The Environmental Sustainability Development Policy Loan (DPL) supports the Government o f Mexico’s medium-term, outcome-based program to promote sustainable development. The overarching objective o f the DPL operation i s to balance socio-economic development with environmental protection and improvement. The operation wi l l complement actions supported by the recently approved Climate Change DPL and wi l l further pursue the general objectives o f a previous Environment DPL Program, by integrating environmental concerns in the sectoral policies and programs o f key development sectors -tourism, energy, forestry, water, agriculture, and housing- as prioritized by the government o f Mexico (GOM). The original Environment DPL Program supported environmental mainstreaming in four o f these sectors (tourism, energy, forestry, and water); the other two (agriculture and housing) have been included at the GOM’s request.

Key actions undertaken by the GOM in preparation for the proposed operation include: (i) the adoption o f Agenda 21 action plans in 35 new tourism destinations, which ensures the integration o f environmental considerations in tourism development and the monitoring o f this development; (ii) GOM’s approval and implementation o f the 2007-20 12 Energy Sector Program to promote increased energy efficiency and energy production from non-hydro renewable sources and regulate sulfur emissions; (iii) increasing the budgetary allocation to CONAFOR to provide greater community access to financial services in order to expand programs supporting sustainable forestry management and compensation

vi

Benefits:

Risks

for environmental services; (iv) approval o f the 2008 Federal Rights Law, which includes provisions for the return o f wastewater discharge fees to municipalities and industries to promote pollution reduction; and CONAGUA’s modification o f the Operational Rules o f i t s eight ongoing programs to promote reduced overexploitation o f water resources; (v) SAGARPA’s modification to the Operational Rules o f i t s Sustainable Natural Resource Use in Primary Production Program to incorporate environmental sustainability criteria and SEMARNAT and SAGARPA’s signature o f an agreement to implement joint actions aiming to reduce the negative environmental impacts associated with agricultural practices within the Mexican Mesoamerican Biological Corridor; and (vi) CONAVI’s publication o f cross-sector guidelines for incorporating environmentally sustainable practices into housing construction. Actions supported in the tourism sector include the implementation o f cooperative approaches involving public entities, the private sector, and other community stakeholders for jo int action in addressing environmental problems to improve environmental conditions at tourist sites. In the energy sector, the actions supported contribute to reducing local air pollution by improving energy efficiency, promoting alternative renewable energy sources, and reducing sulfur emissions. In the forestry sector, new financing sources support sustainable forestry management practices. Actions in the water sector promote efficient water usage and contribute to reducing water pollution. In addition, actions in this sector identify key instruments and approaches for improved integrated water resource management and support the development o f action plans to pi lot these instruments in flagship projects involving the participation o f water users and other stakeholders. In the agricultural sector, the actions contribute to the sustainable management o f natural resources, including water conservation, which benefits small-scale farmers. Actions in the housing sector incorporate environmental criteria in new housing developments, contributing to the design and construction o f energy- and water-efficient housing. Macroeconomic risks are associated with effects on the Mexican economy o f (i) a sharper slowdown o f the US (and global) economy, decelerating growth o f non-oil exports and reducing the f low o f workers’ remittances, (ii) higher levels o f international commodity and food prices leading to further pressures on domestic inflation, (iii) increased uncertainty with respect to credit conditions for the access o f emerging markets to the international capital markets, and (iv) declining o i l production. However, several factors are in place to reduce these risks, including: a healthy financial system that has begun to expand domestic credit as a share o f GDP; more dynamism in exports to non-US destinations; favorable terms o f trade with high o i l prices; and the further consolidation o f prudent macroeconomic policies in both the fiscal and monetary realms.

vi i

Project ID Number:

Political risks include opposition to government reforms and changes in high and mid-level staff within key ministries that may result in a loss o f momentum to complete the reforms supported by the program. These risks are mitigated by the following factors: (i) the legal and regulatory framework established under the second operation o f the Environment DPL program (ENVDPL II), which supported the enactment o f laws and regulations that provide a solid foundation for the continuity o f sectoral reforms; and (ii) the design o f the operation, which anchors the formulation o f sector environmental strategies on consensus-building among different stakeholders, ensuring a broad discussion o f the issues and promoting buy-in with respect to strategy proposals from the sectors.

Institutional and stakeholder risks are associated with (i) working with new sectors that have not systematically incorporated environmental considerations into their agendas in the past; and (ii) the promotion o f public participation and greater accountability. These risks are linked to weak local institutional capacity and to the absence o f upstream accountability frameworks. They are addressed by the following measures, some o f which were initiated and supported under the previous Environment DPL Program (ENVSAL I and ENVDPL 11)’ and are part o f the GOM’s current environment program: (i) shared sectoral agendas that clearly delineate implementation and oversight responsibilities; (ii) a capacity building program; (iii) an accountability framework and a tracking system that monitors environmental indicators in the different sectors; (iv) transparency and accessibility o f environmental public information systems; (v) an enhanced communication strategy for the sector; and (vi) the development and dissemination o f guidelines for public participation in EIA processes and other participatory mechanisms. PO955 10

... V l l l

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROGRAM DOCUMENT

FOR A PROPOSED ENVIRONMENTAL SUSTAINABILITY DEVELOPMENT POLICY LOAN

TO THE UNITED MEXICAN STATES

I. INTRODUCTION

1. This document proposes an Environmental Sustainability Development Policy Loan o f US$300.75 million to the government o f Mexico (GOM). This development policy loan (DPL) aims to support the government’s efforts to mainstream environmental concerns in the development agenda o f key sectors (tourism, energy, water, forestry, agriculture, and housing) in Mexico.

2. By supporting environmental improvements in these areas, the Bank continues a long- standing and comprehensive engagement with Mexico on the environment, where efforts have centered on policy development, institutional strengthening, air pollution prevention, water resources management, climate change, conservation o f natural resources, and solid waste management. This engagement includes a vast number o f analytical and advisory activities (AAA) that have played a key role in guiding the Bank’s program and policy dialogue on the environment. Chapter IV’s section on analytical underpinnings (para. 128- 147), summarizes this work as well as i t s contributions to the design o f the proposed DPL.

3. The proposed operation benefits from the experience the World Bank has gained through i t s broad environment program in Mexico. The operation pursues the general objectives o f the previous Environment DPL Program (comprised o f the Environment Structural Adjustment Loan, ENVSAL I, and the Second Environment Development Policy Loan, ENVDPL 11). These objectives were to mainstream environmental concerns in key development agendas o f four sectors (tourism, energy, forestry, and water) as prioritized by the government, and improve the effectiveness and efficiency o f local environmental management processes.

4. In addition, it complements the recent Climate Change DPL, which aims to support the GOM in integrating climate change considerations in public policy. While the Climate Change DPL underscores Mexico’s leadership on global environmental issues, the proposed operation also highlights Mexico as being on the forefront o f both national and local environmental issues where environmental sustainability i s increasingly becoming a transversal element o f public policy. Although these environmental issues are often politically sensitive (e.g., the environmental impacts stemming from the energy, agricultural, and water sectors), the government i s taking important steps to address them.

5. The sectors included in the operation’s design have been selectively chosen by the GOM to continue promoting environmental improvements in the areas o f energy, tourism, water, and forestry-sectors with established environmental agendas-and to also support new areas, such as housing and agriculture, which have only recently begun to integrate environmental concerns into their programs.

6. Further, the proposed DPL i s aligned with the strategies included in the government’s environmental sustainability agenda, outlined in the 2007-20 12 National Development Plan (NDP).’ This agenda seeks to advance the mainstreaming o f environmental concerns into the development planning process in order to promote sustainable production and consumption practices, prevent environmental degradation and i t s costs, and ensure development opportunities. The NDP recognizes that those elements that make up the environment must be managed in an integrated manner, and with this in mind, includes strategies for areas such as water, forests, climate change, biodiversity, solid waste, and cross-cutting environmental sustainability policy instruments.

7. Given i ts strong support to the NDP, the operation i s also consistent with the 2008-20 13 Country Partnership Strategy (CPS). In particular, the operation directly supports the achievement o f the Strategy’s country development objectives targeted toward assuring environmental sustainability. By supporting these objectives, the CPS aims to achieve the following goals: (i) increased electricity generation from renewable sources, (ii) an increased number o f hectares under sustainable forest management, and (iii) increased coverage o f municipal wastewater treatment, all o f which are expected outcomes o f the proposed operation.

8. This report i s organized as follows; Chapter I1 describes the country’s economic context, including recent economic developments and the macroeconomic environment. Chapter I11 presents the government’s reform agenda and discusses the measures i t has taken to address the challenges it faces, including specific measures supported by the constituent operations o f the DPL program. Chapter IV discusses the rationale for the Bank’s involvement in the reform efforts in Mexico and the lessons learned from ENVSAL I and ENVDPL 11. Chapter V describes the specific objectives o f this operation, including prior actions completed by GOM. Finally, Chapter V I discusses implementation o f the proposed operation.

‘ Presidencia de la Republica. Plan Nacional de Desarrollo 2007-2012. Mexico City: Gobierno de 10s Estados Unidos Mexicanos. 2007. (http:.//pnd.presidencia,gob,mx)

2

11, COUNTRY CONTEXT

A. RECENT ECONOMIC DEVELOPMENTS

9. Over the past four years (2004-2007), the Mexican economy has experienced a period of balanced and broad-based expansion of economic activity at an average annual rate o f gross domestic product (GDP) growth o f 3.8 percent. A vigorous global economic expansion contributed to the enhanced growth performance as exports increased at a double-digit annual average rate o f growth. Enhanced price stability contributed to a healthy growth o f domestic demand as a result o f an improved purchasing power o f wages and salaries and an expansion o f domestic credit and consumer lending. The evolution o f the main macroeconomic indicators over the past four years confirms a picture o f balanced growth (Table 1).

10. Fiscal policy has been successfully focused on a reduction of the public sector deficit and a decline in the public sector debt-to-GDP ratio. Higher-than-expected o i l and tax revenue allowed the public sector to increase current and capital expenditures and, at the same time, post a modest fiscal surplus over the past two years. Public expenditure increased by almost 2 percentage points o f GDP, providing an additional impulse to domestic demand in this period. A balanced budget requirement i s part o f a federal budget and fiscal responsibility law adopted in 2006. In terms o f the broader Public Sector Borrowing Requirements (PSBR) that includes off-budget spending, the Mexican public sector also has managed to restrain i t s debt financing requirements to about 1 to 2 percent o f GDP.

Table 1: Mexico’s Selected Economic Indicators

X B R (%GDP) -1.9 -1.5 -0.9 -1.3 Net public sector debt (% GDP) 36.8 35.3 32.5 31.5 O.W. % in foreign currency 37.3 32.4 28.1 25.7 Source: Bank staff calculation based on SHCP, Bunco de Mkxico and INEGI

11. The Mexican public sector remains heavily dependent on oi l revenue which in 2007 made up 35 percent o f total public sector revenue, whereas non-oil tax revenue remained at a modest 10 percent o f GDP. Oil production has dropped from a high o f about 3.4 mi l l ion barrels per day in 2004 to about 3.1 mi l l ion barrels per day in 2007 and to some 2.8 mi l l ion barrels per day in recent months. Current proven reserves o f o i l are in the order o f 10 years o f production and Mexico i s the only major o i l producer to have suffered a dramatic decline (halving) o f known reserves in recent decades2

Part o f this drop was due to a change in the methodology.

3

B. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY

12. International capital markets, credit rating agencies, and international institutions al l recognize the progress achieved in macroeconomic stability and the strengthening o f the fundamentals o f the Mexican economy. The G O M maintains an investment grade rating by al l three major credit rating agencies, two o f which improved their rating last autumnq3 The most recent IMF Article I V consultation and Board discussion “commended the improvements in macroeconomic and financial policies that have helped Mexico to reduce significantly external and internal vulnerabilities over the years.”4

13. The recent international financial market turmoil i s leading to tighter credit conditions and a global re-pricing o f risk. In l ine with other major emerging markets, spreads on Mexican sovereign debt, as measured by the Emerging Markets Bond Index Plus (EMBI+), are up to about 190 basis points (by early September 2008) from a l o w o f about 80 basis points reached in May-June last year. Even though spreads are up, they remain l o w from a historical perspective and do not prevent Mexico f rom having ample access to international capital markets. The immediate impact o f the international financial market crisis on the Mexican financial system has been relatively moderate as domestic financial intermediaries had almost no exposure to U.S. subprime mortgage risk. Despite i t s l o w level o f penetration, domestic savings and credit intermediated through the Mexican financial system continues to expand at a healthy pace -from 34.8 percent o f GDP in 2000 to 5 1.9 percent in 2007- and, more recently, i s reflected in a strong growth o f bank credit to the private sector.

14. The Mexican economy i s currently facing a cyclical slowdown of economic growth. The Mexican economy has strong l i n k s to the Unites States economy - the destination o f more than 80 percent o f merchandise exports and the source o f about $24 bi l l ion (2.3 percent o f GDP) in remittances last year. During the last recession in the United States, Mexico suffered with a slight contraction o f GDP in 2001 and very slow growth during 2002 and 2003. So far, the Mexican economy has withstood the economic difficulties o f i t s main trading partner and commodity price pressures well. Economic growth in the f i rs t hal f o f 2008 slowed down to 2.7 percent. There are a variety o f reasons why the economy i s better structured to withstand the current downturn: a healthy financial system that has begun to expand domestic credit as a share o f GDP; more dynamism in exports to non-US destinations; favorable terms o f trade with high o i l prices; and the further consolidation o f prudent macroeconomic policies in both the fiscal and monetary realms.

15. International commodity and food prices are driving up domestic inflation hurting the poor disproportionately and prompting a tightening of monetary policy. Despite the recent downward trend in commodity prices, the Mexican economy i s facing an increase in consumer price inflation largely resulting from higher international commodity and food prices. Variations in international commodity prices take time to translate into domestic inflation because o f the time lags in domestic price adjustment. The sharp increase in inflation, to 5.4

Fitch Ratings and Standard & Poor’s increased their sovereign rating to BBB+ (two notches above investment grade rating) last September and October, respectively. In addition to strong macroeconomic policies, both rating agencies refer to the adoption of reform to the civil servants’ pension scheme and the fiscal reform package as critical elements in their decision to increase their credit rating.

3

See IMF Country Report 0713 79 at htttx/lwww. imf. orglexternaVpubslftlscrl2007lcr073 79 .pdf

4

percent in July 2008, led the monetary authorities to hike the (overnight) interest rate from 7.5 to 8.25 percent over the past few months and to raise their projected inflation for the next eight quarters. The latter postpones convergence to the medium-term inflation objective o f 3 percent till the end o f 2010. The monetary tightening risks a sharper downturn in economic activity in the short term. The most recent quarterly inflation report o f the central bank lowers the estimate o f 2008 GDP growth to 2.25-2.75 percent.

16. Food prices were up by 9.4 percent in July 2008 compared to a year earlier. This above average increase in the price o f food has affected the purchasing power o f the poor in particular, as a larger share o f their income -up to 40 percent- i s dedicated to food. For this reason, the G O M announced a series o f measures to moderate food price increases and mitigate the impact o f price increases on the poor including a temporary increase o f the transfer to households under i t s Conditional Cash Transfer program.

17. Domestic fuel pricing policies have moderated the impact o f higher international o i l prices on domestic inflation. For more than a decade, the government has maintained a policy o f monthly fuel price adjustments largely in line with domestic inflation. While this policy has been successful in terms o f economic stabilization and the generation o f fiscal revenue, the sharp international price increase has left the level o f domestic fuel prices behind the international price levels for the past two years. As a result, fuel subsidies -accounted for in the budget as a negative excise tax- are estimated to reach up to 2 percent o f GDP this year. A gradual elimination o f these subsidies is envisaged over the next few months as a result o f slightly higher periodic price adjustments for domestic sales o f gasoline and diesel as wel l as a moderation o f international prices.

18. The GOM aims at enhancing structural economic growth and aspires to reach a medium-term growth rate of 5 percent. The National Program for Financing Development (PRONAFIDE) 2008-20 12 provides a detailed assessment o f the public and private finance needs to attain the economic growth, employment creation, and poverty reduction targets set out in the 2007-2012 National Development Plan (NDP). The program projects a GDP growth o f 5.2 percent by 2012 that requires a combination o f an increase o f total factor productivity by 1.4 percentage points and an increase o f public and private investment by 3 percentage points o f GDP between 2008 and 2012 (Table 2). The projections in this medium-term economic program are based on an output growth in the United States close to its potential and the implementation o f government policies as set out in the N D P and the more detailed sectoral programs, in particular with regard to an ambitious program o f infrastructure investments that raises the level o f public investments to 4.3 percent o f GDP on average for the 2007-2012 period (compared to a level o f 2.1 percent observed between 2001 and 2006).

Table 2: Mexico’s Macroeconomic Projections PRONAFIDE 2008-2012

Source: SHCP and Bunco de Mkxico

19. Environmental degradation and unsustainable use of natural resources can affect the country’s prospects for long-term economic growth. Not incorporating the environment and i t s potential impact on the tourism sector (which contributes about 8 percent o f GDP) would seriously compromise growth. In the case o f the energy sector, environmental impacts on human health can affect productivity. One estimate suggests that a 10 percent reduction in ozone and fine particulate matter levels would be associated with health and productivity benefits o f US$2 billion per year.5 With respect to the forestry sector, continued deforestation would be associated with increased frequency o f floods and landslides, loss o f agricultural land due to erosion and loss o f water retention, and loss o f livelihoods o f forest dwellers, most o f who are impoverished. Water pollution has been estimated by the National Water Commission (CONAGUA) to result in significant loss o f social welfare.

20. Impacts of environmental degradation on human health, economic activities, and social welfare indicate that the incorporation of environmental concerns in key economic sectors i s critical to ensure the sustainability of long-term economic growth. Safeguarding the environment and resource base - over the long-term - serves as a complement to sound macroeconomic policies in enabling sustained high quality growth. Since much environmental degradation results from productive sectors, there i s a growing need for inter-sectoral coordination in order to address them adequately. Specifically, the environment sector must coordinate i ts efforts with those o f the economic sectors that contribute to environmental degradation.

21, Mexico fully meets the policy requirement of OP 8.60 for a sound macroeconomic framework. Mexico has maintained a solid macroeconomic framework which has moderated output volatility and strengthened economic growth. A consistent set o f macroeconomic policies, including monetary policy within an inflation targeting framework, a flexible exchange rate, a balanced budget fiscal policy and public debt management that favors the development o f domestic capital markets, should allow Mexico to cope with the effects o f a global economic slowdown and provide the fundamentals for enhanced economic growth in the medium term.

Evans, John et al. “Health Benefits of Air Pollution Control, ” Air Quality in the Mexico Megacity, Mexico City: Kluwer Academic Publishers. 2002.

6

111. THE GOVERNMENT’S PROGRAM

A. GOVERNMENT’S OVERALL PROGRAM

22. The costs of environmental degradation and depletion of natural resources in Mexico have fallen steadily from 10.9 percent of GDP in 1999 to 9.2 percent in 2004.6 Though s t i l l high, these figures illustrate Mexico’s efforts to reduce the loss o f social welfare associated with environmental degradation and unsustainable use o f natural resources, as well as the constraints that these costs impose o n the country’s social and economic de~elopment .~ Furthermore, they indicate the need to provide continuity to environmental mainstreaming in key productive sectors to (i) use Mexico’s r ichly endowed natural environment as a source o f competitive advantage in tourism and world markets; and (ii) conduct interventions to mitigate the negative impacts o f environmental degradation, on human health, productivity, and competitiveness.

23. In 2007, the GOM presented its 2007 - 2012 National Development Plan (NDP), which outlined an extensive reform program focusing on five strategic pillars including security and the rule of law, competitiveness, equality of opportunity, environmental sustainability, and effective democracy. The Plan’s environmental sustainability pillar stresses the importance o f the environment in enhancing the country’s competitiveness and both economic and social development, as wel l as the importance o f mainstreaming the sustainability principle in sectoral policies.

24. The strategies included in the NDP’s environmental sustainability agenda are fully aligned with the operation’s actions. For example, the N D P calls for improvements in integrated and sustainable water management, by strengthening the technical and financial autonomy o f water operators, and promoting efficient water usage in agricultural activities through reductions in consumption. In addition, the N D P aims to halt forest degradation, through reforestation programs, promoting the sustainable use o f forest resources, designing and implementing mechanisms that provide payments for environmental services to the communities that protect forested areas, and stopping agricultural expansion in forested areas.

25. At the outset of the current administration, the GOM requested the Bank’s support for the strategic components of its reform program described above. This operation complements the recently approved Climate Change DPL. In addition, i t continues to support the general objectives o f the previous Environment D P L Program (comprised o f the ENVSAL I and ENVDPL 11) and supports the government’s program to promote sustainable development, by mainstreaming environmental concerns in the development agenda o f key sectors. Drawing from the Bank’s role as an honest-broker and analytical work, the program assists the G O M in: (i) integrating environmental sustainability considerations into the tourism agenda; (ii) integrating environmental sustainability considerations into the energy sector agenda; (iii) increasing

Instituto Nacional de Estadistica Geogrdjica e Informcitica; Sistema de Cuentas Econdmicas y Ecoldgicas de Mkxico 1999-2004, Mexico, 2007.

Air pollution alone accounts for about 88% of the total cost of environmental degradation in Mexico. Overall, the energy sector accounts for 47% of these costs followed by agriculture, livestock production and manufacturing with 18%, 17% and 16% respectively. www.inegi.gob.mx.

7

7

appropriate financing for sustainable forestry; and (iv) increasing water use efficiency and reducing water pollution. In addition, the proposed operation also supports two new policy areas that are o f economic importance, by integrating environmental sustainability considerations into the agriculture and housing sector agendas. Turning the concept o f environmental sustainability into a transversal element o f public policy figured prominently in previous administration and wi l l continue to be a priority for the current administration, as reflected in the NDP.

B. ENVIRONMENTAL CHALLENGES IN THE TOURISM SECTOR AND GOVERNMENT STRATEGY

26. The tourism sector has been one of Mexico’s main drivers of economic growth. The sector generates approximately 8 percent o f the country’s GDP and over 5 percent o f paid jobs nationwide.’ The tourism industry also provides relatively high-paying jobs, with high average annual earnings relative to the national average and contributes to regional development. In 2007, the sector generated foreign currency inflows o f US$12.9 billion, the third largest amount after o i l exports and remittances and, for the f i rst 6 months o f 2008, US$7.3 billion.’ Mexico’s tourism sector has Significantly increased i ts share o f the international tourism market over the last five decades, and ranked eighth among world tourist destinations in 2006.’0

27. Environmental quality will largely determine the sector’s competitiveness. Surveys conducted by SECTUR in 2002,2003, and 2006 and a strategic environmental assessment (SEA) prepared under ENVDPL 11, with financing from a PHRD preparation grant, revealed that environmental quality was one o f the variables that most significantly influenced the selection o f tourist destinations. The SEA, which aimed to identify the sector’s main sustainability challenges and generate proposals to address them, found that the sector i s s t i l l oriented towards a “quantitative growth” model in which tourist arrivals are expected to increase at an annual rate o f 4.1 percent over the next twenty years, constituting the main driver o f an expected annual growth in the sector’s income o f 6.7 percent during the same period. The assessment also pointed to the risks o f failing to incorporate environmental considerations in the development and management o f tourist destinations, as environmental quality was rated as barely satisfactory.” Thus, in the absence o f markedly improved environmental management, the competitiveness o f Mexico’s destinations i s likely to erode in the short term. Consequently, the implementation o f policies aimed to enhance the sustainability o f Mexico’s destinations could ensure that the country’s rich environment remains a source o f competitive advantage, particularly as an increasingly larger segment o f the tourist market shifts from massive “sun and sand” destinations to “theme” travel.

28. In order to promote environmental protection and assure quality o f tourism products, the SEA recommended a shift from a quantitative growth model to a qualitative model, which would attract tourists who are willing to spend more on higher-end tourism, thereby increasing revenues

Instituto Nacional de Estadfstica, Geografia e Informhtica. Sistema de Cuentas Nacionales de Mkxico: Cuenta

Presidencia de la Republica. Segundo Informe de Gobierno. Mexico City: Gobierno de 10s Estados Unidos Satdite del Turismo de Mbxico, 1999-2004. (www.inegi.gob.mx)

Mexicanos. 2008. lo World Tourism Organization. Tourism Highlights 2007 Edition. UNWTO. 2007.

Secretaria de Turismo. hdice de Satisfaccidn, Turismo Internacional Ae‘reo, 14 Destinos, Resultados Anuales 2002. Mexico City: SECTUR. (www.sectur.gob.mx) and Secretaria de Turismo. Perfil y Grado de Satisfaccidn, de 10s Turistas: Cuarto Trimestre. Mexico City: SECTUR. (http:Nwww,sectur.gob,mx).

8

generated from tourism and simultaneously reducing adverse environmental impacts o f tourism. As part o f GOM’s efforts to diversify its tourism offerings and promote sustainable nature tourism, a Strategic Plan for Nature Tourism was presented in November 2006 by SECTUR in collaboration with SEMARNAT, Ministry o f Economy, SAGARPA, Ministry o f Social Development (SEDESOL), Commission for Development o f Indigenous People, National Commission for Natural Protected Areas (CONANP for i t s acronym in Spanish), National Tourism Fund (FONATUR, for i t s acronym in Spanish) Mexican Council for Tourism Promotion (Consejo de Promocidn Turistica de Mexico) and CONAFOR. This plan provided the basis for preparing a National Strategy for Sustainable Tourism Development and Recreation in Natural Protected Areas in Mexico, which was presented in September 2007 by SECTUR in collaboration with SEMARNAT and CONANP.

29. In addition to improving the quality o f tourism, GOM recognizes the need to take measures to protect i t s natural resources from continued adverse environmental impacts o f tourism. One such measure supported under ENVSAL I, was the charging o f user fees for maritime activities, protected areas, and whale watching respectively, with a provision for earmarking revenue generated for reinvestment in the particular tourism resource generating the revenue.’* Through such measures, Mexico has been able to protect i t s natural resources and increase tourism revenues simultaneously. l3

30. The GOM continues to recognize the importance o f ensuring that tourist destinations are sustainable as part o f the government’s broader efforts to strengthen the sector’s competitiveness. The National Program for Tourism (NPT), which defined the national tourism policy for the 2001-2006 period, had the following key objectives: (i) attaining sustainable destinations, (ii) developing competitive tourism businesses, and (iii) achieving satisfaction o f tourists traveling to Mexico. This approach to promoting sustainable tourism continues to be embodied in the new 2007-2012 National Tourism ProgramI4 as one o f the three main strategic areas to be addressed.

31. Recognizing the importance o f tourism to regional development, GOM has adopted the Agenda 21 for Mexican Tourism as a framework for action to promote sustainable development o f tourism. A enda 21 i s a program run by the United Nations (UN) related to sustainable development.” It i s a comprehensive blueprint o f action to be taken globally, nationally and locally by organizations o f the UN, governments, and major groups in every area in which humans impact the environment. In Mexico, Agenda 21 i s spearheaded by SECTUR and SEMARNAT and aims to facilitate collaboration between federal, state and municipal level governments, tourism business owners, academia, non governmental organizations and the local communities, for the improvement o f tourism activities and living conditions in tourist

In Los Cabos, for example, the profile o f whale watching has been elevated by enforcing controls on tourist numbers - a maximum o f six people to a boat - and access o f tourists to the animals - maintaining a minimum distance to the animals; and ensuring that guides are well trained. In this way, the adverse impacts on the environment and natural resources are reduced while promoting tourism activities l3 Charging user fees and earmarking these for management o f protected areas, have resulted in revenues amounting to MXN 145,000,000 in 2006 (a 400% increase from 2004).

(www.sectur.gob.mx) l5 The number 21 refers to the 21st century.

Secretaria de Turismo. Programa Sectoral de Turismo 2007-2012. Mexico City: SECTUR. 2007. 14

9

destinations. The Agenda 21 program for Mexican Tourism proposes strategies and actions in the short, medium and long terms that a im to (i) strengthen the sustainable development o f tourism areas; (ii) promote participation o f local communities in tourism-related activities; and (iii) ensure the preservation o f natural and cultural resources o f tourist destinations in Mexico. Local Agenda 21 Committees in these tourist destinations play a central role in building consensus among stakeholders for the implementation o f strategies to maximize social welfare, economic benefits and environmental quality.

32. The GOM has continued to take actions to promote sustainability in the development o f tourism through the development o f a system o f tourism sustainability indicators, which represent a key element in the establishment o f Agenda 21 at the local level. The system provides a diagnostic tool which allows the GOM to measure and monitor the conditions - environmental, socio-economic, supply and demand for tourism, and urban development - o f each tourist destination and to aid in decision making relating to sustainable tourism development.

33. Based on information obtained from the indicators o f sustainable tourism development, GOM also identified priority areas for action according to the type o f destination. In beach destinations, priority areas include (i) wastewater treatment; (ii) wastewater reuse; (iii) increasing population growth rates; (iv) environmental programs in businesses; and (v) ecological land use planning. Tourism in the Cancun corridor along the Costa MaydRiviera Maya, for example, i s particularly sensitive to environmental degradation, including pollution o f groundwater and nearshore coastal waters through nutrient enrichment, sediment, and possibly pathogens; increased demand for seafood that puts heavy pressure on coral reefs; increased demand for water, energy, land and other natural resources as a result o f a population growth. In destinations such as Pueblos Mdgicos16 (Magical Villages), identified priority areas included (i) wastewater treatment; (ii) lack o f sanitary landfill; (iii) ecological land use planning; (iv) precarious housing conditions; and (v) street (informal) vendors. In cities classified as world heritage sites, the challenges identified included (i) wastewater treatment; (ii) waste management; (iii) adequacy o f certified guides; (iv) ecological land use planning.

34. The GOM has continued to make efforts to promote good environmental practices in tourism facilities and destinations. A certification scheme launched joint ly by SECTUR, PROFEPA, and the Mexican Association o f Hotels and Motels, in 2004, aimed to recognize responsible environmental performance by tourist facilities. Aspects examined under the certification program include efficient water use, quality and quantity o f discharges, efficient use o f electrical energy and fuels, proper management o f chemical substances, compliance with legal instruments such as environmental impact statements (manifestacidn de impact0 ambiental) among others.

35. In addition, as part o f the GOM's efforts to provide a strong foundation for integrated tourism development, SECTUR has been collaborating with SEMARNAT with respect to

l6 The Programa Pueblos Mdgicos (Magical Villages Program) is an init iative led by Mexico's Secretariat o f Tourism (SECTUR), in conjunction with other federal and state agencies, to promote a series o f towns around the country that offer visitors a "magical" experience - by reason o f their natural beauty, cultural riches, o r historical relevance. The program was launched in 2001, and by 2007, a total o f 32 towns and villages in 24 different states had been awarded the tit le pueblo mdgico.

10

sharing pertinent information for the development o f land use plans in regions and municipalities where there i s pronounced tourism activity or the potential for tourism development. Through these efforts, SECTUR in collaboration with SEMARNAT has participated in the development o f ecological land use plans in key tourism destinations including, among others, the Gulf o f California, Gulf o f Mexico, and Baja California.

B.l ACTIONS SUPPORTED BY THIS OPERATION

36. This operation has assisted the GOM in consolidating the institutional reforms that have been implemented since 2001 to mainstream environmental considerations in the tourism sector. Continued implementation o f Mexico’s Agenda 21 for Tourism i s at the core o f the GOM’s efforts to ensure sustainable tourism development. As such, this operation has supported the adoption o f Agenda 21 action plans in 35 new tourism destinations, resulting in a total o f 90 tourist destinations implementing such plans by the end o f 2008 (up from 55 in 2006).

37. The GOM’s approach to promoting tourism development while ensuring environmental protection, has a strong focus on ensuring that local actors at the municipal level are actively engaged in sustainable tourism development. The implementation o f local Agenda 2 1 action plans i s important because the plans provide a proven and effective mechanism to bring together the government, owners o f tourism businesses, academia, non governmental organizations, civil society members, and other stakeholders to build consensus around the development and implementation o f actions to slow down or reverse environmental degradation and ensure that environmental quality remains a source o f competitive advantage for tourist destinations.

38. This operation has helped advance the implementation of Agenda 21 plans through the development of a methodology to incorporate environmental considerations into urban and regional planning in tourist destinations based on principles of strategic environmental assessment. This measure ensures that adequate environmental infrastructure i s in place to service tourists and local populations, as well as to protect the environment. Along this line, the operation i s expected to result in the monitoring o f an additional 35 tourism destinations under an environmental sustainability indicator systems established by SECTUR to measure good environmental performance. In addition to new destinations, existing indicator systems are being updated in key tourist destinations, including Cancun, Cozumel, Guanajuato, Mazatlan, Nuevo Vallarta, Puebla and Valle de Bravo. Using the sustainability indicator system to identify key environmental problems o f the 72 destinations utilizing such indicator systems in 2006, the GOM identified the following priority areas for investment: (i) adequate waste management, notably development o f sanitary landfills and promotion o f waste recycling; (ii) promotion o f environmental management in businesses; and (iii) ecological land use planning.

39. An additional action supported by the operation i s the promotion o f good environmental practices in tourism facilities and destinations through the government’s Programa de Calidad Ambiental Turistica. Through this program which aims to strengthen the impacts o f the Agenda 21 Program, the operation supports a 50 percent increase in the number o f tourism enterprises - such as hotels, restaurants, botanical gardens, zoos, dolphin aquariums, sports clubs, and golf courses - with Certificacidn de la Calidad Ambiental Turistica developed by SECTUR, PROFEPA and the Association o f Mexican Hotels and Motels in municipal jurisdictions. The program aims to recognize responsible environmental performance by tourist facilities and

11

encourage environmental compliance. Parameters examined under the certification program include efficient water use, quality and quantity o f discharges, efficient use of electrical energy and fuels, proper management o f chemical substances, compliance with legal instruments such as environmental impact statements (manifestacidn de impacto ambiental) among others.

40. Additional actions supported by this operation also include the GOM’s development o f regulations o f the General Law for the Prevention and Integrated Management o f Wastes, which was enacted in October 2003 with support o f ENVDPL I1 to promote improved solid waste management. The development o f these regulations responds directly to one o f the key problems identified through SECTUR’s tourism sustainability indicator system i.e. , inadequate waste management at tourist destinations.

41. Furthermore, the proposed loan has supported, as an additional action, the adoption o f a unified sustainable tourism strategy that wi l l strengthen the competitiveness o f the sector both in the short and long term. This strategy i s in l ine with the 2007-2012 NDP, which aims to orient tourism policy toward the development o f competitive and diversified tourism services within a general framework o f sustainable tourism development. The SEA conducted during the preparation o f the ENVDPL I1 identified the challenges associated with a “quantitative growth” model and recommended redefining the national tourism policy to generate a “qualitative growth’’ model in which annual tourist arrival growth rates remain relatively modest, but the sector’s income grows steadily, as tourists are willing to spend more on a diverse range o f superior quality goods and services. This SEA constitutes a key input in the high-level workshops that this operation i s supporting to help build consensus among all stakeholders around the new national tourism policy.

C. ENVIRONMENTAL CHALLENGES IN THE ENERGY SECTOR AND GOVERNMENT STRATEGY

42. Mexico’s economic growth depends to a large extent on the development and performance o f i t s energy sector. Although the energy sector only accounts for 2.6 percent o f GDP and 7.9 percent o f all exports, it i s a critical component o f Mexico’s fiscal balance. In 2007 oi l revenues made up almost 40 percent o f the national budget.17 In fact, the Mexican Petroleum Company (Petrdleos Mexicanus, PEMEX) ranks as the country’s top earner o f net income (US$104.5 billion in 2007) and top exporter (15 percent o f the income associated with the current balance o f payments). Moreover, Mexico i s the sixth largest global producer o f oi l and nineteenth largest gas producer. ’* However, the long-term sustainability o f PEMEX’ s revenue stream, which since 2004 has benefited greatly from the increase in o i l prices, i s being threatened by the gradual depletion o f i t s proven hydrocarbon reserves and by the lack o f investment and technological knowledge, most notably in deep off-shore exploration activities. l 9

Secretaria de Hacienda y Credit0 Publico; Noviembre 2007.Estadisticas Oportunas de Finanzas Publicas y Deuda

Secretaria de Emergia; April 2008. Diagnostic0 Situaci6n de PEMEX. www.sener.gob.mx Although PEMEX was the sixth largest oil company in the world in terms o f revenue earnings in 2000, i t s

17

Publica. 18

standing fe l l to eleventh place in 2007.

12

43. Mexico’s demand for energy has increased over the last decades; a trend that i s likely to continue given its linkages with the country’s economic growth. At the same time, however, energy and carbon intensities have decreased. Mexico’s abundant fossil fuels have constituted the primary source to meet this growing demand, with hydrocarbons accounting for 90 percent o f primary energy production in 2006.20 Yet, Mexico’s energy intensity (total primary energy supply/GDP) has steadily decreased over the last decade, which also implies a reduction in carbon intensity. From 1990 to 2002, GHG emissions from the energy sector increased by 24.8 percent, at an annual rate o f 1.9 percent, while GDP increased at an annual rate o f 2.9 percent during the same period.

44. Mexico’s oil (PEMEX) and electricity companies (CFE and Luz y Fuerza Centro, LFC) face important challenges which affect the country’s economic growth and competitiveness: high costs o f production and supply; the burden o f high and/or regressive subsidies (in electricity and fuels); the need to replace old and inefficient generation and production equipment; and the need to improve the overall performance and quality o f service and products. The GOM i s currently assessing the energy sector’s performance, with a special focus on the oi l sector, and discussing possible avenues for i t s modernization.

45. The GOM has made a number o f advances in managing environmental impacts associated with the energy sector, in particular the sector’s negative impacts on health. GOM interventions have achieved a reduction in the severity o f air pollution in various urban areas. Annual mean concentrations o f PMlo in Mexico’s highest polluting cities have generally decreased.21 In Mexico City, PMlo concentrations decreased from 56.0 pg/m3 in 2005 to 48.9 pg/m3 in 2007; while in Monterrey, these annual mean concentrations have decreased from 87.8 pg/m3 in 2005 to 80.7 pg/m3 in 2007, and in Guadalajara have decreased from 53.0 pg/m3 to 41.4 pg/m3 during this same period.22 With support under the ENVDPL 11, SENER has worked with other energy sector agencies and with environmental authorities to strengthen the national clean fuels policy. PEMEX has made advancements in improving fuel quality by reducing the sulfur content from 1000 to 300 ppm in premium gasoline used in the Mexico City Metropolitan Area, Monterrey, and Guadalajara. ENVDPL I1 also supported the design and implementation o f actions to address indoor air pollution caused by domestic consumption o f fuel wood, including small electrification projects in selected states. These projects served as a catalyst for a World Bank and GEF-financed National Program for Rural Electrification.

46. Other advances in mitigating the sector’s environmental impacts include (i) the implementation o f environmental management systems to reduce contamination by PEMEX and the Federal Electricity Commission (Comisidn Federal de Electricidad, CFE); (ii) measures to increase energy generation from renewable sources, including the approval o f fiscal provisions in 2004 for the accelerated depreciation o f renewable energy capital (see Table 3); (iii) the development o f mandatory standards for equipment, sectoral programs, implementation o f methodologies for measuring and monitoring energy efficiency baselines by sector, as well as business models and contract forms for third party delivery o f energy efficiency measures; and

2o Secretaria de Energia, Balance Nacional de Energia 2006. Mexico City: SENER. 2007. 2 1 PMlo stands for particulate matter up to 10 microns in size. 22 Presidencia de la Republica. Segundo Informe de Gobierno. Mexico City: Gobierno de 10s Estados Unidos Mexicanos. 2008.

13

(iv) the publication o f electricity subsidies in individual utility bills, as a first step in addressing existing distortions in the electricity sector.

Year

Table 3: Renewable Energy Production (Hydroelectric and Geothermal Power Plants and Wind) and Energy Efficiency

Gross renewable energy production in Giga-wattshour and percentage of

total electric energy production

Energy efficiency (Giga- wattshour saved by

institutional programs)

2005 2006 2007

I 2004 1 30.737.8 (13.1%) I 27.578 I 34,154.6 (13.9%) 19,659 36,057.6 (14.1%) 21,681 31,218.1 (1 1.8%) 22,428

47. As part of its efforts to promote its clean energy agenda, the GOM recently approved the Law for the Promotion and Development of Biofuels, which integrates social and environmental considerations into its basic principles. The Law aims to “promote and develop biofuels with the intention o f enhancing energy diversification and sustainable development as pre-conditions to strengthen Mexico’s agricultural sector.” As a result o f SEMARNAT, SENER, and SAGARPA’s joint efforts, the law integrates social and environmental considerations into the basic principles and criteria established for developing the biofuel industry. For instance, the Law mandates the preparation o f ex-ante analyses to assess the impacts of programs and projects in terms o f environmental sustainability and food security.

48. The Bank has played a role in supporting inter-governmental coordination in order to help ensure appropriate environmental safeguards are incorporated into the country’s biofuels program. This support has been provided during preparation o f a Bank-financed, low-carbon country case study (MEDEC). The Bank wi l l continue to collaborate with the GOM to monitor the implementation o f these safeguard mechanisms.

49. Despite the progress achieved over the last decade in improving the energy sector’s environmental performance, Mexico continues to face a number of challenges in this respect. The energy sector i s a leading source o f air, water, and soil contamination, with fuel quality playing a major role in the severity o f transport emissions. A diagnostic report on PEMEX released by SENER in April 2008 states that despite recent efforts to reduce sulfur oxides (SOX) - 18 percent between 2001 and 2006 from the introduction o f new technologies for sulfur recovery in gas processing operations - SOX and carbon dioxide (C02) emissions increased by 10 percent as result o f gas flaring activities in 2007. Also, although PEMEX lowered i t s water consumption by 20 percent from 2001 to 2006, only 11 percent o f water consumed i s recycled, putting pressure on hydrological resources and critical basins located in the northern and central parts o f the country.23 In addition, there are s t i l l about 1,000 hectares and 147 dam sites that need to be remediated due to hydrocarbon spi l ls and other waste contamination produced as a result o f well perforation activities.

23 Today, PEMEX consumes a total o f 228 million cubic meters per year o f water (81 percent supplied from fresh water resources) and recycles only 11 percent of this amount (equivalent to the consumption o f a city with a population o f 340,000 inhabitants).

14

C.l ACTIONS SUPPORTED BY THIS OPERATION

50. Although the energy sector faces significant environmental challenges, Bank support helps maintain an open door for continued collaboration in addressing the challenges faced by this sector. The proposed DPL has supported the approval and implementation of the GOM’s 2007-2012 Energy Sector Program, which proactively addresses the environmental impacts o f the energy sector by recognizing the sector’s potential contributions to sustainable development through increased energy efficiency and energy production from renewable sources. Specifically, the Energy Sector Program aims to (i) secure the energy supply required by the economy; (ii) strengthen the capacity o f state owned enterprises in the energy sector to improve the quality o f products and services; and (iii) promote energy efficiency and the use o f renewable energy resources in order to reduce the environmental impacts derived from the use o f fossil fuels. I t i s important to note that this i s the first time a national energy program has included the promotion o f energy efficiency and the use o f renewable sources, in an effort to reduce the environmental impact derived from fossil fue l use, as one o f i t s primary pillars. The main objectives o f this program are aligned with the National Development Plan’s pillar on environmental sustainability. In particular, the Energy Sector Program 2007-2012 aims to increase the availability o f fuels with l o w sulfur content and reduce sulfur emissions from petroleum refineries.

5 1. The 2007-2012 Energy Sector Program emphasizes the importance o f implementing energy security and technology diversification policies through the addition of renewable energy capacity in electricity generation. As such, the DPL supports actions to promote non- hydro renewable energy sources. CFE has gradually increased the share o f renewable energy capacity in the country’s generation stock. For instance, f rom July 2002 to December 2006, a total o f 1,093 MW o f renewable source based capacity were added into the system, including eolic (La Venta II), geothermal (Los Azufres II), and hydroelectric (Manuel Moreno Torres) plants. By the end o f 2006, the share o f renewable energy capacity had reached 23 percent o f the total generating capacity (excluding nuclear); o f which 2 1 percent was hydroelectric capacity. In the 2008-2017 Electricity Subsector Investments Program, CFE aims to add 1,492 M W o f hydroelectric capacity, 100 M W o f eolic capacity, and 146 MW o f geothermal capacity before the end o f 2009, with an aggregated investment estimated at US$1.9 billion. In addition, under the 2007-2012 Energy Sector Program, the GOM has set a target to increase the aggregated capacity share o f geothermal, wind, and solar based generation from 2 percent in 2006 to 6 percent by 2012.

52. The DPL’s support of the Energy Sector Program also promotes the continued implementation of the GOM’s energy efficiency measures, which seek to double by 2012 the energy savings in electricity consumption attained up to 2006. In this respect, the 2007- 2012 Energy Sector Program proposes the fol lowing strategic actions: (i) to design and implement policies and financial mechanisms to accelerate the adoption o f energy efficient technologies in both the public and private sector; (ii) to optimize energy supply and consumption in public entities; (iii) to improve coordination among the public and private sector, and c iv i l society to promote the efficient use o f energy; (iv) to support the reduction o f energy consumption at the residential level (buildings); (v) to promote efficient energy generation through self-supply and cogeneration schemes; and (vi) to strengthen the regulatory framework for cogeneration schemes, among others.

15

53. Lastly, the proposed DPL’s support o f the Energy Sector Program promotes actions targeting air pollution, through the approval and implementation of mandatory standards (norma Oficial Mexicana) for sulfur recovery at four petroleum refineries. By adopting these standards, refineries located in Cadereyta (Nuevo Leon State); Ciudad Madero (Tamaulipas); Tula (Hidalgo); and Salamanca (Guanajuato) are expected to reduce their sulfur emissions by at least 90 percent in 2008. These four refineries accounted for approximately 60 percent o f total sulfur emissions from Mexico’s petroleum refineries in 2007.24

54. The Energy Sector Program’s implementation i s expected to help increase energy savings (measured in GWh) for 2008 by at least 10 percent more than the savings reported for 2007. Furthermore, the share o f renewable energy capacity in the power sector (specifically, from non- hydro sources) i s expected to increase from 2 percent in 2006 to 2.7 percent by the end o f 2008. This expected outcome i s fully aligned with the goals o f both the CPS and NDP, under the environmental sustainability pillar, which aim to increase energy generation from renewable sources by 3 percentage points in 20 12. These outcomes demonstrate a strong commitment o f the new administration to improve the sector’s environmental sustainability.

55. An additional action supported by the proposed DPL operation i s the approval and implementation o f PEMEX’s Environmental Protection Strategy. PEMEX has designed a comprehensive Environmental Protection Strategy that proposes concrete actions to be implemented from 2007 to 2012. The strategy i s structured around three pillars: (i) reducing the environmental risks o f operating activities and maintaining their compliance with environmental regulations; (ii) incorporating environmental externalities into business and investment decisions; and (iii) promoting social environmental responsibility. PEMEX has estimated that an investment o f about US$7 billion will be needed to finance the actions associated with the strategy’s first pillar, including improvements in fuel quality (such as those supported under the Program for Clean Fuel Production) and operational activities across all segments o f the ind~stry.~’ This Strategy marks the first time environmental sustainability considerations have been included into the business planning process and investment decisions. Considering the scale and long history o f environmental challenges in the o i l sector, the Strategy i s a significant milestone in environmental policy.

D. ENVIRONMENTAL CHALLENGES IN THE FORESTRY SECTOR AND GOVERNMENT STRATEGY

56. Mexico’s forests cover close to 30 percent o f the country’s land territory (30.5 million hectares o f temperate forest and 26.5 mill ion hectares o f tropical forest).26 An additional 40 percent o f the territory including xerophytic vegetation (58.5 million hectares) i s also under the responsibility o f the National Forestry Commission (CONAFOR). The forestry sector

24 In 2007, these refineries had the following SOX emissions: 25,978 tonnes in the Cadereyta, Nueva Leon refinery; 30,825 tonnes in the Ciudad Madero, Tamualipas refinery; 75,057 tonnes in the Tula, Hidalgo refinery; and 37,946 tonnes in the Salamanca, Guanajuato refinery. PEMEX. Informe Desarollo Sustentable. (2007). 25 http://desarrollosustentable.pemex.com; and PEMEX Estrategia de Proteccidn Ambiental2007-20 12. 26 Garcia Trujillo, Zazilha (2006) Perfil de inversion Mexico. PPT presentation for the Foro internacional de inversion en bosques tropicales.

16

contributes around 1.4 percent o f GDP,27 and generates over 100,000 permanent jobs that pay an income 3 to 4 times higher than that o f agricultural activities.28 Although an estimated 38 percent o f Mexico’s total forested area has commercial potential (21.6 million hectares2’), only around 15 percent (8.5 million hectares) o f the area i s currently managed under approved sustainable management plans.

57. In addition to the lack of sustainably managed forests, other sectoral environmental challenges include deforestation and degradation. Deforestation i s mainly driven by conversion to pasture and, to a lesser extent, agriculture. The lack of incentives for landowners to sustainably manage forests, combined with weak institutions, has lead to the continued loss o f forest cover. The rate o f forest cover loss was reported as 234,000 hectares per year for 2006. 30

58. Forest degradation i s predominantly attributed to over exploitation, illegal logging, forest fires, direct grazing, shifting agriculture, fuel wood collection, and forest pathogens. Illegal logging supplies as much as half o f the wood market according to estimates by the Federal Attorney for the Protection o f the Environment (PROFEPA), the entity responsible for enforcement, and has been estimated to represent a loss o f around US$400 million per year to the poor ejidos (communal land holdings under the Mexico’s agrarian reform law) and communities that own the forested lands. Eighty-three percent o f Mexico’s forests are owned by indigenous communities and ejidos, and it i s estimated that o f the 12 to13 million people that live in forest areas about 5 million o f them are indigenous people. Ensuring the sustainability o f Mexico’s forests i s crucial to improve the livelihoods o f poor rural populations, remedy environmental degradation through soil and water conservation, mitigate climate change, support the expansion o f theme-based tourism, and develop competitive timber and non-timber products for domestic and international markets.

59. Addressing the challenges of the forestry sector has become a national priority for the GOM. In 2001, CONAFOR was created by Presidential Decree to promote the sector’s productive, protection, conservation, and restoration activities. CONAFOR led the preparation o f the National Forestry Program, based on the sector’s long-term vision for year 2025. The sector’s medium-term priorities, as defined in the Program, include: (i) regulatory and policy reforms to consolidate decentralization processes in the forestry sector; (ii) the development o f a forest information system to facilitate planning and decision-making; (iii) an increase in employment and income-generating options for forest dwellers, reduction o f negative environmental impacts on water basins and soils, and fostering o f biodiversity conservation; (iv) the promotion o f the sustainable use o f forest resources; (v) an increase in the sector’s productivity and competitiveness; and (vi) the promotion and development o f an environmental services market. Thanks to CONAFOR’s community forestry programs indigenous communities and ejidos have increased their participation in legal timber production.

27 Merino et a1 (2008) ). The biggest contribution o f the forestry sector to the national GDP in the decade considered occurred in 2000 (1.6%), after this year the contribution has been constantly reduced until reaching 1.39% in 2005.

Torres Rojo, Juan Manuel (2004) Estudio de Tendencias y Perspectivas del Sector Forestal en Amtrica Latina a1 aiio 2020, Informe Nacional MBxico, SEMARNATFAO 29 Merino et a1 (2008) 30 Presidencia de la Republica. Segundo Informe de Gobierno. Mexico City: Gobiemo de 10s Estados Unidos Mexicanos. 2008.

17

60. Since 200 1 the Mexican government has substantially increased forest subsidy programs that assist communities in developing forest management plans, reforestation activities (commercial plantation and forest restoration), use o f non-timber forest products, sustainable management o f fauna, payments for ecological services, among others. By up-dating management plans communities continue to be legal producers and can have access to benefits such as payments for ecological services, certified wood prices, etc. By 2006, the Payment for Environmental Services (PES) program has incorporated 0.7 mill ion hectares for the protection o f watersheds and other environmental services such as carbon sequestration, biodiversity, and agro-forestry systems.

61. Despite the above advances in sustainable forestry management, however, capacity- building programs such as the Forest Resources Conservation and Sustainable Management Project (PROCYMAF for i t s Spanish acronym) have provided insufficient coverage and comprise the lowest amounts o f CONAFOR’s total funding. PROCYMAF, for example, allocated only about 1 percent o f total CONAFOR funding in the six poorest forestry states, while funding for the Payment for Environmental Services Program accounted for 8 percent o f total government forestry funding between 2000 and 2007.

D.l ACTIONS SUPPORTED BY THIS OPERATION

62. This operation has supported CONAFOR in increasing community access to financial services in an effort to expand forestry management programs and promote the protection of critical watersheds under the PES program. This program expansion wi l l be supported by (i) an increase in CONAFOR’s budget for forestry programs and (ii) an increased availability o f loans for sustainable forestry management with liquid guarantees provided by CONAFOR. The increased budget provided to the CONAFOR’s national forest sector development program, Prokrbol, to promote sustainable forest management and conservation activities i s expected to be a key element in reducing deforestation and forest degradation.

63. Under the operation, CONAFOR has not only upscaled i t s initiatives and programs such as ProArbol and PROCYMAF to more states, but has also linked these programs together and mainstreamed the tools they have developed for sustainable forest management and conservation throughout the country. These tools include community technical assistance and investment models developed through the PROCYMAF, supporting Sustainable Forest Management Plans in ejidos and communities (expanding from 6 to 12 states); the PES program that has established, as o f 2006, contracts covering 700,000 hectares to conserve forest areas, (and with the DPL’s support i s expected to incorporate an additional 1.1 million hectares o f conservation areas that protect critical watersheds); and COINBIO, the indigenous community conservation program, that provides conservation and sustainable use alternatives with particular focus on high biodiversity ecosystems. The states have also recently increased their buy-in and collaboration with CONAFOR as a result o f the growing interest and success o f these forestry alternatives.

64. Additionally, a Poverty and Social Impact Analysis (PSIA) o f current and potential financial services and instruments for the forestry sector has been conducted. This analysis presents policy options to increase the poor’s access to community forestry support under the Prokrbol program and additional forestry financing. The DPL operation wi l l support CONAFOR’s pro-poor programs, access to financing, and other actions to achieve more socially

18

equitable results.31 An estimated 2,300 communities and ejidos are implementing sustainable forestry management plans. The DPL operation aims to support the provision o f technical assistance to 400 communities and ejidos to update or prepare Sustainable Management Plans for SEMARNAT’s approval. To address organizational weaknesses, social capital growth, and improved ecosystem management in the ejidos and communities, the government has promoted the creation o f Community Forest Enterprises (CFEs) that are the Mexican “model” o f community forest management.

65. Additional actions supported under this operation include the continued implementation o f the General Law for Sustainable Forestry Development, enacted in 2003, and associated regulations, supporting the implementation o f consultation mechanisms that have contributed to improving ProArbol’s operational rules, along with strengthening the capacities o f vulnerable groups, such as indigenous peoples and ejidatarios, to take advantage o f the new legal framework.

E. ENVIRONMENTAL CHALLENGES IN THE WATER SECTOR AND GOVERNMENT STRATEGY

66. Mexico’s water resources are currently under significant stress and are becoming a limiting factor that affects the economic development of many sectors. Although water extraction represents 16 percent o f resource availability at the national level, this figure i s above 57 percent in the country’s northern regions and around 154 percent in the Mexico City Valley.32 Overexploitation o f groundwater has increased steadily over the last few decades and by 2006, the 104 aquifers that provided almost 60 percent o f the volume o f groundwater extraction were overexploited. Water quality has also deteriorated steadily partly from the lack o f wastewater treatment with only around 24 percent o f wastewater being treated in 200620. In 2003, official sources concluded that concentrations o f fecal coliform were above 1,000 MPNIl00 ml in 59 percent o f the monitored water bodies.33 Additionally, Mexico i s already being affected by ENS0 (El Nifio Southern Oscillation)-related events, especially drought/floods, and wi l l be further affected by climate change, particularly changes in precipitation leading to floods in some regions and droughts in others. Combined with increased intensity and frequency o f hurricanes and changes in temperature, these factors are likely to cause soil degradation, desertification, and present further challenges to water resources management in economic sectors such as

3’ Preliminary findings o f the PSIA on forestry financing suggest that the distribution o f overall public resources allocated through the three main forestry programs (PRODEPLAN, PROCYMAF and PSA) favors private medium to large size forestry businesses. PRODEPLAN i s the largest o f the three with 68% o f total funding, followed by PSA at 3 1% and 2% at PROCYMAF 11. Within PRODEPLAN, private farmers (as compared to ejidos and communal lands) account as the majority of beneficiaries (94%) and have been allotted 81% of its funds. In 2006, 225 million pesos were dispersed. Average land size for PRODEPLAN beneficiaries totaled 27 hectares with a range from 5 ha to 1,652 ha. Beneficiaries with 5 hectares received funding between $33,000 - $45,000 pesos in contrast to $1 1 million for one 1,652 hectares farmer. 32 According to the United Nations, severe water stress occurs when extraction i s equal to more than 40 percent o f availability. CONAGUA, Estadisticas del Agua en Mkxico 2007. 33 According to Mexican norms, water cannot be used for consumption or agricultural purposes if concentrations o f fecal coliforms are above 1,000 MPNi100 ml. SEMARNAT, lnforme de la Situacidn del Medio Ambiente en Mkxico, Compendio de Estadisticas Ambientales 2005.

19

agriculture, energy, forestry, and tourism that are heavily dependent on water quality and quantity.34

67. Water, which i s directly linked to sustainable growth and poverty reduction, i s perhaps Mexico's most urgent environmental problem today. Pressure on Mexico's water resources has grown tremendously over the past decades, reflecting rapid population growth from 25 million people in 1950, to over 100 million today. Moreover, the availability o f water i s inversely related to the demand for it. W h i l e population growth has occurred nationwide, it has been markedly greater in the semi-arid and arid, industrialized north, northwest, and central regions; these regions are now experiencing major water shortages with severe consequences for further development. Indeed, north, central and northwestern regions in Mexico account for 87 percent o f GDP and 77 percent o f the population, but the same region has only 3 1 percent o f the runoff.

68. The National Water Commission (CONAGUA, for its Spanish acronym, Comisidn Nacional de Agua), a decentralized agency under SEMARNAT, i s the entity that i s primarily responsible for all issues related to water resources management. During the past years, CONAGUA has been focusing i t s efforts on (a) legally registering and regularizing all water users (including dischargers); (b) developing mechanisms for approving new water rights and water right transfers; (c) establishing River Basin Councils (RBCs) and Aquifer Committees; (d) preparing national and regional water plans; (e) improving groundwater and surface water (quantity and quality) monitoring, modeling and assessment; (0 improving meteorological services; and (g) improving the operation o f hydraulic infrastructure. The legislation establishes three basic instruments for water management: concessions to take water, permits to discharge effluents into national waters and the Public Register o f Water Rights.

69. Water issues cut across a number of sectors. From the perspective of quantity, 80 percent o f water consumption i s by the agriculture sector, and the remaining 20 percent by industry, municipalities and rural domestic use. On the other hand, water quality i s affected by water discharges from municipalities, industries and the tourism sector, as well as diffuse pollution from agriculture and livestock production. In particular, for the case o f water scarcity, priority issues that need to be addressed include (i) overexploitation o f surface and ground water, (ii) use o f scarce water resources for low value crops, (iii) a weak institutional framework for local water management, (iv) inadequate water rights administration, and (vi) inappropriate fees for the use o f national waters (for example water fees are applied mainly to industry to a lesser degree to municipalities and farmers are exempt) and agricultural electricity subsidy (Tarfa 09) provide a strong disincentive to save water in irrigation, which i s by far the largest water user.

70. As part of the GOM's efforts to address the challenges of the water sector, CONAGUA developed the 2007-2012 National Water Program which described the objectives, strategies and targets in line with the 2030 vision o f sustainable human development. The Program's key objectives included: (i) improving water productivity in the agriculture sector; (ii) increasing the coverage and quality o f drinking water, sewerage, and sanitation; (iii) promoting an integrated and sustainable management o f water in basins and

34 World Bank Climate Change Assistance for Mexico - Current Activities and Options for Future Collaboration (August 3,2007).(internal document)

20

aquifers; (iv) improving technical, administrative and financial developments in the water sector; (v) consolidating public participation in the planning and management o f water and promoting a water culture; (vi) decreasing risks and effects o f floods and droughts through organizational arrangements, efficient information and alert systems, and drought management plans; (vii) evaluating the impacts of climate change in water resources; and (viii) creating a culture o f compliance with the requirements o f the National Water Law.

71. The 2004 amended legal framework restructures key functions of CONAGUA at the basin level. The mandate to decentralize the functions o f CONAGUA to the River Basin Agencies (Organismos de Cuenca) i s one o f the major reforms o f the amended law. In addition to the River Basin Agencies, the recent amendment o f the National Water Law empowers the River Basin Councils (Consejos de Cuenca) to be key players in the administration o f the Water Financial System (SFA- Sistema Financier0 de Agua), which the law mandates but does not define35. Currently there are 25 Basin Councils. The Basin Councils’ function i s to formulate and agree on activities to improve water resources management and on the need for water infrastructure in their respective basin36. According to the amended Law, the Basin Councils are expected to guide, together with CONAGUA, the work o f the aforementioned Basin Agencies.

72. The amended legal framework improves the public water rights registry as part of efforts to improve the enforcement of water use rights and promote the functioning of water markets. The public water rights registry i s available to the public at CONAGUA’s web site: www.cna.Izob.mx. Additional efforts by CONAGUA to increase efficiency in the use o f water and foster water markets include the publication o f water availability data for 188 aquifers and for the country’s largest watershed, the Lerma-Chapala basin, and the disclosure o f data on water availability, which provides authorities and water users with reliable information for a more transparent allocation o f the resource among all water users.

73. During 2007 CONAGUA continued publishing water availability information, issuing water rights and improving the water rights registry, improving measurement and monitoring o f water use and discharges, increasing compliance visits and enforcement, and assessing water quality o f water bodies.

E.1 ACTIONS SUPPORTED BY THIS OPERATION

74. Developing the policy reforms that are required to promote sustainable water resource management in Mexico will take time and i s both politically and technically difficult, particularly with respect to the decentralization o f planning, investment programming, and operational responsibilities to lower level organizations. The actions supported by the operation constitute the first phase o f this reform process. Although their scope can be considered modest compared with the magnitude o f the problem, these actions will contribute to Mexico’s water agenda by promoting water pollution reduction and water use efficiency improvements.

35 The exact role o f the basin level institutions in the SFA remains to be defined through the regulations o f the amended National Water Law. 36 The territory covered by some basin agencies (such as the Lerma Basin) covers up to f ive states, while on the other hand some states (such as Sonora) include territory covered by up to f ive basin agencies.

21

75. The Environmental Sustainability DPL has supported the inclusion of provisions for the return of wastewater discharge fees to municipalities and industries in the 2008 Federal Rights Law as well as their implementation. Just as the PRODDER program returns water use fees to municipalities for investments in water supply and sanitation, this law allows for discharge fees to also be used for investment. Municipalities and industries will be able to utilize funds collected through these fees to finance an approved action plan to improve the quality o f the discharges and bring them into compliance with the law. The action plan can include wastewater treatment, changes in production processes, and discharge control. This could potentially be a large funding source for construction o f wastewater treatment plan by municipalities and industries. The extension o f PRODDER to also return collected discharge fees to polluters, together with the recently launched Competitive Fund Program, by which CONAGUA provides a subsidy to municipalities requesting it on the basis o f the volume o f wastewater actually treated, would encourage implementation o f structural and non-structural measures to improve the water quality o f discharges by municipalities. The Water Sustainability o f the Valley o f Mexico Program, launched by the current administration, has a sanitation component, which aims to address both water quantity and quality problems in the Valley o f Mexico on an integrated manner.

76. The operation has also supported modifications to, as well as the approval of, operating rules for eight of CONAGUA’s ongoing programs in irrigation and drainage, and water supply and sanitation. These modifications will provide specific requirements for accessing financial resources through the programs, including mandates for improvements in water use efficiency, reduction in losses, improvements in water measurement, and where possible reductions in water rights concurrent with reductions in water usage.

77. The GOM i s currently discussing further revisions to the amended National Water Law.37 The reasons for these further revisions came from general concerns within the Mexican water community that inter alia: (i) the institutional framework i s too complex with too many entities being created and an unclear division o f responsibilities at the basin level; (ii) the amended law does not adequately take into account the present weakness o f CONAGUA’s regional offices, which will need a longer transition time before they can fully take on the responsibilities laid out in the law for Basin Agencies; (iii) questionable responsibility linkages between the local, basin and central levels; and (iv) penalties for non compliance set unrealistically high. There is a general consensus with the Mexican water community and G O M that decentralized water resources management to basins and aquifers i s essential in order to be able to implement integrated water resources management and solve overexploitation, contamination, and inefficient allocation problems. It i s clear that any new amendment to the water law will not back track on this objective. However, the transition to decentralized water resources management i s expected to take considerable time and effort.

78. CONAGUA’s commitment to move towards decentralization i s demonstrated by the launching of small-scale flagship projects. Guidelines have been developed for the planning and implementation o f these small local flagship projects that would be designed to be prepared in a decentralized participatory manner and implemented within a five-year timeframe. These flagship projects would be designed to pi lot and demonstrate decentralized water resources

37 The ENVDPL I1 supported the passage o f amendments to this law in 2004.

22

management and solutions to real problems o f allocation, contamination, and overexploitation, as well as to improve the economic and social value related to water resources utilization while at the same time stopping and reversing environmental degradation.

79. A PSIA on the water sector was carried out during preparation, which analyzes the status of local groundwater institutions and the foreseeable poverty impacts o f groundwater overexploitation. The study found that poorer farmers have limited access to irrigation water and concluded that impacts on poorer farmers from reduced subsidies would be limited. CONAGUA has challenged this conclusion since i t i s not representative o f the situation on the ground, and has requested firther analysis be carried out on this subject before drawing policy conclusions. At present, farmers meeting eligibility criteria and able to provide the required co-financing are able to access programs that support the shift to irrigation-efficient methods. The flagship projects wi l l include measures to support small and medium producers to benefit from financing and technical assistance programs to shift to more productive water consumption saving alternatives.

F. ENVIRONMENTAL CHALLENGES IN THE AGRICULTURE SECTOR AND GOVERNMENT STRATEGY

80. Overall the agriculture sector plays an import role in the Mexican economy, but since 1990, this role has been reduced. Primary agriculture generated around 4 percent o f GDP and 13 percent o f employment in 2007 compared to 8 percent and 27 percent, respectively, in 1990. Despite this decline, agriculture represents the main source o f income for the rural poor. In 2003, about 23 percent o f the total population lived and worked in rural (primarily agricultural) areas. * 81. Mexico has high public spending in agriculture and rural development relative to the average for the LAC region and other middle income countries (MICs). The total federal spending on rural development programs was approximately US$14.3 billion or 7.8 percent o f the total federal spending in 2006, and for agriculture alone, approximately US$6.5 billion or 26 percent o f the agricultural GDP (three year average for 2003-2005). To put these figures into perspective, among LAC countries Mexico had the second highest public agricultural spending per worker, the highest per hectare, and also the highest ratio between the share o f agriculture in public expenditure and i t s share in GDP. Also, beyond LAC countries, Mexico’s producer support level i s below OECD average, but i s one o f the highest among the MICs.

82. Despite high spending in the sector, agricultural growth and productivity have been lagging since the 1980s, compared to the Mexican economy as a whole, and to other MICs and major regional competitors. I t i s not surprising that agriculture has been growing at a much slower pace (1.8 percent between 1980 and 2006) than the economy as a whole (2.7 percent for the same time period) given the expected decline o f the share o f agriculture as countries develop. However, Mexico’s low agricultural growth rate stands out compared to MIC

INEGI statistics (2007), SAGARPA Logros de la Administracibn Publica Federal (2008), OECD (2008). 38

Environmental Performance of Agriculture in OECD Countries since 1990.

23

countries as a whole (3.0 percent for the same time period) as well as major LAC countries such as Brazil (3.5 percent), Chile (4.6 percent) and Argentina (2.2 percent); rural poor have not been incorporated in other sectors, rather migration mainly to the USA has been the alternative for this population contributing to a further decline as reflected in low productivity rates. Total Factor Productivity (TFP), which measures productivity growth not captured by the increases in individual production factors, has been low for Mexico since the 1980s, with an annual rate o f 1.5 percent, lower than that o f major L A C competitors and the L A C average.

83. While the overall agriculture performance has been weak, regional performance has been mixed. Noticeably, there are two sides to Mexican agriculture: the dynamic commercial farmers mostly in the north and the poor small farmers mostly in the central and southern regions. In the northern States, irrigated lands have yields and productivity similar to US standards. For example, the yield o f corn in Sinaloa i s 8.6 metric tons (MT)/ha and 7.3 MT/ha in Chihuahua, which are comparable to the U S level o f 8.5 MT/ha. These farmers have rapidly expanded the production o f grains for the domestic market and the export o f f ru i ts and vegetables to the U S since the signing o f NAFTA. They have provided most o f the dynamism to the rural economy. Meanwhile, the productivity o f the small scale, rain-fed agriculture o f the South (where 86 percent o f the farmers reside), has been stagnant and falling behind the pace o f irrigated agriculture. Long structural problems such as land conflicts, poor infrastructure and services, and continued, limited access to education and health services have affected rural growth.

84. As agriculture faces challenges in increasing its productivity and competitiveness, it also faces challenges in integrating principles o f sustainable use o f natural resources. The high intensity and expansion o f agriculture i s putting high pressures on water resources and biodiversity. Agricultural water use, particularly in northern areas subject to rapid intensification and expansion o f irrigated agriculture, exceeds available water resources and i s causing depletion o f aquifers. The number o f overexploited aquifers has increased from 20 to 102 between 1970 and 2003. Sixteen percent o f the 653 aquifers are overexploited. Pressures on biodiversity (e.g., wild species and natural habitats) are caused by deforestation, which also has negative impacts on soil conservation. One o f the main culprits o f this deforestation i s the clearing o f land for agricultural purposes. Other issues o f increasing concern are increased use o f pesticides and green house gas emissions, mainly though the use o f internal combustion engines for machinery and electricity generation for heating and cooling.

85. Reducing the negative impacts o f agriculture on water resources represents an extraordinary challenge and requires reforms in the water sector as well as other sectors. Some o f these reforms are currently being implemented, including the purchasing o f water rights in areas where aquifers are overexploited. While improvements have been made in increasing water use efficiency in Irrigation Districts and Irrigation Units, these improvements are being undermined by electricity subsidies for pumping and low irrigation charges.

86. Small scale farmers can play an important role in sustainably managing natural resources since small scale farmers hold the stewardship o f the majority o f natural resources in Mexico, e.g., 83 percent (SRA, 2008) o f all forests in Mexico and around 90 percent o f lands in protected areas are community owned. However, major agricultural and social programs that target these small farmers, such as PROCAMPO, are not designed specifically to encourage

24

sustainable use. With the lack o f an integrated rural development policy, agricultural programs may even negatively impact the sustainable use o f natural resources since close to 30 percent o f the public agriculture spending i s linked to input usage or to output volumes.

87. The relationship between agriculture and environment i s recognized in the Mainstreaming Agenda agreed between SAGARPA and SEMARNAT, which supports the integration of environmental considerations in the agriculture sector. This agenda focuses on the following areas: (i) climate change, (ii) ecological land zoning, (iii) sustainable use o f natural resources, (iv) agricultural pollution prevention and control, and (v) scientific research, capacity building, and education. In line with the Mainstreaming Agenda, SAGARPA i s undertaking various programs to enhance agricultural sustainability, which include (i) a program to promote sustainable use o f natural resources from primary production (conservation and sustainable use o f land and water resources, livestock, biogenetic resources and biodiversity, bio- energy and alternative sources, fisheries); (ii) insurance against climate impacts on agricultural and livestock producers; (iii) purchasing o f productive assets, which provide financial support for the construction o f greenhouses, among other purposes; and (iv) FIRCO, which promotes environmentally and economically sustainable agro-processing facilities, while contributing to the goals o f the National Strategy on Climate Change by facilitating the adoption o f emission- reduction technologies. Although these initiatives are limited in scope and population coverage, they are f i rs t steps in reversing a sector policy that has not been very effective in promoting sustainable development and reducing poverty.

F.l ACTIONS SUPPORTED BY THIS OPERATION

88. It will take time to undertake the policy changes that are required to address agricultural environmental concerns, some o f which are politically difficult, particularly with regard to the reduction o f electricity subsidies for water pumping. The actions supported by the operation constitute the first phase o f needed agricultural pol icy reforms, promoting sustainable agriculture.

89. This operation has supported modifications to, and the approval of, operating rules for SAGARPA’s program on Sustainable Natural Resource Use in Primary Production. These modifications include specific sustainability criteria to address environmental concerns in two o f the program’s components: (i) livestock, which promote improved land management practices in pastoral land, including reforestation, protection and natural regeneration; and (ii) productive reconversion, which promotes conservation tillage systems on agricultural land.

90. The inclusion o f environmental sustainability critieria in the operating rules o f the above programs i s an important first step in implementing SEMARNAT and SAGARPA’s joint agenda to address environmental challenges in agriculture, as environmental concerns have not been systematically incorporated in sectoral reforms in the past. Further, since the joint agenda addresses poverty issues and factors that affect productivity, the operation will also help ensure that poor farmers benefit from these programs.

91. The Environmental Sustainability DPL has also supported the development of a large scale joint initiative in agriculture and environment for ecosystem preservation. Representatives f rom SEMARNAT and SAGARPA, as well as other agriculture and

25

environmental stakeholders, have developed and signed an agreement to (i) limit the expansion o f agricultural land within the Mexican Mesoamerican Biological Corridor (CBMM), an area covering about 6.9 million hectares or 3.5 percent o f the Mexican terr i t~ry,~’ and (ii) promote the sustainable management o f natural resources within the C B M M with low agricultural production.

1,of)o l--_.-_--_-ll_.__l-l--ll 900 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

700 ...........................

800 . . . . . . . . . . . . . . . . . . . . . . .

6 0 500 5

200 ........................................................

100 ........................................................... 7

G. ENVIRONMENTAL CHALLENGES IN THE HOUSING SECTOR AND GOVERNMENT STRATEGY

92. The Mexican Government has recently implemented a set o f reforms to increase access to housing, which has resulted in an important expansion of the sector. Between 2001and 2007 the number o f loans for housing and housing improvements almost tripled, from 293,000 in 2001 to 883,433 in 2007. Although housing loans are s t i l l dominated by the public sector, private funding has increased i ts share gradually from 1 percent to 13 percent during the same period, increasing the relative importance o f the sector for the economy. From 2001 to 2007, the mortgage portfolio relative to GDP grew from 5.5 percent to 11 percent. The Bank has been a key partner to the government in both enabling and strengthening housing markets. In 1999, the Bank provided direct support in establishing the Sociedad Hipotecaria Federal, with the mandate to develop the primary and secondary mortgage markets for middle income households. In 2004, 2005, and 2007, respectively, a programmatic series o f DPLs supported broader sector reforms on housing subsidies, expansion o f the housing finance and savings programs to lower income segments, slum upgrading, and fostering low- and moderate- income land development. The associated Housing and Urban Technical Assistance Loan (HUTAL) supports analytical work to design and implement housing sector programs.

93. Currently, the Bank i s preparing a new operation to support the federal mortgage company (SHF - Sociedad Hipotecaria Federal) new strategic plan 2008-2012, which aims to increase access to housing finance for the population with income below 6MW (around US$10,800 per year).

94. The increase in the housing stock, estimated from 24.7 million in 2000 to 30.4 million in 2006, has surpassed the ability to adequately provide basic infrastructure and services. Site selection for city growth and housing construction as well as basic infrastructure services provision are municipal responsibilities and as such, vary greatly in their capacity and resources. In 2007, around 104 different regulatory frameworks existed for housing construction

39 This corridor covers area in four states: Campeche, Chiapas, Quintana Roo, and Yucatan.

26

in the 55 metropolitan areas where 70 percent o f the population lives;40 out o f the 18,000 hectares that were earmarked for urban development in 2000, 85 percent lacked a comprehensive urban development plan that would allow an orderly and planned provision o f infrastructure.

95. The lack of orderly expansion in cities, which to a large extent i s due to increased housing construction, has generated excessive exploitation o f natural resources, particularly water resources and forest areas and i s jeopordizing the sustainability of some cities. Housing construction in Mexico i s highly concentrated, with the ten largest developers responsible for around 35 percent o f the new housing market. Typically new housing in Mexico i s concentrated in medium and large developments that range between 500 and 15,000 units. Water scarcity represents an important challenge for the expansion o f the housing sector. Mexican cities use 10.7 cubic km annually, o f which 36.4 percent derives from surface water and 63.6 percent i s extracted from the aquifers. These amounts are equivalent to 8 percent o f the total national consumption o f surface water, and 24 percent o f aquifers. As a reference, the agricultural sector accounts for 81 percent o f the use o f surface waters and 70 percent o f aquifers. In terms o f wastewater treatment, Mexican cities generate 242 cubic meters o f residual water, o f which 85 percent are collected but only 30.8 percent i s treated. The highest percentages o f treated waters by metropolitan areas are in Monterrey (1 5 percent o f the total national treated water) and Chihuahua (8.4 percent o f the total national treated water).

96. In 2007, Mexican cities generated about 37 million tons of solid waste in urban areas. These are mostly produced in the central region (50 percent), followed by the North (27 percent) and the Mexico City metropolitan area (1 3 percent). The country has achieved important results in the creation o f new sanitary landfills. Between 1995 and 2007, the number o f sanitary landfills tripled and the quantity delivered increased from 5.9 million tons per year to 20.8 million tons per year. For the year 2007, this amount accounts for 57 percent o f the total solid waste generated. The remaining 43 percent i s either delivered to other “controlled zones” (10 percent) or deposited to open dumps (33 percent) 41,

97. Historically, the residential sector has been the largest consumer of electricity, not only in terms of quantity but also in the number of users. It represents 25 percent o f total energy consumption (total consumption i s 160,384GWh). O f this, 61 percent i s used for cooking, 28 percent for water heating, 5 percent for lighting and 3 percent for temperature conditioning. In comparison, in OECD countries the largest share o f total energy consumption goes towards temperature conditioning and water heating.

98. As a first step to address these issues, CONAFOVI (now CONAVI) prepared and published three “Green Guidelines” for the: (i) design and incorporation of green spaces into housing developments, (ii) efficient use o f energy, and (iii) efficient use o f water resources in housing developments. These guidelines defined good environmental practices establishing alliances among agencies working on sustainable housing development. It i s important to note that adherence to the guidelines was not mandatory, nor were they associated with any federal housing credit or subsidy program. Additionally, CONAVI initiated three pilot

40 CONAVI, Programa Nacional de Vivienda 2007-2012 41 Presidencia de la Republica. Segundo Znforme de Governo. Mexico City Gobierno de 10s Estados Unidos Mexicanos. 2008.

27

programs for green housing design in the States of Baja California, Nuevo Leon and San Luis Potosi jointly with CONAGUA, Trust Fund for Electrical Energy Savings, CONAFOR, Mexican Construction Industry Association, and National Industry Association o f Housing Development and Promotion.

99. I n 2006, Congress approved a new Housing Law which incorporated a new mandate for sustainability of the housing sector. The new Housing law approved in June 2006 provides a more comprehensive institutional setting for the sector and mandates for the first time the environmental sustainability o f the housing sector.42 The law defines the National Housing System incorporating other relevant sectors such as environment, transport, and finance in the policy discussions. It defines a new governing body within CONAVI in which the ministries 6f Energy, Economy, Water, Transport, Environment, and Finance Secretariats all participate in formulating sector programs. In addition, the new law incorporates mechanisms for subsidy targeting in line with the Social Development Law issued by the Fox admini~trat ion.~~ In particular, the law mandates that one o f the main objectives o f the housing policy should be to incorporate environmental considerations and an efficient use o f resources in policies and programs. This contrasts with the previous law (1984) which only envisaged the promotion o f environmentally friendly building materials.

100. Since its start in 2007, the Calderon administration has maintained the previous government’s commitment to further expansion of the housing sector, while at the same time addressing the sector’s sustainability challenges. The 2007-201 2 National Development Plan (NDP) aims to increase access to housing for the poorest segments o f the population in an orderly, rational, and sustainable c~ntext.~~Importantly, the NDP establishes the goal o f 1 million new housing loans and/or subsidies per year from 20007 to 2012. In September 2007 the National Housing Commission published the 2007-20 12 National Housing Program (NHP)45. The NHP further describes the conditions upon which the sector will deliver the goal and sets four main objectives for Mexico’s housing policy, including; (i) increase access to housing finance, particularly for the lower-income population, (ii) promote a sustainable housing sector development, (iii) consolidate and integrate the housing sector institutional framework, (iv) establish a subsidy policy that fosters housing finance for the poor and that fosters the sustainable housing sector growth.

101. In accordance with the new housing law, CONAVI in close coordination with SEMARNAT established the Programa Transversal para e l Desarrollo Sustentable de la Vivienda in 2007 to implement the necessary actions for improving the environmental sustainability o f the housing sector. This cross-agency program seeks to guarantee that a maximum number o f new housing constructions incorporate sustainability criteria. As such,

www .diputados. gob.mx/LeyesBiblio/doc/LViv. doc 42

43 i.e. subsidies have to be targeted to the poor as defined by SEDESOL, have to differentiate between income levels, should be established with equity criteria, procedures for their operation should be transparent and with a fixed time for execution

httu://pnd.calderon.presidencia.nob.mx/udfE~ie2 Economia Competitiva v Generadora de Emuleos/2 13 Constr The section on housing and construction may be seen at 44

uccion v Vivienda.udf 45 The 2007-2012 National Housing Program: Hacia un Desarrollo Habitacional Sustentable may be seen at: http://www.conavi.gob.mx/PROG~MA~NACIONAL~DE~VIVIENDA~2007-20 12-VERSION-EJECUTIVA,pdf

28

these agencies agreed to promote housing design and the use o f building materials and technologies that take into account the efficient use o f resources, develop new technologies for housing construction, foster sustainable housing through fiscal, financial, and economic incentives, and establish a certification mechanism that guarantees housing quality and efficiency. C O N A V I and SEMARNAT have agreed to use the following tools to implement the Programa Transversal:

Reform and creation o f necessary regulatory framework, and standardization o f norms; Certification programs for housing developments; Creation o f financial schemes to foster environmentally sustainable housing developments; Promotion o f research and development, capacity building, and dissemination o f best-practice, and; Generation o f incentives for the densification o f cities.

102. The main effort on standardization of norms has been the development o f a Housing Construction Code. As construction standards are a municipal responsibility, there are currently a large number o f construction codes in Mexico with different standards, different supervision methods, and variability in their implementation. Although it makes sense to have the construction standards defined at the lowest possible level o f administration; several o f the negative externalities o f the sector are regional or national. A good example has been the mitigation and rehabilitation efforts made by the federal government after natural disasters affecting sites that were not suitable for housing in the first place. To foster standardization C O N A V I i s developing a federal construction code that will provide a framework for the standardization and a continuous update o f the existing local construction codes. As municipal governments are autonomous to a large extent, the federal government can only provide incentives for local governments and housing developers to foster adherence by linking the code in later stages to federal loan and subsidy programs. The federal construction code i s expected to bring about a decrease in the risks associated with exposure to natural disasters and to foster the housing insurance market in Mexico. A f i rst draft o f the Construction Code has been prepared and shared through three consultation forums with the main stakeholders, including developers, financial institutions, State and municipal governments and civ i l society.46 The code was developed as a modular system (based on the International Code Council (ICC) model) whereby the local government can adopt gradually different modules according to their priorities. This i s important given the heterogeneous nature o f the municipalities in the country. The Bank financed Housing and Urban Technical Assistance Loan i s partially financing several parts o f the Construction Code project.

103. Additionally, CONAVI, with the Bank’s support, i s preparing a Strategic Environmental Assessment (SEA) of the Housing Sector. In January 2007, C O N A V I began conducting the SEA which will serve as a master plan for incorporating environmental considerations in housing policies and programs in coordination with SENER, CONAGUA, IMTA (Mexican Institute for Water Technology), and SEMARNAT. SEMARNAT i s partially financing this assessment, which reflects the importance o f both this tool and i t s interinstituional approach to these agencies. The SEA is expected to be finalized in December 2008. The Bank

46 The Construction code can be seen at: http://www.conavi.gob.mx/publicaciones/cevOOl-332.pdf

29

financed Housing and Urban Technical Assistance Loan i s also supporting the SEA, which calls for regional diagnoses and recommendations relating to zoning and land use (including considerations on water availability, air quality, and green areas); technologies (building materials and systems); demographics; financing (innovative instruments to finance environmentally friendly houses); uti l i t ies and public services (transport, access, energy use, water use, drainage, solid waste disposal); and standards (such as construction),

G.l ACTIONS SUPPORTED BY THIS OPERATION

104. The proposed DPL operation has supported the development and approval of cross- sector guidelines for incorporating environmentally sustainable practices into newly constructed homes, financed under the federal subsidy program. To support the goal o f delivering six million loans for housing acquisition and improvement during 2007-20 12 and given that 60 percent o f the housing demand lies in the population earning between 1 and 5 minimum wages (around US$1,800 and US$9,000 per year, respectively), the GOM launched a new credit-linked housing subsidy program with a significantly expanded budget allocation to US$400 million for 2008.47 The new Programa de Esquema de Financiamiento y Subsidio a la Vivienda, or Esta es tu Casu (supported under the Housing DPL Program) provides a combination o f upfront subsidy to beneficiaries and a credit guarantee to the financial intermediary for the acquisition o f a housing unit or serviced lot given a modest amount o f beneficiary savings. Those eligible include: (i) the insured population with an individual income below 2.6 minimum wages (MW); and (ii) non-insured persons with household incomes below 5MW.48 The operational guidelines published by CONAVI outline the program objectives, eligibility criteria, and implementation arrangement^.^^ Under the program, the maximum subsidy amount i s fixed at US$5,000 for the lowest income households and decreases as income rises. In 2007, CONAVI delivered 120,000 subsidies and the goal for 2008 i s 140,000, o f which 45,000 were delivered during the first quarter o f 2008.

105. The subsidy program’s guidelines, supported under the proposed operation, establish that those housing units that incorporate certain sustainability criteria will be eligible for a 20 percent greater subsidy from the federal government. To define and measure this “sustainability criteria” CONAVI issued in February 2008 the Criteria and Indicators for Sustainable Housing Developments prepared together by CONAVI, SEMARNAT, SENER, CONAGUA (Comisi6n Nacional del Agua), SEDESOL (Secretaria de Desarrollo Social), and twelve other institutes and associations. These criteria set the basic standard for housing construction for: (i) land use, and site locations and characteristics, (ii) energy consumption, (iii) water resources, and (iv) solid waste management. They include (a) a set o f criteria for the design and construction o f sustainable housing developments, and (b) a set o f indicators that determine the degree to which the housing unit can be considered “sustainable.” The criteria fully factor in the housing unit’s impact on the environment (including an examination o f the disposal o f residual material from housing construction and the building techniques employed), while the indicators measure the uni t ’s energy efficiency and conservation o f water resources. Estimates suggest that

47 The 2005 and 2006 budget allocations for the existing credit-linked subsidy program - PROSAVI were just below M$100 million, and even during the peak periods the budget was never higher than M$200 million.

A Minimum wage i s an income measure used for social programs, including housing. One minimum wage i s a proximately US$140 a month. “See http://www.shf.gob.mx/programas_de_sh~ROGRAMASUBSIDIO.html for the program rules.

48

30

incorporating the minimum water and energy efficient technologies will cost around US$1,500 for each new house and wi l l provide an estimated home monthly savings o f US$20 per month or US$7,000 over a 20-year period. The increased subsidy which covers 66 percent o f the installation cost should be adequate to compensate between the public versus private gains from the installation o f efficient technology. As the program evolves it i s likely that CONAVI wi l l adjust these amounts to reach an optimum level.

106. Linking the Criteria and Indicators for Sustainable Housing Developments to the primary federal housing subsidy program marks the government’s f i rs t efforts to mainstream environmental considerations into federal housing policy. In the past, managing the sector’s environmental impacts were solely the responsibility o f local government authorities. However, recognizing that (i) negative externalities o f un-orderly city growth and unsuitable housing construction and siting can create regional and/or national impacts (e.g., due to natural disasters and other causes) and (ii) disorganized municipal growth partially results from increased access to housing finance from federal programs, the federal government has taken a lead in creating incentives for incorporating sustainability criteria into the housing sector. Even though the federal government cannot impose municipal building standards, CONAVI’s cross-sectoral guidelines aim to indirectly influence better organized municipal growth. This action i s also intended to serve as a good practice example to local governments who have the authority to establish legislation on construction siting and standards.

107. There are two factors that wi l l determine the rate at which newly constructed homes incorporate these environmentally sustainable practices: (i) their voluntary nature and (ii) the time required to build developers’ awareness o f these practices and factor them into their construction plans. Since construction standards are a municipal responsibility, CONAVI’s programs aim to build consensus and promote best-practice among both local governments and developers; however they can not be enforced. Linking the criteria to an additional subsidy, however, i s expected to create the necessary incentives for developers. Also, once developers and local governments decide to participate in the program, it i s expected to take at least one year to demonstrate significant results given the timing required to both plan and build housing units.

31

IV. BANK SUPPORT TO THE GOVERNMENT STRATEGY

A. LINK TO COUNTRY PARTNERSHIP STRATEGY

108. The proposed operation i s part o f the transition between the prior Mexico Country Partnership Strategy (CPS) for FY05-FY08 and the new Mexico CPS for FY08-FY13 (Report No. 42846-MX, dated March 4, 2008). I t i s consistent with the new CPS’s joint emphasis on development policy lending and support for the environment.

109. The FY08-FY 13 CPS i s closely aligned with the same five pillars o f the government o f Mexico’s 2007-2012 National Development Plan (NDP): security and the ru le o f law, competitiveness, equality o f opportunity, environmental sustainability, and effective democracy. The loan will be a key instrument in responding to the environmental sustainability pillar, which aims to turn the concept o f environmental sustainability into a transversal element o f public policies and assure that all public and private investments are compatible with environmental protection. The CPS refers to the DPL operation as supporting the pillar’s objectives. An example o f this support i s the close alignment between the goals or expected outcomes o f both the CPS and DPL. Three o f the results expected during the CPS’s implementation period are consistent with the DPL’s expected outcomes (increased energy generation from renewable sources, increased number o f hectares under sustainable forest management, and increased coverage o f municipal wastewater treatment).

B. COLLABORATION WITH THE IMF AND OTHER DONORS

110. Mexico has no Purchases or Loans outstanding with the IMF and maintains periodic bilateral discussions as part o f the Fund’s regular surveillance program. The last Article IV consultation was concluded by the IMF Executive Board on December 3,2007. Staff members in the IMF and Bank maintain formal and informal contact exchanging ideas and coordinating activities on economic development and public policies in Mexico, as well as on specific technical assistance requests by the GOM.

C. RELATIONSHIP TO OTHER BANK OPERATIONS

111. In the water sector, Mexico supported by the Bank-financed Water Resources Management Project has made significant strides in putting in place the necessary building blocks in order to improve water resources management, including: (a) improvements to surface water and groundwater monitoring networks in terms o f both quantity and quality; (b) improvements in data management systems including GIs; (c) improvements in meteorological services; (d) development o f hydrologic, hydro geologic and water quality models and assessments; (e) development o f meteorological and hydrological forecasting models; (f) implementation o f a national dams registry and dam safety program; (g) identification, registry and issuing o f water rights to water users; (h) implementation o f a discharge permitting and control system; (i) improvements in water rights administration; (i) preparation o f planning studies for all major river basin and selected aquifers; (k) establishment and strengthening o f river basin councils and aquifer committees.

32

112. Supported by the Bank-financed Irrigation and Drainage Sector Loan (FY92-FY00) and On-Farm Irrigation Improvement Project (FY94-FY02), Mexico has also achieved significant success in transferring irrigation systems to water user organizations, which has resulted in operation and maintenance improvements as wel l as increased collection o f water tariffs from water users. In addition, an ongoing project in Integrated Irrigation Modernization (FY06-FY09) seeks to improve the efficiency o f irrigation systems and increase the value o f production per unit o f water consumed.

113. The Modernization of the Water and Sanitation Sector Technical Assistance Project (FY06-FY09) supports the Government's efforts to develop the tools and instruments to induce local authorities to improve the financial sustainability and efficiency o f water supply and sanitation service provision. This will imply a shift toward "performance based" allocation o f public (federal and state) transfers. Through the implementation o f this project, CONAGUA i s developing new regulations that provide clear incentives for efficiency improvement, including making the transfers dependent on the progress in realizing genuine improvements in efficiency and service. The project also supports the improvement o f the commercial and operational efficiency in a group o f selected uti l i t ies.

114. The recently approved Climate Change DPL supports three specific actions that demonstrate Mexico's leadership at the global level on climate change issues: (i) submission o f the Third National Communication to the UNFCCC in 2006; (ii) approval in May 2007 o f the National Climate Change Strategy by the Intersecretarial Commission on Climate Change (CICC) reinforcing the institutional and strategic framework in place; and (iii) initiation o f sectoral programs for energy, and environment and natural resources (forestry in particular). The D P L also paves the way for Bank assistance to the GOM in the following areas: (i) access to new financing sources for long-term mitigation and adaptation; and (ii) advisory services for mitigation and adaptation. The Climate Change D P L and the Environment Sustainability D P L complement each other, as the Climate Change loan recognizes Mexico's contributions at the global level, whi le the Environment DPL mainstreams domestic and local environmental considerations into national agendas and programs.

115. Third Affordable Housing and Urban Poverty Reduction DPL: The Mexico housing and urban poverty reduction program continues to be robust with strong ownership from the Government o f Mexico. The number o f housing subsidies continues to increase while being better targeted to the poor and (for the first time in Mexico) creating incentives for the used housing market. Policy reforms supported by the program will have significant environmental benefits. Informal settlements suffer from numerous environmental and social problems due to lack o f basic services. The proposed loan will support policies such as promoting slum upgrading; pursuing formal housing development in suitable, well-selected and well-designed areas; and streamlining environmental considerations in housing policies.

116. The Bank i s also providing strong support to the forestry sector, through both Bank and GEF-financed operations. A Community Forestry project, begun in 1997, has supported the community forestry practices o f 2,400 indigenous communities and ejidos, through tailored interventions, including (i) land use planning instruments, (ii) training, (iii) preparation, supervision and certification o f forest management plans, and (iv) strengthening o f private technical services providers and government institutions at the state and federal levels. A Bank

33

and GEF-financed Payments for Environmental Services project aims to strengthen the National Payment for Environmental Services Program launched in 2003 through both local and regional mechanisms, such as promoting the participation o f beneficiaries through water user fees and the development o f a GEF endowment to support PES for biodiversity conservation. The GEF-financed Mexico Mesoamerican Biological Corridor project i s contributing to the mainstreaming o f biodiversity criteria in rural and regional investments in seven states in southern Mexico and strengthening the collaboration between rural development and environmental institutions. The operation’s main objective i s to halt deforestation and habitat loss, focusing on a re-orientation o f rural development programs.

D. LESSONS LEARNED

1 17. The proposed Environmental Sustainability DPL builds upon lessons learned from the previous ENVSAL I and ENVDPL I1 operations, which are captured in the Implementation Completion and Results Report that was submitted to the Board in March 2008 (Report No. ICR0000737), and are presented in the following paragraphs.

1 18. Inter-sectoral Technical Working Groups (ITWGs) require substantial resources and commitments, but the benefits far outweigh the costs. The ENVSAL I demonstrated that inter-institutional coordination i s a complex process that requires substantial efforts and unwavering commitments on the part o f participating entities which are required to undergo a profound learning process and adopt significant behavioral changes. This learning process i s challenging and carrying out these commitments i s both difficult and time consuming. On the other hand, this operation also showed that where institutional coordination was successful, it led to enhancements in the quality o f outputs. The ITWGs became fully functioning and adequately staffed entities, providing significant opportunity for cross-fertilization between institutions in different sectors.

119. The ITWGs for the energy, forestry, water, and tourism sectors, which were established under the Environment DPL Program, will continue to play an important role in the proposed DPL operation. Given the multisectoral nature o f the DPL’s reforms, these groups, which promote coordination and consensus building, will continue to help ensure a broader discussion o f issues and buy-in with respect to sectoral strategy proposals and instruments. For example, the Intersectoral Commission on Tourism, created by the President in 2004, continues to provide the institutional framework for better inter-institutional coordination among federal authorities, the private sector, and civil society around the sector’s main challenges and opportunities. This Commission i s responsible for setting the country’s tourism agenda. In the agricultural sector, representatives from SAGARPA and SEMARNAT have worked together to develop criteria and benchmarks for environmentally sustainable agricultural practices in their respective programs, as well as prepare an agricultural sustainability agenda to promote the sustainable management o f natural resources in the Mesoamerican Biological Corridor. In addition, to support sustainable housing, CONAVI, SEMARNAT, SENER, CONAGUA, SEDESOL, among other institutions and associations, have together prepared “Criteria and Indicators for Sustainable Housing Developments.”

120. To ensure intersectoral coordination, a champion i s imperative. To ensure that inter- institutional coordination efforts are sustained throughout Program implementation and beyond,

34

it i s essential that an entity take a leading role in overseeing these efforts, particularly as participating entities undergo an initial learning process and define their functions within intersectoral working groups. SHCP and SEMARNAT assumed this coordinating role, helping to ensure the success o f the Program’s coordination efforts.

12 1. During the preparation o f the Environmental Sustainability DPL, the leadership o f SHCP and SEMARNAT has continued to encourage other implementing agencies to participate actively and has been an important factor in the fulfil lment o f the operation’s reforms. For example, their leadership has enabled the integration o f environmental concerns into sectoral agendas, e.g., in agriculture and housing, where environmental mainstreaming was previously not prioritized.

122. Trust fund resources have been indispensable for providing technical assistance to advance the GOM’s reform program and to strengthen coordination among key stakeholders. Although GOM has enough resources to finance reforms for the environment sector, the results o f Bank support have underscored the added value o f the Environment D P L Program both in terms o f technical assistance provided and the institutionalization o f spaces for intersectoral cooperation and dialogue which probably would not have been created otherwise. The Japan Policy and Human Resources Development Fund (PHRD) provided important resources (over U S $ l million) that allowed for the development o f key analytical work and stakeholder participation for the preparation o f the E N V S A L I and E N V D P L I T . The use o f PHRD grant funds provided a positive incentive for mainstreaming environmental concerns in key economic sectors. Trust fund resources have also facilitated the carrying out o f Poverty and Social Impact Analysis (PSIA) o f the reforms implemented in the water and forestry sectors.50 Both analytical work and stakeholder participation have proved indispensable to advance a far reaching reform program for environmental mainstreaming and strengthening o f environmental management.

123. The proposed D P L has also benefited from a PHRD grant to support the preparation o f the operation’s reforms as well as continued intersectoral cooperation and dialogue. For example, during preparation o f the Environmental Sustainability DPL, the PHRD supported two workshops with various government institutions to review lessons learned from the Environment DPL Program and how best to build on these lessons in the design o f the proposed operation.

124. Importance of focusing on a select number of central actions, impacts, and results in the design of the Program. The ENVSAL I had a large number o f prior actions that covered a broad range o f development areas. Consequently implementation and supervision covered a wide range o f topics, presenting challenges in terms o f sufficient human and budgetary resources and constant dialogue between the Bank and GOM throughout the period o f implementation. I t was determined that for future operations in the Program fewer prior actions should be selected in such a way that they are strategically important, will address the sectoral priorities o f the country, and therefore will s t i l l have development impact. As such, the number o f prior actions under the E N V D P L I1 was l imited to five actions.

’’ Water and forestry sectors were prioritized in the PSIA, within the context o f existing budgetary and time constraints.

35

125. The proposed operation’s design reflects this ENVSAL I lesson, by limiting the number o f prior actions to nine strategically important actions that address the country’s sectoral priorities.

126. Importance of establishing specific, measurable, and relevant outcome indicators. A relevant set o f monitorable and meaningful outcome indicators should be established at the outset o f a Program, along with clearly-defined baseline and target values to monitor progress and evaluate outcomes. Some o f the indicators established for the Environment DPL Program were overly complex and ambitious. Further, although target values were defined during the course o f Program implementation, the lack o f a definition o f baseline and target values at the outset made it more difficult to assess the Program’s overall progress during implementation.

127. The operation’s design also reflects this lesson, by defining the baseline value o f a core set o f outcome indicators as well as target values to measure progress. These indicators were selected in agreement with government counterparts.

E. ANALYTICAL UNDERPINNINGS

128. The operation rests on a solid analytical foundation that includes studies financed under the Japanese PHRD preparation grant, as well as a number o f recent AAA products covering the energy, forestry, water, agriculture and housing, agriculture sectors. This analytical work, which has supported the Bank’s strong ongoing policy dialogue and has helped inform the government’s policy choices in these sectors, i s presented below.

E.l ANALYTICAL WORK SUPPORTING THE TOURISM SECTOR

129. A PHRD preparation grant under ENVDPL I1 supported the government in carrying out an SEA o f the tourism sector. This SEA i s being used to inform the development o f a policy on sustainable tourism development. Key recommendations o f the SEA included (i) strengthening inter-sectoral coordination between SECTUR, SEMARNAT and other institutions; (ii) developing a master plan for tourism development, in addition to the National Tourism Plan, which includes measurable goals for quality, quantity and diversity o f tourism products that are specific to each tourist destination or region; (iii) developing fiscal incentives to promote innovative and environmentally sustainable tourism projects; among others.

130. The government began implementing the SEA’S recommendations under the Environment DPL Program. The Environmental Sustainability DPL provides continued support in their implementation.

E.2 ANALYTICAL WORK SUPPORTING THE ENERGY SECTOR

131. The Bank has played an important role in supporting the introduction o f renewable energy sources in the country’s energy consumption. As part o f this support, a PHRD preparation grant under the ENVSAL I financed a prospective analysis on the use o f renewable energy in Mexico, up to 2030.

36

132. ESMAP has also provided support to promote renewable energy development, through the following studies: (i) an examination o f the Current Situation and Perspectives for Renewable Energy in Mexico, (ii) the development o f an Action Plan for the Large Scale and Sustainable Implementation o f Renewable Energy, (iii) a Portfolio Approach to Energy Planning in Mexico, and (iv) an Economic Analysis o f Mexico Wind Projects. These studies have helped identify concrete policy and institutional changes required to promote renewables, examine how new methodologies can help Mexico better account for the value o f renewable energy capacity, and examine the economic impact o f adding a large wind farm to Mexico’s grid.

133. GEF resources have financed additional studies supporting the development o f a Renewable Energy Law (pending Congressional approval) and economic assessments o f concentrated solar power technology to support CFE in developing solar thermal hybrid projects, as well as a 2005 International Grid-Connected Renewable Energy Policy Forum. This forum was organized by the GEF, World Bank, SENER, and the Global Wind Energy Council to bring leading organizations and academia together to discuss the latest research, as well as innovative economic, financial, and regulatory mechanisms regarding grid-connected renewable energy.

134. In addition, the Bank i s supporting an ongoing study on Low Carbon Development (MEDEC Electricity Sector Study) in an effort to identify policies, programs, and projects with the potential to mitigate greenhouse gas emissions. This study i s examining strategies for generating electricity from renewable energy sources.

135, Bank-supported analytical work has strengthened the country’s institutional capacity to design and implement renewable energy policies and has helped pave the way for large scale renewable energy initiatives. Under the Environmental Sustainability DPL, the Bank continues to play an advisory role in the area o f grid-connected renewable energy.

136. The Bank has also supported analytical work in the area o f energy efficiency, including the design o f mechanisms to facilitate affordable financing for small-scale energy efficiency projects. Under the ongoing Low Carbon Development Study, an assessment o f electricity subsidies i s estimating how modifications to tariff structures would affect the magnitude and distribution o f these subsidies. The Bank has also maintained a close dialogue with the investment fund for electricity energy savings (FIDE, for i t s acronym in Spanish) and CFE on two new potential initiatives: a Large Scale Compact Fluorescent Lamps Replacement Program and a CFE Energy Efficiency Program. The Bank’s collaboration i s expected to help build an understanding o f the linkages between electricity subsidies and residential consumption, as well as assist the government in meeting energy efficiency targets set out in the 2007-2012 Energy Sector Program.

E.3 ANALYTICAL WORK SUPPORTING THE FORESTRY SECTOR

137. The Bank i s providing technical assistance in the following areas: reforestation, conservation, deforestation prevention, including building the knowledge base on deforestation, and mainstreaming biodiversity concerns in forest policy. In particular, the Bank has (i) supported workshops and seminars to assist CONAFOR, with the assistance o f the BioCarbon Fund, in developing a reforestation and avoided deforestation project; (ii) through a

37

Memorandum o f Understanding, provided technical assistance and supported seminars that promote continued expansion o f community forestry programs in an effort to prevent deforestation; (iii) supported analytical work on the state o f the forestry sector in an effort to update the knowledge base on deforestation, and (iv) promoted information exchanges on payment for environmental service programs in Latin America to support their continued improvement.

13 8. In addition, the operation’s PHRD preparation grant provided technical assistance in updating the Forest Fund and developing new financing schemes for the forestry sector. This work has helped design the loan guarantees provided by CONAFOR under the operation for sustainable forest management.

E.4 ANALYTICAL WORK SUPPORTING THE WATER SECTOR

139. Mexico - Infrastructure Public Expenditure Review (IPER, 2005). The IPER presents options for addressing infrastructure service needs in Mexico, including (a) improvements in program design and budget allocations, (b) efficiency gains in service provision, and (c) increased private sector participation and financing in a manner consistent with the government’s goals for economic growth, and within i t s fiscal constraints. The IPER provided a point o f departure for dialogue and consensus building on ways to better and more fully use current and potential available resources (e.g., water user fees and pollution penalty charges) in the provision o f water supply and sanitation services. The IPER constituted one o f the key underpinnings in the formulation o f the National Infrastructure Plan launched by the Calderon Administration.

140. Mexico - Water Public Expenditure Review (WAPER, 2006) analyzed government financing, pricing, and cost recovery policies in the water sector and raised awareness on the critical water related problems, including the overexploitation and contamination o f surface and groundwater resources in vast regions o f the country, the need to further strengthen Mexico’s water institutions to adopt an integrated water resources management approach, and the urgency to provide incentives for reducing water pollution, improving water use efficiency, and increasing water productivity. Some o f the WAPER’s policy recommendations are actions supported by this program.

141. The Bank has supported additional AAA work in the water sector, including: (a) the Role o f the Water Rights Adjustment Program in Water Sustainability and Rural Development (2005), which analyzed approaches to reduce the over-concessioning o f water rights in areas o f overexploitation; (b) a Review o f Policy Interventions in the Water Sector (2006) that analyzed different government policies and subsidies, and their impacts on the water sector; (c) the Financing o f the Water Sector Study (2008) which was requested by the Secretary o f Finance to streamline the various water supply and sanitation programs; (d) a Policy Note on Water Quality (under preparation), which supports the development o f policy dialogue on water quality issues, particularly on wastewater management; and (e) a workshop on strategic environmental and social assessment (2008), which aimed to strengthen the capabilities o f national water authorities for integrating environmental and social considerations into sector planning.

142. As a follow up to these AAA products, the Bank has recently begun work on a Study o f Output-Based Financing Mechanisms for the Water Sector, aimed at developing transparency

38

and accountability measures in the sector. Also, under the new business model for Mexico, the Bank will support the Flagship Interventions in Water Resources Management in local areas with serious water related problems with a view to demonstrating actions that effectively reduce overexploitation and contamination, while improving water resources allocation. In addition, a PHRD grant supporting the operation's preparation provided financing for the development o f a strategy to promote private sector participation in the water sector.

E.5 ANALYTICAL WORK SUPPORTING THE AGRICULTURAL SECTOR

143. The ongoing Mexico Agriculture and Rural Development Public Expenditure Review looks at agriculture and rural development (ARD) public expenditure with an emphasis on agricultural spending, and examines i t s efficiency and impact on equity in order to support the GOM in assessing i t s policy reform options. The study also analyzes the institutional and implementation design elements that impinge on the effectiveness o f ARD programs.

144. The Mexico Agricultural Commodity Policy Notes examine the probable effects on Mexican producers and consumers o f an end to trade barriers for three sensitive agricultural products (corn, beans, and sugar). The analysis considers several dimensions o f competitiveness o f Mexican producers vis a vis their counterparts in the United States, market structure in Mexico and the US, the impacts o f increased import competition on consumers, and most importantly policy options for the Government to support producers in responding to increased competition and in taking full advantage o f opportunities opened by NAFTA.

145. The Bank i s also providing technical assistance to FIRCO, an agency supporting both environmentally and socially sustainable agro-processing that includes the adoption o f emission- reduction technologies.

E.6 ANALYTICAL WORK SUPPORTING THE HOUSING SECTOR

146. The Mexico Financial Sector Assessment Program Update (Report No. 38310, December 2006) assesses progress in the financial sector reform agenda for 2001-06 and identifies reform gaps and priorities that could be addressed by the incoming administration. It provides key recommendations for a medium-term reform agenda on mortgage lending and housing subsidies. 5 1

147. In addition, the Bank i s providing technical assistance in evaluating subsidy programs, designing new land development mechanisms for low income housing, undertaking an SEA o f the housing sector, and designing a framework to modernize property registries. The SEA i s expected to help integrate key environmental considerations into sector policies, including subsidy and registry policies.

5 ' h t t p : / / i m a g e b a n k . w o r l d b a n k . o r g / s e r v l e t B / 2 O O 6 / l 2 l 2 9 l O O O O 2 O 9 5 3 ~ 2 O O 6 1229 1 10355R enderedlPDF/383 1 O.pdf

39

V. THE PROPOSED DEVELOPMENT POLICY LOAN

A. OPERATION DESCRIPTION

148. Environmental sustainability i s one o f the key pillars o f GOM’s 2007-2012 National Development Plan and the proposed operation i s part o f the country’s plan to promote environmental sustainability. This i s also one o f the primary areas o f Bank engagement in the 2008-2013 Country Partnership Strategy (CPS) for Mexico, reflecting the priority that the government attaches to enhancing environmental sustainability.

149. The proposed operation pursues the general objectives o f the previous ENVDPL program (supported in 2004 and 2006 by ENVSAL I and ENVDPL 11). The program’s first operation, ENVSAL I, supported initial actions including the setting o f medium-term targets to mainstream environmental concerns in key sectors and the establishment o f favorable institutional conditions for the implementation o f reforms. The second operation, ENVDPL 11, supported the development o f legal and regulatory frameworks and the continuation o f GOM’s efforts to consolidate and deepen the impact o f the program’s reforms.

ers on a coordinated accountability

gthen environmental

40

B. POLICY AREAS

150. This operation supports actions that promote environmental sustainability which i s in l ine with FY 2008-2013 Country Partnership Strategy (CPS) for Mexico and the GOM’s National Development Plan (2007-2012). This DPL focuses on the following prior actions taken by GOM in an effort to mainstream environmental sustainability in the six priority sectors:

0 In the tourism sector, the operation supports the adoption o f Agenda 2 1 action plans in 35 new tourism destinations, ensuring the integration o f environmental considerations in tourism development and the monitoring o f this development with a sustainability indicators system;

For the energy sector, prior actions include the adoption and initial implementation o f the 2007-201 2 Energy Sector Program to promote increased energy efficiency and energy production from non-hydro renewable sources and regulate sulfur emissions;

Inforestry, the GOM has increased the budgetary allocation provided to CONAFOR to increase community access to financial services in order to expand programs that promote improved forestry management and expand the Payment for Environmental Services program to conserve additional forest area that protects critical watersheds;

In water, the Federal government has included in the 2008 Federal Rights Law provisions for the return o f wastewater discharge fees to municipalities and industries, through CONAGUA, to carry out investments in pollution reduction; as well as CONAGUA’s modification o f Operational Rules o f eight o f i t s ongoing programs in irrigation, drainage, water supply, wastewater, and sanitation to promote reduced overexploitation o f water resources;

0 In the agriculture sector, SAGARPA has modified the Operational Rules o f i t s Sustainable Use o f Natural Resources in Primary Production Program to incorporate environmental sustainability criteria; and SEMARNAT and SAGARPA have signed an agreement to implement joint actions aiming to reduce the negative environmental impacts o f agricultural practices in the municipalities within the Mexican Mesoamerican Biological Corridor.

For the housing sector, CONAVI has published cross-sector guidelines for incorporating environmentally sustainable practices into housing construction and i s offering o f incentives to encourage their voluntary adoption.

0

0

151. Looking forward, the Bank will support the GOM in the task o f implementing the reforms relating to environmentally sustainable improvements in these key sectors. The Bank’s value added l ies in i ts convening power, the provision o f global expertise in this highly specialized field, and resource mobilization.

C. LOAN AMOUNT AND TRANCHING

152. The loan i s expected to be disbursed immediately upon effectiveness.

The proposed US$300.75 million loan will be made to the United Mexican States.

41

VI. OPERATION IMPLEMENTATION

A. POVERTY AND SOCIAL IMPACTS

153. The provisions o f OP8.60 apply to the Environmental Sustainability D P L and the operation i s expected to have a significantly positive poverty and social impact. In general, improvements in environmental sustainability are expected to benefit the poor. The Bank’s assessment o f poverty in Mexicos2 points out the adverse effect environmental degradation has on the poor, particularly in terms o f health. Water and air pollution result in ill health, especially o f the poor, and degradation and unsustainable agricultural and forestry practices adversely affect livelihoods as wel l as increase the vulnerability o f the poor to natural disasters. Therefore, it is expected that, as a whole, the measures supported by the Environmental Sustainability D P L will enhance environmental and health conditions that allow for more productive workdays and a better l i f e for the poor. However, impacts on poverty vary depending on the actions promoted by each o f the operation’s reforms and the involved stakeholders. This section provides an overview o f potential poverty and social impacts associated with the reforms supported by this operation in the tourism, energy, forestry, water, agriculture, and housing sectors.

154. To inform the D P L dialogue during preparation, Poverty and Social Impact Assessments (PSIAs) o f the water and forestry sectors were conducted, given the sectors’ l ikely distributional impacts (see Annex 4). The rationale for focusing PSIAs on these two sectors includes their importance to the GOM’s development agenda, and the impacts that this agenda will have on poor stakeholders. The likely stakeholders for forestry and water sector reforms include forest dwellers, small farmers, ejidatarios, and indigenous people.

155. By analyzing the distributional impact o f pol icy reforms on the well-being or welfare o f different stakeholder groups, with particular focus on the poor and vulnerable, these assessments have an important role in the development and implementation o f poverty reduction strategies in Mexico.

156. Tourism sector. The tourism sector, which generates approximately 8 percent o f Mexico’s GDP and over 5 percent o f paid jobs nationwide, has an important role in nationwide employment and poverty reduction.53 At the same time, if not properly planned, the development o f tourism activities can also lead to undesirable social outcomes such as increased migration to tourist destinations and proliferation o f unplanned and precarious housing settlements. The DPL activities within this sector were developed to enhance the government’s efforts to mainstream environmental considerations and several o f the key activities to do so are also geared to provide positive poverty and social impacts. A central action, the implementation o f Agenda 21 in 35 tourism sites, offers several important social benefits. First, it promotes the participation o f local communities in tourism-related activities, which will enable residents to be empowered members o f planning processes and have a more significant voice in determining how tourism activities

52 Poverty in Mexico: An Assessment of Conditions, Trends and Government Strategy. Washington, DC: The World Bank, June 2004.

Instituto Nacional de Estadistica, Geografia e Informhtica. Sistema de Cuentas Nacionales de Me‘xico: Cuenta Sate‘lite del Turismo de M h i c o , 1999-2004. (www.inegi.gob.mx) 53

42

will advance within their communities. Second, the establishment o f Local Agenda 21 committees made up o f local residents provides a means for sustained citizen engagement and creates a mechanism through which authorities and developers can be held accountable if citizens’ interests are ignored.

157. In terms o f poverty impacts, the operation also supports the Government o f Mexico’s continued enactment and enforcement o f the General Law for the Prevention and Integrated Management o f Wastes, to promote improved solid waste management. While this i s important for the tourism sector’s global competitiveness, it also offers important health and poverty reduction benefits to the local communities.

158. Energy sector. In the energy sector, policy reforms supported by the loan wi l l contribute to providing access to safe and clean energy and related services, thereby reducing air pollution and mitigating i ts impacts on human health and associated costs related to treatments o f respiratory diseasess4 and the loss o f income generation opportunities. These costs have a more severe impact on the precarious economic equilibrium o f poor households. Research carried out in other countries suggests that the urban areas inhabited by the poor tend to share the highest levels o f contamination.

159. Additionally, the renewable energy program supported by this operation wi l l contribute to diversifying energy sources and developmentladaptation o f innovative technologies for alternative energy sources (geothermal, wind and solar). The focus in increasing energy efficiency, particularly by industry and commercial users, could generate substantial investment savings and reduce the dependency on contaminating sources.

160. Forestry sector. The Forestry PSIA reaffirms the need to target ejidos and forest communities in forestry programs. From 2000 to 2006, three out o f fifteen CONAFOR Programs (e.g., PRODEFOR, PRODEPLAN and PRONARE) accounted for 63 percent o f the total funding, while for the same period, funding to poor forestry community programs was limited to only 1.4 percent. In 2005, PROCYMAF (community forestry program) supported around 450 forestry community groups (at a cost o f $145,044 pesos per beneficiary (community, ejido, and/or their associations)), 50 percent less community groups than in previous phases. In the same year, PRODEFOR supported 5,126 beneficiaries at a cost o f $6,540 per beneficiary. This uneven allocation o f resources suggests that public funding in the sector has had a socially regressive distribution. Growth o f forestry activities in ejidos and communities has also been very limited.

16 1. The increased budgetary allocation provided to CONAFOR supported by this operation i s sizable and signals a greater emphasis to supporting sustainable forestry programs in Mexico. The forestry sector resource allocations have tended to be uneven and skewed to larger, private landowners. Under this operation, budget for programs targeting CONAFOR’s pro-poor programs provide greater access to financing and technical assistance, specifically targeting ejidos and indigenous communities to promote a more socially equitable distribution o f forest investments.

According to a survey conducted by the INE, the average annual total cost o f the treatment o f frequent respiratory 54

diseases in Mexico City ranges between MXN 13,565 (asthma) and MXN 8,641 (bronchitis).

43

162. Water sector. Reforms under the proposed DPL, aimed at increasing water use efficiency and reducing water pollution contribute to improved health conditions in the poorest segments o f the population and to enhanced water resource management. An analysis o f increased water and wastewater fees has been carried out and this increase i s not estimated to have significant distributional impacts. The analysis takes into account the price increases experienced by 21 water operators to cover incremental operating and maintenance costs, which on average are 15 percent after undertaking wastewater investments, and calculates average expenditure impacts for households using the 2006 household expenditure survey conducted by INEGI. The analysis shows that the average household share o f water expenditures would r ise from 0.7 percent to 0.8 percent, which i s a l o w percentage compared to international benchmarks (e.g., water expenditure as a percentage o f total household expenditures among those earning less than US$3,000 per year is 1.2 percent in Colombia, 0.9 percent in Brazil, 1.5 percent in Peru and 2.3 percent in Jamaica)55. For households in the lowest deciles, the water expenditure share would r ise from 1.0-1.1 percent to 1.2-1.3 percent, and for those in the highest deciles from 0.5-0.8 percent to 0.6-0.9 percent. Although the analysis i s not a full welfare analysis, it indicates that in the case o f Mexico and under current financial investment rules - where investment costs o f wastewater treatment plants are not financed by households - the distributional impacts associated with higher wastewater fees are not l ikely to be significant.

163. Complementary activities under the flagship projects (proyectos emblemciticos) supported by this operation will help to improve planning practices in the formulation o f integrated sub- basidbasin management plans with the participation o f al l relevant stakeholders.

164. Agriculture sector. The agriculture sector provides livelihoods for approximately 25 percent o f the Mexican population that still lives in rural areas in extreme poverty conditions. Among these poor rural communities, those in forestry areas, o f which the most vulnerable are indigenous, depend on hunting and gathering in addition to rain-fed agriculture. The farming in which they are engaged, in most o f the cases, takes place without appropriate technical assistance or access to financial services and commercialization and their lands are often under threat by expanding agro-businesses and extensive cattle raising. Therefore, activities supported by the DPL explicitly work to protect the livelihood o f small farmers and indigenous communities in the forestry areas o f the Mexican Mesoamerican Biological Corridor while enhancing their practices so they are more environmentally sustainable. The activities in the D P L that aim to accomplish these objectives include legal measures to establish limits on agricultural land expansion by agro-businesses and regulations to prevent land use conversion. Since the Mexican Mesoamerican Biological Corridor is governed by the federal government and not municipal authorities, these regulations can be strongly enforced at the national level.

165. Housing sector. The housing sector in Mexico has faced significant social and poverty risks due to the shortage o f affordable and safe housing available to the poorest sectors o f society. The actions supported by the DPL in the housing sector confront these risks by offering financial incentives for voluntary compliance with guidelines for incorporating environmentally sustainable practices into newly constructed homes, financed under the federal subsidy program. The incentives will be offered to two key stakeholder groups: potential low-income homeowners

According to the “base o f the pyramid database”. http://earthtrends,wri,org/searchable_db/index.php?theme=5 55

44

and affordable housing developers. For poor citizens seeking affordable housing, the DPL supports a government program begun in 2007 to provide loans and credit-linked subsidies for housing acquisition and improvement to citizens earning between 1 and 5 M W (around US$1,800 and US$9,000 per year). For housing developers o f developments geared to low- income (below 4 minimum wages), the DPL supports the provision o f a 20 percent greater subsidy from the government if new developments meet sustainability criteria. There i s reduced risk that the increased costs o f compliance will make the final product inaccessible to the poor because o f the government sponsored subsidy and voluntary compliance.

166. Mexico has institutionalized i t s consultation framework, requiring the discussion o f national policies with stakeholders and thereby providing a space for civil society to participate in a regular dialogue with the GOM. Although the Social Participation in Planning Law (Participacidn Social en la Planeacidn) requires that national policies be discussed with stakeholders, i t s application has been uneven across the tourism, energy, forestry, water, agriculture, and housing sectors.

167. In the tourism sector, consultation has been strengthened through Agenda 21 multi- stakeholder committees, who have promoted broad local community participation in decisions supporting sustainable tourism development. In forestry, CONAFOR has established a Consultative Technical Committee to serve an advisory role in the areas o f forest protection, conservation, and management. The committee, comprised o f representatives from civil society, professional and producer associations, specialists, and users o f environmental services, convenes each month with federal, state, and municipal-level government agencies. In the water sector, the government has created water basin organizations (Organisrnos de Cuenca) and water basin councils (Consejos de Cuenca) to bring together government and water users in a participatory forum to promote consensus-building among stakeholders. In housing, CONAVI coordinates housing policy and provides a permanent consultation forum to promote dialogue between private and public stakeholders. These consultations with civil society representatives have brought about a series o f housing reforms.

B. IMPLEMENTATION, MONITORING AND EVALUATION

168. Each one o f the sectoral ministries and agencies involved in this operation (SHCP, SAGARPA, SEMARNAT, SENER, SECTUR, CONAFOR, CONAVI, and CONAGUA) wi l l be responsible for implementation o f the proposed components o f the operation and for reporting progress. The Environment and Natural Resources Secretariat (SEMARNAT) will be responsible for coordinating actions among other concerned agencies.

169. A set o f outcome indicators for measuring the operations’ achievement o f development objectives were agreed with government counterparts during preparation (Table 4). Indicators supporting environmental improvements in the forestry, energy, and water sectors are closely aligned with the government’s indicators for i t s 2007-2012 NDP. SEMARNAT, the primary counterpart agency for the loan, wi l l be in charge o f overall monitoring and evaluation for the loan and for collecting the appropriate data to follow the indicators with each o f the sectoral ministries and agencies involved in the operation (SENER, SAGARPA, SENER, SECTUR. CONAFOR, CONAVI, and CONAGUA). SEMARNAT has created an environmental

45

mainstreaming office, responsible for establishing and following indicators used to monitor the Ministry’s joint agendas with other l ine ministries. This office will play a key role in overseeing M&E implementation.

170. The government’s annual status report, published each September, on the implementation o f the NDP will also provide timely information to measure progress on i ts efforts to assure environmental sustainability.

Table 3: Proposed Moni tor ing Indicators

TOURISM Integrate environmental sustainability considerations into the tourism sector agenda.

ENERGY Integrate environmental sustainability considerations into the energy sector agenda.

FORESTRY Increase support for sustainable forestry management.

WATER Increase water use efficiency

Outcome Indicators Mayors, civic officials, and tourism operators are implementing Agenda 21 action plans in an additional 35 destinations by 2008, to improve environmental conditions in tourist destinations, as identified through the System of Sustainability Indicators (Sisrema de Indicadores de Sustentabilidadpara el Turismo). (Baseline for 2006: 55 tourism destinations)

SECTUR monitoring sustainability indicators of Agenda 2 1 action plans in an additional 35 tourism destinations by 2008. (Baseline for 2006: 5 5 tourism destinations)

An additional 50% o f tourism enterprises are operating in line with environmental quality criteria established by SECTUR, PROFEPA, and Asociacidn Mexicana de Hoteles y Moteles. (Baseline for 2006: 200 tourism enterprises)

Increased annual electricity savings by at least 10% in 2008 as compared to 2007. (Baseline for 2007: 21,441 million Kilowattshour)

Share of renewable energy capacity (non-hydro) in the power sector increased from 2.0% in 2007 to 2.7% in 2008.

Mandatory standards (Norma Ojicial Mexicana) for recovering sulfur at petroleum refineries have been published and implemented, with the purpose of reducing sulfur emissions. (Baseline for 2006: No regulations in place)

Twelve states are implementing community forestry programs, up from six states in 2006.

An additional 1 .O million hectares are being sustainably managed in accordance with approved management plans. (Baseline for 2006: 8.5 million hectares)

CONAFOR has begun payment to titleholders o f an additional 1.1 million hectares of forest land for the protection of critical watersheds under the Payment for Environmental Services Program. (Baseline for 2006: 0.7 million hectares)

Municipality and industry treatment of wastewater collected has increased by at least four percentage points (Baseline for 2006: 36.1% o f

46

Key Issues and Objectives and reduce water pollution.

AGRICULTURE Integrate environmental sustainability considerations into the agriculture sector agenda.

HOUSING Integrate environmental sustainability considerations into the housing sector agenda

Outcome Indicators the flow collected in sewerage networks was treated)

Average global efficiency (a measure combining physical losses due to leakages and poor maintenance and commercial losses due to poor financial management and illegal use) o f 80 water operators, serving localities with 20,000 or more inhabitants, has increased by at least two percentage points (Baseline for 2006: 36.2%)

Irrigation Districts have invested in modernized infrastructure in an additional 350,000 hectares to improve efficiency in water use (Baseline for 2006: 2.08 million hectares)

0

0 Identification o f priority areas for improved land management practices, including reforestation, protection, and natural regeneration measures, in pastoral lands covering about 125,000 hectares. (Baseline: unknown; initiative introduced in 2008 )

Introduction o f conservation tillage in 50,000 hectares o f agricultural land. (Baseline: unknown; systematic monitoring introduced in 2008)

Implementation o f 32 productive conservation projects and adoption o f 24 communication strategies within the framework o f the Mexican Mesoamerican Biological Corridor. (Baseline for 2006: zero; Mexican Mesoamerican Biological Corridor agreement signed on April 7, 2008)

0 Increased number o f newly constructed homes incorporating energy efficiency and water conservation measures in line with CONAVI’s criteria. (Baseline: zero; cross-sector guidelines issued in March 2008)

C. FIDUCIARY ASPECTS

171. In general, the public financial management (PFM) systems in Mexico are adequate for DPL lending, as documented in the 2003 Country Financial Accountability Assessment, 2007 Country Procurement Assessment Report (currently at i t s final stages), and other analytical work. Indeed there i s room for improvement in some areas, such as procurement and accounting practices that are not up to international standards. However, there are plans underway, which the Bank i s supporting, to move in this direction.

D. DISBURSEMENT AND AUDITING

172. The Ministry o f Finance (SHCP) has designated BANSEFI as financial agent o f the Borrower with regard to the loan, Under this arrangement, the Bank would make the single tranche disbursement (upon effectiveness) to a designated account in U S $ o f the financial agent56 for subsequent credit to an account o f the National Treasury (TESOFE/SHCP). The amount o f the single tranche i s US$300.75 million, which would become available to finance general

56 The use o f a financial agent and designated account i s a local standard procedure established by the government for control purposes, as based on the results o f the F M analysis the Bank does not deem necessary any additional arrangements.

47

budget expenditures through the PFM systems. I f requested by the Bank, SHCP would provide the Bank with a written confirmation o f the described transaction.

173. Based on the review o f external audit reports and the extensive flow-of-fund experience between the Bank and BANSEFI, nothing has come to the attention o f Bank staff that would indicate that the banking control environment into which the loan proceeds would flow i s other than adequate.

174. arrangements are deemed necessary for this DPL.

Based on the assessment o f the PFM and banking environments, no additional fiduciary

E. ENVIRONMENTAL ASPECTS

175. The provisions o f OP8.60 on Development Policy Lending apply to the Environmental Sustainability DPL. The project i s expected to have significant positive impacts on the environment and natural resources, as it plays an important role in helping to mainstream environmental considerations in key sectors (water, energy, tourism, forestry, housing, and agriculture) in Mexico and in the country’s overall approach to development. Since the raison d’etre o f the operation i tse l f i s to support the government in mainstreaming environmental considerations into a number o f key sectors, the operation’s design i s proactive with respect to internalizing environmental concerns. This occurs at distinct levels. At the sectoral level, policy reforms in the water, energy, and housing sectors support the integration o f environmental concerns by helping to increase efficient water use and reduce water pollution, and to increase energy efficiency and renewable energy initiatives. Policy reforms relating to participatory planning and environmental quality certifications will help integrate environmental sustainability in the tourism sector. In agriculture, policy reforms through new joint initiatives wi l l help support sustainable natural resource management. And in the housing sector, policy reforms under this operation aim to incorporate environmental sustainability practices promoting energy efficiency and water conservation into housing construction. Other positive impacts on the environment are expected to derive from improved environmental management at the national and local levels, in which the program places particular emphasis in assuring improved transparency and accountability.

F. RISKS AND RISK MITIGATION

176. The main macroeconomic risks to this operation could be associated with effects on the Mexican economy o f (i) a sharper slowdown o f the US (and global) economy, decelerating the growth o f non-oil exports and reducing the flow o f worker’s remittances, (ii) higher levels o f international commodity and food prices leading to further pressures on domestic inflation, (iii) increased uncertainty with respect to international financial markets tightening the credit conditions for the access o f emerging markets to the international capital markets, and (iv) declining oi l production. However, several factors are in place to reduce these risks, including: a healthy financial system that has begun to expand domestic credit as a share o f GDP; more dynamism in exports to non-US destinations; favorable terms o f trade with high oi l prices; and

48

the further consolidation o f prudent macroeconomic policies in both the fiscal and monetary realms.

177. The risks that political events could pose for the operation include opposition to government reforms and changes in high and mid-level staff within key ministries that may result in a loss o f momentum to complete or implement the reforms supported by the program. These risks are mitigated by the following factors: (i) the legal and regulatory framework established under the second operation o f the Environment DPL program (ENVDPL 11), which supported the enactment o f laws and regulations that provide a solid foundation for the continuity o f sectoral reforms; and (ii) the design o f the operation, which anchors the formulation o f sector environmental strategies on consensus-building among different stakeholders, ensuring a broad discussion o f the issues and promoting buy-in with respect to strategy proposals from the sectors.

178. Institutional and stakeholder risks may be associated with: (i) working with new sectors that have not systematically incorporated environmental considerations into their agendas in the past, and (ii) the promotion o f public participation and greater accountability. These risks are linked to weak local institutional capacity and to the absence o f upstream accountability frameworks. They are addressed by the following measures, some o f which were initiated and supported under the Environment DPL Program (ENVSAL I and ENVDPL II), and are part o f the current GOM’s environment program: (i) shared sectoral agendas that clearly delineate implementation and oversight responsibilities, (ii) a capacity building program; (iii) an accountability framework and a tracking system that monitors decentralization o f environmental functions and competencies; (iv) transparency and accessibility o f environmental public information systems; (v) an enhanced communication strategy for the sector; and (vi) the development and dissemination o f guidelines for public participation in EIA processes and other participatory mechanisms.

49

ANNEX 1: LETTER OF DEVELOPMENT POLICY

50

51

Anexo 1. Plan Nacional de Desarrollo y el cornpromiso de MCxico hacia el desarrollo sustentable.

El compromiso de gobierno para el desarrollo sustentable se define en e l Plan Nacional de Desarrollo 2007-20 12 (PND), estableciendo las prioridades, objetivos, y las estrategias de la Administracibn Publica Federal (APF). L a sustentabilidad Ambiental es uno de 10s cinco pilares del Plan y acentua la importancia que tiene e l medio ambiente en mejorar la competitividad, asi como el desarrollo economico y social del pais. Como tal, esto pretende avanzar en la integration de 10s intereses ambientales en el proceso de planificacion para promover l a produccion y el consumo sustentable, prevenir l a degradacih ambiental y sus costos, y asegurar e l desarrollo de oportunidades L a coordinacion intersectorial tendra un papel esencial en apoyar la sustentabilidad ambiental.

En particular, l a agenda gubernamental para el medio ambiente se centra en el equilibrio de la competitividad de 10s sectores productivos, asi como en e l desarrollo social, con l a p ro tecc ih del medio ambiente (la mitigaci6n del cambio de climatico, reforestacion, agua y la conservacion del us0 de suelo, l a p ro tecc ih de diversidad biolbgica, l a p lan i f icac ih ecolbgica, y l a direcci6n ambiental). Estas Sueas pueden ser dirigidas por tres lineas de acci6n: empleo sostenible de recursos naturales, protecci6n de medio ambiente, y educacion y cultivo de conciencia para mantenimiento ambiental.

El capitulo sobre l a sustentabilidad ambiental del PND reconoce que aquellos elementos que constituyen e l medio ambiente deben ser manejados de manera integral, dado que un cambio en un elemento puede causar cambios en otros. Con esto en mente, se incluyen estrategias y prioridades en las siguientes hreas: agua, bosques, cambio climatico, diversidad biologica, desechos solidos peligrosos, y un numero de instrumentos de politica publica que apoyan l a sustentabilidad ambiental.

Las estrategias del PND dirigidas a mejorar el medio ambiente en 10s sectores de agua y forestal e s t h estrechamente alineadas con las acciones apoyadas por e l DPL. Por ejemplo, e l P N D fortalece la integracion y el manejo de la sustentabilidad del agua, reforzando l a autonomia tecnica y financiera de 10s operadores de agua, promoviendo e l us0 eficiente del agua en actividades agricolas para reducir del consumo. Ademas, otra meta del PND es detener la degradacion forestal, con programas de reforestacion, promoviendo el empleo sustentable de recursos forestales, diseiiando y poniendo en practica 10s mecanismos que proporcionan pagos por servicios ambientales a las comunidades que protegen Sueas forestales, y el cambio de us0 de suelo.

52

Anexo 2: Componentes generales del prCstamo para el desarrollo de politica de sustentabilidad ambiental

I. Antecedentes

En 2007, el GOM present6 el Plan Nacional de Desarrollo 2007 - 2012 (PND). El cual conti1 n un extenso programa de reformas que se centra en cinco objetivos estrategicos: (i) Seguridad Estatal y Derechos; (ii) Competitividad Economics y Generation de Empleo; (iii) Equidad de Oportunidades; (iv) Sustentabilidad Ambiental; y (v) Democracia Eficiente. L a base de l a sustentabilidad ambiental del PND enfatiza la importancia que tiene el medio ambiente en conseguir la competitividad del pais, tanto en el desarrollo economico como en l o social, de igual importancia es la integracion de 10s principios de sustentabilidad en la politica sectorial.

Con el apoyo del Banco en las dos operaciones previas, un avance significativo fue obtenido en acciones de integracion de temas ambientales en el agua, turismo, energia y de silvicultura. Condiciones favorables, tambien fueron creadas para l a implementacion de reformas necesarias para mejorar l a integracion del medio ambiente en estos sectores. L a coordinacion interinstitucional entre sectores claves, fue dirigida por la primera operation, completada en 2004, la cual apoy6 las modificaciones de leyes para facilitar mejoras y aumentar la transparencia en l a gesti6n ambiental.

Estas reformas que continuaron hasta 2006, apoyaron a l a coordinacion interinstitucional con el desarrollo de marcos legales y reguladores, como la Agenda 21 que planifica el turismo sustentable y l a ley para l a Silvicultura Sustentable y sus regulaciones.

11. Justificacibn

El prestamo mantendra la integracion ambiental en agendas de desarrollo dentro de sectores claves. Los sectores para ser apoyados han sido escogidos basandose en 10s siguientes criterios: (i) urgencia basada en su acoplamiento con el crecimiento e inversion, en terminos de impacto potencial o como un compromiso de crecimiento, como en e l cas0 del agua; (ii) urgencia como resultado de l a degradacion; (iii) convenio con la disminucion de l a pobreza, particularmente en casos donde e l recurso natural es esencial para la vida sustentable, como en e l sector de l a silvicultura; y (iv) oportunidad basada en el consenso sectorial, como en e l cas0 de la agricultura.

Basado en estos criterios, 10s sectores claves identificados para el apoyo son e l agua, la energia, l a silvicultura, e l turismo, l a agricultura, y l a vivienda.

111. Acciones principales de operacibn

L a operation comprende las siguientes acciones principales, que son compatibles con 10s principios y las lineas de accion seg6n el Plan Nacional de Desarrollo (PND 2007-2012), y ayudarh a asegurar l a inclusion de consideraciones para la sustentabilidad ambiental en el desarrollo de 10s sectores identificados como prioritarios. Las acciones principales para cada sector son:

53

Turismo

L a adopci6n y l a implementacih de Agenda 21 que planifica 17 nuevos destinos turisticos, de este modo han incrementhdose el numero de 10s destinos turisticos que han adoptado tales proyectos, de 55 en 2006 a 72 en 2008. Agenda 21 han resultado ser un mecanismo eficaz para unir 10s sectores publicos y privados, y otros agentes para construir e l acuerdo general alrededor del desarrollo y l a puesta en practica de acciones para reducir l a rapidez o invertir la degradacibn ambiental y asegurar que la calidad ambiental deja una ventaja competitiva para 10s destinos turisticos.

El Desarrollo de una metodologia para incorporar consideraciones ambientales en la planificacibn urbana y regional de destinos turisticos basados en 10s principios de evaluacih estratdgica ambiental, que podria reforzar l a competitividad del sector tanto en e l corto como en e l largo plazo. Como parte de la metodologia, un indicador cuantitativo ambiental esta siendo implementado en destinos turisticos seleccionados para supervisar e l funcionamiento ambiental.

L a Consol idacih de una estrategia de turismo unificada y sustentable que incluya la d is t r ibuc ih de inversiones en las siguientes areas: (i) manejo adecuado de deseshos, (ii) promocion de direcci6n ambiental en negocios, y (iii) plani f icac ih ecol6gica de us0 de suelo.

Asegurar e l us0 de las regulaciones de la Ley General para l a Prevenci6n y Direcci6n Integrada de Desechos desarrollada en 2006, mejorando el manejo de desechos solidos

Enerda

0 L a Adopcibn e implementacion del programa sectorial de Energia 2007-2012 que activamente dirige 10s impactos ambientales del sector energetic0 incorporando consideraciones sustentables a1 desarrollo de politicas. Esperan que el Programa ayude a aumentar e l ahorro de energia en a1 menos el 50 '% mas que 10s ahorros reportados hacia 2006.

0 Incrementar la capacidad de energia renovable en l a generacih de reservas del pais. Hacia 2006, esto alcanz6 e l 23 % de l a energia total, e l 21 YO f i e generacion de energia hidroeldctrica, y l a parte restante h e geotdrmico, el viento y la capacidad solar.

0 L a Aprobacion e implernentacion de la Estrategia de Proteccion a1 medio ambiente de PEMEX, disefiada a (i) reducir riesgos ambientales y asegurar e l cumplimiento de actividades operativas; (ii) incorporan temas ambientales en decisiones de negocio y de inversion; y (iii) promover la responsabilidad social ambiental

Silvicultura

0 L a Silvicultura es uno de 10s sectores prioritarios para el Plan Nacional de Desarrollo, por l o tanto, e l presupuesto de l a CONAFOR tuvo un incremento en mas del 80 % en

54

relacion a 10s niveles de 2006, permitiendo l a creacion del programa ProArbol, que registra 250 millones de hrboles para recuperar areas de recarga de mantos acuiferos. El acceso a un mayor n ~ m e r o de servicios financieros por parte de la comunidad duplico e l n b e r o de estados que ahora ponen en practica programas de silvicultura de 6 a 12, con un millon de hectareas adicionales con un manejo sustentable El Pago de una compensacih de servicios ambientales a poseedores del titulo por e l PES, asegurb 600,000 hecthreas adicionales para l a protection de cuencas en estado critico. Concluir e l analisis de pobreza e impact0 social de servicios financieros e instrumentos para el sector de la silvicultura, presentando opciones de politica para aumentar e l acceso a las comunidades pobres que protegen la silvicultura, bajo ProArbol y mecanismos de financiacion adicionales. A1 menos 2,300 comunidades y ejidos han aprobado proyectos de direction de silvicultura sustentables, y proporcionaron l a ayuda tCcnica a 400 comunidades y ejidos para poner a1 dia y preparar l a Direccion Sustentable.

Agua

0 I n c l u s i h e implementacion de abastecimientos para l a compensacih de cuotas a aguas negras de 10s municipios e industrias bajo ley Federal de Derechos 2008. Estos cuotas son invertidas por 10s municipios en e l abastecimiento de agua y el saneamiento.

0 Modification y aprobacibn de Reglas de Operacibn para ocho programas en curso en irrigation y drenaj e, y abastecimiento de agua y saneamiento, estableciendo requerimientos especificos para tener acceso a 10s recursos financieros.

0 Desarrollo de directrices para la planificacion descentralizada y participativa, y la puesta en marcha de pequeiio buque insignia local programado para l a gestion de recursos hidricos.

Anricultura

0 Desarrollar y firmar l a agenda de sustentabilidad agricola para promover l a gestion sustentable de recursos naturales a l o largo del corredor Biologico Mesoamericano, limitando l a extensi6n de agricultura dentro del corredor, estableciendo regulaciones para prevenir e l cambio de us0 de suelo. Definir l a agenda en conjunto, entre agencias agricolas y ambientales, incluyendo l a definition de criterios ambientales y buenas practicas para la conservacih y empleo sustentable de la diversidad biologics en las Reglas de Operation de 10s programas.

0

Vivienda

El Programa de Vivienda Nacional ha publicado nuevas directrices de sector para incorporar practicas ecologicamente sustentables en l a construction de vivienda y ofrecer incentivos para promocionar su adopcion voluntaria.

55

Official English Translation

Mr. Robert Zoellick President The World Bank Washington, D. C. USA

Re. Policy Letter o f the Government o f Mexico for the Environmental Sustainabilily Development Policy Loan

Dear Mr. Zoellick:

In order to ensure environmental sustainability, the Government o f Mexico has promoted a series o f political and institutional reforms aiming to attain sustainable development, which wi l l allow to enhance the country’s competitiveness and economic and social development in the country, and at the same time protecting the environment.

To support these efforts, the Government i s requesting financial support from the World Bank as well as ongoing collaboration in executing the policy measures included in the Environmental Sustainability Development Policy Loan.

This operation builds on reforms supported under an earlier Environment Development Policy Programmatic Loan (Environmental Programmatic DPL), which comprised the Environment Structural Adjustment Loan (Env SAL I), and the Second Environment Development Policy Loan (ENVDPL II), and also complements the recently approved Climate Change DPL. The Environment Programmatic DPL assisted in the implementation o f the Environment and Natural Resources National Program for 2001 -2006 (PNMARN) enableling the integration o f sustainability measures into policies and programs o f several economic sectors (e.g., water, forestry, energy and tourism).

The present operation will consolidate and deepen the impacts o f the reforms implemented under the Environment Programmatic DPL in the above-mentioned sectors. Some o f the relevant achievements within the Environment Programmatic DLP were: (i) development o f fiscal environmental instruments to decrease overexploitation o f natural resources and increase investments in tourism; (ii) development o f medium-term targets to guide and monitor the incorporation o f environmental concerns in key economic sectors; (iii) establishment o f four Inter-sectoral Technical Working Groups (ITWGs) to define priorities and agendas for the energy, forestry, water and tourism sectors; (iv) enactment o f fiscal instruments through the municipal water fees; (v) adoption and implementation o f Agenda 2 1 for planning sustainable tourism in key destinations; and (vi) approval o f the Sustainable Forestry Law and i t s by-laws; and (vii) evaluation o f programs to improve the quality o f fuels for transport and establishment o f incentives to promote renewable and energy efficiency.

56

It is also worth mentioning that this operation will expand i t s scope to two new policy areas, agriculture and housing, integrating environmental sustainability criteria in the agenda o f both sectors.

To count with the continuous financial and technical assistance support f rom the Bank i s o f high important to SEMARNAT to further advancing the implementation and execution o f the development and environmental policies, and therefore once again, we request the Bank support through the Environmental Sustainability Development Policy Loan in the amount o f US$300 mi l l ion during fiscal year 2009, which will allow us to attain sustainable development objectives.

Sincerely,

Attachment 1. The National Development Plan and Mexico’s Commitment to Sustainable Development

The Government’s commitment to sustainable development i s defined in the 2007-201 2 National Development Plan (NDP), establishes the priorities, objectives, and strategies o f the Federal Public Administration (FPA). Environmental sustainability i s one o f the Plan’s five pillars and stresses the importance o f the environment in enhancing the country’s competitiveness and economic and social development. As such, i t seeks to advance the mainstreaming o f environmental concerns into the development planning process in order to promote sustainable production and consumption practices, prevent environmental degradation and i t s costs, and ensure development opportunities.

Inter-institutional and cross-sectoral coordination will play an essential role in supporting environmental sustainability.

In particular, the Government’s environmental agenda centers on balancing the competitiveness o f productive sectors, as wel l as social development, with environmental protection (mitigation o f climate change, reforestation, water and soil conservation, biodiversity protection, ecological planning and environmental management). These areas can be addressed through three lines o f action: sustainable use o f natural resources, environmental protection and education and awareness-raising for environmental sustainability . The NDP’s chapter on environmental sustainability recognizes that those elements that make up the environment must be managed in an integrated manner, given that a change in one element can cause changes in others. With this in mind, it includes strategies and priorities in the following areas: water, forests, climate change, biodiversity, hazardous solid wastes, and a number o f public pol icy instruments that support environmental sustainability.

The NDP’s strategies aimed at environmental improvements in the water and forest sectors are closely aligned with the actions supported under the Environment Sustainability DPL. For example, the NDP promotes sustainable and integrated management o f water resources, by

57

strengthening the technical and financial autonomy o f water operators, and promoting efficient water usage in agricultural activities through reductions in consumption. In addition, another target o f the NDP i s to halt forest degradation, through promoting the sustainable use o f forest resources, designing and implementing mechanisms that provide payments for environmental services to the communities that protect forested areas, and avoiding land use changes.

Attachment 2: General Components of the Environmental Sustainability Development Policy Loan

I. Background

In 2007, the GOM presented i t s 2007 - 2012 National Development Plan (NDP), which outlined an extensive program o f reforms centering on the following five strategic objectives: (i) State Security and Rights; (ii) Economic Competitiveness and Employment Generation; (iii) Equity o f Opportunity; (iv) Environmental Sustainability; and (v) Effective Democracy. The Plan’s Environmental Sustainability pillar emphasizes the importance o f the environment in achieving country’s competitiveness, in both economic and social development, as well as the importance o f mainstreaming the sustainability principle in sectoral policies.

With Bank support under two previous operations, significant progress was obtained in actions to mainstream environmental issues in the water, tourism, energy and forestry sectors. Favorable conditions were also created for the implementation o f reforms necessary for enhancing the integration o f environmental criteria in these sectors. Inter-institutional coordination between key sectors was particularly focused by the first operation (Env SAL), completed in 2004, which also supported modifications o f laws to facilitate improvements and increase transparency in environmental management.

These reforms, which continued through 2006, further supported inter-institutional coordination and the development o f legal and regulatory frameworks, such as Agenda 2 1 for sustainable tourism planning and the Law for Sustainable Forestry and i t s by-laws.

11. Justification

The loan will maintain mainstreaming o f environmental concerns in key sectoral development agendas. The sectors to be supported have been chosen based on the following criteria: (i) the urgency o f the issue based on i t s linkage with growth and investment, either in terms o f potential impact or as a growth constraint, as in the case o f water; (ii) the urgency o f the issue based on degradation; (iii) linkage with poverty alleviation, particularly in cases where the natural resource i s essential to sustainable livelihoods, such as in the forestry sector; and (iv) opportunity based on cross-sectoral consensus, as in the case o f agriculture.

Based on these criteria, the key sectors identified for support are water, energy, forestry, tourism, agriculture and housing.

111. Main Actions o f the Operation

58

The operation i s comprised o f the following principle actions, which are compatible with the principles and l ines o f action outlined in the National Development Plan (PND 2007-2012), and will help ensure the inclusion o f environmental sustainability considerations in the development agendas o f the sector identified as priorities. The main actions for each sector are:

Tourism

The adoption and implementation o f Agenda 2 1 action plans for 3 5 new tourism destinations, thereby increasing the number o f tourist destinations that have adopted such plans, from 55 in 2006 to 90 in 2008. Agenda 21 has proven to be an effective mechanism to bring together the public and private sectors, and other stakeholders to build consensus around the development and implementation o f actions to slow down or reverse environmental degradation and ensure that environmental quality remains a source o f competitive advantage for tourist destinations. Development o f a methodology to incorporate environmental considerations into urban and regional planning in tourist destinations based on principles o f strategic environmental assessment, which could strengthen the competitiveness o f the sector both in the short and the long term. As part o f the methodology, a quantitative environmental indicator i s being applied to selected tourism destinations to monitor environmental performance. Consolidation o f a unified sustainable tourism strategy, which includes prioritization o f investments in the following areas: (i) adequate solid waste management, (ii) promotion o f environmental management in businesses, and (iii) ecological land use planning. Ensure application o f the regulations o f the General Law for the Prevention and Integrated Management o f Wastes developed in 2006, improving solid waste management.

Energy

Adoption and implementation o f the 2007-201 2 Energy Sector Program, which proactively addresses the environmental impacts o f the energy sector by incorporating sustainability considerations into sectoral policy making. The Program i s expected to help increase energy savings by at least 50% more than the savings reported for 2006. Increased share o f renewable energy capacity in the country’s electricity generation. By 2006, this shared reached 23% o f the total energy, 21 % o f which was from hydroelectric power generation, and the remaining portion from geothermal, wind and solar. Approval and implementation o f PEMEX’s Environmental Protection Strategy, designed to (i) reduce environmental risks and ensure compliance o f operating activities; (ii) incorporate environmental issues into business and investment decisions; and (iii) promote social environmental responsibility

Forestry

e Forestry i s one o f the priority sectors for the National Development Plan, therefore, CONAFOR’s budget was increased in more than 80% in relation to 2006 levels, allowing the creation o f the ProArbol Program, which supported the production o f 250 million trees for reforestation in 2007.

59

The modification o f the Operating Rules facilitated access to a larger number o f financial services. In terms o f community forestry management, the number o f states that are now implementing community forestry programs doubled from 6 to 12, and an additional one mi l l ion hectares have been incorporated into sustainable management. Payment for environmental services provided to titleholders o f additional 600,000 hectares for the protection o f critical watersheds. Concluded a poverty and social impact analysis o f current and potential financial services and instruments for the forestry sector, presenting policy options to increase access o f the poor to communities that protect forest under the Prokrbol Program and additional financing mechanisms. At least 2,300 communities and ejidos have approved sustainable forestry management plans, and technical assistance was provided to 400 communities and ejidos to update or prepare Sustainable Management Plans.

Water

0 Inclusion and implementation o f provisions for the return o f wastewater discharge fees to municipalities and industries under the 2008 Federal Rights Law. These funds are invested by municipalities in sanitation and wastewater treatment. Modification and approval o f Operational Rules for eight on-going programs in irrigation and drainage, and water supply and sanitation, establishing specific criteria for accessing financial resources. Development o f guidelines for the decentralized participatory planning and implementation o f a f i rst flagship projects for decentralized water resources management.

Agriculture

0 Developed and signed an agricultural sustainability agenda to promote the sustainable management o f natural resources along the Mesoamerican Biological corridor, limiting the expansion o f agriculture within the corridor, establishing regulations to prevent land use conversion.

0 Definition o f a joint agenda between agricultural and environmental agencies, including the definition o f environmental criteria and good practices for conservation and sustainable use o f biodiversity in the Operating Rules o f programs.

Housing

0 The National Housing Program has published new cross-sector guidelines for incorporating environmentally sustainable practices into housing construction and i s offering incentives to encourage their voluntary adoption.

60

ANNEX 2: ACHIEVEMENTS UNDER THE PREVIOUS DPL OPERATIONS

The first two operations (ENVSAL I and E N V D P L 11) supported actions in the following five sectors: (i) Tourism; (ii) Energy; (iii) Forestry; (iv) Water; and (v) Environmental Management. The achievements supported by these operations are presented below.

A. Tourism Sector

The Bank’s operations have provided critical support to help the GOM advance in the implementation of its ambitious reform agenda in the tourism sector. The E N V S A L I supported the design o f the government’s Program aimed at ensuring the mainstreaming o f environmental concerns in tourism by fostering a structured approach to inter-agency coordination, policy discussion, and the definition o f sequential institutional reforms to achieve clearly defined medium-term goals. The GOM has found the Inter-sectoral Technical Working Group (ITWG) for the tourism sector, created under E N V S A L I, to be an appropriate body to define and build consensus around priority reforms in the sector. ENVDPL I1 further supported the G O M with upstream analytical work and direct responses to mitigate the environmental challenges faced by the tourism sector, which has constituted the basis for informed dialogue and policy making within the ITWG and with other stakeholders.

With the Bank’s support, the GOM has advanced in the instrumentation of a comprehensive set o f policy reforms. Reforms supported by the E N V S A L I and ENVDPL T I included (i) reforming the fiscal framework to allow for earmarking o f revenues generated by user fees for maritime activities, protected areas, and whale-watching, with provisions for reinvestment o f resources in the income-generating activity; (ii) issuing the General Law for Prevention and Integrated Waste Management, which fosters the development o f mechanisms for the design and implementation o f waste management plans in tourist sites;57 (iii) developing a public policy for cruises, which contains provisions to mitigate their environmental impacts; and (iv) creating the Inter-secretarial Tourism Commission to articulate the efforts o f federal authorities, private sector and c iv i l society to respond to the sector’s main challenges and opportunities.

The ENVSAL I and ENVDPL I1 have also supported the implementation of various programs and activities aiming to incorporate environmental considerations in the tourism sector. Mkxico Limpio y Querido was implemented under the ENVSAL I with the aim o f reducing pollution in tourist destinations, particularly from solid wastes. Under the ENVDPL 11, the G O M advanced in: (i) the adoption in 14 destinations o f local Agenda 21 action plans, which provide a framework for action aimed at strengthening the capacity o f local and regional actors to promote sustainable development in main tourism destination^^^; (ii) the development o f a

57 The General Law for Prevention and Integrated Management o f Wastes has created the conditions for ensuring that municipalities assume the responsibility for collection, transport and final disposal o f wastes, as well as for the separation o f solid municipal wastes from hazardous wastes. Also, the Law incorporates the private sector in the psrovision o f waste management services and in the use o f waste sub-products in activities such as energy generation.

The local Agenda 21 action plans have promoted collaboration among the public sector, private sector, and civil society to develop investment plans to address sustainable development priority issues in the main tourist destinations. Local Agenda 2 1 plans also have facilitated agreements for increases in tar i f fs for the provision o f water, wastewater treatment, and waste management services.

61

certification scheme to recognize responsible environmental performance by tourist facilities based on established environmental indicators o f sustainable tourism; (iii) the development and use o f a set o f indicators and benchmarks to measure good environmental performance in tourist facilities and destinations; and (iv) the operation o f the Integrated Program for Clean Beaches to monitor and publicly disclose water quality data o f Mexican beaches.

Under E N V D P L 11, a Strategic Environmental Assessment (SEA) o f the Mexican tourism sector was conducted. The key recommendations o f the SEA are presented in Box 1 below. Some o f the recommendations o f the SEA are already being implemented by the G O M while others will be implemented under ENVDPL 111.

B. Energy Sector

ENVSAL I and ENVDPL I1 have contributed to the GOM’s efforts to enhance the sustainability o f the energy sector by supporting the consolidation of inter-sectoral coordination mechanisms and the completion o f analytical work. These elements have facilitated consensus-building and informed dialogue among key stakeholders in order to sustainably advance towards the achievement o f clearly defined medium-term goals. In particular, the ITWG established under ENVSAL I has become the decision-making locus for the development and implementation o f an environmental policy for the energy sector. Analytical work completed under ENVDPL I1 to support the functioning o f the ITWG included a 25 year prospective on the use o f renewable energies in Mexico.

Incorporation of environmental considerations in the GOM’s energy policy has provided an enabling institutional framework to pursue concrete actions aimed at enhancing the sector’s contributions to sustainable development. Such actions have included: (i) the reduction o f sulfur content from 1000 to 300 ppm in Premium gasoline used in the three largest

62

cities, and assessment of investment needs to reduce sulfur content in all gasoline and diesel by 2008; (ii) implementation o f environmental management systems to reduce contamination by PEMEX and the Federal Electricity Commission, (iii) design and implementation o f small rural electrification projects to reduce domestic consumption o f fuelwood for cooking, heating, and lighting, which constitute the basis for a National Program for Rural Electrification supported by the World Bank and GEF, (iv) measures to increase energy generation from renewable sources, including the approval in 2004 o f fiscal provisions for the accelerated depreciation o f renewable energy capital; (v) development of mandatory standards for equipment, sectoral programs, implementation o f methodologies for measuring and monitoring energy efficiency baselines by sector, as well as business models and contract forms for third party delivery o f energy efficiency measures; (vi) publication o f electricity subsidies in individual utility bills, as a f i rst step in addressing existing distortions in the electricity sector; and (viii) establishment o f a Clean Development Mechanism Office in 2004 to increase the portfolio o f carbon offset investments suitable for Carbon Finance, and (ix) creation in 2005 o f the Inter-sectoral Commission for Climate Change, which wi l l implement the national policies on climate change.

C. Forestry Sector

With the Bank’s support, the GOM has advanced in the sequential implementation of institutional reforms aimed at environmental mainstreaming in the forestry sector. The ENVSAL I and ENVDPL I1 supported the GOM’s efforts to (i) establish appropriate goals for the medium-term; (ii) implement key building blocks to move towards these goals; (iii) ensure coordination and strengthened consensus among key stakeholders; and (iv) systematically measure progress and impact. An ITWG was established for the forestry sector and continues to play a key role in inter-sectoral coordination and consensus-building. Based on the ITWG’s structured approach to inter-agency coordination for policy formulation, the GOM has advocated major reforms in the sector’s legal framework. As part o f the actions supported under ENVDPL 11, the General Law for Sustainable Forestry Development was enacted by Congress in 2003, while the corresponding regulations were published in 2005. The Law defines the responsibilities o f different federal agencies, sub-national governments and other stakeholders with the aim o f ensuring (i) the protection, sustained provision, and valuation o f environmental goods and services; (ii) increased social participation in the establishment o f policies and the design and implementation o f programs through the development o f sector-specific cultural and educational programs and considerations to address the needs o f indigenous groups; (iii) mitigation o f environmental risks and impacts associated with sector activities; and (iv) advancements in decentralization o f forestry functions and coordination with sub-national entities to integrate resources.

With the support of ENVDPL 11, the GOM conducted a study to promote adequate valuation of environmental services and establish the fiscal, market, and financial mechanisms to facilitate payment for the preservation of forest ecosystems in an effort to alleviate poverty. The study examined the lack o f adequate funding for sustainable forest development, as well as the risks that result from the extended maturity periods that characterize investment in sustainable forest management. These mechanisms also allow the conservation o f carbon in forest ecosystems, in line with the new National Strategy on Climate Change developed in 2007.

63

D. Water Sector

Institutional coordination and analytical work fostered by ENVSAL I and ENVDPL I1 has provided critical support to the Government’s reform program. ENVSAL I supported the incorporation o f the National Water Program as an integral component o f the ENRP. The ITWG created under ENVSAL I has played a crucial role in building consensus to carry out legal reforms designed to increase incentives for water conservation and increasing resources for investments and management through an increase and rationalization o f water fee collection.

Key milestones as the GOM moved forward with its program on water to achieve its established indicators for 2006 (ENVSAL) included: (i) the development o f a consensus on solutions to the water problem. For each presidential administration, the Mexican Government prepares a National Development Plan. Within the context o f th is plan a National Water Plan (NWP) was prepared for the period from 2001 to 2006, which provided overall strategy and policy in the water sector;(ii) increased incentives for water conservation and increased resources for investments and management through increase and rationalization o f water fee collection. A Presidential decree to encourage municipalities to pay water fees and to increase investment in hydraulic works was published in the Diario OJicial, December 21, 2000 issued to permit exoneration o f past debts to the federal government for municipalities which agree to pay water fees in the future and agree to forgo federal funding for water supply and sanitation in the event o f non-payment o f fees. Subsequently the Ley Federal de Derechos was modified to include a provision that up to 100 percent o f municipal water fees collected may be returned to municipalities respectively, in accordance with an incentive scheme under which municipalities need to have an equal amount o f funds to be used in Water Supply and Sanitation (WSS) investments (PRODDER - Programa de Devolucidn de Derechos). The combination o f this decree and law change has resulted in an increase in collection o f water fees from municipalities from $441 million pesos in 2001 to $1,529 million pesos in 2006 and an increase o f resources for investment in WSS facilities in municipalities from $1 1,754 million pesos in 2002 to $21,607 million pesos in 2005. Potable water and sanitation coverage increased during this period from 87.8 percent in 2000 to 89.6 percent in 2006 and from 76.2 percent in 2000 to 86 percent in 2006, respectively facilitated by this decree and legal change.59

Actions completed by the GOM for ENVDPL I1 included: (i) passing o f amendments to the National Water Law, which strongly emphasized decentralization o f water resources management to river basin organizations and participation o f water users and other stakeholders in water resources planning and management; (ii) publication o f water availability data and an improved water rights registry as foundational steps in the implementation o f a functioning water rights market, consistent with the current regulatory framework; (iii) initiation o f an Integrated Program for Clean Beaches (Programa Integral de Playas Limpias) in 2003 to monitor and publicly disclose water quality data o f Mexican beaches; although the program met initial resistance stemming from concerns on potential negative publicity caused by water pollution warnings, it has triggered substantive efforts by national and sub-national governments for the adequate treatment o f wastewater discharges; and (iv) Local Agenda 21 plans have been initiated and have facilitated agreements for increases in tariffs for the provision o f water, wastewater treatment, and waste management services. Water quality along monitored beaches

59 Estadisticas del Agua en Mixico, 2007

64

has improved going from 93.7 percent o f samples meeting water quality standards in 2003 to 96.5 percent in 2005.60

Under the leadership o f CONAGUA, there has been progress toward integrated management of water resources. The main efforts o f the new approach attempt to limit the extraction o f water from the over-exploited aquifers or surface water bodies in order to meet sustainability objectives. Actions in the water sector supported by ENVDPL I1 contribute to: (i) implementation o f a measurement system for water-use by parties that have water rights; (ii) adjustment o f regional water programs based on actual water availability; (iii) establishment o f schemes to ensure that water users comply with their water rights and discharge obligations, and that water rights are consistent with water availability; and (iv) elaboration and start up o f implementation o f an integrated wastewater strategy to augment the percentage o f wastewaters that are treated.

The supported reforms have brought concrete environmental outcomes in the water sector. The results o f the adopted reforms and policies were the following: significant reductions in the over-exploitation o f 4 aquifers (Santo Domingo, Caborca, Delicias and Aguascalientes) following agreements with water users to reduce their water rights concessions; formulation o f participation plans for integrated water resources management for the Apatlaco River Basin and for aquifers in the states o f Aguascalientes, Queretaro, San Luis Potosi, Guanajuato, and Sonora; increased in the volume o f wastewater treated (from 60.2 m3/s in 2003 to 74.4 m3/s in 2006); reduction o f industrial pollution as a result o f the closing o f industrial plans because o f lack o f pollution control compliance; and increased water productivity in irrigated agriculture measured in kilogram per cubic meter o f water use.. .

E. Environmental Management

Supporting the GOM’s efforts to improve the effectiveness and efficiency of environmental management has been one of the main objectives of ENVSAL I and ENVDPL 11. The first operation assisted in the decentralization o f environmental management by supporting (i) amendments to four laws to enable decentralization o f federal environmental functions in areas including conservation o f soils, flora, fauna, and forest resources, impact assessment administration, and coastal management; (ii) development o f state eligibility criteria and procedures for decentralization; and (iii) preparation o f publicly disclosed decentralization plans by more than 20 states. ENVSAL I also supported the establishment o f the Environmental Institutional Development Program (PDIA), as a pilot matching grant scheme to fund capacity building in states that had prepared a decentralization plan. Further reforms supported by the operation enabled public access to information on Environmental Impact Assessment and issuance o f other permits.

The ENVDPL I1 was instrumental both in advancing further reforms to strengthen environmental management and in helping the GOM to overcome the obstacles found during the implementation of reforms supported by the first operation. Actions supported by ENVDPL I1 included the development by SHCP o f economic instruments to augment funding for environmental management at the federal and sub-national levels; as well as the

Estadisticas del Agua en Mbxico, 2007 60

65

regular publication by SEMARNAT o f environmental indicators on the state o f the environment and institutional efforts to revert environmental degradation. The second operation also supported analytical work to identify the reasons why decentralization efforts had resulted in only one function being transferred to a sub-national government. Based o n the study’s results, SEMARNAT modified i t s decentralization policy by defining priority functions to be decentralized, setting monitoring and evaluation mechanisms to oversee sub-national agencies’ performance, and increasing the scope o f PDIA to include more sub-national entities.

66

8 8

e

0 c c) .-

0 c ?-' .3

ANNEX 4: POTENTIAL POVERTY AND SOCIAL IMPACTS

The potential uneven effect o f reform implementation on different stakeholders and sectors o f the population i s one o f the main challenges that the GOM, through the implementing agency SEMARNAT, will have to face concerning the social and poverty impacts o f the environmental reforms. Poverty and Social Impact Analyses (PSIAs) have been carried out to focus on the forestry reforms, which are l ikely to have important distributional impacts, and will complement a programmatic AAA on water issues that i s looking at distributional implications o f the new water policies. The rationale for focusing PSIAs on Mexico’s water and forestry sector includes their high placement on the GOM agenda, and the impacts that the reform agenda in these sectors will have on a well organized and influential set o f stakeholders. The likely stakeholders for forestry and water sector reforms include forest dwellers, small farmers, ejidutarios and indigenous people.

Through an analysis o f the distributional impact o f pol icy reforms o n the well-being or welfare o f different stakeholder groups, with particular focus on the poor and vulnerable, these PSIAs have an important role in the elaboration and implementation o f poverty reduction strategies in Mexico. The main findings from these PSIAs are presented below.

Poverty and Social Impacts o f Groundwater Exploitation

It has been widely recognized that the unsustainable use o f water in Mexico i s a threat for development and that this problem particularly affects poor populations. The demographic growth from 25 mi l l ion people in 1950, to over 100 mi l l ion today and the spatial concentration o f economic activities, most o f them in the center and arid northern zones o f the country, represent a serious challenge for the sustainable use o f water. Overexploitation o f groundwater has increased steadily over the last decades; it i s estimated that by 2006, the aquifers that provided almost 60 percent o f the volume o f groundwater extraction were overexploited. Water quality has also deteriorated steadily, partly as a result o f lack o f wastewater treatment, with only around 24 percent o f wastewater being treated in 2006. Agriculture, which accounts for only about 3.5 percent o f GDP, i s the primary user o f water, absorbing nearly 80 percent o f Mexico’s water supplies. However, agriculture production remains as the main source o f income for a large number o f poor farmers and rural laborers. The challenge i s to change this pattern causing the minimal social disruption and contributing as much as possible to poverty reduction.

This situation i s spurred by a geographical bias that concentrates public expenditures in irrigation, and other infrastructure in the northern states where water availability i s the lowest. While continued support for water resources management i s essential for addressing the social and environmental challenges o f groundwater depletion in the North o f the country, investments in agricultural development in the poorer South could make a substantial contribution to poverty reduction and sustainable development.

The findings o f the PSIA suggest that public resources in the water sector also favor medium to large producers over smaller farmers. It identified that the technical requirements and matching contributions established in some o f SAGARPA’s and CONAGUA’s programs limit the access o f poor farmers. The small farmers who do not have the ski l ls and marketing opportunities to make efficient use o f modern irrigation systems are often left behind. For instance, the Tarifa 9

73

subsidy strongly favors richer farmers; o f the 105,000 recipients o f the subsidy, 68,000 receive an annual subsidy o f less than Mx$20,000, while 33 users receive a subsidy o f over Mx$500,000, which amounts to a Gini coefficient o f 0.91. Because the subsidy lacks conditions to reduce water extraction and adequate monitoring, it i s causing an increase in irrigated area rather than reducing extractions. This maintains a high profitability o f land and consequently a distortion in the agriculture sector with distributional impacts.

On the poverty impacts o f aquifer overexploitation, the PSIA reached three main conclusions that are key. At the macro or country level, there i s no significant impact. Despite the lack o f counterfactual evidence for Mexico as whole, it i s important to consider the pockets o f rural poverty where water depletion i s causing substantial problems to rural families. At the local level, PSIA indicated that the rural poor are affected by the current situation o f aquifers overexploitation because they lack the capital to adapt to falling water tables and they are more likely to give up their productive activities than wealthier farmers. Additionally, analyses made o f the l i n k s between water overexploitation and poverty in other areas o f the world, indicate that there are severe poverty impacts when aquifers collapse or reach a critical level o f depletion.

These conclusions are central to any policy on groundwater in Mexico. It was traditionally thought that irrigation and subsidies for pumping needed to be sustained for i t s positive impacts on rural poverty. Furthermore, changes in regulation o f electricity tariffs if targeted at pockets where rural poor are concentrated may help to signal better use but have no impact on rural poverty. In the reform o f groundwater, Mexico needs to consider proper instruments o f social policies to serve i t s rural poor. On a local level, strategies to manage the transition o f poor farmers from irrigated agriculture to other economic endeavors also need to be incorporated in the policy framework.

In addition, the PSIA highlights that public investments in irrigation systems and subsidizing electricity for pumping in areas o f overexploited aquifers are somewhat unsustainable policies and may lead to real and strong negative impacts on the poor and the environment. International experiences show that as some aquifers get to a point o f no return, the poor wi l l be affected the most as they have fewer opportunities to move to better locations. Groundwater depletion may also be contributing to the migration o f people from poor rural areas to urban centers in Mexico and to the U.S.

Several studies carried out in the water sector point to the need to decentralize water management so as to directly involve water users in devising solutions to overexploitation, contamination and inefficient allocation o f resources. This operation wi l l support actions targeting poor producers through reforms which include: (i) flagship projects (proyectos emblemdticos) which aim to address environmental degradation, while improving production among small farmers; (ii) strengthening local organizations to play a decision making role in water resource management; and (iii) modifying the operating guidelines for eight o f CONAGUA’s irrigation, drainage, and water supply and sanitation programs to improve the efficiency o f water usage and reduce losses.

Poverty and Social Impacts in Forestry

The PSIA found that the forestry sector and specifically the forest poor are affected by persistent environmental degradation, climate change, deforestation, a lack o f competitive markets and

74

weak forestry management practices. In particular, the PSIA recognizes that the growth o f forestry activities in ejidos and communities in poor areas i s s t i l l very limited - despite the fact that between 70 and 85 percent o f Mexican forests i s within the boundaries o f ejidos and communities. The total population in the forest regions i s between 12 to 13 million with the majority living in poverty, including 5 mill ion people o f indigenous descent. The PSIA found that poor people in forest regions are disproportionably dependent on natural resources, and they lack assets, savings, and abilities to withstand environmental shocks. Any downturn in their income and livelihood might lead to irreversible damages such as withholding food for children at critical stages o f their development, withdrawing children from school, and abstaining from accessing necessary health care. There are clearly negative impacts on children, women, and the elderly. A main outcome o f the PSIA i s that ejidos and forest communities face numerous problems related to accessing financial assistance, and to the effectiveness and sustainability o f CONAFOR programs. Some reasons identified were: (i) the conservative risk management o f funds; (ii) the need for equity in selection criteria and disbursement mechanisms; (iii) the weak organizational capacity o f these groups; (iv) low quality and productivity; (v) low funding allocation to poorest states by some programs; and (vi) land tenure issues.

Communities in poor areas in Mexico have limited access to funding programs, and are often not specifically targeted as beneficiaries. For instance, PRODEPLAN which does not focus on poor forest landowners specifically targets large, private landowners who receive the majority o f funding. Under the PRODEPLAN framework, the size o f funds allocated i s proportional to the authorized lands intended for commercial plantation use and requires that the recipients provide up to 35 percent in matching investment funds, favoring private landowners who hold larger land plots and have better equity status. Furthermore, there are significant differences in the distribution o f funding among the various states. For instance, CONAFOR data show that although most o f the PRODEPLAN funding went to highly marginalized states, the average funding per recipient was smaller when compared to recipients from low or medium marginalized states. This reflects bias in recipient criteria, disbursement mechanisms, and selection standards toward the rich.

Capacity-building programs such as PROCYMAF have insufficient coverage and comprise the lowest amounts o f CONAFOR’s total funding. PROCYMAF, for example, allocated only about 1 percent o f total CONAFOR funding in the six poorest forestry states (where 90 percent o f forest production occurs); thus leaving out some o f the targeted groups who cover about 80 percent o f lands in Mexico. The PSIA also notes that other factors such as disparity in land size, the level o f marginalization, the lack o f capacity and the inequality in funds allocated for community forestry programs are key obstacles for the forest poor.

Funding from the Payment for Environmental Services Program (or Pago por Servicios Ambientales) accounted for 8 percent o f total government forestry funding between 2000 and 2007. The program itself allocates the majority o f funds to hydrological environmental services, given the complex yet important relationship between the water and forestry sectors. However, accessing these funds i s difficult, as the selection criteria may not maximize benefits to water users or increase equity. In fact, a criticism raised by Instituto Nacional de Ecologia (INE) i s that the program has provided funding to areas where the deforestation risk i s low. The ownership structure (such as collective tenure) i s a key constraint to accessing PSA funds and affects the

75

distribution o f resources. For example, high cooperation costs may lead a particular ejidu or community to choose individual activities or individual tenure over collective ones. PRODEPLAN and PSA operational regulations should be modified to meet the needs o f poor forestry groups.

Most forestry development activities, whether they are related to production or capacity building, require consistent medium- to long-term support for achieving sustainability. This i s not always possible because CONAFOR programs allocate funds on an annual basis. A multi-year approach to the provision o f funds and technical assistance may be more effective, and i s recommended for CONAFOR programs.

While a majority o f ejidus and communities are at a financial and technical disadvantage when competing with richer, larger landowners for PRODEPLAN funding, there are some synergistic opportunities for these two groups to create associations o f ejidus or communities. The lack o f technical capacity on part o f these communities, a narrow policy design, and a complicated proposal process are often barriers for poor landowners. However, the establishment o f powerful associations or community organizations can increase the capacity to compete for PRODEPLAN funding, and to better access PROCYMAF resources.

To address organizational weakness, social capital growth, and better ecosystems management in the ejidus and communities, the government has promoted the creation o f Community Forest Enterprises (CFEs) that are the Mexican “model” o f community forest management. The CFEs face future sustainability challenges o f strengthening social capital o f community institutions; diversification o f products and access to emerging markets; over-regulation; globalization processes and competition with products from commercial forestry plantations; and access to the international market for certif ied products by small producers.

Ensuring forests’ sustainability i s crucial to improve the livelihoods o f poor and vulnerable rural populations, address environmental degradation, and open development alternatives such as production o f timber and non-timber products for domestic and international markets and the expansion o f eco-tourism. Accordingly, this DPL will support strengthening the capacity o f these vulnerable groups to benefit from the new legal framework provided in the Forestry Law - taking greater advantage o f sustainable and productive uses of forest areas; and incorporating evaluation criteria to improve their access to CONAFOR‘s Pro-Arbol promotional programs. In addition, the loan supports the establishment o f benchmarks for forestry sector programs that aim to create income-generating alternatives to improve the livelihoods o f forest communities (e.g., PROCYMAF and PSA); and consolidating the certification framework developed under the new ~ r u - k r b u ~ program.

76

ANNEX 5: MEXICO AT A GLANCE

Page 1 of 3

Mexico a t a glance 811yo8

Mewo

105 2 1,954

10 76

cJ89 9 9,4 I O

11,9w

32 2-1

5

74 23

93 90

111 1 I@

91 TT

Lets, 4IDMCII a calib

5 6 20,421

13 78

2.661 4.785 3,682

5 5 4 2

73 22

5

91 89

121 116

91 77

Upper mddk

i n m

01 1 41.466

@ S 75

4.797 5,913

10,879

5 7 4 9

70 22

94 92

115 711

93 01

A p distribution, 2006

Fenwe

Net Aid Flows

(USS mWms1

is80

55

9 15 i s

0 0 1

26 3 33 4

0 0 144

67 6 f94 357

9 @ 33 6 22 3 57 4

65 1 I O 0 27 2

20 7 13 0 22 0

1'990 ma 2007'

156 .s6 247

23 24 154 9 15 26

51 .I 1 P

0.1 0.0 0.0 2 .1 2

28 7 9 5 4 0 28 1 12 1 4 7

2 8 9 5 109 106 loo tF4

a3 3 590 105 2 262,710 581.428 i,cr?,815

(46 of GDP) 7 8 4 2 3 7

28 4 280 359 20 e 20.3 $86 63 7 67.8 60 3

69 6 670 654 8 4 11 1 102

23 1 239 258

18 6 33.9 263 19 7 329 299 2 0 3 205 254

G r M h of GDP and GDP wr calpits (K)

1980-90 ~~so-zooo 2000-07 iaverage snnuaf grcwth %)

2 1 1 7 1 0 1 1 2 6 2 6

0 8 1 5 2 0 ( 1 3 8 1 5

1 4 2 9 3 1 1 5 4 3 0 9

1 4 2 3 .1 6 2 4 1 8 7 0

-33 4 7 7 8

70 i4.e 5.7 1.0 12.3 6.3

77

Papa 2 of 3

#ex/co

3alance of Paymats and Trade

(US% mi#iona) Total merchandise expwts (fob) Tdal merctrendise mapocts ( c 4 Net vada in pDods and SowYIcen

Currmt accarnt balsnce

Workers’ remittances and

a& a % of GDP

ampen5aQon of e r n o p e s (receipts)

R e s m , nckldbyl qold

Central Governnmt Finance

(% of G W ) C U M revenue (4ndudmg grants)

Cumnt expenWe

Overail surplwfdeficd

Highest margmd tax rate (%)

Tax revenue

lndivldwtl coorpwate

External Debt and Resource Flows

IUSSm#lms) Total debt ouhrtrcnding 8nd d~sbursed

ToZal -1 (% of GDP)

2000 2007

168,455 271,875

-10,681 -16,013

-18,684 -5,525 -3.2 -0.5

$74,458 m,w

7,525 230%?

35.565 51,211

31.6 22.2 10.6 9 0 20.1 173

-11 D O

40 29 35 29

26.0 16.9

17,977 24,686 447 -882

Compesition of total wternal debt, 2007

Private Sector Devdopmeiit

Tin= required to Mart a hmlness (days: Cost lo start a busvlcss I% ol GNI pr capital Time requrrsd to regtster proesrty (days’

Rankscr as a m@or constramt to Lnrsrihess t% of nmagen surveyRd who agree$

Antiwq&bve or mfwmal practices CwrUphOn

Srock markct capfiallzation IX of GDPi Bank cdwita to as& ratio p4)

2000 2007

- 27 - 13.3 - 74

. 190 17 8

21.5 3 8 9 9.6 13.2

Tecfiiiolopy and Infrartnictun

Paved roads (% of toto!) Fired lrne end mobile W e

High technobogy e*p& ww*m [per loo peopi%l

(%of mu[actrsrcd expaw

Environment

Apncultuml krnd (56 of land mea: Fcfert area (’Q of land area) ~a t io i ta~~y potceted areus (m of land mea

Fnsihwehr resources per caprta (cu wkn~ Freshwater withdrawal (% of ntemal rewcB8,

C 0 2 emssiom, per caplta (mi)

GQP per u n R ofemrgy use (sa05 PPP 5 per kg of 011 eqUnrElen1)

Energy use per mspita (kg of oif equhrcilent]

(USS m#mns)

IBRD Total debt oulstsndtnp end disbursed D&uraementa P r i n w l repayments lntereat paynments

IDA Total debt outstanding and dlsLKIrsed Disbursemanta Total debt serrice

IFC (&a/ pw) Total drr&urred and OUtStMdglg p o ~ O l s 0

Dlsbursemtnts for IFC own accoum Pomoko sales, prepaynients and

repayments for IFC o w accounl

of Much IFC own acccunl

MIGA Gross exposun New guarantees

2000 Zoo6

328 970

27 74

224 169

55 55

10.7

3 967

20 Y

19 7

4 3 4 3

7‘1 6 6

1.534 1 7 1 2

11.444 4540 1,748 671 f 330 342

890 232

1.234 1,146 723 711 179 92

66 168

78

Page 3 of 3

Mjllennium Development Coals Mexico

With selected targets to ameve between f990 and 2015 ieslimste cIOsesr to W e shown, +/- 2 pars)

Goal I: halve the ratea for $1 a day poverty and mainutrctioi 1990 1995 2000 2006 Poverty headcount raim ai $1 a day IPPP, % of populetron) 8 3 e i 6 3 4 5

fixire of mcome w consompiim to the w e a t qundrle (36) 3 5 3 6 33 PreveQcnce of na8nutrfim (% of chiMren under 5) 16 6 16 9 7 5

Pave* headwunl ratlo at n a m l poverty &ne (% of poputatatlcnl 22 4 37 1 a4 2 17 6

Goat 2: enaw that c h i h are able to complete primary schooling P r m Mhwi enrolment (net, X) 99 99 P r m w ocmpltban rate (% of relevant age ppoup) 86 9s 99 103 Secondary schcd e n r o w @rosa, %) 53 72 85 Ywm rats (% of psopk agea 1524, 95 9% 97 96

Goat 3: elimin&e Osndef disparity In education and empower w o w Ratlo of prb to bop n p n ~ r y and secondary educam ( W ) Women empsoysd n the nmgncultural sector (% of ncaagnculhrrnl employment] PrcpMtion of seats hald by women in Mhon~l parilenrerrt (W)

98 1Of 35 36 37 37 12 I# 18 23

Goat 4 reduce under4 mortality by Wo-thirds undsr-5 mcrtSS@ rate (per 1,000) 46 36 30 28 infant mort&tty rate (per 1,W live brrths) Measles immrswzetton (propomon of --year dc4 immunized, X

37 30 25 23 75 90 96 96

Goal 5: reduce ineternal mxtalrty by three-fourth Maternal mortality ratio (mobeked &mate, per lW,oOO kve krths) E m s attended by skill%d health S W i% of l o a )

63 86

Goal 6: hslt and hegin to rtrerae the m a d of HIWAtDS and other major discarm Preaenct of HI+/ (% of popuiation &gee 15-49) Contraceptive prevalence (35 of women ages 15-49) 65 70 lnctdence of luberculasrs (par 100,Oex) people) 49 42 37 3.1 Ttskrwloeis mses detected under DOTS {%} 15 66 81

0 .7

Goat 7: halve the propoction of wopk wrthout wstalnsble ec-tcss to barac need! Access to an i m m & war source (% of pogulaiion) 80 91 Accesa to improved sandatton fsciUldres (% of powtetwn) 66 n Fmest area (% of totei land aree) 32 2 28 9 Elabcnally protected are= (%of total land area) CO2 rnissims fmetnc tons per cap&) 5 0 4 4 4 3 4 3

10 2

GDP per unit of energy uac (constrwrt 2005 PPP $ per kg of OLI equrvsknt) 6 1 6 2 7 2 6 6

Goal 0: develop a nlobol parbterahip for development 7 10 n 74 0 0 S 18 1 3 6 14

5.4 9.6 4.4

+Prmwy net rnrolkncnr raw

+Raw of g8k (0 bDyr m pnmar~ Z 5 e m d u y odocabon

I Measles tmrnunlratlcn (% od I-year olds) fCT indicaton (per 100 people)

Note F p m in Ralics an fcd years oMer than M s e spcclfied indicates data are not arailabk Btl5LO8

DweEcpmeni Euxrcnrcs Development Data Group (DECDG)

79

- - o n : :

0 00

ANNEX 7: STATEMENT OF IFC's HELD AND DISBURSED PORTFOLIO

MIS

Country: Mexico

International Finance Corporation Statement of IFC's Committed and Outstanding Portfolio

Amounts in US Do//ar Millions Accounting Data As Of: OM012008

Report Run Date, 08/19/2008

Page 1

2008 AluwuEW 2 w 7 1 m 200612038 lWY19ay1888/ ieee m 203Y 2008 2006

2004 2002 2ooY 2007 2ww 2w5 2WY 2m l W M o 4 1 2 0 0 8 1997ixxW laszl1WY 1 w 2Mo 189912W7 2 0 3 2wB 2007 2001

Mol x46 19981 lsas 199% 19971 1999

2007 m 3

2 w 20041 m 2W7

zwii ZWY 2 w 7

2oq7

2w2

2001

1887 IMd 2008 u 2MB !&ab 2w2 zu4%lhu

10 71

7 w 33 49

10 57 8 52 3 70

31 08 84 67 69 24 55 05 964

2 76

5 0 0 22 25

18 30

850 5 69

7 50 211 62

0 59 1321 4000

20 w 7 j 2

58 90 170

11 97 0 42

030 0 78

14 76 600

50 W 6 03 0 01

0 8 0 0 8 0

20 00

989 868

170 OW

10 w

5 53

5.w

0 24

10.00

5.w

3.92

59.02

12.39

3 19

1 .Bo

0 16

20 00 17 83 5890

170

12 00 33 48 11 97 10 99 8 52 4 24

31 84 84 87

128 25 59 04 964

11 80

2 76 14 76 800

5000 803 0 01

12 39 500

22 25 080 080

18 30 OW EBB

1366 5 68 170 0 00 7 50

211 62

4 51 23 21 40 W

5 53

20 w

12.86

5 28

41 24

24 40

11 w

2.08

24 00

6 52 3 70 0 65

76 47 40 10 1585 984

2 76

22 25

1830

8 5 0 5 69

7 5 0 211 62

0 59

22 94

0 33 7 12

58 41 170

356 0 42

OM 0 76

14 76 6 73

603 0 01

080 080 604

989 868

170 0 00

10 00

4 79

0 24

10 w

5 00

3 82

22 21

11 12

2.45

0 12

0 33 7 12

56 41 170

24 W 358 0 42 8 52 4 24

1042 76 47 88 31 18 30 964

10 00

2 76 1476 5 73

6 03 0 01

11 12

22 25 0 8 0 080 6M

18 30 999 888

13 62 5 69 170 OW 7 50

211 62

4 51 10 00 22 84

4 79

1288

5 28

41 24

24 40

11 00

2 0 8

81

MAP SECTION

CitlaltCitlaltéépetl (5,747 m) petl (5,747 m)

SSii ee rr rr aa

MMaa

ddrr ee

OOcc cc ii dd ee nn tt aa ll

SS iieerrrraa MMaaddrree ddee ll SSuu rr

SSii ee

rr rr aaMM

aadd

rr eeOO

rr ii ee nn tt aall

CAMPECHECAMPECHE

CHIAPASCHIAPAS

TABASCOTABASCO

OAXACAOAXACA

GUERREROGUERRERO

COLIMACOLIMA

JALISCOJALISCO

NAYARITNAYARIT

ZACATECASZACATECAS

TAMAULIPASTAMAULIPAS

NUEVONUEVOLEONLEON

C O A H U I L AC O A H U I L A

C H I H U A H U AC H I H U A H U ASONORASONORA

D U R A N G OD U R A N G O

SAN LUISSAN LUISPOTOSIPOTOSI

MICHOACANMICHOACAN PUEBLAPUEBLA

VERACRUZVERACRUZ YUCATANYUCATAN

QUINTANAQUINTANAROOROO

S INA

LOA

S I NA

LOA

MazatlMazatláánn

TorreTorreóónnMatamorosMatamoros

LaredoLaredo

OjinagaOjinaga

Los MochisLos Mochis

NavojoaNavojoa

NogalesNogalesSanSan

FelipeFelipe

LoretoLoreto

SonoitaSonoita

AguaAguaPrietaPrieta

GuaymasGuaymas

TehuantepecTehuantepec

FronteraFrontera

VillahermosaVillahermosa

TuxtlaTuxtlaGutierrezGutierrez

OaxacaOaxaca

ChilpancingoChilpancingo

ColimaColima

GuadalajaraGuadalajara

TepicTepic

DurangoDurango

SaltSaltííllollo

ChihuahuaChihuahua

CuliacCuliacáánn

HermosilloHermosillo

MexicaliMexicali

GuanajuatoGuanajuato

PachucaPachuca

AguascalientesAguascalientes

QuerQueréétarotaro

MoreliaMoreliaTolucaToluca

CuernavacaCuernavaca PueblaPuebla

TlaxcalaTlaxcala

JalapaJalapa

San LuisSan LuisPotosPotosíí

CiudadCiudadVictVictóóriaria

ZacatecasZacatecas

MonterreyMonterrey

MEXICOMEXICOCITYCITY

YYaaqquuii

RRiioo BBrraavv oo

FFuueerrtt ee

SSaallaaddoo

LLeerrmm

aa

BBaallssaass

UUssuummaacciinnttaa

CCoonncchhooss

BAJABAJACALIFORNIACALIFORNIA

BAJABAJACALIFORNIACALIFORNIA

SURSUR

MEXICOMEXICO

MORELOSMORELOS

DISTRITO FEDERALDISTRITO FEDERAL

HIDALGOHIDALGOGUANAJUATOGUANAJUATO

AGUASCALIENTESAGUASCALIENTES

TLAXCALATLAXCALA

QUERQUERÉÉTAROTARO

RioGrande

GUAGUATEMALATEMALA

CAMPECHE

CHIAPAS

TABASCO

OAXACA

GUERRERO

COLIMA

JALISCO

NAYARIT

ZACATECAS

TAMAULIPAS

NUEVOLEON

C O A H U I L A

C H I H U A H U A

BAJACALIFORNIA

BAJACALIFORNIA

SUR

SONORA

D U R A N G O

SAN LUISPOTOSI

MICHOACAN

MEXICO

MORELOS

DISTRITO FEDERAL

PUEBLA

HIDALGOVERACRUZ

GUANAJUATO

AGUASCALIENTES

TLAXCALA

YUCATAN

QUINTANAROO

S INA

LOA

QUERÉTARO

Tapachula

PuertoEscondido

Acapulco

PuertoVallerta

Mazatlán

TorreónMatamoros

Laredo

Ojinaga

Los Mochis

Navojoa

Nogales

Ensanada

Tijuana

SanFelipe

SantaRosalia

Loreto

Cabo San Lucas

Sonoita

AguaPrieta

Ciudad Juárez

Guaymas

Veracruz

Tampico

Tehuantepec

Cozumel

Cancun

Frontera

Chetumal

Merida

Villahermosa

Campeche

TuxtlaGutierrez

Oaxaca

Chilpancingo

Colima

Guadalajara

Tepic

Durango

Saltíllo

Chihuahua

Culiacán

Hermosillo

Mexicali

La Paz

Guanajuato

Pachuca

Aguascalientes

Querétaro

MoreliaToluca

Cuernavaca Puebla

Tlaxcala

Jalapa

San LuisPotosí

CiudadVictória

Zacatecas

Monterrey

MEXICOCITY

UNITED STATES OF AMERICA

GUATEMALA

BELIZE

HONDURAS

ELSALVADOR

Yaqui

RioGrande

Rio Brav o

Fuert e

Salado

Lerm

a

Balsa s

Usumacinta

Conchos

PACIFICOCEAN

Gulf of Mexico

Bay of Campeche

Gulf ofTehuantepec

Gulf of

Honduras

Gu

l fo

fC

a l i f or n

i a

To Los Angeles

To Gila Bend

To Albuquerque

To Alamogordo

To Midland

To San Antonio

To San Antonio

To Houston

To San Salvador

Si e r r a

Ma

dr e

Oc c i d e n t a l

S ierra Madre de l Su r

Si e

r r aM

ad

r eO

r i e n t al

Citlaltépetl (5,747 m)

115°W

30°N30°N

25°N

15°N

25°N

20°N

15°N

110°W

110°W

105°W 100°W 95°W 90°W

105°W 100°W 95°W

85°W

MEXICO

This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other informationshown on this map do not imply, on the part of The World BankGroup, any judgment on the legal status of any territory, or anyendorsement or acceptance of such boundaries.

0 100 200

0 50 100 150 200 Miles

300 Kilometers

IBRD 33447

NO

VEM

BER 2004

MEXICOSELECTED CITIES AND TOWNS

STATE CAPITALS

NATIONAL CAPITAL

RIVERS

MAIN ROADS

RAILROADS

STATE BOUNDARIES

INTERNATIONAL BOUNDARIES