Document of

The World Bank

Report No. T-7280 -HO

TECHNICAL ANNEX

FOR A PROPOSED CREDIT

OF SDR 144.3 MILLION

TO THE

REPUBLIC OF HONDURAS

FOR A

HURRICANE EMERGENCY PROJECT

December 14, 1998

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CURENCY EQUIVALENTS(Exchange Rate Effective December 1, 1998)

Currency Unit = Lempiras (L)US$1 = Lempiras (L) 13.76

FISCAL YEARJanuary 1 to December 31

WEIGHTS AND MEASURESMetric System

ABBREVIATIONS AND ACRONYMS

CAETF Central America Emergency Trust FundCAS Country Assistance StrategyCG Consultative GroupCONE National Emergency Commission (Comision Nacional de Emergencia)ECLAC Economic Commission for Latin America and the CaribbeanEDUCO Community-based Education Program of El SalvadorESAF Enhanced Structural Adjustment FacilityFIAS Foreign Investment Advisory ServiceHEP Hurricane Emergency ProjectHIPC Highly-Indebted Poor Country InitiativeIDA International Development AssociationIDB Inter-American Development BankIFC International Finance CorporationIMF International Monetary Fund:MIGA Multilateral Investment Guarantee AgencyMph Miles per hourOED Operations Evaluation DepartmentPFP Policy Framework PaperRUTA Multi-agency Regional Unit for Technical AssistanceSDR Special Drawing RightsUNAT Technical Support Unit (UnidadNacional de Apoyo Tecnico)UNDP United Nations Development Programme

Vice President: Shahid Javed BurkiCountry Director: Donna Dowsett-CoiroloSector Leader, PREM: Ian BannonTeam Leaders: Suzana Augusto/John Stein

HONDURAS

PROPOSED HURRICANE EMERGENCY PROJECT

TECHNICAL ANNEX

Table of Contents

I. COUNTRY BACKGROUND AND HURRICANE MITCH .......................................................... IA. Background ............................................................ IB. Hurricane Damage ............................................................ IC. Response to the Hurricane ............................................................ 3

II. ECONOMIC IMPACT OF HURRICANE MITCH .......................................................... 4A. Macroeconomic Framework Prior to the Hurricane ............................................................ 4B. Economic Impact ............................................................ 5C. Government Measures ............................................................ 6

III. PROJECT OBJECTIVES AND DESCRIPTION ........................... ................................ 7A. IDA Strategy ............................................................ 7B. Project Objectives ............................................................ 9C. Project Description ............................................................ 9

IV. INSTITUTIONAL ARRANGEMENTS/PROJECT IMPLEMENTATION .................. 10A. Project Organization and Management ........................................................... 10B. Procurement ........................................................... 10C. Disbursements ........................................................... 11D. Financial Management and Monitoring ........................................................... 12

V. AGREEMENTS REACHED ........................................................... 13

Text Tables:Table 1: Summary of Damages and Replacement CostsTable 2: Key Economic Indicators, 1996-99Table 3: Procurement Procedures

Attachments:Attachment 1: Positive List of ImportsAttachment 2: Monitoring IndicatorsAttachment 3: Balance of Payments, 1996-99Attachment 4: Central Government Operations, 1996-99Attachment 5: Map Section

I. COUNTRY BACKGROUND AND HURRICANE MITCH

A. Background

1. Honduras is the third poorest country in the Latin America and Caribbean Region, withincome per capita of $700 million in 1997, over half of its population in poverty, one third inextreme poverty and relatively weak social indicators. Except for two coastal strips, oneextending about 640 km along the Caribbean Sea and the other 64 km on the Pacific Ocean,Honduras is a plateau, consisting of broad, fertile plains broken by deep valleys, and traversed bymountain ranges in a northwestern to southwestern direction. The mountains, which are volcanicin origin, rise to maximum elevations of more than 2,800 m. Most of the country's rivers draintoward the north into the Caribbean Sea. Average annual rainfall ranges from 1,016 mm in somemountain valleys to 2,540 mm along the northern coast. Like its neighbors in Central America,Honduras, is prone to national disasters, especially hurricanes and earthquakes. Normally, thesehurricanes affect Honduras' Caribbean coast to the north, as was the case with Hurricane Fifi, inSeptember 1974, which caused extensive damage and loss of life in that part of the country.

2. On October 24, Tropical Storm Mitch was upgraded to a hurricane that quicklydeveloped into one of the strongest and most damaging storms ever to hit Central America. Atits height on October 26 and 27, Hurricane Mitch sustained winds of 290 kph and dumped heavyrains over the region. Although the winds diminished as the hurricane traveled inland overHonduras on October 30, the storm continued to produce torrential rains, causing catastrophicfloods and landslides. After its slow, destructive march north and west across Honduras andGuatemala, Mitch dissipated over southeastern Mexico but again gained strength causingflooding in Florida. Hurricane Mitch is considered the worst natural disaster to have affectedHonduras in modern times. Coming after copious winter rains in the previous weeks, which hadswollen rivers and saturated soils, the hurricane's strong winds and relentless rain caused riversto overflow and severe landslides. The sheer length of time that it remained centered overHonduras, combined with its trajectory, resulted in incredibly heavy damage to all parts of thecountry.

B. Hurricane Damage

3. Within Central America, Honduras bore the brunt of Hurricane Mitch. As the stormntraveled inland, it dumped one year's worth of rain in a few days. The worst damage was in theAtlantic Coast, Sula Valley, the Central Region and the South, but no part of Honduras escapedsome impact. Preliminary estimates indicate that about 4.8 million people (three of every fourHondurans) were affected. Unlike previous natural disasters, Hurricane Mitch wreaked havoc inHonduras' two largest cities, the capital Tegucigalpa, and San Pedro Sula. About 40 percent ofthe capital was damaged, half of its 1 million inhabitants were affected, and the city was cut offfrom the rest of the country for almost a week. Much of the Government's own institutionalinfrastructure was damaged, including destruction of the Ministry of Education and extensivedamage to the Ministry of Finance. San Pedro Sula, the country's industrial and agriculturalheartland, suffered damage to its international airport, road and bridge infrastructure, and itswater and sewerage systems. Estimates of the damage and reconstruction costs were prepared byworking teams of donor representatives and the authorities, coordinated by the TechnicalSupport Unit (UNAT) of the Ministry of the Presidency. IDA staff in Tegucigalpa assisted the

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effort to produce the first damage assessment. A summary of their preliminary estimates ispresented below.

* The Human Cost. Preliminary estimates indicate that about 5,660 people died, but there arean estimated 8,000 persons missing, suggesting that the total number of deaths could besubstantially higher. As a direct result of the hurricane, an estimated 285,000 people had tobe placed in temporary shelters, including about 85,000 children under 5.

* Transport. Damage to the road network isolated a number of regions in the country,including the capital. The hurricane damaged or destroyed an estimated 60 percent of mainand secondary paved roads (1,600 km), and 20 percent of unpaved secondary and tertiaryroads (2,390). About 100 bridges (8 in Tegucigalpa) were completely destroyed or sufferedextensive damage.

* Water. Water systems in all major urban areas were damaged. In Tegucigalpa, about 23 kmof the water distribution system were damaged. Damage estimates are still incomplete forthe rest of the country, but the Government estimates that 47 major water systems and 1,500of the 4,000 rural systems were damaged.

* Energy and Telecommunications. None of the large hydroelectric stations suffered majordamage, but there was considerable damage to substations, and transmission and distributionlines. The hurricane damaged about 45,000 phone lines.

* Education. The Ministry of Education estimates that 17 percent of the country's 9,548primary schools were damaged. This implies that unless school repairs are quickly carriedout, or alternative arrangements made, about 100,000 children could be unable to start theschool year in February. About 40 secondary schools were also damaged. In addition, mosteducational establishments not affected by the hurricane are being used as temporaryshelters. The Ministry of Education building in Tegucigalpa was completely destroyed,including all the Ministry's administrative and academic records.

* Health. The majority of hospitals and health centers suffered some damage. Of Honduras'27 hospitals, 14 were left with no water. At least 4 of these reported extensive infrastructuredamage. Also, 12 hospitals reported damage to their electricity systems. There is littleinformation on damage to rural health posts and clinics, but it is believed to be extensive.Unsanitary conditions and contaminated water are placing large parts of the population atrisk of transmitted diseases such as dengue, cholera and leptospirosis.

* Housing. The Government estimates that the hurricane affected the housing conditions ofabout 661,760 people (82,720 families). Of these, about 285,000 were evacuated totemporary shelters and another 396,000 are living in precarious housing. The authoritiesestimate that about 33,220 new houses will be needed and about 49,500 will need to berehabilitated. These estimates are likely to rise considerably, as more information iscollected from isolated rural areas.

* Agriculture. Most of the basic grains production was lost. This will severely impact poor,small-scale farmers who are the main producers of basic grains. Export products also

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suffered extensive damage, including bananas, shrimp, pineapples, African palm, melons andother fruits.

* Environment. Some ecologists believe that hurricanes are a natural cycle and are necessaryto thin forests, lower the salinity of coastal waters and scrub underwater reefs and removecollected debris and pollution. However, the magnitude of Hurricane Mitch and its impacton some of the same places damaged by extensive forest fires last summer, will likely have asevere impact on coastal areas and fragile offshore ecosystems. The fires deforested largemountain areas, and then-absent the trees and undergrowth-torrential rains causedmassive erosion. Small streams became raging torrents that spilled from their banks.carrying with them trees and debris. Thousands of mature trees spilled from the mouths ofrivers into coastal areas on the Caribbean Sea.

4. Preliminary Estimates of Damage and Replacement Costs. A preliminary estimateprepared by UNDP and ECLAC (Table 1) suggests total direct and indirect damage of $3.6billion (equivalent to 74 percent of Honduras' 1997 GDP). Replacement costs are estimated at$5 billion.

Table 1: Summary of Damages and Reconstruction Costs ($ million)Direct Indirect Total Replacement

Damage Damage Damage CostsTOTAL 2.177.4 1,461.1 3.638. 4.987.7Social Sectors 305.4 719.4 1,024.8 580.5Housing 259.1 675.3 934.4 484.0Health 25.6 36.7 62.3 64.5Education 20.7 7.4 28.1 31.2Infrastructure 347.6 164.2 511.7 713.2Roads, bridges, telecommunications 314.1 140.0 454.1 571.4Water and sanitation 24.2 7.2 31.3 118.6Energy 9.3 17.0 26.3 23.2Productive Sectors 1,477.6 577.1 2,054.8 3,694.0Agriculture, livestock, fisheries and forestry 1,387.3 274.2 1,661.5 2,990.7Manufacturing 15.8 196.3 212.1 381.8Trade, restaurants, hotels 74.5 106.7 181.2 326.2Environment 46.8 0.4 47.2 n.a.Source: UNDP/ECLAC, A Preliminary Assessment of Damages Caused by Hurricane Mitch, December 10, 1998.

C. Response to the Hurricane

5. After the initial shock over the intensity of Hurricane Mitch, the Government activatedthe National Emergency Commission (CONE), and an Information and Damage AssessmentCenter to coordinate immediate relief efforts and assess damages. CONE and Government teamsworked with the UN system and emergency response teams from IDA and other donors todetermine priorities, channel immediate support and coordinate international assistance. TheGovernment also put in place mechanisms to provide food and emergency health care to about285,000 people in approximately 1,000 shelters, much of this with active help from reliefagencies, other Governments and Honduras' own private sector. In terms of transportinfrastructure, both the Northern corridor between San Pedro Sula and Tegucigalpa, and the

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Southern corridor between Choluteca and Tegucigalpa were reopened (in some cases usingtemporary solutions such as Bailey bridges, or temporary routes around bridges and across thedryer sectors of river beds) within about a week, reestablishing some road communicationsbetween the capital and parts of the country, and enabling the shipment of food, fuel andemergency materials to get to the capital. Water service is being reestablished gradually in thecapital and major cities using temporary solutions, such as local wells, and the Government istrying to acquire materials for the most urgent repairs to the primary and secondary distributionnetworks. The Government is also working with the Panamerican Health Organization toimplement a massive vaccination campaign, rehabilitate basic health services and implement avector control program.

6. The international community responded swiftly to the disaster, benefitting from theemergency response capability of the U.N. and a number of countries. The primary focus was onrescuing communities, establishing communications, distributing emergency food and medicinesto affected communities, and organizing shelters for displaced populations. There was also amajor task of disposing of the dead, both human and animals, to prevent the spread of disease.IDA staff on the ground in Honduras moved quickly to help the Government coordinate withother donors and conduct a preliminary damage assessment. IDA also reallocated andrestructured existing operations, prepared supplemental credits, and quickly disbursed the secondtranche of the Public Sector Modernization Adjustment Credit and its associated Fifth Dimensionresources (totaling $38 million), which provided much-needed balance of payments support.

11. ECONOMIC IMPACT OF HURRICANE MITCH

A. Macroeconomic Framework Prior to the Hurricane

7. Until Hurricane Mitch struck, Honduras' economy had been improving steadily duringthe previous two years. Economic growth had rebounded to 4.9 percent in 1997, from 3.7percent i-n 1996, and was on pace for growth of 5.5 percent in 1998. Average real wages hadincreased by about 8 percent in 1997, after no growth the previous two years, and whileunderemployment remained significant, open unemployment had fallen slightly to 4 percent in1997, Annualized inflation fell from 26 percent in 1997 to 13 percent in September 1998.

8. The consolidated public sector deficit fell to 3 percent of GDP in 1997, from 4.2 percentin 1996, while public savings increased slightly to 6.1 percent of GDP. In April 1998, theGovernment adopted a fiscal package aimed at increasing social spending and promoting privateinvestment through lower income tax rates to bring them in line with the rest of Central America,and the phasing out of the net assets tax and export taxes. To meet the fiscal costs associatedwith the increased spending and tax reductions, the sales tax rate was increased from 7 to 12percent. Preliminary data for the first nine months of 1998 indicated that fiscal performance wasin line with a fiscal deficit target of 2.5 percent of GDP.

9. The current account deficit fell from 4.6 percent of GDP in 1996 to 2.7 percent in 1997.In the first nine months of 1998, merchandise exports in dollar terms increased by an estimated20 percent relative to the same period in 1997, mainly due to strong growth in coffee andnontraditional exports. Merchandise imports also grew strongly, and the current account deficitwas projected to fall slightly to 2.4 percent of GDP in 1998. Gross international reserves

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increased from $476 million at end-1997 to $515 million at end-September 1998, but fell slightlyin terms of months of imports.

10. The Governnent was also making steady progress in its structural reform program. Thisincluded: approval of the Telecommunications Law and the Law for Concessioning of AirportServices in late 1995, which authorized the privatization strategy for these two sectors;,presentation to the Assembly of the new Civil Aviation Law, which provides a modemframework for the development of the sector; approval of a new tariff structure for electricity in1995 and tariff adjustments in 1996 and 1997; approval of the amendments to the General PublicAdministration Law in December 1996, which provided the framework for restructuring ofpublic sector entities; a 14 percent reduction in public employment positions;ad e e inpublic management, such as decentralization of the procurement function.

11. In April 1998, the Assembly approved legislation establishing a single regulatory agencyfor the electricity sector (a key requirement for establishing a tariff policy consistent with long-run marginal costs and for facilitating privatization). In August, the Government approved astrategy for the privatization of electricity distribution, and in September a decree permitting thestart of the bidding process for the privatization of the telecoms company, HONDUTEL, waspassed. The decree complemented the previously-approved privatization law, by strengtheningtransparency and accountability provisions in the privatization process to be followed. In lateOctober, the Government sent to the Assembly draft legislation that would permit concessions tothe private sector for the construction and management of infrastructure projects and encourageprivate investment in the mining sector. Measures were also adopted during 1998 to strengthenthe regulatory framework of the financial sector. Prudential banking regulations were issued oncapital adequacy, loan classification requirements, connected lending, and limits on externalborrowing. Other regulations were being prepared to limit the open foreign exchange positionsof commercial banks, establish a deposit insurance system, and regulate the operations of thestock exchange, insurance companies, and voluntary private pension funds.

B. Economic Impact

12. Estimates of the damage to the economy are still being refined. The Authorities estimatethat real GDP growth could drop to 3 percent in 1998 (this modest decrease is because thehurricane struck late in the calendar year), but would turn negative by at least 2-3 percent in1999, compared with projected annual growth of 5-6 percent prior to the hurricane.Unemployment is likely to rise substantially as workers are being laid off in agriculture andmanufacturing pending the reactivation of production. Inflation is expected to increase to 16percent by December 1998 (13 percent through October) and about 18 percent by end-1999, dueto the relaxation of emergency price controls and shortages of food and other goods. Pre-Mitchestimates projected a decline in inflation from 15 percent in 1998 to about 10 percent in 1999.

13. Preliminary estimates indicate that the overall deficit of the Central Government couldwiden to 4 percent of GDP in 1998 and to 8 percent or more in 1999, from 2.5 percent projectedprior to the hurricane. The higher deficit would be financed largely by external grants andcredits. Central Government current revenue (excluding grants) is expected to fall to 16.7percent of GDP in 1998 and 14.4 percent in 1999, compared with about 17.7 percent projectedprior to the hurricane. This would reflect mainly the impact of lower growth on revenues fromthe income, sales, and petroleum taxes. Import duties are also expected to fall due to damage to

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customs posts, and temporary duty exemptions on imports of food, raw materials, and equipmentto support the rehabilitation and reconstruction effort. Primary expenditures of the CentralGovernment are expected to increase by 3 percentage points of GDP in 1998 and 4 percentagepoints in 1999, relative to levels contemplated in the budget, due to additional spendingrequirements related to emergency relief, and reconstruction needs.

Table 2: Key Economic Indicators, 1996-99Projections

Pre-Hurricane Post-Hurricane1996 1997 1998 1999 1998 1999

GDP Growth (%) 3.7 4.9 5.5 6.0 3.0 -3.0Inflation (end-year, %) 25.5 12.8 15.0 10.0 16.0 18.0

Central Government Balance (% GDP) -3.9 -3.1 -2.5 -2.4 -4.2 -8.0Total revenues 16.8 16.9 17.8 17.6 16.7 14.4Total expenditures 20.7 20.0 20.3 20.0 20.9 22.4

Current Account Balance (% GDP) -4.6 -2.7 -2.4 -2.6 -7.7 -7.9Debt Service Ratio (before debt relief) 33.5 25.0 22.0 26.0 24.0 31.0Gross Reserves (months of imports) 1.7 3.1 3.0 3.6 2.6 3.2Source: Staff estimates, IMF and Government of Honduras.

14. Commercial banks and other financial institutions are expected to be affected byhurricane-related losses experienced by major borrowers, that will require the restructuring ofsome loans and write-offs of others. An assessment of the losses and measures to deal with themis being carried out by the Banking Commission, with the assistance of the IMF and IDA. Atthis time, the Central Bank is not considering special lines of credit to the banks to deal with theeffects of the disaster, but is encouraging the banks to deal with their clients on a case-by-case.The Government is discussing with NGOs and the agriculture development bank (BANADESA)mechanisms to support the reestablishment of rural credit schemes.

15. The current account deficit is expected to widen to about 8 percent of GDP in 1998 andin 1999 (compared to under 3 percent estimated prior to Mitch), owing mainly to the projectedfall in exports and higher imports associated with the reconstruction effort and the rebuilding ofinventories. Rough estimates indicate a financing gap of about $500 million (about 10 percent ofGDP) in 1999. The estimate for 1999 takes into account about $290 million in insuranceproceeds (to Honduran insurance companies reinsured outside the country), but excludes theeffects of possible flow rescheduling of obligations coming due to Paris Club creditors. TheGovernment expects to fill the 1999 financing gap through the reprogramming of existing credits(mainly from IDA and IDB), disbursements of new grants and credits, emergency balance ofpayments support from IDA and the IMF, and further debt relief, including disbursements underthe recently-established Central America Emergency Trust Fund (CAETF) to cover the servicingof multilateral debt.

C. Government Measures

16. The Government is taking steps to limit the effects of the disaster on inflation and interestrates, and setting the stage for economic recovery. A revised Central Government budget for1999 is being prepared to take account of the changed outlook for revenues and expenditures.

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The Government aims to limit domestic financing to about 1 percent of GDP in 1998-99, in partby reallocating spending to emergency needs and seeking concessional financing and grants tomeet its reconstruction needs. Monetary policy will aim to limit inflation by containing thegrowth of the money supply. In the external sector, the Government will aim to maintainconfidence in the exchange rate system by continuing to hold regular auctions, allowing theexchange rate to fluctuate within the band, and maintaining a minimum level of grossinternational reserves equivalent to about 3 months of imports.

17. On the structural front, the calendar for privatization of the telecoms company and theelectricity sector, as well as the concessioning of airports, are under review, pending a fullassessment of damages and the rehabilitation needs. IFC is discussing with the Governmentpossible support to keep the privatization of the telecoms company on track. The BankingCommission will maintain close supervision over the financial system, in particular bycontinuing with its program of on-site supervision supported by IDA and the IMF, and assessingthe effects of the disaster on loan portfolios and insurance companies, some of which have beenseriously affected by the hurricane damage.

18. The Government plans to resume discussions in mid-January 1999, aimed at finalizing aneconomic program that could be supported by an ESAF. The Authorities believe that an ESAF-supported program, aimed at maintaining macroeconomic stability, improving the climate forforeign investors, and deepening structural reforms, would be essential to restore confidence inthe economy and support the recovery. They also see this as an essential step toward Honduras'eventual inclusion under the HIPC initiative.

III. PROJECT OBJECTIVES AND DESCRIPTION

A. IDA Strategy

19. At the time the hurricane struck, IDA had its Central America transport team, a missionworking with the IMF on the debt sustainability analysis and the Policy Framework Paper (PFP),and the staff of its Liaison Office in Tegucigalpa. They formed the core of IDA's emergencyresponse team, supplemented by disaster specialists and other task managers who traveled to thecountry as soon as physical conditions permitted. Immediate needs included helping theGovernment to assess damage, prioritize interventions, and coordinate with other externaldonors. This effort has included IFC staff, who have been coordinating with the country team inheadquarters, and have traveled to Honduras to review with the Government and the privatesector ways to assist them deal with the effects of the hurricane, and possible support to keep theGovernment's privatization program on track. FIAS is also discussing with the Governmentpossible support for a foreign investment promotion strategy, and MIGA has indicated itswillingness to work closely with the Government to help in mobilizing private investment for therecovery and reconstruction. In the process, IDA has prepared its own three-part strategy toassist Honduras respond to this natural disaster.

* Emergency Financing, Macroeconomic Assistance and Debt Relief. The Government hasan urgent need for emergency financing of critical imports, while sustaining macroeconomicstability. The proposed fast-track Hurricane Emergency Project (HEP) would meet this

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immediate need. It complements actions by IDA in the two weeks following the hurricane torelease the second tranche of the Public Sector Modernization Adjustment Credit andassociated Fifth Dimension resources, which also provided balance of payments support at acritical juncture. Considering the emergency in Honduras, the Board approved that action ona no-objection basis in three days, rather than the standard ten. IDA staff have also beencooperating with the IMF on a preliminary reassessment of Honduras' macroeconomicsituation. Finally, at the request of a several governments, IDA has established a CentralAmerica Emergency Trust Fund (CAETF) to which contributions are being made to supportHonduras, and other hurricane-affected countries cover multilateral debt service payments.As soon as conditions permit, IDA and the IMF, in consultation with the IDB, will carry outa comprehensive debt sustainability analysis which would determine Honduras' eligibility forthe HIPC initiative.

* Short- to Medium-Term Rehabilitation. IDA staff are working with counterpartGovernment agencies and other development partners to reprogram IDA operations and/orprocess supplemental financing to provide for urgent rehabilitation of damaged social andeconomic infrastructure. Given the extent of the damage and the need for quick support,IDA staff believe that reprogramming of the existing portfolio-as opposed to designing anew, multi-sector hurricane rehabilitation project-is the fastest and most flexible way tomeet Honduras' short-term rehabilitation needs, given that speed is of the essence. Based onpreliminary damage estimates, we anticipate that several ongoing IDA operations would berestructured within existing credit amounts to finance about $70 million of rehabilitation-related expenditures. In addition, supplemental funding will be proposed for ongoing healthand transport projects, in the amounts of $10 and $20, respectively. These figures maychange as work with Government counterparts and other donors continues and as medium-term rehabilitation needs are better defined.

L Longer-Term Reconstruction. A new Country Assistance Strategy (CAS) was underpreparation at the time that Hurricane Mitch struck Honduras. Up to that point, IDA had heldCAS discussions in which it had agreed with the Government on the primary objectives andlikely lending and non-lending services. It had also initiated a dialogue with representativesof civil society and was about to formalize the consultation process on the proposed CAS,which was scheduled to be presented to the Board in February 1999. The new CAS underpreparation did not propose a major change with respect to the strategy of the previous CAS,but rather a shift in emphasis, placing greater focus on human capital, targeted povertyinterventions, rural development, environment, and institutional strengthening. In the socialsectors, discussions were well advanced on IDA support to pilot a community-basededucation model (along the successful EDUCO model in El Salvador) and improved healthcare quality through decentralization. The social safety net would also be strengthened bysupporting successful pilot initiatives by the Social Investment Fund targeting women,indigenous groups, municipal strengthening and rural credit. In rural development, we wereworking with the Government on a broad agenda to support rural growth and povertyalleviation, including support for land titling, a land fund and an assessment of options in thedesign of a viable rural credit system to benefit small, poor farmers. On the environment, weplanned to complement work under the GEF-funded Meso-American Biological Corridorproject with an operation to protect the Coral Reef, and as part of a regional initiative, hadplanned work on disaster prevention and mitigation. Institutional strengthening would be an

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over-riding objective, including support for improved governance and transparency,decentralization and strengthening of local governments, and economic management. Interms of structural reforms, we had started work with the Central Bank on strengthening theprudential regulation and supervision of the financial system, and support for pension reform.

20. The extent of the economic and social devastation caused by Hurricane Mitch calls for afundamental review of Honduras' future development strategy. While long-term developmentobjectives of poverty reduction, sustainable and equitable private sector-led growth,environmental protection, strengthening of the financial system, and modernization of the statemay not have changed, the pace and sequencing efforts in all sectors have necessarily beenaffected by the hurricane. Therefore, the draft CAS will need to be reformulated to support thelonger-term reconstruction of Honduras. While the priorities on which we were working arelikely to remain valid, and we propose that IDA remain heavily engaged in the social sectors andrural poverty, issues that will have to be addressed include the possible need to direct a largervolume of resources toward infrastructure rehabilitation, especially transport and water(depending on the support forthcoming from other donors), and toward work on the financialsystem and private sector development. The share of the country program devoted to quick-disbursing balance of payments support will also necessarily increase beginning with theproposed HEP. Strengthening the country's institutional capacity for disaster preparedness andmanagement will be very important, and the emphasis on decentralization and local partnershipswhich is already a strong feature of our portfolio will become more important than even in therecovery process. Finally, the role of other parts of the Bank Group in supporting private sectordevelopment is likely to expand.

B. Project Objectives

21. The proposed Hurricane Emergency Project is part of the first phase of IDA's strategy toassist in the recovery and reconstruction of Honduras (para. 19). It would assist the Governmentin maintaining macroeconomic stability through financing of imports associated with rebuildingsocial and economic infrastructure, and reestablishing production levels in response to thedamage caused by Hurricane Mitch. The performance of the project would be measured by howwell Honduras maintains macroeconomic stability in 1999 and beyond, especially in terms of thecurrent account deficit and the budget deficit of the Central Government.

C. Project Description

22. The Hurricane Emergency Project will provide immediate, quick-disbursing support tofinance a positive list of imports needed for the rehabilitation effort while supportingmacroeconomic objectives. While the proposed credit would be entirely quick-disbursing, it isonly one part of an unbundled set of actions by the Bank Group to respond to the effects of thehurricane. The project will, inter alia, provide assistance for imports of: (i) constructionmaterials and equipment, water, land and air transport vehicles, petroleum, and fuel products thatare needed for rehabilitation of physical infrastructure; (ii) seeds, fertilizers, agriculturalequipment, materials, machinery and fuel needed to reestablish agricultural production; (iii)medical supplies and equipment needed to replenish stocks of hospitals, health centers, healthposts and outreach programs; (iv) school supplies and equipment for educational facilities thatwere damaged or destroyed; and (v) machinery, spare parts and equipment for commercial andindustrial companies.

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23. The size of the proposed credit at SDR 144.3 million ($200 million equivalent) is basedon the Government's request for emergency assistance and an assessment of the adverse effectsof Hurricane Mitch on the balance of payments after taking account of the assistance expectedfrom the IMF, IDB, and other donors.

IV. INSTITUTIONAL ARRANGEMENTS/PROJECT IMPLEMENTATION

A. Project Organization and Management

24. Project implementation arrangements have been streamlined to conform to the emergencynature of IDA's assistance. In addressing IDA's fiduciary responsibilities, IDA has sought toensure that: credit proceeds are administered prudently, and only used to finance imports ofitems included on the positive list; required procurement, accounting and auditing procedures arefollowed, and appropriate retention of documents is provided to allow for IDA supervision andindependent audits.

25. The Project will be implemented by the Ministry of Finance, with the assistance of theCentral Bank of Honduras. The execution of an Implementation Agreement, satisfactory to IDA,defining the assistance to be provided by the Central Bank of Honduras is a condition ofeffectiveness. The Ministry of Finance will provide the basic information on imports (based onCustoms Declarations) and the National Division of Customs will maintain the respectivesupporting documentation. The credit will finance 100 percent of the delivered cost of eligibleimports, excluding import duties and taxes, subject to a positive list agreed with Government(Attachment 1). The Central Bank will prepare Statements of Expenditure in an agreed formatbased on the information received from the Ministry of Finance through its National Division ofCustoms.

B. Procurement

26. Credit proceeds would be made available to finance public and private sector importsagainst documentation evidencing that the imported goods were both on the positive list andprocured following agreed procurement procedures. Imports financed with credit proceedswould be limited to goods from eligible countries as per the Bank's Procurement Guidelines(Guidelines for Procurement under IBRD Loans and IDA Credits, dated January 1995, revisedJanuary and August 1996, and September 1997). No more than 50 percent of the credit would beused to finance the import of any category of eligible imports on the positive list. In order toavoid excessive transaction costs for IDA, public and private sector import contracts of less than$20,000 would not be eligible for financing with credit proceeds.

27. The credit would be used to finance only imports procured in accordance with theprocedures presented in Table 3 below. All procurement of imports by the private sector of $3million or above will be based on Simplified International Competitive Bidding Proceduressubject to prior review by IDA. Imports by the private sector less than the equivalent of $3million will be acquired based on established commercial practices and will not need the priorreview of IDA

28. Public sector imports financed under this project would follow Simplified InternationalCompetitive Bidding procedures, as provided under IDA's Procurement Guidelines (Clauses2.63 and 2.64). Contracts let by the public sector of $1 million or above will be subject to priorreview by IDA. However, to facilitate the speedy import of items required immediately for therecovery effort, public sector imports of less than $1 million equivalent and awarded betweenOctober 25, 1998 and June 30, 1999 may be made based on international shopping procedures asper IDA's Procurement Guidelines (Clauses 3.5 and 3.6). The Project would finance the importof fuel and fertilizers by both private and public importers through established internationalcommodity markets, or through simplified procurement procedures provided for under the IDA'sProcurement Guidelines.

Table 3: Procurement Procedures

PROCUREMENT CATEGORY PROCUREMENT METHODPublic Sector Procurement

Commodities Through established international commoditymarkets, or other channels of competitiveprocurement as defined in Clause 2.65 of IDA'sProcurement Guidelines

Goods, valued at or more than $1 million Simplified international competitive biddingprocedures under Clauses 2.63 and 2.64 ofIDA's Procurement Guidelines

Goods, for contracts awarded between In accordance with international shoppingOctober 25, 1998 and through June 30, procedures under Clauses 3.5 and 3.6 of IDA's1999, valued at less than $1 million Procurement GuidelinesPublic sector import contracts costing less Ineligible for financing under the Projectthan $20,000

Private Sector ProcurementCommodities Through established international commodity

markets, or other channels of competitiveprocurement as defined in Clause 2.65 of IDA'sProcurement Guidelines

Goods for contracts valued at or more than Simplified international competitive bidding$3 million procedures under Clauses 2.63 and 2.64 of

IDA's Procurement GuidelinesGoods for contracts valued at less than $3 Based on established commercial practicesmillionPrivate sector import contracts costing less Ineligible for financing under the Projectthan $20,000

C. Disbursements

29. The proceeds of the credit would be disbursed against 100 percent of the delivered cost ofimports, excluding imports duties and taxes, subject to the agreed positive list. Modisbursements would be made for used or luxury goods, or for military equipment.

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Disbursements in respect of expenditures under contracts for goods procured by the public sectorcosting less than $1 million equivalent and under contracts for goods for the private sectorcosting less than $3 million equivalent and for commonly traded commodities would be madeagainst Statements of Expenditures, for which supporting documentation would be retained bythe National Division of Customs and made available for review by IDA financial managementand procurement specialists and project auditors. The project would be implemented over a one-year period and is expected to be completed by December 31. 1999. The Closing Date for thiscredit would be June 30, 2000.

30. Retroactive Financing. Retroactive financing in the amount of SDR 28.86 million, 20percent of the credit amount, would be provided to finance expenditures incurred before loansigning but after October 24, 1998. the approximate date of onset of devastation caused byHurricane Mitch.

31. Special Account. The Borrower may request disbursement through a US Dollar SpecialAccount to be established in the Central Bank of Honduras, with an initial authorized allocationof $50 million, 25 percent of the total credit amount. The Special Account would be replenishedas and when needed to ensure timely disbursements of funds to cover eligible imports.

D. Financial Management and Monitoring

32. The Central Bank of Honduras has in place an appropriate mechanism to monitor andreport on the financial transactions pertaining to this operation. The Ministry of Finance wouldprovide at all times adequate staff for managing the Project and maintaining proper accounts andrecords. The Central Bank will prepare quarterly reports on the financial transactions related tothe project within such period. Such reports will be provided to the Ministry of Finance within15 days of the end of each quarter. The quarterly financial reports will reflect the total transfersof resources of the credit and show the total of eligible financed imports based on the agreedpositive list (corresponding to the lists of imports provided by the National Division ofCustoms).

33. Quarterly progress reports of monitoring indicators, the Project's financial transactions,and quarterly audits of project accounts, the Special Account and Statements of Expenditures byan independent private accounting firm acceptable to IDA, will be provided by the Ministry ofFinance within 30 days of the end of each calendar quarter. The fourth quarter audit report willpresent the cumulative balances to the end of the year. The retaining of an auditing firmacceptable to IDA is a condition of effectiveness.

34. The Project's monitoring indicators are described in Attachment 2. Quarterly reports onthe progress against these macroeconomic indicators will be prepared and sent to IDA within 30days of the close of each quarter.

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V. AGREEMENTS REACHED

35. Effectiveness Conditions.

(a) Execution of an Implementation Agreement with the Central Bank of Honduras;

(b) Retaining of independent auditors acceptable to IDA for purposes of auditingProject accounts, the Special Account. and disbursements against statements ofexpenditures.

Attachment 1

HONDURAS

HURRICANE EMERGENCY PROJECT

Positive List of Imports

Construction materials

Water, land and air transport vehicles

Seeds

Fertilizer

Agriculture equipment and inputs

School supplies and equipment

Medical supplies and equipment

Petroleum and fuel products

Construction equipment and industrial machinery, spare parts and raw

materials

Attachment 2

HONDURAS

HURRICANE EMERGENCY PROJECT

Monitoring Indicators

The objective of the Hurricane Emergency Project is to assist the Republic of Hondurasto finance critical imports needed for the rehabilitation and rebuilding effort while maintainingmacroeconomic stability. The following preliminary indicators would be used to monitormacroeconomic stability:

* The balance of payments current account deficit expected not to exceed 8 percent of GDP in1999; andThe overall fiscal deficit of the Central Government expected not to exceed 8 percent of GDPin 1999.

These indicators would be adjusted accordingly, as macroeconomic estimates and projectionsare refined, as reflected in the subsequent Government economic program.

Attachment 3

HONDURAS

HURRICANE EMERGENCY PROJECT

Balance of Payments, 1996-99($ million)

Pre-Hurricane Post-Hurricane

1996 1997 1998 1999 1998 1999

Current Account (including transfers) -189 -127 -129 -139 -420 -445

Trade Balance -336 -455 -549 -686 -814 -1,247

Exports 1,423 1,536 1,739 1,784 1,598 1,288

Imports -1,759 -1,991 -2,288 -2,470 -2,412 -2,535

Services' -130 16 74 182 11 367

Transfers 277 312 345 364 383 436

Capital Account 228 303 179 84 156 119

Overall Balance 12 196 50 -56 -265 -326

Change in Intern. Reserves (- = increase) -83 -280 -62 -180 0 -180

Exceptional Financing (net) 71 84 12 0 12 0

Financing Gap 0 0 0 242 253 506

Memorandum items:

Current Account (% of GDP) -4.6 -2.7 -2.4 -2.6 -7.7 -7.9

Gross Intern. Reserves ($ million) 283 591 653 833 591 771

Gross Intern. Reserves (months of imports) 1.7 3.1 3.0 3.6 2.6 3.2

Financing Gap (%of GDP) 0 0 0 4.1 4.6 9.6

1. For 1999, includes expected insurance proceeds of about $290 million under the Post-Hurricane projection.Source: Staff estimates, IMF and Government of Honduras.

Attachment 4

HONDURAS

HURRICANE EMERGENCY PROJECT

Central Government Operations, 1996-99(% of GDP)

Pre-Hurricane Post-Hurricane

1996 1997 1998 1999 1998 1999

Total Revenues 16.8 16.9 17.8 17.6 16.7 14.4

Tax Revenues 15.8 15.9 17.1 16.7 16.0 13.8

Non-Tax Revenues 1.0 1.0 0.7 0.9 0.7 0.6

Total Primary Expenditure 16.2 15.9 16.8 17.1 17.4 19.3

Current Expenditures 11.8 11.7 11.4 11.6 12.0 12.9

Capital Expenditures 4.4 4.3 5.4 5.4 6.2 6.4

Current Primary Balance 5.0 5.2 6.3 5.9 4.7 1.5

Primary Balance 0.6 5.2 6.3 5.9 4.7 1.5

Interest Obligations 4.5 4.1 3.4 2.9 3.5 3.1

Current Account Balance 0.4 1.1 2.9 3.0 1.2 -1.8

Overall Balance -3.9 -3.1 -2.5 -2.4 -4.2 -8.0

Total Financing 3.9 3.1 2.5 2.4 4.2 8.0

External 3.3 2.2 1.0 1.6 2.7 6.9

Internal 0.6 0.9 1.5 1.8 1.5 1.1

Source: staff estimates, IMF and Ministry of Finance

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