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PROGRAM INFORMATION DOCUMENT (PID) CONCEPT STAGE Report No.: AB3668 Mexico - Climate Change Development Policy Loan Operation Name LATIN AMERICA AND CARIBBEAN Region General water, sanitation and flood protection sector (50%); Sector General energy sector (25%); Forestry (25%) P110849 Project ID THE UNITED MEXICAN STATES Borrower(s) SEMARNAT Implementing Agency February 19, 2008 Date PID Prepared February 27, 2008 Estimated Date of Appraisal Authorization Estimated Date of Board April 8, 2008 Approval (I) Key development issues and rationale for Bank involvement 1. Mexico emits 643 million t CO2e (or about 1.5%) of total greenhouse gases (GHG), which makes it the twelfth largest GHG emitter in the world and second largest in Latin America (see Figure 1 for Mexico’s share of carbon dioxide emissions excluding land-use change and forestry, and Annex 2 for a comparison of the top 20 emitters of all GHG including land-use change and forestry). Mexico’s emissions have been growing steadily over the past 25 years (see Figure 2) and are now equivalent to about 6 t CO2e per capita (including emissions from land-use change and forestry). The carbon intensity of the Mexican economy is 837 t CO2e per million US$ of GDP. The main sources of Mexico’s GHG emissions include energy generation (24%), transport (18%), forests and land-use change (14%), waste management (10%), and agriculture (7%). The oil and gas sector is responsible for about 12% of GHG emissions, about half of which is classified under energy generation. Figure 1: Mexico’s Share of CO2 Emissions (excluding land-use change and forestry) in 2005 Source: Energy Information Administration, www.eia.doe.gov/environment.html Figure 2: Mexico’s CO2 Emissions (excluding land-use change and forestry) from 1984 to 2005 Mexico: Total CO2 Emissions 450 400 350 300 250 200 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 Source: Energy Information Administration, www.eia.doe.gov/environment.html 2. Mexico will be disproportionately affected by climate change, in particular hurricanes, changes in temperature, precipitation (more rain leading to floods in some regions, less rain leading to droughts in other areas), and the extent and frequency of floods and droughts. The country’s large and relatively exposed coastline along the Gulf of Mexico is a frequent landfall point for hurricanes. The cost of hurricane impacts has steadily increased in Mexico. Recent data indicates a 1000% increase in damages compared to the decade of the 1950s. Projected sea level increases will lead to further impacts on the Gulf Coast.1 Also, recent studies on the vulnerability of hydrologic regions in Mexico suggest that potential changes in air temperature and precipitation may have a dramatic impact on the pattern and magnitude of run-off on soil moisture and evaporation.2 Recent data from IPCC assessments on projected forced hydro-climatic changes indicate that Mexico may experience significant decreases in run-offs in the order of 10 to 20% nationally and up to 40% along the Gulf Coast wetlands as a result of global climate change.3 These climate change impacts would further aggravate the country’s available water supply and given current pressures on water resources, which have grown tremendously over the past decades, constitute a priority adaptation issue. Reduced runoffs would also negatively affect the integrity of major ecosystems, including the system of wetlands in the Gulf of Mexico as well as the remaining primary forests in the north of the country. 3. On May 25, 2007 President Calderón announced the National Climate Change Strategy, which places climate change at the heart of the country’s national development policy. The Strategy identifies options for decoupling GHG emissions from economic growth. It also proposes a long list of potential climate change mitigation (i.e., GHG emission reduction) activities, as well as general ways to reduce vulnerability to climate change. Please refer to Annex 3 for a discussion of the Strategy.4 4. In the Strategy, the country commits itself to reducing GHG emissions on a voluntary basis (as a non-Annex I country, Mexico has no formal obligation to reduce its emissions by 2012). The Strategy recognizes the possibility for the country to adopt voluntary commitments, and to have those monitored by the international community (‘pledge and review’). However, no penalty would be incurred for noncompliance, and the pledge would not compromise Mexico’s basic right to economic development. In 1 Hurricane intensity has been increasing in the Caribbean basin with a 40% increase in category 4 and 5 hurricanes generated and reaching landfall over the past five years compared to a comparable period staring in 1970 in the North Atlantic. A recent analysis commissioned by the Bank indicates that a further increase should be expected as a result of increase sea surface temperatures in the Caribbean. 2 Run-off generally is equal to the difference between precipitation and evapo-transpiration and, hence, from a resource perspective, runoff is a measure of sustainable water availability. 3 These results have been confirmed through an independent assessment using the Earth Simulator. 4 Please see www.semarnat.gob.mx/Documents/Estrategias_libro_completo_compress2.pdf for the complete Strategy in Spanish. An executive summary in English can be found at www.un.org/ga/president/61/followup/climatechange/Nal_Strategy_MEX_eng.pdf . addition, emission reductions over and above the country’s voluntary commitments could be offered for sale as carbon credits on the international market. 5. The GOM has confirmed that it is working on a Special Climate Change Program (Programa Especial de Cambio Climático) to be adopted in 2008. This Program will be adopted under the 20072012 National Development Plan, and expand upon the 2007 National Climate Change Strategy, in particular by identifying priorities and financing needs for climate change mitigation. 6. Mexico City has also issued a Local Climate Change Strategy and is the first city in Latin America to have done so.5 The strategy calls for measures to reduce the carbon footprint of economic sectors and in particular, it focuses on reducing emissions from its transport sector, which accounts for about 40% of the emissions in the Mexico City metropolitan area. The strategy also prioritizes adaptation activities to climate impacts. 7. Mexico is the only developing country to have submitted a third National Communication under the UN Framework Convention on Climate Change.6 In this communication, Mexico reported its latest GHG emissions levels and trends, and described the measures that were being taken to adapt to and mitigate climate change. This communication, which preceded the adoption of the National Climate Change Strategy, shows Mexico’s commitment to analyze and address the climate change challenge. 8. Beyond strategies and programs, the country is already taking steps to reduce emissions from its business-as-usual scenario. In particular, visible and well-publicized initiatives are underway to increase reforestation and reduce flaring in the oil and gas sector.7 9. With these strategies, analyses and investments, Mexico assumes a position of leadership among developing countries. Mexico is part of the “G8+5” group of countries (G8 plus Brazil, China, India, Mexico, and South Africa) formed for the Clean Energy Investment Framework and Gleaneagles Dialogue. 10. To implement its National Climate Change Strategy (NCCS), the Government of Mexico (GoM) has requested a Development Policy Loan (DPL) in the amount of US$500 million. It is to be presented to the Board for its approval jointly with a new Country Partnership Strategy (CPS) before the spring meetings (April 11-12, 2008). The request underlines the GoM’s interest in a continued, strong engagement with the Bank, under a new business model deemed more appropriate for a leading emerging market economy like Mexico. The DPL would support government priorities within its climate change agenda. 11. Mexico is making renewed progress on its legislative reform agenda addressing some longstanding as well as newly emerging structural challenges in enhancing economic growth and reducing the still high levels of poverty. In its first year, the current administration led by President Calderón made progress in proposing, negotiating, and obtaining legislative approval of laws and amendments to the Constitution aimed at strengthening the performance of the public sector. These include reforms to the federal government workers’ pension scheme, the tax policy and administration, intergovernmental Gobierno del Distrito Federal. 2006. Estrategia local de acción climática de la ciudad de México: Acciones locales, Logros globales. Gobierno del Distrito Federal, México. 5 6 Please see http://unfccc.int/resource/docs/natc/mexnc3.pdf. 7 Illustrations are the emphasis that top public officials give in the public appearances on tree plantation through the PROARBOL program, or the Tres Hermanos associated gas flaring reduction project between PEMEX and Statoil (see http://www.statoilhydro.com/en/NewsAndMedia/News/2007/Pages/CuttingCarbonEmissionsWithPemex.aspx ) fiscal relations, and public expenditure policy and management, which were approved last year and are currently under implementation. 12. The proposed operation would be the first in a number of larger, annual Development Policy Loans (DPLs) that make up a streamlined lending program to support an expanded set of analytical and advisory services. As outlined in the Mexico 2008-2013 CPS, to be presented to the Board at the same time as the proposed loan, the GoM has requested the Bank to change its lending and advisory services program over the next few years to a series of on-demand analytical and advisory services and streamline the bulk of its lending program into one larger, annual Development Policy Loan of up to US$1 billion. The streamlined lending approach aims to minimize the transaction cost of borrowing from the Bank, thereby providing access to low-cost financing and freeing up human and budgetary resources for an enhanced, higher-value program of advisory services. The amount of the proposed DPL is below the annual target of the streamlined lending program in order to provide a transition towards the newly defined Bank support program as well as space for on-going FY08 pipeline operations. The strategy also foresees a series of smaller, environmentally-focused investment loans and grants. 13. Mexico has maintained a solid macroeconomic framework which has moderated output volatility and strengthened economic growth. A consistent set of 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 of domestic capital markets, has led to a substantial improvement of the fundamentals of the Mexican economy. The evolution of the main macroeconomic indicators over the past five years confirms a picture of balanced growth with a significant reduction of vulnerabilities to external shocks. 14. Fiscal policies, successful in reducing the public debt-to-GDP ratio, have been complemented by a debt management strategy that has favored domestic currency financing of public debt. Over the past five years, the GoM has consistently implemented a debt management strategy aimed at reducing the exchange rate and interest rate vulnerability and rollover risk, shifting away from external debt and increasing the share of fixed-rate instruments at longer maturities. Mexico now periodically issues fixedrate peso bonds with maturities of up to 30 years. The average maturity of domestic debt increased to 5.5 years by the end of 2007. 15. Despite a reduction in the absolute level of gross public external debt, the GoM has expressed its interest in keeping a liquid long-term yield curve in international bond markets as well as maintaining an active relationship with multilateral agencies. The reduction of foreign currency financing of Mexico’s public debt and its accumulation of international reserves increased its capacity to withstand turmoil on international capital markets and avoid external payment crises which disrupt economic growth and poverty reduction. Government debt management strategies take into account a combination of cost and risk considerations to reduce the longer-term borrowing cost. Even though the spread between the cost of Bank loans and Mexican global bonds has substantially narrowed over the past few years, Bank financing remains an approximate 100 basis points less expensive for Mexico at the moment. 16. The Bank’s engagement to date in Mexico on climate change issues has entailed support for 25 initiatives, financed by IBRD loans, GEF grants, carbon finance emission reduction purchase agreements, grants for capacity building in the carbon finance area, and grants for economic sector work and knowledge products. These initiatives are the result of a long-standing dialogue with a wide range of Mexican stakeholders and center on the following main objectives: (i) support for adaptation; (ii) policy development and institution building; (iii) first-of-a-kind mitigation projects and programs; and (iv) identification and promotion of short-term and long-term mitigation options (II) Proposed objective(s) 17. The objective of the proposed operation is to support the government’s efforts under its National Climate Change Strategy to (a) mainstream climate change considerations in economic policy making and (b) identify opportunities and measures to mitigate the impacts of climate change. Further, the proposed operation is part of the country’s plan to promote environmental sustainability, which, in addition to targeted social programs, infrastructure, rural development, and competitiveness, is one of the planned areas of Bank engagement in the 2008-2013 Country Partnership Strategy (CPS) for Mexico. The CPS also highlights the partnership with Mexico on climate change, aiming to (a) identify and implement measures to address key vulnerabilities to climate change; (b) collaborate with Mexico's scientific community and government agencies in the strengthening of institutional capabilities and access to knowledge on climate change; and (c) promote low carbon development. In addition, environmental sustainability is one of the key pillars of GoM’s 2007-2012 National Development Plan. 18. President Calderon’s announcement of the National Climate Change Strategy and its adoption by the Intersecretarial Commission on Climate Change in May 2007 constitute the prior action for this operation. The proposed operation provides overall budget support in recognition of the significant contribution that the National Climate Change Strategy will have on Mexico’s development agenda. The Strategy establishes the framework and represents the vital first steps for confronting the challenges of climate change in a comprehensive and integrated fashion. The Strategy was a truly national effort and a major undertaking by several Ministries, coordinated by the Secretariat of Environment and Natural Resources (SEMARNAT). It distinguishes Mexico among most other major developing countries. Only South Africa, Mexico, and China have also adopted such a strategy. 19. The following draft Policy Matrix summarizes the operation’s objectives, prior action, and expected outcomes. Key Objectives Mainstream climate change considerations in economic policy making Prior Action Adoption of National Climate Change Strategy Key Outcomes Knowledge about impacts of climate change on major on potentially vulnerable areas (e.g., coastal areas and highlands) and people (e.g., those in peri-urban areas, coastal areas, and those living at higher elevations) disseminated to relevant groups and organizations Practitioners and technical experts brought together with economic decision-makers (in same key sectors as above) Costs of confronting climate change (‘Stern report a la Mexicana’) analyzed and discussed Identify climate change mitigation opportunities Adoption of National Climate Change Strategy Special Climate Change Program (Programa Especial de Cambio Climático) adopted under the 2007-2012 National Development Plan (Plan Nacional de Desarollo), which identifies priorities and financing needs for mitigation actions Programmatic CDM activities and CDM projects developed in priority sectors (e.g., waste management, transport, tourism, energy, water, and forestry) Low-Carbon Country Case Study (MEDEC) completed Country ready for reducing emissions from deforestation and forest degradation (REDD) (III) Preliminary description 20. To support the GoM in better adapting to climate change, the operation will foster the mainstreaming of climate change considerations in economic policy making. First, it will raise awareness on climate change by: (i) disseminating and discussing the National Strategy on Climate Change amongst government and civil society groups; (ii) sharing knowledge on the impacts of climate change on potentially vulnerable areas (e.g., coastal areas and highlands) and people (e.g., those in periurban areas, coastal areas, and those living at higher elevations); (iii) inter-agency coordination and bringing together policy practitioners and technical experts with key decision-makers, especially in the economic sectors affected by changes in water resources; and (iv) considering the development of on the ground demonstration projects to help in climate risk management in key sectors. Second, it will support the analysis of the costs of confronting climate change (both through mitigation and adaptation measures). This study will provide the analytical foundation for identifying concrete programs and financing sources. 21. This operation will also facilitate the identification of mitigation opportunities, in particular through the adoption of the Special Climate Change Program. 22. Further, the operation will identify and develop particular programmatic CDM activities, other CDM projects, and build capacity for reducing emissions from deforestation and forest degradation (REDD). The Bank will assist in the identification and development of programmatic CDM activities in priority sectors that the GOM has identified, e.g., waste management, transport, tourism, energy, and water resources. Developing a CDM program of activities may require cross-sectoral coordination, as well as strengthening the institutional capacity of sectoral/regional agencies. REDD is also a priority for the GOM, and the country will develop its capacity, also referred to as ‘readiness,’ to undertake REDD activities. By building its readiness for REDD, Mexico can acquire the methods and systems that will allow it to benefit from financial incentives in the post-2012 climate change regime. 23. The identification and development of programmatic CDM activities and REDD programs are expected to complement the ongoing Low-Carbon Country Case Study (MEDEC) and the existing grants under the Bank-managed CF-Assist program. Moreover, the Bank can facilitate financing of the programmatic CDM activities and REDD programs under the proposed Climate Investment Facility, the recently announced Norwegian initiative on tropical forests, and the new carbon facilities proposed by the Bank, namely the Carbon Partnership Facility and the Forest Carbon Partnership Facility. (IV) Environment Aspects 24. The provisions of OP8.60 apply to the proposed operation. The operation is expected to have positive impacts on the environment and natural resources. The operation is precisely designed to reduce the adverse environmental impacts of climate change. It supports the government’s efforts under its National Climate Change Strategy, in particular the reduction of GHG emissions on a voluntary basis. Therefore, in the short term, no environmental costs are expected from the implementation of the National Climate Change Strategy. It is possible, however, that in the medium to long term, certain mitigation and adaptation measures might have indirect environmental impacts due to the need for relocating infrastructure or agricultural activities. These costs would be justified by the paramount objective of protecting this infrastructure or agricultural potential in the first place. However, environmental assessments for the corresponding investments would be needed so that these indirect costs can themselves be mitigated. 25. With respect to social aspects, the short-term priority for the Bank is to support the scientific modeling of climate change effects on the country and in the region to build the scientific base that will lead to adaptive measures. This modeling is expected to provide better estimates of these corresponding costs, including costs for their mitigation. (V) Tentative financing Source: Borrower International Bank for Reconstruction and Development Total (VI) Contact point Contact: Benoit Bosquet Title: Natural Resources Mgmt. Spec. Tel: (202) 458-0923 Fax: (202) 614-1190 Email: [email protected] ($m.) 0 500 500