Document ofThe World Bank

Report No: 33228-MX

GEF PROJECT BRIEF

ON A

PROPOSED LOAN

IN THE AMOUNT OF USD 81 MILLION

AND

PROPOSED GRANT FROM THEGLOBAL ENVIRONMENT FACILITY TRUST FUND

IN THE AMOUNT OF USD 15 MILLION

TO THE

NACIONAL FINANCIERA

FOR A

ENVIRONMENTAL SERVICES PROJECT

September 27, 2005

CURRENCY EQUIVALENTS

(Exchange Rate Effective as of August 16, 2005)

Currency Unit = Mexican Peso (MXP)10.61 pesos = USD$1

FISCAL YEARJanuary 1 – December 31

ABBREVIATIONS AND ACRONYMS

BMP Best Management Practices , Mejores Prácticas de ManejoCABSA Program to Develop Environmental Services Markets for Carbon Capture and Biodiversity and

to Establish and Improve Agroforestry Systems, Programa para Desarrollar el Mercado de Servicios Ambientales por Captura de Carbono y los Derivados de la Biodiversidad y para Fomentar el Establecimiento y Mejoramiento de Sistemas Agroforestales

CAS Country Assistance Strategy , Estrategia de Asistencia al PaísCBD Convention on Biological Diversity, Convenció de BiodiversidadCCMSS Mexican Civil Council for Sustainable Forestry , Consejo Civil Mexicano para la Silvicultura

SostenibleCDM Clean Development MechanismCFE Federal Electricity Commission, Comisión Federal de ElectricidadCNA Nacional Water Comisión, Comisión Nacional del AguaCOINBIO Indigenous and Biodiversity Conservation Project , Proyecto de Conservación de la

Biodiversidad en Comunidades Indígenas de los Estados de Guerrero, Michoacán y OaxacaCOLPOS Postgraduates College, Colegio de PostgraduadosCONABIO National Commission for Biodiversity Knowledge and Use, Comisión Nacional para el

Conocimiento y Uso de la BiodiversidadCONACYT National Committe for Science and Technology, Consejo Nacional de Ciencia y TecnologíaCONAF National Forestry Council, Consejo Nacional ForestalCONAFOR National Forestry Commission, Comisión Nacional Forestal (Executor of the current Program)CONANP National Commission for Natural Protected Areas, Comisión Nacional de Áreas Naturales

ProtegidasCONAPO National Forestry Council, Consejo Nacional de la PoblaciónCPAR Country Procurement Assessment Report, Evalución de los Sistemasde adquisiciones del PaísEA Environmental Assessment, Análisis AmbientalEnvSAL I & II Environmental Structural Adjustment Loan, Préstamo de Ajuste Estructural AmbientalFAO Food and Agricultural OrganizationFFM Mexican Forestry Fund, Fondo Forestal MexicanoGEF Global Environment FacilityIBRD International Bank for Reconstruction and DevelopmentINE National Ecology Institute, Instituto Nacional de EcologíaIPDP Indigenous Peoples Development Plan, Plan de Desarrollo para Pueblos IndígenasGOM Government of Mexico, Gobierno de México

LFD Federal Rights Law, Ley Federal de Derechos (sets fees for national resources and services)MBC Mesoamerican Biological Corridor, Corredor Biológico MesoamericanoMSP Medim-sized project, Proyecto de tamaño medianoMXP Mexican pesosNAFIN GOM’s Development Bank, Nacional Financiera, S.N.C. (Financial Agent for the Loan)NGO Nongovernmental organization, Organismo No Gubernamental

NPA Non Protected Area , Area No ProtegidaOECD Organization for Economic Cooperation and Development

Organización para la Cooperación y Desarrollo EconómicoPCABSA Capacity-Building Program for Carbon Production, Biodiversity and Agri-Forestry System

Derivatives, Programa de Construcción de Capacidades para la Producción de Servicios Ambientales de Carbono, Biodiversidad y derivados de los Sistemas Agroforestales

PCU Project coordination unit, Unidad de coordinación del proyectoPEMEX Mexican Petroleum Company, Petróleos MexicanosPES Payment for Environmental Services, Pago por Servicios Ambientales PHRD Policy and Human Resources DevelopmentPOA Annual Operational Program, Programa Operativo AnualPROCYMAFI & II

Community Forestry Management and Conservation Program in Mexico, partially funded with WB resources. Loan 4137-ME, Programa de Desarrollo Forestal Comunitario I y II (Proyecto de Conservación y Manejo Sustentable de Recursos Forestales en México financiado parcialmente con recursos del Banco Mundial. Préstamo 4137-ME)

PRODEFOR Forest Development Program, Programa para el Desarrollo ForestalPRODEPLAN Forest Plantation Program, Programa de Plantaciones ForestalesPROCOREF Program for Forest Conservation and Restoration, Programa de Conservación y Restauración

ForestalPROFAS Reinforcement Program for Forest Self-Management, Programa de Fortalecimiento a la

Autogestión de los SilvicultoresPSAH Payments for Hydrological Environmental Services Program, Programa de Pago por Servicios

Ambientales HidrológicosPSTyP Register of Technical and Professional Services, Padrón de Servicios Técnicos y ProfesionalesRAN National Agrarian Registry, Registro Nacional AgrarioRPC Priority Conservation Regions, Regiones Prioritarias de ConservaciónSAO Oaxaca Environmental Services, Servicios Ambientales de OaxacaSINAP National System of Natural Protected Areas, Sistema Nacional de Areas Naturales Protegidas

Vice President: Pamela CoxCountry Director: Isabel Guerrero

Sector Director: John RedwoodSector Manager: Abel Mejia

Sector Leader: Ethel SennhauserTask Team Leader: Mark Austin

MEXICOEnvironmental Services

CONTENTS

Page

A. STRATEGIC CONTEXT AND RATIONALE......................................................................1

1. Country and sector issues....................................................................................................1

2. Rationale for Bank involvement..........................................................................................4

3. Higher level objectives to which the project contributes.....................................................4

B. PROJECT DESCRIPTION..................................................................................................6

1. Lending instrument..............................................................................................................6

2. Project development objective and key indicators..............................................................6

3. Project components..............................................................................................................7

4. Lessons learned and reflected in the project design..........................................................11

5. Alternatives considered and reasons for rejection.............................................................12

C. IMPLEMENTATION.........................................................................................................14

1. Partnership arrangements (if applicable)...........................................................................14

2. Institutional and implementation arrangements.................................................................14

3. Monitoring and evaluation of outcomes/results................................................................16

4. Sustainability and Replicability.........................................................................................17

5. Critical risks and possible controversial aspects...............................................................18

6. Loan/credit conditions and covenants...............................................................................20

D. APPRAISAL SUMMARY..................................................................................................20

1. Economic and financial analyses.......................................................................................20

2. Technical............................................................................................................................22

3. Fiduciary............................................................................................................................22

4. Social.................................................................................................................................22

5. Environment......................................................................................................................24

6. Safeguard policies..............................................................................................................25

7. Policy Exceptions and Readiness......................................................................................25

Annex 1: Country and Sector or Program Background..........................................................26

Annex 2: Major Related Projects Financed by the Bank and/or other Agencies..................39

Annex 3: Results Framework and Monitoring.........................................................................41

Annex 4: Detailed Project Description......................................................................................52

Annex 6: Implementation Arrangements..................................................................................74

Annex 7: Financial Management and Disbursement Arrangements......................................78

Annex 8: Procurement Arrangements.......................................................................................83

Annex 9: Economic and Financial Analysis..............................................................................84

Annex 10: Safeguard Policy Issues.............................................................................................90

Annex 11: Project Preparation and Supervision......................................................................98

Annex 12: Documents in the Project File..................................................................................99

Annex 13: Statement of Loans and Credits.............................................................................101

Annex 14: Country at a Glance................................................................................................104

Annex 15: Incremental Cost Analysis......................................................................................106

Annex 16: STAP Roster Review...............................................................................................114

Annex 17: Pilot Site Selection Criteria....................................................................................115

Annex 18: Detailed Lessons Learned.......................................................................................120

Annex 19: Payment for Environmental Services-Water Program (PSAH).................................126

Maps

A. STRATEGIC CONTEXT AND RATIONALE1. Country and sector issues.

1. Since the 1994 crisis, Mexico had undertaken impressive reforms leading to a major political and economic transformation in the last decade. Yet, there is still a substantial agenda that the government seeks to advance within the context of its National Development Plan, including very important poverty reduction, improved competitiveness, environmental management and institutional change.

2. The problems of water scarcity and deforestation are two important environmental challenges facing Mexico. Mexico is experiencing rapid environmental degradation, including one of the region’s fastest rates of deforestation. This degradation is aggravating already severe water scarcity and contamination problems, threatening current and future economic activity and the welfare of Mexico’s people, and leading to the loss of globally-important biodiversity.

3. Water . Water consumption patterns in Mexico are unsustainable. According to the National Water Commission (CNA), 66% of the 188 most important aquifers in the country suffer from overexploitation, and another 28% are in a fragile equilibrium.

4. Deforestation . In recent decades, Mexico has suffered one of the world’s highest deforestation rates, second only to Brazil. FAO had consistently reported a loss of around 1.3% per year, of which 66% occurred in tropical forests, including areas of high biodiversity value. In 1993, Mexico had 70 million ha of forest and tropical forest. By 2000, 3.1 million ha had been transformed to agricultural uses and 5.1 million ha had been converted to pasture, with only 1.7 million ha being reforested or regenerated.

5. Water problems and land use change are closely related. Rapid deforestation has adversely affected the regulation of water flows and the sedimentation of reservoir. Scientific work highlights the role that cloud mountain forests play in providing surface water flows during the dry season in Mexico’s Veracruz watersheds. There is evidence of an environmental service provided in this case by dry tropical forests that of reducing the risk of floods during storms in western Jalisco. Also, there is evidence that the Sierra Gorda’s forests are fundamental for water recharge in the aquifers supplying the cities of Queretaro and San Juan del Rio.

6. Critical Ecosystems and Globally Significant Biodiversity . Mexico is one of the mega-biodiversity countries in the world, with first place in reptilian diversity, second in mammal and fourth in plant diversity. Its plant diversity exceeds that of the United States and Canada combined. Mexico is regarded as one of the world’s most important centers of genetic diversification in plants and one of the areas where agriculture originated. Some 120 cultivated plant species belonging to 39 families originated in Mexico, including cocoa, kidney beans, maize and tomatoes.

7. Land use change is eroding Mexico’s extraordinary biological wealth. One third of birds and nearly 66% of amphibian, reptile and mammal species are at risk. 2,582 species and subspecies are at risk (161 more than under the previous 1994 standard), of which 41 are already extinct in the wild, 1,215 are endangered or threatened with extinction, and 1,326 are subject to special protection. Although the 154 federally administered natural protected areas (NPAs) cover almost 19 million hectares, many areas with important biodiversity do not have protected status.

8. Rural Poverty and Forests . Mexican forests are located almost entirely in common property lands, the owners of which are among the poorest in the country. Nearly 85 percent of

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localities in forested areas have a “high” or “very high” marginality index. This has two important implications. First, poverty is one of the driving forces in deforestation. Second, poor households are highly dependent on forest resources, so degradation of these resources hinders their ability to sustain their livelihoods. The indigenous people of Mexico have an important presence in forested areas. 20% of ejidos or communities that have more than 100 ha of forests have a large majority of indigenous households, compared to only 2% of ejidos without forests.

9. Government Strategy . These challenges are being met with efforts by the government and civil society. To halt and reverse the deforestation trend, the Mexican government has committed to a “zero deforestation” target. In April 2001 the Government of Mexico created the National Forest Commission (CONAFOR) with the mandate to support sustainable production of forests and conservation of forest resources based on a Strategic Forestry Program (2000-2025) with a 25 year horizon. CONAFOR’s creation and its long-term plan, represents a significant effort to reverse the deterioration and depletion of natural resources, and to transform this national problem into a productive asset through the launching and implementation of guidelines for sustainable management of forests, water and soil of new programs. Its sectoral approach is complemented by the Sustainable Development Program (Programa de Desarrollo Sustentable del Gobierno Federal) which represents a formal effort to build synergies and complementarities among the different government policies and instruments which have historically responded to oftentimes conflicting sectoral interests. The policy strategy dealing with forests has a series of programs that support commercial forestry, build capacities among poor forest-owning communities, and invest in reforestation.

10. PSAH . The Payments for Hydrological Environmental Services Program (PSAH), started in October 2003, was designed to complement other initiatives by providing economic incentives to avoid deforestation in areas where water problems are severe, but where in the short or medium term commercial forestry could not cover the opportunity cost of switching to agriculture or cattle ranching. PSAH consists of direct payments to landowners with forests in good state of conservation. Payments are made for watershed conservation, management, and restoration aimed at preserving temperate and tropical forest lands (and in particular, high montane cloud forests) associated with the supply of water to communities. Part of its innovative approach is that it is funded through an earmarked percentage of the water fees collected under the Federal Rights Law (LFD).

11. Since the PSAH’s inception in 2003, it has had rapid acceptance. MXP200 million (US$18.2 million) were allocated from the national budget in 2003, and MXP300 million in each of 2004 and 2005. The program pays MXP300/ha (US$27.3) to conserve forests, and MXP400/ha ($US36.4) to conserve cloud forests. In 2003 more than 900 applications were received offering close to 600,000 ha, of which 271 were selected, incorporating 127,000 ha into the program. In 2004, Congress increased the PSAH’s budget by 50%. 960 applications were received, of which 352 were chosen, covering about 180,000 ha.

12. Despite the program’s achievements, there remains room for improvement. In particular, the following areas need to be addressed; (i) the majority of the contracted area is outside the priority conservation areas—less than 14% of the area enrolled in 2003 and 2004, for example, was located in areas with over-exploited aquifers; (ii) most of the enrolled area is at low risk of deforestation—less than 20% of the area enrolled in 2003 and 2004 was in areas with high or very high risk of deforestation, while 62% was in areas of low or very low risk of deforestation; (iii) most contracts have gone to the better organized, more developed communities and ejidos,

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and to private owners, even though their opportunity cost tends to be higher; (iv) budgetary limitations impose a 5-year limit on payments to any one participant, putting conservation beyond that period at risk; and (v) there is a lack of training and capacity building (on both the supply and demand sides) to develop local markets.

13. Market Driven Payments for Environmental Services (PES) . The proposed project will address these weaknesses. Its primary objectives are to (i) secure the long-term sustainability of the PES program by developing new, sustainable long-term financing mechanisms based on payments from service users; (ii) increase the program’s efficiency and cost-effectiveness by focusing it in areas of greatest deforestation risk and overexploited watersheds with areas of water scarcity; (iii) improve its contribution to poverty reduction; (iv) increase its contribution to the conservation of globally important biodiversity by focusing it in critical ecosystems.

14. PES programs are also more likely to be sustainable because they depend on the self-interest of the affected parties rather than taxes, tariffs, philanthropy or the whims of donors. By providing payments on an ongoing basis, PES programs avoid the pattern of short-term adoption followed by rapid abandonment that has characterized past approaches. They can also help reduce poverty because the areas that provide environmental services (and receive payments) correlate highly with areas of rural poverty. The project builds on previous experience with the use of PES, including a successful nation-wide program in Costa Rica that is supported by the Bank and GEF, and a wide range of small-scale initiatives throughout the region, including several in Mexico itself.

Country GEF Eligibility and Drivenness

15. Mexico ratified the Convention on Biological Diversity on March 11, 1993. It is also a signatory to the Convention on International Trade in Endangered Species of Wild Flora and Fauna (CITES) and the Cartagena Protocol on Biosafety). The project’s objectives are fully consistent with guidance from the Conference of the Parties of the Biodiversity Convention regarding conservation and sustainable use of biological diversity. The project is consistent with the guidelines and decisions of a number of CBD Conference of the Parties in particular, with the Addis Ababa Principles and Guidelines number 12 which was adopted by CBD VII Decision 12 under Article 10. The project contributes to the Article by promoting economic incentives to generate additional benefits to indigenous and local communities and stakeholders who are involved in the management of any biodiversity. Furthermore, the project also contributes to the Decision 14 (Biological Diversity and Tourism) and 16 by creating appropriate mechanisms to capture the economic benefits of ecological services. In addition, the project is also consistent with the COP VI Decision 15 (Incentive measures).

16. To address the daunting challenge of environmental issues in the country, the Government of Mexico (GOM) has taken a number of actions including legislative, institutional and budgetary. For example, the GOM created the National System of Protected Natural Areas (SINAP) in 1986 to provide protection to some of its rich habitats and biological diversity. With the support from GEF and the World Bank, an endowment fund was created to capitalize financial resources to provide long term financing for protecting the SINAP. Furthermore, the Mexican government has pledged to be committed to a “zero” deforestation target. In addition, the government has been piloting economic incentives mechanism for changing land holder behaviors to promote conservation measures. The introduction of fiscal instrument (e.g., water fee) and PSAH program are examples of GOM’s serious commitment in conservation and

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sustainable use of its natural resources. To advance this agenda, the GOM has requested the World Bank and GEF to help them prepare the proposed project.

2. Rationale for Bank involvement

17. The World Bank has considerable experience in the design, implementation, and support of PES programs in developing countries. Several Bank projects that use PES are under implementation with GEF cofinancing, and others are under preparation (see Table A1-5). In parallel, the Bank has been undertaking research on PES and providing the results to practitioners through capacity-building efforts. No other institution has the same depth of experience in implementing PES approaches.

18. GEF support is warranted because the project would help (i) conserve globally significant biodiversity, including critically endangered endemic species, (ii) enhance the Mexico sections of the MBC, (iii) pilot PES as a sustainable, long-term conservation instrument that could be scaled up and replicated in Mexico and serve as a model for other countries, (iv) research links between land use change and environmental services; and (v) increase carbon sequestration and knowledge about biocarbon sinks. Without the GEF increment, environmental services payments might not provide sufficient incentive to adopt land uses that would yield global benefits in addition to local and national benefits.

3. Higher level objectives to which the project contributes

19. The environmental objectives of the Mexican government are to increase sustainable development as a shared responsibility; facilitate decentralization of environment management and increased public participation; promote payment for environmental services program; decrease loss of temperate and tropical forests; conserve biodiversity; and increase sustainable water resource management (2001-2006 Mexico Environment and Natural Resources Program).

20. The 2005-2008 Mexico CAS addresses four core issues: (a) the reduction of poverty, (b) environment management, (c) increased competitiveness, and (d) improved governance. It builds on the positive experience of the EnvSAL (a development policy loan, or DPL) in its review of existing programs and incentive structures, to address the implicit short-term tradeoffs between social protection and environmental protection.

21. The CAS recognizes that Mexico faces tremendous pressure on its natural environment; to the degree that failure to reverse some of the most damaging trends may not only act as a brake on continued economic growth, but even contribute directly to reduced social welfare and increasing poverty. The CAS addresses the need to consolidate the regulatory and legal framework for environment issues and support implementation of measures aimed at watershed recovery, reforestation, decontamination, clean production, management of ecosystems, and biodiversity conservation. The CAS notes that vulnerability to natural disasters is closely related to rural poverty and that low productivity and high population pressures have depleted natural resources in many rural areas, caused soil erosion and land degradation, led to loss of habitat, biodiversity, and natural forests, and exacerbated problems in water management and conservation. In response, the CAS supports development of markets for environmental services and strengthening of protected areas management.

22. The project is consistent with the Bank’s 2002 rural and environment strategies for Latin America. The rural strategy aims to reduce poverty and promote growth within the context of

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sustainable natural resources management and calls for better integration of environmental issues into rural development to build consensus around possible “win-win” opportunities. The environment strategy promotes sustainable, integrated management of natural resources and ecosystems with a focus on highly degraded and disaster-prone areas. The project would support both strategies by developing PES markets that generate win-win opportunities for poverty alleviation, economic growth, and environmental protection.

23. The project also takes into account the Bank’s 2002 Forest Strategy, which is built on (a) harnessing the potential of forests to reduce poverty, (b) integrating forests in sustainable economic development, and (c) protecting global forest values. The strategy notes that addressing these three aspects together is complex and multifaceted—not merely about growing trees but rather supporting a complex interaction of policies, institutions, and incentives. It focuses on economic policies and rural strategies that embrace both sustainable use and conservation of vital environmental services, seeking to build markets and financial instruments in support of private investments in sustainable natural resource management.

24. The GEF operational program goal supported by the project. The proposed project supports the GEF Biodiversity Focal Area by protecting natural habitats and biological diversity through forest conservation, reversion of marginal agricultural areas to forest, and promotion of sustainable practices in agriculture. It supports Operational Programs 3 (Forest Ecosystems) and 4 (Mountain Ecosystems) by promoting conservation of biodiversity in key forest and mountain ecosystems. Within the Biodiversity Focal Area, the project particularly fits with two Strategic Priorities: Catalyzing Sustainability of Protected Areas (SP1) and Mainstreaming Biodiversity in Production Landscapes and Sectors (SP2).

25. Under SP1, the project would help ensure sustainability of the national protected areas system by providing a mechanism for long-term financing of biodiversity conservation in the buffer zones of protected areas and the corridors that connect them, including the Mexican portion of the Mesoamerican Biological Corridor.

26. Under SP2, the project will focus on two types of activities: (i) facilitating the mainstreaming of biodiversity within productive landscapes, and (ii) developing market incentive measures. Facilitating the mainstreaming of biodiversity within productive landscapes. Through this type of activity the GEF seeks to support development of the institutional capacities of government agencies and other stakeholders that would help secure biodiversity conservation. This could be achieved through enabling legislation, removing barriers to conservation, reforming or creating policies, institutional structures, and management procedures, generating relevant knowledge, and building partnerships between agencies, local communities, and the private sector. Activities of this type under Component 2 of the project include strengthening the capacity of national institutions such as CONAFOR, community associations, NGOs, and academic institutions to support development of PES markets in Mexico. Component 1 activities will help create an enabling environment for development of a PES market in Mexico and generate financial resources for the PES program.

27. Developing market incentive measures . Through this type of activity in SP2, the GEF seeks to support innovative market incentive structures (such as demand and supply side interventions, certification of suppliers, purchasing agreements, and codes of conduct) that would catalyze market forces. In doing so GEF seeks to develop partnerships with private sector stakeholders, small- and medium-size enterprises, and others to catalyze the development of innovative processes and

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activities that improve market efficiency and the ability to provide biodiversity and productive system gains. Activities of this type under Component 1 of the project will support the development of PES markets whereby land users will receive economic incentives for adopting and/or maintaining land use practices that generate valuable ecosystem services. The markets will be piloted in eight priority areas that provide environmental benefits at the local, national, and global levels. These mechanisms will support land use practices such as forest conservation and management, reforestation, and sustainable agroforestry systems that improve water quality, increase base flows during the dry season, help regulate groundwater and surface flows, and maintain or enhance biodiversity both on-site and by protecting critical ecosystems.

28. The project would also complement the SINAP II Protected Areas Project, a GEF co-financed project to strengthen protected areas management. The project's goal is to promote the conservation and sustainable use of biodiversity in Mexico through the consolidation of the National System of Protected Areas (SINAP). Specific objectives are to: 1) conserve globally important biodiversity in selected areas of SINAP; 2) Promote the economic, social and environmental sustainability of productive activities in selected protected areas; 3) Promote social co-responsibility for conservation; and 4) Promote the inclusion of biodiversity conservation and sustainable use criteria in development projects and other practices affecting selected Protected Areas. The proposed project would complement the SINAP II objective by improving habitats on private lands in buffer zones and corridors around and between protected areas, thereby improving the viability and biodiversity conservation value of the protected areas themselves. Developing PES markets will also foster and strengthen partnerships between local and national government, NGOs, community organizations, and the private sector and will help promote an integrated ecosystem approach to watershed management.

B. PROJECT DESCRIPTION

1. Lending instrument.

29. Fixed-Spread Loan (FSL). The proposed project would be financed through an IBRD loan of US$81.0 million, a GEF grant of US$15.0 million, government counterpart funds of US$43.3 million, project beneficiary contributions of US$32.7 million and the Biodiversity endowment fund interest earning of 1.5 million for a total project of US$173.3 million.

2. Project development objective and key indicators

30. The project development objective is to improve the provision of environmental services that bring both national benefits (primarily water services) and global benefits (primarily increased biodiversity conservation) by strengthening and expanding the PSAH and CABSA programs and supporting the establishment of local payments for environmental services (PES) mechanisms.

31. The objective will be achieved through (i) strengthening the capacity of CONAFOR, INE, community associations, and NGOs to increase flexibility and improve efficiency of existing service provision to support long-term development of PSAH program in Mexico; (ii) establishing sustainable long-term financing mechanisms; (iii) establishing legal, institutional, and financial arrangements to pilot market based mechanisms for payment for environmental services, (iv) documenting links between land use changes and water services improvements and

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biodiversity conservation, (v) defining good practices to replicate, scale up, and sustain PES market based programs.

32. The global environment objective of the project is to enhance and protect biological diversity and preserve globally significant forest and mountain ecosystems. This would be done by improving the targeting of the existing PSAH program, by piloting a market-based system to contract environmental services and by establishing an endowment fund for biodiversity conservation to provide long-term financing for payment for environmental services. The project will ensure that only sites with globally significant biodiversity will receive GEF funds under the national or local programs in the project area. In addition, these sites (see Annex 17) are recognized as part of the national protected areas system. Furthermore, all land management systems with PES support under the project (from any funding source) will be biodiversity-friendly (see Annex 10 for details).

33. As detailed in Annex 17, all eight of the pilot sites where PES systems would be established, strengthened, or continued under the project were chosen to overlap with at least two of the following high-priority biodiversity conservation designations: (i) existing Natural Protected Areas; (ii) Priority Terrestrial Ecoregions established by CONABIO; (iii) Important Bird Areas that are vital to the survival of endemic species or to protecting key bird breeding, feeding, and migration areas; and (iv) Ramsar Wetlands of International Importance.

34. Key performance indicators related to the project development and global environment objectives are:

At least 100,000 hectares under environmental service contracts that contribute to increase hydrological services, biodiversity conservation and carbon sequestration financed wholly or partially from new financing sources established under the project;

Stand-alone local PES mechanisms designed for at least two pilot sites for contracting (buying and generating) environmental services in priority areas, including functioning M&E systems by EOP;

500,000 ha under environmental service contracts that contribute to increase hydrological services financed from existing funding sources;

At least 15 proposals for carbon sequestration projects are submitted to potential buyers; Institutional arrangements for facilitating PES mechanisms management and learning

established, properly staffed, and resourced to continue beyond the EOP to replicate and scale up PES market based program;

CONAFOR and INE use state of the art techniques and procedures to monitor data on implementation and impacts of both the national PES program and pilot local PES mechanisms (i.e., vegetation cover, land use practices, ecosystems and habitats, indicator species of conservation interest, water discharge, sediment production and transport, biochemical oxygen demand (BOD) and total suspended solids.);

CONAFOR and INE use the information to evaluate and draw conclusions on (i) the links between land use changes and environmental services, (ii) buyers’ responses, (iii) community acceptance of the PES mechanism, and (iv) sustainability of the mechanism measured by the ratio of payments from local buyers of ES and CONAFOR’s operational costs;

200,000 ha of forests and other natural ecosystems of global biodiversity significance placed under effective conservation (protection and sustainable management) by landowners before

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EOP in the buffer zones of protected areas and the corridors that connect them, including the Mexican portion of the Mesoamerican Biological Corridor;

XX number of PES contracts to conserve forests or other natural ecosystems by EOP; Effective biodiversity conservation in the project sites measured by vegetation cover and

indicator species of conservation interest; and Improved water services in pilot watersheds measured by indicators appropriate to local uses,

such as seasonal mean and peak flows, reduction of sediment production and transport, biochemical oxygen demand (BOD) and total suspended solids.

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3. Project components

35. The proposed project would increase substantially the development of markets for environmental services in Mexico by (i) developing new, sustainable financing mechanisms for environmental services, which could be channeled either through the existing PES programs or through new, stand-alone local PES mechanisms; (ii) strengthening and improving the efficiency of existing PES programs (PSAH and CABSA); (iii) stimulating the development of stand-alone local PES programs; and (iv) assisting local communities in service provision. Component 1

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Table 3: Project Component Costs and Financing (million US$)

Component /Sub-component

Total GEF IBRD Government Benefi-ciaries

$ % $ % $ % $ % $ %I. Developing Sustainable Financing Mechanisms

21.36 12 10.58 71 1.59 2 9.19 17   

a. Development of financing mechanisms from water users

1.95 1 0.49 3 0.95 1 0.51 1  

 b. Development of financing mechanisms from biodiversity users

18.47 10 9.68 65 0.30 0.4 8.50 16   

 - Local PES Program for

Biodiversity1.47 1 1.18 8 0.30 0.4      

 - Development and

capitalization of biodiversity endowment fund

17.00 9 8.50 57      8.50  16  

 c. Development of financing mechanisms from carbon users

0.94 1 0.42 3 0.34 0.4 0.18 0.4  

 II. Developing And Strengthening PES Delivery Mechanisms

3.70 2 1.20 8 1.63 2 0.88 2  

 a. Strengthening of existing PES programs

2.48 1 0.75 5 1.13 1 0.61 1   

b. Support development of stand-alone local PES programs

1.10 1 0.33 2 0.50 1 0.27 1  

 c. Matching Funds for Local Financing Mechanisms

0.13 0 0.13 1           

III. Supporting Environmental Services Providers

2.00 1 0.80 5 0.78 1 0.42 1  

 a. Technical Assistance 1.00 1 0.40 3 0.39 0.5 0.21 0.5    b. Organizational Assistance 1.00 1 0.40 3 0.39 0.5 0.21 0.5    IV. Payment To Services Providers

148.6082

1.58 11 73.29 91 40.99 77 32.73

V. Project And Program Management

0.97 1 0.46 3 0.34 0.4 0.18 0.4   

Contingencies/unallocated 5.16 3 0.39 3 3.11 4 1.67 4 0.00  Total: 181.

79  15.0

0  80.7

3  53.3

3  32.7

3 

focuses on developing sustainable financing mechanisms. Component 2 activities support the development and strengthening of PES delivery mechanisms. Component 3 supports environmental service providers. The actual flow of payments to participants and the ongoing operational costs of the program are tracked under component 4. Finally, component 5 undertakes project management (See Annex 4 for details).

Component 1: Developing Sustainable Financing Mechanisms ($21.36 million, of which $ 10.58 million from GEF)

36. The main objective of this component is to develop new, sustainable financing sources based on payments from service users, which could then be channeled either through the PSAH or through stand-alone local PES mechanisms, as appropriate. To achieve this objective, this component will help develop financial mechanisms based on the main types of environmental services: water quality and regulation, biodiversity conservation, and carbon sequestration. These financial mechanisms would be piloted in about eight promising sites identified by CONAFOR (see Annex 17). Some sites might focus on a single financing mechanism while others include multiple financing mechanisms, depending on the services being generated and the interests of users.

37. Key outputs from this component include (a) pilot financing mechanisms with local water services in at least seven sites, including some mechanisms that channel payments through the PSAH and others that channel payments through stand-alone local PES programs; (b) pilot financing mechanisms for local biodiversity users (primarily the tourism industry) in at least four sites; (c) development and initial capitalization of an endowment trust fund for biodiversity conservation to ensure the availability of long-term funding for cases where water-based payments would be insufficient to ensure conservation of biodiversity; (d) pilot financing mechanisms for carbon buyers in at least two sites; and (e) replication strategies to expand the use of these mechanisms beyond the pilot sites.

38. Key inputs for the success of this component include (i) providing the necessary resources for CONAFOR to implement the activities; (ii) providing adequate resources to design and implement the operational manual; and (iii) providing resources to design and capitalize the biodiversity endowment fund.

Component 2: Developing and Strengthening PES Delivery Mechanisms ($3.70 million, of which $1.20 million from GEF)

39. The objectives of this component are to strengthen the existing PSAH and CABSA delivery mechanisms and to support the development of new, stand-alone delivery mechanisms for local PES markets. Having financing is not sufficient; mechanisms are needed to act as intermediaries between service users and service providers. These mechanisms must undertake functions such as determining how best to generate the services that users are paying for, identifying critical areas and land use practices to be targeted, negotiating with and contracting service providers, monitoring compliance, making payments, and monitoring impacts. CONAFOR has already created the PSAH (and on a smaller scale CABSA) to undertake this role. However, both PSAH and CABSA are young mechanisms that require considerable strengthening and improvement to increase their efficiency and their capacity to handle the greater and more complex demand generated through component 1 (see Annex 6 on institutional arrangements).

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40. Key outputs from this component include (i) stronger capacity in CONAFOR and other national institutions, market intermediaries, community associations, and NGOs to undertake the functions necessary to implement PES programs, (ii) greater efficiency and effectiveness of the PES programs of PSAH and CABSA, including revised rules and location-specific operational manuals to better target programs and differentiate between specific local situations, (iii) improved compliance and impact monitoring to increase the credibility and sustainability of PES programs, (iv) better promotion to foster broader support and participation in the programs, (v) development of stand-alone PES programs closely attuned to local conditions and separate from existing delivery mechanisms, (v) a matching fund system to help local financing mechanisms get started and transition to self-sufficiency.

41. Key inputs for the success of this component include (i) financial resources and technical assistance to help existing PES mechanisms carry out the activities and capacity building envisioned, (ii) equipment, training, resources, and technical assistance to improve compliance and impact monitoring, (iii) resources, TA, training, and study trips to help local stakeholders develop their own customized stand-alone PES mechanisms, (iv) resources to design rules and arrangements for a program of matching funds.

Component 3: Supporting Environmental Service Providers ($2.00 million, of which $0.80 million from GEF)

42. This component would focus on removing obstacles that may prevent communities from participating in either national PES program or local PES mechanisms with a particular focus on problems faced by poor communities.

43. Key outputs from this component include (i) identification and resolution of technical issues that constrain potential environmental service producers from participating in PES programs, (ii) greater capacity of service providers to fulfill contract commitments, (iii) more equitable distribution of the costs and benefits of participation in the program, and (iv) greater transparency in decisionmaking and greater participation of vulnerable and marginalized groups.

44. Key inputs include (i) consultancies to identify key technical issues and constraints to participation and to identify the organizations most capable of providing appropriate technical assistance, (ii) resources to contract the appropriate technical assistance, and (iii) funding to train and support local community technicians to work with communities in developing customized capacity building strategies and act as liaisons between communities and the project.

Component 4: Payment to Service Providers ($148.60 million, of which $1.58 million from GEF)

45. The objective of this component is to finance and make actual payments to environmental service providers and ensure that they are being compensated properly. This component will channel payments from the financing mechanisms developed in component 1, through the delivery mechanisms developed and strengthened under component 2, and to the service providers supported through component 3. While the bulk of project financing is allocated to this component, most of the activities to actually arrange, structure, and monitor this flow of financing are carried out under other project components.

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46. The key output of this component is the financing of payments to environmental service providers from financing sources via the FFM or stand-alone delivery mechanisms. Key inputs include the resources generated by the full range of PES financing mechanisms and funding sources already in existence or developed under component 1, including:

Share of water tariffs from the Ley Federal de Derechos (LFD) that are earmarked for PES. New financial resources from water users generated by mechanisms developed under

component 1A. Tourism industry fees and contributions developed under component 1B. GEF and Biodiversity Conservation Endowment Fund resources. Carbon sales from programs supported under component 1C. World Bank resources to finance pilot PES programs and matching fund.

Component 5: Project and Program Management ($0.97 million, of which $0.46 million from GEF)

47. This component focuses on project management mechanisms including planning and monitoring and evaluation (M&E). It would help new and existing entities and mechanisms in the national government conduct project coordination and supervision and strengthen the effectiveness and quality of project operations.

48. Key outputs include (i) establishment of a PCU within CONAFOR to manage the project, (ii) overall financial management and control of financial flows, (iii) project planning, and (iv) project and program monitoring and evaluation.

49. Key inputs include (i) salaries for staff of the PCU, (ii) office equipment, vehicles, and hydrological and biodiversity monitoring equipment, and (iii) resources to create and maintain performance monitoring and evaluation systems and modules.

4. Lessons learned and reflected in the project design

50. Design of the proposed project has been enriched by lessons and recommendations from several initiatives, including relevant projects cofinanced by GEF and/or other donors (listed in Annex 2). The main lessons, detailed in Annex 18, are from three broad sources: (i) Mexico’s current Payments for the Hydrological Environmental Services (PSAH) Program; (ii) other payment for environmental services initiatives; and (iii) the GEF-supported Biodiversity Conservation and Sustainable Use in Productive Landscapes Project in Chiapas.

51. Lessons from Mexico’s PSAH program. While this program has been quite successful, there have been challenges with too many payments going to low priority or low risk areas, most contracts going to the better organized or more developed services providers even though their opportunity cost to provide services is higher, lack of arrangements for longer term payments, and lack of training and capacity building to develop local markets. Some specific lessons include:

High-level government commitment is crucial for funding and sustainability. Eligibility criteria must be designed carefully to avoid excluding key areas for biodiversity or

water services. Payments must be differentiated to fit local conditions. The same payment that attracts excess

interest (overpays) in one area may generate little interest (underpays) in another.

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Payment levels and targeting should be based on both expected benefits and opportunity costs to achieve the most benefit at the least cost and ensure long-term sustainability.

Eligibility criteria must be clearly defined and consistently enforced. While not targeting the rural poor, the program must ensure that they can participate. Trust must be built between communities and program technicians through a transparent,

long-term relationship.

52. Lessons from other payment for environmental services initiatives. The design of proposed project has been enriched by lessons and recommendations from several PES projects, including the Costa Rica Ecomarkets project, the regional Silvopastoral project in Central and South America, and the El Salvador Payment for Environmental Services project, all supported by GEF and the World Bank. In addition, the proposed project has gleaned lessons and recommendations from a number of publications including from the World Bank, Forest Trends, and IIED. Some of these lessons include:

Country ownership must be attained at the highest levels of government. The project approach should be flexible to adapt to specific needs in different areas. Services being provided should be clearly identified to encourage potential buyers. Programs should start from the demand side to ensure development of mechanisms that

supply the right services, in the right places, at the right prices. Quantifying the costs and benefits of environmental services is essential, including the

willingness of users to pay for services and the payment to provide services. Payments must be continuous and open-ended so that the project's benefits are not lost. Scheme should be piloted first before scaling up. Institutional arrangements should avoid being cumbersome, allow for a transparent process,

and include strong input from community organizations and local governments. Monitoring and evaluation enhance the credibility and replicability of PES programs. Regulatory and information barriers should be removed to level the playing field and foster

participation. Extension services are vital to raising awareness and helping service providers adapt their

land use practices.

53. Lessons from GEF-supported biodiversity conservation and sustainable use projects. One of the key lessons learned from projects supported by GEF includes the importance of stakeholder participation and ownership and involving local populations and institutions in project design and implementation to ensure long-term conservation. The design of the Mexico project includes technical assistance for ejidos, communities, and local NGOs to support forest conservation activities carried out by a range of local stakeholders. Projects throughout the MBC and other SANP projects with buffer zone communities indicate the importance of:

Limiting project focus so that activities are targeted and appropriate to local situations. Strengthening institutional sustainability is critical to program sustainability. Clearly defining the roles of the project and the communities is critical to avoid creating false

expectations or leaving ambiguities that cause implementation delays. Monitoring is important to measure conservation impacts and effectiveness. Cost-benefit analysis needs to be clearly presented and made available to decision makers.

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5. Alternatives considered and reasons for rejection

54. Land acquisition. Land acquisition, particularly from individual landowners, can be a useful tool for establishing, expanding, or consolidating protected areas when (i) the landowners in question are more interested in selling their land for a reasonable price than in managing it for long-term conservation and (ii) the entity managing the land after acquisition would protect and manage the land better than the original landowners. However, most of the lands eligible for PES under this project (80 percent of Mexico’s forest land) are owned collectively by communities and ejidos. With a modicum of technical assistance and the financial incentive provided by PES contracts, many Mexican communities and ejidos are willing and able to protect and manage their lands effectively from a long-term conservation standpoint. In any case, the outright sale and purchase of community and ejido land is not currently permitted under Mexican law; even if it were, it would likely be problematic from a social and political standpoint.

55. Eco-labeling. Even when eco-labeling or certification schemes promotes adoption of improved land used practices and recognition of good forest practices or management among buyers of forest products, this alone would not be enough to increase public awareness of environmental services, because most of the time, the direct beneficiaries of environmental services are not themselves the direct buyers of goods from certified forests, establishing some limits to develop local markets for environmental services. An advantage of this approach is the possibility of obtaining funds from people interested in good forest management.

56. Payments for environmental services based on deforestation risk analysis. Recently, deforestation risk analysis has been used as a criterion for CONAFOR´s budget allocation for hydrological environmental services payments. The model has demonstrated that areas with a higher deforestation risk are located near major cities, population centers, and areas with better road communications (in more densely populated areas) where there is a high opportunity cost for conservation because of more competitive land uses such as for urban development. Although this alternative would have the greatest impact on deforestation, it could substantially increase the PES program’s costs since there would be pressure to raise payment levels based on the high opportunity cost to forest owners rather than the much lower management or conservation costs required to maintain the environmental services. Some land speculation could also be expected, provoking an undesirable behavior pattern by rewarding those who put forest lands at risk. This approach was considered unsustainable, even in the short-term. On other hand, this model has also demonstrated that forest areas under the National Protected Area Program are less affected by deforestation and thus there is a tendency to exclude those areas in a PES scheme. Finally, available information for developing this model has limited capabilities to explain deforestation on a local or regional basis.

C. IMPLEMENTATION1. Partnership arrangements (if applicable)

2. Institutional and implementation arrangements

57. The National Forestry Commission (CONAFOR) will execute the project and have responsibility for all technical and fiduciary aspects of the project, overall management and

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supervision of the grant/loan, and monitoring and evaluation. Direct implementation will provided by a Project Coordination Unit (PCU), based in Guadalajara City (CONAFOR’s HQ), which will be fully integrated within Production and Productivity General Coordination Department of CONAFOR. The Project will also have liaison units in each of the States/Regions where potential “Promising Areas” are identified.

58. The financial agent for the project will be the by Nacional Financiera (NAFIN), a federal development agency responsible for managing the administration of many different projects receiving both national and external financing. NAFIN would be responsible for the overall financial management of the Project, and would manage the project’s Special Accounts. NAFIN would also be responsible for all formal correspondence concerning the Project with the Bank, including prior review for consultant and other contracts, and matters pertaining to the Loan Agreement.

59. In September 2003, an Advisory Committee for the PSAH project was formed. The committee’s function is to act as a consultative and advisory body for project design and implementation of the PES project. The committee usually meets monthly. It reviews advances in achievement of the preparation objectives, the preparation schedule, current relevant PSAH and other international experiences. The committee consists of 17 individuals from government and private institutions, NGOs and academic bodies. The NGOs PRONATURA, the Nature Conservancy, and the Mexican Civil Council for Sustainable Forestry (which operated the first Smart Wood/FSC Certification Service in Mexico), bring with them their broad-based knowledge accumulated through practical experience of developing projects on environmental issues in Mexico. Academic institutions are represented by two researchers from the National University (UNAM) and the National Council of Science (CONACYT-Centro GEO). The Ford Foundation is also a member of the Advisory Committee. Additionally, there are government representatives from the National Institute of Ecology, the National Forestry Commission, and the Ministry of Finance. Other relevant players, namely representatives of local PES schemes, will also be invited to join the Advisory Committee.

60. The highest decision making body of the project will be CONAFOR’s Governing Body. It is made up of representatives from several different Federal Government Ministries: National Defense, Finance and Public Credit, Social Development, Environment and Natural Resources, Economy, Agriculture, Agrarian Reform, Tourism, and the National Water Commission. This body will approve the Annual Implementation Plans and Quarterly Project Reports.

61. The PCU will include a coordinator, two subcoordinators (one each for PSAH and CABSA), an administrative assistant, an accountant, a procurement specialist and technical staff (natural resource management specialist, agricultural economist, and hydrologist). A summary of project management activities and It will also include 80 facilitators which will reside in the state and regional CONAFOR offices. The PCU will be responsible for and directly execute all project components. Other institutional actors in the project include NGOs (acting as PES intermediaries), community associations, and universities. There are currently approximately 156 accredited professional service providers listed on the CONAFOR register (PSTyP). In addition to these service provides, additional personnel and/or consultant services for technical assistance, sub-projects and independent verification tasks will be recruited.

62. The project considers a gradual incorporation (two to three per year) of the promising areas (pilot areas), ensuring first that the pilot area teams have been recruited, equipped and

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allocated the necessary budget to hire sufficient technical and professional consultants to achieve the Project’s local objectives.

63. Key stakeholders and participating government agencies will receive training to facilitate coordination, increase understanding of the PES system, and help them assume their roles in the system. The PCU’s functions will include processing environmental service contracts with private landowners, signing environmental services purchase agreements with the private and public sector, monitoring compliance, and preparing reports. NGOs will operate as intermediaries serving as ES contract promoters, providing technical assistance for Component 3, and compliance monitoring.

64. The PCU will maintain satisfactory financial management and procurement procedures during project implementation. The financial management and procurement assessments described in Section D3 have identified areas that need to be addressed and include time-bound action plans agreed with CONAFOR. The PCU is completely intetgrated into the institutional structure of CONAFOR and meant to be a sustainable unit.

65. A project Operational Manual will include all rules and regulations for implementation of each project component and operation of the PCU (planning, monitoring, evaluation, institutional arrangements, environmental review, reporting, communication, human resources, risk, coordination, procurement, and financial management). A specific annex of the Manual will define the operations of PES. The Operational Manual and any changes to it will require no objection from the Bank.

66. A Project Implementation Plan (PIP) will be prepared by CONAFOR to be submitted to the Bank for no objection prior to the start of each budget year. It will be broken down into Annual Implementation Plans (AIP) and will include four principal sections: (i) description of project activities to be executed during annual time periods; (ii) Gantt Chart/project scheduled with timing of activities, relationship with other activities, and responsible entity; (iii) budget plan; and, (iv) procurement plan. The AIP will be the principal tool for project execution and supervision of the Bank.

67. Disbursements will be transaction-based against statements of expenditure (SOEs), full documentation, direct payments, or special commitments, but they may later become based on Financial Management Reports (FRMs) if the Borrower so chooses. A special account denominated in U.S. dollars will be maintained and operated by the NAFN. Deposits into the special account and replenishments up to the authorized allocation set out in the legal agreement would be made on the basis of applications for withdrawals prepared by the project and accompanied by the supporting documentation in accordance with Bank disbursement procedures. Accounting and financial reporting will be done by the PCU and NAFIN under Bank rules spelled out in the Operational Manual. Separate accounts will be opened to handle multiple sources of financing (IBRD, GEF, private sector payments). Audits of project and NAFIN accounts will be carried out under TORs by firms acceptable to the Bank. The project includes financing for audits.

68. The main capacity constraints related to procurement and financial management will be detailed in the upcoming procurement and financial management assessments. To support the GOM in addressing the administrative capacity limitations, the Bank will provide sufficient training to the PCU’s procurement and financial management staff and NAFIN if needed.

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3. Monitoring and evaluation of outcomes/results

69. A key objective of the project is learning. PES programs are by nature country and site specific. Therefore about two percent of the project budget is dedicated to monitoring and evaluation. Monitoring and evaluation has been mainstreamed into almost all project components and will be conducted at three levels: (i) contract compliance, (ii) impact monitoring, and (iii) project implementation. Table 4 shows monitoring and evaluation costs by subcomponent.

Table 4: Monitoring and Evaluation Costs (million US$)Component Cost1A. Development of financing mechanisms from water users 0.381B. Development of financing mechanisms from biodiversity users 0.301C. Development of financing mechanisms from carbon users 0.402A. Strengthening of existing PES programs 0.442B. Support development of stand-alone local PES programs 0.083B. Organizational Assistance 0.515D. Project and Program Monitoring and Evaluation 0.78

Total 2.89

70. During project implementation special quarterly reports will be prepared on the lessons learned during the previous quarter, semester, and year, and on plans for incorporating those lessons into future activities. Learning workshops are planned semiannually to coincide with Bank supervision missions. It is critical to understand for each site the causal links between specific land use changes and environmental services and the amount of change needed to produce specific quantities of those services. A critical weakness of many PES programs is that these links are poorly documented. For that reason, design of an intensive monitoring program for this project is a condition of effectiveness. In addition, site-specific indicators will be defined in each area as part of the environmental service contracts themselves. While causal linkages are site specific, the results and learning from the eight initial pilot sites will provide valuable guidance and insights for replication within Mexico and for PES programs in other countries.

71. By project effectiveness an M&E system and methodology will be put in place to track project implementation, compliance of land users with services contracts, and progress in attaining results. The system will have six modules: (i) Management Information System to track results and financial indicators and provide feedback for decision making; (ii) environmental services contract compliance; (iii) annual beneficiary assessments to report target groups’ perceptions; (iv) site-specific monitoring and global biodiversity and hydrology evaluation studies to quantify land use changes/impacts and environmental services produced, with baseline assessments for each site and each contract and both midterm and final project studies; (v) data collection to better understand causal links between land use changes and environmental services; and (vi) standard auditing and supervision missions at least twice a year to review the technical, fiduciary, and safeguards aspects.

72. The PCU will be responsible for overall project monitoring, including the activities of the project (PES, PSAH, CABSA). The PCU will aggregate M&E inputs for project-level decision making and reporting. The baseline, beneficiary assessments, and impact evaluation studies will

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be contracted out, and the PCU will be in charge of coordination and technical supervision of the studies. CONAFOR will provide overall project oversight and World Bank staff and consultants will conduct periodic supervision missions (see Annex 3).

4. Sustainability and Replicability

73. Ensuring long-term sustainability of the PSA program is a major objective of the project. Current funding is only guaranteed for five years at a time, and its future is entirely dependent on continued government support of the program. The project will pilot the development of new financing mechanisms based on demand from water users, the local tourism industry, and carbon buyers. Once established, these mechanisms have the potential for being highly sustainable, as they depend on the mutual self-interest of service users and service providers. For this to occur, it is important that the program actually generate the services desired by the service users. Thus the project devotes considerable attention to both ex ante technical studies (to ensure that payments are carefully targeted to generate the desired services) and ex post monitoring (to demonstrate that services are being generated, and make adjustments if they are not). Sustainability also requires credible and effective institutions acting as intermediaries between service users and providers, and the project supports considerable capacity building to ensure this.

74. Conserving biodiversity benefits through PES poses particular challenges. The project addresses these in part by piloting the development of financing mechanisms based on demand from the local nature-based tourism industry. It also supports the creation and capitalization of an endowment trust fund that will provide sustainable long-term financing to PES targeted at biodiversity conservation in the buffer zones of protected areas and the corridors that connect them, including the Mexican portion of the Mesoamerican Biological Corridor, thus helping to ensure the sustainability of the national protected areas system. The financing for biodiversity conservation will be in areas where payments for local water or tourism services or carbon sequestration services are insufficient.

75. The pilot efforts to develop new financing mechanisms at pilot sites will lead to a replication strategy being developed for the development of additional such mechanisms throughout the country. The experience accumulated under the project should allow such replication to occur rapidly and on a large scale, by identifying conditions conducive to their development and potential pitfalls. It will also lead to the development of an array of standardized instruments which could easily be used in new settings with appropriate adaptations to local conditions.

Replicability:

76. The Mexican PSAH is only the second effort in any developing country to develop a nationwide PES program (the other being Costa Rica’ PSA program). The lessons learned here, in a context much more complex than Costa Rica, will also provide valuable lessons for the many other countries contemplating this approach. At the same time, the parallel effort to stimulate the development of stand-alone local PES mechanisms will also provide valuable lessons to countries opting for a more decentralized approach. Although a wide variety of such stand-alone local PES mechanisms has emerged spontaneously throughout the region, this is one of the first efforts to attempt to systematically encourage and support their development (the other being the recently approved El Salvador Environmental Services Project). The proposed project includes a strong replication activity. A replication strategy will be developed along with

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evaluation of the project and drawing of lessons at the mid-term and end of project which will be widely disseminated within Mexico, in the region and globally through workshops, seminars, trainings, publications and website.

5. Critical risks and possible controversial aspects

Risk to PDO/GEO Rating Risk mitigation measuresPolitical pressure to shape the PES program to achieve non-environmental goals

L/M This has already been observed to some degree in the current PSAH program. The move to a more targeted system based on objective targeting criteria will reduce this risk. This risk would not affect payments made with financing by local service users and GEF, as these payments would be made under rules agreed to by the users.

Unwillingness to pay for services by service users

M A variety of experiences in Mexico and in the region show that there can be willingness to pay. The project will provide technical information to demonstrate likely benefits and establish a strong monitoring framework. The project will also provide short-term incentives for the creation of local financing mechanisms through the matching fund.

Lack of capacity of national and local institutions to support the long-term development of environmental service markets

L Mexico has several strong national institutions which have already built up experience in PES by examining other countries and, since 2003, operating the PSAH. The project will support further capacity building in both national and local institutions.

Risk to component results Rating Risk mitigation measuresLow participation rates of land users L Experience to date of the PSAH shows a high

willingness to participate, with applications far exceeding available funds. In areas with higher opportunity costs, the project will support the provision of higher payments. The project also includes a component to provide direct support to poor communities who might encounter difficulties in participating.

Difficulty in identifying the land uses that generate the desired environmental services

M Mexico has already undertaken considerable efforts to compile and review available data. The project will support targeted technical studies at pilot sites to fill gaps in the data, and a strong impact monitoring system to verify that services are being generated or indicate what changes may be needed.

Willingness to pay by service users is insufficient to offer payments that induce

L If willingness to pay is too low, then PES will not proceed at that site. PES discriminates

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land user participation between things worth doing and those not worth doing.

Political opposition to differentiated payments by areas that would receive lower relative payments

M Differentiated payments to be introduced gradually, initially in conjunction with new financing mechanisms which provides an objective reason for the differentiation.

Overall risk rating M

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6. Loan/credit conditions and covenants

77. Effectiveness conditions:

i. Accounting and financial management system implemented and staffed within CONAFOR that is acceptable to the World Bank, including procedures for operations and maintenance during project implementation.

ii. PCU fully staffed with qualified personnel, including project coordinator, procurement specialist, accountant, and executive secretary, on a no objection basis from the Bank.

iii. Operations Manual satisfactory to the Bank.iv. Content of the PIP satisfactory to the Bank.v. M&E system developed and ready for project implementation.

78. Other conditions:

i. Counterpart resources from the GOM will be available at the times specified and amounts agreed within the Legal Agreements, PIP and AIPs.

ii. Annual implementation plans for all components of the project will be submitted to the World Bank for no objection prior to the beginning of each budget year.

iii. Agreed plans of accounts and auditing will be implemented by the project. Terms of reference for auditing and a short list of firms will be provided to the Bank prior to signing.

iv. Quarterly and annual reports will be prepared by the PCU according to agreed formats in the Operations Manual and submitted to the World Bank within 30 days of the end of each quarter, and by January 31 of each year.

v. The Bank and the GOM will conduct a midterm review of project implementation progress and attainment of the project’s impact and outcome objectives, not later than the end of the third project year.

vi. Procurement for all project components will be carried out in accordance with agreed categories in the IBRD and GEF project legal agreements and Operations Manual, and will follow the Guidelines for Procurement under IBRD Loans and IDA Credits (May 2004). All contracting of consultants and consulting services will be in accordance with the Guidelines for Selection and Employment of Consultants by World Bank Borrowers (May 2004).

D. APPRAISAL SUMMARY1. Economic and financial analyses

79. Demand for services. PES programs depend on service users paying for the services they receive.

Water services. The main national service the PES program is expected to help generate is improvements in water services. Depending on the nature of local service users, this may take the form of improving water quality (by reducing contamination and/or improving natural filtration), reducing sediment loads, increasing dry season water flows, or reducing the risk of flash flooding. Existing local PES initiatives in Mexico have demonstrated that there is a willingness to pay for water services. In Costa Rica, a number of hydropower producers,

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bottlers, hotels, irrigation systems, and municipal water supply systems, generating over US$0.5 million a year. {Data currently being collected on numbers and types of water users at each pilot site}

Local biodiversity services. The project will also pilot new financing systems based on use of ecosystem services by the growing nature-based tourism industry. {Data currently being collected on local nature-based tourist industry at each pilot site}

Carbon sequestration services. {Data currently being collected on potential for and costs of carbon sequestration activities at each pilot site}

80. Supply of services. Inducing land uses to adopt practices that bring benefits to others requires compensating them, at a minimum, for the difference in net returns they will receive with the new land uses compared to those they would have received under their most privately-profitable alternative. Studies by INE estimate the average opportunity cost at the pilot sites to be between US$30 and US$150/ha, with wide variations within sites. At Cerro Grande, for example, the mean opportunity cost is about US$150/ha but 20% of producers have opportunity costs of US$50/ha or less. The areas that would need to be conserved at each site have not yet been determined. This is a process that will be undertaken under implementation, based on detailed diagnostics of precise problems facing local service users and technical studies to identify the sources of these problems. As a very crude, order-of-magnitude estimates of possible costs, if about 5% of current forest area at the sites needs to be conserved, the annual cost would be about US$10 million. For a number of reasons, these figures are likely to be over-estimates. {Data currently being collected will allow a better estimate of likely costs, but these will only be determined with precision by technical studies to be carried out during implementation}

81. Increasing PES efficiency. The current PSAH program has a one-size-fits-all approach, with a single activity being supported (conservation of existing forest) and a single price being offered nationwide (except that cloud forests are paid slightly more). Experience worldwide has shown this approach to be inefficient, potentially leading to considerable ‘conservation’ of forest at little risk of being lost or with low actual benefits, and failure to conserve forests at high risk of deforestation or with high benefits. The PSAH’s initial experience bears out these lessons. The more targeted and differentiated approach to be introduced under the project will help increase efficiency substantially. This will be reflected most obviously in a greater area being conserved per dollar spent. Indicators are being developed to attempt to derive estimates of environmental services generated per dollar spent.

82. Financial analysis. Expansion of PES beyond the area supported by existing financing streams will only occur as additional financing comes on line through the development of new financing mechanisms. All financing mechanisms which channel their funds through the PSAH will also have to contribute to the PSAH’s administrative costs (including the cost of monitoring). Stand-alone PES mechanisms would have to cover their own administrative costs; technical assistance would be provided to such mechanisms to help them achieve financial sustainability.

83. Incremental cost. The baseline project would focus on areas of national importance—primarily water services. This project would also provide some global benefits, but they would be limited. The GEF alternative boosts the global benefits provided by the project considerably. It supports the conservation and sustainable management of natural ecosystems in Mexico by developing new sustainable financing mechanisms explicitly targeted at paying for conservation

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in critical ecosystems that would not have been covered (or covered to a much smaller extent) in the baseline project. The difference – Incremental Costs – between the cost of the baseline scenario (US$235.956 million) and the GEF alternative (US$267.102 million) is estimated at US$31.146 million, of which only US$15.00 million is requested from the GEF.

2. Technical

84. PES markets are an innovative approach with few operational examples. Lessons learned from the state-of-the-art system in Costa Rica, the preparation of the El Salvador Environmental Services Project and other cases have been incorporated into the project design (see Section B4). Eight primary pilot sites (promising sites) have been selected and project preparation is now focusing on in-depth analysis of demand for environmental services for each area. Additional work to finalize pricing structures, targeting, and the establishment of local mechanism for collection and payment of fees will be done during project implementation.

85. The project is consistent with the government’s needs and will address constraints in environmental conservation, including financing. If successful, the project will demonstrate that a local market driven PES system can function in Mexico and provide the framework for sustainable sources of local financing for environmental protection. From the experience with the PSAH, local communities have indicated a high willingness to participate as purchasers of environmental services.

3. Fiduciary

86. Financial Management. The Bank has carried out a preliminary Financial Management Assessment (FMA), which involved ensuring that project design allows for an appropriate level of transparency, facilitating oversight and control while also supporting smooth implementation. Based on this analysis, the regional financial management team (LCOAA) has concluded the following: (i) CONAFOR has experience with Bank projects and with the types of activities to be carried out in this operation, and its record to date on FM matters has been satisfactory; (ii) certain actions will need to be taken to strengthen program financial management prior to the launching of the Bank–financed project, especially in terms of written procedures and reporting formats. These procedures should reflect the simplifications proposed in the FM/Disbursements section of the Bank’s Review of Country Systems document, which was delivered to the federal government in July 2005; and (iii) Nacional Financiera (NAFIN) will provide implementation support and oversight based on its many years of experience as financial agent. Financial management risk for this project will be determined during project appraisal, but it is expected that any significant risks will be mitigated by using project resources to strengthen weak financial management areas.

4. Social

87. Consultations with stakeholders and analysis of issues and risks have been carried out to help select potential sites for local PES programs, including a preliminary social assessment of five of the sites considered promising for project implementation. A full social assessment is underway and will be completed prior to project appraisal.

88. Risks and mitigation. The risk of negative socioeconomic impacts on both service users and service providers is strongly mitigated by the inherent theoretical foundation of the PES

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concept—that these systems, and their long-term sustainability, rely on voluntary participation grounded in the perceived self-interest and well-being of the participants. In addition, provisions for ongoing consultation and participation are included throughout the project components to ensure relevancy, feedback, and compliance.

89. Concerns about social and political risk are greater on the side of environmental service providers because these ejidos and comunidades agrarias in forest areas tend to correspond to some of the poorest communities in the country, with the highest marginalization indexes, and large shares of indigenous people.

90. However, while there are risks related to overcoming obstacles to participation and equitable distribution of benefits, the PES payments are expected to have positive socioeconomic impacts by providing additional income and encouraging land uses that yield greater long-term benefits and security. In addition, the participatory action plan outlined below will build capacity and strengthen community cohesion and social capital.

91. Partial social assessment. A participatory social consultation included (i) interviews with 74 ejido and indigenous community leaders, NGO workers, community/ejido technical field workers, and local managers and staff of protected areas and CONAFOR, and (ii) 20 participatory workshops with 278 participants, including three workshops specifically for women (66 indigenous, 10 nonindigenous).

92. Participatory action strategy. These consultations helped craft a project design that emphasizes strong indigenous community and ejido participation in a strategy that integrates the following pillars of action:

Making environmental services a source of income for the ejido/community by paying for conservation activities. This is clearly preferred by local inhabitants to payment for mere ownership of the forest.

Promoting reestablishment of collective administration and control of common property and reactivating ejido/community assemblies and the assertion collective rights under specific cultural and sociopolitical conditions.

Providing technical assistance in sustainable management of both ejido/community lands and individual agricultural holdings.

Strengthening social capital and local capacity for ejido/community planning, land and forest management, and design of development subprojects.

Building local capacity to attract public programs and funding for specific environmentally friendly subprojects.

Establishing new local participatory committees with a range of local stakeholders in potential PES areas to represent social and community concerns in the negotiation of PES arrangements and commitments.

93. Ongoing community liaison and consultation arrangements. Participants in the consultations made clear that they value knowledge and capacity building and that they demand regular face-to-face communication and outreach, with clear rules, on a long-term basis, with stable technical personnel who are directly accountable to them.

94. “Community technicians,” hired by the project under component 3, would maintain close interaction and consultation with local communities and leaders and play a key role in addressing community problems and concerns and defining how to tailor the strategy to local conditions.

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The PCU would provide training and facilitate horizontal peer-to-peer learning and knowledge sharing between the community technicians.

95. In addition, indigenous ejidos and communities would select community members to serve as liaisons with the technicians and the project. The liaisons, who would receive stipends or scholarships, would facilitate follow up on activities agreed with the technicians, serve as translators at community meetings, and help disseminate technical knowledge. They also would participate in regional seminars several times a year for training and knowledge sharing.

5. Environment

96. Positive Environmental Impacts. The project is expected to be overwhelmingly positive from an environmental standpoint, by using PES to induce rural landowners to maintain the forests or other natural vegetation on their lands, thereby (i) conserving globally significant biodiversity, (ii) maintaining or improving hydrological functions, and (iii) reducing greenhouse gases by storing carbon. The currently proposed eight pilot sites all contain substantial areas of forests and other natural vegetation that is important for all these types of environmental services. In addition to these pilot sites at the national level, the project would promote the establishment of local level PES systems at other sites of conservation interest, either for water users interested in improved upstream watershed management, or for tourism operators and others interested in maintaining biodiversity and scenic beauty.

97. Project Expenditures. A substantial proportion of project funds (including IBRD loan, GEF grant, and Mexican counterpart) would go to landowners as PES, either during project implementation or (in the case of project-supported trust funds) later in the future. The remaining project funds would go mostly to technical assistance, consulting services, training, promotional campaigns, and institutional strengthening needed to establish and strengthen PES programs and their long-term funding mechanisms. No civil works are expected to be procured under the project. The main on-the-ground environmental impacts associated with project expenditures would thus be the maintenance of desired vegetative cover on the rural landholdings of PES recipients.

98. Environmental Management Plan. The only possible adverse environmental impacts would be strictly unintended; they could possibly involve (i) tradeoffs between different environmental objectives (such as biodiversity vs. improved water flows); (ii) misallocation of PES funds (such as landowners who have not complied with their contracts, or environmentally inappropriate land uses); or (iii) perverse incentives (such as new people moving onto lands eligible for PES benefits). The Environmental Management Plan (EMP) for this project is intended to prevent these types of unintended negative impacts, by incorporating within the project’s Operational Manual (i) eligibility and prioritization criteria for the types of lands and landowners that could receive PES contracts and (ii) review procedures and specific responsibilities within CONAFOR to ensure that all contracts are awarded, administered, and supervised in accordance with these criteria. The PES eligibility criteria are expected to require, inter alia, (i) no clearing of forests or other natural habitats to establish new agricultural systems; (ii) any reforestation must be with species native to the site; and (iii) all eligible landowners (whether communities, ejidos, or individuals) will need to present evidence of legally secure land tenure and long-term residence in the PES eligible area. Within any watershed selected for PES support, the prioritization criteria will tend to favor the conservation of native forests (or other natural habitats) over the maintenance of agro-ecosystems (such as shade coffee), although the

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latter could receive PES contracts where an insufficient area exists of the original natural ecosystem.

6. Safeguard policies

Safeguard Policies Triggered by the Project Yes NoEnvironmental Assessment (OP/BP/GP 4.01) [X] [ ]Natural Habitats (OP/BP 4.04) [X] [ ]Pest Management (OP 4.09) [ ] [X ]Cultural Property (OPN 11.03, being revised as OP 4.11) [ ] [X]Involuntary Resettlement (OP/BP 4.12) [ ] [X]Indigenous Peoples (OD 4.20, being revised as OP 4.10) [X ] [ ]Forests (OP/BP 4.36) [X] [ ]Safety of Dams (OP/BP 4.37) [ ] [X]Projects in Disputed Areas (OP/BP/GP 7.60)* [ ] [X]Projects on International Waterways (OP/BP/GP 7.50) [ ] [X]

7. Policy Exceptions and Readiness

99. The project does not require any exceptions from Bank policies. The project does meet the Regional criteria for readiness for implementation.

* By supporting the proposed project, the Bank does not intend to prejudice the final determination of the parties' claims on the disputed areas

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Annex 1: Country and Sector or Program Background

MEXICO: Environmental Services of the Forest

Country and sector issues.

1. Since the 1994 crisis, Mexico had undertaken impressive reforms leading to a major political and economic transformation in the last decade. Today, the country enjoys a more open political and economic system, is more integrated into the world economy, belongs to the OECD, has investment grade in the financial markets and has strong ownership of its development strategy. Yet, there is still a substantial agenda that the government seeks to advance within the context of its National Development Plan, including very important poverty reduction, improved competitiveness, environmental management and institutional change.

2. The problems of water scarcity and deforestation are two important environmental challenges facing Mexico. Aquifer overexploitation, water quality degradation and high deforestation rates put at risk critical ecosystems, globally significant biodiversity, the availability of natural capital for future economic growth, and the capacity of future generations to achieve a level of welfare equal or better to the present generation. Indigenous peoples, rural poverty and land tenure issues all share key relationships with maintaining and conserving forests in Mexico.

3. Water and Forest. Water consumption patterns in Mexico are unsustainable. According to the National Water Commission (Comisión Nacional de Agua: CNA), 66 percent of the 188 most important aquifers in the country suffer from overexploitation. The average extraction for human use is 190 percent the level of natural recharge, a path towards depletion. The rest of the other 188 aquifers are also in a state of decline: 28 percent are considered in equilibrium (extraction between 105 percent and 95 percent of recharge), a fragile situation when consumption is projected to grow and natural recharge is threatened by deforestation.

4. Deforestation. Mexico’s biological wealth is in serious danger, and is undervalued as a primary factor in socioeconomic development. Loss of forests and biodiversity have been attributed to social capital loss and pressures deriving from the unsuitability of former development policies. For example, conversion of natural habitats to unsustainable agricultural schemes, deforestation in temperate and tropical forests due to land use change or illegal logging, overgrazing in arid zones, illegal trade of threatened species, conservation conflicts in protected areas, lack of integrated coastal zone management programs, and risks of genetic contamination.

5. In recent decades, Mexico has suffered one of the world’s highest deforestation rates, second only to Brazil. FAO had consistently reported a loss of around 1.3 percent per year, of which 66 percent occurred in tropical forests, including areas of high biodiversity value. In 1993, Mexico had 70 million ha of forest and tropical forest. By 2000, 3.1 million ha had been transformed to agricultural uses and 5.1 million ha had been converted to pasture (Velasquez et al., 2002). In contrast, only 1.7 million ha of agricultural land, pasture ground or degraded forest had experienced natural or human-assisted recovery, and could once again be classified as being in a good state of conservation in 2000. Furthermore, where forests do remain standing, poor management practices have resulted in genetic quality degradation and the loss of regenerative capacity.

6. The causes of deforestation are multiple. They include natural hazards such as pests and fires but the main driving force appears to be intentional land use changes by individual or collective

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land owners. Agriculture expanded at an annual rate of 2 percent between 1993 and 2000, while pastures grew at an annual rate of 4.6 percent. Illegal logging is also a cause of concern both because it degrades the forests and because this damage lowers yields and increases the risk that rightful forest owners take into account when deciding over the alternative uses of their land.

7. The extremely rapid rates of deforestation have had negative implications for the regulation of water flows, the sedimentation of reservoirs, changes in rainfall patterns, the conservation of biodiversity, and the release of carbon in the atmosphere, contributing to climate change. Given the country’s decreasing soil quality and increasing water scarcity, both of which are associated with forest loss, understanding the sources of deforestation is becoming a central policy issue at a national level. Scientific work highlights the role that montane cloud forests play in providing surface water flows during the dry season in Mexico’s Veracruz watersheds. There is evidence of an environmental service provided in this case by dry tropical forests, that of reducing the risk of floods during storms in western Jalisco. Also, there is evidence that the Sierra Gorda’s forests are fundamental for water recharge in the aquifers supplying the cities of Queretaro and San Juan del Rio.

8. Critical Ecosystems and Globally Significant Biodiversity. Mexico is one of the mega-biodiversity countries in the world, with second place in reptilian diversity, third in mammal diversity, and fifth in both amphibian and plant diversity (Table A1-1). Its plant diversity exceeds that of the United States and Canada combined. Mexico also ranked eighth in fish diversity and fifteenth in bird diversity. With 1.3 percent of the world’s land area, it hosts about 12 percent of known terrestrial biota with very high endemicity. Mexico contains the five main types of Latin American and Caribbean terrestrial ecosystems listed by WWF, nine of the 11 main types of habitats in the region and 51 of the 191 ecoregions identified. Of these 51 ecoregions, 14 (covering over 40 percent of national territory) have priority at the international level regarding their biodiversity and current conservation status. There are nine large natural vegetation types in Mexico, classified according to their ecological characteristics.

Table A1-1: The World’s Five Most Biodiverse Countries, 2004Rank Mammals Amphibians Reptiles Vascular plants

1 Indonesia (667) Brazil (695) Australia (880) Brazil (56,215)2 Brazil (578) Colombia (623) Mexico (837) Colombia (51,220)3 Mexico (544) Ecuador (428) Indonesia (749) China (32,200)4 China (502) Peru (361) Brazil (651) Indonesia (29,375)5 U.S.A. (468) Mexico (358) India (521) Mexico (26,071)

Source: World Resources Institute, 2005 (from WRI website). “Earth Trends Data Tables: Known and Threatened Species.” Based on information for 2004 from UNEP-WCMC and IUCN.

9. The total number of known species in Mexico is about 65,000, but there are thought to be at least 212,000, as many areas and many taxonomic groups have not yet been studied in detail.1

There are at least 6,000 known species of fungi in Mexico (9 percent of the world total). Mexico’s vertebrate fauna are among the richest in the world, with over 5,000 species (almost 10

1 For example, the National Biodiversity Information System (SNIB) which integrates taxonomic, ecological, geographic and bibliographical information related to Mexico’s biodiversity and biological resources has data on 8,176,000 specimens - this figure has increased by 3,676,000 since 1998.

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percent of the world total), of which about 1,000 (20 percent) are endemic. Invertebrate species number almost 30,000, taking into account only marine invertebrates and arthropods, of which nearly 7,000 (almost 25 percent) are endemic to Mexico.

10. Priority Terrestrial Regions have been identified, whose ecosystems are richer and more specific than in the rest of the country and which have significant ecological integrity. These 151 regions cover over 50 million ha (over one-quarter of the territory). The most important states in terms of species richness are Oaxaca, Chiapas, Veracruz, and Guerrero. There are about 23,000 known plant species, including algae, bryophytes, pteridophytes and phanerogams. The total number is about 36,000 (i.e. over 10 percent of the world’s known species); 10,000 (40 percent) are endemic.

11. Mexico is regarded as one of the world’s most important centers of genetic diversification in plants and one of the areas where agriculture originated. Some 120 cultivated plant species belonging to 39 families originated in Mexico, including cocoa, kidney beans, maize, and tomatoes.

12. Mexico’s biological wealth is extraordinary but the future is precarious. One-third of birds and nearly 66 percent of amphibian, reptile, and mammal species are at risk. The wild species whose state and patterns of conservation are in decline are legally protected by Mexican Official Standard NOM-059-ECOL-2001; 2,582 species and subspecies are at risk (161 more than under the previous 1994 standard), of which 41 are already extinct in the wild, 1,215 are endangered or threatened with extinction, and 1,326 are subject to special protection.

Table A1-2: Species of Wild Flora and Fauna at Risk, 2001Probably

extinct in the wild Endangered Threatened

Subject to special

protection Total at riska Total numberb

Mammals 7 43 124 121 295 491Birds 19 72 107 173 371 1,054Reptiles 0 15 109 342 466 704Amphibians 0 6 42 148 196 290Freshwater fish 11 70 74 30 185 ??Arthropods 0 16 11 19 46 ..Fungi 0 10 25 7 42 ..

Vascular plants 4 141 350 486 981 10,819

Total 41 373 842 1,326 2,582

a) Total at risk or extinct. Sum of previous columns. b) Total number of species known. Source: NOM-059-ECOL-2001.

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Table A1-3: Vegetation Types, 2000

Vegetation typeSurface area

(‘000 hectares)Share of national

territory (%)

Temperate forest 34,504 17.6

Conifer forest 12,854

Conifer and holm oak forest 7,829

Holm oak forest 11,997

Mesophilic montane forest 1,824

Tropical rain forest 34,229 17.5

Evergreen and sub-evergreen rain forest 11,144

Sub-broadleaf rain forest 4,649

Broadleaf rain forest 17,810

Low thorny rain forest 626

Scrub 55,588 28.4

Xerophilous scrub 49,386

Mezquital 3,186

Chaparral 3,016

Grassland 16,352 8.3

Induced grassland (not cultivated) 6,665

Natural grassland 9,687

Other types of vegetation 9,829 5.0

Sandy desert vegetation 2,172

Halophilous vegetation 5,283

Hydrophilous vegetation 2,246

Palm forest 128

Total 150,503 76.8Source: National Institute for Statistics, Geography and Information Technology, 2002.

13. Protected Areas. Nearly 60 percent of the surface area under protection is in biosphere reserves. Most are managed for sustainable use of natural ecosystems (IUCN category VI); and a few are strict nature reserves (IUCN category Ia). The second most important type of protection (27 percent of protected territory) consists of protected areas of flora and fauna (IUCN category VI). National parks (IUCN category II) account for 7 percent of the total area under protection. There are various other categories of protected areas, including forest reserves (IUCN category VI). The National System of Protected Natural Areas (SINAP) includes natural areas of special national importance due to their biodiversity and ecological characteristics; 41 natural areas are currently included, one of which is state-administered. The 40 Federally administered natural areas cover almost 10 million ha (i.e. 55 percent of the total designated area) but only about 5 percent of this area is government property.

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14. Not all the areas with relevant biodiversity are covered by a status of NPA. The National Commission for NPAs has produced a map of Priority Areas for Conservation, which includes the SINAP, plus the areas that should be incorporated under some kind of protection, including economic incentives and legal agreements with their proprietors.

15. Land tenure and Forests in Mexico. Any initiative to protect forest must take into account the structure of incentives embedded in the land tenure arrangements. Mexico has a special land tenure structure, resulting from more than seven decades of agrarian reform. Large private estates (known as latifundios) and land belonging to the government were redistributed among organized groups of peasants in an institutional arrangement involving both individual plots and common property areas (uso común). This type of property are known as either Ejidos, which include more individual plots, and Comunidades Agrarias, which are mainly common property. Reforms to the Agrarian Law in 1992 granted ejido members more clearly defined individual property rights for their plots, making them almost private property. Because the majority of forests are under common property regimes, their land tenure rules have important implications for conservation programs.

16. Common property implies a potential problem of collective action. This does not mean that all forests in Mexico face the “tragedy of the commons”, but it certainly makes it possible that costly cooperation creates departures from what would be optimal decisions. Several studies in Mexico (Mc Carthy et al., 2001; Muñoz et al., 2003; Alix et al., 2004) have pointed out that high cooperation costs increase the probability that a particular ejido or comunidad will choose individual activities or tenure over collective ones, a problem for forests which tend to be associated with the latter options.

17. Rural Poverty and Forests. Mexican forests are in the unique situation of being located almost entirely in common property lands, the owners of which are among the poorest in the country. While the incidence of poverty is high in all Mexican rural areas, it is particularly high in forested areas. Nearly 85 percent of localities in forested areas have a “high” or “very high” marginality index. This has two important implications. First, poverty is one of the driving forces in deforestation (Guevara and Muñoz, 1996; Deininger and Minten, 1999). Empirical studies in Mexico suggest that poverty is strongly linked to increases in the deforestation rate. Deininger and Minten (1999) found that municipalities with higher levels of poverty lost a larger proportional share of their forests during the 80s than others of similar characteristics but less poverty. The econometric pixel approach developed by INE (Muñoz et al., 2004) also confirms the hypothesis, providing evidence that during the 1990s poverty and marginalization levels in the villages closest to a particular tract of forests increased the probability of it being deforested. These results do not imply that deforestation was higher in poorer areas. In fact, the influence of other variables like distance to market, slope and potential yields, result in a higher deforestation in the richer parts of the country. However, the effect of poverty still makes a difference when comparing forests of similar location and characteristics.

18. Second, poor households are highly dependent on forest resources, so degradation of these resources hinders their ability to sustain their livelihoods. High levels of marginalization and poverty are a challenge for sustainability because it favors short term projects in agricultural or livestock land uses against a longer-term planning strategy that includes forestry (Guevara and Muñoz, 1990). Third, people living in poverty and lacking land titles have stronger incentives to deforest in order to claim as their own the common property land recently cleared for cultivation. Poverty may encourage deforestation as a short-term survival strategy and excessive

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deforestation may accentuate poverty in the long run. Under certain circumstances poor farmers have stronger incentives to protect the environment than wealthier farmers, because the consequences of failing to achieve sustainability have worse consequences to them.

19. PES schemes have the potential for simultaneously alleviating poverty and addressing some of the most important environmental problems Mexico faces.

20. Indigenous Communities and Forests. The indigenous people of Mexico have an important presence in forested areas. Estimates show that 20 percent of the ejidos or comunidades that have large tracts of forests (>100 ha) also have a large majority of indigenous households. In comparison, only 2 percent of the ejidos without forests have a similar indigenous presence.

21. Indigenous communities have a unique perspective about their forests, stemming from the long-term ties that bind them to their ecosystems. This provides them with a stock of traditional knowledge about its goods and services, allowing them to obtain more value from the same plot of forest than, for example, new immigrants to the region. Also, strong ties within the community due to a shared identity and extended family relations would imply higher costs of opportunistic behavior and make indigenous ejidos more efficient at achieving cooperative outcomes. These two elements would have the effect of increasing the relative profitability of keeping the forest, reducing the incentives to switch to agriculture or cattle operations. It is possible that forests themselves could have cultural importance for the indigenous people, so traditions and rules about its use would reflect the local bequest and existence values and help preserve them despite generating less income than its alternatives.

22. The small property ejidos and communal owners of forest resources in Mexico have been slowly developing capacities to manage their resources and to successfully market their products, especially as technology changes and markets become increasingly complex, global and more competitive. In many cases, communities and “ejidos” have set up community enterprises to add value to timber and are in the process of taking advantage of Non Timber Forest Products, some of which have significant economic value and market potential. Although they have a traditional attachment to the forests, including a rich spiritual tradition rooted in the forest, they have not, in general, been able to reach a comfortable level of income to conserve natural areas that have both spiritual and material value. Also, most of the rural indigenous people inhabit in a broad range of ecological niches, many of them catalogued as fragile and remote. There exists a strong overlapping among indigenous communities and ejidos and high biodiversity areas, including the ones recognized as protected areas.

23. Government Strategy – These challenges are being met with efforts by both the government and civil society. The federal government has relatively recent laws governing water resources (December 1992, extensively modified in April 2004), forests (February 2003), and sustainable rural development (December 2001), which by definition includes “ensuring the permanent conservation of natural resources, biodiversity, and environmental services.”

24. These laws are based on Article 27 of the Constitution, vesting the federal government with original control of all land, water, and natural resources as well as responsibility for creating laws to govern their use, preservation, and restoration to ensure environmental balance and the public good. In addition, Article 4 of the Constitution gives individuals the right to a natural environment that is “adequate for their development and well being.”

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25. Mexico’s environmental strategy is contained in a National Biodiversity Strategy published in 2000 as part of its obligations under the CDB and in a set of integrated five-year programs issued in 2001 for National Development (PND), Environment and Natural Resources (PNMA), Water (PNH), and Forests (PNF). The biodiversity strategy has four main lines of action: (a) protection and conservation, (b) valuation, (c) knowledge and information management, and (d) diversification and use. The strategy calls for legal, administrative, and political mechanisms to be established whereby the beneficiaries of environmental services help finance environmental and biodiversity conservation and proposes that economic analysis be conducted to valuate environmental services related to soil fertility and regulation of hydrological cycles. Although the integrated five-year sectoral programs are designed for 2001–06, they were not developed as and are not considered to be self-contained instruments with a defined end date, but rather as a stage in a larger strategic plan for Mexico that looks forward to 2025 and beyond.

26. Other important legislation facilitates these programs. In 1996 the Income Tax Act was amended to make all donations to NGOs carrying out conservation projects in natural protected areas tax deductible and in 2001 Congress reformed the Federal Law on Rights (LFD) which sets a wide range of fees both for government services such as granting concessions and licenses as well as for use of natural resources including recreational, commercial, and extractive activities. For example, in 2002, fees for the use, enjoyment, and exploitation of marine national parks generated 11 million pesos, which was used to help finance conservation of marine biological resources through investments in equipment, operation, and management of the natural areas that generated the resources.

27. Throughout the twentieth century forest policy in Mexico suffered from lack of continuity, unstable and changing policies, and poor coordination of programs between federal, state, and local government. However, forest policy and planning is one of the areas in which Mexico made the most dramatic improvements in recent years, putting into place laws, institutions, and programs that are considered by some experts to be among the best in the developing world. In April 2001 the government created the National Forest Commission (CONAFOR) with the mandate to support sustainable production of forests and conservation of forest resources. In June 2001 the 2000–2025 Strategic Forestry Program (PEF) was completed, which in turn was the basis for defining the 2001–06 National Forest Program (PNF), and in February 2003 the Sustainable Forest Development law was issued.

28. The PEF calls environmental services “the most important and transcendent ecological assets of mankind.” It details the problems and obstacles to creating environmental services markets as a tool for natural resource conservation and proposes a range of activities, grouped into five major strategies, to help develop such markets: (a) evaluation of potential, (b) pilot projects, (c) feasibility of PES mechanisms, (d) research and training, and (e) market development and instrumentation. The PNF includes these strategies and actions, as well as a specific goal of establishing and promoting PES markets that encompass 600,000 hectares.

29. The creation of CONAFOR and the long-term forest strategy represents a significant effort to reverse the deterioration and depletion of natural resources and to transform this national problem into a productive asset through the launching and implementation of guidelines for sustainable management of forests, water, and soil. Its sectoral approach is complemented by the Sustainable Development Program (Programa de Desarrollo Sustentable del Gobierno Federal) which represents a formal effort to build synergies and complementarities among the different government policies and instruments that historically have responded to oftentimes conflicting

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sectoral interests. To halt and reverse the deforestation trend, the Mexican government has pledged to be committed to a “zero” deforestation target. The Forest Resource Assessment of December 2004 is consistent with the estimates made by CONAFOR that the deforestation rate, which averaged more 900,000 hectares per year between 1993 and 2000, had dropped to about 400,000 hectares per year by 2002.

30. .The policy strategy dealing with forests has a series of programs that support commercial forestry, build capacities among poor forest-owning communities, and invest in reforestation. Based on the research on the causes of deforestation and the existing policy array to reduce it, the basic policy proposal of Payments for Hydrological Environmental Services Program (PSAH), started in October 2003, was to create a financial link between those who gain from environmental services and the owners of the forest that are likely to provide those services.

31. PSAH Program. The PSAH was designed to complement other initiatives by providing economic incentives to avoid deforestation in areas where water problems are severe, but where in the short or medium term commercial forestry could not cover the opportunity cost of switching to agriculture or cattle ranching. PSAH consists of direct payments to landowners with forests in good state of conservation. Payments are made for watershed conservation-management-restoration, aimed at preserving temperate, tropical, and particularly high mountain cloud forest lands associated with the supply of water to communities.

32. Part of its innovative approach is that it is funded through an earmarked percentage of the federal fiscal revenue derived from water fees, creating a direct link between those who benefit from the environmental services and those who provide them.

33. Lakes, lagoons, aquifers and rivers are considered national property in Mexico and are managed by the federal government. The government charges for the utilization of national goods (natural resources like water and minerals) through the Federal Rights Law (Ley Federal de Derechos - LFD). Articles 222, 223, and 224 contain the water fees, charged to different users and collected by the National Water Commission (CNA). Farmers pay nothing, municipalities very little, while manufacturing companies and service providers pay the highest fees. The LFD is presented and approved each year by Congress. The initiative is prepared by the Ministry of Finance (SHCP) and can be modified by the Congress’ commissions. INE and CONAFOR prepared a modification of Article 223 that earmarked a specific share of water revenues for payments for forest environmental services.

34. A fiscal instrument was established (the Mexico Forestry Fund, FFM) to pay for the hydrological environmental services and to be a commitment device to ensure participants that the resources that would pay them for the following 5 years were already set aside.

35. Since the program’s inception in 2003, it has had rapid acceptance with over three times the amount of applications from environmental services provides than funds available. Initially MXP200 million (US$18.2 million) per year of the annual water revenues were allocated. In 2004 and 2005, the amounts approved were MXP300 million. The payment scheme is MXP300 per ha (US$27.3) to all forests except cloud forests, which receive MXP400 per ha (US$36.4). In 2003/2004 the program signed 623 contracts with service providers covering 297,000 has. In 2005, the program has received 411 applications for PES funding.

36. Eligibility criteria for PSAH contracts in the 2002-2005 time period were: (i) the forest area committed per beneficiary should have a forest cover equal to 80 percent or more; (ii) forested

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area should not be more than 4,000 ha nor less than 50, unless several beneficiaries having adjacent lands totaling this minimum submit a joint application—applications were not accepted from beneficiaries who, together with hectares approved in previous applications, exceed 4,000 ha; (iii) the area under forest management (timber forest) either in recovery or lying fallow, should not exceed 200 ha per beneficiary; (iv) in cases of common land in an agrarian nucleus, the representation bodies should be in compliance with organization requisites laid down in the Agrarian Law and that the decision to apply for inclusion into the Program should be taken by agreement of the general assembly of said agrarian nucleus, and that the surface areas committed and proposed for entry into the Program should not be the subject of any agrarian litigation; and in cases of privately owned plots of land, that no litigation should exist regarding legal ownership or possession of the land, or any other; and, (v) communities must be of 5,000 or more inhabitants.

37. Despite its achievements, there remains room for improvement. In particular, the following areas need to be addressed: (i) the majority of the contracted area is outside the priority conservation areas—less than 14 percent of the area enrolled in 2003 and 2004, for example, was located in areas with overexploited aquifers; (ii) most of the enrolled area is at low risk of deforestation—less than 20 percent of the area enrolled in 2003 and 2004 was in areas with high or very high risk of deforestation, while 62 percent was in areas of low or very low risk of deforestation; (iii) most contracts have gone to the better organized, more developed communities and ejidos, and to private owners, even though their opportunity cost tends to be higher; (iv) budgetary limitations impose a 5-year limit on payments to any one participant, putting conservation beyond that period at risk; and (v) lack of training and capacity building (on both the supply and demand sides) to develop local markets.

38. Market Driven Payments for Environmental Services (PES). The proposed project will address these weaknesses. Its primary objectives are to: (i) secure the long-term sustainability of the PES program by developing new, sustainable long-term financing mechanisms based on payments from service users; (ii) increase the program’s efficiency and cost-effectiveness by focusing it in areas of greatest deforestation risk and overexploited watersheds with areas of water scarcity; (iii) improve its contribution to poverty reduction; (iv) increase its contribution to the conservation of globally important biodiversity by focusing it in critical ecosystems.

39. A key aspect of the proposed project is a PES market based approach. The PES market based approach creates mechanisms that substitute for missing markets. It is based on the principle that those who provide valuable environmental services should be compensated and those who benefit from such services should pay for them. PES programs promise to be more efficient than traditional command-and-control approaches because market-based instruments naturally seek the highest benefits at the lowest cost. Moreover, they give service users a strong incentive to be proactive in ensuring that their money is spent effectively.

40. PES programs are also more likely to be sustainable because they depend on the self-interest of the affected parties rather than taxes, tariffs, philanthropy, or the whims of donors. By providing payments on an ongoing basis, PES programs avoid the pattern of short-term adoption followed by rapid abandonment that has characterized past approaches. They can also help reduce poverty because the areas that provide environmental services (and receive payments) correlate highly with areas of rural poverty. The project builds on previous experience with the use of PES, including a successful nationwide program in Costa Rica that is supported by the Bank and GEF, and a wide range of small-scale initiatives throughout the region, including several in Mexico itself.

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41. Another key aspect of the proposed project is a focus on reducing land degradation, conserving forested areas, reverting marginal agricultural areas to forest, and encouraging more sustainable land use in agriculture. It would create PES mechanisms to provide incentives to hillside farmers and other land users in at least 8 project sites (See Annex 17).2

42. It would also create a framework for application of PES market based approaches that could be applied to other areas on a decentralized basis, responding to local needs and conditions in particular watersheds. Mexico already has some experience with local, self-organized, environmental services markets to solve specific problems. A recent study commissioned by the World Bank and CONAFOR conducted a rapid assessment of 40 experiences related to payment for environmental services in Mexico, and a detailed analysis of 10 of those cases. The cases involved water supply and hydrological services, biodiversity, carbon capture, risk mitigation, and landscape values (ecotourism). They included a range of stakeholders and participants, from local communities and civil society organization to the federal government and international agencies. All the cases affected local watershed and ecosystem management in some way and usually involved more than one kind environmental service.

43. Although the great majority of the PES systems are still under development or negotiation, there are a handful of decentralized PES systems that are already under implementation. For example, the Parque de la Joy–La Barreta (Queretaro) and Municipio de Coatepec (Veracruz) PES systems channel public and private money through municipal trust funds to the owners of land in the watersheds that provide water regulation, quality, and supply services to municipal water users (as envisioned in Component 1A of the proposed project). The land owners are rewarded for including new areas under formal conservation commitments or for improving conservation and land use practices in areas that have been degraded. The source of funds may include money from municipal and local government budgets, fees to urban users of water services, or earmarking of a share of money spent on urban construction projects.

44. The strong national interest in PES is reflected in the GOM establishment of the Mexican Forest Fund and transfer of MXP300 million a year to the program. The development of the proposed PES project for Mexico is based on lessons from the PSAH program and other experiences in Latin America.

Country GEF Eligibility and Drivenness

45. Mexico ratified the Convention on Biological Diversity on March 11, 1993. It is also a signatory to the Convention on International Trade in Endangered Species of Wild Flora and Fauna (CITES) and the Cartagena Protocol on Biosafety). The project’s objectives are fully consistent with guidance from the Conference of the Parties of the Biodiversity Convention regarding conservation and sustainable use of biological diversity. The project is consistent with the guidelines and decisions of a number of CBD Conference of the Parties in particular, with the Addis Ababa Principles and Guidelines number 12 which was adopted by CBD VII Decision 12 under Article 10. The project contributes to the Article by promoting economic incentives to generate additional benefits to indigenous and local communities and stakeholders who are involved in the management of any biodiversity. Furthermore, the project also contributes to the

2 The criteria used for site selection were (a) institutional framework, (b) hydrology and other biophysical conditions, (c) locations that can build local biological corridors, (d) land-use practices, (e) national, regional, and global biodiversity significance, (f) potential supply and demand for ecosystem services, (g) socioeconomic factors, and (h) likelihood that land use changes promoted by an ecosystem service market would support development of local biological corridors.

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Decision 14 (Biological Diversity and Tourism) and 16 by creating appropriate mechanisms to capture the economic benefits of ecological services. In addition, the project is also consistent with the COP VI Decision 15 (Incentive measures).

46. To address the daunting challenge of environmental issues in the country, the Government of Mexico (GOM) has taken a number of actions including legislative, institutional and budgetary. For example, the GOM created the National System of Protected Natural Areas (SINAP) in 1986 to provide protection to some of its rich habitats and biological diversity. With the support from GEF and the World Bank, an endowment fund was created to capitalize financial resources to provide long term financing for protecting the SINAP. Furthermore, the Mexican government has pledged to be committed to a “zero” deforestation target. In addition, the government has been piloting economic incentives mechanism for changing land holder behaviors to promote conservation measures. The introduction of fiscal instrument (e.g., water fee) and PSAH program are examples of GOM’s serious commitment in conservation and sustainable use of its natural resources. To advance this agenda, the GOM has requested the World Bank and GEF to help them prepare the proposed project.

Rationale for Bank involvement

47. The World Bank has considerable experience in the design, implementation, and support of PES programs in developing countries. Several Bank projects that use PES are under implementation with GEF cofinancing, and others are under preparation (see Table A1-5). In parallel, the Bank has been undertaking research on PES and providing the results to practitioners through capacity-building efforts. No other institution has the same depth of experience in implementing PES approaches.

48. GEF support is warranted because the project would help (i) conserve globally significant biodiversity, including critically endangered endemic species, (ii) enhance the Mexico sections of the MBC, (iii) pilot PES as a sustainable, long-term conservation instrument that could be scaled up and replicated in Mexico and serve as a model for other countries, (iv) research links between land use change and environmental services; and (v) increase carbon sequestration and knowledge about biocarbon sinks. Without the GEF increment, environmental services payments might not provide sufficient incentive to adopt land uses that would yield global benefits in addition to local and national benefits.

Table A1-5: World Bank Projects with PES Components

Country, project

Total cost

World Bank loan

GEF grant

Main features(US$ million)Costa Rica: Ecomarkets Project 49.2 32.6 8.0 Effective 2001. Supports PES programColombia/Costa Rica/Nicaragua:

Regional Integrated Silvopastoral Ecosystem Management Project

8.45 - 4.5 Effective 2002. Piloting PES to promote adoption of silvopastoral practices

South Africa: Cape Action Plan for the Environment (CAPE)

49.6 - 9.0 Effective 2004. Uses PES to conserve the Cape Floristic Region

El Salvador: Enviromental Services Project

14.5 5.0 5.0 Approved by GEF and IBRD June 2005. Piloting market based PES program

Panama: Rural Poverty and Natural Resource Management II

50.0 6.0 Under preparation. Will use PES to improve biodiversity conservation and

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generate water servicesVenezuela: Canaima National Park

ProjectUnder preparation. Will use payments

from HEP producers to support conservation of Canaima NP

Bolivia: Consolidating Support for the National Protected Areas System

Under preparation. Will pilot use of PES as financing source for PAs

Costa Rica: Scaling Up and Mainstreaming Payments for Environmental Services Project

Under preparation. Will ensure long-term sustainability of the PSA program by developing new financing sources and improve the program’s efficiency.

Note: Only includes projects with explicit PES components.

Higher level objectives to which the project contributes

49. The environmental objectives of the Mexican government are to increase sustainable development as a shared responsibility; facilitate decentralization of environment management and increased public participation; promote payment for environmental services program; decrease loss of temperate and tropical forests; conserve biodiversity; and increase sustainable water resource management (2001-2006 Mexico Environment and Natural Resources Program).

50. The 2005-2008 Mexico CAS addresses four core issues: (a) the reduction of poverty, (b) environment management, (c) increased competitiveness, and (d) improved governance. It builds on the positive experience of the EnvSAL (a development policy loan, or DPL) in its review of existing programs and incentive structures, to address the implicit short-term tradeoffs between social protection and environmental protection.

51. The CAS recognizes that Mexico faces tremendous pressure on its natural environment; to the degree that failure to reverse some of the most damaging trends may not only act as a brake on continued economic growth, but even contribute directly to reduced social welfare and increasing poverty. The CAS addresses the need to consolidate the regulatory and legal framework for environment issues and support implementation of measures aimed at watershed recovery, reforestation, decontamination, clean production, management of ecosystems, and biodiversity conservation. The CAS notes that vulnerability to natural disasters is closely related to rural poverty and that low productivity and high population pressures have depleted natural resources in many rural areas, caused soil erosion and land degradation, led to loss of habitat, biodiversity, and natural forests, and exacerbated problems in water management and conservation. In response, the CAS supports development of markets for environmental services and strengthening of protected areas management.

52. The project is consistent with the Bank’s 2002 rural and environment strategies for Latin America. The rural strategy aims to reduce poverty and promote growth within the context of sustainable natural resources management and calls for better integration of environmental issues into rural development to build consensus around possible “win-win” opportunities. The environment strategy promotes sustainable, integrated management of natural resources and ecosystems with a focus on highly degraded and disaster-prone areas. The project would support both strategies by developing PES markets that generate win-win opportunities for poverty alleviation, economic growth, and environmental protection.

53. The project also takes into account the Bank’s 2002 Forest Strategy, which is built on (a) harnessing the potential of forests to reduce poverty, (b) integrating forests in sustainable

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economic development, and (c) protecting global forest values. The strategy notes that addressing these three aspects together is complex and multifaceted—not merely about growing trees but rather supporting a complex interaction of policies, institutions, and incentives. It focuses on economic policies and rural strategies that embrace both sustainable use and conservation of vital environmental services, seeking to build markets and financial instruments in support of private investments in sustainable natural resource management.

54. The GEF operational program goal supported by the project. The proposed project supports the GEF Biodiversity Focal Area by protecting natural habitats and biological diversity through forest conservation, reversion of marginal agricultural areas to forest, and promotion of sustainable practices in agriculture. It supports Operational Programs 3 (Forest Ecosystems) and 4 (Mountain Ecosystems) by promoting conservation of biodiversity in key forest and mountain ecosystems. Within the Biodiversity Focal Area, the project particularly fits with two Strategic Priorities: Catalyzing Sustainability of Protected Areas (SP1) and Mainstreaming Biodiversity in Production Landscapes and Sectors (SP2).

55. 1. Under SP1, the project would help ensure sustainability of the national protected areas system by providing a mechanism for long-term financing of biodiversity conservation in the buffer zones of protected areas and the corridors that connect them, including the Mexican portion of the Mesoamerican Biological Corridor.

56. Under SP2, the project will focus on two types of activities: (i) facilitating the mainstreaming of biodiversity within productive landscapes, and (ii) developing market incentive measures. Facilitating the mainstreaming of biodiversity within productive landscapes. Through this type of activity the GEF seeks to support development of the systemic and institutional capacities of government agencies and other stakeholders that would help secure biodiversity conservation. This could be achieved through enabling legislation, removing barriers to conservation, reforming or creating policies, institutional structures, and management procedures, generating relevant knowledge, and building partnerships between agencies, local communities, and the private sector. Activities of this type under Component 2 of the project include strengthening the capacity of national institutions such as CONAFOR, community associations, NGOs, and academic institutions to support development of PES markets in Mexico. Component 1 activities will help create an enabling environment for development of a PES market in Mexico and generate financial resources for the PES program.

57. Developing market incentive measures. Through this type of activity in SP2, the GEF seeks to support innovative market incentive structures (such as demand and supply side interventions, certification of suppliers, purchasing agreements, and codes of conduct) that would catalyze market forces. In doing so GEF seeks to develop partnerships with private sector stakeholders, small- and medium-size enterprises, and others to catalyze the development of innovative processes and activities that improve market efficiency and the ability to provide biodiversity and productive system gains. Activities of this type under Component 1 of the project will support the development of PES markets whereby land users will receive economic incentives for adopting and/or maintaining land use practices that generate valuable ecosystem services. The markets will be piloted in eight priority areas that provide environmental benefits at the local, national, and global levels. These mechanisms will support conservation of natural forest and changes in land use practices such as agroforestry, forest management, reforestation, afforestation, and sustainable agricultural production systems that improve water quality, increase base flows during the dry

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season, help regulate groundwater and surface flows, and maintain or enhance biodiversity both on-site and by protecting critical ecosystems.

58. The project would also complement the SINAP II Protected Areas Project, a GEF co-financed project to strengthen protected areas management. The project's goal is to promote the conservation and sustainable use of biodiversity in Mexico through the consolidation of the National System of Protected Areas (SINAP). Specific objectives are to:1) conserve globally important biodiversity in selected areas of SINAP; 2) Promote the economic, social and environmental sustainability of productive activities in selected protected areas; 3) Promote social co-responsibility for conservation; and 4) Promote the inclusion of biodiversity conservation and sustainable use criteria in development projects and other practices affecting selected Protected Areas. The proposed project would complement the SINAP II objective by improving habitats on private lands in buffer zones and corridors around and between protected areas, thereby improving the viability and biodiversity conservation value of the protected areas themselves. Developing PES markets will also foster and strengthen partnerships between local and national government, NGOs, community organizations, and the private sector and will help promote an integrated ecosystem approach to watershed management.

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Annex 2: Major Related Projects Financed by the Bank and/or other Agencies

MEXICO: Environmental Services of the Forest

Sector Issue Project Latest Supervision(PSR ratings)

Bank FinancedImplem.

Progress (IP)Dev.

Obj (DO)Financial incentives for commercial forest plantations, particularly in degraded lands where incentives may be as much as 65% of reimbursement of investments. CONAFOR/SEMARNAT, in operation since 1998.

PRODEPLAN.Report, 1999

S S

Community Forestry Program, financed by the World Bank, to provide technical assistance to indigenous communities and ejidos for sustainable management of natural forests, and to improve their livelihood through diversifying production. Includes a fund for non-traditional forest products and non-timber products. CONAFOR/SEMARNAT, in operation since 1997.

PROCYMAFP007700

S S

World Bank SAL which is currently supporting the GOM in reviewing the impact on the environment and natural resources of related policies and instruments from relevant sectors (Water, Forests, Energy and Tourism), and developing adequate policy framework and economic instruments to promote sustainable development. The World Bank – Mexico Environmental Structural Adjustment Loan has identified and is addressing some of the most relevant barriers to mainstreaming environmental concerns and biodiversity conservation objectives in productive landscape and relevant economic sectors. SEMARNAT, in operation since 2002.

Environmental Structural Adjustment Loan (EnvSAL)

P074539

S S

World Bank technical assistance and investment loan supporting the modernization of the meteorological service, security at dams, and aquifer and watershed management. National Water Commission (CNA/SEMARNAT), in operation since 1996.

Water Management Invest Loan.

P007713

S S

GEF Grants Administered by the World BankThe Natural Protected Areas projects: FANP I and SINAP II, have focused on the financial requirements of administering the NPA System, providing for an endowment which produces annual financial yields to support an initial 10 (and eventually 24) NPAs, under the Mexican Fund for Conservation, a private non-profit financial institution created in 1994 with the support of Mexico’s NAFTA partners.

GEF-WB Natural Protected Areas System.

P065988

S S

Is an institutional mechanism designed to reorient rural/regional development investment in 4 States in the South of Mexico, to foster biodiversity-friendly investments in the connecting areas between NPAs in Chiapas and the Yucatan Peninsula, on the southern border of Mexico with Guatemala and Belize.

GEF-WB Mexico-Mesoamerican Biological Corridor (MBC),

P060908

S S

Complementary to the Community Forestry World Bank loan designed to assist poor peasant and indigenous communities in

GEF-WB Indigenous and

S S

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sustainable forest management, and to improve their living conditions. Operates in the States of Oaxaca, Guerrero and Michoacan, in areas where satellite images show the best conserved forests on communally owned properties.

Community Conservation.

P066674

An innovative approach to conservation that recognizes the fact that 90% of Natural Protected Areas are on privately owned lands (individual and communal properties), where there are no incentives or legal agreements to promote or guarantee adequate participation by, or commitment from, the owners to conserve their lands.

GEF-WB Medium-size project Private Lands Legal and Financial Conservation Mechanisms

P065923

S S

Developed a systematic approach to carbon sequestration methodologies on poor quality hillside lands.

Hillside Management

P077213

S S

Developed certification mechanisms to take advantage of niche markets for biodiversity-friendly coffee from plantations in the buffer area of a biosphere reserve.

El Triunfo Productive Landscape

P060558

S S

Other Development AgenciesTwo related projects supported by the GEF through UNDP, to promote participation of local players in conservation efforts headed by the National Commission for Natural Protected Areas (CONANP/SEMARNAT). Both could be candidates for a future decree to create new protected areas, or to produce new instruments to promote sustainable practices whilst conserving biological diversity. Another initiative is the Indigenous and Biodiversity Conservation Project (COINBIO), also oriented towards good management of biological diversity and based on capacity developed by, and the extension mechanisms of, PROCYMAF and PROCYMAF II.

GEF-UNDP Three Priority Eco-regions and the Sierra Gorda Biosphere Reserve

Permanent program operated by CONAFOR/SEMARNAT with the participation of local communities, governments and the military, and financially assisted by bilateral North American co-operation agreements.

Forest Fire Prevention and Combat Program.

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Annex 3: Results Framework and Monitoring

MEXICO: Environmental Services of the Forest

Results FrameworkPDO/Global Environment Objective Outcome Indicators Use of Outcome Information

Project development objective is to improve the provision of environmental services that bring both national benefits (primarily water services) and global benefits (primarily increased biodiversity conservation) by strengthening and expanding the PSAH and CABSA programs and supporting the establishment of local payments for environmental services (PES) mechanisms.

The objective will be achieved through (i) strengthening the capacity of CONAFOR, INE, community associations, and NGOs to increase flexibility and improve efficiency of existing service provision to support long-term development of PSAH program in Mexico; (ii) establishing sustainable long-term financing mechanisms; (iii) legal, institutional, and financial arrangements to pilot market based mechanisms for payment for environmental services, (iii) document links between land use changes and water services improvements and biodiversity conservation, (iii) define good practices to replicate, scale up, and sustain PES market based programs.

At least 100,000 hectares under environmental service contracts that contribute to increase hydrological services, biodiversity conservation and carbon sequestration financed wholly or partially from new financing sources established under the project.

YR1-YR3: Low implementation levels may indicate ineffective institutional arrangements or poor selection of land uses promoted by the PES system.

YR4: feed into strategy for replicating PES program.

Stand-alone local PES mechanisms designed for at least two pilot sites for contracting (buying and generating) environ-mental services in priority areas, including functioning M&E systems by EOP

Develop and refine additions to the operational manual for PES on how to develop local funding mechanism. YR4 feed into strategy for replicating PES.

500,000 ha under environmental service contracts that contribute to increase hydrological services financed from existing funding sources;

YR1-YR4: Assess whether targeted milestones are being accomplished and make adjustments.

At least 15 proposals for carbon sequestration projects are submitted to potential buyers.

YR1-YR4: Assess whether targeted milestones are being accomplished and make adjustments.

Institutional arrangements for facilitating PES mechanisms management and learning established, properly staffed, and resourced to continue beyond the EOP to replicate and scale up PES market based program.

YR1-YR4: Assess whether institutional arrangements are sufficient to establish and maintain PES program. Make adjustments as needed.

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PDO/Global Environment Objective Outcome Indicators Use of Outcome Information

CONAFOR and INE use state of the art techniques and procedures to monitor data on implementation and impacts of both the national PES program and pilot local PES mechanisms (i.e., vegetation cover, land use practices, ecosystems and habitats, indicator species of conservation interest, water discharge, sediment production and transport, biochemical oxygen demand (BOD) and total suspended solids.)

YR1-YR4: Monitoring institutional capacity to design and implement methodologies to measure the impact of land use changes on environmental services. Adjust institutional strengthening activities if needed.

CONAFOR and INE use the information to evaluate and draw conclusions on (i) the links between land use changes and environmental services, (ii) buyers’ responses, (iii) community acceptance of the PES mechanism, and (iv) sustainability of the mechanism measured by the ratio of payments from local buyers of ES and CONAFOR’s operational costs.

YR1-YR4: results of monitoring all indicators to feed into strategy for replicating PES program.

The global environment objective of the project is to enhance and protect biological diversity and preserve globally significant) forest and mountain ecosystems.

200,000 hectares of forests and other natural ecosystems of global biodiversity significance under effective conservation (protection and sustainable management) by landowners before EOP in the buffer zones of protected areas and the corridors that connect them, including the Mexican portion of the Mesoamerican Biological Corridor.

YR3-YR4: Monitoring of land use changes impact on biodiversity to assess effects.

XX number of PES contracts to conserve forests or other natural ecosystems by EOP.

YR3-YR4: Monitoring of land use changes impact on biodiversity to assess effects.

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PDO/Global Environment Objective Outcome Indicators Use of Outcome Information

Effective biodiversity conservation in the project sites measured by vegetation cover and indicator species of conservation interest.

YR3-YR4: Monitoring of land use changes impact on biodiversity to assess effects.

Improved water services in pilot watersheds measured by indicators appropriate to local uses, such as seasonal mean and peak flows, reduction of sediment production and transport, biochemical oxygen demand (BOD) and total suspended solids.

YR3-YR4: Monitoring of water quality impacts from land use changes. Used to adjust types of land use changes and volume of changed needed to generate increased water quality.

Intermediate Results(One per Component) Results Indicators Use of Results MonitoringComponent One:

Developing Sustainable Financing Mechanisms: Financial Mechanisms for Water, Biodiversity and Carbon have been created

Component One :

Financing mechanisms based on local demand are in place in at least six sites.

Component One:

Develop and refine additions to the operational manual for PES on how to develop local funding mechanism. YR4 feed into strategy for replicating PES.

An endowment fund for biodiversity conservation has been established to provide long term funding for biodiversity of global significance by project year 3;

YR1-YR2: Develop legal and institutional arrangement for the fund.

A strategy has been developed for capitalizing the endowment fund by project year 3;

YR2-YR3: Lessons from other countries and implementation of the various PES programs in the country. A low level of capitalization amount may indicate ineffective strategy and/or its implementation.

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Intermediate Results(One per Component) Results Indicators Use of Results Monitoring

A biodiversity conservation funding window has been established within FFM by project year 2;

YR1-YR2: Develop legal and institutional arrangement for the fund.

Component Two:

Developing and Strengthening PES Delivery mechanism: Existing PES Program have been strengthened, Local Stand-alone PES Programs have been established and a Matching Fund program will be operating

Component Two:

Operating rules of PSAH and CABSA programs are enhanced by end of project year 1;

Component Two:

Monitoring (compliance and impacts) systems of PSAH and CABSA programs are improved and under implementation by end of project year 1;Substantial increase in the efficiency with which PSAH/CABSA funds are used: - at least 75% of area contracted in priority areas; Appropriate contracting, monitoring and payment systems have been developed and under implementation in at least 2 watersheds to run the stand-alone PES Program by EOP;

Component Three:

Supporting Environmental Service Providers: Technical and Organizational Assistances

Component Three:

Local facilitators with site specific knowledge have been recruited and trained to provide TAs;

Component Three:

80% of service providers are satisfied with the timeliness and quality of TA;

Participation of ejidos in pilot sites increased by 50% over the national average;

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Intermediate Results(One per Component) Results Indicators Use of Results MonitoringComponent Four:

Payment to Service Providers

Component Four:

FFM will continue to receive at least US$30 million a year;

Component Four:

80% of service providers are satisfied with the PES program and payments received;

Participation of ejidos in pilot sites increased by 50% over the national average;

Component Five:Project and Program Management

Component Five:

A Project Coordination Unit (PCU) staffed, including regional facilitators, and functioning within CONAFOR at all times during the project with sufficient capacity to carry out all project activities.

Component Five:

Annual performance evaluations of PCU staffed to be conducted.A project management information system to be installed and functioning during the life of the project.Quarterly physical and financial status reports prepared and submitted to the Bank.Semiannual documents on lessons learned and policy implications are prepared. To coincide with supervision missions.Planning process, as defined in the Operations Manual, to be followed which defines when and how Annual Implementation Plans (AIP), quarterly and monthly plans will be prepared based on Project Implementation Plan (PIP).Project communications strategy developed and implemented.

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Arrangements for results monitoring

1. Monitoring and evaluation has been mainstreamed into almost all project components and will be conducted at three levels: (i) contract compliance, (ii) impact monitoring, and (iii) project implementation. Table A3.1 shows monitoring and evaluation costs by subcomponent.

Table A3.1: Monitoring and Evaluation Costs (million US$)Component Cost1A. Development of financing mechanisms from water users 0.381B. Development of financing mechanisms from biodiversity users 0.301C. Development of financing mechanisms from carbon users 0.402A. Strengthening of existing PES programs 0.442B. Support development of stand-alone local PES programs 0.083B. Organizational Assistance 0.515D. Project and Program Monitoring and Evaluation 0.78

Total 2.89

2. The project would be guided by semiannual learning reviews of project results to coincide with Bank supervision missions on which basis CONAFOR and the Bank would identify specific measures to: (i) address any areas of implementation weaknesses; and (ii) adapt project design to ensure objectives are met. These measures for improvement would be reflected in the CONAFOR quarterly learning reports and their proposal for the forthcoming year’s Annual Implementation Plan including project budget. It is expected that CONAFOR and INE would involve third party, independent evaluators for environmental contract monitoring and to perform technical biodiversity, carbon sequestration, and water quality impact studies.

3. Institutional issues: Monitoring and evaluation of project outcomes/results (both intermediate and end of project) will be coordinated by the Project Coordination Unit (PCU) in CONAFOR. Trained staff from specialized agencies and NGOs will have the responsibility to collect and analyze field data, while INE, and the PCU will archive and distribute relevant and timely information to assist in effective decision making for project management.

4. The monitoring and evaluation process will function as a mechanism for assessing project impacts and as a day-to-day management tool. An M&E system will be developed to provide accountability and to strengthen the capacity of CONAFOR for planning and monitoring of overall project activities. The M&E system will also support the project supervision process by ensuring that baseline and follow-up data for the key performance indicators are collected and made available on an ongoing basis and at strategic times including project start-up (underway before project effectiveness), midterm review and project closing. A baseline study will be carried out at inception, and follow-up evaluations at both midterm and project closing. Site-specific baselines studies will be performed before work begins in the pilot areas and baseline studies will be phased in on the national PSAH and CABSA programs. Site-specific follow-up evaluations will be carried out to measure impacts of land use changes on anticipated environmental services. Specific project implementation monitoring data will be provided on agreed upon report formats, included in the operations manual, and will be required for the twice-yearly supervision missions. CONAFOR will develop the project monitoring system that

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would record the planning, physical implementation, performance of local technical assistance, and development objective indicators from the project’s Results Framework.

5. NAFIN will monitor financial and procurement management for the project as a whole. Financial information on inputs, outputs, budgeting, treasury, accounting, and audits would be monitored. The project will send to the Bank quarterly financial management and procurement reports. Monitoring and processing of procurement of services, goods, works, and sub-projects would be carried out by the PCU in coordination with NAFIN. The annual planning processes would be monitored with specific indicators on planning performance defined in the Results Framework. The physical implementation of the project would be monitored based on the specific outputs and monitoring indicators for the project components as defined in the Results Framework. Information from the monitoring system would be analyzed by project management and disseminated according to the project’s communication strategy to appropriate stakeholders. The project would provide the Bank with progress reports every quarter and an update on legal covenants compliance every six months.

6. Data collection: The PCU will coordinate collection of component results indicators. Data for monitoring and evaluation of Component 1 will come from the geographic information and statistical reports from CONAFOR facilitators, NGOs acting as PES transaction intermediaries. These facilitators and NGOs will also monitor contract compliance from farmers in the project area watersheds and from the external annual audits.

7. Semiannual Evaluations. A key objective of the project is learning how to implement an effective PES market based program in Mexico. Semiannual learning workshops are planned to coincide with supervision missions to identify and discuss lessons learned during project implementation with project stakeholders and beneficiaries. The PCU will submit quarterly reports on lessons learned and plans for incorporating those lessons into future activities.

8. Midterm evaluation. The Bank’s supervision team, together with a team of external reviewers and key stakeholders, will conduct a midterm evaluation of project execution. It will be conducted no later than three years after of the first disbursement. The external review will focus on (i) progress in achieving project outcomes, (ii) institutional arrangements for project implementation, (iii) operational manual[s] for payments for environmental services mechanisms, (iv) effectiveness and suitability of the monitoring system, and (v) review of both the project implementation plan and general project operation manual. In preparation for the MTR the PCU will prepare reports on the key elements of the PES system: (i) perceptions from key stakeholders; (ii) assessment of institutional arrangements and recommendations; (iii) scientific lessons from the links between land use and environmental services; and (iv) progress on biodiversity conservation.

9. Final Evaluation. A final evaluation will be conducted in the last semester of project execution. The key objectives of the final evaluation will be to (i) assess attainment of the expected project results, (ii) use the results to design a strategy for replication in future projects, and (iii) design a strategy for mainstreaming future PES market based programs.

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Arrangements for Results Monitoring{The Results Monitoring Arrangement will be finalized at appraisal}

Target Values Data Collection and Reporting

Outcome Indicators Baseline YR1 YR2 YR3 YR4Frequency and

Reports

Data Collection

InstrumentsResponsibility for Data Collection

PES mechanisms designed for at least two sites for contracting (buying and generating) environmental services in priority areas;

None --- Yearly project reports

MTR and Impact Evaluation Studies

Project Coordination Unit (PCU)

At least 100 hectares under environmental service contracts that provide environmental services in biodiversity conservation and/or water services.

None --- ---

Quarterly and Annual project implementation reports

Project management information system

CONAFOR/PCU

Institutional arrangements for facilitating PES mecha-nisms management and learning established, prop-erly staffed and resourced to continue beyond the EOP to replicate and scale up PES market based program.

None

Quarterly and Annual project implementation reports

Project management information system

CONAFOR/PCU

CONAFOR and INE use state of the art techniques and procedures to monitor implementtation and impacts of the pilot PES mechanisms: vegetation cover, land use practices, landform, ecosystems and habitats, in the dimensions of composition, structure

Annual project reports

Reports CONAFOR/INE

50

and function, water discharge, sediment production and transport, biochemical oxygen demand, and total suspended solids.

Effective biodiversity conservation in the project sites measured by vegetation cover and indicator species of conservation interest.

Baseline MTR EOP Site specific evaluations

Specialized surveys INE

200,000 ha of forests and other natural ecosystems of global biodiversity significance under effective conservation (protection and sustainable management) by landowners before by EOP.

Baseline 50% 80% 80% 100% Site specific monitoring design

Continuous monitoring and Studies

INE

XX number of PES contracts to conserve forests or other natural ecosystems by EOP

None 25% 50% 80% 100% Site specific monitoring design

Continuous monitoring and Studies

INE

Results Indicators for Each Component

Component One :

Financial Mechanisms for Water, Biodiversity and Carbon have been created

Baseline --

Financing mechanisms based on local demand are in place in at least one site.

Financing mechanisms based on local demand are in place in at least three sites.

Financing mechanisms based on local demand are in place in at least six sites.

Quarterly and Annual project implementation reports

Reports and Supervision missions

CONAFOR/INE

An endowment fund for biodiversity conservation

None Legal and institutional

Strategy developed

Fund established

Quarterly and Annual project

Repots and supervision

CONAFOR/INE

51

has been established to provide long term funding for biodiversity of global significance by project year 3;

analysis implementation reports mission reports

A biodiversity conservation funding window has been established within FFM by project year 2;

NoneLegal and

institutional arrangement

Funding window

established

Quarterly and Annual project implementation reports

Repots and supervision mission reports

CONAFOR/FFM

Component Two :

Developing and Strengthening PES Delivery mechanism

Baseline

Operating rules of PSAH and CABSA programs are enhanced

Quarterly and Annual project implementation reports

Repots and supervision mission reports

CONAFOR/INE

Improved monitoring system in place

Baseline

Monitoring (compliance and impacts) systems of PSAH and CABSA programs are improved and under implementation

Quarterly and Annual project implementation reports

Repots and supervision mission reports

CONAFOR/INE

Substantial increase in the efficiency with which PSAH/CABSA funds are used: - at least 75% of area contracted in priority areas;

BaselineLessons learned drawn;

Training provided;

Substantial increase in

efficiency in at least 25% of

the areas

Substantial increase in

efficiency in at least 75% of

the areas

Quarterly and Annual project implementation reports

Repots and supervision mission reports

CONAFOR/INE

Stand-alone PES Program under implementation in at least 2 watersheds.

None Appropriate contracting, monitoring and payment

Appropriate contracting, monitoring and payment

Stand-alone PES Program developed in at least 2

Stand-alone PES Program under implementation

Quarterly and Annual project implementation reports

Repots and supervision mission reports

CONAFOR/INE

52

systems have been designed

systems have been implemented

watersheds. in at least 2 watersheds.

Component Three:

Technical and Organizational Supporting Environmental Service Providers

Baseline

Local facilitators with site specific knowledge have been recruited and trained to provide TAs

Local facilitators provide TAs;Participation of ejidos in pilot sites increased by 15% over the national average

Local facilitators provide TAs;At least 50% of service providers are satisfied with the timeliness and quality of TA;Participation of ejidos in pilot sites increased by 30% over the national average

Local facilitators provide TAs;At least 80% of service providers are satisfied with the timeliness and quality of TA;Participation of ejidos in pilot sites increased by 50% over the national average

Quarterly and Annual project implementation reports

Repots and supervision mission reports

CONAFOR/INE

Component Four :

Payment to Service Providers

FM will continue to receive at least US$30 million a year;

Baseline

FFM will continue to receive at least US$30 million a year;

Demand for participation in the PES Program is high.

FM will continue to receive at least US$30 million a year;

15% of service providers are satisfied with payments received

FM will continue to receive at least US$30 million a year;

50% of service providers are satisfied with payments received

FM will continue to receive at least US$30 million a year;

80% of service providers are satisfied with payments received

Quarterly and Annual project implementation reports

Repots and supervision mission reports

CONAFOR/INE

Component Five :

Project and Program Management

None PCU established and staffed;Resources for PCU to carry out its activities budgeted;Project

PCU established and staffed;Resources for PCU to carry out its activities budgeted;Project

PCU established and staffed;Resources for PCU to carry out its activities budgeted;Project

PCU established and staffed;Resources for PCU to carry out its activities budgeted;Project communication

Quarterly and Annual project implementation reports

Repots and supervision mission reports

CONAFOR/INE

53

communication strategy developed

communication strategy implemented

communication strategy implemented

strategy implemented

54

Annex 4: Detailed Project Description

MEXICO: Environmental Services of the Forest

1. The proposed project would increase substantially the development of markets for environmental services in Mexico by (i) developing new, sustainable financing mechanisms for environmental services, which could be channeled either through the existing PES programs or through new, stand-alone local PES mechanisms; (ii) strengthening and improving the efficiency of existing PES programs (PSAH and CABSA); (iii) stimulating the development of stand-alone local PES programs; and (iv) assisting local communities in service provision.

2. Figure A4-1 illustrates the main components of PES programs, and how the various project components support their development. Component 1 focuses on developing sustainable financing mechanisms. Component 2 activities support the development and strengthening of PES delivery mechanisms. Component 3 supports environmental service providers. The actual flow of payments to participants and the ongoing operational costs of the program are tracked under component 4. Finally, component 5 undertakes project management.

Figure A4-1: Structure of the Project

2A

2B 2B

3

1B1C1A

LFD

Water usersVoluntary payments Water

fee

Local financing

mechanism

Water services

Land users

Environmental services

Component 1.Developing sustainable financing

mechanisms

Component 2.Developing and strengthening PES delivery mechanisms

Component 3.Assisting service

providers

Global community

Biodiversity Trust Fund

Biodiversity conservation

Local tourism industry

Local financing

mechanism

Biodiversity conservation

Stand-alone local PES

Carbon buyers

Carbon payments

Carbon sequestration

Stand-alone local PES

CONAFOR (PSAH/CABSA)

FFM

55

3.Table A4-1

shows the indicative costs and source of financing for each component.

4. Key project beneficiaries would be (a) members of the mostly poor rural ejidos and communities that would be paid to provide environmental services and (b) users of environmental services who would receive increased or improved services and/or be protected from degradation of those services. The global community would also benefit through the conservation of biodiversity of global significance and increased carbon sequestration. The project will ensure that only sites with globally significant biodiversity will receive GEF funds under the national or local programs in the project area. Furthermore, all land management

Table A4.1: Project Component Costs and Financing (million US$)

Component /Sub-component

Total GEF IBRD Government Benefi-ciaries

$ % $ % $ % $ % $ %I. Developing Sustainable Financing Mechanisms

21.36 12 10.58 71 1.59 2 9.19 17   

a. Development of financing mechanisms from water users

1.95 1 0.49 3 0.95 1 0.51 1  

 b. Development of financing mechanisms from biodiversity users

18.47 10 9.68 65 0.30 0.4 8.50 16   

 - Local PES Program for

Biodiversity1.47 1 1.18 8 0.30 0.4      

 - Development and

capitalization of biodiversity endowment fund

17.00 9 8.50 57      8.50  16  

 c. Development of financing mechanisms from carbon users

0.94 1 0.42 3 0.34 0.4 0.18 0.4  

 II. Developing And Strengthening PES Delivery Mechanisms

3.70 2 1.20 8 1.63 2 0.88 2  

 a. Strengthening of existing PES programs

2.48 1 0.75 5 1.13 1 0.61 1   

b. Support development of stand-alone local PES programs

1.10 1 0.33 2 0.50 1 0.27 1  

 c. Matching Funds for Local Financing Mechanisms

0.13 0 0.13 1           

III. Supporting Environmental Services Providers

2.00 1 0.80 5 0.78 1 0.42 1  

 a. Technical Assistance 1.00 1 0.40 3 0.39 0.5 0.21 0.5    b. Organizational Assistance 1.00 1 0.40 3 0.39 0.5 0.21 0.5    IV. Payment To Services Providers

148.6082

1.58 11 73.29 91 40.99 77 32.73

V. Project And Program Management

0.97 1 0.46 3 0.34 0.4 0.18 0.4   

Contingencies/unallocated 5.16 3 0.39 3 3.11 4 1.67 4 0.00  Total: 181.

79  15.0

0  80.7

3  53.3

3  32.7

3 

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systems with PES support under the project (from any funding source) will be biodiversity-friendly (see Annex 10 for details).

5. As detailed in Annex 17, all eight of the pilot sites where PES systems would be established, strengthened, or continued under the project were chosen to overlap with at least two of the following high-priority biodiversity conservation designations: (i) existing Natural Protected Areas; (ii) Priority Terrestrial Ecoregions established by CONABIO; (iii) Important Bird Areas that are vital to the survival of endemic species or to protecting key bird breeding, feeding, and migration areas; and (iv) Ramsar Wetlands of International Importance.

Component 1: Developing Sustainable Financing Mechanisms ($21.36 million, of which $10.58 million from GEF)

6. PES programs are intended to remedy situations in which service providers have no incentive to provide services that benefit others. The incentive provided by PES programs, however, lasts only as long as the payments themselves last—when payments cease, providers might no longer have an incentive to provide services. A fundamental aspect of PES programs, therefore, is that payments need to be long-term. Creating sustainable financing mechanisms that capture demand for environmental services is critical to the development of PES programs. Current financing for the PSAH relies entirely on an allocation of resources from the current water fee revenue stream, while CABSA is funded out of general revenue.

7. The main objective of this component is to develop new, sustainable financing sources based on payments from service users, which could then be channeled either through the PSAH or through stand-alone local PES mechanisms, as appropriate. To achieve this objective, this component will help develop financial mechanisms based on the main types of environmental services: water quality and regulation, biodiversity conservation, and carbon sequestration. These financial mechanisms would be piloted in about eight promising sites identified by CONAFOR (see Annex 17). Some sites might focus on a single financing mechanism while others include multiple financing mechanisms, depending on the services being generated and the interests of users.

8. The lessons of other PES efforts indicate that PES mechanisms need to be adapted to site-specific conditions to be efficient. While following guidelines set by CONAFOR, the details of individual mechanisms will therefore differ in terms of the specific services they seek to generate and the land uses they support.

9. PES operations will be guided by a General Operations Manual, which will specify procedures for assessing applicability of the PES approach at potential sites and will guide development of individual PES mechanisms at the sites selected for implementation, each of which will have its own Site Specific Field Manual. Site selection will be based on factors such as the likely national and global environmental benefits that would be generated, the presence of service users willing to pay for the services they seek to obtain, the willingness of land users to change their land use practices in exchange for suitable compensation, and the existence of institutions that can help implement a PES mechanism. An initial version of this manual will be prepared prior to the beginning of implementation, but it is expected that the manual will be revised frequently during implementation to incorporate lessons learned. A key element of this

57

component is establishing the monitoring mechanisms, learning processes, and knowledge base to replicate the approach in other areas.

10. Key outputs from this component include (a) pilot financing mechanisms with local water services in at least seven sites, including some mechanisms that channel payments through the PSAH and others that channel payments through stand-alone local PES programs; (b) pilot financing mechanisms for local biodiversity users (primarily the tourism industry) in at least four sites; (c) development and initial capitalization of a trust fund for biodiversity conservation to ensure the availability of long-term funding for cases where water-based payments would be insufficient to ensure conservation of biodiversity; (d) pilot financing mechanisms for carbon buyers in at least two sites; and (e) replication strategies to expand the use of these mechanisms beyond the pilot sites.

11. Based on these pilot experiences, an analysis will be carried out during project years three and four to create a replication strategy for widespread development of local environmental services markets in the country.

12. Key inputs for the success of this component include (i) providing the necessary resources for CONAFOR to implement the activities; (ii) providing adequate resources to design and implement the operational manual; and (iii) providing resources to design and capitalize the biodiversity endowment fund.

Subcomponent 1A: Development of financing mechanisms from water users ($1.953 million, of which $0.488 million from GEF)

13. The aim of this subcomponent is to develop long-term financing mechanisms from water users at each pilot site. Water services are among the most important services that ecosystems provide, particularly in a relatively dry country like Mexico. Land use change can affect the quantity, quality, and timing of water flows to downstream water users, potentially leading to problems such as seasonal water shortages, lower water quality, or catastrophic flooding. Water services also provide the most promising approach to developing sustainable financing mechanisms, because fees linked to water use can generate a continuous flow of funds. But such payments are likely to be forthcoming only as long as the water users receive the services they want.

14. At each of the promising sites identified by CONAFOR, the key activities are:

Initial diagnosis of uses to (i) fully understand the nature of water use and the problems water users are facing or could face (municipal water supply, for example, has very different requirements from hydroelectric power production); and (ii) verify that upstream land use affects the desired services (in some cases problems might originate from other sources, such as overuse of water downstream or from point source contamination, neither of which is amenable to resolution through PES).

Targeted technical studies to (i) clearly identify the specific upstream land use changes that need to be promoted or discouraged and the critical areas in the watershed in which to do so,

58

such as erosive areas if sedimentation is the problem or groundwater recharge areas if insufficient recharge of aquifers is the problem; (ii) estimate the size of the area that needs to be conserved, and the cost of that conservation; (iii) estimate the likely impact of conservation in terms of additional services or averted loss of services; (iv) estimate the value of this impact to water users (for example, costs avoided); and (v) design a monitoring system that would allow the effectiveness of PES-supported conservation to be assessed.

Promotional efforts to show water users the benefits and practicality of PES approaches, including, as appropriate, broad promotional efforts targeted at end-users and more technical information targeted at intermediaries (for example, managers of water supply companies).

Negotiations with water users and other stakeholders to agree on payment levels and rules for their use, including agreeing on how payments would be apportioned in cases where there are multiple water user groups, possibly with conflicting requirements.

Assistance to water users in establishing appropriate financing mechanisms that could channel payments either through PSAH or through a stand-alone local PES mechanism (with the assistance of activities under component 2B).

15. These efforts in the pilot sites would be backed and complemented by broader efforts, and lead to the development of a replication strategy. Activities will include:

Evaluating experience in other Latin American countries with different approaches to generating financing from water users (for example, charging end-users directly versus using existing financial flows)3 and coordinating payments when there are multiple groups of users, possibly with different needs.

Designing monitoring systems so that they also allow (i) investigation of specific impacts to improve overall knowledge of the link between land use and water services, and (ii) testing and validating hydrological models so that they can more confidently be used to predict impacts of land use change.

Developing streamlined diagnostic methods to more rapidly and economically assess the potential for PES at future sites.

Developing a range of standardized financing approaches tailored to the main types of situations encountered (for example, single versus multiple water user groups; high-value versus low-value water uses; avoiding future problems versus addressing current problems) to allow faster implementation of additional mechanisms.

Improving criteria to identify promising areas for implementation of new local financing mechanisms based on water payments, and application nationwide.

Development of a nationwide replication strategy based on lessons learned.

3 Both approaches have been used. For example, the city of Heredia, Costa Rica, has added an explicit conservation fee to water bills (Cordero, 2003) while in the city of Quito, Ecuador, the water and electric utilities are using part of their current revenues to contribute to a PES fund (Echevarría, 2002).

59

Subcomponent 1B: Development of financing mechanisms from biodiversity users ($18.473 million, of which $9.678 million from GEF)

16. The aim of this subcomponent is to develop financing mechanisms based on local and global biodiversity benefits. In several of the pilot sites, efforts will be made to develop financing mechanisms based on the local, nature-based tourism industry. This effort would be complemented by development of a biodiversity endowment fund to capture and channel payments for biodiversity conservation from the global community. The incremental resources from GEF will also be used to design local PES programs that conserve globally significance biodiversity.

17. Local PES Program for Biodiversity: Mexico has a growing nature-based tourism industry that depends on healthy natural ecosystems to attract visitors. This activity will work with the local tourism industry at several pilot sites to develop financing mechanisms under which commercial tourism enterprises contribute on an ongoing basis to support conservation of the ecosystems from which they benefit. This is an innovative approach for which there are only a few working examples anywhere in the world. In the promising sites identified by CONAFOR where there is significant nature-based tourism, key activities would include:

Initial diagnosis of uses to fully understand (i) the nature, size, and structure of the tourist industry at the site; (ii) the ways in which it uses biodiversity; (iii) how it is or would be affected by changes in land use.

Targeted technical studies to (i) clearly identify the specific land use changes that need to be promoted or avoided to generate the desired services, including identification of critical areas within the ecosystems (for example, areas critical to avian biodiversity, when the industry focuses on bird watching); (ii) estimate the size of the area that needs to be conserved and the cost of that conservation; (iii) estimate the likely impact, in terms of improved services or averted loss of services, from conserving biodiversity of interest to the tourism industry; (iv) estimate the value of this impact to the tourism industry (for example, changes in the number of visitors or in the fees it can charge); and (v) design a monitoring system that would allow the effectiveness of PES-supported conservation to be assessed.

Promotional efforts to show the tourism industry the benefits and practicality of PES approaches, including, as appropriate, broad promotional efforts targeted at tourists and more technical information targeted at tourist industry firms (hotels, tour operators, etc).

Negotiations with the tourism industry and other stakeholders to agree on the level of payments and rules for their use, including agreeing on how payments would be apportioned in cases where there are multiple user groups, possibly with conflicting requirements.

Assistance to the tourism industry in establishing appropriate financing mechanisms that could then channel payments either through CABSA or through a stand-alone local PES mechanism (with the assistance of activities under component 2B).

18. These efforts in the pilot sites would be backed and complemented by broader efforts and would lead to development of a replication strategy that would include:

60

Evaluating alternative approaches for generating financing from tourism (for example, charging tourists directly versus assessing fees on tour operators) and coordinating payments when there are multiple groups of users.

Designing monitoring systems that allow investigation of specific impacts, thus improving the overall knowledge of the link between land use and biodiversity.

Development of streamlined diagnostic methods that more rapidly and economically assess the potential for PES at other sites.

Development of a range of standardized financing approaches tailored to the main types of situations encountered (for example, a concentrated versus segmented tourism industry; high-value versus low-value tourism; or avoiding future problems versus addressing current ones) to allow faster implementation of additional mechanisms.

Improving criteria to identify promising areas for implementation of new local financing mechanisms based on tourism payments, and application nationwide.

Development of a nationwide replication strategy based on lessons learned.

19. Development and capitalization of a biodiversity endowment fund: Since biodiversity conservation in Mexico also provides benefits far beyond those received by the local tourism industry, it is appropriate that the global community support Mexico’s biodiversity conservation efforts. Most global funding sources for biodiversity conservation, however, including GEF and other donors, are not equipped to provide the long-term funding flows that PES programs require. The biodiversity subcomponent would also include the development of an endowment fund to ensure the availability of long-term funding for cases where payments from water users or the local tourism industry would be insufficient to ensure conservation of biodiversity. This effort will be closely coordinated with similar efforts underway in Costa Rica and El Salvador to establish and capitalize endowment funds for use in PES programs. Specific activities will include:

Development of an endowment trust fund, using best practices learned from previous efforts, including evaluation of (i) existing trust funds to assess their suitability to take on this added role; (ii) creation of a new, stand-alone trust fund dedicated to this purpose; and (iii) creation of a window within the Fondo Forestal Mexicano.

Development of operational rules for trust fund resources to help ensure that they are used in a cost-effective way for conservation of globally significant biodiversity.

Initial capitalization using part of the GEF grant and partly from counterpart financing.

Development of a strategy to attract additional contributions.

61

Subcomponent 1C: Development of financing mechanisms from carbon users ($0.936 million, of which $0.416 million from GEF)

20. Some initial but limited exploratory work has been undertaken on the potential for securing financing through the nascent market for carbon sequestration based on land use. The aim of this subcomponent is to strengthen CONAFOR’s ability to promote land use change projects that sequester or conserve carbon in forest and agroecosystems while also promoting biodiversity conservation and poverty alleviation. To this end the project will support (i) strengthening PSAH–CABSA to facilitate their preparation of projects and proposals to attract funding from carbon markets; (ii) establishing financing mechanisms to improve incentives for land use changes that seek to attract carbon market participants; and, (iii) analyzing, designing, and implementing financial instruments to facilitate carbon sequestration transactions between land users, CONAFOR, carbon market intermediaries, and carbon buyers. Key activities will include:

Establishing a unit within CONAFOR to coordinate efforts to promote, prepare, and transact carbon sequestration services based on land use in coordination with the Mexican CDM Office.

Establishing technical know-how and experience in the formulation, evaluation, and preparation of carbon sequestration projects eligible for registration as CDM activities or for financing by other interested buyers.

Assessing potential for selling land-use based carbon sequestration under the rules of the First Commitment Period (only reforestation allowed).

Improving special targeting of existing activities.

Compiling and assessing available data on rates of carbon sequestration under different land uses and leveraging ongoing monitoring efforts under the other components to improve understanding of carbon sequestration under different land uses.

Reviewing approaches for demonstrating additionality; analyzing baseline methodologies for carbon sequestration based on land use to be used or explored by others and assessing their suitability for Mexico so as to build up a portfolio of applicable methodologies; and assessing transaction costs and exploring instruments to facilitate the flow of resources to land users.

Working with the BioCarbon Fund and/or other interested buyers to prepare no less than 20 CDM projects for consideration by the international carbon trading community.

Monitoring progress in defining rules for carbon sequestration based on land use under the Second Commitment Period, and preparing Mexico to take advantage of them.

Component 2: Developing and Strengthening PES Delivery Mechanisms ($3.704 million, of which $1.199 million from GEF)

21. The objectives of this component are to strengthen the existing PSAH and CABSA delivery mechanisms and to support the development of new, stand-alone delivery mechanisms

62

for local PES markets. Having financing is not sufficient; mechanisms are needed to act as intermediaries between service users and service providers. These mechanisms must undertake functions such as determining how best to generate the services that users are paying for, identifying critical areas and land use practices to be targeted, negotiating with and contracting service providers, monitoring compliance, making payments, and monitoring impacts. CONAFOR has already created the PSAH (and on a smaller scale CABSA) to undertake this role. However, both PSAH and CABSA are young mechanisms that require considerable strengthening and improvement to increase their efficiency and their capacity to handle the greater and more complex demand generated through component 1 (see Annex 6 on institutional arrangements).

22. A key outcome from this component will be to strengthen the capacity of CONAFOR and other national institutions, market intermediaries, community associations, and NGOs to undertake the functions necessary to implement PES programs. In particular, this component would increase the efficiency and effectiveness of the PSAH and CABSA by supporting their evolution toward a more differentiated and targeted set of programs rather than their current one-size-fits-all approach. A second subcomponent would support development of stand-alone local PES mechanisms.

23. The incremental resources from GEF will be used for both strengthening the existing PES programs and developing new stand-alone ones that specifically generate global biodiversity benefits.

Subcomponent 2A: Strengthening existing PES programs ($2.484 million, of which $0.745 million from GEF)

24. Improving efficiency. A critical lesson from earlier PES efforts worldwide is that to be efficient they must be tailored to local situations: that is, they must target payments to the areas where services are being generated and structure payments based on both the extent of benefits and the cost of providing them in each area.4 The major thrust of this subcomponent is to help CONAFOR develop revised operational rules for the PSAH and CABSA programs to convert them from their current one-size-fits-all methodology to a targeted and differentiated approach. Specific activities would include:

Separating the general principles that govern the PES program from their specific application in a given location (area-specific operational manuals).

Developing and applying a system of operating rules throughout the PES program to ensure that it avoids causing environmental or social harm (see Annex 10 on Safeguards for details).

Developing procedures and establishing mechanisms to (i) negotiate with local service users (such as water users and the tourism industry) if they wish to contract the PSAH to undertake PES on their behalf; (ii) incorporate these agreements into operational manuals for the affected areas; (iii) report back to service users on land user compliance, impact on the

4 Initial lessons from Mexico’s PSAH confirm this lesson: the PSAH’s current payment scheme, which only differentiates between cloud forests and other forests, has attracted a large number of applicants, but most have been outside the most important areas for water supply. Less than 14 percent of the area enrolled in 2003 and 2004, for example, was located in areas with overexploited aquifers.

63

services desired by the service users, and financial accounts; and (iv) resolve disputes that may occur.

Evaluating the trade-off between greater efficiency and higher transaction costs resulting from improved targeting and differentiation.

Evaluating and testing alternative approaches to improve targeting and cost-effectiveness, including assigning points to applications based on the degree to which they meet various criteria, bidding systems, etc.

Changing promotion and other strategies so they are case-specific rather than nationwide.

25. Improving compliance monitoring. PES programs make payments conditional on compliance with contracts. Therefore, a robust monitoring system needs to be in place to track the implementation of service contracts. This component will strengthen CONAFOR’s capacity to monitor compliance of contracts it is administering and explore cost-effective methods to undertake such monitoring.

26. Improving impact monitoring. Being able to assess the extent to which PES-supported land uses succeed in generating the desired environmental services is critical to the credibility and sustained financing of PES programs. Without such monitoring, mechanisms based on voluntary payments by service users would soon collapse, and mechanisms based on funding from government budgets could be highly inefficient. Technical studies to be carried under components 1A, 1B, and 1C will identify the gaps in current monitoring systems and develop proposals for improving them. This component will assist the relevant institutions (for example, CNA for water, CONABIO for biodiversity) to implement these proposals, including developing appropriate mechanisms to support long-term funding. Monitoring systems will also be leveraged to undertake targeted research to clarify links between land uses and environmental services. Specific activities would include:

Buying equipment and training operators.

Establishing institutional arrangement to ensure that monitoring is funded over time.

27. The incremental resources from GEF will be used for both compliance and impact monitoring of contracts that generate global environmental benefits.

28. Promotional efforts. An important part of PES programs is raising awareness at all levels of society of the importance of environmental services and how PES programs work. PES programs require ample support from the general population and in particular those who are participants in the program and those who are directly affected by the environmental services. Furthermore, it is important to raise the awareness of service providers and to continue reinforcing lessons and knowledge gained by the PES program. The promotional campaign will be oriented at gaining support from the general population and from the public and private sector, especially the water supply utilities, electricity utilities, and other private and public sector agencies that benefit from environmental services. In addition, the campaign will be oriented at promoting incorporation of land users into the PES program and retaining their

64

participation. Therefore, a communication strategy will be devised to (i) disseminate information about the PES program’s objectives, implementation strategy, and the eligibility criteria; (ii) establish a two-way channel to motivate stakeholders and ensure ownership by beneficiaries; and (iii) build a mechanism for dialogue and exchange of information between stakeholders (see subcomponent 5D).

29. The main outputs of this subcomponent would include:

Revised rules under which new PES contracts (including renewals of existing contracts) are issued, including definition of eligible areas, criteria for eligibility within these areas, criteria for selecting applicants when applications exceed available funding, activities to be undertaken by participants, payments offered, and other aspects. These rules would no longer be identical nationwide but rather would be differentiated across and within regions according to local conditions (types of service being sought, nature and severity of threat to services, cost of alternatives, type of ecosystem, etc.).

Procedures for incorporating the requirements of external funding sources (for example, funds provided by local water users, or by GEF) into site-specific operational manuals.

Institutional capacity to monitor impacts.

Institutions sufficiently strengthened to implement and improve PES programs.

Subcomponent 2B: Support to the development of stand-alone local PES programs ($1.095 million, of which $0.329 million from GEF)

30. In many cases, local conditions will require arrangements that differ substantially from arrangements elsewhere, or allow much simpler and cheaper arrangements than is possible in a national program. At the promising sites where such conditions exist, the program will work with interested local service users and providers to help them develop stand-alone programs, complementing the work done on creating financing mechanisms in components 1A and 1B.5

31. Developing local payment arrangements. Although the required functions of PES mechanism are similar everywhere, the details of the arrangements are likely to vary substantially from case to case because of the diversity of conditions encountered. In many cases existing institutions, initially created for other purposes, can be used to undertake some of the necessary functions. No single recipe will be applicable everywhere, Activities under this subcomponent will include:

Training workshops on the functions that need to be undertaken to establish a functioning PES program (as listed above); study trips to functioning local mechanisms in Mexico and other countries in the region; and measures to ensure cross-fertilization between groups attempting to develop these mechanisms under the project.

5 The local service users have the option to create their own PES mechanisms, which will also provide incentives to CONAFOR to be competitive and cost-effective.

65

Technical assistance, as necessary, on the development of appropriate contracting, monitoring, and payment systems to service users attempting to develop stand-alone mechanisms.

A systematic effort to derive lessons from pilot efforts and development of a training and dissemination program based on these lessons.

Development of a range of standardized approaches and instruments (e.g. standardized contract types dealing with various situations).

32. A key outcome from this subcomponent will be establishment of several stand-alone PES mechanisms closely attuned to local conditions in the promising sites.

Subcomponent 2C: Matching funds for local financing mechanisms ($0.125 million, of which $0.125 million from GEF)

33. Funds from the project would also be used to provide initial matching funds to financing mechanisms based on local demand (whether channeled through the PSAH/CABSA or through stand-alone mechanisms) to help spur their development and overcome initial resistance due to weak data and/or unfamiliarity with the approach. To ensure that this does not become an open-ended subsidy or create perverse incentives to pay for low-value environmental services, these matching funds will (i) never exceed 50 percent of total payments to service providers; (ii) gradually be phased out over five years; (iii) never be provided until an agreement is in place for the service users to eventually take over the entire payment burden, including transaction costs if they choose to channel funds through PSAH; and (iv) never be provided until initial payments from service users have been received.

Component 3: Supporting Environmental Service Providers ($2.00 million, of which $0.80 million from GEF)

34. The main potential providers of environmental services are rural communities known as ejidos and comunidades agrarias (known collectively as nucleos agrarios). Problems within these ejidos may prevent them from participating, hinder them from delivering the contracted services, or result in equity problems if the costs and benefits of participation are unevenly distributed between members of the communities. This component would focus on removing obstacles that may prevent these communities from participating either in national PES programs or local PES mechanisms, with a particular focus on problems faced by poor communities. Therefore, key activities of this component will facilitate the participation of environmental service providers in the PES program.

35. Technical assistance. The current PSAH program requires participating providers to conserve existing forest. Even such an apparently simple measure may benefit from technical assistance (TA) on the best and most cost-effective ways of preventing encroachment by livestock or avoiding forest fires. As the PES program becomes more targeted and differentiated it will, in many cases, require more intensive management of participating areas, for example in reforestation and reestablishment of native species. Many potential participants, particularly in poorer communities, may require TA to be able to implement the required measures. The activities envisioned in this subcomponent are:

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Identifying specific technical issues in which potential participants may lack the expertise that would allow them to participate in the PES program (for example, cost-effective ways to reduce the risk of forest fires).

Identifying organizations capable of providing such assistance (extension services, NGOs) and contracting them to provide it.

Developing the capacity of environmental service producers.

36. Organizational assistance. As mentioned above, the ejidos and indigenous communities that are the main potential environmental service providers may have problems that hinder them from participating in the program, delivering contracted services, or addressing equity issues if costs and benefits are unevenly distributed among their members. For example, some ejidos do not hold regular assemblies, which is a requirement for participating in the program. Those that do not have statutes regulating access and management of natural resources, or whose statutes are not respected, may be find it difficult to comply with environmental service contracts.

37. To help address such problems the program will support “community technicians” who are knowledgeable about the local area and are recognized and respected by the local communities with which they will work. These local technicians, working in conjunction with ejidos, communities, and other landowners, will identify and develop a strategy to create and/or strengthen the capacity of service providers and ensure that vulnerable and marginalized groups, including indigenous groups and women, can participate in the PES program. Furthermore, the strategy will articulate mechanisms to promote transparency in decisionmaking and distribution of benefits.

Component 4: Payment to Service Providers ($148.599 million, of which $1.578 million from GEF)

38. The objective of this component is to ensure that service providers are being compensated and are generating the desired environmental services for which the service users are paying. This component will channel payments for water, biodiversity, and carbon service contracts from the financing mechanisms developed in component 1, through the delivery mechanisms developed and strengthened under component 2, to the service providers supported through component 3. While the bulk of project financing—the actual payments to service providers—is allocated to this component, most of the activities to arrange, structure, and monitor this flow of financing are carried out under other project components.

39. The PES system will only function when environmental services providers are compensated for their services. This subcomponent focuses on ensuring that contracts are signed with service providers that generate specific environmental benefits and that they are paid for the services. Modalities of land use, site-specific conditions, and expected environmental benefits determine the level and source of payments. For example, financial resources generated from GEF cofinancing will fund service contracts that generate global environmental benefits in a particular site. The service contracts are funded through the following potential sources:

The financial resources allocated to the PSAH from the water tariff—LFD. It is estimated that the FFM will continue to receive about US$30 million a year that it does now.

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Financial resources from water users, generated by mechanisms developed under component 1A. It is envisioned, based on analysis of initial demand, that beneficiaries of environmental services would provide at least US$XX [to be determined at appraisal/negotiation] million a year by the end of the project.

Fees and contributions from tourism enterprises that benefit from environmental services, generated by mechanisms developed under component 1B. It is envisioned, based on analysis of initial demand of the tourism sector, that these beneficiaries of environmental services would provide at least US$XX [to be determined at appraisal/negotiation] million to the fund during the project.

Financial resources from GEF and the Biodiversity Conservation Endowment Fund, which is primarily capitalized through GEF contribution, counterpart financing and support from other bilateral/multilateral entities.

Revenue generated from carbon sales generated from programs support under component 1C.

World Bank and government financing for pilot PES systems and the matching fund program.

40. It is important to note that all these funding sources have different restrictions on their use. Funds provided by each individual mechanism financed by water users developed under component 1A, for example, will only be available for use in the upper watersheds that contribute to the water services they seek. Component 2A will put in place measures to allow and ensure that CONAFOR uses these multiple funding sources appropriately.

41. When local financing mechanisms choose to channel their payments through stand-alone local PES mechanisms rather than through PSAH/CABSA, CONAFOR will provide, on a time-limited basis, Mexican government and World Bank matching funds under component 2C. CONAFOR will also track such payments, but will not have any other role in administering them.

Component 5: Project and Program Management ($0.972 million, of which $0.456 million from GEF)

42. This component focuses on project and program management mechanisms including monitoring and evaluation (M&E) and implementation plans. The component would support new and existing institutional entities and mechanisms at the national and regional level for overall project coordination and supervision and would help strengthen the effectiveness and quality of project operations. In addition, a strong monitoring and evaluation mechanism will be in place to measure performance at various project milestones.

43. The component will finance costs for consultant services and equipment to carry out managerial, financial, and technical coordination through a Project Coordination Unit (PCU). PCU staff will include a coordinator, two sub-coordinators (one each for PSAH and CABSA), an administrative assistant, an accountant, a procurement specialist and technical staff (natural resource management specialist, agricultural economist, and hydrologist). A summary of project management activities and functions—divided between human resources, equipment, planning

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and monitoring and evaluation—is provided in the subcomponents below. A more detailed description of functions, responsibilities, and associated procedures is found Annex 6 and in the project implementation plan and operations manual.

Subcomponent 5A: Human resources ($0.494 million, of which $0.219 million from GEF)

44. The qualifications and stability of project personnel are critical to the project’s success. The PCU is expected to implement a rigorous system of personnel selection, evaluation, and performance incentives. Selection of personnel will be carried out by a private firm contracted for this purpose. The firm will create the short list, conduct interviews and evaluations, and nominate candidates to the PCU for review and confirmation by CONAFOR. Annual performance evaluations would be conducted by external firms based on benchmarks included in the terms of reference for each position.

45. The administrative staff in the PCU will carry out overall financial administration and control of financial flows. The operations manual defines detailed procedures and processes for budgeting, accounting, treasury, internal control, and auditing. Prior to project effectiveness a project management information system will be designed and installed in the PCU. The project’s Plan of Accounts would be broad and flexible enough to accommodate the needs of both the Bank and the government’s budget and audit agencies.

46. Standard World Bank Financial Management Reports (FMRs) would be generated from this system and sent to the Bank quarterly. The PCU would coordinate annual budgeting with the Ministry of Finance to assure timely release of counterpart funds. The state development bank Nacional Financiera S.A. (Nafin), would operate the project’s IBRD and GEF Special Account, if established, or receive disbursements based on FMRs. Annual project financial reports would be audited by a private accounting firm and under terms of reference, both acceptable to the Bank, and presented within four months after the accounting period.

47. Procurement—The PCU would process all procurement to be carried out during the project. Nafin will solicit all no objections from the Bank. Detailed procurement procedures are included in the operations manual. These procedures include how each type of procurement will be evaluated and selected with associated evaluation tables and methodology. Contract management arrangements for each type of contract are also defined. A procurement information system, as part of the project management information system, will be installed in the PCU to allow for coordination and timely exchange of procurement related information and generation of the Procurement Management Reports on a quarterly basis.

Subcomponent 5B: Equipment ($0.030 million, of which $0.012 million from GEF)

48. The objective of this subcomponent is to provide the PCU and CONAFOR with the required physical resources to manage the project. It includes the acquisition of basic office equipment, vehicles, hydrologic and biodiversity monitoring equipment, and other goods required to carry out project activities. The incremental resources from GEF will be used to acquire both goods and equipment.

Subcomponent 5C: Planning ($0.036 million, of which $ 0.018 million from GEF)

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49. Annual implementation plans (AIPs) prepared by the PCU and approved by CONAFOR and the Bank will be the principle tool for coordination between these three entities. The plans must be presented prior to the start of each budget year and will reflect the activities, goals, objectives, and planned outputs of each component, including the financial and human resources needed to complete all activities. The plans will also analyze execution of the previous year’s plan and recommend changes to remedy shortfalls in implementation, if justified.

Subcomponent 5D: Project and program monitoring and evaluation ($0.412 million, of which $0.206 million from GEF)

50. In view of the project's innovative approach, exceptional attention will be paid to the establishment of a rigorous monitoring and evaluation system. The envisioned M&E system will consist of three modules: (i) a computerized monitoring system that will continuously track progress on a set of process indicators and feed into management’s decisionmaking in real time; (ii) a beneficiary assessment module that will report on a biannual basis on the target group’s perceptions and reactions about project and program progress; and (iii) auditing and supervision missions every six months, or more often if necessary, to review the technical and fiduciary aspects of the project. Given the pilot nature of the project, an intensive monitoring effort will be conducted to ensure that there is abundant (and internalized) learning on the physical land uses being undertaken, their success in generating the desired services, and the effectiveness of institutional arrangements. Specific mechanisms for monitoring the quality and quantity of water, sedimentation, biodiversity, and carbon sequestration will be developed to track and clarify links between land uses and environmental services (subcomponents 1A–1C).

51. Project Management Information System (PMIS). Before project effectiveness, a PMIS would be prepared and installed in the PCU. The system would consist of planning, financial, procurement, human resources, evaluation, monitoring, risk management, and communications modules. Some of the modules would be designed specifically for the project and others would utilize off-the-shelf software and standard databases, word processing, and spreadsheet packages. The project must have the system installed and operational as a Condition of Effectiveness.

52. Risk Management—the PCU would be responsible for defining and implementing the risk management mechanism for the project. This would include the processes and tools for (i) identifying and describing internal and external potential risk events; (ii) quantifying potential project risks—what probability and what impact each potential risk event would have; (iii) risk response preparation that defines potential risk mitigation measures; and (iv) risk response control that focus on monitoring potential risk and regularly updating the risk management plan—archiving outdated risks and adding new ones and continuing the cycle from risk identification through risk mitigation. The PCU coordinator would carry out risk management functions by working with technical specialist and other team members to update and present the risk management plan at the PCU’s regular coordination meetings.

53. Communications. Given the project’s approach, a specific communication strategy and program will be developed. A communications audit will be carried out as part of project preparation and a communication strategy acceptable to the Bank will be prepared. The strategy would support a communication program to (i) disseminate information about the project’s

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objectives, implementation strategy, and eligibility criteria; (ii) establish a two-way channel to motivate stakeholders and ensure ownership by beneficiaries; and (iii) build a mechanism for dialogue and exchange of information between stakeholders. The communications strategy will provide inputs for execution of subcomponent 4C (Promotional Campaign).

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Annex 5: Project CostsMEXICO: Environmental Services of the Forest

Component /Sub-component US $ '000Total1

I. Developing Sustainable Financing Mechanisms  

1.A. Development of financing mechanisms from water users 1,953

1.B. Development of financing mechanisms from biodiversity users 18,473

1.B.1. Local PES Program for Biodiversity 1,473

1.B.2. Development and capitalization of a biodiversity endowment fund 17,000

1.C. Development of financing mechanisms from carbon users 936

SubTotal Component I. 21,362

   II. Developing And Strengthening PES Delivery Mechanisms  

2.A. Strengthening of existing PES programs 2,484

2.B. Support development of stand-alone local PES programs 1,095

2.C. Matching Funds for Local Financing Mechanisms 125

SubTotal Component II. 3,704

   III. Supporting Environmental Services Providers  

3.A. Technical Assistance 1,000

3.B. Organizational Assistance 1,000

SubTotal Component III. 2,000

   IV. Payment To Services Providers 148,599

   V. Project And Program Management 972

   Contingencies (~ 3 percent)

5,155  

 Total 181,7921 Local and Foreign portion of the costs will be calculated at appraisal.

1Identifiable taxes and duties are US$m ___, and the total project cost, net of taxes, is US$m___. Therefore, the share of project cost net of taxes is ___%.

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Annex 6: Implementation Arrangements

MEXICO: Environmental Services of the Forest

1. The National Forestry Commission (CONAFOR) will execute the project and have responsibility for all technical and fiduciary aspects of the project, overall management and supervision of the grant/loan, and monitoring and evaluation. Direct implementation will provided by a Project Coordination Unit (PCU), based in Guadalajara City (CONAFOR’s HQ), which will be fully integrated within Production and Productivity General Coordination Department of CONAFOR. The Project will also have liaison units in each of the States/Regions where potential “Promising Areas” are identified.

2. The financial agent for the project will be the by Nacional Financiera (NAFIN), a federal development agency responsible for managing the administration of many different projects receiving both national and external financing. NAFIN would be responsible for the overall financial management of the Project, and would manage the project’s Special Accounts. NAFIN would also be responsible for all formal correspondence concerning the Project with the Bank, including prior review for consultant and other contracts, and matters pertaining to the Loan Agreement.

3. In September 2003, an Advisory Committee for the PSAH project was formed. The committee’s function is to act as a consultative and advisory body for project design and implementation of the PES project. The committee usually meets monthly. It reviews advances in achievement of the preparation objectives, the preparation schedule, current relevant PSAH and other international experiences. The committee consists of 17 individuals from government and private institutions, NGOs and academic bodies. The NGOs PRONATURA, the Nature Conservancy, and the Mexican Civil Council for Sustainable Forestry (which operated the first Smart Wood/FSC Certification Service in Mexico), bring with them their broad-based knowledge accumulated through practical experience of developing projects on environmental issues in Mexico. Academic institutions are represented by two researchers from the National University (UNAM) and the National Council of Science (CONACYT-Centro GEO). The Ford Foundation is also a member of the Advisory Committee. Additionally, there are government representatives from the National Institute of Ecology, the National Forestry Commission, and the Ministry of Finance. Other relevant players, namely representatives of local PES schemes, will also be invited to join the Advisory Committee.

4. The highest decision making body of the project will be CONAFOR’s Governing Body. It is made up of representatives from several different Federal Government Ministries: National Defense, Finance and Public Credit, Social Development, Environment and Natural Resources, Economy, Agriculture, Agrarian Reform, Tourism, and the National Water Commission. This body will approve the Annual Implementation Plans and Quarterly Project Reports.

5. The PCU will include a coordinator, two subcoordinators (one each for PSAH and CABSA), an administrative assistant, an accountant, a procurement specialist and technical staff (natural resource management specialist, agricultural economist, and hydrologist). A summary of project management activities and It will also include 80 facilitators which will reside in the state and regional CONAFOR offices. The PCU will be responsible for and directly execute all project components. Other institutional actors in the project include NGOs (acting as PES intermediaries), community associations, and universities. There are currently approximately 156

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accredited professional service providers listed on the CONAFOR register (PSTyP). In addition to these service provides, additional personnel and/or consultant services for technical assistance, sub-projects and independent verification tasks will be recruited.

6. The project considers a gradual incorporation (two to three per year) of the promising areas (pilot areas), ensuring first that the pilot area teams have been recruited, equipped and allocated the necessary budget to hire sufficient technical and professional consultants to achieve the Project’s local objectives.

7. Key stakeholders and participating government agencies will receive training to facilitate coordination, increase understanding of the PES system, and help them assume their roles in the system. The PCU’s functions will include processing environmental service contracts with private landowners, signing environmental services purchase agreements with the private and public sector, monitoring compliance, and preparing reports. NGOs will operate as intermediaries serving as ES contract promoters, providing technical assistance for Component 3, and compliance monitoring.

8. The PCU will maintain satisfactory financial management and procurement procedures during project implementation. The financial management and procurement assessments described in Section D3 have identified areas that need to be addressed and include time-bound action plans agreed with CONAFOR. The PCU is completely intetgrated into the institutional structure of CONAFOR and meant to be a sustainable unit.

9. A project Operational Manual will include all rules and regulations for implementation of each project component and operation of the PCU (planning, monitoring, evaluation, institutional arrangements, environmental review, reporting, communication, human resources, risk, coordination, procurement, and financial management). A specific annex of the Manual will define the operations of PES. The Operational Manual and any changes to it will require no objection from the Bank.

10. A Project Implementation Plan (PIP) will be prepared by CONAFOR to be submitted to the Bank for no objection prior to the start of each budget year. It will be broken down into Annual Implementation Plans (AIP) and will include four principal sections: (i) description of project activities to be executed during annual time periods; (ii) Gantt Chart/project scheduled with timing of activities, relationship with other activities, and responsible entity; (iii) budget plan; and, (iv) procurement plan. The AIP will be the principal tool for project execution and supervision of the Bank.

11. Disbursements will be transaction-based against statements of expenditure (SOEs), full documentation, direct payments, or special commitments, but they may later become based on Financial Management Reports (FRMs) if the Borrower so chooses. A special account denominated in U.S. dollars will be maintained and operated by the NAFN. Deposits into the special account and replenishments up to the authorized allocation set out in the legal agreement would be made on the basis of applications for withdrawals prepared by the project and accompanied by the supporting documentation in accordance with Bank disbursement procedures. Accounting and financial reporting will be done by the PCU and NAFIN under Bank rules spelled out in the Operational Manual. Separate accounts will be opened to handle multiple sources of financing (IBRD, GEF, private sector payments). Audits of project and NAFIN accounts will be carried out under TORs by firms acceptable to the Bank. The project includes financing for audits.

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12. The main capacity constraints related to procurement and financial management will be detailed in the upcoming procurement and financial management assessments. To support the GOM in addressing the administrative capacity limitations, the Bank will provide sufficient training to the PCU’s procurement and financial management staff and NAFIN if needed.

13. The institutional framework for the project will be legally defined by a subsidiary agreement between the Ministry of Finance, the Ministry of Environment and Natural Resources, NAFIN and CONAFOR.

Institutional Analysis

14. An Institutional Analysis will be completed before appraisal. It will look at the legal structure, functions and key institutional activities and institutional capacity of the following institutions and entities to implement project activities.

Ministry of Environment and Natural Resources

CONAFOR

INE

Nongovernmental Organizations.

Universities.

Agricultural Associations and Cooperatives.

Community Associations and Ejidos.

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Annex 7: Financial Management and Disbursement Arrangements

MEXICO: Environmental Services of the Forest

1. Financial Management Assessment (FMA). The Bank has carried out a preliminary Financial Management Assessment (FMA), which involved ensuring that project design allows for an appropriate level of transparency, facilitating oversight and control while also supporting smooth implementation. Based on this analysis, the regional financial management team (LCOAA) has concluded the following: (i) CONAFOR has experience with Bank projects and with the types of activities to be carried out in this operation, and its record to date on FM matters has been satisfactory; (ii) certain actions will need to be taken to strengthen program financial management prior to the launching of the Bank–financed project, especially in terms of written procedures and reporting formats. These procedures should reflect the simplifications proposed in the FM/Disbursements section of the Bank’s Review of Country Systems document, which was delivered to the federal government in July 2005; and (iii) Nacional Financiera (NAFIN) will provide implementation support and oversight based on its many years of experience as financial agent. Financial management risk for this project will be determined during project appraisal, but it is expected that any significant risks will be mitigated by using project resources to strengthen weak financial management areas.

2. Implementing entities. The project will be executed by a unit of the Comisión Nacional Forestal (CONAFOR), which resides in Guadalajara, Mexico. CONAFOR has implemented other Bank projects and is currently responsible for the PROCYMAF II project, which became effective in July 2004 and is supported by a Bank loan of US $21 million. CONAFOR’s record in project financial management has been generally good. Due to slow disbursements, there was no project audit report due for PROCYMAF II’s 2004 fiscal year, however the entity audit report for CONAFOR was submitted to the Bank and did not suggest any significant reporting or control issues.

3. Flow of funds and information. As in most Bank–financed projects in Mexico, all project expenditures will first be funded through the country’s budgetary system. Once payments are made to final beneficiaries (payments for environmental services, to consultants, etc.), CONAFOR, with NAFIN’s assistance as required, will request disbursements from the Bank (see reporting and disbursements sections below). The Bank will make its disbursement as a reimbursement to the country’s treasury (TESOFE), or if requested by the government, through a Special Account held by NAFIN and established in US dollars at the Mexican central bank, Banco de México. More precise details of the funds flow processes, especially with regard to the Environmental Services component, will be agreed during project appraisal.

4. Accounting Policies and Procedures. CONAFOR will maintain accounts for preparation of project financial reports. An attempt will be made during project appraisal to bring project accounting procedures, as much as possible, in line with existing procedures within the entity.

5. Information Systems. CONAFOR’s existing entity systems will be used for project accounting and reporting. These systems will be evaluated by a Bank FM specialist during project appraisal. A database of program monitoring indicators will be used to prepare technical monitoring reports, which can be combined periodically with the financial reports in order to have a comprehensive picture of project activities. See Financial Reporting section below.

6. Staffing (key financial management staff). CONAFOR’s current staff should be able to incorporate the project accounting and reporting requirements into their activities. This aspect will be examined in more detail during project appraisal, especially in order to determine whether any financial/accounting

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staff or consultants will need to be added to support project implementation. If necessary, project funds can be used to add one additional financial staff member/consultant.

7. Financial Reporting. Financial Monitoring Reports (FMRs) will include financial and disbursement information, in a format agreed with the Bank. They will be submitted on a quarterly basis by CONAFOR, through NAFIN, and are expected to support withdrawal applications (i.e. loan disbursement requests - see Disbursement Arrangements in this annex). They should be submitted simultaneously to the Task Team Leader and to the Loan/Disbursements Department of the Bank, with the copy for Disbursements also including the Withdrawal Application. During the FM assessment of the PHRD and PDF-B grants, CONAFOR submitted to the Bank, examples of financial/budget reports that it normally submits to SHCP. Attempts will be made to align project reporting with these existing reporting requirements.

8. The physical progress information, traditionally included with the other reports in the FMR, will be provided within the semi-annual progress report, prepared by CONAFOR and submitted to the Bank through NAFIN in April and October of every year. The procurement information normally included in the FMRs will take the form of (at least) annually updated procurement plans and will be submitted to the Bank separate from the financial and disbursement reports of the FMR. The precise formats of the FMR will be agreed by loan negotiations.

9. Annual project financial statements will be prepared by CONAFOR, for the financial audit of the project (see audit section below). The project financial statements should resemble those prepared on a quarterly basis for the FMR, and should be consistent with the formats presented in the standard Terms of Reference for audit, agreed annually between the Bank and the Secretaría de la Función Pública (SFP). The Financial Management section of the project’s Operational Manual (OM) will include detailed information on reporting and monitoring.

10. Internal and External Audit. Annual financial audits covering the management of project funds until they reach final beneficiaries, will be carried out according to Bank policy and in combination with the Country Systems approach currently being implemented in Mexico. The framework for all project audits in Mexico is the Memorandum of Understanding (MOU) agreed between the Government of Mexico and the Bank. The audit will most likely be carried out by the same audit firm that audits CONAFOR as an entity. SRA through NAFIN will provide the audit report to the Bank. CONAFOR’s entity audit report is already being submitted to the Bank as per the audit requirements of PROCYMAF II. The table below summarizes audit requirements. The Financial Management section of the project Manual (OM) will include more detailed information on project audits.

Audit report Due datesProject Audit Audit covering all project activities, due six months after the end of any

fiscal year in which project expenditures were incurred (as determined by the government’s SFP which coordinates audit supervision, and by the Bank). First report will likely be for 2006, submitted by 06/30/2007, unless substantial retroactive expenditures are incurred in 2005. The final audit report will be due six months after the final year of project implementation. The standard period covered is the calendar year (January 1 to December 31).

Disbursement Arrangements and Retroactive Financing.

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11. Method. The National Treasury will prefinance all project operations through CONAFOR’s budget. The Bank will reimburse upon request and against agreed financial reports, as explained in the Financial Reporting section above and as per the flow of funds diagram shown earlier in the index.

12. The following table summarizes, by component/subcomponent, the agreement on the amount of the Loan, the use of funds, and when the Bank will recognize expenditures, for the activities to be financed with loan funds.

[this table to be finalized following project appraisal]

Component/ Subcomponent

Responsible Description (Use) Recognition of Expenditures

1. Developing Sustainable Financing Mechanisms

CONAFOR Consultants, goods, and non-consultant services to ___________

Upon payment to suppliers

2. Developing and Strengthening PES Delivery mechanism

CONAFOR Goods, consultants, training and operating costs

3. Supporting Environmental Service Providers

CONAFOR Goods, consultants, training

Payment to consultants and suppliers of goods and services

4. Payment to Service Providers

CONAFOR Environmental Services: as defined in project documents and Operational Rules

Upon payment for the services

5. Project Management

Goods, consultants, training and operating costs for PCU and Monitoring & Evaluation

Front-end-Fee SHCPNAFIN

.25% of loan amount Automatic (Bank pays to Bank)

13. Statements of Expenditures (SOEs). While it is contemplated that disbursements will be report-based, SOEs may be used for disbursements if deemed necessary. If used, the agreed format of the SOEs will be included in the Operational Manual. SOE would be used for large consultant contracts and for payments for environmental services. In reporting the latter, the Bank will agree with the client as to the type of detail required.

14. Special Account (SA). As part of a streamlining of Bank disbursement processes under the Country Systems initiative, the Bank is working with the government to reduce the number of funds flow processes. One aspect of this is to utilize Special Accounts only when the nature of the project deems the SAs to be necessary. If deemed necessary for this project, NAFIN, as financial agent, will establish in the

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Mexican Central Bank a Special Account in US dollars for the project. The Special Account will likely maintain a “zero balance” status, but will receive Bank funds to reimburse the National Treasury (TESOFE). It would therefore have occasional balances for a brief time until the transfer is made to TESOFE.

15. Retroactive Financing. The project will be eligible to submit applications for retroactive reimbursement, reports on expenditures eligible for loan financing, of up to 10 percent of the loan amount, incurred on or after ____________, 2005.

Allocation of Loan Proceeds (US$ million)

Expenditure Category Amount Financing Percentage

Developing Sustainable Financing Mechanisms

__.0 ___%

Developing and Strengthening PES Delivery mechanism

__.0 ___%

Supporting Environmental Service Providers

.0 %

Payment to Service Providers .0 %Project Management .0 -UnallocatedFront-end Fee (.25%) .2 -Total Financing (Loan and Grant)

1/ Training includes training-related expenses different from consultants for workshops, seminars, and study tours. The loan would finance travel, subsistence, and per diems to trainers and trainees, registration fees, logistical expenses for organization of training events, and training materials.2/ Non-consultant services include services for promotion, publicity, and press advertisements.

16. Operational Manual (OM) and Written Procedures. It will be necessary to include a chapter on FM procedures in the project’s Operational Manual, to cover all aspects of project financial management including the different areas described generally in this annex. An outline of the Financial Manual will be agreed between the Bank and borrower at the project appraisal stage.

17. Supervision Plan. At least one financial management supervision mission will be conducted each year, and a Bank Financial Management Specialist will review the annual audit reports and the semi-annual FMRs. Given the unique nature and size of the project, more intensive supervision will be needed prior to effectiveness and in the first year of implementation.

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Annex 8: Procurement Arrangements

MEXICO: Environmental Services of the Forest

{To be completed before appraisal}

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Annex 9: Economic and Financial Analysis

MEXICO: Environmental Services of the Forest

{Preliminary draft – further work pending, once additional data are collected during preparation.}

1. The project aims to strengthen and expand the use of market-based PES mechanisms whose purpose is to induce land use changes that provide increased levels of environmental services that bring both national benefits (primarily water services, and in some cases landscape benefits) and global benefits (increased biodiversity conservation and carbon sequestration).

2. Eight promising sites for the implementation of pilot PES mechanisms have been identified (see Annex 17). These have been selected from within the areas eligible for PSAH payments, based on the presence of substantial potential demand for water services (urban centers of more than 50,000 people; hydraulic infrastructure serving hydroelectric power producers, industry, irrigated agriculture, domestic use, or tourism) or biodiversity services (priority areas for biodiversity conservation identified by CONABIO, Ramsar sites, ecotourism areas). Several already have local proposals or initiatives for the development of PES mechanisms.

Demand for services

3. Existing local PES initiatives in Mexico have demonstrated that there is a willingness to pay for water services. Since 2001, for example, the town of Coatepec, in the state of Vera Cruz, has been soliciting voluntary donations of MXP1 (about US$0.09) from municipal water users, to be dedicated to watershed conservation. Despite the purely voluntary nature of this contribution, it generated US$9,100 in its first year. {other Mexican examples} Experience elsewhere in the region also shows a willingness to pay for water services from a variety of water users. In Costa Rica, a number of hydropower producers, bottlers, hotels, irrigation systems, and municipal water supply systems, generating over US$0.5 million a year.

4. Preliminary information on the nature and magnitude of water users at each promising site is currently being compiled. This will allow some preliminary estimates to be made of the magnitude of potential payments that might be generated in each case.

5. Water services. Table {A9-1} … Table with data on water service users in each promising site. Number of users, type of use. Any data on amounts currently paid. {…}

6. Domestic water users are likely to be the most important single potential financing source in most of the pilot sites. Domestic water supply systems have been a primary financing source for PES programs throughout the region. Urban centers that contribute to PES programs ranging in size from several million people in Quito, Ecuador, to 3,800 people in Yamabal, El Salvador. Domestic water supply systems are typically eager to ensure they receive a constant flow of high-quality water. It is interesting to note that they rarely pass on the cost of the PES payments to their consumers. Heredia, in Costa Rica, has done so, adding an explicit conservation fee to water bills. Most water supply systems have financed the payments from their regular revenue streams, citing the savings resulting from preserving their water supplies. Table {A9-1} shows the main urban centers that derive their water supplies from the promising sites, and their population. {…}

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7. Hydroelectric power producers have been another major contributor to PES programs. In Costa Rica, four hydropower producers (three private and one state-owned) are contributing to the PSA program administered by FONAFIFO, paying between US$15 to US$40/ha to conserve the watersheds from which they draw their water. Hydropower producer typically wish to avoid sedimentation (if they have reservoirs) or ensure a constant flow of water (run-of-the-river producers). They too have typically financed payments from savings made from reduced dredging costs or higher electricity production, rather than passing the cost on to electricity consumers. As Table {A9-1} shows, there are {…}

8. Irrigated agriculture, as a major water user, has been another common contributor to PES programs. Indeed, some of the earliest PES programs involved irrigation water user associations in Colombia’s Cauca Valley assessing themselves an additional fee to pay for watershed conservation. In Costa Rica, four agribusinesses with substantial irrigated areas pay US$45/ha to FONAFIFO to conserve watersheds. Irrigated areas typically wish to avoid sedimentation, which can clog their pumps and distribution channels, and secure a reliable flow of water. They may also be vulnerable to flooding. As Table {A9-1} shows, there are {…}

9. Biodiversity services. The local tourism industry often relies heavily on natural ecosystems—for scenic beauty and/or for direct use in recreational activities.6 Damage to these ecosystems may result in lower visitation rates or in lower prices. There would thus appear to be considerable potential to develop financing agreements with the tourism industry. Table {A9-1} shows {…}

Supply of services

10. Land users often find that land uses that provide environmental services are less profitable to them than other land uses. Unsurprisingly, they usually adopt those land uses that are most profitable from their own perspective, irrespective of whether they generate environmental services for others or not. Inducing them to adopt land uses that bring benefits to others thus requires compensating them, at a minimum, for the difference in net returns they will receive with the new land uses compared to those they would have received under their most privately-profitable alternative. A comparison of net returns under current land uses to those of land uses that are more desirable from an environmental service perspective provides an estimate of the cost required to induce the desired land use changes.

11. Studies by INE (Jaramillo, 2002, 2004) examined the distribution of returns to agricultural production in Mexico. These can be interpreted as the minimum payments necessary to induce land users not to convert forest to agriculture, as they would be forgoing these potential earnings. This study found average net returns to maize production of US$37/ha and average net returns to livestock production of US$66/ha. About 43% of maize producers had net returns of US$36.4/ha or less, while 20% of livestock producers had net returns of US$36.4/ha or less. That is to say, an annual payment of US$36.4/ha or more would likely attract 43% of maize producers and 20% of livestock producers. The PSAH program subsequently offered payments of US$36.4/ha in cloud forest areas and US$27.3/ha in other areas. It attracted almost 2,000 applications, from which a total of over 300,000 ha were accepted, confirming the widespread willingness to accept the offered payment levels.

6 The tourism industry is also often a major water consumer. It may, therefore, also be involved in PES in this guise as well.

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12. Despite its overall success in attracting applicants, however, the PSAH failed to attract many applicants in many of its priority areas (Muñoz and others, 2005). Less than 14% of enrolled area, for example, was located in areas with over-exploited aquifers. It also tended to attract areas that were at very low risk of deforestation: less than 20% of the area enrolled in 2003 and 2004 was in areas with high or very high risk of deforestation, while 62% was in areas of low or very low risk of deforestation.

13. Table {A9-2} shows the estimated net returns to agricultural production in the promising sites identified by CONAFOR. These can be interpreted as the minimum payments necessary to induce land users not to convert forest to agriculture, as they would be forgoing these potential earnings. As can be seen, these costs are in every case higher than the payments PSAH is currently offering; land users in these areas, therefore, have no incentive to participate. This demonstrates the necessity for a differentiated payment program: if the overall payment level was raised to the levels necessary to secure participation in the highest opportunity-cost areas, the cost of the program would soar. As Table {A9-2} also shows, there is substantial variation in opportunity cost within each site, as well. At Cerro Grande, for example, the mean opportunity cost is about US$150/ha but 20% of producers have opportunity costs of US$50/ha or less.

14. The areas that would need to be conserved at each site have not yet been determined. This is a process that will be undertaken under implementation, based on detailed diagnostics of precise problems facing local service users and technical studies to identify the sources of these problems. Table {A9-2} shows some very crude, order-of-magnitude estimates of possible costs, based on various proportions of forest areas that might need to be conserved. These show that if about 5% of the current forest area needs to be conserved, the annual cost would be about US$10 million. If greater areas need to be conserved, the cost would rise correspondingly.

15. For a number of reasons, these figures are likely to be over-estimates:

The cost estimate depends on the opportunity cost at the site and on the size of forest cover assumed to need conservation. The proportion of total forest area needing to be conserved is likely to be lower at sites with substantial remaining forest cover. These across-the-board estimates do not reflect this.

The opportunity cost estimates are based on returns to agriculture in already-cleared land, and land that is still under forest is likely to be less productive.

The actual payments necessary to induce conservation will depend on which specific areas within the promising sites need to be conserved. These payments may either be higher or lower than assumed in Table {A9-2}, depending on actual opportunity costs in these areas.

16. Note that these estimates assume that the dominant form of PES-supported land use will be conservation of existing forest, as in the current PSAH. In some cases, however, generating the desired environmental services may require additional actions, such as the implementation of improved management in forest, or in some cases reforestation. The costs of these actions would have to be added to the opportunity cost of land.

{…}

Increasing overall program efficiency

{…}

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Table A9-1: Promising sites for development of financing mechanisms

Name State

Area(‘000 ha)

Forest area Main water services

Biodiversity

services (‘000

ha)(%)

Domestic use: urban

centers with >50,000 people

Infrastructure at risk

Reservoirs

Irrigated

area (‘000 ha)

Cancún Quintana Roo

603.2

559.5

92.7

Yes, tourism-related

Cerro Grande Colima and Jalisco

254.5

142.5

56.0

{List towns and their population}

Yes

Coatepec-Pico de Orizaba

Puebla and Veracruz

160.5

51.5

32.1

{List towns and their population}

Copalita Oaxaca 239.3

187.3

78.3

{List towns and their population}

{List infrastructure at risk}

Yes, tourism-related

Monterrey-Cumbres

Coahuila and Nuevo León

1,932.6

1,150.3

59.5

{List towns and their population}

Yes

Sierra San Felipe-Oaxaca

Oaxaca 1,601.0

255.0

15.9

{List towns and their population}

Valle de Bravo-Amanalco

Guerrero and Michoacan

279.0

140.8

50.5

{List towns and their population}

{List infrastructure at risk}

Zapalinamé-Coahuila

Coahuila 1,071.7

888.4

82.9

{List towns and their population

Yes

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Table A9-1: Promising sites for development of financing mechanisms

Name State

Area(‘000 ha)

Forest area Main water services

Biodiversity

services (‘000

ha)(%)

Domestic use: urban

centers with >50,000 people

Infrastructure at risk

Reservoirs

Irrigated

area (‘000 ha)

}

{awaiting additional detail on water and biodi services from CONAFOR}

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Table A9-x: Estimated cost of conservation at pilot sites under different assumptions of area requiring conservation

Forest area('000 ha)

Opportunity cost (US$/ha) Annual cost to conserve* (‘000 US$)

Site

Lowest

20%Lowest 40% Mean

Lowest 80%

5% of forest

10% of forest

20% of forest

Cancún 559.5

14.6

27.2

33.1 58.3 926.2 1,852.3 3,704.6

Cerro Grande 142.5

51.5

106.8

152.2

242.7 1,084.8 2,169.6 4,339.2

Coatepec-Pico de Orizaba

51.5

34.0

63.1

68.5

116.5 176.3 352.7 705.4

Copalita 187.3

34.0

63.1

76.5

121.4 716.4 1,432.7 2,865.5

Monterrey-Cumbres

1,150.3

24.3

48.5

64.1

106.8 3,685.5 7,370.9 14,741.

9 Sierra San

Felipe-Oaxaca255.

0 34.1

63.3

76.5

121.5 975.4 1,950.7 3,901.4

Valle de Bravo-Amanalco

140.8

58.3

106.8

126.2

194.2 888.4 1,776.8 3,553.6

Zapalinamé-Coahuila

888.4 0.0 16.

5 30

.3 58.3 1,345.5 2,690.9 5,381.9

Total 375.2 9,798.4 19,596.

7 39,193.

4

Notes:

* Assumes payment based on mean opportunity cost

Source:

Forest area from CONAFOR, opportunity cost data from INE

{expecting revised opportunity cost/ha estimates from INE; need to adjust to common base year;}

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Annex 10: Safeguard Policy Issues

MEXICO: Environmental Services of the Forest

Environmental Analysis:

1. Overview. This project is intended to be entirely positive from an environmental standpoint. It seeks to improve existing, and develop new, systems of payments for environmental services (PES), thereby encouraging rural landowners to maintain or enhance the vegetative cover on their lands, in terms of hydrological functions, biodiversity, and/or carbon sequestration. The only possible adverse environmental impacts would be strictly unintended; the project design includes mechanisms to prevent any such negative impacts during implementation.

2. Project Summary. The project would expand and improve PES systems in Mexico through (i) developing new, sustainable financing mechanisms for environmental services, which would be channeled either through the existing PES programs or through new, stand-alone local PES mechanisms; (ii) strengthening and improving the efficiency of existing PES programs (PSAH and CABSA); (iii) stimulating the development of stand-alone local PES programs; and (iv) assisting local communities in service provision. See Annex 4 for a more detailed description of each project component.

3. Project Expenditures. A substantial proportion of project funds (including IBRD loan, GEF grant, and Mexican counterpart) would go to landowners as PES, either during project implementation or (in the case of project-supported trust funds) later in the future. The remaining project funds would go mostly to technical assistance, consulting services, training, promotional campaigns, and institutional strengthening needed to establish and strengthen PES programs and their long-term funding mechanisms. The project would purchase office and field equipment, vehicles, and other equipment and supplies, as needed, for the institutional strengthening of implementing agencies and some participating landowners’ associations. No civil works are expected to be procured under the project. The main on-the-ground environmental impacts associated with project expenditures would thus be the maintenance of desired vegetative cover on the rural landholdings of PES recipients.

4. Positive Environmental Impacts. The project is expected to be overwhelmingly positive from an environmental standpoint, by using PES to induce rural landowners to maintain the forests or other natural vegetation on their lands, thereby (i) conserving globally significant biodiversity, (ii) maintaining or improving hydrological functions, and (iii) reducing greenhouse gases by storing carbon. The currently proposed eight pilot sites all contain substantial areas of forests and other natural vegetation that is important for all three types of environmental services (biodiversity, water, and carbon). See Annex 17 for a description of these pilot sites, along with an explanation of how they were selected. In addition to these pilot sites at the national level, the project would promote the establishment of local level PES systems at other sites of conservation interest, either for water users interested in improved upstream watershed management, or for tourism operators and others interested in maintaining biodiversity and scenic beauty.

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5. Potential Adverse Environmental Impacts. Any environmentally adverse consequences from this project would be strictly unintended. Nonetheless, it is important to assess what these adverse impacts might possibly be, in order to design mechanisms to prevent or minimize them. Based on this project’s Environmental Assessment (EA) report and other project preparation work, potential adverse environmental impacts might arise under the following types of scenarios:

a. Tradeoffs Between Different Environmental Objectives. In the overwhelming majority of cases, the conservation of forests or other mature or regenerating natural vegetation poses no significant tradeoffs in terms of preserving biodiversity, maintaining desired water flows, and sequestering carbon. No such tradeoffs have been noted to date in the implementation of the ongoing PSAH and CABSA programs in Mexico, nor in Costa Rica’s Ecomarkets Project. However, as new PES schemes are established under this project (particularly at the local level), it is conceivable that the ideal vegetation management systems for one type of environmental service might reduce another type (for example, optimal water supply vs. flood mitigation vs. the habitat for threatened species);

b. Misallocation of PES Funds. Since environmental service payments are popular with the PES recipients as well as politicians, there might exist pressures to provide these payments even for land uses that are not optimal (nor even desirable) from an environmental standpoint. Such risks might include (i) continuing PES payments to landowners who have not complied with their contracts (and cleared or degraded the natural vegetation) or (ii) authorizing PES payments for maintaining sub-optimal land uses from an environmental services standpoint (such as agricultural systems rather than forests, even in watersheds where enough forested land exists to absorb all the available PES money); or

c. Perverse Incentives. The potential for receiving PES money might induce strategic behavior among rural people that could be environmentally damaging. For example, some people might want to settle within a watershed targeted for PES, thereby clearing forested land to establish their claim.

6. Environmental Management Plan. The Environmental Management Plan (EMP) for this project is intended to prevent the above-mentioned types of unintended negative environmental impacts. The EMP is mainstreamed within the overall project, rather than being a separate component. The environmental safeguards recommended by the EMP (to prevent unintended adverse impacts) will be incorporated as criteria and procedures within the Operational Manual. The details of the Operational Manual will reflect the EMP recommendations and subsequent agreement between the Bank and Borrower; they will be finalized prior to project effectiveness. The Operational Manual will include (i) clear eligibility and prioritization criteria for the types of lands and landowners that could receive PES contracts and (ii) review procedures and specific responsibilities within CONAFOR to ensure that all contracts are awarded, administered, and supervised in accordance with these criteria.

7. To minimize the risk of any unintended, adverse environmental consequences of the types mentioned above, the PES eligibility criteria are expected to require, inter alia, (i) no clearing of forests or other natural habitats to establish new agricultural systems; (ii) any

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reforestation must be with species native to the site; and (iii) all eligible landowners (whether communities, ejidos, or individuals) will need to present a title or other evidence of legally secure land tenure (to prevent the risk of settlement by outsiders seeking PES benefits). Within any watershed selected for PES support, the prioritization criteria will tend to favor the conservation of native forests (or other natural habitats) over the maintenance of agro-ecosystems (such as shade coffee), although the latter could receive PES contracts where an insufficient area exists of the original natural ecosystem (such as at Coatepec, Veracruz). For specific sites with particular hydrological or biodiversity characteristics, differentiated criteria might be established (such as the maintenance of particular animal or plant species of special conservation interest), along with the appropriate PES performance monitoring systems. However, even for locally based PES schemes focused on hydrological benefits from specific watershed management interventions (and not receiving GEF grant funds), the Operational Manual will require that the land management criteria be biodiversity-friendly, and specifically prohibit practices which would harm vulnerable or threatened species. One possible example of such a practice to be avoided is the removal of most snags (standing dead trees) from a forest, because of their importance to many species of cavity-nesting birds. In technically complex cases (such as whether to thin native pine-oak forest to reduce catastrophic fire risks), CONAFOR would require that any PES contracts that would allow such interventions be reviewed and approved by a biodiversity specialist.

Compliance with Safeguard Policies:

8. This project is designed to comply fully with the letter and spirit of applicable World Bank Safeguard Policies, as indicated below.

9. Environmental Assessment. This project is classified as Category B, the appropriate classification for projects which involve natural habitats, but would not lead to their loss or degradation (as is explained in BP 4.04, Paragraph 2). This category is consistent with most other conservation and natural resource management projects in Latin America and the Caribbean (including the PES projects in Costa Rica and El Salvador). In accordance with this classification, a relatively brief, free-standing Environmental Assessment (EA) report is under preparation and will be reviewed by the Bank and publicly disclosed prior to appraisal. The EA will assess the above-mentioned risks of adverse environmental impacts, most of which are rather minor. The EA report will also include the EMP, which will specify the criteria and procedures--including Operational Manual rules--that will be used during project implementation to avoid any adverse environmental impacts (or to minimize them, so that they are not significant). Preparation of the EA (including EMP) includes a number of public consultation meetings about the project design (including the environmental aspects) with a broad range of stakeholders, including representatives of ejidos, indigenous communities, and individual landowners; conservation NGOs; tourism and water user interests; and relevant national, state, and local government entities.

10. Natural Habitats and Forests. This project is fully compatible with both the Natural Habitats OP/BP 4.04 and the Forests OP/BP 4.36. It would not support any clearing or degradation of forests or other natural habitats. On the contrary, it is intended to promote the

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conservation and restoration of forests and other mature natural vegetation, through the mechanism of providing PES to participating landowners.

11. Pest Management. This project does not trigger the Bank’s Pest Management Policy (OP 4.09), because it would not (i) procure any pesticides (or pesticide application equipment), (ii) lead to increased pesticide use, nor (iii) support pest management practices that are risky or unsustainable from an environmental or health standpoint.

12. Cultural Property. This project would not trigger the mitigation requirements of the Bank’s Cultural Property Policy (OPN 11.03). The project is not expected to finance civil works, so there will not be the earth movement that is sometimes associated with archaeological or paleontological chance finds. Moreover, the maintenance of natural vegetation on lands covered by PES contracts is not likely to affect archaeological or other sites of cultural importance. The conditions of PES contracts would not preclude low-impact archaeological or paleontological research or salvage activities.

13. Involuntary Resettlement. This project does not trigger the Involuntary Resettlement OP/BP 4.12, because (i) no taking of land or other assets would take place; (ii) no physical relocation of anyone would be required; and (iii) all PES contracts, and the land use restrictions associated with them, are strictly voluntary with each landowner. In many or most cases, the landowners will be communities or ejidos, rather than individuals. In these cases of collective decision making (where the community or ejido decides to restrict the consumptive use of its own natural resources to obtain a greater overall benefit), the Involuntary Resettlement Policy does not apply (as explained in OP 4.12, Footnote 6). The Social Assessment study (see below) will recommend criteria and procedures to ensure that the decision-making process undertaken by any community or ejido prior to agreeing to a PES contract (and the associated land use restrictions) is legitimate, transparent, and fair to its members (including the poorest).

14. Indigenous Peoples. Because the PCN review for this meeting took place prior to July 1, 2005, this project is covered under OD 4.20, rather than the recently approved (and substantively similar) OP/BP 4.10. A substantial proportion (though by no means all) of PES recipients will be indigenous peoples. To ensure consistency with OD 4.20, an Indigenous Peoples Development Plan will….FILL IN DETAILS.

Summary Social Assessment:

15. Consultations with stakeholders and analysis of issues and risks have been carried out to help select potential sites for establishing local PES programs, including a preliminary social assessment of five of the site considered promising for project implementation. A full social assessment is currently underway and will be completed prior to project appraisal.

16. Participants and Beneficiaries. The populations and communities that will be affected by the project fall into two main categories: (i) environmental services users that will help finance the PES programs, and (ii) environmental services providers who will be compensated for maintaining or adopting desirable land uses and practices. Both service users and service providers are beneficiaries of PES programs.

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17. The financing or service user side of the relationship includes users of water services (municipalities, utilities, irrigators, individual consumers), biodiversity (tourism companies, national and international conservation organizations), and carbon sequestration (CDM and the international community).

18. Recipients of the PES payments—the environmental service providers—include owners of forested land in the targeted watersheds, most of which is commonly owned land held in the form of ejidos and comunidades agrarias. These areas also tend to correspond to some of the poorest communities in the country, with some of the highest marginalization indexes. Ejidos or comunidades with large tracts of forest are also much more likely than unforested landholdings to have significant majorities of indigenous people.

19. PES payments could be decisive in allowing poor and indigenous communities to resist pressure to generate income in the short term through unsustainable activities and instead engage in more sustainable land uses that improve incomes and well-being in the long run while providing benefits to other groups in the form of environmental services.

20. Socioeconomic Risk Mitigation. The risk of negative socioeconomic impacts on both groups is strongly mitigated by the inherent theoretical foundation of the PES concept—that these systems, and particularly their long-term sustainability, rely on voluntary participation based on the perceived self-interest and well-being of the participants. That is, users will pay no more for the services than the perceived benefits they provide, while providers of services will only accept payments for activities if they exceed the opportunity cost of their available alternatives.

21. Areas of concern identified by the project include insufficient awareness of environmental service benefits and costs to support the program, barriers to participation by providers of service due local political and community organizational obstacles or lack of technical capacity, and issues of equitable distribution of costs and benefits.

22. To address these concerns, the project will include considerable promotional, educational, analytical, and consultative activities to ensure that both users and providers of services understand the benefits and costs of the PES system, have input into the design of local PES arrangements, and have the capacity to take advantage of the opportunities offered and meet their obligations as participants. Components 1 and 2 (to develop PES financing and delivery mechanisms) include activities to educate service users, identify their needs, ensure that service payments are targeting the right land uses, monitor both compliance and impacts, and avoid creating perverse incentives. Component 3 of the project (to support environmental service providers) and Component 4 (to pay the providers and monitor delivery of services) help ensure that service providers, and particularly marginalized groups, are capable of participating in, delivering on, and benefiting from the payment systems created. Consultative mechanisms are included throughout the project components to ensure relevancy, feedback, and compliance, not only to protect the interests of stakeholders and mitigate socioeconomic risk, but because the efficacy of the PES mechanisms is almost wholly dependant on their success in providing benefits to stakeholders.

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23. Partial Assessment of Promising Sites. The project will promote and provide technical assistance to interested parties to establish local arrangements for payment of environmental services in about eight promising sites. These sites are areas targeted for special assistance to improve the quality of their environmental services—“areas promisorias para la promocion de los servicios ambientales” or “apromsas.”

24. About 80 percent of forested land in Mexico is held under common property, either as ejido or indigenous community land (indigenous common property is more often categorized as an ejido than named explicitly as indigenous community property). Another 15 percent of forested land is private property, and 5 percent is public property.

25. A participatory social consultation, focused on common property owners who live in the area, was held in five of the six sites in Table A10.1. Most private forested lands are under absentee ownership, and even many of the collective owners work (and live either temporarily or permanently) away from the area due to lack of economic opportunities there.

26. Some of these sites have been declared as natural protected areas, with varying organizational approaches and degrees of success. In those sites there is clear data on the geographic area, population, and number of agrarian communities. Other areas, particularly those not included in previous specific institutional environmental sustainability efforts (the last three mentioned below), still are not precisely defined.

Table A10.1: Basic Data on Six Promising Areas for PES Programs

Potential siteArea (hectares)

Stakeholder population

Agrarian pop. centers

Indigenous population

Cerro Grande, Colima 40,000 4,000 11 2,000Zapalinamé, Coahuila 45,000 5,000 11 -Cumbres de Monterrey, Nuevo Leon

177,000 3,000 27 -

Izta-Popo a (spans several states) 50,000 24,000 15 12,000Zona Maya, Quintana Roo 200,000 22,000 30 22,000Cuenca Copalita, Oaxaca 80,000 26,000 18 26,000

Total 592,000 84,000. 112 52,000a. The calculation of indigenous population in Izta-Popo depends on conceptual definitions. Inhabitants of the higher altitude towns are of indigenous ancestry, have a strong community attachment to the land and keep many elements of an indigenous culture. Most however do not longer speak an indigenous language, or self identify as indigenous.

27. A total of 20 participatory workshops were held in the first five of the abovementioned sites, with a total attendance of 278 local inhabitants. Three of those workshops were held specifically for women (66 indigenous, 10 nonindigenous). In addition to the workshops, interviews were conducted with 74 people, including ejido and indigenous community leaders, NGO workers, community/ejido technical field workers, and local managers and staff of protected areas and Conafor.

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28. Community profile. The inhabitants of these areas largely live in poverty and extreme poverty. Local production, be it agriculture, livestock, or handcrafts, lacks viable market access and therefore is destined for local consumption only. Sustainable and legal forestry is not usually viable economically under present technologies and rules, (except in some places like the Zona Maya in Quintana Roo). Local communities typically survive on cash income from working in nearby cities or commercial agricultural enterprises, or from remittances sent by family members working in the United States.

29. Decline of ejido/community cohesion. The freedom to treat individual holdings within ejidos as private property, combined with extensive migration by property owners, has fundamentally changed the dynamic of community life and rendered ejido and community assemblies largely ineffective for matters other than administering common property. Lack of a communal economic interest or opportunity in the land, combined with indifference to forested property by many rightful owners, has opened the way in many place for opportunistic individuals, sometimes allied with economically or politically powerful outsiders, to engage in a predatory use of common property with little concern for the long-term health or productivity of the land.

30. However, most forest in areas that are promising sites for PES programs demand active care in order to thrive (extracting excess flammable material; preventing the spread of fires and pests; land conservation activities in degraded forests; reforestation activities, etc.). An indifferent community, even without predatory activities, usually leads to deterioration of the forest.

31. Action strategy. In this context, local consultations have helped craft a design that emphasizes strong indigenous community and ejido participation in a strategy that integrates the following pillars of action:

Making environmental services a source of income for the ejido/community. This would be done by paying the ejido/community for conservation activities. This is clearly preferred by local inhabitants to payment for mere ownership of the forest.

Promoting the re-appropriation of collective administration and control of common property. Reactivating ejido/community assemblies and the means to assert collective rights under specific cultural and sociopolitical conditions would help displace the activities of predatory minorities.

Providing technical assistance in sustainable management of ejido/community lands, forested common property, agricultural individual holdings, and other property.

Strengthening social capital and local capacity for ejido/community integrated planning, integrated land and forest management plans, and design of development subprojects.

Building local capacity to attract public programs and funding for specific environmentally friendly subprojects. This amounts to a much needed bottom-to-top mainstreaming of environmental sustainability concerns into public programs.

Establishing a new local entity in potential PES areas to represent social and community concerns in the negotiation of environmental service payment arrangements and commitments. This could take the form, as a first step, of a local participatory committee

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comprising ejido members, indigenous communities, grassroots organizations, NGOs, and other stakeholders.

32. Ongoing community liaison and consultation arrangements. “Community technicians,” hired by the project under component 3, would play a key role in addressing community problems and concerns and defining how to tailor the strategy to local conditions based on intensive interaction and consultation with local communities and leaders. The PCU would also facilitate horizontal peer-to-peer learning and knowledge sharing between the community technicians and provide training specifically designed for their perceived needs. In addition, indigenous ejidos and communities would select community members to serve as liaisons with the technicians and with the project. These liaisons, who would receive stipends or scholarships to cover part of their expenses, would facilitate follow up on activities agreed with the community technicians, translate indigenous languages at community meetings, and help facilitate local absorption of technical knowledge. They would participate in regional seminars several times a year, along with the technicians, to exchange experiences and get specific training.

33. Participants in the consultations made clear that they demand regular face-to-face communication and outreach, with clear rules, on a long-term basis, with stable technical personnel who are directly accountable to them. Another strong message is the very high value they place in knowledge and capacity building.

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Annex 11: Project Preparation and Supervision

MEXICO: Environmental Services of the Forest

Planned ActualPCN review 8/2004 8/2004Initial PID to PIC 9/2004 9/2004Initial ISDS to PIC 9/2004 9/2004Appraisal 12/2005Negotiations 2/2006Board/RVP approval 3/2006Planned date of effectiveness 6/2006Planned date of mid-term review 7/2008Planned closing date 12/2010

Key institutions responsible for preparation of the Project: National Forestry Commission (Comisión Nacional Forestal)

Bank staff and consultants who worked on the Project, included:Name Title UnitStefano Pagiola Sr. Environmental Economist ENVRicardo Hernandez Sr. Environmental Specialist LCSENDinesh Aryal Operations Analyst LCSENAlejandro Deeb Sr. Hydrologist LCSENGeorge Ledec Lead Ecologist LCSENPeter Brandriss Sr. Program Assistant LCSENJohn Kellenberg Sector Leader LCSENGunars Platais Sr. Environmental Economist LCSENMonique Pelloux Patron Team Assistant LCSESMark Austin Sr. Operations Officer LCSERJuan Martinez Sr. Social Specialist LCSEOMartha Molares Legal LEGLADaniel Boyce Financial Management LCOAAEfraim Jimenez Procurement LCOPRCarmen Machicado Operations Officer LCSPSEdgar Ortiz Sr. Forestry Specialist ConsultantMaria Clara Mejia Social Specialist ConsultantJulio Cordoba Sr. Institucional Specialist ConsultantMarco A. Zambrano Environmental Specialist ConsultantBernardo Madriz Institutional Dev. Specialist Consultant

Bank funds expended to date on project preparation:1. Bank resources: USD 100,0002. Trust funds: USD 150,0003. Total: USD 250,000

Estimated Approval and Supervision costs:1. Remaining costs to approval: USD 150,000Estimated annual supervision cost: USD 100,000

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Annex 12: Documents in the Project File

MEXICO: Environmental Services of the ForestProject Documents

Draft Project Appraisal Document 03/01/2005 PADIntegrated Safeguard Data Sheet 03/01/2005 ISDSProject Appraisal Document Data Sheet 03/01/2005 PAD Data SheetProject Information Document 09/15/2004 PIDProject Concept Note 09/02/2004 PCNIntegrated Safeguard Data Sheet 09/02/2004 ISDSGEF Pipeline Entry 09/02/2004 GEF Project Concept PaperMinutes of Concept Review Meeting 08/24/2004 PCN MinutesProject Concept Note Data Sheet 08/17/2004 PCN Data SheetAgreement for Japanese grant TF53337 07/01/2004 Agreement/Official Documents

Project Reports and Studies

Technical assistance for the coordination of the design of the Project, José Armando Alanís de la Rosa Technical assistance for the coordination of the design of the Project, Jaime Baray Terrazas Technical Assistance for the Determination of Areas of Eligibility of Environmental Services, Shatya

Quintero Gradilla Technical Assistance for the Determination of Areas of Eligibility of Environmental Services, Jesús

Gutiérrez Cacique Technical Assistance for the Determination of Areas of Eligibility of Environmental Services, Rodolfo

Valdez García Technical Assistance for the Determination of Areas of Eligibility of Environmental Services, Erika del

Rocío Martínez Guevara Technical Assistance for the Determination of Areas of Eligibility of Environmental Services, David

López Ramírez Technical Assistance for the Determination of Areas of Eligibility of Environmental Services, Victor

Tejada Vázquez Preparation of the Conceptual Project Note (PCN) of Environmental Services from the Forest to the

Fund of BioCarbono of World Bank for the project in Mexico, Edgar Ortiz Malavasi Environmental and Social Assessment of Conceptual Project Note (PIN) for the Fund of BioCarbono of

World Bank for the project in Mexico, Hilda Elizabeth Hesselbach Moreno Social Study, Jorge Franco López Social Study -Fase 2, Jorge Franco López – work in progress Identification of experiences relative to the development of environmental service markets of the forest

in Mexico (case study), Sergio Madrid Zubirán Environmental Assessment of the Impact of the Environmental Service Project of the Forest, Marco A.

Zambrano Chávez Formulation of the Procurement Plan and Operative Manual of Procurements, Bernardo Madriz Specialist in Procurements and Procedures, Alma González Technical Assistance for the Financial Control during the design of the Project for the Market

Development of Environmental Services in Mexico, Ana Ma. Rosales Monroy Study for the Formulation of the Logical Framework, Julio Córdoba Case Study on the Market Development of Environmental Services in Mexico, Scolel-Té, Chiapas – in

progress Case Study on the Market Development of Environmental Services in Mexico, San Pedro Chichila-

Taxco, Guerrero - in progress

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Case Study on the Market Development of Environmental Services in Mexico, Copalita-Huatulco, Oaxaca – in progress

Case Study on the Market Development of Environmental Services in Mexico, Cofre de Perote-Coatepec, Veracruz - in progress

Case Study on the Market Development of Environmental Services in Mexico, Cerro Grande-Colima, Colima y Jalisco - in progress

Case Study on the Market Development of Environmental Services in Mexico, Café de Sombra, Oaxaca - in progress

Case Study on the Market Development of Environmental Services in Mexico, Amanalco-Valle de Bravo, México - in progress

Case Study on the Market Development of Environmental Services in Mexico, San Pedro Atlapulco-Ocoyoacac, México - in progress

Operational Manual on the Environmental Services Project - in progress

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Annex 13: Statement of Loans and Credits

MEXICO: Environmental Services of the Forest

Original Amount in US$ Millions

Difference between expected and actual

disbursements

Project ID FY Purpose IBRD IDA SF GEF Cancel. Undisb. Orig. Frm. Rev’d

P088080 2005 MX Housing & Urban Technical Assistance

7.77 0.00 0.00 0.00 0.00 7.77 0.95 0.00

P085851 2005 MX Basic Education Dev Phase III 300.00 0.00 0.00 0.00 1.50 268.34 -30.16 0.00

P074755 2005 MX State Judicial Modernization Project 30.00 0.00 0.00 0.00 0.00 30.00 0.00 0.00

P087152 2004 MX (CRL1)Savings & Rurl Finance(BANSEFI)

75.50 0.00 0.00 0.00 0.38 72.25 1.29 0.00

P035751 2004 MX Community Forestry II (PROCYMAF II)

21.30 0.00 0.00 0.00 0.00 19.90 2.73 0.00

P035752 2004 MX Irrigation & Drainage Modernization 303.03 0.00 0.00 0.00 0.00 264.02 21.66 0.00

P080149 2004 MX Decentralized Infrastructure Developm

108.00 0.00 0.00 0.00 0.00 108.00 4.00 0.00

P059161 2003 GEF MX-Climate Measures in Transport 0.00 0.00 0.00 5.80 0.00 3.95 5.03 0.00

P074655 2003 MX Rural Finance Develop Struct Adj Loan

505.06 0.00 0.00 0.00 0.00 150.01 0.01 0.00

P070108 2003 MX Savings & Credit Sector Strengthening

64.60 0.00 0.00 0.00 0.00 28.01 7.74 0.00

P065988 2002 GEF MX Consolidat.Prot Areas (SINAP II)

0.00 0.00 0.00 16.10 0.00 5.29 12.83 0.00

P077602 2002 MX Tax Admin Institutional Development 52.00 0.00 0.00 0.00 0.00 40.17 26.49 0.00

P066674 2001 GEF MX-Indigenous&Community Biodiversity

0.00 0.00 0.00 7.50 0.00 5.71 5.60 0.00

P066321 2001 MX: III BASIC HEALTH CARE PROJECT

350.00 0.00 0.00 0.00 0.00 318.07 126.57 2.08

P065779 2001 MX FEDERAL HIGHWAY MAINTENANCE PROJ.

218.00 0.00 0.00 0.00 0.00 32.70 32.70 0.00

P063463 2001 METHANE CAPTURE & USE AT A LANDFILL

0.00 0.00 0.00 6.27 0.00 0.19 6.01 5.48

P060908 2001 GEF MX-MESO AMERICAN CORRIDOR

0.00 0.00 0.00 14.84 0.00 13.28 8.84 0.00

P066938 2000 MX GENDER (LIL) 3.07 0.00 0.00 0.00 0.00 0.68 0.68 0.06

P060718 2000 GEF MX ALTERNATIVE ENERGY 0.00 0.00 0.00 8.90 0.00 2.54 8.90 0.00

P007610 1999 MX FOVI RESTRUCTURING 505.50 0.00 0.00 0.00 0.00 18.63 18.63 0.00

P049895 1998 MX HIGHER ED. FINANCING 180.20 0.00 0.00 0.00 0.00 48.89 48.89 0.00

P044531 1998 MX KNOWLEDGE & INNOV. 300.00 0.00 0.00 0.00 0.00 19.68 19.68 -41.32

P007713 1996 MX WATER RESOURCES MANA 186.50 0.00 0.00 0.00 65.67 12.01 77.68 23.68

Total: 3,210.53

0.00 0.00 59.41 67.55 1,470.09

406.75 - 10.02

MEXICOSTATEMENT OF IFC’s

Held and Disbursed PortfolioIn Millions of US Dollars

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Committed Disbursed

IFC IFC

FY Approval Company Loan Equity Quasi Partic. Loan Equity Quasi Partic.

1998 Ayvi 4.29 0.00 0.00 0.00 4.29 0.00 0.00 0.00

BBVA-Bancomer 20.75 0.00 0.00 0.00 20.75 0.00 0.00 0.00

1995/99 Baring MexFnd 0.00 1.88 0.00 0.00 0.00 1.88 0.00 0.00

1998 CIMA Mexico 0.00 4.80 0.00 0.00 0.00 4.80 0.00 0.00

1998 CIMA Puebla 6.75 0.00 0.00 0.00 3.25 0.00 0.00 0.00

Chiapas-Propalma 0.00 1.00 0.00 0.00 0.00 1.00 0.00 0.00

2001/04 Compartamos 24.46 0.00 0.00 0.00 5.74 0.00 0.00 0.00

2002 Coppel 30.00 0.00 0.00 0.00 30.00 0.00 0.00 0.00

1999 Corsa 5.57 3.00 0.00 0.00 5.57 3.00 0.00 0.00

2005 Credito y Casa 20.59 0.00 0.00 0.00 0.00 0.00 0.00 0.00

2004 DTM 37.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

2001 Ecomex 4.50 0.00 1.50 0.00 2.50 0.00 1.50 0.00

2000 Educacion 5.96 0.00 0.00 0.00 4.36 0.00 0.00 0.00

1997 Fondo Chiapas 0.00 3.35 0.00 0.00 0.00 0.11 0.00 0.00

1998 Forja Monterrey 6.50 3.00 0.00 6.50 6.50 3.00 0.00 6.50

2001 GFNorte 50.00 0.00 0.00 0.00 50.00 0.00 0.00 0.00

1996 GIBSA 10.82 0.00 0.00 36.38 10.82 0.00 0.00 36.38

1996/00 GIRSA 32.14 0.00 0.00 42.86 32.14 0.00 0.00 42.86

1998/04 Grupo Calidra 22.00 0.00 0.00 0.00 21.26 0.00 0.00 0.00

1989 Grupo FEMSA 0.00 0.91 0.00 0.00 0.00 0.91 0.00 0.00

1997 Grupo Minsa 10.38 0.00 0.00 15.58 10.38 0.00 0.00 15.58

1996/99 Grupo Posadas 0.00 0.00 10.00 0.00 0.00 0.00 10.00 0.00

1998 Grupo Sanfandila 5.20 0.00 0.00 1.84 5.20 0.00 0.00 1.84

2004 HipNal 101.50 0.00 0.00 0.00 101.50 0.00 0.00 0.00

2000 Hospital ABC 19.71 0.00 0.00 6.79 0.00 0.00 0.00 0.00

2000 ITR 9.00 0.00 0.00 2.33 9.00 0.00 0.00 2.33

2000 Innopack 0.00 15.00 0.00 0.00 0.00 15.00 0.00 0.00

Interoyal 0.00 0.01 0.00 0.00 0.00 0.01 0.00 0.00

2003 Lomas de Real 51.23 0.00 20.00 104.03 49.94 0.00 20.00 104.03

1998 Merida III 26.55 0.00 0.00 59.48 26.55 0.00 0.00 59.48

2003 Mexmal 0.00 0.00 10.00 0.00 0.00 0.00 10.00 0.00

1995/99 Mexplus Puertos 0.00 1.41 0.00 0.00 0.00 1.41 0.00 0.00

1996/99/00/01

NEMAK 0.00 0.00 0.76 0.00 0.00 0.00 0.76 0.00

2003 Occidental Mex 28.95 0.00 0.00 38.60 28.95 0.00 0.00 38.60

Occihol 0.00 9.99 0.00 0.00 0.00 9.99 0.00 0.00

2003 POLOMEX S.A. 6.00 0.00 0.00 0.00 6.00 0.00 0.00 0.00

2000 Pan American 0.00 4.34 0.00 0.00 0.00 4.34 0.00 0.00

2002 Puertas Finas 11.38 0.00 0.00 0.00 11.38 0.00 0.00 0.00

2002 Qualita 0.00 2.50 3.50 0.00 0.00 2.50 3.50 0.00

2000 Rio Bravo 46.12 0.00 0.00 52.33 46.12 0.00 0.00 52.33

2004 SSA Mexico 45.00 0.00 0.00 0.00 45.00 0.00 0.00 0.00

2000 Saltillo S.A. 32.61 0.00 0.00 37.96 32.61 0.00 0.00 37.96

2000 Servicios 7.50 1.90 0.00 6.67 7.50 1.90 0.00 6.67

2001/04 Su Casita 15.98 0.00 0.00 0.00 15.98 0.00 0.00 0.00

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1997 TMA 1.53 0.00 2.96 5.30 1.53 0.00 2.96 5.30

2003 TMWC 3.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

2003 Valle Hermoso 52.00 0.00 20.00 107.09 46.63 0.00 18.09 96.84

ZN Mexico II 0.00 10.00 0.00 0.00 0.00 6.30 0.00 0.00

1998 ZN Mxc Eqty Fund 0.00 13.87 0.00 0.00 0.00 13.87 0.00 0.00

Total portfilio: 754.97 76.96 68.72 523.74 641.45 70.02 66.81 506.70

Approvals Pending Commitment

FY Approval Company Loan Equity Quasi Partic.

1998 Cima Hermosillo 0.01 0.00 0.00 0.00

2003 Copamex 0.00 0.00 0.00 0.00

2001 Ecomex 0.00 0.00 0.00 0.00

2000 Educacion 0.00 0.00 0.00 0.00

2001 GFNorte-CL 0.05 0.00 0.00 0.10

2003 Mexmal 0.00 0.00 0.01 0.00

2003 Polomex 0.00 0.00 0.00 0.00

Total pending committment: 0.06 0.00 0.01 0.10

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Annex 14: Country at a Glance

MEXICO: Environmental Services of the Forest

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Annex 15: Incremental Cost Analysis

MEXICO: Environmental Services of the Forest

Introduction

1. Two of the most important environmental challenges facing Mexico are water scarcity and deforestation. Aquifer overexploitation, water quality degradation and high deforestation rates are seriously threatening critical ecosystems and globally significant biodiversity. One-third of all Mexico’s bird species and nearly two-thirds of all Mexico’s amphibian, reptile, and mammal species are at risk. Although many wild species are legally protected, 2,582 species and subspecies are at risk, of which 41 are already extinct in the wild, 1,215 are endangered or threatened with extinction, and 1,326 are subject to special protection. The causes of deforestation are multiple, however, the main driving force appears to be intentional land use changes by individual or collective land owners mainly to agriculture.

2. A significant portion of Mexico’s surface area is under some sort of protection, but not all the areas with relevant biodiversity are covered. The National Commission on Natural Protected Areas lists 154 federally administered natural protected areas that cover almost 19 million hectares, but only a small percentage of this area is government property. The Commission has produced a map of Priority Areas for Conservation, which includes the National System of Natural Protected Areas (SINAP), plus the areas that should be incorporated under some kind of protection, including economic incentives and legal agreements with their proprietors.

3. Any initiative to protect forests must take into account the structure of incentives embedded in the land tenure arrangements. Mexico has a special land tenure structure with ownership granted to ejidos, which include more individual plots, and to comunidades agrarias, which are mainly common property. Because the majority of forests are under common property regimes, their land tenure rules have important implications for conservation programs. Furthermore, the owners of these forest areas are among the poorest in the country. They are faced with short-term survival decisions even through their long-term livelihood depends on the protection and sustainable use of these resources.

4. To help address the environmental issues, one of the tools that the Mexican government adopted was to provide economic incentives by creating the program of Payments for Hydrological Environmental Services (PSAH) in 2003. The PSAH program has expanded rapidly, enrolling over 300,000 hectares of forest into conservation by the end of 2004, and has built experience on PES implementation. Initial evaluations, however, show substantial room for improvement. Moreover, the funding and objectives of the current program are very limited.

5. The objective of proposed project is to improve the provision of environmental services that bring both national benefits (primarily water services) and global benefits (primarily increased biodiversity conservation) by strengthening and expanding the PSAH and CABSA (Program to Develop Environmental Services Markets for Carbon Capture and Biodiversity and to Establish and Improve Agroforestry Systems) programs and establishing market-based payments for environmental services (PES) approaches. The objective will be achieved through (i) developing new, sustainable financing mechanisms for environmental services, which could be channeled either through the existing PES programs or through new, stand-alone local PES

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mechanisms; (ii) strengthening and improving the efficiency of existing PES programs (PSAH and CABSA); (iii) stimulating the development of stand-alone local PES programs; and (iv) assisting local communities in service provision.

Baseline Scenario

6. Mexico is a mega-biodiversity country, ranking second in the world in reptilian diversity, third in mammal diversity, and fifth in both amphibian and plant diversity. Its plant diversity exceeds that of the United States and Canada combined. Mexico also ranks eighth in fish diversity and fifteenth in bird diversity. With 1.3 percent of the world’s land area, it hosts about 12 percent of known terrestrial biota with very a high incidence of endemism. Mexico contains the five main types of Latin American and Caribbean terrestrial ecosystems listed by WWF, nine of the 11 main types of habitats in the region and 51 of the 191 identified ecoregions. Fourteen of these 51 ecoregions (covering over 40 percent of national territory) have priority at the international level regarding their biodiversity and current conservation status. There are nine large natural vegetation types in Mexico, classified according to their ecological characteristics.

7. Under the baseline scenario there are very few activities that would lead to sustainable payment for environmental services. Currently efforts are limited to disparate activities aimed at maximizing the returns in terms of water services. In the absence of this project, there would be little incentive for these efforts to orient their objectives towards biodiversity conservation and even less prospect of widespread replication of schemes to encourage payment for environmental services.

8. The consequence of this is that in the absence of this project, the baseline scenario would see very little increase in payment for environmental services and the global benefits in terms of the potential to reduce current threats to globally significant biodiversity would not be realized.

9. Total expenditures under the baseline scenario during the lifetime of the project are therefore US$235.956 million.

10. The following sections give further detail on the baseline scenario for each component and what global environmental benefits they will provide. Following each explanation is a detailed breakdown of economic costs of current initiatives.

Component 1: Developing Sustainable Financing Mechanisms

11. The main objective of this component is to develop new, sustainable financing sources based on payments from service users, which could then be channeled either through the PSAH or through stand-alone local PES mechanisms, as appropriate. Under the baseline scenario, several disparate activities to create markets for water services do exist. However, these are mostly within the specific watersheds that have been targeted for their water and hydrological benefits and are not oriented towards optimizing protection of biological diversity. Indeed, in the baseline scenario, some of the most important areas of biodiversity will not be targeted, those areas that are targeted may not have any biodiversity of global significance, and even where targeted areas do contain globally significant biodiversity it may not be appropriately recognized.

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12. Currently the government is spending US$3.27 million a year to pay for environmental activities to promote water services through the PSAH. Of this amount US$0.29 million is being spent on activities relevant to this component. This equates to US$1.18 million for the duration of the project. There is, however, currently no spending to pay for environmental activities that would specifically promote biodiversity services. In particular, there is no trust fund along the lines of that proposed by the alternative scenario.

13. Currently the government is spending approximately US$0.55 million a year to pay for environmental activities to promote carbon sequestration services through the CABSA. Of this amount US$0.12 million is being spent on activities relevant to this component. This equates to US$0.49 million for the duration of the project.

14. The total baseline amount for this component is therefore approximately US$1.67 million.

Component 2: Developing and Strengthening PES Delivery Mechanisms

15. The objectives of this component are to strengthen the existing PSAH and CABSA delivery mechanisms and support development of new, stand-alone delivery mechanisms for local PES markets. Under the baseline scenario, the PSAH (and on a smaller scale CABSA) will perform this role to a certain extent. However, both the PSAH and CABSA are young mechanisms that are directed towards providing hydrological and carbon sequestration services in limited areas. These will require considerable strengthening and improvement to increase their efficiency and their capacity to handle the increased and more complex demands that would be necessary to achieve the global environmental benefits offered by the alternative scenario.

16. The baseline scenario would therefore only achieve limited biodiversity benefits. Rather, it would concentrate on delivering water and, in the future some carbon sequestration services in a few disparate areas.

17. Subcomponent 2A will build on some baseline activities that are currently being undertaken by the PSAH and CABSA. The current cost per year for these activities is US$0.32 million for the PSAH and US$0.05 million for the CABSA. This equates to US$1.48 million for the duration of the project.

18. Subcomponent 2B may use existing institutions and local service providers initially created for other purposes. It is estimated that the baseline cost of activities on which the project will build is around US$0.14 million per year.

19. The total baseline amount for this component is therefore approximately US$1.62 million.

Component 3: Supporting Environmental Service Providers

20. The only baseline funds going towards providing technical or organizational assistance come from the PSAH and the CABSA. Projected funding for this is US$4.88 million from the PSAH and US$0.81 million from the CABSA.

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21. The total baseline amount for this component is therefore approximately US$5.69 million for the lifetime of the project.

Component 4: Payment to Service Providers

22. In the absence of the GEF Alternative, it is estimated that the PSAH will continue to receive around US$27.27 million a year from water tariffs, or US$109.08 over the life of the project. The baseline revenue from carbon sales is estimated to be around US$1.5 million per year, or US$6.0 million over the life of the project.

23. Furthermore, the baseline includes the US$73.292 million loan from the World Bank and US$32.734 million contribution from the beneficiaries. Although some global environmental benefits will also be achieved by these contributions, they cannot be differentiated to provide the exact amount, and therefore has been included as the baseline.

24. In addition to this, under the baseline US$1.09 million per year would be paid to perform compliance monitoring for the PSAH and US$0.18 million per year for CABSA. This would total US$5.09 million during the lifetime of the project.

25. The total baseline amount for this component is therefore US$226.206 million over the lifetime of the project.

Component 5: Monitoring and Evaluation

26. The costs for the PCU and the functions they perform would be entirely incremental. No baseline costs for this exist.

27. Monitoring and evaluation will partly build on structures provided by the PSAH and CABSA. These would be US$0.66 million from the PSAH and US$0.11 million from the CABSA over the lifetime of the project.

28. The total baseline amount for this component is therefore approximately US$0.77 million for the lifetime of the project.

GEF Alternative

29. The alternative scenario proposed here would leverage the current baseline activities and build on them to ensure that they contribute as much as possible to conserving Mexico’s globally significant biodiversity and increasing carbon sequestration. The project would do this by (i) developing new, sustainable financing mechanisms for environmental services, which could be channeled either through the existing PES programs or through new, stand-alone local PES delivery mechanisms; (ii) strengthening and improving the efficiency of existing PES programs (PSAH and CABSA); (iii) stimulating the development of stand-alone local PES programs; and (iv) assisting local communities in service provision.

30. Sustainability would particularly be ensured through creation of an endowment fund to finance payments for activities that promote conservation of globally significant biodiversity. The project would also catalyze further replication throughout Mexico by reducing barriers to

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creation of new schemes. It would offer the potential for future investment both directly through the endowment fund and through new PES schemes and would serve as a benchmark for promoting such projects in other highly biodiverse countries. Both the immediate and the future global biodiversity benefits of this project would be significant in terms of reducing species loss. In addition, the project would contribute to future carbon sequestration activities.

31. Total incremental costs of this proposed project—the difference between the baseline scenario and the GEF alternative—are therefore calculated to be US$31.146 million, of which $15.00 million is being requested from the GEF.

32. Details on the activities and global benefits that would be achieved by each component of the project and the costs associated with them are presented below.

Component 1: Developing Sustainable Financing Mechanisms

33. Component 1 of this project would produce pilot financing mechanisms for local water service users, local biodiversity users, and carbon buyers. It will also set up an endowment fund to cover continued payment for environmental activities that contribute to biodiversity conservation and will produce replication strategies to ensure that these financing mechanisms proliferate throughout Mexico.

34. The incremental costs of this component under the alternative scenario would be:

US$0.488 million from the GEF, US$0.952 million from the IBRD loan, and US$0.513 million from the Mexican government for developing financing mechanisms for water services.

US$1.178 million from the GEF and US$0.295 million from the IBRD loan for developing financing mechanisms for promoting biodiversity conservation.

US 8.5 million from the GEF for developing and capitalizing the biodiversity endowment fund; and US$8.5 million from the Mexican government to capitalize the biodiversity endowment fund..

US$0.416 million from the GEF, US$0.338 million from the IBRD loan, and US$0.182 million from the Mexican government for developing financing mechanisms to promote carbon sequestration.

35. The total incremental cost of this component is therefore US$21.362 milllion.

Component 2: Developing and Strengthening PES Delivery Mechanisms

36. Component 2 of this project would strengthen the delivery mechanisms already being provided under the PSAH and the CBSA and also strengthen the capacity of CONAFOR, other national institutions, market intermediaries, community associations, and NGOs to implement stand-alone PES programs.

37. The incremental costs of this component under the alternative scenario would be:

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US$0.745 million from the GEF, US$1.13 million from the IBRD loan, and US$0.609 million from the Mexican government for strengthening existing PES programs.

US$0.329 million from the GEF, US$0.498 million from the IBRD loan, and US$0.268 million from the Mexican government for supporting stand-alone local PES programs.

US$0.125 million from the GEF to provide matching funds to promote local financing mechanisms.

38. The total incremental cost of this component is therefore US$3.704 million.

Component 3: Supporting Environmental Service Providers

39. The incremental costs of this component under the alternative scenario would be:

US$0.4 million from the GEF, US$0.39 million from the IBRD loan, and US$0.21 million from the Mexican government for providing technical assistance.

US$0.4 million from the GEF, US$0.39 million from the IBRD loan, and US$0.21 million from the Mexican government for providing organizational assistance.

40. The total incremental cost of this component is therefore US$2.0 million.

Component 4: Payment to Service Providers

41. The incremental costs of providing payments to service providers under the alternative scenario would be:

US$1.578 million from the GEF and US$1.53 million from the government funds for payments to service providers. Although some global environmental benefits will also be achieved by the World Bank, GOM, and beneficiary contributions, they cannot be differentiated to provide the exact amount, and therefore have been included in the baseline.

42. The total incremental cost of this component is therefore US$3.108 million.

Component 5: Monitoring and Evaluation

43. The incremental costs of project and program management under the alternative scenario would be:

US$0.456 million from the GEF, US 0.335 million from the IBRD loan, and US$0.181 million from the Mexican government.

44. The total incremental cost of this component is therefore US$0.972 million.

45. The matrix below summarizes the baseline and incremental expenditures during the project period.

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Cost Category US$ Million Domestic Benefit Global Benefit

Component I

Baseline US$1.67 millionProvision of water services Some services of carbon sequestration. Very

minor accidental conservation of globally significant biodiversity

With GEF Alternative US$23.032million

Enhanced provision of water services

The global environmental consequences of this would be to enhance and protect biological diversity and preserve globally significant forest and mountain ecosystems within Mexico and to encourage and assist further conservation globally.

In addition to this, the project would assist global carbon sequestration

Incremental US21.362 millionComponent 2

Baseline US$1.62 millionProvision of water services Some services of carbon sequestration. Very

minor accidental conservation of globally significant biodiversity

With GEF Alternative US$5.324 million

Enhanced provision of water services

The global environmental consequences of this would be to enhance and protect biological diversity and preserve globally significant forest and mountain ecosystems within Mexico and to encourage and assist further conservation globally. In addition to this, the project would assist global carbon sequestration

Incremental US$ 3.704 million

Component 3

Baseline US$5.69 millionProvision of water services Some services of carbon sequestration. Very

minor accidental conservation of globally significant biodiversity

With GEF Alternative US$7.69 million

Enhanced provision of water services

The global environmental consequences of this would be to enhance and protect biological diversity and preserve globally significant forest and mountain ecosystems within Mexico and to encourage and assist further conservation globally. In addition to this, the project would assist global carbon sequestration

Incremental US$2.00 million

Component 4

Baseline US$226.206 millionProvision of water services Some services of carbon sequestration. Very

minor accidental conservation of globally significant biodiversity

With GEF Alternative

US$229.314 million Enhanced provision of water services

The global environmental consequences of this would be to enhance and protect biological diversity and preserve globally significant forest and mountain ecosystems within Mexico and to

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encourage and assist further conservation globally. In addition to this, the project would assist global carbon sequestration

Incremental US$3.108 million

Component 5: Project Coordination

Baseline US$0.77 millionProvision of water services Some services of carbon sequestration. Very

minor accidental conservation of globally significant biodiversity

With GEF US$1.742 million

Enhanced provision of water services

The global environmental consequences of this would be to enhance and protect biological diversity and preserve globally significant forest and mountain ecosystems within Mexico and to encourage and assist further conservation globally. In addition to this, the project would assist global carbon sequestration

Incremental US$0.971 6 millionTotal Baseline: US$235.956 millionTotal GEF Alternative: US$267.102millionTotal Incremental Costs: US$31.146 million

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Annex 16: STAP Roster Review

MEXICO: Environmental Services of the Forest

STAP REVIEW FOR:

MEXICO: ENVIRONMENTAL SERVICES OF THE FOREST (World Bank-GEF)

Dr. Eduardo R. FuentesSantiago. ChilePhone: (56-2) 220.3125e-mail: eduardo-fuentes@osorno-inc.com

eduardo-fuentes@terra.clOverall AppraisalThis is a well designed project aimed at Payments for Ecosystem Services (PES) in Mexico. The project will strengthen existing PES (water-related) and create new ones (biodiversity, carbon). The design builds upon lessons learned from similar initiatives in Mexico and in the rest of the continent. By having ecosystem users pay for benefits obtained from ecosystem maintenance, the project incorporates privates and especially local indigenous land owners into the conservation effort, a welcome initiative from the overall perspective of the CBD and the GEF.

The project will help protect globally significant biodiversity in Mexico and thus also help contribute to the maintenance of the Mesoamerican Biological corridor. Emphasis will be on forested areas with biodiversity of global significance. The proposed payment for conservation services by the tourist sector is very innovative. Biodiversity concerns will be mainstreamed into tourism, forestry, agriculture environment, and water sectors. There are a few queries that if solved during the remaining preparation time, will improve the project and make it a replicable model in other areas on high biodiversity.

World Bank Response:Thank you. The project design includes a replication strategy and the lessons will be disseminated widely.

1. Scientific and Technical Soundness The project is basically sound and well constructed. Perhaps the most important issue is the existence or non-existence of site-specific reliable evidence that ecosystem services (water supply and biodiversity) are in fact closely connected with the degree of conservation of their flora and fauna. It is known that water services are not always closely connected with the biodiversity in the ecosystems, and users of biodiversity (for example birdwatchers) may be interested only on in some taxa. If true that linkages between services used and ecosystem attributes are weak, it may lead to reluctance to pay for ecosystem maintenance. Good models, surveys and other empirical evidence relevant to each one of the sites would be needed.

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The problem is that obtaining this evidence may take several years and without it, users may not be willing to pay and thus the whole sustainability may be jeopardized. The text is not sufficiently clear regarding how much of this evidence is available at this point.

Unfortunately, the problem may be augmented because so far there have been no specific consultations with ecosystem users at the various sites about their willingness to pay, and the reader is left with the impression of a weak link in the whole argument. Willingness to pay by the tourism sector is particularly intriguing. (Proponents make plausible arguments, however, for why providers would be willing to participate in the scheme).

Both of the issues just raised are included in the list of good practices listed in the project, but so far have not been included in the design.

World Bank Response:We agree that there is much yet to be learned about the hydrological impacts of land use changes at different sites. For this reason, the project will support additional applied, site-specific technical studies to fill gaps in available knowledge of links between land use and water services and biodiversity (through Component 1A and 1B). However, enough is known about the hydrological impacts of land use changes at different sites to serve as a basis for action, as evidenced by the existing Mexican PES programs (PSAH and CABSA), which the project would strengthen and improve upon. The project also supports the establishment and operation of a robust impact monitoring system to verify that the desired services are in fact being generated, or allow mid-course corrections to be made.

There are already incipient PES proposals at several of the pilot sites, indicating a strong interest among at least some service users to pursue this approach. That there are service users actually making payments for conservation – in Mexico and elsewhere in the region – demonstrates that establishing such financing mechanisms is possible. There have been few efforts to extend the approach to the tourism industry to date, so there is much that will have to be learned in doing so, but many of the lessons learned in developing financing from water users is likely to be applicable.

2. Global Benefits Mexico is a Megadiversity country, rich in ecosystem types, species and within-species diversity. The eight demonstration areas correspond to earlier identified sites of globally significant biodiversity. The project would help stop forest conversion and thus contribute to biodiversity conservation. It will also restore damaged ecosystems in otherwise high biodiversity areas.

The connection made between global/domestic benefits and incremental costs deserves special mention. The project aims at water services (local benefits), biodiversity and carbon services (global benefits). It is unclear from the project to what extent improving conditions for water services (domestic benefit) at any one site will actually serve protecting biodiversity. Effects may be marginal, particularly as water services are more related to plant cover and are not closely related to plant or faunal composition. The incremental costs analysis, however, does not seem to reflect this situation. The GEF seems to be asked to support some activities with mostly local benefits as well as those with clear global benefits. Clarifications may be needed.

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World Bank Response:This project would promote, through PES contracts, the conservation of existing natural forests, their restoration through reforestation with native species, or the improvement of agro-forestry systems so that they more closely resemble the original native forest in structure, species composition, and ecological function. Based on the scientific evidence available to date, these land use interventions are highly positive for both the conservation of Mexican biodiversity (since so many endemic Mexican animal and plant species depend upon natural forests for their survival) and for improving water flows--in terms of seasonal peak flows, groundwater recharge, water quality, reduced sedimentation and flood intensity, and (at least in the case of cloud forests) added flows through water harvesting from clouds. Under the project, some locally-based new PES systems might possibly focus on improving hydrological services in areas of lesser biodiversity priority (but not with GEF funds). Conversely, PES contracts in some areas (including natural grasslands and wetlands) might be driven by the desire to conserve biodiversity (such as for eco-tourism) rather than water supply concerns. The Cancun pilot site, for example, was selected almost entirely for its biodiversity conservation benefits. However, the project would not support any PES systems that would encourage land use changes harmful to biodiversity (or to environmental protection in general), as is explained in Annex 10. The project recognizes that the overlap between preserving hydrological services and preserving biodiversity, although considerable, is not 100%. This is illustrated by the impact indicators, for example, in which only a part of the total area to be enrolled under the project is expected to be “of global biodiversity significance.” This is also recognized through the creation and capitalization of the Biodiversity Endowment Trust Fund, which will provide sustainable long-term payments in areas where financing from water users or the local tourism industry is either absent or insufficient to preserve biodiversity of global significance.

3. Innovativeness There are several innovative aspects in the proposal.

The most innovative aspect is the inclusion of the tourist sector as a biodiversity user, eventually paying to maintain them.

The flexible approach allowing for small independent, larger arrangements covering several watersheds and one or more ecosystem services is also innovative.

The trust fund to complement PES in biodiversity is also an innovative instrument.

Connections between a GEF-supported project and support from the Clean Development Mechanism are also an innovative aspect.

4. GEF and Convention Fit The project is consistent with CBD guidance and with GEF policies under SP2, OP3 and OP 4. The proposal is consistent with COP guidance referring to incentive measures, ecosystem services, tourism, and sustainable uses, particularly by indigenous communities.

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The proposal is also consistent with GEF policies regarding conservation and sustainable uses of forested (OP3) and mountain ecosystems (OP4) and, by helping mainstream conservation into production sectors of the economy, with SP2.

5. Consultations and Participation There have been social surveys and consultations but participation of the key actors may still be a weak point in this proposal. Proponents have consulted with government agencies, NGOs, academics, private institutions. But so far a key link in the whole argument, namely willingness to participate of users of services at the specific demonstrations sites has not been secured. This may be a critical area for the coming months of project preparation.

World Bank Response:Additional consultation with stakeholders, including determination of the “willingness to pay” of environmental service users, will take place during project preparation and as part of Component 1. As noted, several of the pilot sites have incipient PES proposals (this was one of the selection criteria), indicating a strong interest among at least some service users to pursue this approach.

6. Capacity-Building The project will strengthen capacities at CONAFOR, market intermediaries, community associations, and NGOs. It will create the enabling environment allowing for a very flexible PES system in the country. The project will help generate new legislation, remove barriers to conservation, change policies, and build partnerships. All these capacities will allow for replication within Mexico. In turn the approach chosen to build capacities could be later replicated in other countries.

7. Sustainability and Replicability It is a big question at his point to what degree the whole effort will be sustainable. Proponents suggest that sustainability will be largely secured by the self interest of suppliers and users of ecosystem services, and the project will trigger the process by providing capacities and substantive resources (nearly $ 150M) to start paying providers. However, the system of PES will be sustainable if this fund is replenished with contributions from beneficiaries of the services. At present we do not know to what extent private beneficiaries will want to pay for the services claimed. As mentioned, unless there is solid evidence for the linkages between ecosystems attributes and services, users may not be interested in PES. Unfortunately, so far there have been no specific consultations on this issue and scientific evidence for close linkages between ecosystem services and biodiversity is unclear from reading the document.

It would also help to see more on how CONAFOR will strengthen and later maintain its capacities to secure long-term sustainability of these efforts.

The project should be replicable both in approaches, types of services as well as specific mechanisms (such as the trust fund) within Mexico and elsewhere. The proposal has several important activities addressing replicability of its components.

World Bank Response:

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The existing PSAH water fee is evidence of considerable willingness to pay for environmental services by water users. Project sustainability will be enhanced through the project’s promotion of additional schemes where environmental service users in specific areas provide funding for PES in their upstream watersheds. The planned biodiversity trust fund and linkages to carbon finance mechanisms will also enhance the project’s long-term sustainability.

8. Miscellaneous The reviewer suggests that in drawing baselines for indicators, testing areas as well as

nearby areas without project be used. These would serve as “controls”.

World Bank Response:Agreed, since measuring significant changes in environmental services through improved land use at a given site will often take longer than the time available for project implementation.

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Annex 17: Pilot Site Selection Criteria

MEXICO: Environmental Services of the Forest

1. Biodiversity in Mexico. Mexico is one of the mega-biodiversity countries in the world, with second place in reptilian diversity, third in mammal diversity, and fifth in both amphibian and plant diversity (Annex A, Table A1-1). Its plant diversity exceeds that of the United States and Canada combined. Mexico also ranked eighth in fish diversity and fifteenth in bird diversity. With 1.3% of the world’s land area, it hosts about 12% of known terrestrial biota, with very high endemism. Mexico’s rich biodiversity includes the wild relatives of some 120 cultivated plant species, including maize, cocoa, kidney beans, and tomatoes.

2. Mexico’s biological wealth is extraordinary, but the future is precarious. About 1/3 of birds and nearly 66% of amphibian, reptile, and mammal species are at risk (see Annex 1, Table A1-2). Historically, much of the species loss and endangerment was due to the introduction of aggressive, non-native species to fragile Pacific island ecosystems, such as the Revillagigedos and Guadalupe islands. Many terrestrial and aquatic species are also threatened by direct exploitation, including over-fishing, uncontrolled hunting, wildlife capture for pets, and collection of rare ornamental plants (such as cacti and orchids). However, by far the greatest threat to Mexican biodiversity today is the destruction and degradation of natural habitats, including many types of forests, shrublands, and natural grasslands. In recent decades, Mexico has suffered one of the world’s highest deforestation rates, second only to Brazil. FAO had consistently reported a loss of around 1.3% per year, of which 66% occurred in tropical forests, including areas of high biodiversity value. A World Bank-World Wildlife Fund study (Dinerstein et al., 1995) identified 33 unique eco-regions (including forests and other ecosystem types) that occur exclusively within Mexico, of which nine are classified as Critical, nine as Endangered, and four as Vulnerable. Many of these unique ecosystems, along with their endemic species, still lack adequate on-the-ground protection; others occur completely outside of formally protected areas.

3. Watershed Management in Mexico. The availability of fresh water is a major constraint on Mexico’s development options, in terms of urban and industrial expansion as well as irrigated agriculture. According to the National Water Commission (Comisión Nacional de Agua: CNA), 66% of the 188 most important aquifers in the country suffer from overexploitation, a fragile situation when consumption is projected to grow and natural recharge is often reduced by deforestation. For example, forests in the Sierra Gorda are believed to be fundamental for water recharge in the aquifers supplying the cities of Queretaro and San Juan del Rio. Mexico’s rapid deforestation also has negative implications for the regulation of water flows, water quality, and the sedimentation of reservoirs and canals. Scientific work to date highlights the role that montane cloud forests play in providing surface water flows during the dry season (as in Veracruz), and that tropical dry forests reduce the flooding risks during storms (as in western Jalisco). Given Mexico’s growing dependence on scarce fresh water resources, combined with vulnerability to seasonal floods in some cities, improving watershed management by retaining and restoring forests and other natural vegetation has become a Government priority. PES mechanisms are seen as a promising mechanism to persuade land users in upper watersheds to adopt conservation practices, using funds made available largely by the downstream water users and urban dwellers who stand to benefit directly from improved water flows, better water quality, increased groundwater recharge, and reduced vulnerability to flooding.

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4. Existing PES Programs. Mexico presently has two PES programs—Payments for Hydrological Environmental Services (PSAH) and Carbon and Biodiversity in Agro-Forestry (CABSA). PSAH provides direct payments to landowners who maintain their natural forests in good condition from a conservation standpoint. The PSAH sites were intended to be chosen on the basis of their hydrological importance, including (i) proximity to downstream areas of water scarcity and (ii) where deforestation risks (due mainly to agricultural or cattle pasture expansion) are significant (so that the PSAH payments would make a real on-the-ground difference in land use and forest cover). CABSA was designed to use PES to (i) conserve biodiversity; (ii) promote carbon storage; (iii) improve existing agro-forestry systems, including through increased use of native forest species; and (iv) convert areas of field crops or pasture to agro-forestry systems.

5. Project Site Selection. Under this project, the areas where PES systems would be established, strengthened, or continued include eight pilot sites. In addition to these pilot sites, other PES areas are expected to be established under this project as a result of local-level initiatives, in which environmental service users seek to use PES to improve hydrological services (water supply, flood protection, or erosion control) or biodiversity linked to eco-tourism. The eight pilot sites are all within reasonable proximity of urban centers, with at least 50,000 inhabitants and a presumed demand for environmental services, such as improved water flows and water quality, flood mitigation, and biodiversity and scenic beauty (for eco-tourism). In addition, all eight sites have (i) important watersheds upstream of in areas where the scarcity of fresh water is a significant concern, (ii) globally significant biodiversity in need of improved conservation, (iii) natural vegetation important for carbon storage, (iv) significant risks of deforestation and other loss and degradation of natural habitats, and (v) extensive community and ejido landholdings potentially suitable for PES contracts. All the pilot sites have been classified as Priority Hydrological Regions (RHP) by the Mexican Government. In terms of biodiversity significance, all pilot sites were chosen to overlap with at least two of the four following categories of high conservation priority: (i) existing Natural Protected Areas (ANP, Areas Naturales Protegidas); (ii) Priority Terrestrial Eco-regions (RTP, Regiones Terrestres Prioritarias), which are areas of high biodiversity conservation priority (with or without existing legal or on-the-ground protection) established by CONABIO; (iii) Important Bird Areas (AICA, Areas Importantes para la Conservacion de Aves), which are important for the survival of endemic bird species or as key bird breeding, feeding, or migration staging areas; and (iv) Ramsar Wetlands of International Importance, which are wetland sites previously designated by the Mexican Government for international recognition as highly important for migratory birds or other biodiversity.

6. Under this project, only sites with globally significant biodiversity will receive GEF funds under the national or local programs in the project area. Furthermore, all land management systems with PES support under the project (from any funding source) will be biodiversity-friendly (see Annex 10 for details). Within the project sites, private landowners (ejidos, communites, and possibly individuals) with secure tenure will be eligible for PES contracts, if they choose to participate. Some of these landholdings will be within the buffer zones of protected areas (where human occupation is legally permitted). Within the eight pilot sites, the lands of sufficient importance for biodiversity conservation to merit GEF-funded or other

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targeted biodiversity conservation payments have already been identified, as have the (often overlapping) lands that would be eligible for PES payments based on hydrological and carbon storage significance (see Table A17-1).

Table A17-1:  Promising Areas and Eligible Hydrological, Biodiversity, and Carbon ServicesSize of area (hectares)

Environmental services eligible for PESPromising area Total Forested Hydrological Biodiversity Carbon Subtotal

Cancún 603,232 559,638 130,712 415,730 9,848 556,290

Cerro Grande (Colima-Villa de Álvarez)

254,503 142,520 27,229 96,919 53,319 177,467

Copalita (Crucecita-Huatulco)

239,291 187,273 67,825 234,195 101,841 403,861

Oaxaca de Juárez 1,601,001 254,980 50,104 1,016,493 778,414 1,845,010

Valle de Bravo 278,993 140,777 24,837 53,496 63,110 141,444

Xalapa-Coatepec 160,497 51,453 18,141 160,497 42,177 220,816

Zapalinamé (Saltillo) 1,071,720 888,351 45,691 85,925 84,619 216,236

Zona Metropolitana Monterrey

1,932,558 1,150,312 222,926 912,019 181,830 1,316,775

Total 6,141,795 3,375,305 587,466 2,975,274 1,315,158 4,877,899

Note: Because areas with eligible services in different categories frequently overlap, the subtotal may count the same hectares more than once.Source: CONAFOR/CGPP/GSM. Based on National Water Commission data and the Municipal Geostatistical Framework of the National Institute of Statistical and Geographic Information (INEGI).

7. Pilot Project Sites. As shown in Table A17-1, the eight pilot project sites total some 4.8 million hectares, of which about ___ ha (___ percent) are likely to be placed under PES contracts during the life of this project (based on the expected availability of funds and demand from potential PES recipients). All these sites are recognized as part of the national protected areas system. They are briefly described below (not in any priority order):

a. Coatepec-Xalapa-Pico de Orizaba. Located in the states of Veracruz and Puebla, this site comprises an important area of remaining cloud forest (much of which has been replaced by shade coffee and other agricultural systems), with humid pine forest at the higher elevations and dry forest in the lower foothills. The cloud forests and adjacent well-shaded coffee plantations harbor many endemic plant and animal species of conservation concern, including the globally threatened Bearded Wood-Partridge Dendrortyx barbatus, for which the Coatepec area is an important stronghold. The project would continue and expand the area of PES payments under a successful ongoing program, which is motivated by water supply concerns for the urban areas of Coatepec and Xalapa. PES payments would maintain the cloud forests and possibly also the shade coffee areas of high watershed and biodiversity conservation value, and reduce the expansion of field crops and pastures to hillside areas.

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b. Colima-Manantlan-Cerro Grande-Villa de Alvarez. Located in the states of Colima and Jalisco, this site comprises a biologically highly diverse mix of moist and dry pine-oak forests, cloud forests, and tropical dry forests. It encompasses a portion of the Sierra de Manantlan Biosphere Reserve, which is renowned for its biodiversity that includes many endemic bird species (including the globally threatened Mexican Woodnymph Thalurania ridgwayi and Black-capped Vireo Vireo atricapillus) and the wild-growing Perennial Maize Zea diploperennis. It also forms a corridor between the Sierra de Manantlan and the Nevado de Colima National Park, with its high-altitude pine and fir forests and substantial eco-tourism potential. Maintaining adequate forest cover is needed for ensuring adequate water supply to Colima city, as well as to reduce the significant soil erosion and landslide problems in the area. PES contracts with the ejidos and communities at this site would serve to prevent further deforestation within areas of high importance for biodiversity conservation, improved watershed management, and carbon sequestration.

c. Huatulco-Crucecita-Copalita/Zimatan. Located on the Pacific slope of the State of Oaxaca, this site encompasses a diverse mix of cloud and humid pine-oak forests in the Sierra de Miahuatlan, lowland tropical (humid and dry) forests in the coastal foothills, and mangroves. The moist forests of the Sierra de Miahuatlan harbor numerous plant and animal species of conservation concern, including the endangered Blue-capped Hummingbird Eupherusa cyanophrys (found nowhere else) and globally threatened White-throated Jay Cyanolyca mirabilis. Huatulco is an important beach resort with growing dependence upon fresh water, and the montane forest cover that helps to ensure its reliability. There is also the potential for expanded eco-tourism, including on community-owned forest lands. PES contracts would reduce deforestation for agricultural expansion, while helping to maintaining water supplies, reduce catastrophic flooding risks, and enhancing the survival prospects of many threatened species.

d. Saltillo-Zapaliname. Located in the states of Coahuila and Nuevo Leon, this site includes the Area Natural Sierra Zapaliname, an official protected area with substantial ejido landholdings suitable for PES contracts. The Sierra Zapaliname contains a diverse mix of native pine and oak forests, along with semi-arid scrub at lower elevations. This mountain range is also an AICA because its pine forests are an important feeding area for the threatened endemic Maroon-fronted Parrot Rhynchopsitta terrisi. The pilot site also includes a highly threatened (by agricultural expansion) natural grassland area known as the Pradera de Tokio, which is the main global stronghold for the endangered Mexican Prairie Dog (Cynomys mexicanus) and Worthen’s Sparrow (Spizella wortheni), as well as an important wintering area for many North American grassland birds. The city of Saltillo is in a semi-arid zone with over-exploited aquifers and depends upon water originating in the Sierra Zapaliname.

e. Valle de Bravo-Amanalco. Located in the states of Mexico, Michoacán, and Guerrero, this site comprises two endangered ecosystems classified as “Highest Priority” in the World Bank-WWF Conservation Assessment of the Terrestrial Eco-regions of Latin America and the Caribbean (Dinerstein et al., 1995): Mexican Trans-Volcanic Pine-Oak Forest in the higher mountains (along with patches of cloud forest) and Balsas Dry Forest in the foothills. The site includes the buffer zone of the Nevado de Toluca National Park. The city of Valle de Bravo and surrounding irrigation districts suffer from over-exploited aquifers and rely upon these

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forests to improve seasonal water flows. PES contracts with ejidos and communities with key forested lands would serve to enhance water flows, protect hydraulic infrastructure from sedimentation, and conserve the habitat of numerous endemic plant and animal species.

f. Cancún-Sian Ka’an. Located in the State of Quintana Roo, this site includes the Sian Ka’an Biosphere Reserve and the El Eden Private Reserve. It comprises humid and dry tropical forests, mangroves, and semi-arid scrub in the extreme north. The site contains most of the diverse endemic fauna and flora of the Yucatan Peninsula and is a concentration area for many species of migratory land and water birds. This pilot area is in the general vicinity of Cancun and the booming tourist resorts of the Mayan Riviera, where there is considerable potential to promote eco-tourism as a complement to the well-developed tourism around beach resorts and Mayan ruins. This is an area where PES arrangements based on maintaining natural habitats for biodiversity-based eco-tourism shows genuine promise. PES contracts would help to ensure that participating communities maintain the natural forest and other biodiversity-friendly vegetation.

g. Oaxaca de Juarez-Sierra San Felipe. Located in the State of Oaxaca, this site comprises the unique dry oak forest and thorn scrub in a portion of Oaxaca’s central valley and adjacent slopes, along with the moist pine-oak and cloud forests in the mountain ranges both north and south of Oaxaca city. The cloud forests in the Sierra de Norte are presently the most extensive ones remaining in Mexico, with numerous plant and animal species of conservation interest. The moist pine-oak forests north of Oaxaca city are the main stronghold of the globally threatened Dwarf Jay Cyanolyca nana. The remaining thorn scrub and dry oak forests in the foothills harbor many range-restricted species, including near-threatened birds such as Pileated Flycatcher Xenotriccus mexicanus and Oaxaca Sparrow Aimophila notosticta. The hydrological services from the mountain forests (both north and south of Oaxaca city) are especially significant because the aquifers that provide water to the city and nearby irrigated lands are classified as over-exploited by the National Water Commission (CNA). Although Qaxaca city is a popular tourist attraction because of its history and nearby archaeological sites, the adjacent mountains (with their pleasant climate, beautiful forests, and exceptional biodiversity) have significant, underutilized eco-tourism potential. PES contracts with communities holding important lands for biodiversity, hydrological functions, and carbon sequestration would serve to limit the clearing of forests for various types of subsistence and commercial agriculture.

h. Monterrey-Cumbres. Located in the states of Nuevo Leon and Coahuila, this site comprises the Sierra de Arteaga, an extensive area of native pine forest, with semi-arid scrub in the lower foothills and moist forest along water courses. It includes the Cumbres de Monterrey National Park and the El Taray Reserve. This site contains a high proportion of the world’s nesting cliffs and feeding area for the threatened endemic Maroon-fronted Parrot. The city of Monterrey has over-exploited aquifers and relies significantly on surface water originating in the pine forests. Conservation of these forests is also considered important for reducing the intensity and damage from periodic floods and gully erosion. PES contracts with ejido landowners in the Sierra de Arteaga would reduce deforestation, as well as the pine forest degradation that results from excessive burning.

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Annex 18: Detailed Lessons Learned

MEXICO: Environmental Services

1. The design of proposed project has been enriched by lessons and recommendations from several initiatives. The key lessons learned from other relevant projects including those co-financed by GEF and/or other donors (listed in Annex 2), has enriched the design of the proposed project. This Annex reviews the lessons learned in: (a) Mexico’s current Payments for the Hydrological Environmental Services (PSAH Program); (b) other Payment for Environmental Services initiatives; and (c) the GEF-supported Biodiversity Conservation and Sustainable Use in Productive Landscapes Project in Chiapas.

Lessons from Mexico’s Payments for the Hydrological Environmental Services Program (PSAH)

2. The proposed project builds on Mexico’s current program of Payments for the Hydrological Environmental Services (PSAH). This program has already been quite successful. In 2003 more than 900 applications were received offering close to 600,000 ha, of which 271 were selected, incorporating 127,000 ha into the program. In 2004, Congress increased the PSAH’s budget by 50%. 960 applications were received, of which 352 were chosen, covering about 180,000 ha. Despite the program’s achievements, there remains room for improvement. In particular, the following areas need to be addressed; (i) the majority of the contracted area is outside the priority conservation areas—less than 14% of the area enrolled in 2003 and 2004, for example, was located in areas with over-exploited aquifers; (ii) most of the enrolled area is at low risk of deforestation—less than 20% of the area enrolled in 2003 and 2004 was in areas with high or very high risk of deforestation, while 62% was in areas of low or very low risk of deforestation; (iii) most contracts have gone to the better organized, more developed communities and ejidos, and to private owners, even though their opportunity cost tends to be higher; (iv) budgetary limitations impose a 5-year limit on payments to any one participant, putting conservation beyond that period at risk; and (v) there is a lack of training and capacity building (on both the supply and demand sides) to develop local markets.

3. Lessons from evaluations of the PSAH program to date have been instrumental in the design of the proposed project. These include:

High Level Government Buy-In: High level government commitment was crucial for PSAH program to obtain funding. In designing the program, a thorough analysis was conducted by experts from universities and the World Bank. After securing the commitment from SEMARNAT and CONAFOR, the PSAH program proposal received support from National Water Commission (CNA) and the Ministry of Finance (SHCP) with a very strong lobby from within the government. The support from the reputable members of academia and professionals and the empirical studies provided the credibility of the program that helped secure CNA’s and SHCP’s buy-in as well as from the large majority of the entire chamber of the legislative branch. Likewise, the proposed project is strongly supported by SHCP and SEMARNAT.

Design eligibility criteria carefully: One of the eligibility criteria for PSAH program participation was that the forest areas should have at least 80 percent forest cover. This criterion excluded some of the most deforested and high deforestation risk areas from the

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program. The project will support a thorough re-appraisal and modification of eligibility criteria.

Differentiate payments: The payment scale of US$27.30 per ha per year (non-cloud forest areas) and US$36.40 per ha per year (cloud forest areas) attracted widespread participation in some areas, but very little in others. In some respect, it was set too high, attracting forest areas that did not have any conversion risk due to low or no opportunity cost. Many of these areas could probably have been enrolled at much lower payments, thus freeing resources for additional areas elsewhere. Attracting participants in areas of high deforestation risk, however, may be difficult at current payment levels, as these areas tend to have high opportunity costs. Raising payment levels across the board to attract these higher-risk areas, however, would result in much higher program costs. A differentiated payment program is needed to escape this trap. A differentiated, targeted scheme will be much more cost effective and less expensive than an undifferentiated payment system that pays everyone the same.

Base payment levels and targeting on both expected benefits and opportunity costs: The overall payment levels of the current PSAH were set based on an analysis of average opportunity costs. Basing payments purely on opportunity cost, however, creates the risk of making payments in areas where very few benefits are being produced. Indeed, the PSAH program has attracted substantial participations in areas with limited or no likely water benefits. The PSAH did partially reflect expected benefits by offering a higher payment for conservation of cloud forests, which are thought to be particularly valuable for water services. In any given area, efficiency of the program requires both (i) targeting payments to high priority areas (of high conservation value as well as relatively high deforestation risk) and (ii) ensuring that PES in these high priority sites are reasonably close to the landowners' actual opportunity costs. Through Components 1, 2 and 4, the project will refine the existing Mexican PES program to promote increased cost-effectiveness, which will, in turn, ensure both (i) greater positive conservation impact for the GEF and other funds invested and (ii) increased likelihood of long-term financial sustainability.

Define – and enforce -- clear Eligibility Criteri: Defining the operational procedure and eligibility criteria should be based on detailed analysis and be adaptive to reflect the lessons learned during implementation of the program. For example, the PSAH program’s operating rules state that eligible areas needed to be located either in the recharge area of an overexploited aquifer, in a watershed with high water scarcity, or where hydrological natural disasters are more frequent. Some of these were difficult to assess to conclude a “yes” or “no” result, and therefore the eligibility criteria was modified from a binary (i.e., “yes” and “no”) to a grading system. Eligibility criteria will only contribute to effectiveness if they are enforced, however.

Ensure the Rural Poor can participate: PES programs are not designed to be poverty reduction programs, and targeting them on the basis of poverty objective risks undermining their primary objective of providing valuable environmental services. However, they can often contribute to this aim, as many potential service providers are poor. This is certainly true in Mexico, where more than 85% of communities with more than 100ha of forest are classified as having high and very high marginalization. To date, however, the most organized communities or ejidos, who were already receiving other government aid and were better off, have received the most benefits from the PSAH program. Emerging lessons indicate that PES programs need to be carefully designed to ensure that the rural poor are

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able to participate. Lack of training and capacity building activities in the PES program for both the supply and demand sides have created a barrier for less organized and marginalized families to participate in the program.Expand the Scope to include Globally Significant Areas: The PSAH program focused only on local and regional environmental and natural resource management benefits. Though there was some overlap between local and global benefits, some of the most vulnerable areas with globally significant habitats and biological diversity were not part of the program. In the design of the proposed project, global environmental objectives have been considered.

Build Trust between Communities and the PES Program Promoters: Creating a long term relationship between communities and the PES program is important. A hasty approach and/or limited transparency can create false expectations and

Lessons from Other Payment for Environmental Services Initiatives

4. The design of proposed project has been enriched by lessons and recommendations from several PES projects, including the Costa Rica Ecomarkets project, the regional Silvopastoral project in Central and South America, the El Salvador Shade-grown Coffee, and the El Salvador Payment for Environmental Services project, all supported by GEF and the World Bank. In addition, the proposed project has gleaned lessons and recommendations from a number of publications including from the World Bank, , Forest Trends, and IIED. Some of these lessons include:

Country ownership: Political “buy-in” is an important aspect and must be attained at the highest levels of executive and legislative branches of the government. Coatepec (Mexico) example highlights the importance of political “buy-in” at the municipal level and at the federal level. It highlights the importance of having discussions and agreements with finance ministry in furthering the environmental agenda, and therefore, should also be a part of the strategy of the program. Furthermore, early identification of supporting local partners (e.g., NGOs) including their capacity is important for promoting participation and strengthen ownership at the local level. It will strengthen the institutional sustainability.

Flexibility in project approach: As evidenced in Coatepec and in other regions and countries, that environmental services are very site specific and consequently the administrative mechanism should be sufficiently flexible to adapt to the different needs that transpire in the country. Payment scheme, for example, should be site specific as demonstrated by the fixed payment of US$90 per ha per year in Coatepec was not sufficient to cover the opportunity cost of some of the most marginalized areas. A balance, however, needs to be found between the efficiency advantages and the higher costs of more accurate targeting. A central aim of the project is to assist CONAFOR in converting the current ‘one-size-fits-all’ approach to a much more targeted and differentiated approach.

Identify the services being provided clearly: Potential buyers are not interested in generic ‘forest services’, nor even in ‘water services’ or ‘biodiversity services’. Rather, they are interested in clean water, or in a reliable dry-season water supply, or in access to genetic information. Without a clear understanding of which specific services a given forest is providing, and to whom, developing sustainable financing mechanisms will be difficult. The design of sustainable financing mechanisms depends on identifying service users and understanding the specific services they use and how these services affect their wellbeing.

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Start with the demand side: Without demand, there can be no market. Beginning from the supply side risks developing mechanisms that supply the wrong services, in the wrong places, or at prices that service users are unwilling to pay.

Quantify environmental services: It is essential to estimate the magnitude of the costs and benefits to be achieved through conservation, including the willingness of downstream users to pay for services is, and the minimum payment level required to induce landholders to adopt conservation land uses.

Make payments continuous and open-ended: Land users should receive payments as long as they comply with the stipulated land use and management activities in their contract. The benefits being sought will generally be enjoyed year after year, as long as appropriate land uses are maintained. Previous approaches have tended to provide only front-loaded payments, coinciding with the project's implementation cycle. The typical result is that once the project ends, land users revert to previous practices and the project's benefits are lost.

Pilot the scheme before scaling up: It is important to initiate work at reasonable scale such as tens of thousands of hectors before scaling it up to hundreds of thousands of hectares. The knowledge from the pilot experiences should be shared with all the stakeholder groups and applied in the design of scale up program.

Developing institutional arrangements that work: Having the right institutional arrangement without creating a cumbersome mechanism is important. How are payments to be made and collected? Who should manage the funds? How can the process be made transparent and avoid corruption? Are indefinite, sustained payments necessary? In addition, current research on scale of intervention mentioned above, speaks to a strong role for community organizations and local governments in the negotiation of management strategies (including payment for environmental services). Mexico, with its ejidos in the rural setting, is well placed to explore this dimension.

Monitoring and Evaluation: The pilot environmental service payment sites are for testing the design and institutional arrangements for a more widespread system. As such, it would be important to monitor (both in-project sites, and nearby out-of-project sites) land use, socioeconomic changes, biodiversity, and other key indicators to properly evaluate the pilots. Monitoring and evaluation is an integral part of project design. It must include the establishment of a baseline, as well as the socio-economic and environmental impacts of the project.

Remove regulatory and information barriers: Reducing excessive regulatory barriers would provide opportunity for landowners to participate in the market. Furthermore, to “level the playing fields”, access to information, that discriminate small landholders to participate in the market need to be removed.

Amenable and effective extension system is necessary: An extension system is not only vital to help farmers and other stakeholders (e.g., fishermen) adapt their agriculture and harvest practices but also to raise awareness about the importance of sustainable management of natural resource base.

Inclusion of nonforest areas in PES schemes: Although the main emphasis in Mexico should still be conservation of existing forests, PES schemes can sometimes usefully support

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reforestation, improved agroforestry systems, and conservation of nonforest natural habitats important for biodiversity.

Biodiversity Conservation and Sustainable Use in Productive Landscape

5. One of the most important lessons learned from projects supported by GEF includes the importance of stakeholder participation and ownership involving local populations and institutions (e.g., local government, community and sectoral organizations, NGOs) in project design and implementation in order to ensure long-term conservation of biodiversity in protected areas, as well as in the production landscape. As such, the design of the Mexico project includes technical assistance for ejidos, comunidades, and local NGOs to support forest conservation activities carried out by individual members of ejidos and comunidades, small landowners, and other rural organizations. Consultations have taken place in priority areas to strengthen local participation in the project.

6. The experience of projects throughout the MBC and other SANP projects with buffer zone communities including Mexico MBC and Mexico Consolidation of the Protected Areas Program (SINAP) indicates the importance of:

Limit Project Focus: Limiting the project focus so that the activities are targeted and limited to those appropriate to the social context and current institutional capacity. It should have measurable results in its own right as well as making a contribution to the longer term plan in conserving the country’s biodiversity;

Strengthen Institutional Sustainability: Strengthening the institutional sustainability include building capacity of the executing entity, strengthening public-private partnerships and building capacity within partner organizations to implement co-management arrangements. Provide a strong administrative and coordinative capacity supported by adequate technical assistance and, initially, close implementation supervision. The strengthened institutional capacity should be both at the national level as well as at the local level. At the site level greater involvement of civil society in park management is expected to contribute to long-term viability and social and institutional sustainability of the protected areas. This project will strengthen public-private partnerships and further build capacity within partner organizations;

Define Rules of the Game and Responsibilities: High quality public participation is key. Project experiences suggest that providing for a strong role for NGOs and the private sector can be very effective during implementation. For example, one of the most important lessons learned from activities associated with the projects within the Mesoamerican Biological Corridor is the importance of involving local populations and institutions in the design, implementation and benefits of the project. This approach helps assure sustained impacts after project completion. Therefore, clearly defining the roles of the project and the communities is critical including in project administration, decision making, and implementation in order to avoid creating false expectations or leaving ambiguities which cause implementation delays;

Monitoring is Important: Ensuring that adequate monitoring and evaluation system is in place. Project activities include developing mechanisms to monitor biodiversity impact and protected area management effectiveness.

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Economic Cost-Benefit analysis needs to be clearly presented and made available to decision makers: In the case of El Salvador coffee, though yields per hectare were lower for shade coffee than for sun coffee or monoculture plantations, production costs were also lower because shade coffee required less fertilizer, pesticides, and fungicides. Lower production cost and multiple use of land (e.g., coffee, timber/firewood and none-timber products) may generate more profit per hectare.

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Annex 19: Payment for Environmental Services-Water Program (PSAH)

MEXICO: Environmental Services

1. Designing the PSAH Program. The PSAH analysis and design phase took from mid-2001 to May 2003. The INE-CONAFOR team was supported by a group of researchers from the Universidad Iberoamericana, the Centro de Estudios y Docencia Económica (CIDE), and the University of California at Berkeley, led by Professors Alain De Janvry and Elizabeth Sadoulet. Additional support was provided by the World Bank’s Environment Department staff, which channeled a donation from the government of Japan to finance data gathering and analysis, and provided advice and feedback throughout the different stages.

2. The initial proposal was presented to the Secretary of Environment and Natural Resources SEMARNAT and CONAFOR’s Director General. Both decided that it would be one of the key policies to be put forward by the administration, and that they would strongly negotiate with the Finance Ministry, Congress, and the agricultural lobbies to pass the necessary legislation.

3. The first step of the strategy was to create a fiscal instrument that would provide the resources for the program, and a trust fund to administer them. This fund was called the Fondo Forestal Mexicano (FFM), which was to serve as a commitment device to assure participants that resources were set aside to provide payments over the five-year span of the environmental services contracts.

4. The strategy to sell the program involved winning over government officials from agencies linked to SEMARNAT, most notably the National Water Commission (CNA). Their reluctance to support the program was due to their view that water scarcity is primarily an infrastructure investment problem. Simultaneously, a strong internal lobbying effort had to convince Ministry of Finance (SHCP) officials that the fiscal instrument was well designed and that it could be approved by Congress. It was too great a departure from existing fee designs to win approval immediately. Staff from CNA and SHCP strongly opposed the PSAH because prior negotiations with municipalities had promised them a 100 percent refund of what they had paid to the federal government for water, so that it would be invested in water supply infrastructure. The main rebuttal given by SEMARNAT to this argument was that it was equally important to invest in natural capital, and that that could only be done at the watershed level.

5. The support of high-level members of academia was essential for conveying the program’s strengths and overcoming early reservations about the program’s innovative nature and concerns over associated risks. In addition, empirical studies and consultations with professionals working with forest communities facilitated an initial review of the PSAH program’s capacity for monitoring and incentives, which in turn developed a more realistic and pragmatic program to operate in the field.

6. During the lobbying process with the Mexican Congress, several key members of the Environment, Natural Resources, and Taxing Commissions where very supportive of the draft initiative, and even declared to opposing Finance Ministry officials that they would present it as their own if these officials effectively blocked its formal presentation by the executive branch. In the end, a compromise version was presented that symbolically excluded municipalities from making the contribution, but the expected amount was effectively earmarked from the water fees

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collected from other users. Interest from different political parties stemming from their diverse agendas (environment, poverty reduction, water supply, and forest conservation) helped build the consensus needed for the initiative to be passed by the Review Commissions and approved by a large majority of the entire chamber.

7. Once the fiscal instrument was approved, a set of operating rules (Reglas de Operación) for the program had to be drafted. During this phase there was very active lobbying by agriculture lobbying groups from the Acuerdo Nacional por el Campo (ANC), an umbrella organization for campesino and producer associations. Since most of the ANC’s associated groups represent producers, their lobbying efforts were aimed at steering payments to communities that already had timber operations or shade-grown coffee plantations. INE and CONAFOR resisted this on the grounds that payments should go to communities that derived little income from their forests and were therefore more prone to deforestation rather than to communities that were already obtaining significant income from their forests and had an interest in preserving them.

8. Noncommercial forest owners are not as well organized as timber producers and lack the lobbying power to compete with the producer groups. In the beginning the Mexican government took a firm position on behalf of the noncommercial owners, but ultimately had to negotiate certain clauses to allow restricted PSAH payments in timber producing areas.

9. Federal Fees Law and the PSAH. Lakes, lagoons, aquifers, and rivers are considered national property in Mexico and are managed by the federal government. This allowed for establishment of a fiscal instrument to pay for hydrological environmental services, because the government can charge for the use of national goods through the Federal Rights Law (Ley Federal de Derechos LFD), which is used to charge for natural resources like water and minerals (Cortina 2002). Articles 222, 223, and 224 of the LFD set out the water fees charged to different users. Farmers pay nothing, municipalities very little, while manufacturing companies and service providers pay the highest fees.

10. The LFD is presented and approved each year by Congress. The initiative is prepared by the Ministry of Finance (SHCP) and can be modified by congressional commissions. The INE-CONAFOR team prepared a modification of article 223 that earmarked a specific share of water revenues to be used as payments for forest environmental services. Initially it allocated 2.5 percent of annual revenues, but negotiations with SHCP changed the allocation to nominal terms: $00 million Mexican pesos (US$18.2 million) per year.

11. Mexican fiscal policy generally discourages the earmarking of taxes. However, thanks to the successful negotiations of Francisco Giner de los Ríos, the then Director General in SHCP’s Undersecretariat of Revenue, several environmental fees were earmarked on the grounds that fees, not taxes, were paid in exchange for the goods and services provided by the government. This is the case, for example, for fees collected from visitors to Natural Protected Areas or for wildlife utilization in federal lands.

12. The justification for excluding municipalities was based on the objectives of a program called the Programa de Devolución de Derechos (PDD in CNA: 2005) that created strong incentives for municipalities to actually collect water fees by linking the amount collected to the budget the federation assigned to municipalities. This political decision was difficult to assess from a public policy perspective because water supply infrastructure deficits are significant in Mexico and the PDD was delivering fee collection results unseen before in Mexico (Sainz and others 2004). On the other hand, a 2.5 percent allocation to natural capital is a very good

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investment given that it is a complement to physical capital. The modifications to the initiative that excluded municipalities definitely softened the political message the PSAH wanted to transmit; which is that all users, and particularly urban centers, should contribute to protecting the ecosystems that supply them with environmental services.

13. Rules of Operation. One of the criteria employed in design of the PSAH program was to give taxpayers the highest value of environmental services for their contributions. This meant that initial payments should target forests that are at risk of deforestation, important for water quality and regulation, and that have a low but positive opportunity cost.

14. The coffee growers wanted to participate in the program, arguing that shade-grown coffee provides an environmental service similar to those provided by forests. The reply was that since the program was at an early stage, with limited funding, resources needed to be channeled to non-income generating forests where PSAH payments could make a greater difference. During final negotiations, the pressure from coffee growers was undermined by making it known that they were already receiving more than 3 billion pesos (US$273 million) each year to ensure their “competitiveness” in the face of a crowded international market.

15. The target was to focus on providing both environmental services and well-preserved forests, even though other ecosystems and agricultural lands could provide such services also. This still leaves a very large area under forests in Mexico, with the restriction of limited funds. Pass/fail criteria were incorporated into the rules of operation of the program to narrow the target areas even more. These are shown on figure 1, and explained in detail below.

Figure 1

Rules of Operation for PSAH (2003-2004)

Good qualityForests&

Forestsimportantfor water

With potentialfuture clients

Providing otherenvironmental

services

&

Overexploitedacquifers

80% cover

H related natural disasters

Water scarcityzones

or

or

Cities > 5K

PriorityMountains

Natural protectedareas

16. Water benefits The PSAH program’s operating rules state that eligible areas needed to be located either in the recharge area of an overexploited aquifer, in a watershed with high water scarcity, or where hydrological natural disasters are more frequent. It was relatively simple to provide an indicator about overexploited aquifers. The National Water Commission had just published in the Federation’s Official Gazette (Diario Oficial de la Federación, DOF: 2003) a note specifying the geographical coordinates for 188 aquifers and their degree of

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overexploitation. This indicator was used in the 2004 map of “elegibility” that CONAFOR used as a guide to approve or reject proposals, and was perceived as objective and fair.

17. There were challenges with the indicators of general water scarcity and vulnerability to natural disasters. In 2003, CONAFOR was reluctant to introduce very specific definitions of eligibility because they had doubts about how much participation there would be. Also the agency was worried that the official indicator for water scarcity, the zonas de disponibilidad from LFD, had its highest scarcity zones concentrated in just a few states. Putting as a prerequisite that participating forests be located in these areas would limit the scope of the program, bring them lower political gains, and fail to send the signal that it truly was a national program. Additionally, the National Disaster Prevention Center (CENAPRED) had not yet produced a map of natural disaster risk that could be used to clearly define priorities.

18. As a result, both of these policy priorities: water scarcity and natural disaster areas, were left without clear indicators. In 2003, it meant receiving many applications supported by local documents of varying scientific value, claiming that a particular forest tract was linked to scarcity or disaster areas. In 2004 it meant that the criteria were not integrated into the “eligible” areas defined by CONAFOR. To correct the mistake, INE suggested incorporating the specific indicators mentioned into the 2005 Rules of Operation, not as prerequisites, but as components of a grading system to evaluate the applications.

19. There was an important debate regarding the hydrological value of different types of forests. A Blue Ribbon Committee was assembled with scientists from Mexico and abroad to help classify forests according to their importance for aquifers and watersheds. Their recommendation put cloud forests in first place for their role in capturing water from fog in the dry season. Dry tropical forests were a potential second place for their role in reducing flood damage in the lower watershed, but there was not enough consensus, so they were placed together with the rest of the forests in a second group, pending more research. Because all types of forests could provide hydrological services, we decided that the privileged place of cloud forests should be reflected in the price paid, not in the eligibility rules.

20. Potential Future Clients. The third criteria for eligibility tried to reflect two facts: (i) that the federal government expected local governments to join in the effort to protect their own watersheds; and (ii) that other proxies for the value of environmental services were needed. That is why a proposed area must either be (i) within the area of influence of a population center of more than 5,000 inhabitants, (ii) inside a Natural Protected Area, or (iii) on a mountain belonging to the “priority mountain program.”

21. The population center option was opened because of our assessment of the capacity of a local government to develop their own PSAH program or to generate enough revenue to make an environmental fee collection worthwhile. If we observe smaller cities and towns interested in our 2005/2006 program to develop local PSAH then we would recommend that the option is extended to them.

22. The “priority list” mountains and Natural Protected Areas criteria were the result of internal lobbying by the officials holding these agendas. The mountains were incorporated because 2002 had been declared the International Year of the Mountains by the UN, and Mexico had done the task of selecting a list of 60 mountains through a multi-criteria analysis. However it had stopped there; the strategic support for these mountains was an unfunded mandate. So their inclusion into the PSAH program was the solution.

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23. The Natural Protected Areas were not included until the 2004 Rules of Operation. The success of the program the previous year had attracted the attention of the agency in charge of them, who saw these payments as a way to ease the application of regulations prohibiting changes in land use to poor peasants. These were understandably reluctant to be providing for free the global service of biodiversity protection, and the regional public good of watershed protection, now that CONANP was pursuing more strongly their compliance. Their inclusion was justified for the purpose of watershed protection, despite the fact that they were not all in critical condition and even fewer offered the possibility of a local government joining in. Some NGOs lauded the fact that we are getting two types of environmental service for the price of one.

24. Forests in good state of conservation. The aim of the PSAH program is to pay for results, for the environmental services in fact being provided. The main target group is noncommercial primary forests. As a practical indicator, the Rules of Operation required 80 percent forest cover in participating plots of land. A challenge was that the criterion wasn’t properly understood in 2003 and faced implementation problems in 2004.

25. In 2003 it was interpreted as requiring 80 percent of the plot to be covered by forests, not as an 80 percent density of forest cover per hectare. That mistake created a bias towards the largest ejidos and comunidades with forests, where agricultural plots were relatively small. In 2004, the personnel responsible for the program mentioned that their satellite imaging system could not correctly interpret the forest cover, and that they were not going to consider it for the evaluation. Furthermore, forester organizations in northern Mexico argued that their forests have naturally low densities. For 2005 CONAF is working on a practical and inexpensive system to estimate density, but in the review of the Rules of Operations some members of the Technical Committee suggested dropping the indicator altogether until this idea can be tested.

26. Choosing the amount paid. To estimate the distribution of the opportunity costs of keeping a forest, a team from INE studied the profits obtained from agriculture and livestock operations near forested areas (Jaramillo 2002). The data was obtained from the main commercial agricultural credit organization of the government, the Fideicomisos Instituidos en Relación a la Agricultura (FIRA). We expected an overestimation of actual rents, since FIRA’s clients tend to be the high end of agricultural production, but this was the only readily available information.

27. The results show average annual profits from corn production of US$37 per hectare, while livestock production yielded US$66 per hectare on average. The estimated distribution showed that with a payment a 200 pesos per hectare (US$18.2) more than two-fifths of forest owners that planted corn fields on forested land would not have done so. The same payment would have stopped 12 percent of pasture owners from deforesting. Table 19.1 shows the results corresponding to the amounts considered in the design phase.

Table A19-1: Percentage of Farmers that Obtained Profits Equal or Lower than the Proposed Amount

Average net profits per year (US$)

Annual payment per hectare

Activity200 pesos(US$18.2)

400 pesos(US$36.4)

Agriculture 37 21 percent 43 percentPasture 66 12 percent 20 percent

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28. The initial proposal was to pay annually 200 pesos (US$18.2) per hectare to owners of all types of forests except for cloud forests, which would be paid 300 pesos per hectare (US$27.3) because of their higher value in terms of hydrological services. This amount would be paid each year, after verifying that no land use change occurred, for five years. During the approval process of the Rules of Operation, rural organizations applied pressure for a higher payment. With a fixed budget that meant less people would receive the benefits of the program, but later it became clear that the organizations’ leaders wanted higher payments focused exclusively on the areas where they had their constituency. After lengthy negotiations, in which CONAFOR took a tough stance, the compromise and current status is to pay 300 pesos per hectare (US$27.3) to all forest except cloud forests, which would receive 400 pesos per hectare (US$36.4).

29. It was decided not to differentiate payments between regions based on opportunity cost, in view of a potential controversy with regional interests groups. Such groups could argue that opportunity costs in their land are in fact higher or that they were being discriminated against, easily derailing the implementation process. The academic advisors had suggested applying an inverse auction to obtain more rents for the water users. That would have created the perfect payment differentiation according to the opportunity costs. However, the potential higher administrative costs, and difficulties selling such an unusual allocating mechanism in Mexico, convinced CONAFOR officials that the two-tiered payment option was the best one for the first version of the program.

30. Opportunity costs might be zero. There are forests which would be preserved independently of governmental intervention, mainly because agriculture and grazing are not profitable. Their owners would clearly be interested in participating in PSAH, since environmental services payments come without an opportunity cost. However, it would be a waste of funds, because no modification of conduct is taking place. For this reasons an instrument (like the deforestation risk map) is required to objectively distinguish between these plots and those at a higher risk of being lost.

31. Opportunity cost might be too high. The self-selection process implies that forests that would yield very high income as agriculture, livestock, industrial, or urban projects choose not to participate in the program. The limit is the amount paid per hectare. A property owner could also just delay other land use activities if participating in the PSAH yields more profits than the cost of delaying.

32. During the initial design stages, local authorities interviewed wanted to have a PSAH program that would provide a solution to urban expansion pressure over natural areas. We avoided assuming that goal because urban land values are significantly higher than agriculture or cattle ranching. Conserving forests in such areas can only be achieved through direct expropriation or prohibiting urbanization by way of direct sanctioning. Once prohibition is in place, some payments for environmental services can come as a way of (partial) compensation, but they would need to be very high to work without zoning regulations or transferable development rights.

33. Limiting benefits. Regarding upper limits to the benefits, the PSAH had two objectives pulling in different directions. On the one hand, there are advantages in protecting large compact areas where the benefits of the program could be easily observed. On the other hand, if more forest owners participated in many different regions, then the program’s profile and learning experience would be enhanced, so it would be preferable to pay many owners to preserve some

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of their forest than to pay a few owners to preserve all of their forest. In the end, two types of restrictions were chosen: the first was a limit of 4,000 hectares for any individual application where there were no commercial timber operations, and a limit of 200 hectares for those with timber operations (a concession to the producers’ lobby) and in those cases only in their conservation areas.

34. Selection process. PSAH funds assigned in the federal budget are transferred to the Mexican Forest Fund. Potential beneficiaries fill out an application form, attaching the necessary documentation to validate their eligibility according to the Rules of Operation. In an initial review, applicants are informed of any missing documentation or their disqualification if they fail to meet any of the requirements. All complete and valid applications that comply are then evaluated by CONAFOR´s regional offices. The implementation and evaluation costs are required by law to be no more than 4 percent of total costs. CONAFOR bears much of the costs through its own staff or by hiring external suppliers, but probably the highest costs are the satellite images and their processing required for monitoring and evaluation.

35. When the contract is breached. The conditions of the PSAH program are simple and at the same time aim to provide well-defined incentives to conserve and protect the forest. In order to perform as a true economic instrument the program must have clear negative consequences for noncompliance. In this case these are of two types. If there was a purposeful land use change, then there is no payment at the end of the year, no matter how small the change was. If deforestation occurred for other reasons, for example because of a forest fire or timber theft, then the participating community is still responsible and does not get paid for what was lost, but does get paid for whatever was preserved. In this latter case, the community must inform CONAFOR of the natural disaster or theft. This helps the agency monitor threats to its priority forests and can offer the support of other programs such as reforestation or forest fire combat training.

36. Deforestation risk. We have argued that if the PSAH aims to have the largest impact in reducing deforestation in areas important for water recharge given a limited budget, it makes little sense to pay for areas that would not be deforested in the near future. This can happen for two reasons: (i) the forest is already generating higher rents than agriculture or cattle ranching, or (ii) neither agriculture nor cattle ranching would turn a profit if they were substituted for forest. The first item could have as an indicator the formal forestry activity and could be used for the eligibility criteria. The second item is more difficult to measure.

37. Knowing that it would be an important targeting problem, INE began to collect data to estimate an econometric model of deforestation. The hypothesis was that the incentives to deforest would be negatively related to the distance from roads and towns, the potential agricultural yields of the land, and the slope of the plot. It would also have an influence from the levels of poverty of the people living next to it, and whether or not there was a National Protected Area declared in the zone.

38. We constructed a data set with a grid of pixels that showed whether or not a hectare of forest in 1993/1994 had been deforested or was still there by the year 2000, which were the years for which we had a forest inventory. Econometric models with qualitative dependent variables (probit and ordered probit) were used, and the predicted probability for forests in the current period was our index of risk.

39. Because the econometric analysis is based in the observation of deforestation patterns during the past decade, we could have biased predictions. Economic growth and increasing trade

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liberalization produced changes in important variables influencing forest opportunity costs. Real corn prices have declined while agricultural wages have increased. However, it is the best estimate we have. INE’s recommendation in the PSAH Technical Committee is that the index is incorporated into the grading system for evaluating proposals. We divided the deforestation risk into quintiles to create risk category tiers. Each pixel then receives a value and the average value from this index is used to evaluate the plot.

40. Implementation. The PSAH program was announced in early October 2003 after long negotiations to get the operating rules approved and was then published in the Official Federal Gazette, and there was little time to undertake promotional activities, receive applications, and evaluate them before the December deadline. It was very important not to wait for another year, since we could loose congressional support if no results were shown during the same year that earmarking of fees was debated.

41. The program was welcomed by collective and private forest owners, who expressed their satisfaction that, for once, all the restrictions they had on land use were being compensated. Communicating in detail the nature and objectives of the operating rules to CONAFOR field operatives was not an easy task. For the communities there is also a problem of communication. Contracting obligations are not clearly explained and understood by the general membership of the ejido. The most common story seems to be that elected representatives of the núcleos agrarios negotiated directly with CONAFOR and only partially informed their members of the restrictions and duties of the program, only asking the community assembly for authorization to participate in a federal program that would transfer financial resources if they conserved the forest.

42. By analyzing the patterns of those who were accepted into the program we observed several deviations from what would have been optimal targeting. What follows has the summary of our findings:

43. 2003-2004 Beneficiaries. The launching of the PSAH program strongly attracted the attention of ejidos, comunidades, and private owners. In 2003, this resulted in the receipt of 900 applications proposing almost 600,000 hectares for the program. Out of these, 271 forest owners with 127,000 hectares were incorporated into the program. In 2004, 960 applications were received and 352 new participants and more than 170,000 hectares were incorporated into the program.

Table A19-2: Applications Received and Approved for PSAH Program, 2003–052003 2004 2005 (Jan-Jun) Total

ReceivedApplications 953 960 630 2,543Hectares 600,000 793,476 640,000 2,033,476

ApprovedApplications 271 352 ProcessingHectares 127,000 184,000 Processing

Note: Applications received may vary since September, 1st is the closing date for registration. Applicants have one more day to apply.

44. During both selection processes a large number of applications were discarded because they were incomplete. The main omissions were the Assembly Record from ejidos or comunidades

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stating the collective owners’ discussion, vote, and decision to participate in the program, or proof of up-to-date tax compliance for private owners. Another important omission was the map of participating plots, which is required for reliable use of satellite imaging to measure forest cover. That is why having participated in the PROCEDE program was a key variable for communal owners, as was having their land in the Public Property Registry for private owners.

45. Independent of the selection criteria used, an important lesson is that payments (US$36.4 and US$27.3 per hectare) were set too high and deforestation risk was not valued. Excessive numbers of applications were in part due to expected payments that were higher than opportunity costs for a large number of participants. This possibility was taken into account since designing the program. It was presumed that lots with high deforestation risk located in important water recharge areas were going to be selected to maximize welfare gains. However, it was determined that CONAFOR’s eligibility criteria were not narrow enough to achieve such goals. Indicators such as deforestation risk and the degree of importance of hydrological services must be given greater weight in the future.

Focalización: Acuíferos sobreexplotados

100.0 %100.0 %100.0 %100.00 %TOTAL

5.3 %8.0 %0.1%13.4 %Sin información

85.04%78.7 %45.4%65.1 %Con margen de

expansión(< - 5%)

0.00 %0.01 %11.3%2.9 %En equilibrio(- 5% a +5%)

9.61 %13.3 %14.5%18.6 %Sobreexplotación

Moderada(+5% a +50%)

0.00 %0.00 %19.5%0.04 %Fuertemente

Sobreexplotados(+50% a +100%)

0.00 %0.02 %9.2%0.05 %Extremadamente Sobreexplotados(+100% a +800%)

Hectáreas beneficiadas por PSAH en

2004

Hectáreas beneficiadas por PSAH en

2003

Población en la zona

Superficie a nivel nacional Tipo de Acuífero

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Focalización: grado de marginación

100100100Total

1.83.42.1Muy Baja3.35.77.9Baja8.67.918.1Media

17.261.446.9Alta69.121.525.0Muy Alta

%Hectáreas %Hectáreas %

Total Nacional en Propiedades Sociales con >100 has de bosque

PSAH 2004PSAH 2003Gradode Marginación

Focalización: Tipo de VegetaciónDistribución de acuerdo al tipo de bosque

0%10%20%

30%40%50%60%70%

80%90%

100%

TODO MEXICO PSAH 2003 PSAH 2004 "Elegibilidad"CONAFOR '04

Bosque de Pino y Pino-Encino Bosque de Encino, Bosque de OyamelBosque Mesófilo Selva BajaSelva Alta y Selva Mediana

137

Focalización: Índice Riesgo Deforestación

100%

22%

30%

20%

17%

11%

%

PSAH 2004

170,105

37,133

50,940

34,953

28,529

18,550

Ha

100%

39%

25%

18%

6%

12%

%

3,424,297

1,350,704

856,519

613,763

198,762

404,549

Ha

Superficie Elegible CONAFOR

164,263100%100%Total

68,81542%20%Muy Bajo

50,04630%20%Bajo

28,44617%20%Medio

11,0347%20%Alto

5,9224%20%Muy Alto

Ha%%

PSAH 2003Bosques a nivel

nacionalÍndice de Riesgo de

Deforestación(por quintiles)

138