Colombia - Small-scale Industry Project

Report No. 499a-CO Appraisal of a Small-Scale Industry Project t s Colombia December 11, 19747 Regional Projects Department RETURN TO Latin Arnerica and the Caribbean R P R S D S Regional Office REPORTS DESK. WITHIN FILE COPY Not for Public Use 'QNE WEEK C Document of the International Bank for Reconstruction and Development International Development Association This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report  CURRENCY EQUIVALENTS (as of September 30, 1974) Currency Unit= Colombian Peso US$1 = Col$26.40 Col$l = US$o.037 Col$l million = US$37,878 ACRONYYiS ACOPI - Asociacion Colombiana Popular de Industriales (Colombian Association of Small Manufacturers) AID - Agency for International Development ANDI - Asociacion Nacional de Industriales (National Manufactu- rers' Association) BR - Banco de la Repu'blica (3olombials Central Bank) CAJA - Caja de Credito Agrario Industrial y Minero (Agricultural, Industrial and Mining Bank) CFP - Corporaci6n Financiera Popular DANE - Departamento Nacional de Estadistica (National Department of Statistics) FICITEC - Fundaci6n para el Fomento de la Investigacion Cientifica y Tecnologica (Fundation for the Development of Scien- tific and Technological Research) FNA _ Fondo Nacional del Ahorro (National Savings Fund) IFF - Industrial Financial Fund IPI - Inisttuto de Fomento Industrial (Induwtrial Developm.nt Institute) KfW - German Kreditanstalt fuer Wiederaufbau PROEXPO - Fondo de ?romocion de &cportaciones (Dcport Promotion Fund) SENA - Servicio Nacional de Aprendizaje (National Vocational Train- ing Organization) StI - Small- and Medium-scale Industry SSI - Small-scale Industry UNIDO - United Nations Industrial Development Organization  COLOMBIA APPRAISAL OF A SMALL-SCALE INDUSTRY PROJECT TABLE OF CONTENTS Page No. BASIC DATA ON CFP SUMMARY AND CONCLUSIONS ....................... i-iii I. INTRODUCTION ................................... 1 II. SMALL- AND MEDIUI-SCALE INDUSTRY IN COLOMBIA ... 2 A. Economic Setting .......................... 2 B. Structure and Performance .... ............. 2 C. Industrial Financing and Interest Rates ... 5 D. Technical Assistance ..... ................. 7 E. Government Policies ..... .................. 8 F. Prospects ................................. 9 III. CORPORACION FINANCIERA POPULAR .10 A. Organization .10 B. Procedures .11 C. Resources .12 D. Financial Position and Results .13 E. Past Operations .15 F. Projections .16 IV. THE PROJECT .17 A. Project Description and Components .17 B. Project Cost and Financing .19 C. Procurement and Disbursement .21 V. BENEFITS AND JUSTIFICATION . .21 VI. AGREEMENTS REACHED AND RECOMMENDATION .22 This report is based on the findings of appraisal missions, composed of Messrs. P. Knotter, P. Azevedo-Moura, A. Canellas, A. Cracco and Ms. K. DiTullio, which visited Colombia in November/December 1973 and May 1974.  Table of Contents (Continued) ANNEXES 1 Declaration of Policies and Procedures 2 List of Shareholders as of September 30, 1974 3 List of Board Directors and Alternates as of September 30, 1974 4 List of Loan Committee Members as of September 30, 1974 5 Organization Chart as of September 30, 1974 6 Terms of Reference for the Organization Study (Draft) 7 Summary of Technical Assistance Activities from 1971 to 1973 8 List and Characteristics of Borrowings as of December 31, 1973 9 Statement of Arrears as of December 31, 1973 10 Equity Investments Held as of December 31, 1973 11 Past and Projected Income Statements as of December 31, for the Period 1968-78 12 Past and Projected Balance Sheets as of December 31, for the Period 1968-78 13 Analysis of Loan Approvals from Inception through December 31, 1973 14 Summary of Past Operations from 1968 to December 31, 1973 15 Summary of Projected Operations for the Period 1974-78 as Compared to 1973 16 Projected Sources and Uses of Funds for Periods Ending December 31, 1974-78 17 Past and Projected Financial Ratios 1S Expected Real Financial Charges to Subborrowers on Fixed Asset Subloans 19 Eligible Technical Assistance Services and Programs 20 Analysis of Project Costs Eligible for Bank Financing 21 Estimated Schedule of Disbursements 22 Loan Monitoring 23 Understandings Reached with CFP_on Measures to Improve Its Operational Effectiveness APPENDICES 1 Financial Assistance to Small- and Medium-Scale Industry 2 Technical Assistance to Small- and MIedium-Scale Industry  COLOMBIA: SMALL-SCALE INDUSTRY PROJECT CORPORACION FINANCIERA POPULAR Basic Data 1. Year of establishment: 1967 2. Ownership (Sept.30, 1974): Number of Shares i___ (Par Value = Col$100.0) Public Institutions 1,346,775 99,999 Private Shareholders 19 0,001 Total 1,346, 794 100,000 3. Operations Loans: 1970 1971 1972 1973 1974 To1$ millio (une) Approvals 89.3 182.7 180.4 274.4 113.3 Disbursements 67.0 137.0 211.0 210.0 118.2 Equity Investments Approvals - - 0.2 3.6 3.0 Disbursements - - 0.2 3.6 - 4. Financial Performance (a) Total Assets: 98.4 196.5 303.0 416.9 h69.3 Loan Portfolio 94.7 189.9 290.2 364.9 403.9 Equity Portfolio 1.0 1.0 1.3 4.8 4.8 Total Debt 55.8 131.7 235.3 319.8 307.5 Equity 42.5 64.8 67.7 97.1 149.3 Debt/Equity Ratio 1.3:1 2.0:1 3.4:1 3.3:1 2.0:1 (b) Net profit after tax and provisions as % of aver- age equity 4.9 4.8 4.3 5.4 2.7 Reserves and Provisions as % of loan portfolio 1.9 2.2 2.9 2.7 4.5 Financial Expenses as i of average total assets 3.0 5.5 8.4 7.7 4.2 Administrative Expenses as % of average total assets 5.4 6.8 6.3 6.2 2.9 LCPDF November 1974   COLOMBIA APPRAISAL OF A SMALL-SCALE INDUSTRY PROJECT SUMMARY AND CONCLUSIONS i. This report appraises a project to assist Corporacion Financiera Popular (CFP), a Government-owned development finance company (DFC), in al- leviating two major development constraints of Colombian small-scale indus- try (SSI)--lack of access to credit and insufficient technical assistance. The proposed US$5.5 million Bank loan would also help strengthen CFP which, as the only financial institution in Colombia serving exclusively small- and medium-scale industry (SMI), has made a valuable contribution to its development. Since assisting SSI is much more complex than the traditional Bank DFC lending for mostly medium and large Colombian industry (five loans, totalling US$162.5 million since 1966), the proposed project -- the first Bank operation to assist SSI in Latin America--has experimental characteristics. ii. For many years, manufacturing has been a leading growth sector. It has made a substantial contribution to accelerating economic growth (to an estimated 7.3% in 1973) and to Colombia's successful export diversification drive. Exports of manufactured goods rose from USA64 million in 1967 to an estimated US$260 million last year. SMI, accounting for 41% of labor and 24% of value added in manufacturing, however, has not grown as rapidly as large industry, reflecting Government policies little conducive to SMI's expansion. Other factors have been the inherent difficulties which are common to SMI in most developing countries, such as inadequate raw material supply, obsolete machinery, crowded work shops, shortage of entrepreneurs and qualified technicians and low capacity utilization in some branches. Government policies and technical assistance by public and private institu- tions have lacked coordination and long-term planning. This would suggest establishing a Government SMI agency. iii. Despite its handicaps, Colombian SMI is efficient in many product lines, and competitive with large industry. It is also successfully perform- ing an important economic and social role in decentralizing industry, diversifv- ing production, creating employment, forming entrepreneurs and skilled workers and, perhaps, improving income distribution. Since prospects are good for further high growth of industrial investment and output, scope and potential of SMI are considerable. iv. As can be expected of a DFC growing rapidly in a difficult envi- ronment, CFP has to strengthen some of its financial and organizational aspects. However, CFP's management team should be able to overcome most pro- blems prior to full loan commitment. On balance, CFP would be a suitable recipient of Bank funds.  - ii - v. CFP's projections show further rapid growth and an urgent need to widen its equity and borrowing base. CFP's debt service coverage and finan- cial condition would develop satisfactorily. The proposed loan would assist in CFP's resource mobilization by arranging to obtain from various sources a financial package commensurate with CFP's future resource needs, and by filling CFP's remaining resource gap in 1975-76. vi. The proposed US$5.5 million loan would comprise (i) a US$5 million portion, representing the foreign exchange component of a lending p,-ogram to finance establishment and expansion of privately-owned small industrial firms and (ii) a US$0.5 million technical assistance component to finance consultants, cost of CFP's technical assistance activities and of technical assistance to sub-borrowers. Total project cost is estimated at US$10.2 million; the pro- posed loan would contribute 53.9%, CFP 30.4% and sub-borrowers 15.7%. vii. The proposed loan would be made to 13anco de la Republica (BR), Colombia's central bank and the proceeds would be relent to CFP. Ultimate beneficiaries would be given the opportunity to borrow in foreign exchange at 13% p.a. or in pesos at 24% p.a., allowing for a higher spread to CFP (5.5% for peso subloans; 5.25% for foreign exchange subloans) than is usual under Bank DFC lending to larger industrial firms. Technical assistance financing would be only provided in the form of peso subloans at a cost of 15% p.a. to small industrial firms. Because of the project's experimental nature, the lending program component would be divided into two US$2.5 million tranclhes; release of thie second tranche would depend on satisfactory performance by CFP. Given recent increases in Colombia's inflation, the interest rate for the second tranche would also be agreed upon in this connection. viii. Subloans with a minimum maturity of four years would be used for fixed asset financing (including construction of industrial buildings) and would have a maximum limit of Col.$2.5 million for ultimate beneficiaries with total assets below Col.$10 million, and of Col.$4 million for those with total assets between Col.$10-20 million. To ensure appropriete chan- nelling of Bank funds to Colombia's SST only 25% of the US$5 million lending program would be allocated to the latter category. To maintain adequate Bank monitoring of the project, free lirit subloans would be limited to Col.$1.5 million (about US$57,000). ix. Equipment would be unsuitable for builk procurement through inter- national competitive bidding, but CFP would satisfy itself that goods and services procured are competitive in quality and price. Disbursement of Bank funds would be made for 90% of expenditures for specific fixed assets (equip- ment, machinerv, construction) and 100%Q of consultants' cost for technical assistance. Under this forn,ula, disbursements would he equivalent to the estimated foreign exchange component of the project. x. The project's direct and indirect benefits slhould be substantial. Most significantly, it would provide urgently needed financing and technical assistance for some 200 development projects, help develop managerial and technical skills in SSI, contribute to strengtheiinio CFD and improve know- ledge of sector problems. Overall, the financial and economic rate of return of suhproiects wo7uld be satisfactorv and, in most cases, wouldl exceed 15Z.  - iii - xi. With the assurances listed in Chapter VI obtained during negotia- tions, the project is suitable for a Bank loan of US$5.5 million equivalent to BR, for a fixed term of 12 years including a 3-1/2 year grace period.   COLOMBIA SMALL-SCALE INDUSTRY PROJECT I. INTRODUCTION 1.01 The Corporacion Financiera Popular (CFP), a Government-owned de- velopment finance company (DFC), has applied for a Bank loan to finance the foreign exchange component of its lending to small-scale industry (SSI). The proposed US$5.5 million loan would be guaranteed by the Republic of Colombia and granted to Banco de la Republica (BR), Colombia's central bank, for relending to CFP. Established in 1967, CFP is the only financial insti- tution in Colombia dedicated entirely to assisting small- and medium-scale industry (SMI). 1.02 Since 1966, five Bank loans totalling US$162.5 million have been made available to about 200 mostly medium- and large-size industrial enter- prises through private DFCs (financieras). Only 6% of Bank funds have gone to clients with total assets below Col$10 million and the average subloan amount has been over US$400,000 as against an expected US$25,000 average for CFP's relending. The proposed project would complement past Bank lending by alleviating two major development constraints of Colombian small industry-- lack of access to credit and insufficient technical assistance. 1.03 The principal objectives of the proposed loan are to: (a) provide term financing at reasonable conditions for the establishment and expansion of small manufacturing enterprises; (b) strengthen CFP, particularly by improving its resource allocation ability, internal organiza- tion and procedures and ensuring a sufficient resource base; (c) help improve technical assistance to CFP's bor- rowers and provide financing for it; and (d) initiate reviewing of SSI policies with the Government. 1.04 The proposed project is of an experimental character since the task of assisting Colombia's SSI is substantially more complex than the Bank's traditional lending to the local development banks. Nevertheless, it is a worthwhile experiment which would improve the Bank's knowledge in a field in which it still has relatively little experience. The proposed project would be the first Bank operation solely to assist SSI in Latin America.  - 2 - 1.05 After a preliminary review in June 1973, missions, consisting of Messrs. Knotter, Azevedo-Moura, Cracco, Ms. DiTullio (of the Bank) and Mr. Canellas (IBRD/UNIDO Cooperative Programme), appraised the project in November/December 1973 and May 1974. This report is based on the missions' findings. II. SMALL- AND MEDIUM-SCALE INDUSTRY IN COLOMBIA A. Economic Setting 1/ 2.01. With average annual real increases in value added of 6.3% in 1950-70, well above the annual 4.9% GDP increase, manufacturing industry has been a leading sector. In 1971-73, manufacturing grew even more rapidly, by an estimated growth average of 9% annually, and helped in accelerating economic growth to an estimated average 6.7% per annum. Manufacturing accounts now for about one-fifth of GDP. At the same time, Colombia's persistent export diversification drive has led to an impressive expansion of non-traditional exports, accounting for half of the estimated US$1.1 billion merchandise exports in 1973 as compared to 20% in 1960. Exports of manufactured goods (mainly textiles, chemicals and wood products) of an estimated US$260 million -- up from US$64 million in 1967-- made an important contribution. Nevertheless, exports still represent only small fractions of the output of most industrial firms and are generally of little importance for small enterprises. 2.02 Rapid population growth and rural migration are contributing to severe unemployment and housing shortages in urban areas. To maximize urban employment, the Government started implementing a housing construction program in 1972 but unemployment in most of Colombia's major urban centers has continued to increase. Industry's importance in alleviating the unemployment problem is shown by an estimated 5-6% employment increase in manufacturing in 1972, which is above the very high 3.5% annual growth of Colombia's labor force. While the higher GDP growth in recent years also makes prospects brighter for reducing unemployment, it has also been accompanied by strong inflationary pressures. Consumer prices increased 22% in 1973, up from 14% a year earlier and a 7.5% p.a. average in 1967-70; recent and proposed Government measures may help to slow inflation in the near future. B. Structure and Performance 2.03 While the proposed loan is designed to benefit mostly SSI, there is not yet a generally accepted definition for either small- or medium-scale industry in Colombia. Virtually, each institution involved in these sub- sectors uses its own concept. For the purpose of the following analysis, 1/ The general economic background is covered in the most recent economic report on Colombia, No. 138-CO, dated May 15, 1973.  -3.. SMI is defined as manufacturing units with 5-99 workers 1/ and treated jointly. Total assets of Col$20 million 2/ would be the upper limit for borrowers under the proposed loan. This would exclude many of the more capital intensive firms employing 50 workers and more, and would channel Bank funds to those enterprises which find it hardest to obtain credit. Following CFP's most recent lending pattern, most recipients are expected to have total assets in the Col$3-6 million range. 2.04 SMI plays an important role in Colombia's industrial development (para. 2.23). According to DANE's latest manufacturing census (1969) 3/, it comprises 91% of the manufacturing firms, employs 41% of industrial labor and contributes 24% of value added in manufacturing. It also accounts for an estimated one-third of net industrial investment. 2.05 Colombia's mountainous geography caused the existence of a number of rather independent local or regional markets. Colombian SMI is therefore geographically more widespread (less than one-quarter of the establishments are in the Bogota area) than in other Latin American countries and it plays an important role in regional industrial development -- without unduly sacri- ficing efficiency (para. 2.23). Due to fragmentation of national markets, the average size of industrial firms is smaller than would be otherwise ex- pected. Nine-tenths of the companies in SMI have total assets below Col$5 million. 2.06 Requiring less capital investment per job than large industry, SMI provides an effective and important means to create employment, train un- skilled labor and build up entrepreneurial talent. Moreover, with unskilled workers forming 57% of its personnel, compared to about 40% for large indus- try, SMI is an important training ground for industrial workers. Many of these, subsequently, join large firms where professional opportunities and remuneration are more attractive, wlhich is the result of better union effec- tiveness in attaining higher wages and more generous social benefits. 4/ 1/ For this range, detailed statistics of DANE, the national department of statistics, are available for 1963 and 1969. 2/ Larger firms are likely to have access to Bank funds through the finan- cieras. 3/ DANE: Boletin Mensual de Estadistica No. 259, February 1973 4/ While during 1963-69 gross value added per worker grew 1.9% annually in real terms for both SMI and the manufacturing sector as a whole, average salaries only rose 1.6% p.a. for the former against 2.4% p.a. for total manufacturing.  - 4 - 2.07 SMI has grown less rapidly than large industry in terms of number of firms, labor force, salaries, gross production and value added, as the following DANE statistics for 1963-69 show. Indications are that this trend continued through 1973. Small and Medium Manufacturing Industry in Colombia (Col$ million at 1958 prices) Average Annual In- 1963 1969 crease 1963-69 (in %) % of % of Small & Total Amt./No. Total Mfg. Amt./No. Total Mfg. Medium Mfg. Mfg. Firms (No.) 7,314 93.9 6,528 91.3 -1.7 -1.3 Workers (No.) 120,899 44.7 134,274 41.3 1.8 3.1 Gross Pro- duction 4,555.9 35.7 5,650.5 30.7 3.7 6.1 Gross Value Added 1,476.2 26.3 1,905.8 23.7 4.4 6.2 2.08 Colombian SMI confronts several problems and it is difficult to identify any single constraint as being "critical" or to quantify its impact. Among the principal reasons for the slower growth of Colombian SMI are limited access to financing and inadequate technical assistance, reflecting Government policies little conducive to its expansion 1/ (details paras. 2.11-2.22). Other factors have been the inherent difficulties which afflict SMI in many developing countries. These industries often operate with obsolete machinery and in crowded workshops; management seldom knows about modern production and marketing methods and financial operational controls, and there is a shortage of entrepreneurs and qualified technicians. The proposed loan would assist in alleviating at least some of these difficulties. 2.09 Small firms in many Colombian industries are also affected crucially by inadequate raw material supply. Small individual orders, import licensing 1/ Although a number of companies in SMI succeeded in growing into large industrial firms, they have not been fully replaced by the creation of new small enterprises. More assistance to SMI, particularly to new entrants, would broaden the base for further industrial growth and div