Tunisia - Industrial Finance Project

Report No. 1734b-TUN 4I Tunisia: Appraisal of an Industrial Finance Project consisting of a Loan to Banque de Developpement Economique de Tunisie and a Loan to the Government for Smail Scale Enterprises November 29, 1977 Industrial Development and Finance Division Europe, Middle East and North Africa Region FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Rate of Exchange of the Tuniian Dinat (D) $ 2.32 _D 1.00 DO.43 $1.00 ABBREVIATIONS AFI - Agence Fonciere Industrielle (Industrial Estates Agency) API - Agence de Promotion des Investissements (Investment Promotion Agency) BDET - Banque de Developpement Economique de Tunisie CNEI - Centre National des Etudes Industrielles COFIT - Compagnie Financiare et Touristique FOPRODI - Fonds de Promotion et de Decentralisation Industrielle (Industrial Promotion and Decentralization Fund) KIC - Kuwait Investment Company PMM,4 - Peat. Marwick, Mitch,l1, anA Co. (auditors). UTICA - Union Tunisienne de l'Industrie, du Commerce, a et de l'Artisanat  FOR OFFICIAL USE ONLY APPRAISAL OF AN INDUSTRIAL F'INANCE PROJECT CONSISTING OF A LOAN TO BANQUE DE DEVELOE'PEMENT ECONOMIQUE DE TUNISIE AND A LOAN TO THE GOVERNMENT FOR SMALL SCALE ENTERPRISES TUNISIA TABLE OF CONTENTS Page No. BASIC DATA SUMMARY .............................................. i - iv I. INTRODUCTION ......................................... 1 II. THE ENVIRONMENT ...................................... I A. Manufacturing Sector ............................ I B. Small Scale Enterprises (SSEs) .... .............. 3 C. Financial Sector ................................ 6 III. BDET'S INSTITUTIONAL DEVELOPMENT .... ............ 7 A. Ownership, Board and Committees .... ............. 7 B. Management and Organization ..................... 8 C. Statutes and Policies ........................... 8 D. Procedures . ..................................... 9 IV. BDET'S OPERATIONS .................................... 10 A. Characteristics ................................. 10 B. Economic Impact ................................. 11 V. BDET'S FINANCIAL SITUATION ............ .. ............. 13 A. Resource Position ............................... 13 B. Auditors' Reports on BDET ....................... 14 C. Quality of BDET's Portfolio ..................... 15 D. Financial Performance and Position .... .......... 17 VI. BDET'S PROJECTED OPERATIONS AND FINANCIAL SITUATION .. 17 A. Projected Operations ............................ 17 B. Resource Mobilization ............................ 18 C. Financial Projections ............................ 19 This report was prepared on the basis of the findings of an appraisal mission of June 1977 composed of Messrs. Franco Batzella, Fernan Ibanez and Bernard Snoy, and a preappraisal mission of March 1977, composed of the same team and accompanied by Mr. Bernard Decaux (Consultant). This document has a mtricted distribution and may be usd by recipients only in the performance of their omcial dutia. Its contents may not otherwise be disclosd without World Bank authorization.  TABLE OF CONTENTS (Continued) Page No. VII. STRUCTURE OF THE PROJECT; OBJECTIVES AND FEATURES OF THE PROPOSED LOAN ................ .................. . 21 A. Loan to BDET ................ . ................... 21 B. Small Scale Enterprises (SSE) Component ........ 23 VIII. RECOMMENDATIONS .................... ................. 26 ANNEX 1 Table 1.1 Volume of Main Industrial Products, 1969-76 Table 1.2 Value of Main Industrial Products, 1969-76 Table 1.3 Industrial Production Index Table 1.4 Investment Projects in Manufacturing Industries Approved by the Agency for Promotion of Investments 1973-June 1976. Table 1.5 Medium-Term Lending Rates of Commercial Banks ANNEX 2 The Small Scale Industry Sector in Tunisia I. Characteristics II. Small Industry Constraints and Problems III. Administrative and Policy Framework Table 1 Distribution of Manufacturing Enterprises by Size, 1969 and 1973 Table 2 Distribution of Non-Agricultural Enterprises by Size, 1976 Table 3 Structure of Industrial Sector by Number of Firms (1973) Table 4 Mfanufacturing Activities. Number of Establishments by Size of Employment in 1973 Table 5 Regional Distribution of lndustrial Activities, 1973 Table 6 Industrial Sector - Total Employment Table 7 Investment and Employment in FOPRODI Projects (1976-77) ANNEX 3 BDET - Ownership Structure as of December 31, 1976 ANNEX 4 BDET - Board of Directors and Executive Committee ANNEX 5 BDET - Organization Chart ANNEX 6 BDET - Summary of Operations 1972-76 ANNEX 7 BDET - Analysis of Approved Operations 1973-76 ANNEX 8 BDET - Distribution of Approved New Project Operations by Size of Project ANNEX 9 BDET - Resource Position as of December 31, 1976 Page 1: Overall Situation Page 2: Status and Conditions of Long-Term Domestic Borrowings Page 3: Status and Conditions of Long-Term Foreign Borrowings  TABLE OF CONTENTS (Continued) AIINEX 10 BDET - Summary of Audit Results for 1974, 1975 and 1976 Accounts ANNEX 11 BDET - Outstanding Loan and Equity Investments as of December 31, 1976 ANNEX 12 BDET - Loan Portfolio Analysis: Arrears in Principal and Interests over Three Months ANNEX 13 BDET - Analysis of Loan Portfolio as of December 31, 1976 Loans for which the Auditors Have Recommended the Constitution of Provisions ANNEX 14 BDET - Audited Income Statements, 1972-1976 ANNEX L5 BDET - Audited Sheets, 1972-1976 ANNEX 16 BDET - Performance Indicators 1972--1976 ANNEX 17 BDET - Assumptions Underlying Projected Operations 1977-1981 ANNEX 18 BDET - Projected Operations, 1975-1]979 ANNEX 19 BDET - Projected Resource Needs, 1977-1979 ANNEX 20 BDET - Projected Income Statements, 1977-1981 A4NEX 21 BDET - Projected Cash Plow, 1977-1981 ANNEX 22 BDET - Projected Balance Sheets, 1977-1981 ANNEX 23 BDET - Industrial Sector Supporting Institutions 1. Thd Investment Promotion Agency (API) 2. Industrial Land Agency (AFI) 3. The Office of Vocational Training, Migration and Employment (OTTEEFP) 4. The National Center for Industrial Studies (CNEI) 5. Union Tunisienne de l'Industrie, du Commerce et de l'Artisanat (UTICA) ANNEX 24 Fonds de Promotion et de Decentralisation Industrielle (FOPRODI) ANNEX 25 Technical Assistance System for Small Scale Enterprises ANNEX 26 Schedule of Disbursements   TUNISIA BANQUE DE DEVELOPPEMENT ECONOMIQUE DE TUNISIE (BDET) Basic Data Currency equivalents 1974 1 US Dollar = Dinar 0.4365 1 Dinar US $ 2.2910 1975 1 US Dollar = Dinar 0.4023 1 Dinar US $ 2.4857 1976 1 US Dollar = Dinar 0.4314 1 Dinar US $ 2.3180 Year of establishment: 1959 Year of reorganization: 1965 Number of professional Staff : 64 Ownership (as of December 31, 1976) Dinars Percent Tunisian public and semi-public institutions 1,770,620 29.51 Tunisian private banks 514,800 8.58 -/ Tunisian individuals 1,175,900 19.60 Total Tunisian 3,461,320 57.69 Foreign financial institutions 1,916,640 31,94 IFC 600,000 10.00 Foreign individuals 22,040 0.37 Total 6,000,000 100.00 1/ Including bearer shares.  Key financial indicators (at year end) 1974 1975 1976 Total assets (Dinar thousands) 45,587 56,970 74,381 Share capital (Dinar thousands) 4,500 6,000 6,000 Total equity (Dinar thousands) 6,709 8,411 8,204 1/ Total loan portfolio (Dinar thousands) 31,464 43,627 53,619 Total equity portfolio (Dinar thousands) 3,924 4,603 6,576 Debt/equity ratio (a) Original IBERD definition 4.1 3.5 (b) New IBRD definition 2/ 4.6 6.4 Administrative expenses (Dinar thousands) 626 768 769 Net profit (Dinar thousands) 571 725 659 Net profit/average equity (in %) 10.2 8.8 7.9 Dividends (Dinar thousands) 180 270 360 Operations (Dinar thousands) Approvals Foreign currency loans 24,673 17,026) 27,237 Dinar loans 9,343 3,614) Equity participations 2,675 1,724 2,981 Total 36,691 22,364 30,308 Commitments Foreign currency loans 10,733 13,414) 19,238 Dinar loans 5,000 3,919) Equity participations 1,494 913 2,384 Total 17,227 18,246 21,622 Disbursements Foreign currency loans 8,960 10,767) 14,203 Dinar loans 4,000 4,000) Equity participations 1,185 945 2,061 Total 14,145 15,712 16,264 1/ Includes profits net of prepaid taxes 2/ The new definition excludes the Government advances towards a capital subscription of Dinar 4 million. EMENA/IDF  Basic Data on Bank Group Loans and Investments A. Status of Bank Loans (US $ thousands) as of December 31, 1976 Date of Rate of Amorti- Amount of effectiveness interest zation Loan net of Commitments Disburse- Outstanding cancellation ments 449-TUN 7/11/66 6 - 6.25% 1968 - 19 84 4,722 4,722 4,722 759 512-TUN 4/6/68 6,25-6.50% 1969 - 19.83 9,292 9,292 9,292 2,980 648-TUN 3/31/70 7% 1971 - 1987 9,297 9,297 9,297 4,594 798-TUN 4/13/72 7.25% 1971 - 1986 10,000 9,742 9.045 7,123 881-TUN 5/24/73 7.25% 1974 - 1988 14,000 13,958 13,240 10,604 1189-TUN 6/7/76 8-50% 1977 - 1991 20,000 11,047 2,116 2,116 B. Status of IFC Investments Equity (US $) No. 106 TUN Approved 5/10/66 632,305 No. 177 TUN Approved 6/2/70 575,926 Total commitments 1,208,231 Total disbursements 1,208,231 Held by IFC at December 21, 1976 1,208,231   SUMMARY i. The project appraised in this report comprises (i) a $30 million dfc-type loan to Banque de Developpement Economique de Tunisie (BDET) includ- ing $2 million'reserved for financing expansions of existing Small Scale Enter- prises (SSEs); and (ii) a $5 million line of -redit to the government for newly created SSEs. The SSE component is a pilot scheme -- therefore somewhat risky. It will be centered around BDET, but part of the funds will be channelled by the government to SSEs through the branch network of commercial banks. Tech- nical assistance to SSEs will also be organized in the framework of the project. ii. Since the early 70's, the development of Tunisia's manufacturing industry is gradually changing its orientation from import substitution towards export-oriented activities. The Fifth Plan (1977-81) foresees, for the manufacturing sector, investments of D 950 million, with priority given to investment decentralization; an increase inT value added at 11.7% p.a. in real terms; the doubling of manufacturing exports; and the creation of 90,000 jobs. Most employment creation would be in the private sector; this requires encouragements to new entrepreneurship, in medium and small scale industries (paras. 2.01-2.06). iii. There are an estimated 80,000 SSEs in Tunisia, of which 18,000 in the manufacturing sector, but information on SSEs is scanty. SSE deve opment has been at a disadvantage in the past, because the development strate v of Tunisia gave priority to large and medium enterprises. The government; s;ti- tude has now changed, as SSEs are seen as potential contributors to solve '-- country's unemployment problems. In 1975 the government set up a budget- financed fund (FOPRODI) intended to provide financial assistance to the estab- lishment of new SSEs. An extension service catering to SSEs will be organized by API (Agence de Promotion des Investissements) and will coordinate other forms of assistance available to SSEs (paras. 2.06-2.12). iv. The Tunisian financial system is tightly regulated by the authori- ties. BDET plays a key role in financing the industrial sector; commercial banks are also induced to finance industrial projects with medium term loans (up to 7 years). Interest rates were maintaiLned at a low level during the Fourth Plan, which hampered the development of medium and long term credit instruments. Following discussions with the Bank, IFC and the IMF, the Central Bank made a study of interest rates which led to their overall in- crease by up to 1-3/8 points. Medium-term rates for rediscountable loans to industry range now between 8 and 8-1/4%. The rate payable on new BDET long-term loans to resident industrial borrowers will also increase from 8% to 9% as of January 1, 1978 following the Government decision to abolish its 1% rebate on such loans. Further liberalization of credit, and measures to vitalize the capital market are subjects of the ongoing dialogue between the authorities and the Bank (paras. 2.13-2.17). v. BDET carried out a reorganization in 1976, which resulted in con- siderable improvement of the effectiveness of its management. BDET's house  - ii - has been put in order in the areas of financial management and quality of portfolio. Procedures are satisfactory, though improvements are needed as regards appraisals and, especially, supervision. Recognizing the progress made, the Bank agreed, in 1976, to a relaxation of some of the provisions in BDET's policy statement (Chapter III). vi. BDET's approvals declined in 1975, largely because of a resource squeeze, and of the increased competition of commercial banks since the author- ities extended the limit of commercial bank's medium term credit from 5 to 7 years. Approvals picked up again in 1976 (D 30 million) with more new (versus expansion) projects, and with an increase in the average size and duration of loans. Tourism financing was reduced to 25% of total, as agreed with the Bank. Slightly less than one half of BDET's operations are in the Tunis metropolitan area (paras. 4.01-4.06). vii. BDET contributes about 30% of total term lending to the industrial and tourism sector. In the 1974-76 period BDET-financed projects generated on average about 9,000 new jobs per year, at an average investment cost per job of about D 9,000. Export projects were only 4% of BDET's 1976 approvals while projects of new entrepreneurs were 13%. The financial and economic returns of BDET's projects are generally satisfactory (better than 15%). BDET's activity in the capital market declined in importance in the past two years (paras. 4.09-4.14). viii. Total available term resources almost doubled between 1974 and 1976; the Bank's share in BDET's resources declined from 37% to 25%. BDET has been successful in mobilizing new resources, especially in the Arab world. In 1976 BDET borrowed for the first time in the free, international market. The bond issue, of 7 million Kuwaiti dinars, was subscribed by the Kuwaiti Investment Company (KIC). Due to the thinness of the Tunisian domestic bond market, BDET's principal source of domestic financial resources are the Government and the Central Bank (paras. 5.01-5.03). ix. BDET's auditors issued a clean opinion on the 1975 and 1976 accounts, with two minor reservations. Provisions have been brought to a satisfactory level, and the arrears situation has improved and is now brought under control. Reschedulings, however, have been high in 1976 (17% of loan portfolio) largely as a result of delays in the implementation of recently approved projects. Good progress has been made in validating mortgages of hotel borrowers, in line with the timetable agreed with the Bank. The yield of BDET's equity in- vestments declined to less than 4% in 1976 (paras. 5.04-5.13). x. BDET's profitability remained adequate and permitted an increase in dividends from 6% to 7% in 1976. Capital structure is satisfactory. The Bank agreed, in 1976, to an increase of the debt/equity ratio limit from 5:1 to 7:1. but excluding subordinated loans from the equity base (paras. 5.14-5.15). xi. BDET's yearly approvals are expected to increase gradually to D 40 million ($100 million) by 1981, providing about 30% of total term financing for industrial projects. In line with the Plan's guidelines BDET will give  - iii - priority to (a) labor intensive projects; (b) export-oriented projects; (c) projects outside Tunis; (d) projects of new entrepreneurs; and (e) SSE proj- ects. Bank funds will be reserved essentially for the financing of the above priority categories (paras. 6.01-6.03). xii. To finance its operation programs BDET will have to mobilize D 143 million during the Fifth Plan (1977-81), of which D 56 million ($130 million) in the two years 1978-79. Only D 21 million are already identified. The proposed Bank loan and local bond issues will only partly fill the resource gap. BDET will have to borrow up to D 20 million in the international markets before the end of 1979 (paras. 6.04-6.06). xiii. BDET profitability would decline in the next few years, due to the effects of the Government-imposed low interest rates policy of the recent past, coupled with the rising cost of resources. BDET's current nominal lending rate of 9% (which together with other financial charges and taking into account the collection of interest six months in advance corresponds to an effective lending rates of about 9.65%) will not be sufficient for BDET to maintain an adequate profitability. Yet, except in the case of tourism proj- ects for which BDET has agreed to increase its lending rate to 9.5%, the rate cannot be further increased for fear of jeopardizing BDET's competitive posi- tion with respect to commercial banks which extend rediscountable medium-term loans to industry at an average rate of 8 to 8-1/4%. Agreement was reached during negotiations on a system of Government rebates on the cost of BDET's foreign exchange resources obtained at non-concessionary terms, calculated in such a way as to ensure, on an ex-ante basis, an adequate spread on BDET's operations. This will also permit BDET to aclequately remunerate its capital, which will increase from D 6 million to D 10 million between 1978 and 1980. The Government's share in BDET's capital might increase somewhat from the current 12% following the capital increase. The debt/equity ratio will be maintained within 8:1 excluding subordinated loans from equity (paras. 6.07- 6.11). xiv. The main objectives of the proposed loan to BDET are: (a) helping BDET finance priority projects in accordance with the Plan's strategies; this includes the leading role BDET is expected to play in the proposed scheme of assistance to SSEs; and (b) helping BDET establish itself as a viable borrower in the international financial markets: Bank resources are expected to decline to 17% of BDET's indebtedness by 1979. The loan would be repayable in 13 years on a level principal payments basis (paras. 7.01-7.04). xv. The $7 million SSE component of the proposed loan will finance both newly established SSEs costing less than D 200,000 at 1976 prices and expan- sions of existing SSEs with fixed assets of less than D 100,000 at 1976 prices. $5 million will be lent to the Government for onlending to new SSEs through the existing FOPRODI scheme. BDET will participate in the scheme and will administer Bank selection and disbursement procedures. FOPRODI does not finance expansion projects, so $2 million of the SSE component will be lent  - iv - directly to BDET for onlending to eligible SSE expansion projects. SSE loans will have terms of 7-11 years, and carry on 8 to 8-1/4% interest rates. The banks administering FOPRODI will be encouraged to participate with their own resources in the financing of SSE projects, as Bank funds will not cover over 50% of total investment costs (paras. 7.06-7.10). xvi. In parallel with the Bank-financed scheme of financial assistance to SSEs, the Government agreed to set up a system of technical assistance for SSEs, based on the existing structure of API which is already in charge of determining, on behalf of the Government, projects' eligibility for FOPRODI assistance. The technical assistance scheme when completed will consist of about 20 specialists of whom 16 in API's regional branches. They will co- ordinate all forms of technical assistance which other agencies will be able to offer SSEs. API will be assisted, for the initial two years of this experience, by foreign experts, whose cost will be financed by a bilateral or multilateral aid agency (paras. 7.09-7.10). xvii. The project is suitable for Bank finance, in view of the conditions agreed with the Government and BDET, as regards, on the one hand, BDET's opera- tions and its use of the Bank's funds, and, on the other hand, the setting up of a system of financial and technical assistance to SSEs (Chapter VIII).  I. INTRODUCTION 1.01 This report appraises a project consisting of (i) a dfc-type loan of $30 million to Banque de Developpement Economique de Tunisie (BDET) including $2 million to be earmarked for financing exp .sions of existing small scale enterprises (SSEs); and (ii) a line of credit of $5 million to the Government to provide financial and technical assistance to newly created SSEs in Tunisia. 1.02 BDET provides term loan financing as well as equity investments to industry and tourism; it has received so far six Bank loans for a total of $69 million. IFC holds 10% of BDET's share capital. The previous Bank loan was made in early 1976, and is now fully committed. The appraisal report (No. 962- TUN) for that loan, which this report updates, was distributed to the Executive Directors on December 19, 1975. BDET has made considerable progress since it was last appraised. A seventh loan to BDET would have three principal objec- tives: (i) to help finance the foreign exchan,ge component of high priority industrial projects; (ii) to help BDET establish itself as a viable borrower in international financial markets; and (iii) to serve as a vehicle for the Bank to start financing SSEs in Tunisia. 1.03 The SSE component of the proposed project is of an experimental nature and contains an element of risk becausE the Bank has never before fi- nanced SSEs in Tunisia and there are no estab'Lished structures in the -ountry specifically geared to assisting SSEs. The proposed scheme will be cer.-ered around BDET; however, since BDET has no decentralized outlets, part of tu, funds destined to SSEs will be lent to the Government for channelling to SSEL through the regional branch network of four commercial banks. Financial assistance to SSEs will be complemented by the creation by the Tunisian gov- ernment of a system of technical assistance services to SSEs. No such system exists now in Tunisia, and its creation will require the assistance of expa- triate experts to be financed by multilateral or bilateral aid agencies. The objectives of the SSE component of the proposed project include: ti) an insti- tution building goal, consisting of helping the Government devise the creation of necessary structures for fostering the development of SSEs; and (ii) preparation of a more comprehensive Bank-financed follow-up project. II. THE ENVIRONMENT 1/ A. Manufacturing Sector 2.01 During the early 1970's, while the bulk of manufacturing investment was still concentrated in industries catering to the local market, a strong effort was made to promote export-oriented manufacturing industries, and 1/ A report entitled "Economic Position and Prospects of Tunisia; Review of the Fifth Development Plan 1977-1981 (1539-TU), was issued on May 2, 1977; it reviews the results of the Fourth Plan (1973-76) and assesses prospects for the Fifth Plan.  -2- to prevent the expansion of import-substitution activities beyond their limits of efficiency. Simultaneously, the public sector's role as entrepreneur was de-emphasized and a generous incentive system was created to promote private investment. 2.02 By 1976, at the end of the Fourth Plan (1973-76) the manufacturing sector accounted for 11.2% of GDP compared with 8% in 1960. A break-down by branches shows a predominance of food processing (33%), textiles and leather (25%) and, mechanical and electrical industries (13.6%). About 70% of all manufacturing production was generated in the North East, of which 59% in Tunis alone. Employment in the manufacturing sector, including the informal sector, amounted to 270,000 jobs, or 14.2% of Tunisia's labor force in 1976. 2.03 Overall, industry has performed well during the Fourth Plan (Annex 1). The investment target was exceeded in real terms by 20%, with most of the increase taking place in the private sector. Employment creation also exceeded the target by creating 61,000 new jobs, or 50% more than expected. Value added in real terms increased at 6.5% p.a. Good overall results have been fostered by (i) the system of investment incentives (mainly tax exemp- tions) granted by the Investment Code modified in 1974 and by the 1972 export promotion law; and (ii) by the establishment of new institutions to assist industry such as API 1/, responsible for the administration of the investment laws, and AFI 2/ responsible for acquiring and developing industrial land (Annex 23). 2.04 The Fifth Plan (1977-1981) objectives for the manufacturing sector aim essentially at the continuation of the policies of the Fourth Plan, with the following emphasis: (i) a growth in value added in real terms at 11.7% p.a., with non-agricultural industries growing at 15.9% p.a.; (ii) total investment of D 950 million, at current prices, equivalent to 23% of total planned investment; (iii) increase of manufacturing exports from D 151 million in 1976 to D 327 million in 1981; and (iv) creation of 90,000 new jobs, or 43% of all non-agricultural employment to be created during the Plan period. The public sector will continue to play a leading role in implementing strategic projects of a capital-intensive, high-technology nature and will be reponsible for implementing over 50% of the proposed investment program. The financial 1/ One of the primary functions of API (Agence de Promotion des Investisse- ments) is to assist prospective investors both at home and abroad by dif- fusing information and expediting procedures in determining eligibility of new investments for government incentives. Between 1973 and mid-1976, API approved 3,494 new projects with a total investment of D 657 mil- lion and an employment generation potential of 123,000 new jobs. 2/ AFI (Agence Fonciere Industrielle) was also created in 1973. The nature of its work has made AFI's take-off look less impressive than API. However, the initial efforts devoted to land acquisition, loca- tional analysis, and initiation of civil works, will have an impact on industrial expansion during the Fifth Plan.  -3- performance of government-owned enterprises has been weak in the past, requir- ing frequent budgetary transfers, largely because of low initial capitaliza- tion and unrealistic pricing policies. This is now changing, as the Govern- ment has adopted the policy of granting public sector enterprises greater autonomy while requiring that they become self-supporting. Private investment is expected to be predominant in export-oriented manufactures, such as elec- trical and mechanical goods assembly, garments, leather products, and textile manufacture (Annex 1, Table 1.4). An important role is also assigned to small scale industries in providing employment and in improving income distribution. 2.05 Performance of Tunisian industry during the first half of the 70s supports the feasibility of Plan's targets. Their actual achievement will require however, that project identification, preparation and execution capa- bilities (eg. API) be further strengthened. At present, only about 70% of the expected manufacturing investment for 1977-81 is properly identified and over D 300 million are still unidentified. The bulk (67%) of identified manufac- turing investment for the Fifth Plan is in relatively capital-intensive public sector projects (petrochemicals, basic chemicals, and cement) with an average cost per job of about $30,000. In order to reach the target of 90,000 new jobs in manufacturing, nearly 40,000 jobs will have to be created through cu- rrently unidentified projects at an average cost per job of less than $18,000; this would require intensified support of small and medium enterprises in the light manufacturing subsectors. B. Small-Scale Enterprises (SSEs) 1/ 2.06 Tunisians have a long tradition of craftsmanship and business capa- bilities and the number of small non-agricultural enterprises, defined as those employing less than 50 workers, is estimated to be close to 80,000 (18,000 of them in manufacture). Yet Tunisia's administrative, fiscal and financial system have not favored the development of SSEs in the past. Tunisia's industrial development strategy in the last two decades has given priority to large scale public enterprises and, more recently, to modern medium-size privately owned enterprises benefiting from generous incentives and institutional support. This process has not favored SSE development, be- cause (a) investment incentives were linked to criteria into which SSEs do not fit, such as the absolute size of employment creation and value of exports 2/; (b) SSEs had limited access to the banks' financing; and (c) the authorities provided no assistance geared to the needs of SSEs. 2.07 SSEs have not been comprehensively studied in Tunisia. According to the 1973 industrial census (which excluded all firms employing less than 5 1/ See also Annex 2 for a more detailed description of the SSE sector. 2/ Although a change of the investment laws is not foreseen in the immediate future, ways to eliminate the implicite bias against SSEs are being studied by the government. This aspect will require further discussions during preparation of the proposed follow-up SSE project.  - 4 - people) small industrial firms employing between 5 and 50 workers accouinted for 21.4% of industrial employment, for 77% of industrial establishments, but for only 15% of the manufacturing sales (see Annex 2, Tables 1 and 5, for dis- tribution of SSEs by size and region). In 1976, a complete inventory of all non-agricultural enterprises in major cities was started. The survey identi- fied in Sousse, Sfax and Gabes alone 5,023 manufacturing firms with 1 to 10 employees. Such figures, compared with the census figure of 281 firms for the entire country, show the importance of SSE activities not covered by the census. 1/ 2.08 The SSE sector is mainly oriented toward the production of household goods for local markets. Three groups accounted, in 1973, for 63% of produc- tion: food and beverages (36%), metal products (15%) and textiles (12%). Small firms were also important in furniture and building materials. Informa- tion is not available regarding fixed assets in SSE manufacturing in Tunisia. 2.09 FOPRODI Scheme. A change in the Government's previous attitude of benign neglect was marked by the creation, in 1974, of the FOPRODI (Fonds de promotion et de decentralisation industrielle), a budget-financed fund intended to encourage the sponsors of small industrial projects, especially those out- side Tunis. Under the FOPRODI scheme (Annex 24), eligible entrepreneurs 2/ obtain subsidized personal loans to supplement their venture capital and to help them acquire a majority ownership in the equity of the new enterprises; the smaller projects (total cost under D 30,000 3/) are also eligible for subsidized long-term credits to the SSE itself, as opposed to the entrepreneur. Eligibility for FOPRODI assistance is determined by API. FOPRODI itself is not an institution; it is administered through participating commercial banks,9 which are expected to contribute their own resources in term-loan financing, necessary to complete the financial plan for FOPRODI projects. Since it became operative (in December 1975) until May 1977, FOPRODI has financed 81 projects, with total investments of D 7,093,148 and creating of 2,553 new jobs (Annex 2). 2.10 Other steps are being taken now towards an integrated program in support of SSEs. Of particular relevance are the creation of an SSE policy making unit in the Ministry of the Economy, and the decision to set up a countrywide system of technical assistance to SSE which will be built around the API network of regional branches and will combine efforts with AFI, CNEI (Centre National d'Etudes Industrielles--Annex 23) and local governments. 1/ Preliminary data on employment for the Sousse province alone show 3,018 people employed in this sub-group in 1976. The census shows a total of 1,643 for the country as a whole in 1973. 2/ Tunisian citizens with technical qualifications willing to devote them- selves full-time to the new enterprise and sponsoring a project costing less than D 200,000 (this limit has been revised upwards to D 500,000 in October 1977). 3/ This limit has been revised upwards to D 75,000 in October 1977.  -5- 2.11 SSE Constraints and Problems. Excessive import protection and indiscriminate import substitution during the 60's favored the subsistence of traditional SSEs by conserving inefficient structures and reducing competition. The negative effects of such policies became more apparent when the gradual opening up of the economy, in the early 70's, caught SSEs out of step in the transition towards modern and efficient production units. Major problems adversely affecting their productivity and constraining their growth, are not different from those observed in other countries at similar stages of develop- ments. They include: outdated machinery, deficient production planning and accounting-management, lack of quality control, poor plant layout and product design, poor working facilities. In marketing their products, SSEs cannot cope with market fluctuations due to acute shortages of raw materials (sub- ject to import licensing) and to limited access to institutional finance. A characteristic of Tunisian SSEs is the regional concentration of some small industries, like weaving in Monastir, carpet making in Kairouan, metal fabri- cating in Sousse and Sfax. Such regional specialization favors integration with large, modern plants and upgrading of productivity through subcontracting. 2.12 Strategy for SSE Development. A strategy to develop SSEs should aim simultaneously at employment creation and at :improving productivity. Unemploy- ment has been singled out by the government and the Bank as the most important problem facing the Tunisian economy. 1/ SSE development can make a substantive contribution to gainful employment generation if the productivity and competi- tiveness of the small shops now working on a stop-go basis is effectively increased. This is possible through upgrading operating techniques and re- placing equipment. 2/ SSE viability and self sustained growth can be attained by focussing their potential on activities with insignificant economies of scale, catering to specialized or low-priced market niches, or complementary to production processes of large firms. 2.13 The transition from traditional small shops into small but efficient units requires some support by the Government, through various forms of tech- nical and financial assistance aiming at putting SSEs on an equal footing with the larger firms. In the Tunisian environment, this may eventually require the establishment of a specialized agency, where all forms of public assistance to SSE development would be centralized. The Government is not yet prepared to take this step, and prefers, at this stage, to put the emphasis on reinforc- ing, and better coordinating among themselves, ongoing initiatives toward assisting SSEs. API, which is responsible for selection of projects eligible for FOPRODI assistance, and which already disposes of a decentralized network of regional branches, appears to be the most suitable agency to coordinate ongoing efforts of assistance to SSEs, and to establish, within its organiza- tion, an extension service catering to SSEs. 1/ In the non-agricultural sector, unemployment in 1976 amounted to 22% of the registered labor force (Tunisia-Special Economic Report, 1977). 2/ Modernization does not imply, in this context, over-mechanization and labor displacement. Appropriately chosen equipment and technologies can upgrade quality, improve competitiveness, expand operations and, even- tually, generate (or maintain) permanent employment.  -6- C. Financial Sector 2.14 Tunisia's financial community is composed of 10 commercial banks, two development finance companies (BDET, which finances industry and tourism, and COFIT, which finances exclusively tourism), another small investment bank, two savings institutions and several insurance companies. Off-shore banks are being set up in Tunisia following a 1976 law which permits their establishment but limits their activity to foreign currency financing. The authorities use an array of monetary policy instruments, including the administrative determi- nation of interest rates, reserve ratios related to banks' liabilities, and variable reserve requirements; however, the Central Bank has relied primarily on prior approval of large credits granted by commercial banks, and on redis- count ceilings, to implement its credit policies. 2.15 While the large industrial development projects in Tunisia, gener- ally sponsored by public sector enterprises, are financed by the government or through direct foreign borrowings, the authorities rely on the banking system for the financing of the medium and small scale industrial development proj- ects. BDET plays a central role in this respect (30% of total term credit extended to the industrial sector was held by BDET as of end 1976) 1/ and for this reason the authorities channel toward BDET concessionary foreign exchange loans as well as long-term local currency resources. Commercial banks are encouraged to participate in the development financing effort by the require- ment that 18% of their deposits be placed in medium-term private loans, and by the availability of rediscounting facilities for refinancing further commer- cial bank lending to the private sector. Term credit represented 36% of total commercial banks' credit to the economy at end 1976. 2.16 The overall level of interest rates has been kept low (Annex 1, Table 1.5) during the Fourth Plan period (1973-76) compared with the rate of inflation (4.1% in 1974, 9.6% in 1975 and 5.4% in 1976). Private savings (in- cluding those of public sector enterprises) averaged about 20% of GDP during the Fourth Plan, and financed about 60% of total investments. Low interest rates, however, have been partly responsible for insufficient mobilization of savings through medium and long-term financial instruments. The domestic capital market (especially the bond market) is extremely thin and remains a major weakness of Tunisia's financial system. Furthermore, on the the demand side, the ceilings on interest rates have deprived the banks of the incentive to take term risks, and resulted in a rationing and possible sub-optimal allo- cation of medium and long-term credit. Partly as a result of discussions with the Bank, IFC, and the IMF, the Government has become increasingly aware of these problems particularly in view of the resource mobilization effort needed to finance the investment targets of the Fifth Five-Year Plan (1977-81). 2.17 In 1977, the Central Bank conducted a major study of the structure and level of interest rates of commercial banks. Following its conclusions, 1/ BDET also plays an important role in the financing of tourism investment. As of end-1976, BDET held 22% and COFIT 18% of total term credit extended to the tourism sector.  - 7 - the Central Bank raised its official rediscount rate from 5% to 5.75%, effec- tive September 1, 1977, and deliberated that the commercial banks' deposit and lending rates be increased by up to 1-3/8 percentage points (Annex 1, Table 1.5). Medium-term lending rates for rediscountable loans to the industrial and tourism sectors (other than to resident export-oriented enterprises and to enterprises in the least developed regions) have been increased from a range of 6.25-8%, to a range of 8-8.25%.1/ The rate payable on new BDET long-term loans to resident industrial borrowers will also increase from 8% to 9%, as of January 1, 1978, following the Government decision to abolish its 1% rebate on such loans. These are steps in the right direction. The authorities intend to closely monitor the development of the domestic inflation rate (which is currently projected to be kept below 7% p.a. during the Fifth Plan period) as well as the level of lending rates in the international market, with a view to maintain domestic interest rates significantly positive in real terms, and to harmonize them with interest rates prevailing abroad. 2.18 In parallel with the Central Bank's study on interest rates, the Ministry of Finance has prepared a study on the domestic capital market; the study's conclusions recommend legislative measures to be taken in order to foster the development of the market. These include: the creation of new, more attractive types of securities (convertible bonds, investment fund shares, etc.); the revamping of laws and regulations affecting the bourse and the stock brokers (at present, only banks can operate as brokers in the Tunis bourse); encouragements to the banks to promote the placement of savings by the public in securities, and to be themselves more active in the market; a rationalization of tax and other incentives to both issuers and buyers of securities; and, finally, higher yields on bond issues. The implementation of these measures has not yet been decided. This, together with the still excessive rigidity of the Central Bank's control over credit and interest rates, and with the tightness of exchange controls (including the desirability of passing on the exchange risk to the ultimate borrowers of foreign exchange loans--see also para. 6.06) is the object of the ongoing dialogue between the Bank and the Tunisian authorities, on the reform of the financial system. III. BDET INSTITUTIONAL DEVELOPMENT A. Ownership Board and Committees 3.01 Since the last Bank loan appraisal, the ownership structure of BDET has remained substantially unchanged (Annex 3). The Tunisian public sector held at the end of 1976 29.5% of BDET's capital and the Tunisian private sector 28.2%, the remainder being divided between IFC (10%) and other foreign 1/ The range of rates for rediscountable medium-term loans financing resident export-oriented enterprises and enterprises in the least developed regions was also narrowed from 6.25-7.25% to 6.75-7%.  - 8 - shareholders (32.3%). The decision to raise BDET's share capital from D 6 million to D 10 million (paragraph 6.11) might result in an increase of the share of the public sector as some of the other shareholders might decide not to exercise fully their subscription rights. 3.02 The composition of BDET's Board of Directors (Annex 4) reflects BDET's ownership structure. The Board delegates to the Executive Committee (composed of the Tunisian members of the Board) the authority to approve loans and investments of up to D 300,000. The Management Committee (BDET manage- ment and department heads), approves operations up to D 50,000. The Board meets quarterly, the Executive Committee once or twice a month, and the Management Committee as often as needed. B. Management and Organization 3.03 The Bank's concern in late 1974 that the departure of BDET's manag- ing director might excessively weaken the institution's top management has not been confirmed by events. As agreed during negotiations for the sixth Bank loan, BDET has taken measures to improve management effectiveness. BDET's organization was radically restructured in 1976, in an effort to decentralize the decision-making function at the middle management level. Six new depart- ments replace the three previously existing ones (Annex 5). Four departments are headed by young, capable and dynamic Tunisian professionals who have been promoted from the ranks. Experience with the new organization over the last fifteen months is definitely positive. Further improvements in procedures especially as regards bookkeeping, follow-up and internal audit are now being introduced on an experimental basis following the recommendations of a compre- hensive organization study conducted for BDET by Peat, Marwick, Mitchell and Co. (PMM) and by Cabinet FINOR. The Bank is satisfied that PMM and FINOR's recommendations will allow BDET to cope more effectively with the increasing volume of business. C. Statutes and Policies 3.04 Except for the authorization to increase BDET's capital from D 6.0 million to D 10.0 milion, BDET's statutes are unchanged since the last Bank loan appraisal. BDET's Board adopted a few changes in BDET's Policy Statement including: (a) an increase, from 25% to 30% of BDET's total financing, of the limit to BDET's lending to public sector enterprises (which increasingly turn to BDET as a lender of last resort); (b) an increase in the limit to BDET's exposure to a single borrower, from 20% to 25% of BDET's equity; and (c) a new definition of BDET's debt/equity limit, which is now seven times BDET's equity (excluding subordinated government loans) compared to the previous limit of five times equity plus subordinated government loans considered as quasi- equity. The Bank concurred with these changes in view of BDET's improved per- formance and strengthened financial situation (para 5.15).  - 9 - 3.05 In October 1975, BDET's Board approved a new amendment to BDET's Policies Statement specifying that BDET's activities in the tourism sector will remain of a secondary nature, and will not, in general, exceed one fourth of BDET's financing (see para 4.04); with the Bank's approval (para 5.15) BDET's management intends to submit shortly to its Board, for approval, an- other amendment increasing from 7:1 to 8:1 the ceiling for BDET's debt-equity ratio. BDET and the Government have also sought Bank agreement to increase to 40% of BDET's total lending the limit on BDET's exposure to the public sector. Prima facie, this request does not appear to be warranted (para 4.03). D. Procedures 3.06 Project Appraisal. BDET's appraisal work has further improved over the past two years and overall BDET's appraisal reports are generally compre- hensive and sound. Further improvement can be achieved in (i) market studies, which should better assess competition; (ii) the assessment of a project's employment creation; and (iii) the evaluation of physical and financial con- tingencies. BDET has undertaken to strengthen its appraisal work in the above mentioned areas. 3.07 Project Supervision. Project supervision remains the weak link in BDET's organization, and progress in this area has fallen short of the expecta- tions expressed in the last appraisal report. While about 100 of BDET's cus- tomers (currently numbering about 400) are deemed to be in need of close supervision, only 25 customers were visited by the supervision staff in 1975 and 40 in 1976 with only a few of them in their start up period. The work of the project supervision division is poorly coordinated with that of the opera- tional units in charge of projects appraisal, promotion, equity participations and loan collection. BDET's management is aware of this problem and has agreed to submit to its Board and implement a comprehensive program of action for the supervision division. This program provides for (i) strengthening of the supervision division staff, which will be increased from 4 to 7 profes- sionals, (ii) implementation of procedures and information flows which would improve the supervision division's integration within BDET following PMM and FINOR's recommendations (para 3.03); (iii) systematic planning of visits to customers in their start up period or having failed to submit satisfactory informations (para 5.05); (iv) strengthening of the quality of supervision reports and (v) submission to BDET's Board in the first half of 1979 of a synthetic report giving a feedback of supervision activities. 3.08 Promotion. Over the last two years, BDET's promotional efforts have shifted away from regional business solicitation, which was not deemed suffi- ciently profitable, towards the identification of large innovative industrial projects. BDET's promotional efforts have led to the implementation of three large projects in 1976, costing D 4.8 million in total, of which D 2.7 million financed by BDET: they are a velvet fabric manufacturing plant, a vegetable fat plant, and a conveyor belts plants. Several other industrial projects in different branches (including starch-glucose, chlorine, aluminum sections,  - 10 - asbestos-cement pipes, luxury shoes for exports, car assembly, synthetic fibers etc.), are now being studied by BDET, which is also actively looking for potential Tunisian promoters and foreign technical or financial partners. 3.09 Procurement and Disbursement. BDET's procurement and disbursement procedures continue to be satisfactory. At the Bank's request, however, BDET has undertaken that projects appraisal reports would include in the future a more thorough coverage of procurement matters. IV. BDET'S OPERATIONS A. Characteristics 4.01 Annexes 6 and 7 contain a summary of BDET's operations over the last five years. The sharp increase in operations in 1974 reflect the 1973-74 boom in Tunisia's industrial sector, and contrast with a marked decline in applica- tions and approvals in 1975. This decline resulted itself from the increased competition from commercial banks (due to a change in banking regulations extending from 5 to 7 years the maximum length of medium term credit) and BDET's resource constraints made particularly acute by the protracted negotia- tions of the sixth Bank loan, pending which other foreign lenders adopted a wait-and-see attitude. Operations picked up again substantially in 1976 with approvals amounting to D 30.3 million ($71.5 million equivalent) and commit- ments amounting to D 21.6 million ($50.9 million equivalent). 4.02 The increase of BDET's approvals of new projects (75.5% in 1976 compared to 60.9% in 1975 and 39.3% in 1974) as opposed to expansion projects can be explained by the fact that commercial banks' cheaper credit at terms of up to 7 years is better suited to modernization and expansion projects than BDET's loans. This also explains why the proportion of foreign currency loans declined to 58.4% of total approvals in 1976 while that of dinar loans increased to 31.5% and that of equity investments to 10.1% (Annex 6), since new projects tend to involve higher local currency expenditures (mainly for construction) and higher needs for equity funds than expansion and moderniza- tion projects. Also it explains the longer maturity of BDET's loans: in 1976, over 50% of approved loans were for 10 years or more. 4.03 The proportion of BDET's new approvals in the public sector decreased from 25.1% in 1974 to 14.3% in 1975 and 11.7% in 1976. In terms of commitments however the share of the public sector was 21.0% in 1975 and 22.1% in 1976. In view of BDET's past record, and of an analysis of BDET's pipeline of projects under preparation, it appears unlikely that the present limit of 30% for BDET's public sector commitments will constitute a significant constraint. 4.04 The bulk of BDET's operations is now concentrated in the manufac- turing sector. BDET's portfolio of industrial loans and equity investments is spread over a wide range of subsectors (Annex 7). It was agreed for the  - 11 - sixth Bank loan that BDET would progressively reduce its excessive exposure in the tourism sector, which was about 41% of portfolio at the end of 1974, to 25% of total financing. This target was achieved by the end of 1976. For the future, BDET believes that it continues to have an important, though secondary, role to play in tourism, especially for co-financing projects which are too large for a single institution to assume the entire risk. BDET however foresees no need to exceed the agreed exposure limit of 25%. This view is reflected in an amendment to BDET's Policy Statement recently approved by BDET's Board. 4.05 Despite a substantial increase in the amounts approved, the number of approvals declined from 141 in 1975 to 124 in 1976. The resulting increase from D 158,600 to D 244,400 in the average size of BDET's operations reflects increases in project costs as well as a lesser emphasis on smaller projects especially those for expansion and modernization. In 1976, 84 projects involv- ing BDET's financing of less than D 200,000 ac:counted for only 17.6% of the total amounts approved, as compared to 114 projects accounting for 34.7% of the total in 1975. Eight projects involved BDET's financing of D I million or more in 1976, and accounted for 42.1% of the total amounts approved, as com- pared to 3 projects accounting for 17.2% of the total in 1975. 4.06 There has been a slight decrease in the proportion of approved opera- tions for projects located in the Tunis area. In 1976 this area accounted for 48.1% of the amounts approved compared to 50.1% in 1975. Most of the rest how- ever went to urban centers on the relatively developed coastal strip. BDET intends to launch a new promotion effort for its services outside of the Tunis area, with particular emphasis on the less developed regions of the interior (para. 6.02). B. Economic Impact 4.07 Contribution to Investment and Share in Term Lending. In the manu- facturing sector, BDET's disbursements accounted for about 15% of total invest- ment both in 1975 and 1976. BDET's share in total outstanding term lending to the industrial sector (including construction) remained also remarkably stable at about 30%. BDET has also maintained at approximately 22% its share in total term lending to the tourism sector. In percentage of the total investment cost of approved projects for all sectors, BDET's financial contribution reached a high point of 47% in 1975, due to the unusual concentration of industrial proj- ects in that year, and went back to 37% in 1976. 4.08 Employment Creation. Employment generation associated with BDET's financed projects decreased from the record level of about 12,000 in 1974 1/ to about 7,900 in 1975 and 6,500 in 1976 while the average investment cost per job after decreasing from about D 8,100 in 1974 to D 6,000 in 1975 went 1/ These numbers are based on BDET's appraisal reports.  - 12 - up again in 1976 to over D 12,500 ($29,500 equivalent). These figures are influenced by the relative proportions of new vs. expansion projects, (and of industrial vs. tourism projects). Investment cost per job for new projects increased from about D 5,500 in 1974 to about D 9,000 in 1976 reflecting increases in the cost of imported capital goods and a certain decrease in the relative importance of smaller projects (Annex 8). BDET's financing of small projects with total costs of less than D 150,000 declined from 11.8% of total in 1974 to 8.4% in 1975 and only 3.8% in 1976. Yet these projects consist- ently involved on the average an investment cost per job of less than D 4,000. BDET's financing of large projects with investment costs exceeding D 1 million increased from 58.9% of the total in 1974 to 67.5% in 1976 while the average cost per job of such projects increased in the same period from about D 6,900 to D 17,200. During the Fifth Plan period, BDET is committing itself through a strategy statement approved recently by its Board (para 6.02) to a stronger promotion of labor intensive projects, with particular emphasis being given to projects with an investment cost per job not exceeding D 4,600 (US$10,670 equivalent) at 1976 prices. 4.09 Export-oriented Projects. In 1976 exclusively export-oriented projects accounted for only 4% of BDET's industrial sector financing. This low percentage reflects both the difficulties encountered by Tunisian resident enterprises (as opposed to non-resident enterprises benefiting from the mar- keting experience of foreign parent companies) in penetrating foreign markets. BDET strategy statement for the Fifth Plan Period (para 6.02) includes export- oriented projects among its priorities for promotion and financing. Also, a closer cooperation is expected between BDET and the Export Promotion Center (CEPEX). 4.10 Promotion of Entrepreneurship. While commercial banks are often reluctant to finance projects whose sponsors do not have a past record as enterpreneurs, 34 such projects (out a total of 124 approved by API) were financed by BDET in 1976, accounting for D 3.9 million, i.e. 13% of BDET's total approvals. Eleven more projects, accounting for D 623,000 were approved in 1976 for expansion of SSEs with assets of less than D 150,000. 4.11 Financial and Economic Profitability. A sample of projects approved by BDET in 1976 and the early part of 1977 shows internal financial rate of returns (FRR) ranging from 15 to 35% and averaging about 20%. Larger projects submitted to BDET's Board and for which the internal economic rate of return (ERR) has also been computed showed in most cases an ERR generally higher than 20%, which is satisfactory, even after taking into account BDET's occasionally optimistic assumptions. 4.12 Contribution to the Development of Tunisia's Capital Market. In 1976 BDET subscribed about D 2.4 million in new equity participations, i.e. 11% of total 1976 commitments. BDET's portfolio management for individual and corporate clients increased from D 3.5 million at the end of 1974 to D 7.8 million at the end of 1976. On the other hand BDET is encountering difficul- ties in selling shares from its own portfolio. Sales of shares declined from D 318,400 in 1974 to D 250,000 in 1975 and D 152,000 in 1976. At the same time BDET's total interventions in the Tunisian stock exchange declined from  - 13 - D 944,000 in 1974 to D 688,000 in 1975 and D 385,000 in 1976. Although part of this decline reflects a reduction in the overall activity of the Tunis stock exchange, BDET's share in total trading declined from 4.7% in 1974 to 3.7% in 1977. BDET's role in this area should be reviewed in light of the conclusions of'the recent report prepared by the Ad Hoc Committee on the Tunisian Financial Market (para 2.17). During negotiations, an informal understanding was reached that BDET would submit to its Board and to the Bank before the end of 1978 a plan of action to strengthen its contribution to the development of the Tunisia's Capital Market. V. BDET'S FINANCIAL SITUATION A. Resource Position 5.01 BDET's resource position as of December 31, 1976, is described in Annex 9 which also provides details on the status and conditions of domestic and foreign long-term borrowings. The evolution of the total resources avail- able to BDET -- on a commitment basis -- over the last two years may be sum- marized as follows: December 31, 1974 December 31, 1976 Amounts in Amounts thousand dinars % thousand dinars % Equity 6,710 15.2 8,688 10.4 Subscribed but unpaid capital 1,500 /1 3.4 - - Long term domestic borrowings 4,807 10.9 16,151 19.5 Long term foreign borrowings 31,170 70.5 58,192 70.1 of which IBRD (16,547) (37.4) (20,099) (24.9) 44,187 100.0 83,031 100.0 A BDET's share capital increase of 1974 from D 3 million to D 6 million was paid-in in two equal tranches, the first in 1974 and the second in 1975. BDET has been quite successful in borrowing new domestic and foreign long-term resources, permitting a decline of the share of Bank funds. BDET's equity is due to increase over the 1978-80 period when share capital will be raised from D 6 million to D 10 million. BDET secured in 1977 a new DM 10 million loan from KfW (D 1.6 million equivalent), a KD 7 million line (D 10.3 million equivalent) from the Arab Fund for Economic and Social Development, and a sixth line of credit of D 2.5 million equivalent from the French Caisse Centrale de Cooperation Economique.  - 14 - 5.02 In accordance with understandings reached during the negotiations for the sixth Bank line of credit, BDET obtained from the Government a D 4 million subordinated loan, which is to be partly converted into equity to the extent BDET's existing shareholders do not exercise their subscription rights (para. 5.15). BDET may avail itself of the still unused D 2.5 million Central Bank rediscount facility. Other resources obtained by BDET on the Tunisian market include several 10-year bond loans issued from 1973 to 1975 and placed with the commercial banks (at 5.5%) and with the public (at 5.75%, or 7% in the case of subscribers not qualifying for tax exemption). More recently, however, the thinness of the Tunisian capital market, and the competition of Government securities have made it increasingly difficult for BDET to issue bonds aimed at the Tunisian public. A D 1.0 million issue of March 1977 met only very limited success and had to be closed at a level of D 100,000. BDET hopes to obtain more success with future domestic bond issues, once the proposed measures to revitalize the Tunisian capital market are implemented by the Government (para 2.17) and, especially, if the Ministry of Finance, following the general increase in commercial banks' interest rates decided by the Central Bank in September, 1977 (para 2.16) permits, as expected, that higher interest rates be offered also on bond issues. 5.03 In 1976 BDET issued a bond loan of 7 million Kuwaiti dinars (D 10.3 million) on the international financial market. The loan was guaranteed by the Tunisian Government and underwritten by Kuwait Investment Company (KIC). This operation is the first of its kind undertaken by a Tunisian financial institution and illustrates BDET's determination to gain access to the inter- national capital market. Full repayment of the principal of this loan is expected in 1979 and 1980 but there is a distinct possibility to revolve the loan. Unfortunately the high cost of this issue (8.5%) would leave BDET with a narrow spread on its long-term loans and would have already caused losses of D 76,000 on short-term placement of that portion of the loan which could not be immediately onlent at long-term. On the basis of an ad-hoc agreement, the Government compensated BDET in 1976 for this loss, and informally agreed to ensure, with a special subsidy, that the servicing of this loan would not cost BDET more than 6% p.a. B. Auditors' Reports on BDET 5.04 The audit reports on BDET's 1975 and 1976 accounts were jointly prepared by the Tunisian firm Cabinet Finor, and Peat, Marwick, Mitchell and Company (PMM). The increasingly important role played by Finor illustrates the development of the local auditing profession 1/, an objective supported by the Government and the Bank. 1/ Large companies seeking rediscounted medium term loans, and major public sector enterprises are now frequently required by the Central Bank to be audited by an independent Tunisian firm. This has encouraged the estab- lishment of numerous auditing firms in Tunisia which are rapidly gaining experience. Tunisian firms are no longer discouraged by the authorities from seeking an association with foreign auditing firms of international standing, as in the case of Finor and PMM.  - 15 - 5.05 The audit reports on BDET's 1975 and 1976 accounts were ready on schedule and were made available to Board members in accordance with under- standings reached during the negotiations for the sixth Bank loan. The main results of the audit reports for 1974, 1975 and 1976 are summarized in Annex 10. The 1976 audit gave an unqualified opinion on BDET's accounts with only two reservations. The first reservation is basically related to inadequate reporting on 50 of BDET's clients, accounting for 3.2% of portfolio at end- 1976, a situation which should considerably improve once BDET's supervision activities are strengthened (para 3.08). 5.06 The second reservation concerns a loan of D 877,500 to an hotel com- pany which has been in deficit since 1975. BDET is taking steps to force the hotel owners to redress the situation by changing management arrangements. BDET confirmed during negotiations that all necessary measures will be taken to ensure full recovery of this loan. C. Quality of BDET's Portfolio 5.07 BDET's portfolio at the end of 1976 amounted to D 61.4 million ($144.8 million equivalent). Annex 11 divides BDET's portfolio at December 31, 1976, into medium-term loans (4.0%), long term loans (85.3%) and equity invest- ments (10.7%) and provides a picture of the portfolio's sectoral breakdown. From the point of view of risk, BDET's portfolio is now well diversified. 5.08 Loans in Arrears. A detailed comparative analysis of BDET's loans in arrears of over three months is given in Annex 12. The arrears situation, particularly in the tourism sector, has dramatically improved since the time of the last appraisal, following a strong resurgence of tourism in 1975 and 1976, and assertive action on the part of BDET in collecting loans in arrears. At the end of 1976, the portion of the tourism sector loan portfolio affected by arrears of over three months had decreased to 17.1%, compared to 41.1% at the end of 1974. In the industrial sector, the corresponding portion has also gone down from 7.4% at the end of 1974 to 4.7% at the end of 1976. Total arrears of over three months in principal and interest represented 1.7% of total loan portfolio at end 1976 compared to 3.7% at end 1974 and 2.4% at end 1975. 5.09 Loan Reschedulings. Loans reschedulings have increased from 1974 to 1976 as follows: 1974 1975 1976 Number of loans rescheduled 33 35 41 Amounts involved - in thousand dinars 3,451 6,237 9,765 - in percentage of total loan portfolio at year end 11.0% 14.3% 17.8% Estimated potential arrears of over 3 months as % of loan portfolio, if no loans had been rescheduled 4.0% 3.3% 2.6%  - 16 - Most reschedulings consist of shifting forward the loans' amortization sched- ules by one year or less. The increase in the percentage of the loan port- folio being rescheduled is largely due to delays in the completion of projects approved in the 1974 industrial investment boom. However, BDET should be more cautious in its projections of client's financial needs, and grant, when appro- priate, longer grace periods. BDET's Supervision Division should follow up closely the performance of clients having obtained reschedulings. Agreement was reached during negotiations that, should reschedulings affect in any year more than 15% of BDET's loan portfolio, a special report on reschedulings would be submitted to BDET's Board. 5.10 Loan Security. BDET's loans to industrial customers are backed by chattel mortgages which are generally valid and sufficient to cover risks. Only seven industrial sector loans are to companies in difficulty against which BDET has collateral of an uncertain value (Annex 13). The taking of mortgage securities on many hotel loans, which was a major issue during negotiations for the sixth Bank loan, has been making substantial progress. Further energetic action will still be needed on the part of BDET. Agreement was reached during negotiations that, in the future, BDET's hotel loan con- tracts should include a timetable for the mortgage validation process. 5.11 Equity Portfolio. BDET's equity portfolio, estimated at acquisi- tion cost, increased from D 3.9 million at the end of 1974 to D 6.6 million at end of 1976, while its book value went from D 4.5 million to D 7.4 million and its estimated market value from D 5.0 million to D 7.2 million. The snare of tourism investments has declined from 35.6% to 30.4% of total. Except for a hotel management company jointly owned by BDET and COFIT, BDET does not own more than 40% of the capital of any company, and half of its participations are in the range of 10% to 20% of total shares. Cash dividends on 1975 operations were declared in 1976 by 22 of the 78 companies in which BDET held shares and amounted to D 120,877 (compared to D 100,506 in 1975) producing an average yield to BDET of 2.5% on equity investments, (compared to 5.4% in 1973, 3.9% in 1974 and 2.6% in 1975). The decrease in the yield is largely due to the increasing proportion of new companies in which BDET holds shares. 5.12 Capital gains on BDET's equity portfolio have declined from D 154,700 in 1974 to D 73,600 in 1976, as a consequence of a decrease in the volume of sales (para 4.12). For 1977 BDET plans to sell about D 150,000 worth of shares, a substantial increase compared to 1976, but still only 2.3% of BDET's equity portfolio. A more aggressive policy of portfolio management would con- tribute to revitalizing the Tunisian capital market. 5.13 Provisions. At the time of the last appraisal provisions were still considered by the auditors and by the Bank as insufficient to cover BDET's risk of losses. Since then, BDET has built up its provisions to a fully satisfactory level, as recommended by the auditors (Annex 10).  - 17 - D. Financial Performance and Position 5.14 Profitability. BDET's audited income statements and balance sheets for the years 1972 to 1976 are shown in Annexes 14 and 15, and the relevant performance indicators are presented in Annex 16. BDET's income almost doubled from 1974 to 1976, reflecting basically the growth of BDET's loan port- folio, which increased by 74%, as well as an increase in its average interest rate from 8.u% in 1974 to 8.6% in 1976. Dividends and capital gains declined from 7.8Z of average equity portfolio in 1974 to 3.4% in 1976 (see paragraphs 5.11-5.12 above). Expenses have also doubled from 1974 to 1976, the main cause being interest expenses on term borrowings which increased by 140%. Administrative expenses (including depreciation) decreased from 1.8% of total assets in 1974 to 1.5% in 1976, which represents a good performance. Net profits increased by 78%, yielding in 1976 a return on average net worth of 9.7%, compared to 8.5% in 1974 and 8.3% in 1975. In 1977, BDET was able to raise its traditional 6% dividends distribution to 7%, which remains however well below what most commercial banks in Tunisia pay (i.e., between 10% and 12% of par value). Earnings per average share outstanding in 1976 were D 0.701. 5.15 Capital Structure. According to the Loan Agreement for the sixth Bank loan, BDET's debt/equity ratio was not to exceed 5:1. The Government subordinated loan of D 4 million, however, was to be included in the equity base on the assumption that most of it would be converted into shares in 1976 and 1977, to permit BDET's capital to increase from D 6 to D 10 million (para. 5.02). Given the lower-than-expected volume of business in 1975 BDET decided, with the Bank's concurrence, to delay the capital increase until 1978-80. About three-quarters of the capital increase appeared then likely to be sub- scribed by existing shareholders other than the Government. The rationale for including the Government subordinated loan in the equity base was thus no longer there, and the agreed debt/equity ratio limitation was redefined accord- ingly, and increased to 7:1. The ratio is expected to exceed 7:1 in 1977 and to stabilize thereafter slightly below 8:1 as BDET's capital increase takes place (para 6.11). BDET's improved financial situation, reflected in the auditors' opinion on the 1975 and 1976 accounts warrants an increase from 7:1 to 8:1 in BDET's debt/equity ratio limit. Given BDET's increased provisions against possible losses on loans and investments (para 5.13), the proposed 8:1 limit would adequately protect the risk of BDET's lenders, and would reflect fairly the company's debt servicing capacity. The Bank agreed, therefore, to the increase in the limit (para 3.05). VI. BDET's PROJECTED OPERATIONS AND FINANCIAL SITUATION A. Projected Operations 6.01 BDET's assumptions and projected operations are given in Annexes 17 and 18. BDET expects to continue to supply manufacturing with about 30%  - 18 - of all the term credit--domestic and foreign--foreseen in the Plan (D 482 million, including D 164 million for private enterprises). Private sector industrial lending will continue to be the principal responsibility of BDET. 6.02 The sectoral orientation of BDET's projected industrial lending reflects that of the Fifth Plan (1977-81), with the main emphasis on electro- mechanical industries (especially light industry largely sponsored by private sector investors) followed by the construction, and construction materials industries (though this branch is likely to be largely developed by the public sector), and by the textiles, chemical, food processing, and wood and paper industries. The Plan assigns priority to labor intensive and to export oriented industries, the development of new entrepreneurships, and places great emphasis on the need to decentralize industry away from the coastal urban areas in general and from Tunis in particular. BDET's Board approved in October 1977 a strategy statement for the Fifth Plan Period declaring that BDET will make all efforts to finance and promote priority projects having the above described characteristics, specifically: -(a) labor intensive projects, defined as projects with an investment cost per job not exceeding D 4,600 at 1976 prices 1/; (b) export-oriented projects (defined as those expecting to export more than 20% of production) promoted by Tunisian sponsors; (c) decen- tralized projects, especially those in the interior; (d) project sponsored by new entrepreneurs (especially Tunisian workers returning from abroad) having the required technical qualifications, and the intention to personally attend to the management of the enterprise; and (e) small-scale industrial projects (see Chapter VII). On the basis of past experience, and of an analysis of BDET's project pipeline, BDET is aiming at meeting the following objectives during 1978-1979: at least 15% of BDET's new approvals should go to labor intensive projects; 15% to projects of new entrepreneurs; and 50% to projects outside Tunis. No quantitative target has been established for export-oriented projects given the uncertainties of the international climate for Tunisian exports. Understanding was reached during negotiations that the proceeds of the Bank's loan would be essentially reserved for the financing of the priority projects identified in the above mentioned strategy statement. 6.03 BDET's capacity to handle the projected volume of operations detailed in Annex 18 has been demonstrated in the period 1974-76, when BDET's approvals averaged D 30 million per year, and BDET's management and staff had to devote much time and energies to strengthen BDET financial situation and internal organization. Further improvements in the effectiveness of BDET's staff are expected as the recently appointed middle level managers gain experience, and as the company's procedures are further streamlined (para 3.03). B. Resource Mobilization 6.04 In order to finance the program of operations detailed in Annex 18 BDET will have to raise, in the period 1977-1981, D 143 million of new finan- cial resources (on a commitment basis). Of the resource requirements for 1/ This meets the Bank's Urban Poverty Program criteria, which set the threshold for Tunisia at an investment cost of $10,690 (D 4,608) for a 15-year job.  - 19 - 1978 and 1979, estimated at D 56.2 million, only D 21.2 million have been identified (excluding the proposed Bank loan). These include, beside cash generation and the partial payment of the capital increase, one new French line of credit (partly at concessionary conditions), one new loan from Qatar, one new loan from the Arab Fund for Social and Economic Development, and a local bond issue. The resulting resource gap for 1978-79, of D 35 million, could be covered in part by the proposed Bank loan (D 12.9 million) and in part by domestic bond issues. The latter should become less difficult to pLace (para 2.18 and 5.02) than in the recent past, but they can hardly be expected to yield more than D 2 million in the next 2 years. As a conse- quence, unless other unforeseen sources of concessionary financing become available (a possibility not to be excluded, but on which BDET does not count) BDET will have to borrow the equivalent of D 20 million ($46 million) in the international capital market before the end of 1979. 6.05 BDET confirmed during negotiations that the Government has approved its resource mobilization plan for the 1977-79 period which calls for a D 10 million borrowing in the international capital in late 1977/early 1978 and a second borrowing for the same amount in late 1979. Preliminary contacts that BDET has had with lenders in the Euro-currency market indicate that this objective is realistic. To attain it, however, BDET may have to accept floating interest rates, a risk which BDET has been so far reluctant to bear. Initially, at least, the guarantee of the Government will be necessary to contain the cost of new foreign borrowings in the open market. 6.06 The Government is not yet prepared to permit BDET to pass on the foreign exchange risk to industrial borrowers, on grounds that the inconvert- ibility of the dinar prevents residents from covering their foreign exchange position, and that the tightening of credit conditions, begun with the recent increase of the overall level of interest rates, must be carried out gradually. As a consequence, the Government will continue to bear the foreign exchange risk on BDET's foreign borrowings. This is one of the matters being discussed in the framework of the on-going dialogue between the Tunisian authorities and the Bank on national financial policies. C. Financial Projections 6.07 BDET's Profitability and Interest Rates. BDET's financial projec- tions are presented in Annexes 18 through 22. Under current circumstances, net profits as percent of average net worth would decline from a range of 8.3% to 9.7% in the period 1973-76 (Annex 16) to a mere 8% in 1977 and 1978. This is largely due to the Government having imposed on BDET artificially low lending rates of 8% in 1974 and 1975, and 9% (including a 1% Government sub- sidy on loans to resident industrial borrowers) in 1976 and 1977, in the face of the steadily increasing cost of BDET's borrowed resources, which rose from 5.4% in 1974 to 6% in 1976 and which is projected to reach 6.3% by 1978. Dur- ing negotiations of the 6th Bank loan BDET and the Government had agreed to suspend the effectiveness of the arrangement by which any difference between the actually realized spread on BDET's operations and a minimum of 2.5% would  - 20 - be debited to a Government account (interest equalization account). This was intended to eliminate a form of automatic subsidization of BDET by the Govern- ment. However, though the form of the negotiated agreements was adhered to, the Government had to intervene, at end 1976, to supplement BDET's income (para 5.03). 6.08 BDET will have to seek similar Government interventions in the next few years given the restrictions that Government policies, and the competition with commercial banks, impose on its ability to raise lending rates to a level sufficient to ensure an adequate profitability. Agreement was reached with BDET and the Government during negotiations on the principle that the interest rate actually payable on long-term loans to BDET's clients should be higher by at least one percentage point than that payable on commercial banks' medium- term loans to industry. BDET confirmed that, following the elemination of the 1% Government rebate (para 2.18), the interest cost to be borne by industrial borrowers on new BDET loans will increase from 8% to 9% as of January 1, 1978. Taking into account that, unlike most Tunisian commercial banks, BDET charges interest on its loans six months in advance (which amounts to a 0.4% increase in the effective lending rates) and that its various commissions and fees (other than commitment fees) are equivalent to an annual interest rate sur- charge of about 0.25%, it appears that BDET's nominal rate of 9% on long-term loans corresponds to effective cost of resources to its industrial borrowers of about 9.65%, i.e. more than 1% above commercial banks medium-term rates for rediscountable loans to industry, which are in the range of 8% to 8-1/4% (para 2.18). As long as commercial banks rates remain in this range, BDET feels it cannot raise its nominal rate above 9% for industrial borrowers lest it jeopar- dizes its competitive position. For new tourism loans (for which generally BDET does not have to compete with the commercial banks given the longer maturities required), however, BDET confirmed during negotiations its inten- tion to raise its nominal interest rate from 9 to 9.5%, which would correspond to an effective cost of funds of about 10.15%. This increase affecting only up to 25% of BDET new loans will, however, be insufficient to ensure BDET an adequate profitability, assuming that new resources will be borrowed domesti- cally at a cost of no more than 7% p.a., and that the cost of foreign exchange resources borrowed from 1978 onward will average 8%, and assuming further that the Government will continue to contribute to the servicing of the Kuwaiti dinar KIC bond loan issued in 1976 at 8.5% (para 5.03). 6.09 A form of Government intervention will thus continue to be neces- sary to ensure BDET's financial equilibrium, at least as long as commercial banks rates restrict BDET's ability to raise its lending rate to the level required to ensure an adequate profitability. The Government however concurs with the Bank that its contribution to BDET's profitability should be deter- mined ex-ante, rather than ex-post, thus encouraging BDET to aim at maximizing its operating spread rather than relying on a Government-guaranteed spread. Understanding was reached during negotiations that the Government would selectively subsidize the cost of BDET's foreign exchange borrowings obtained at non-concessionary terms in such a way as to ensure a gross spread of 2.5- 3% on these resources.  - 21 - 6.10 On the basis of the assumptions made above, BDET's net profit as per- cent of average net worth is expected to decline slightly (to 9.2%) in 1977 then rise again to 9.7% in 1978, 11.2% in 1979, and over 12% thereafter. The expected improvement in BDET's profitability will be partly due to the increasing efficiency of BDET's staff, as reflected in the relative decline of administrative expenses from 1.5% of average total assets in 1976, to about 1% by 1981. Profits so projected should permit the company to remunerate out- standing shares at 8% p.a. in 1977 through 19793 (compared to the traditional 6% dividends paid by BDET until 1975). Dividends should be increased to 10% beginning in 1980, thus bringing the yield of BDET's share more in line with that of other banks in Tunisia. At the same time BDET would be able to continue to carry out the very prudent provisions policy it adopted in 1974, while moderately building up its free reserves. 6.11 Share capital increase. In order to maintain the debt equity ratio below 8:1 (para 5.15) new shares would have to be subscribed early in 1978 and paid in in three tranches within 1980. M4ost foreign shareholders, have already announced their intention to exercise their preemptive rights. IFC is also considering exercising its rights. The Government will maintain its share in BDET's ownership by converting into shares part of the D 4 million advance made in 1975 and 1976. As agreed, a greater portion of the Government advance may have to be converted into capital, with the Government acting as a sub- scriber of last resort, in case preemptive rights not exercised by existing shareholders (which may be the case with some of private Tunisian shareholders to whom the short-term yield of BDET's share is not sufficiently attractive) are not taken by other shareholders or by other new private sector subscribers. Direct Government ownership of BDET's shares could thus double, in relative terms, from 12% to 24%, bringing the total of BDET's shares held by public sector institutions (including the Central Bank and various Government-owned companies) to slightly more than 40% of capital. BDET would in any event remain a majority privately owned institution. VII. STRUCTURE OF THE PROJECT, OBJECTIVES AND FEATURES OF THE PROPOSED LOAN A. Loan to BDET 7.01 The proposed loan to BDET will provide needed support for BDET's operational strategy as explained in para 6.02. Firstly, the loan will help BDET meet its foreign exchange resource requirements for the financing of industrial projects especially in the private sector, in the framework of the priorities set by the Fifth Five-Year Plan (1977-81). The earmarking of the loan for priority projects is intended to encourage BDET to concentrate its promotional activities towards areas where special efforts are necessary at this stage of the country's economic development. It is expected that about 60% of the loan will finance projects located outside the Tunis area, thus contributing to the industrial decentralization policy of the Government.  - 22 - Probably 25% of the subprojects financed with the proposed Bank loan, will be sponsored by new entrepreneurs. Assuming a favorable international climate for Tunisian exports abroad, export-oriented projects sponsored by Tunisian entrepreneurs are expected to represent at least 10% of projects financed under the Loan. This will require special promotional efforts, because this type of activity has been so far the almost exclusive monopoly of large public-sector enterprises and of foreign investors. About one-third of the proposed loan is expected to finance projects meeting the labor intensity criterion of D 4,600 (at 1976 prices) invested per job created, which falls well within the Bank's Urban Poverty Guidelines for Tunisia. Labor-intensive projects alone would thus generate about 2000 new jobs, compared to the 1500-2000 jobs expected to be created by other projects financed with the proceeds of the loan. The proposed loan to BDET will also include a $2 million tranche to be earmarked for the financing of expansions of existing SSEs; furthermore, BDET is expected to take a leading role in implementing the SSE component of the proposed Project (Section B of this Chapter). 7.02 The second objective of the proposed loan, is to help BDET establish itself as a viable borrower in the international financial markets, thus becom- ing less and less dependent on concessionary financial resources, and on World Bank loans in particular. Continued Bank support will help consolidate BDET standing on the international financial community. The Bank's share in BDET's total borrowed resources is declining. On a balance sheet basis, at end-1976 it was 23% of total term borrowing of BDET, compared to 48% at end-1974; it is projected to decline to 18% of borrowed resources by the end of 1979 and to 15% by 1981. As mentioned (para 6.05) BDET will submit to the Bank a resource mobilization plan as part of agreements to be negotiated. 7.03 BDET will maintain its debt/equity ratio at or below 8:1. In its financing operations, BDET will continue to observe the following limitations which are specified in BDET's Policy Statement: exposure to a single customer should not exceed 25% of BDET's equity; financing of public sector enterprises should remain less than 30% of total financing; tourism sector financing should continue not to exceed 25% of total financing. The free limit for sub- projects not subject to prior Bank approval will remain D 300,000 ($705,000). 7.04 The proceeds of the loan, other than the $2 million portion to be earmarked in the Loan Agreement for SSE expansion projects, will be used for financing (a) the full cost of directly imported equipment or services needed for the implementation of eligible subprojects; and (b) 70% of the cost of equipment previously imported in Tunisia, and purchased locally for the imple- mentation of eligible subprojects. Taking into account that the loan will be committed over a 2-year period, and given that the average term of BDET's long- term loans is about 12 years, with a 2-year grace period, the loan should be repaid in a period of 13 years, including a 4-year grace period, on a level principal payments basis. The estimated schedule of disbursements is shown in Annex 26.  - 23 - B. Small Scale Enterprise (SSE) Component 7.05 The main objective of the SSE component of the project is to coordi- nate and strengthen on-going initiatives in the field of SSE development, by providing financial resources through the commercial banks' branch networks, with BDET participating in the effort, and administering Bank procedures for subproject selection and disbursement of funds; and by fostering the creation, in parallel, of a system of technical assistance for SSEs, centered around API. It is expected that the experience of this pilot project will lead to the identification of the most suitable channels for a possible future project of the Bank fully devoted to SSE financing. The SSE component of the proposed loan will consist of two sub-components: (i) $5 million to be lent to the gov- ernment for the financing of newly created SSEs through the existing FOPRODI mechanism (paragraph 2.09 above and Annex 24); and (ii) $2 million to be lent to BDET to finance expansion projects of SSEs, which are not presently eligible for FOPRODI assistance (FOPRODI being basically intended to encourage new ventures). Both SSE sub-components will benefit from the technical assistance scheme for SSEs to be set up by API (para 7.10). 7.06 The $5 million sub-component to be borrowed by the Government will be channelled through a special account with the Central Bank of Tunisia and drawn upon by the four commercial banks (Societe Tunisienne de Banque, Banque Nationale de Tunisie, Union Internationale de Banques, and Banque du Sud, which together cover the whole country through a wide network of branches) currently administering POPRODI as well as by BDET which would become the fifth bank participating in the scheme. The establishment of the special account referred to above is a condition of effectiveness of the proposed loan. Bank funds will be used to finance a new FOPRODI credit facility that will complement in the form of medium- and long-term loans the financing plan of newly created SSEs which qualify for concessionary FOPRODI loans for the constitution of their equity capital (see Annex 24). The eligibility criteria for the Bank funds will be, however, slightly more restrictive than those currently established for FOPRODI, in that: (i) total project cost including working capital should not exceed D 200,000 ($460,000 equivalent) at 1976 prices, which is in line with the Bank's working definition of SSEs; (ii) normally the investment cost per job created or maintained should not exceed D 4,600 ($10,700 equivalent) at 1976 prices, which is in line with the Bank's Urban Poverty Program criteria; and (iii) the promoter should be willing to make use of the available technical assistance deemed necessary by API. 7.07 The operational arrangements for the $5 million SSE sub-component will be the following: (i) Promotion, identification, initial'screening and appraisal of eligible SSE projects will be the responsibility of the banks (four commercial banks and BDET) administering FOPRODI. A summary appraisal report will be prepared for each SSE project by the sponsoring bank under a simplified procedure,  - 24 - and with the possible assistance of API. The report will spell out the project's total investment cost, including the needs for working capital, and will propose a financing plan detailing the respective contributions of (a) promoters in the form of equity (at least 30%, part of which can be financed out of the existing FOPRODI concessionary loan facility), (b) the subloan to be made out of the Bank funds, which should not exceed on the average 50% of total project cost; and (c) the sponsoring bank in the form of a term loan out of its own resources (which in consequence should be about 20% of total project cost). The report will also specify the number of jobs to be created and the forms of technical assistance required by the SSE. (ii) Once the SSE project and its financing plan have been approved by the supporting bank and API, the SSE appraisal report will be sent to BDET which will (a) verify that the project complies with the Bank eligibility criteria (paragraph 7.06); (b) submit to the Bank on behalf of the Government approval and disbursement applications; and (c) maintain the necessary documentation, particularly as re- gards disbursement, available for inspection by Bank super- vision missions. (iii) The SSE's repayment obligation for the Bank funds will be toward FOPRODI (i.e. the Government) but the responsibility of loan collection will remain with the banks sponsoring the project, which will share evenly with the Government the risk of loss on both FOPRODI loans financed out of the Bank funds and term loans made out of their own resources. For their services, the participating banks will receive from the Government commissions patterned after those they cur- rently receive for the administration of the existing credit facilities (flat percentage commission on disbursements of FOPRODI funds and commission based on the amount of prin- cipal and interest recovered on behalf of FOPRODI with an increasing percentage depending on the recovery ratio; see Annex 24). These arrangements will be reflected in the FOPRODI agreements between the Government and the participating banks. The same agreements will also specify the banks' commitment to participate with their own resources -- generally with 20% of the projects' costs -- in the financing of FOPRODI assisted projects. The amendment of the FOPRODI agreements to these effects, as well as the signing of a similar agreement between the Government and BDET, are a condition of effectiveness of the proposed loan. 7.08 The second SSE sub-component, amounting to $2 million will be part of the loan to BDET but will be earmarked to finance the expansion of exist- ing SSEs with net fixed assets valued (before expansion and excluding land) at less than D 100,000 ($235,000 equivalent) at 1976 prices. The conditions  - 25 - of subloans and the eligibility criteria for such expansion projects will be similar to those applying to subloans for newly created SSE projects, but the repayment obligation of borrowing SSEs will be toward BDET with no risk- sharing mechanism between BDET and the Government. In order to ensure that SSE expansion projects will receive appropriate attention BDET will set up a special unit staffed by two SSE specialists. The unit will be responsible for the processing of these projects as well as for administering Bank funds of thie $5 million SSE sub-component to be channelled through the FOPRODI scheme. The establishment of this unit is a condition of effectiveness of the proposed loan. 7.09 The terms of Bank-financed FOPRODI subloans for SSEs are expected to be between 7 and 11 years, with grace periods between 2 and 3 years. Cor- respondingly, the SSE component will be repayable to the Bank, by the Govern- ment and BDET respectively, over a period of 13 years, including 4 years of grace, on a level principal payment basis. Such a term is expected not to create restrictions on the appropriate duration of subloans, while keeping the possible roll-over of funds to no more than about 25% of the SSE compo- uent. The cost of funds to SSE borrowers will be the same as the cost charged by commercial banks on medium-term loans to larger industrial enterprises, currently in the range of 8 to 8-1/4% except f'or subloans financing invest- ments in the less developed regions of the interior and industrial investments of export-oriented enterprises, for which the rates will be between 6.75 and 7%. The foreign exchange risk on the Bank funds will be assumed by the government. Although Bank funds will be usable to finance one half of the full investment cost of SSE projects, without distinguishing between foreign and local currency expenditures, it is expected that on average this will imply little, if any, local currency financing with Bank funds, as the foreign exchange costs of SSE investments in Tunisia are estimated to vary between one-third and two-thirds of total costs, averaging about 40% of total. The estimated schedule of disbursements is shown in Annex 26. 7.10 Techncial Assistance. The establishment of a system to deliver technical assistance to SSEs is one of the major objectives of the projezt. The Government intends to entrust to API the responsibility of setting up such a system, making use of API's existing network of 4 regional branches (which is expected to expand to 8 branches in the near future). There will be a central core of four SSE experts at API's headquarters, in Tunis, and a small unit of two experts in each regional office. API's technical assistance staff will receive the support of CNEI and of AFI, whose activities in the field of SSE development will be coordinated by API. The scheme, which would be initially staffed by 20 specialists, is conceived in view of the needs of Tunisian SSEs in general. Initially, API's technical assistance staff would concentrate on identifying SSE projects and assisting sponsors in preparing their project, obtaining the financing, and properly implementing the proj- ects. Later, the API-centered extension service will provide follow-up assistance, especially in the areas of financial management, marketing and improvement of productivity. API is expected to need initially specialized expertise, estimated at 69 man-months, to establish the central core of four SSE experts and train the experts in the regional offices. At least two and  - 26 - at most four expatriates (depending on the availability of Tunisian experts with the appropriate profile and SSE experience to fill two of the four posi- tions envisaged) will be recruited by the Government. Financing of the foreign exchange cost of the expatriates is expected to come from bilateral and/or multilateral aid agencies. However, it was agreed with the Government during negotiations that, if firm commitment from these sources is not obtained by July 1, 1978, a portion of the loan to the Government, amounting to $300,000, would be earmarked to finance the foreign exchange cost of these experts. Agreement was also reached on a timetable for the establishment of the tech- nical assistance system and on the principle of periodic consultations between the Bank and the Government to review the functioning of the system (Annex 25). 7.11 Benefits and Risks of the SSE Component. It is expected that the SSE component of the Project will finance between 50 and 60 new sub-projects and between 20 and 30 expansions. About 2,300 new employments will be created, at an average cost/job of $7,000, and half of the sub-projects are likely to be located outside of the Tunis metropolitan area. In addition, the Project will have an important institution building effect. Beside supporting API in its efforts to set up a country-wide network of assistance to SSEs, it will reinforce the FOPRODI scheme which could eventually be institutionalized and 4ecome a suitable counterpart for the Bank in future larger operations specifically oriented towards SSEs. Moreover, the efforts to be undertaken by BDET in developing a specialization for SSEs will leave open an alternative channel for further Bank assistance to SSEs in Tunisa. The relative lack of experience, both in the Bank and in Tunisia, in assisting Tunisian SSEs en- tails a moderate risk that the Project's targets will not be fully achieved. The risk, however, is well worth taking, also because the proposed mechanism will ensure that the Project's funds will be used for worthwhile projects, even if no success were to be obtained by the Project in its institution building objectives. VIII. AGREEMENTS REACHED AND RECOMM4ENDATIONS 8.01 During negotiations, agreement was reached on the following prin- cipal issues affecting the loan to BDET: (a) distinction between the traditional dfc portion of the loan ($28 million), reserved for financing industrial projects in the framework of the priorities estab- lished by the Fifth Five-Year Plan (1977-81) (paras. 6.02 and 7.01), from the $2 million portion of the loan to be earmarked for expansion of existing SSEs (para. 7.08); (b) strengthening of BDET's appraisal work (paras. 3.06; and 3.09); (c) strengthening of BDET's supervision work (para. 3.07);  - 27 - (d) BDET's plan of action to strengthen its contribution to the development of Tunisia's Capital Mlarket (para. 4.12); (e) measures taken by BDET to ensure full recovery of a loan to an hotel company (para. 5.06); (f) BDET's submission to its Board of a special report on loan reschedulings, should these affect in any fiscal year more than 15% of its loan portfolio (para. 5.09); (g) inclusion in BDET's hotel loan contracts of a timetable for the mortgage validation process (para. 5.10); (h) BDET's maximum debt/equity ratio of 8:1 (paras. 3.05 and 5.15); (i) BDET's resource mobilization plan (para. 6.05); (j) BDET's long-term lending rates for industrial and tourism proj- ects (para. 6.08); and (k) Government's contribution to BDET's profitability in the form of subsidies towards the cost of selected BDET's foreign exchange borrowings obtained at non-concessionary terms (para. 6.09). 8.02 Agreement was also reached on the following principal issues affecting the SSE component: (a) SSE eligibility criteria (para. 7.06); (b) operational arrangements, including BDET's role of intermediary between the Bank, the Government and the commercial banks participating in the FOPRODI scheme, risk-sharing between the commercial banks and the Govern- ment, and the remuneration of commercial banks (para. 7.07); (c) onlending rates for the SSE component (para. 7.09); and (d) design, staffing, financing and timetable of establishment of the system of technical assistance to SSEs (para. 7.10). 8.03 Subject to the conditions of effectiveness described in paras 7.06, 7.07 and 7.08, which apply to both loans, the project is suitable for a Bank loan of US$30 million to BDET on the terms outlined in paragraph 7.04 and for a Bank loan of US$5 million to the Government for onlending to SSEs through the FOPRODI's scheme on the terms outlined in paragraph 7.09.   ANNE I Table 1.1 Table/Tablaao 1.1 VOLUME OF MAIN INDUSTRIAL PRODUCTS, 1969 - 1976 (in thousands of tons unless indicated otherwise) PRINCIPAUX PRODUITS INDUSTRIEIS EN QUANTITE, 1969 - 1976 (en ailliers de tonm.s ou aotre unite specifice) AcCals/Raal9 isations Est. /Et. 1969 1970 1971 1972 1973 1974 1975 1976 sECTeURs/PRODuITs SECTORS/PRODUCCSS Mining Mines Crude Oil 3707 4146 4097 3977 3870 4130 4600 3900 Petrole brht Phosphate rock 2600 3023 3162 3387 3474 3823 3456 3400 Phosphate Iron Ore 945 773 935 884 809 795 614 535 Mineral de fer Lead concentrate 38 37 34 33 25 21 18 15 Concentre de plomb Zinc Concentrat 3 17 22 22 20 16 11 14 16 Concentre de ziin Natural Gas (10 3) - - - 19 112 199 210 250 Cez naturel (10 m3) Salt (sea) 283 245 250 284 355 300 423 425 Sel marin Chemical fluor-spar - 17 28 41 43 28 34 38 Spath-fluor chimique Barite and others 12 14 6 30 19 17 15 20 Baryt et divers Food Processing Industries Alimntaires Cereal Products n.a. n.C. n.e. 691 752 795 852 922 D4rives cerealiers Olive oil 55 25 90 180 75 130 117 160 Huile d'olive Sugar 54 78 81 88 80 77 86 97 Sucre Wine (1000 hi) 847 600 950 1000 1100 1200 1000 1000 Vins (1000 hl) Beer (1000 hl) 169 201 265 330 375 363 320 375 Biere (1000 hl) Canned fruit and vegetable 29 32 34 31 43 48 50 54 Conserves fruits et legumes Biscuits, chocolates 6 7 9 8 9 9 10 11 Biscuits, chocolat Tobacco na. n.a. n.a. n.a. n.S. n.a. n.a. na. Tabac Textiles Clothing Leather Textilej; H.abillementCuir Yarn]f5ons) 5220 6679 8002 11070 12265 13218 14430 14430 Fili (oneres) FabricJ (1000 m3) 27087 32069 35298 64263 69361 75373 81100 91400 Tissus ./(l00 m3) Shoes (1000 pairs) 3303 3848 4200 4857 4853 4054 5072 6404 Chaussures (1000 paires) Carpets (ton) 764 901 1000 1190 1261 1020 1314 1782 Tapia (tonnes) Construction Materials Materisu. de Construction Cement 605 547 584 628 525 538 613 580 Ciment red Ceramics 230 270 269 296 285 315 521 945 C;ramique ro-ge Lime ., 194 213 234 223 243 260 290 290 Chaux 2 Tile (1000 m2) - - - 276 510 585 723 1010 Carrea.o do faience (1000 m Chemicals Chimie Myperphosphate 58 28 7 9 23 58 10 90 hyperphosphates Single Superphosphate 33 33 36 41 50 29 52 50 Super simple Triple S.perphosphate 333 372 424 414 400 410 305 350 Super triple Phosphoric acid 9 7 1 62 93 124 102 220 Acide phosphorique Fertiltzer - - - 9 11 14 17 26 Engrais Composes Paper and others Papier et divers Pulp 20 19 20 22 23 23 22 24 eate a papier Nevsprint - 2 12 14 18 22 15 16 Papier d'impression Packaging 12 13 14 16 15 15 18 19 Emballage en papier 1/ Series since 1970 do not correspond with previous series/ Lea series depuis 1970 no correspondent pas aux series *nterieures Source: Ministere du Plan  I'-' 20 20 CC 2.2 '-0 'CC o 0 CD 0. CO CD 20 20202020200 202 00200'0 'OC-020200 00 20 2