Morocco - Ninth Banque Nationale Pour Le Developpement Economique (BNDE) Project

Document of The World Bank l copy FOR OFFICIAL USE ONLY Report No. 3407-MOR MOROCCO STAFF APPRAISAL REPORT NINTH BNDE PROJECT June 2, 1981 Regional Projects Department Europe, Middle East and North Africa Region 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.  CURRENCY EQUIVALENT Currency Unit = Dirham (DH) US$1 = DH 5* FISCAL YEAR January 1 - December 31 GLOSSARY OF ABBREVIATIONS BCM Banque Commerciale du Maroc BCP Banque Centrale Populaire BdM Banque du Maroc BMCE Banque Marocaine pour le Commerce Exterieur BMCI Banque Marocaine pour le Commerce et l'Industrie BNDE Banque Nationale pour le Developpement Economique BRP Banque Regionale Populaire CCG Caisse Centrale de Garantie CDM Credit du Maroc CMPE Centre Marocain de Promotion des Exportations DFC Development Finance Company EEC European Economic Community EIB European Investment Bank ERR Economic Rate of Return FRR Financial Rate of Return ITC International Trade Center LIBOR London Inter-Bank Offered Rate MCI Ministry of Commerce and Industry PPAR Project Performance Audit Report SGMB Societe Generale Marocaine de Banques SSI Small Scale Industry * US$ I = DH 5.26 as of 5/25/81; DH 4.33 as of 1/1/81; DH 3.76 as of 1/1/80.  FOR OFFICIAL USE ONLY MOROCCO BNDE IX PROJECT Table of Contents Page No. I. INTRODUCTION ............................................. 1 II. THE INDUSTRIAL SECTOR .................................... 2 A. Performance and Constraints .......................... 2 B. The 1981-85 Plan ..................................... 3 C. Investment Demand in Manufacturing and BNDE'S Role ... 4 III. THE FINANCIAL SECTOR ..................................... 6 A. Impact of the 1978-1980 Austerity Plan .... ........... 6 B. Interest Rates and Cost of Capital .... ............... 7 C. Financial Intermediaries for Financing Industry 8 IV. BANQUE NATIONALE POUR LE DEVELOPPEMENT ECONOMIQUE (BNDE).. 9 A. Structure ............................................ 9 B. Management and Staff ................................. 10 C. Operations ........................................... 12 D. Resource Position .................................... 13 E. Financial Performance ................................ 15 F. Quality of Portfolio and Audit ....................... 16 G. Resource Requirements ................................ 19 H. Prospects ............................................ 21 V. THE PROJECT. ..22 A. Objectives .23 B. Justification .23 C. Loan Features .24 * D. Procurement and Disbursement .25 E. Benefits and Risks .26 VI. AGREEMENTS REACHED AND RECOMMENDATIONS ..26 This report was prepared by Messrs. J.M.R. Feige, M. Diop, E. Forestier and J.F. Landeau, who visited Morocco in November 1980 to appraise the project. This document has a restricted distribution and may be used by recipients only in the perforrnance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization-  Table of Contents (Continued) ANNEXES Annex 1: Structure of Interest Rates Annex 2: Trends of Export Activity in Manufacturing Annex 3: Estimated Resource Position as of December 31, 1980 Annex 4: Income Statements 1977-80 Annex 5: Cash-flow Statements 1977-79 Annex 6: Balance Sheets 1977-80 Annex 7: Analysis of Financial Data Annex 8: Past Operations (1977-1980) and Forecast (1981-1984) Annex 9: Major Assumptions for BNDE's Five-Year Operational and Financial Forecasts (1980-1984) Annex 10: Estimated Resource Requirements Annex 11: Projected Income Statements 1981-84 Annex 12; Projected Source and Application of Funds 1980-1984 Annex 13: Projected Balance Sheets 1981-84 Annex 14: Projected Ratios Annex 15: Project File Annex 16; Estimated Disbursement Schedule for the Proposed Loan  I. INTRODUCTION 1.01 The objectives of the proposed BNDE-IX project are to support Government objectives of industrial development in Morocco namely: (i) improving the efficiency and fostering competitiveness of existing industries; (ii) promoting and diversifying manufactured exports; and (iii) encouraging increased private investments. 1.02 The proposed project provides for a loan of US$70 million to BNDE for (i) a traditional line of credit of $56 million with the objective of providing funds to finance part of the foreign exchange cost of industrial projects through 1981-83; (ii) a pilot component of $14 million to finance the foreign exchange cost of export-oriented industrial projects. 1.03 The BNDE-IX loan follows the previous loan to BNDE by the Bank (Loan 1428-MOR, US$45 million) which became effective in December 1977, and which is now essentially fully committed. The loan would finance mainly BNDE's traditional industrial projects satisfying, in particular, a minimum economic rate of return. The pilot export component is designed to improve BNIDE's promotion and financing of export-oriented projects. BNDE will develop and test special procedures to identify and select a limited number of such projects from its pipeline for financing under the proposed loan, and such projects would also be specially supe.tseA to provide useful feedback data to prepare BNDE for a possible furtlher Banik loan focussing on the financing of projects designed for export-oriented industries. Project Performance Audit Report (PPAR) 1.04 The relevant PPAR is No. 1805, dated November 23, 1977, covering the fifth loan to BNDE (Loan 736-MOR). The Completion Report forming the basis for the PPAR was prepared at the same time as the appraisal of the eighth loan to BNDE (Loan 1428-MOR). Points stressed in the PPAR such as the need for realistic interest rates, and the dangers inherent in financ- ing large public sector projects in which BNDE's influence on project design is marginal, had been taken into account in BNDE VIII and are also fully reflected in the preparation of BNDE IX (paras. 3.08, 3.09 and 4.28).  - 2 - II. THE INDUSTRIAL SECTOR A. Performance and Constraints Performance 2.01 In order to redress its rapidly deteriorating external financial situation, the Government initiated an interim Austerity Plan (1978-80). The Plan curtailed the growth of large capital intensive industries and developed an industrial policy more adapted to the objectives and limited resources of the country: continuation of economically justified long-term investments (cement and sugar for local market; phosphoric acid for exports); development of the manufacture of intermediate and capital goods; strengthening of the industrial exports policy; industrial decentraliza- tion; and the promotion of SSI for employment creation. At the same time the Government reassessed its industrial development strategy which had previously been based on investments in large capital intensive and mainly public sector enterprises, and on a policy of import substitution for consumer and intermediate products. Investments decreased substantially, imports of manufactured goods (mainly intermediates and capital goods) dropped by 15% in volume in 1978-79, the growth of manufacturing slowed down to 4.5% p.a. in those years, and the growth of employment deceler- ated. Fxports of manufactured goods increased in volume at about 17% p.a. in 1980; as compared with 10% p.a. during 1973-77, contributing to a reduc- tion in the deficit of the balance of payments from 17% of CDP in 1977 to an estimated 8%A: in 1980. Textiles and chemicals emerged as significant export industries with food processing, which has traditionally exported about 7% of its production; these three sectors account for about 90% of manufacturing exports. The share of manufactured exports in total exports increased from 23.6% in 1975 to 38.5% in 1979. The export potential for manufactured goods will be more fully developed under the new 1981-85 Plan (para. 2.05). Constraints 2.02 There are several constraints that still limit the possibilities of growth of the manufacturing sector: the balance of payments deficit remains substantial, and limits increases in imports of equipment and raw materials for industry, resulting in under-utilization of capacity; the pervasive lack of well-trained technicians and foremen in manufacturing; and the current incentive system (para. 2.09). 2.03 Foreign investments have been limited as a result of the moroc- conization policy introduced in the early 70's, administrative delays, and the shortage of skilled labor, even though guarantees are provided for the transfer of dividends and the repatriation of capital. The incentives of the Investment Code (duty exemptions on imported equipment, 2% interest rebates on long and medium term BNDE loans to manufacturing, and income tax  - 3 - exemptions) have not encouraged industrial enterprises to select labor intensive processes, and the exports incentives (tax exemptions on import- generated profits, and lower interest rates on short-term export credits) have been insufficient to offset the negative impact of protection on the price of local inputs and the relatively higher profitability of the domestic market. B. The 1981-85 Plan 2.04 General Objectives and Strategy. A rapid rate of population growth (over 3% p.a.) and a high level of unemployment (9.7% in 1980) require an acceleration of the growth of output and employment. The Plan targets a GDP growth of about 6.5% annually, which would allow an annual increase in consumption of about 2.5% per capita in real terms and an annual growth of employment of 3.7%, i.e. slightly more than the projected 3.3% annual growth of the labor force during the period. To achieve this objective while overcoming the severe foreign exchange and savings con- straints of the past few years, the Plan emphasizes export-oriented growth with a projected real growth of exports of 8.5% p.a., and a major domestic savings effort. However, the large volume of investments, estimated at DH 110 billion in 1981 prices, to support this strategy means that external financing requirements will remain substantial over the 1981-85 period. 2.05 The Industrial Sector. Industrial investment is projected to total DH 20.9 billion (19% of total investments) during 1981-85 and gene- rate a growth rate of 8.4% p.a. in industrial value added, increasing industrial employment by 5.3% p.a. The 1981-85 Plan for industry gives first priority to the increase of industrial exports, as without such exports Morocco could not continue importing the raw materials and equip- ment goods it needs without further destabilizing its balance of payments. Under the 1981-85 Plan, investments in export-oriented projects, including manufacturing, would total about DH 11.6 billion (55% of total projected investments) of which DH 10.7 million are for large projects for phosphate derivatives in which Morocco has a marked competitive advantage. Exports of industrial products are projected to grow by 13.3% p.a. and their share in total exports should continue rising, reaching 45% by 1985 compared to 38.5% in 1979. 2.06 The other major objectives for industry in the new Plan are (i) the promotion of labor intensive small and medium scale industries (12% of total industrial investment or DH 2.6 billion); the Bank is supporting this effort through the Second Small Scale Industry project (SSI-II), presented to the Board in July, 1981; and (ii) the selective development of engineer- ing industries (15% of total industrial investments or DH 3.1 billion). The recent review of the engineering industries by the Bank 1/ should 1/ Morocco-Review of the Engineering Industries - February 2, 1981.  - 4 - further help to develop this subsector where imports represented 60% of total manufacturing imports in 1977. 2.07 Bank Support. The Bank supports the Plan's objectives and would, through the proposed project, the SSI-II project, other supportive action to industry, and its sector work help the Government reach these objec- tives. In addition, a number of measures to be taken to strengthen exports, to reform the incentive system for industry, and to improve the procedures for project selection and evaluation, project tendering and product standardization were agreed upon during recent discussions on industrial policy in Morocco. Financing for some of these measures is pro- vided under the SSI-II project. 2.08 Concerning export promotion, the recently created Centre Marocain de Promotion des Exportations (CMPE), assisted by the International Trade Center (ITC) in Geneva, should become the central institution for the pro- motion and the development of exports. ITC has proposed a 3-year (1982-84) assistance program to CMPE to be financed by UNDP. 2.09 A revision of the incentives system (Protection, Investment and Export Codes) will be undertaken by the Government after a series of studies to assess the current system and to recommend appropriate changes, are completed by the end of this year; these studies, supported by the Bank, have been in progress since 1979. They will serve as a basis for rationalizing the protection and price structure, and for recommending new incentive systems. Government recommendations for reformulating the struc- ture of protection and of the incentive codes are expected in the first quarter of 1982, and the promulgation of a new Export and Investment Code is scheduled for the end of 1982, while the completion of a gradual reform of the protection structure and tariffs is envisaged by mid-1983. The new Codes are expected to reduce administrative delays, and the various biases that exist presently between sectors and between firms. They are also expected to offer more effective incentives to foreign investors to award subcontracting contracts to Moroccan firms, and encourage transfers of technology particularly needed by the engineering industries. C. Investment Demand in Manufacturing and BNDE's Role 2.10 The new Plan estimates the amount of investments in the manufac- turing sector only (excluding OCP 1/) at DU 10.2 billion (US$2.0 billion) in 1981-85, 80% of which in the private sector and 20% in Government sponsored projects (sugar mills, and a steel rolling mill in particular). Besides its own direct lending activity, BNDE plays a major role in the distribution of medium-term loans by commercial banks to the industrial 1/ OCP has an ambitious investment program of about US$2 billion over the 1981-85 period for which, as for past icvestmeAxts, it has alreadJ secured its own external financing.  sector. Medium-term loans for industry, initially extended by commercial banks, may be rediscounted with the Central Bank (BdM) but only if appraised and approved by BNDE. During the 1974-78 period BNDE has been instrumental in providing financing for 45% of all industrial projects approved under the 1973 Investment Code, for 24% of total investment costs of all industrial projects, of which 16% consisted of BNDE's direct loans and 8% of rediscountable loans extended by commercial banks and approved by BNDE. BNDE will continue to have a major responsibility in the financing of manufacturing investments, and BNDE's approvals forecasts for 1981-85 show that BNDE will provide $92 million/year financing for the manufactur- ing sector, of which $60 million in the form of direct BNDE loans, $31.5 million in rediscountable medium term loans, and $0.5 million in BNDE's equity participations. This $92 million compares to total average invest- ments projected (excluding OCP) of US$408 million per year; as a result, in 1981-85, BND)E's share in the financing of the manufacturing sector (excluding OCP) should remain close to the 24% level achieved in 1974-78. However, besides the rediscountable loans and the SSI investment program to be carried out mainly by commercial banks, the value of investments in manufacturing (excluding OCP) to be financed by BNDE itself through direct lending would increase from 16% in 1974-1978 to about 20% in 1981-85, reflecting BNDE's financing of a larger number of industries. This increase reflects a somewhat ambitious program for BNDE, in view of the need to put greater emphasis on the quality of project appraisal in order to more carefully select projects to reduce the future risks of arrears, and to improve the current level of profitability. It also suggests that BNDE needs an increasing technical and institutional assistance in order to keep up its key position as the major source of financing for the manufac- turing sector, and the only financial institution authorized to provide industrial projects with contractual long term financing under the 1973 Investment Code. Under the proposed Bank loan, BNDE would receive over a 30-month period (mid 1981-end 1983) about US$20 million annually, or about 33% of its projected direct annual lending requirement for manufacturing. 2.11 In line with the 1981-85 Plan orientation to give high priority to the increase of manufactured exports BNDE, under the proposed project, would have to allocate a minimum of US$l0 million or 20% of the loan amount to export-oriented projects. 1/ Total investment in manufacturing for export-oriented projects (excluding OCP) would total DH 763 million or US$153 million during 1981-1984 ($38 million/year), mainly in textiles and food processing (see Annex 2) and BNDE could be expected to finance these projects with an annual amount of US$9 million 2/. The export loan com- ponent of the proposed project (US$4 million p.a.) would therefore provide 44% of BNDE's projected needs for financing export projects during the 1/ See definitions in para. 5.08. 2/ Assuming that BNDE finances 23.8% of the total investment of these projects, in line with the average percentage of financing in manufac- turing projects provided in 1974-78.  - 6 - commitment period of the proposed loan. The financing of export-oriented projects is a practically new activity for BNDE, and BNDE must develop its identification and appraisal capability in this field (see Chapter IV). As of September 1980, BNDE's tentative pipeline of 8 export-oriented projects totalled US$18 million in investment costs, with a total direct financing requirement of US$5 million from BNDE. III. THE FINANCIAL SECTOR 3.01 Morocco has a well developed financial sector. It consists of fifteen commercial banks, five specialized institutions, and two savings banks, which are controlled by the Banque du Maroc (BdM), Morocco's Central Bank. Medium- and long-term financing is provided to private investors mainly by three of the specialized institutions; the agricultural credit bank (CNCA), the housing and tourism bank (CIH), and the industrial bank (BNDE), all of which have received Bank loans. There is also a capital market at the Casablanca stock exchange where shares of private companies are listed and traded, but its role is limited (less than 300,000 shares traded in 1979) and has been declining (volume of shares traded declined by 75% between 1975 and 1979). A. Impact of the 1978-1980 Austerity Plan 3.0? Late in 1977, the Government recognized the need to bring public consuraption, investment, and imports under an increased control to avoid a liquidity crisis. To restore the balance between investment and savings, several deflationary measures were taken in 1978. Public capital expendi- tures were curtailed by limiting Government reliance on both Central Bank advances and foreign loans with maturities of less than ten years; short- term credit by commercial banks to the private sector was tightened; and interest rates on time deposits were increased to stimulate domestic savings, the low level of which is a serious weakness of the Moroccan economy. 3.03 As a result of these actions and other austerity measures, the Moroccan economy entered a recession cycle. The industrial production index did not rise between 1978 and 1979, and capital expenditures declined (in current prices) by 27% in 1978 and 13% in 1.979. Preliminary data for 1980 seem to indicate, however, a turnaround in both production and invest- ment trends in the manufacturing industry. 3.04 To curb inflationary pressures, the Government limited the growth of short-term credits to 10% in 1979, but freed the growth of rediscount- able medium-term credits and of loans to exDorters. The results did not meet the Government's expectations, because short-term credits granted by the banking system increased by 13% in 1979 while medium-term ereditg  decreased by 2/; the same undesirable pattern, but more pronounced, was observed during the first ten months of 1980. The credit squeeze worsened the traditional poor liquidity of the Moroccan commercial banks, leading them to rely considerably more on the Central Bank rediscount and on the interbank short-term money market, where interest rate reached 10.5% in late 1979. This situation did not ease in 1980 and, for the first time since 1975, the Central Bank raised its basic rediscount rate, from 4.5% to 6%. * B. Interest Rates and Cost of Capital 3.05 The Government determines interest rate ceilings on both deposits received and loans granted by financial institutions in Morocco. The interest rate structure was overhauled on October 1, 1980 in consultation with the IMF; the new structure is detailed in Annex 1. Interest rates were increased on the average by one-half percent on term deposits to attract more savings, and lending rates were also raised by 1-2% because of higher inflation and increased cost of borrowing for financial institutions (para. 3.07). This followed a previous raise in interest rates on term deposits in mid-1978. Term deposits increased by 36% in 1978 and 24% in 1979, and the share of deposits maturing beyond four months in the total rose from 61% in 1977 to 65% in 1979. The recent restructuring is expected to continue this trend. 3.06 Cost of Resources. The cost to the commercial banks of local cur- rency resources varies widely depending on their maturity: sight deposits yield no interest, except for Moroccan workers abroad on repatriated sav- ings (3% p.a.), and insurance companies (4% p.a.); short-term deposits yield from 4% p.a. for one-month deposits to 9% for eighteen-month deposits, and there is no ceiling for deposits maturing beyond eighteen months. Cost of rediscount facilities at the BdM ranges from 3.5% for commercial paper for agriculture to 5% for medium-term paper, while the basic rediscount rate is 6%. Local currency bonds carry interest rates up to 10% p.a. and can be issued only by specialized financial institutions (CIH, BNDE, CNCA) and large public enterprises. The cost of directly contracted foreign exchange resources is not regulated by the Government and thus reflects international rates, although the Government influences the choice of borrowed currencies, and indirectly their cost, because it bears the exchange risk. 3.07 Lending Rates. For the first time since 1975, lending rates were raised across the board in October, 1980. The maximum rates charged by commercial banks on rediscountable loans were increased from 8% to 9% p.a. for short-term loans, and from 8% to 10% p.a. for medium-term loans. BNDE is now charging a single rate (12% p.a.) on all its loans regardless of maturity, instead of 10% for medium-term loans and 11% for long-term loans as was the case until October 1980.  - 8 - 3.08 Effective Cost of Borrowing. In spite of this rate restructuring, the effective cost of capital for industrial borrowers is 10% p.a. regard- less of maturity. This is because all BNDE-financed industrial projects approved under the 1973 Investment Code are eligible for a 2% per annum interest rate rebate. (The same applies to Bank-financed SSI subloans with a maturity of more than seven years because their interest rate is pegged to BNDE's.) 3.09 Interest rates have, however, been positive in real terms in most recent years and are expected to remain positive given projected inflation rates. Inflation remained moderate through 1976 because of an array of price controls and subsidies, which shielded domestic prices against rapid changes in international price levels. Inflationary pressures, however, developed in 1977 and prices as measured by the cost-of-living index rose 12.5%. Austerity measures imposed in 1978 slowed down the inflation rate to 9.7% in 1978, 8.3% in 1979, and 9.4% in 1980. Over the commitment life of the proposed project (from 1981 through 1983), nominal and effective rates (12% and 10%) are expected to be positive compared to projected inflation rates averaging 8-9% p.a. C. Financial Intermediaries for Financing Industry 3.10 The Commercial Banks. At the end of October 1980, the fifteen commercial banks had total assets of DH 20.5 billion ($4.1 billion). The degree of concentration is high: two banks (BCP and BMCE) accounted for 44% of total assets at the end of 1979, and five other banks (BCM, BMCI, CDM, SGMB, and iMICB) accounted for another 43%. The banking network totalled 543 branches at the end of 1979, but its geographical distribution is uneven because 25% of all branches are located in Casablanca and another 50% in cities along the Atlantic coast. 3.11 Financial intermediaries are responsible for the bulk of medium- and long-term credits to the economy, and had granted 84% of outstanding loans at the end of 1979, compared to 16% by the commercial banks. Finan- cial intermediaries are specialized by sector of activity. CNCA lends pri- marily to agriculture and to agro-business operations 1/, CIH lends to tourism projects and housing 2/, and CDG is a Government institution in charge of public fund management (e.g., pension and insujrance funds, postal savings, etc.). BNDE plays a key role in financing capital expenditures of the Moroccan industry (see Chapter TV). 1/ See Staff Appraisal Report on CNCA IV (No. 2426-MOR, dated April 30, 1979). 2/ See Staff Appraisal Report on CIH IV (No. 3014-MOR, dated December 18, 1980).  - 9 - 3.12 Financing of industrial investment takes various forms, from medium- and long-term credits granted by commercial banks and BNDE, to supplier credits from abroad, leasing, and equity participation. There are no data on supplier credits. Although discussions with industrial pro- moters showed that these credits are available, the exchange risk involved is often a deterrent. Banks, such as BMCI, offer 3-year loans limited to the financing of equipment; processing delays are short, but the cost is higher than medium-term credits. Leasing, introduced in 1965, is offered bv three institutions (Maroc-Leasing, Maghrebail, Credico), but its impact is still marginal with financing peaking at DU 121 million in 1977. Equity participations are taken occasionally by the banks and BNDE, but there is no company specializing in venture capital although the idea is under consideration. There are also less orthodox forms of financing such as short-term credits to promoters to help them raise the necessary equity, and short-term revolving credits to allow banks a greater spread than on straight medium-term loans; the extent of such practices is not known. IV. BANQUE POUR LE DEVELOPPEMENT ECONOMIQUE (BNDE) A. Structure 4.01 Since the Bank's last appraisal of BNDE in 1976, the corporate status of BNDE has remained unchanged, but its ownership structure has somewhat been altered. Details on BNDE's organization and ownership structure are available in the Project File, and major features are summarized below. 4.02 Ownership and Control: As agreed with the Bank, BNDE doubled its capital to DH 140 million ($28 million) in December 1977. The Moroccan Government directly controls 34% and indirectly another 16% through Caisse de D6pot et de Gestion (GDG; 11%), Societe Nationale d'Investissement (SNI; 2.2%) and five other publicly controlled financial institutions (2.8%). Consenuently, Government control has increased since 1976 from 38% to 50%, principally through CGD which was not previously a BNDE shareholder. The increase in Government ownership is not expected to influence BNDE's policies and management; furthermore, CDG's presence in BNDE's Board in the person of its competent and highly regarded Director-General constitutes a positive development. 4.03 Board and Committees: Except for the above, no major changes in institutions represented in BNDE's Board have occurred since the last Bank appraisal. Foreign institutions, including IFC, are represented by eight directors compared to ten for the Moroccan Government and two for private Moroccan shareholders. IFC is the sole foreign member of the Executive Committee of BNDE which meets monthly to review and recommend final approvals of all loans amounting to DH 7 million or more (DH 4 million before 1979).  - 10 - B. Management and Staff 4.04 There have been major changes in BNDE's management and staff starting with the appointment in January 1978 of Mr. Abdelkader Benslimane, former Finance Minister, as President Director-General. At about the same time, BNDE's experienced Director of the Economics Department and his deputy left BNDE to fill senior positions elsewhere. Two other depart- ments, Engineering and Promotion, were also without a titular Director at the time of appraisal. These latter developments had affected BNDE's performance negatively, particularly as regards its economic projects and sector work; in addition, inadequate follow-up on loans resulted in mount- ing arrears. 4.05 These problems were regularly discussed with BNDE during super- vision missions, and were examined in detail during the appraisal in November 1980. Partly as a result of these discussions, the President instituted a broad organizational review of the staffing and management needs of BNDE in the light of its widening scope of operations. As a result, a new organizational structure 1/ was put into force on January 5, 1981. 4.06 The reorganization involves the consolidation of the present six Departments into four larger ones, each headed by a Director seconded by a full time Deputy Director. In addition to the present three Directors who are confirmed in their respective expanded Departments (i.e. Finance and Loan Administration, Project Appraisal, Follow-up and Legal), the former Director of the Promotion Department, who had been on secondment as a Vice-President to the African Development Bank, takes over the newly created Development Department. The new structure aims to group in each new department related and complementary activities for better coordination and efficiency. Two Deputy Directors-General will coordinate operations between the four Departments, and act for the President Director-General during his absence. 4.07 Within the new structure greater autonomny and authority will be given to the Directors, and the appointment of Deputv Directors allows better supervision and provides training for potential future senior managers. The Appraisal Department will include four Divisions: for Engineering, for Financial and Economic Appraisal, for Rediscounted Loans (para. 2.09), and for Small and Medium Scale (SMI) Projects; an Export Promotion lUnit has been set up (para. 5.13) in this Department, and is expected to develop into a full Division when the work-load warrants this and suitable additional staff has been attracted. The new Development Department will also have four Divisions, namely the new Sector Studies 1/ Details in the Project File.  - 11 - Division, the Investments Division dealing with equity participations, an External Relations and Promotion Division, and a Statistics Division. The Finance Department will contain a Treasury Division and a Loan Administra- tion Division. Finally, the Follow-up and Legal Department will have a Division for Follow-up, which will control projects under construction and in consultation with the Finance and Appraisal Departments arrange periodic visits to projects and consultations with clients, a Legal Division for general legal work, and a Division for Loan Recovery. The latter Division, which will include lawyers as well as financial analysts and can draw on staff of other departments, was especially created to deal with the serious loan arrears situation at BNDE (para. 4.25); it started to take strong action in early 1981, including arranging visits by BNDE management if pay- ments due are delayed by a month, and to initiate legal action if payments cannot be agreed upon after this period. 4.08 The strong caliber of the Department Directors and their deputies, the increased responsibilities delegated to them by the President, and the morale boost created by the promotion of younger but experienced profes- sionals to Division Chief positions, have all strengthened BNDE's institu- tional base. BNDE's performance is expected to significantly improve once the key Divisions are adequately staffed. A staffing plan was agreed upon at negotiations to ensure an adequate number of experienced staff will be placed in the newly-formed Divisions which will play important roles in BNDE's future operations (Follow-up, Loan Recovery, Export Promotion, and Sector Studies). Also, in view of the substantial size of BNDE's loan portfolio (over 500 loans under supervision), the growing complexity of its operations (i.e., SSI financing, export financing, etc.) and the need to tighten supervision of clients, a computerized management information system for administrative functions, loan supervision, and appraisal is required; the financing will be provided by the Kuwait Special Fund. 4.09 At the end of 1980, BNDE's total staff of 170 included 78 profes- sionals, compared to 60 professionals in 1976. The professional staff includes 6 engineers and 2 junior engineers (compared to a total of 4 junior engineers in 1976) and 19 economists; the economic staff of BNDE was more than doubled during 1980 in anticipation of the above mentioned reorganization. 4.10 Training of Staff: In view of the recent reorganization, and the increases in staff and changes in functions which have occurred, further training is essential. For example, the staff of the Export Promotion Unit would benefit from exposure to international or national agencies in other countries that are concerned with export promotion; also, the new economists, as well as existing financial, economic and engineering staff, could benefit from training designed to sensitize them to the subsectoral impact of projects as well as their social and economic evaluation. To determine the training requirements, it was agreed with BNDE that a senior consultant will visit BNDE this year to agree on suitable training programs.  - 12 - C. Operations 4.11 Characteristics of Operations; BNDE's operations experienced a substantial slowdown in 1978-79 as a direct result of the economic reces- sion in the country which led many industrialists to delay their invest- ments. However, since end-1979, a marked increase in operations, so far particularly reflected in approvals and commitments, has started as shown below: Table 4.01: MOROCCO - CHARACTERISTICS OF BNDE's OPERATIONS (DH million) (DH5=$l) 1977 1978 1979 1980 No. Amount No. Amount No. Amount No. Amount (DH Millions) Direct Loans Approvals 84 742.4 63 312.8 64 454.6 n.a. 658.6 Commitments - 717.2 - 344.7 - 266.2 - 511.3 Disbursements - 715.1 - 491.0 - 372.0 - 386.1 Investments Commitments 4 11.6 4 7.3 4 11.2 - 22.4 Disbursements - 7.7 - 8.5 - 3.0 - 18.2 Rediscounted Loans 282 370.8 191 171.9 198 201.6 271 377.8 4.12 The average size of direct BNDE loans declined to DH 6 million ($1.2 million) during the 1978-80 period, compared to DH 9.4 million ($1.9 million) in 1976-77, indicating the shift to smaller projects; these smaller projects also required shorter terms (about 7 years) as compared with loans for large, often state-owned, enterprises. The general decrease in the size and terms of BNDE's direct loans partly reflects Morocco's industrial investment strategy which increasingly emphasizes smaller indus- tries. This is a desirable development, since BNDE can play a more impor- tant financial and technical role in the smaller private enterprises (see also PPAR 1805) as the large state-owned enterprises have contributed more than proportionally to their portfolio to BNDE's arrears problems (para. 4.27). 4.13 During the period 1977-80, over 75% of the amount of BNDE's approvals were in the private sector, compared to 45% in 1974-76, as the Government curtailed the development of large new projects. Following the Moroccanization laws of 1973, loan approvals for foreign-controlled enter- prises have dwindled to an insignificant level (about 3% of the total in 1979/80). During the period 1977-80, 39% of BNDE's approvals were for loans to the manufacturitg icd,-stty (mechanv&ical U%, ioo& pTlcessing 1%%,  - 13 - textiles 8%, cement 4%, others 1%); transport accounted for 21%, and mis- cellaneous for the rest (fishing, hotels, etc.). 4.14 The geographic distribution of BNDE's loans continues to reflect the concentration of industries in the Casablanca-Mohammedia area. This area accounted for about 60% of all BNDE's loan and equity investment approvals in 1974-80. The balance of approvals was generally well spread over other major urban centers (i.e. Rabat, Marrakech, Agadir, Fes, Tanger, etc.). 4.15 During the period 1977-79, BNDE committed 12 new equity invest- ments for DP 30.1 million ($6.0) compared to 28 investments for DH 33 mil- lion ($6.6 million) during the period 1974-76. As of December 31, 1979, BNDE held participations in 34 industrial enterprises accounting for 60% of total outstanding equity investments of DH 96.7 million ($19.3 million), in 6 tourism enterprises (15% of total), and 8 financial institutions (25% of total). 4.16 Bank Loans to BNDE. The Bank has made eight loans to BNDE amount- ing to $184.7 million, net of cancellations. The BNDE VII loan (1061-MOR) of $30 million was fully committed and disbursed before the original clos- ing date of December 31, 1979. The BNDE VIII loan (1428-MOR) of $45 million became effective December 21, 1977, and is now fully committed; disbursements amounted to $26 million as of May 1, 1981, or 40% below the expectations at the time of appraisal. The slow disbursement pace stems from the economic slowdown experienced in Morocco during 1978-80 (para. 2.01); the loan is now expected to be fully disbursed within six months of the original closing date of September 30, 1981. The ERR of projects under Loan 1428-MOR ranged from 18% to 50%, well above the 10% minimum. 4.17 During 1977-79, the total investment cost of projects involving BNDE financing amounted to about DH 5 billion ($1 billion), compared to DH 6 billion ($1.2 billion) in 1974-76. BNDE's direct loan and equity approvals for these projects amounted to DR 1.5 billion ($300 million) and rediscounted loan approvals to DH 0.7 billion ($140 million); the balance was provided from equity funds, Government grants, and other loan financing mostly in the form of suppliers' credits. D. Resource Position 4.18 BNDE's resources position as of December 31, 1980 is detailed in Annex 3 and summarized below;  - 14 - Table 4.02: MOROCCO - BNDE RESOURCE POSITION AS OF 12/31/80 (DH 5 = 1) DH'00O Percentage Resources Equity, Reserves and Provisions 262,670 9.3 Local Borrowings 881,666 31.3 IBRD Loans 214,391 7.6 Other Foreign Borrowings 1,183,289 41.9 Undisbursed Borrowings 278,889 9.9 Total Resources 2,820,905 100.0 Applications Loans Outstanding 2,504,492 Investments 114,584 Other 27,665 Total Applications 2,646,741 Available for Disbursements 174,164 Less Undisbursed Commitments 370,679 Resource Gap (December 31, 1980) 196,515 4.19 BNDE's resource gap of DH 197 million (t39 million) as of December 31, 1980 is mainly due to the resurgence of BNDE lending activity in 1980 after a pause in 1979. Direct lending commitments, which reached DH 511 million ($102 million) in 1980, went up 92% compared to 1979 reflecting the upsurge in economic activity following the 1978-79 reces- sion. Since the previous appraisal at the end of 1976, BNDE's continuous resource mobilization efforts have been successful and total outstanding resources increased by 60% from DH 1,768 million ($354 million) at the end of 1976 to DH 2,821 million ($564 million) in September 1980. As regards local currency, which represented 41% of total resources as of December 31, 1980, BNDE has received resources from share capital increase (DH 70 mil- lion in 1977), net cash generation and local borrowings. Bond issues (most of them 15-year at 7.5%) represented 90% of local borrowings or 31% of total resources in December 1980. 4.20 As regards foreign exchange resources, the Bank has continuously supported BNDE's objective to diversify its sources of funds. This objec- tive has been substantially achieved. The proportion of Bank funds decrea- sed from 42% of total resources outstanding in mid-1974, to 20% at the end of 1976 and to 8% in December 1980. Other foreign exchange resources come from a variety of sources such as public institutions in capital surplus Arab countries, ADB and KfW, as well as two LIBOR indexed Euro-dollar borrowings contracted in 1976 and 1977 for a total amount of US$165 million and representing 19% of total resources outstanding in September 1980.  - 15 - E. Financial Performance 4.21 Profitability. As indicated in Annexes 4 and 7, BNDE's profit- ability has been sound during the 1977-1979 period although it declined significantly in 1979. Profit before taxes declined from DP. 42.7 million ($8.5 million) in 1978 to DP 37.6 million ($7.5 million) in 1979, but recovered to DH 40 million in 1980. This decrease is mainly due to the high cost of LIBOR indexed Euro-dollar borrowings, the average cost of which increased from 13% in 1978 to 20% in 1979 and the first half of 1980. This resulted in the fall of BNDE's interest spread which declined from 1.8% in 1977 to 1.0% in 1979 and was 1.2% in 1980. However, the Euro-dollar borrowings are being repaid rapidly and will have been com- pletely repaid in 1982, while BNDE has just increased its nominal interest rate to a uniform 12% p.a. for all loans compared to 10% for medium-term loans (up to 7 years) and 11% for long-term loans; as a result, the interest spread is expected to rise to 1.6% in 1981, 2.2% in 1982 and 3.0% in 1983, provided BNDE does not again have to increase its borrowings in the expensive Euro-currency market (Annex 14). In addition, BNDE's annual administrative expenses have remained relatively low and represented about 0.7% of average assets in 1980. The deteriorating trend in BNDE's profit- ability reversed in 1980, and BNDE's profitability is expected to continue to improve and remain satisfactory during the 1981-84 period (see Annexes 11 and 14). To ensure that BNDE maintains a satisfactory level of profit- ability, it will be a condition of the proposed loan that BNDE maintains on a best effort basis its profit before tax at a minimum of 25% of its equity from 1982 onwards. Although in recent years this percentage was below 20% (Annex 7), BNDE's reduction in euro-currency borrowings and new interest policy would permit it to adhere to this agreement (Annex 14). 4.22 Financial Position. BNDE's audited balance sheets for the 1977-79 period, and unaudited balance sheet as of December 31, 1980 are detailed in Annex 6 and show that BNDE's total assets increased by 33% between 1977 and 1980 with an increase of DH 506 million ($101 million) (+ 29%) in its net portfolio outstanding. This growth of BNDE's lending activity particularly in 1978 has brought about a 10% increase in term borrowings, from DH 1,688 million ($338 million) in 1977 to DR 1,855 million ($371 million) in 1980. Consequently, the debt-equity ratio increased from 8.9:1 in 1977 to 9.9:1 in 1978 (i.e. almost the 10:1 limit agreed with BNDE in the 1061 MOR Bank Loan Agreement). Decreased borrowings in 1978 and 1979 coupled with high repayments contributed to a lower debt-equity ratio (9.7:1 at end 1979, and 9.3:1 at end 1980); projections (Annex 14) indicate that the debt-equity ratio will remain well below 10. As a result, no capital increase is con- sidered necessary for 1981-83. However, if the 1981-85 Plan generates a vigorous upturn of the economic activity, BNDE's commitments could be higher than projected, requiring a more aggressive plan of resources mobilization. If so, the debt-equity ratio would increase again, and its evolution should be reviewed carefully during supervision. 4.23 Liquidity and Debt Service. BNDE ended the year 1980 with a rela- tively tight liquidity situation. This is attributable to a lower growth  - 16 - of cash generation from operations, and the increased level of arrears which created a liquidity squeeze between loan collections and debt repay- ments. At the time of appraisal of the BNDE-VIII loan (1428-MOR) the risk of a liquidity squeeze was recognized; to minimize this risk an agreement was reached with BNDE to maintain a minimum debt service ratio of 1:1. 1/ The ratio has evolved as follows: Table 4.03: MOROCCO - BNDE DEBT SERVICE RATIO (December 31) 1977 1978 1979 1980 (D- 5 = $1) ------------Actual