Document of The World Bank FOR OFFICIAL USE ONLY Ag- o y)) Co Repwct -N. P-3887-CO REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN ALN AMOUNT EQUIVALEN-T TO US$90 MILLION TO BANCO DE LA REPUBLICA WITH THE GUARAN=TE OF THE RE?UBLIC OF COLOMBIA FOR A DEVELOPMENT BANKING PROJECT October 18, 1984 This documet has a restricted distribution and may be used by recipients only in the performnance of their official duties. Its contents smay not otherwise be disclosed without World Bank authorization. CURRENCY EQUIALENTS Currency Unit Peso - Col$ Average Calendar 1982 Average Calendar 1983 US$1 = Col$64.102 USSI ColS78.857 ColSl = USSO.0156 ColSl = US$J.0i27 Exchange Rate Effective September 30, 1984 US$1.00 = Col$107.01 Col$1.0O0 USSO.0093 Weights and Measures Metric System FISCAL YEAR January I to December 31 GLOSSARY OF ABBREVIATIONS BCH Banco Central Hipotecario BR Banco de la Republica (Colombia's Central Bank) CAVIs Corporaciones de Ahorro y Vivienda (Savings and Loan Associations) CDTs Certificates of Deposit (Certificados de Deposito a Tercino) CFCs Companias de Financiamento Comercial CFP Corporacion Financ.era Popular COLCIENCIAS Fondo Colombiano de 'tvestigaciones Cientificas y Proyectos Especiales (Colombian Fund for Scientific Research and Spec.al Projects) DDC Department of Development Credit of BR DFC Development Finance Company DTF Weekly Index of CDT Interest Rates ERR Economic Rate of Return FFAP Fondo Finarciero Agropecuario (Agriculture and Livestock Fund) FF1 BR's Fondo Financiero Industrial (Industrial Financing Fund) FIP BR's Fondo de Inversiones Privadas (Private Investment Fund) FRR Financial Rate of Return CDP Gross Domestic Product FIB Inter-American Development Bank IFC International Finance Corporation, a member of the World Bank Group IIT Instituto de Investigaciones Tecnologicas (Technological Research Institute) LIBOR London Interbank Offered Rate PROEXPO Fondo de Promocion de Exportaciones (Export Promotion Fund) SEC Securities and Exchange Commission UPAC Units of Constant Purchasing Power (Indexed Instruments Issued by the Savings and loan Corporations) USAID United States Agency for International Development FOR OmCUL USE ONLY - _ C-TAIA DE PROJECT LAN AND PROJECT SIEAR 1. Borrower: Banco de la RepubUca 2. Guarantor: Republic of Colombia 3. Financial nterinediaries: Private development finace companies (DFCs) meting certain miniiwmI conditions a 4. Beneficiaries: Manufacturing. agroindustrial, tourism and AdiLnUg enterprises for investment financing. BR's DDC, and DFCs for technical assistance. 5. Amount: US$90.0 million equivalent 6. Terms: Interest at the Bank's standard variable rate, plus standard commitment and front-end fees. Repayment in 17 years, including 4-1/2 years of grace. 7. ,l Tnterest (%)2/ Naximwm Terxs Dollar Funds Peso Funds (Years) To Sub- To Sub- To DFC borrower To DFC borrower Maturity Grace Subloans LIBOR-0.5 LIBOR+2.5 DTP-1.0 DTF+3.0 15 3 Equity Investments - Not App. - Not App. 15 3 Special Projects (Technology Development and Pollution) - LIBOR+2.5 - DTF+3.0 15 5 8. Project Description: A. The provision of equity and medium- and long-term debt financing for private enterprises engaged in manufacturing, tourism or mining activities, for projects aimed at increasing or rationalizing production, technological improvement or pollution control. 1/ Eanco de la Republica would assume the foreign exchange risk on the loan. 2/ Interest rates for dollar as well as peso denominated sub-loans and equity investments would be variable and subject to adjustment semi-annually. This documentbus a rsrieF1ddribu*iokandnybcxsedb Precipensonlt performncofe the officialduxtes. Its conten ma nt otherwise be disiedl -1 without Wod lnk authorizatioL - i - B. The streaghteniug of the Governcent's financial sector reforis by primarily (1) helping to develop uechanis- aimed at developing a long-ter credit market; and also (Ui) carrying out a program of technical assistance for the staff of the Borrower and of the DFCs in operating the variable interest rate system and related financial sector *iagezent issues, and carrying out a program of technical assistance for the Superintendency of Banks to enhance its banking supervisory capabilities. 9. Estimted FY 85 FT 86 FT 87 FT 88 FY 89 FY 90 Disbursements Annual 2.0 15.0 25.0 23.0 15.0 10.0 Cumulative 2.0 17.0 42.0 65.0 80.0 90.0 10. Rate of Return: Sub-projects requiring Bank financing in excess of US$300,000 equivalent will not be approved unless their projected FRR and ERR in real terms is IIZ or higher. Below US$300,000, only the FRR in real terms of IIZ or higher will be required. II. Risks: The project faces two main risks: lower than anticipated demand for Investment financing, and failure of -second category DFCs to meet conditions for continued participation in the project. In the first case, either a portion of the loan would have to be cancelled or the cowuitment and disbursement periods would have to be extended. In the other case, legal remedies were agreed upon that would allow to exclude such DFC. from participation in the project. 12. Staff Appraisal: Report No. 4947(a)-CO of October 18, 1984 INTERNAION BL ANK FOR AECONS CIO I) DE.VEPMEWT REPORT AND RECGMENDAION O THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN OF US$90 ILLION TO BANO DE LA REPUBLICA WM THE GUARANTEE OF THE REPUC OF COLOMBIA FOR A DEVELPMET BANKING PROJECT 1. I submit the following report and recouzinndation on a proposed loan to Banco de la Republica, with the guarantee of the Republic of Colombia, for the equivalent of US$90 million, the proceeds of which vould be on-lent to private development finance companies (DFCs) to finance productive Invest- ment, technological improvement and pollution control in private enterprises engaged in manufacturing, tourism or mining activities in Colombia. The loan would bave a term of 17 years, including a 4-1/2-year grace period, at the standard variable interest rate and will bear a front-end fee of US$224,439. VART I - TBK 3011 2. An economic mission visited Colombia in July 1982 and its report (4444-CO) was distributed to the Executive Directors in August 1983. This mission was followed by a small updating mission which visited the country in February 1984. Also, a mission to review the external sector and agriculture visited Colombia during April/Nay 1983, and its report (4981-CO) was distrib- uted to the Executive Directors in April 1984. This section reflects both missions' major findings. Country data sheets are presented in Annex I. Background 3. The Colombian economy has become more resilient to external shocks as a result of the structural changes that have occurred over the past thirty years. Rapid economic growth has resulted in a substantial structural trans- formation of the country from a predominantly rural and self-contained eco- nomy to a more diversified urban, industrial, services and open economy. Colombia has reached a point where population pressure on land no longer increases much, if at all. Public sector investment and output now play a greater role, primarily as a result of increased activity on the part of decentralized agencies and public enterprises. Also, non-coffee exports, particularly exports of manufactured goods, expanded rapidly and the range of products sold abroad widened considerably. The growing urban-Industrial- services oriented economic activity and a rapid expansion of surplus labor in rural areas attracted by higher wages and better services in the cities bas given rise to rapid rural-urban migration. This phenomenon, together with the increased participation of women in the labor force, has been instru- mental in reducing poverty and improving income distribution over time. Financial and capital markets have evolved pari-passu with the growing needs 1/ This section is an updated version of Part I of the report for the Cucuta Water Supply and Sewerage Project (No. P-3869-CO of August 17, 1984). of the economy, and Colombia has become an active participant in interna- tional capital markets. 4. Real GDP per capita rose by about 2.2Z on average during the 1950-83 period, with each succeeding decade registering greater gains in per capita income. This was the result of lower population growth, which after having remained in the 3.0% to 3.5% range during the 1950. and early 1960s, declined dramatically after 1965 as a consequence of a sharp fall in the fertility rate. Greater economic and educational opportunities for women, rapid rural-urban migration, rising per capita income and increased effec- tiveness of family planning programs contributed to the decline in fertil- ity. Colombia's population is presently growing at an annual rate of 2.0Z. As a result of the high proportion of women now entering childbearing years, this rate of population growth is likely to continue until the early 1990c. 5. The combination of rising per capita income and expanded public services has brought about a significant improvement in the welfare of the poorest, in absolute and relative terms. As a result of increased sanitation control, improved diets and better bealth care, the crude death rate fell by over 50% and life expectancy rose from 48 years in the early 1950s to 64 years currently. The child mortality rate declined from 11 per thousand in the early 1960s to 4 per thousand in the late 1970s. Infant mortality fell to 54 per thousand in the late 1970s, from about 124 per thousand in the early 1950s. School enrollment ratios have increased substantially at all grade levels since the 1960s and, by the late 1970s, 80Z of urban children aged 7 to 14 were enrolled in school. The poorest income groups have experi- enced the greatest increases in electricity and water services in recent years and have benefitted more than the average of the population from services of the national health system. In spite of this progress, Colombia remains largely underdeveloped, with a relatively small modern sector super- imposed on a broad, traditional and economically poor base. Development has been concentrated in relatively few areas of the country, public services are still not available to many of the rural and urban populations and unemploy- ment and underemployment are relatively high. The coverage of health care and water supply requires further improvement, and adequate housing is not available to a substantial portion of the population. Rapid migration to the large and medium-sized cities has created urban development problems, with attendant social difficulties. Moreover, in spite of the steady increase in per capita income over the past 30 years, substantial efforts are still required to improve and extend the benefits of development to the poorest income groups. 6. In large part, the achievements of the past 30 years were the results of government efforts to stimulate the productive sectors, provide the required economic and social instrastructure and establish an effective institutional base in the economy. In the 1950s and early 1960s, development policy favored Import substitution supported by high tariff protection and the provision of economic infrastructure by the public sector. It was during this period that the country's major coumnication and transportation net- works were developed and the transformation to a semi-industrial economic structure began in earnest. By the mid-1960s, the prospects for further import substitution were substantially diminished, and the country was con- fronted with great economic uncertainty, arising from the fact that economic activity and the balance of payments were heavily influenced by developments -3 - in the world coffee market. In order to ease this constraint, during 1967 the authorities adopted an outward-looking development strategy, expanding and diversifying exports and, among the export markets, increasingly tapping the Andean Group countries. Export promotion policies, including frequent small exchange rate devaluations, export tax rebates and other export incen- tives were introduced and the authorities began lowering tariffs somewhat and freeing capital maricets from controls as means of raising efficiency and increasing the competitiveness of Colombian goods in external markets. These measures were highly successful in relieving the foreign exchange constraint and stimulating growth and employment. However, by the mid-1970s the economy was once again experiencing difficulties caused primarily by the world recession and by excessive Central Bank financing of the Central Government's overall fiscal deficit. Recent Economic Developments 7. In late 1974, the Government introduced a wide range of measures designed to correct the structural and policy weaknesses prevailing in the economy at that time. Before these reforms were fully effective, the economy was subjected to strong inflationary pressures arising from a sharp increase in world coffee prices. The increased receipts from coffee exports, together with some official surrender of foreign exchange from illegal exports, caused a turnabout in the balance of payments. Incomes rose rapidly and st-Inlated aggregate demand; inflation accelerated. Economic growth also accelerated, and unemployment fell substantially, both in rural and urban areas. Largely as a con.-4equence of increased coffee tax revenues, the public finances generated overall surpluses averaging about 1% of GDP during the 1976-78 period and, by the end of 1979, net official international reserves had risen to about US$4.1 billion, equivalent to about 12 months imports of goods and non-factor services. 8. While beneficial in many respects, the foreign exchange boom had a somewhat negative impact on the evolution of the Colombian economy, largely as a consequence of the need for measures to stabilize the economy. Public investment was curbed, thereby delaying some badly needed additions to econo- mic and social infrastructure. The rate of currency devaluation was slowed, and the conversion of export receipts into pesos was delayed to moderate the growth of domestic deawnd, with adverse effects on export expansion and diversification. Also, the Government was compelled to maintain high reserve requirements and expand controls over credit thereby reducing, in real terms, the financing available to the private sector via the official capital market. 9. The stabilization measures were virtually unchanged from early 1977 through 1979 and were partially successful in restraining aggregate demand growth, but relatively high inflation persisted. In response to the effects of increasing restraint on aggregate demand and the troublesome financial market distortions caused by inflation and the extended period of monetary restraint, the authorities began in late 1979 to adjust the stabilization program. The rate of peso devaluation was advanced to increase export incen- tives and reduce borrowing abroad, and in early 1980, credit restraints were relaxed by lowering reserve requirements. At the same time, interest rates on time deposits captured by commercial banks and development finance companies--and on lending therefrom--were freed from controls. To offset the -4 - inflationary effects of these measures, the authorities further liberalized import payments and adopted the policy, supported by the emission of new sbort-tern certificates, of not expanding the subsidized selective credit operations of the Central Bank in excess of the resources captured from private savings for this purpose. The authorities also increased the sur- veillance and control of the illegal export trade. The effects of the above measures were not inmediately notlceable. Real GDP growth declined to 4% in 1980, unemployment started to creep up, and inflationary pressures continued. 10. In 1981 the economic situation took a turn for the worse and the problems have continued through 1983. Real GDP growth which had decelerated to 2.5Z in 1I81 fell to 0.92 in 1982 and to about 0.8Z in 1983. Agricultural output was hard-hit both in 1982 and 1983 as the production of cotton, oil seeds and other agricultural commodities dropped as a result of low interna- tional prices, reduced fertilizer use and adverse weatber. Industrial activity deteriorated on account of depressed aggregate demand, and unutil- ized capacity continued to increase, particularly in manufacturing. After experiencing a surplus for six years, a deficit emerged in the resource balance in 1981 of about US$1.5 billion, which continued at roughly this level through 1983. These deficits resulted mainly from a drop in exports by about 92 annually in real terms: major reasons were the slowdown in world demand, a major devaluation and the introduction of import restrictions in Venezuela-a major trading partner--in 1983, and the reduction in Colombia's coffee export quota in the International Coffee Agreement significantly below the 1981 coffee export level. Net foreign exchange reserves declined by about US$1,800 million in 1983 and Colombia's net international reserves were equivalent to about 6.7 months of imports of goods and non-factor service at year end. To a significant extent, the fall in foreign exchange reserves was caused by the difficulties in tapping capital markets which resulted from the external debt problems of other countries. Inflation slowed down in 1983 to a ZO average for the year, down from 282 in 1981 and 25% in 1982. 11. Since 1983 the Government has been introducing a series of measures designed to stimulate aggregate demand and to initiate the adjustment process required to expand and diversify non-coffee exports, stimulate domestic pro- duction, and resi economic growth. The rate of peso devaluation is being accelerated with a view to regaining the 1975 real exchange rate during 1985; the housing construction industry is being provided with incentives to mobil- ize an increasing amount of resources; and open market operations are being discontinued to increase liquidity in the economy. Temporary import restric- tions are being introduced to arrest the falling foreign exchange reserves; these are to be lifted once the real exchange rate achieves its equilibrium level and exports respond fully to this incentive. The stabilization measures introduced in 1977 have been gradually dismantled, followed by government legislation, weasures and regulations designed to reduce the fiscal deficit and ease distortions and restrictions in the financial system. While these measures bave been in the right direction, there is need for significant additional efforts, as recognized by the authorities. In particular, the country continues to be affected by the tight international capital market in 1984: a sharp reduction in the credit lines available to Colombia resulting from the overall debt problem of Latin America has con- tributed further declines in foreign exchange reserves. The continuing pressure on the external sector has brought to the Government's attention the need for further and timely actions to reverse the current trends. Such a -5 - policy package would need to include vigorous export promotion, stepped-up external resource mobilization, promotion of foreign investment, assistance to resolve private sector financial difficulties and fiscal and monetary measures for adjustment. Development Strategy 12. The Government's strategy for accomplishing its development objec- tives is set forth in the 1983-86 National Development Plan. This strategy emphasizes growth with equity with the purpose of expanding the benefits of development to Colombia's population. This is to be achieved through increasing participaEtion of all social and regional groups in the process of economic growth. The strategy also places high priority on the resumption of growth while maintaining price stability. The strategy strengthens the previous emphasis on export promotion as a means of supplementing domestic demand and assuring balance of payments stability, and on policy measures designed to increase economic efficiency and raise institutional capacity. It proposes a continuation of the large effort in public investment, giving high priority to energy, agriculture and industrial projects and to the pro- vision of transport infrastructure. Economic decentralization, regional autonomy and the uniting of regional grovth centers through improved tran- sport, communication and financial links are directed towards creatinga an integrated national market. The development plan's strategy also vplaces. emphasis on the promotion of both small-scale and commercial a culture as a means of diversifying and increasing exports, assuring adequate to sic food supplies, holding down inflation and contributing to the Government s nutri'- tion and welfare goals. Industrial policy objectives are to provide an environment of certainty, along with adequate credit and infrastructure, that entrepreneurs are encouraged to invest and expand output. .Because its benefits in opening foreign markets, creating employment and\bringing in new technology, private foreign investment is to be encouraged. '\The finan- cial sector is also to be strengthened. The Government's approach to helping the poor takes on a new orientation in the development plan's strategy. Its efforts are focused upon improving -fficiency in the jise of resources, broad- ening coverage of services and strengthening the social service institu- tions. Programs in the housing, health, and education sectors are to be better focused and integrated, and selected low Income and disadvantaged groups, such as workers in the informal sector, children and unemployed youth, are singled out for special attention. Combined with a significant expansion in construction of low-income housing and the extension of the Integrated Rural Development (DRI) program, the new directions given to social programs are expected to raise significantly the welfare of low income groups in Colombia. 13. After many years of being a net petroleum exporter, Colombia became a net oil importer in the mid 1970s and, in recent years, 10-15% of merchandise imports have been accounted for by petroleum. In the absence of rapid energy development, energy shortages could become a major constraint on growth later in this decade. Resolution of the energy problem depends on the country's success in developing its abundant domestic energy resources- hydroelectricity, coal and natural gas--and also upon increasing petroleum exploration and development. The strategy for doing this will require energy pricing policies that balance consumption with energy resource availabili- ties, a least cost program of investments, sufficient domestic and external -6 - financing for these investments, strengthened sector institutions, improved program execution capability and rapid carrying out of investments. Although planning and policy making have improved substantially in many energy sector institutions in recent years, further improvements in overall sector planning and coordination are needed. A recently completed National Energy study carried out by the Government is providing the basis for seeking such improvements. Additionally, recent oil pricing decisions have gone a con- siderable way towards providing the correct signals for regulating consump- tion and encouraging production. the prices paid to producers (primarily foreign companies) for 'incremental' and 'new' crude provide adequate produc- tion incentives, and the retail prices of petroleum products have been increased substantially in recent years, reflecting, on the whole, interna- tional levels. 14. Colombia's agricultural growth performance has slowed down markedly in recent years. Both demand and supply constraints have been responsible for this. To increase output, utilization of additional acreage for cultiva- tion is projected to involve greater investment than in the past, implying the increasing need to pursue options of'yield improvements. In addition to productivity gains, additional land could and should be brought under irriga- tion and/or drainage for more intensive cultivation. Watershed management and forestry development should also become integral parts of a long-term strategy for growth and for conserving the natural resources. The generation and delivery of technological innovations should receive priority in the array of long-term measures. Research and extension institutions are in need of rehabilitation and strengthening. Marketing constraints also need to be relaxed if higher production is to be sustained. Sufficient credit availabi- lity for production and marketing is also essential. Recently the Government initiated a major policy redirection to address these issues and the develop- ment plan assigns a key role to future investments in the sector. 15. Colombia's high transportation costs and inadequate services could become a constraint on economic growth and exports, affecting particularly the development of the country's vast coal reserves and its agriculture. The State Railway is in poor condition and the road network needs maintenance and rehabilitation. The authorities have taken steps to improve the country's infrastructure and the development plan assigns an important share of future investments to the sector. An important part of this effort is the ongoing Rural Roads, Railway Rehabilitation, and Highway Sector Projects. Investment and its Financing 16. An increase of public sector investment will be required in the next several years to carry out the development strategy outlined in the development plan. Over the 1984-86 period, such investment is expected to increase by about 2Z p.a. in real terms. The energy and transportation sectors are expected to account for the bulk (about half) of this investment; however, real increases in investment are also expected in the small- and medium-scale agriculture, housing, nutrition and health, industry (including mining), water and sewerage, and education sectors. Overall, public fixed investment is projected to average 7% of GDP during the 1984-86 period, and is expected to total Col$1,890 billion. Private investment will have to increase also during this period to provide the goods and services required by the expanding economy. - 7 - 17. The execution of the Investment program will demand a major resource mobilization effort on the part of Colombia's public sector. In particular, the size of the overall Central Government deficit will have to be reduced significantly. The buoyancy of the tax system (excluding coffee tax revenues and receipts from earnings on foreign exchange holdings), which has declined in recent years, will have to be increased through new taxes and better tax administration; the growth of expenditures will have to be checked; resources will have to be used more efficiently; and the charges levied for public services will h>ave to be raised substantially in real terms. A package of measures to tackle some of these issues was approved by Congress in 1983, including measures related to broadening the base and increasing the average rate of the sales tax, increasing other indirect taxes, reducing the earmarking of revenues, reducing tax evasion, and strengthening tax administration. Additional actions on both revenues and expenditureb have been proposed to Congress, all of which, when approved, are expected to have a significant effect in reducing the fiscal deficit in 1985. Since this effort is likely to coincide with increased private sector demand for investment resources, the importances of measures to expand domes- tic savings cannot be over-stressed. The recent capital market liberaliza- tion should encourage savings. A significant increase in voluntary private savings is not likely, however, as long as inflation remains high. Conse- quently, stabilization remains a sine qua non for the country's future growth and development. Growth and Balance of Payments Prospects 18. Given the country's strong resource base, sound economic management and the efforts mounted to realize the required increases in capital inflows envisioned during 1984-86, Colombia's growth prospects for this decade are reasonably good and significant advances in economic welfare are anticipa- ted. However, because of the decline in coffee prices from the previous boom levels and the weakening in exports caused by the recession and by import restrictions in some of Colombia's traditional markets, in addition to the need to increase imports to develop the country's resource potential and restore higher economic growth, the current account deficit of the balance of payments is projected to average US$1.7 billion per year during 1984-86, equivalent to about 5% of GDP. Almost half of the deficit is projected to be financed by reducing foreign exchange reserves and by direct foreign invest- ment. By the end of this period, net official international reserves would have fallen to a level of about three months of imports of goods and non- factor services (a level which is adequate for Colombia) without prejudice to the country's creditworthiness. This should be sufficient to support an average growth of real GDP of 2X during this period. Beyond 1986, the current account deficit should improve as a result of increasing export proceeds (particularly coal) and a leveling-off of imports resulting from increased domestic production of petroleum. The current account deficit would gradually fall to about 1.5Z of GDP by 1990. To achieve real GDP growth of about 2Z per annum during 1984-86, gross fixed investment will have to be maintained at 19Z of GDP to complete existing long-gestating projects in the energy and mining sector, and to avoid too large an increase in foreign indebtedness, gross national savings would need to average about 18Z of GDP. 19. Gross external capital requirements are projected to total about US$7,772 million in current prices for the 1984-86 period, for an annual -8- average requirement of about US$2,591 million. Net foreign investment is expected to account for US$825 million during 1984-86. This should provide about 112 of the gross external financing required. Of the remaining 892 (US$6,947 million) about US$5,271 million, has been either comitted or Is expected to be secured from multilateral and bilateral sources, while t1.e difference, US$1,676 million, will need to be borrowed abroad from financial markets and suppliers' credit sources. At the end of 1983, Colombia's public and publicly guaranteed external debt disbursed and outstanding amounted to US$6.9 billion, equivalent to 18.5Z of GDP. The Bank/IDA share of this external debt was 22Z. Reflecting the recently increased Colombian borrowing from comnercial sources, this share is expected to remain at about 202 during 1984-86. The public debt service ratio at the end of 1983 was 202 and is expected to climb to 282 by 1986, peak at about 282 in 1988 and then decline gradually to 232 in 1990. The World Bank's share in public debt service is expected to remain below 252 during 1984-86. With continued sound economic anti financial management, Colombia iL expected to maintain its creditworthi- ness through and beyond the 1984-90 period. PART II - MAE GROU OPZRATIC IN COLGIDIA 20. The proposed loan, the 110th to be made to Colombia, would bring the total amount of Bank loans to Colombia to US$4,341.9 million (net of can- cellations). Of this amount the Bank held, as of March 31, 1984 US$2,981.3 million; IDA made one credit of US$19.5 million for highways in 1961. Dis- bursements have been completed on 66 loans and the IDA credit. Before 1979, disbursements averaged US$86 million equivalent per year, but had increased to US$250 million per year by 1982 and US$294.5 million in 1983. While lower than those recorded in Latin America for similar projects, concentrated efforts to overcome problems in project execution have resulted in signific- ant increases in the disbursement record in 1983 and 1984. Improving per- formance of social sector institutions, gradual containment of inflationary pressures and the effects of the recently introduced fiscal reforms, which should improve counterpart funding, and increased Bank lending for infra- structure projects, all point to a higher level of disbursements in the future. IFC has made investments and underwriting commitments of US$119.9 million in 29 enterprises and, as of March 31, 1984, it held US$48.0 million. Annex II contains a sumary statement of Bank loans, the IDA credit and IFC investments as of March 31, 1984. 21. Since the initial loan was made in 1949, Bank lending to Colombia has become quite diversified. Although through the mid-1960s, 882 of the loans made were for power or transport, since then the Bank has broadened its participation in lending for agriculture and industry, and initiated lending for irrigation and watershed management, education, water supply, telecomu- nications, urban development and nutrition. By the late 1970s, 53Z of the loans made to Colombia were for projects other than transport and power. Of the loans made since 1978, 39% were for power and transport, 16Z each for agriculture and industrial projects, 7Z each for projects in water supply and urban development, 4Z each for projects in telecommnications and irrigation, and 72 for education, nutrition and multipurpose projects. The diversifica- tion was a desirable aim as it helped provide close contact with a broader range of Colombia's development problems. The experience gained has served to identify areas in which the Bank's role can only be a marginal one and, thm, t enable lending to be focussed upon sectors in which the Bank's presece cam hae a meaningful imact. 22 lBank lending to Colombla in FY84 consisted of lons for power sec- tor financing, coal exploro, ea e reconstruction, agricultural diversification and multipurpose water supply and electricity, totalUng US$464.1 million. In addition, the Bank participated in two B-loans for a total of 14% of the loans, or US$28.75 mllion. Tn response to Colombia having undertaken a gradual adjustment process to expand and diversify non- coffee exports and resume growth, the thrust of Bank support has shifted towards str ng the Covenment's programs, enhancing the effectiveness of resource use, ana empbasizing quick-yielding investmuents- Loa recently approved by the sBard and a mmber of operatio s at an advanced stage of pre- paration reflect this overall direction. Regarding frastructural invest- lmts, the FY85 program strses r ation, modernization and a more intensive use of facilities already in place, as in the cases of the recently approved water supply and electricity distribution projects. Ihe recently approved power development finance project was entirely geared towards com- pletion of ongoing projects. Similarly, Increased emphasis has been placed on directly productive operations, such as the already-approveda agricultural diversification and small-scale industry projects. Ihe project described in this report and the petroleum project which is to be considered by the Board separately fall in this category. Beyond FY85, work is also underway on projects for further petroleum development, electric power, agricultural extension and marketing. fertilizers, and irrigation for possible considera- tion by the Executive Directors during the next two years. 23. The proposed Bank lendilg is consistent with the Government's development strategy. Nature loans would finance agriculture and industry to support the GCoverment in its efforts to raise overall productivity, income and employment, and to increase and diversify exports, and help develop renewable sources of energy through lending for hydropower an arrnaging asociated co-financing. Closely related to these objectives would be Bank lendlng for infrastructure that would facilitate the increasing inter- regional flow of goods and services. Finally, several loans are being pre- pared in support of the Government's efforts to help the poorer segoents of the Colombian population. Proposed lending for furtber rural development, agricultural credit, health, water supply and sewerage, and irrigation pro- jects are principally designed to improve the standard of livIng of the poor. 24. Ihe operations of external lenders in Colombia are shown in Ahnex I. While IBRD. IDB and bilateral sources provided about 75Z of total external finaucing to Colombia in the 1961-72 period, their share had decreased since then to some 49Z for the 1975-82 period and is expected to dec'lie further to about 4OZ of external capital requirements during the 1980O. Like the Bank, 1DB has given increased emphasis to energy-related projects in addition to those for low-cost housing, urban and rural develop- ment, agrarian reform, university education, water supply, rural electrifica- tion and land erosion control which are aimed at imroving living standards of the lower Income population. In the future, it proposes to assist Colombla in developing sources of domestic energy and in expanding productive sector activities to help generate increased employment. USAID has supported program in education, rural development and small farm development, but is phasing out its program in Colombia. The Goverment of Canada, the Federal - 10 - Republic of Germany and the Netherlands have also provided concessional financing for basic needs and regional integration projects. X HI - MM ninDS L AND FINANCIAL SECOrS Iv CIAIBI& Industrial Sector Structure, Growth and Performance2/ 25. Between the late 1940s and the late 1970s, Colombia witnessed rapid growth of its nufacturing industry. At first, industrial expansion was spurred by policies favoring import substitution and was supported by the provision of infrastructure and public services. By 1967, local industry supplied the internal market with most consumer goods, about two-thirds of intermediate products and about one-half of capital goods. In 1966/67, the Government adopted an outward-looking development strategy that emphasized export expansion and diversification, which was consistently carried on into the mid-1970s. With the large growth and diversification of manufactured exports, industrial output gained impetus and so did employment; between 1967 and 1974, the growth rate for the sector reached an annual average of 8.6Z. By the end of the 1970s, employment in manufacturing reached about 2 million and the contribution of manufacturing to Colombia's gross domestic product equalled 17%. This had been made possible through a combination of natural resources, human skills, entrepreneurial initlative and Government policy. 26. Starting in 1981, however, industrial growth stagnated (see para. 10). At the same time, export receipts accumulated during the coffee boom and an overvalued exchange rate boosted demand for imported products. Sub- sequently, weakened international demand, competition from contraband and substantial devaluation of the currencies of Colombia's foremost Latin American trading partners led to a decline in manufacturing production and exports. As a result, consumer goods industries, which during the 1960s and 1970s saw their sbare of industrial output decline from about 80% to about 50%, have assumed greater importance at the expense of industries producing intermediate and capital goods. 27. Reacting to falling foreign exchange reserves resulting from rapidly decreasing export receipts in the early 1980s, the Government reverted to protectionist measures, introducing licenses for most imports and raising customs duties. These measures are intended to be temporary and to be removed as soon as the balance of payments and exports improve. Simul- taneously, to enhance Colombia's ability to compete abroad, additional export incentives were provided through higher tax rebates for exported goods and later-in 1983-the rate of currency depreciation was accelerated. Despite the current recession, which has significantly weakened the finances of industrial enterprises, the manufacturing sector faces a critical need to modernize its equipment in order to reduce costs, improve the quality of its products and increase its competitiveness. Many firms are already taking the necessary actions, especially in non-metallic minerals (cement), food, 2/ A report entitled -ColombLa - Manufacturing Sector Developments and Changes in Foreign Trade and Financial Policies (No. 4093-CO)- was distributed to the Executive Directors on January 21, 1983. - 11 - beverages and tobacco, textiles and basic metals, and this effort represents an importaat source of demand for long term investment credit. Recent surveys conducted by Banco de la Republica (BR). Colombia's Central Bank, and DFCs indicate that investments currently planned by m3nufacturing firms for 1985-1986 add up to some US$600.0 million, of which approximately 40Z is essentially aimed at modernizing equipment and increasing productivity. Overall, the growing importance of intrasectoral linkages, combined with the changing structure of incentives and ongoing modernization in intermediate and capital goods producers, can be expected to create significant investmeat opportunities for these firms. The Financial Sector and the DFCs 28. The Colombian financial sector enjoyed a prolonged period of stability and was characterized by a relatively simple institutional system comprising mainly commrcial banks and investment banks (Corporaciones Financieras-DFCs) until the late 1960s. A series of economic developments in the subsequent period, especially the perceived conflicts between stabili- zation and financial sector liberalization policies in the face of high inflation rates during the 1970s and early 1980s, led to numerous changes in the institutional structure of the system as well as financial instruments. Most important among these changes were: (a) periodic but small movements towards financial sector liberalization as a means to increase the volume of resources intermediated by the institutionalized (formal) system; (b) further growth of a flourishing extra-bank (informal) market as a response to strong financial sector repression which prevailed over a major part of the decade and prevented the institutionalized financial system from meeting fully the demand for intermediation; some of the informal market was later regulated under the name of Companias de Financiamiento Comercial (CFCs); and (c) the creation of new categories of financial intermediaries: Corporaciones de Aborro y Vivienda (CAVIS) and Companias de Financiaziento Comercial (CFCs) and of new instruments such as certificates of deposits (CDTs) and indexed instruments (UPAC) to mobilize resources to meet specific evolving needs in the economy. 29. The complexity of these developments has put strains on the tradi- tional framework of financial institutions, especially on the Superintendency of Banks, which regulates financial institutions and is responsible for over- seeing their financial soundness. By the end of the 1970s, several incon- sistencies were visible in the institutional framework and in the body of financial regulations. The liberalizing measures introduced periodically over the last decade have not succeeded in reducing the fragmentation of the financial markets. Instead, they have led to a complex system in which the institutionalized free market coexists with a compartamentalized system of official lines of term credit, principally to industry and agriculture, and a large and growing informal market. The structure of market incentives in recent years made it more profitable, even for intermediaries traditionally oriented towards term financing, to move increasingly towards short term operations. A de facto multibanking system has resulted from the formation of groups of entities working in the different specialized markets and linked by common ownership, but uncontrolled linkages between financial and non- financial groups have become widespread, in the absence of adequate regula- tion of such groups. - 12 - 30. The sources of the above can be traced In part to the conflicting, or at least competing, objectives which the Government tried to prsue with its financial policies. Among the competing objectives were: (a) to sake available rediscounted credit from the Central Bank to priority sectors; (b) to increase the intermediation of resources through the institutional financial system; and (c) to use regulation of the financial sector as an instrument to control inflation. The relative weight given to these ais differed at various periods during the 1970s. In the early 1980s, the diffi- culties that DFCs faced in tapping international capital markets, because of the banking community's concerns regarding its exposure to Latin America's mounting debts, and the weakening of the financial situation resulting from the downturn of economic growth, caused the authorities to reappraise the setup of the financial sector. To this end, the Government requested the Bank, in mid-1982, to review the situation with particular regard to the DFCs, and to propose, where warranted, remedial action. 31. The preparation and discussion of the ensuing report (-The Colombian Investment Banking System and Related Financial Sector Issues - Report No. 4274-C0, distributed to the Executive Directors on August 1, 1983), provided an opportunity to address the more fundamental structural weaknesses of the financial sector. The report noted, among other problems: Ca) the tendency of the private DFCs to operate increasingly in the short term market; (b) the relatively less dynamic resource mobilization by the DFCs in comparison with other types of financial institutions; and (c) the observed limited impact of the DFCs in stimwlating risk capital investments in the productive sector. These factors have led to a dilution of the iden- tity of the DFCs as genuine investment banks. 32. The causes for the above situation can be traced to, among other aspects, the regulatory and incentive framework, and the early stage of development of the Colombian capital markets. The principal factors that were specifically identified which have led to this situation were: (a) the lack of adequate mechanisms to facilitate using short term deposit resources for mediumr- and long-term lending; (b) the competitive disadvantages faced by the DFCs vis-a-vis other types of financial institutions with respect to the type of deposit accounts permitted, size of branch network, etc.; (c) a relatively high degree of concentration of financial power characterized over the last decade by the emergence of -de facto- financial/industrial groups, and the absence of a comprehensive regulatory framework to control activities of these groups and to define clearly the mutual responsibilities and obliga- tions of the majority owners and minority shareholders; and (d) a tax system that favored heavy debt financing by industrial firms in preference to ade- quate capitalization and acted against a satisfactory development of the stock market and wide distribution of share ownership. 33. To address these concerns, and in accordance with the findings of the Bank's report, the Government, in a first stage effort, undertook all the key reform measures which are needed to strengthen the DFC system. These reforms, which were introduced under the authority of existing legislation, and which form the basis for this operation, include abolition of the risky auto-finance companies (a device to finance parent company requirements tbrough ad hoc subsidiaries raising funds from the public', and the provision of financing to encourage greater equity investments by the public. Also, incentives to increase equity investments have been strengthened with the - 13 - elimination of the double taxation of dividends and the marginal reserve requirements on coooercial banks. Moreover, the Central Bank is now publish- ing an index of deposit costs as a reference rate to facilitate introduction of variable interest rates in the DFC operations, which shoald reduce risks of term tranformation (see para. 34). To help build up their reserves and profits, the rules governing the Central Bank's official financing funds have been modified to allow the DFCs higher spreads and the use of variable interest rates on part of the funds. The DFCs have also been authorized access to emergency discounts in the case of possible financial difficulties and have been allowed to increase their spreads on funds from the Central Bank's credit lines. In addition, to address issues transcending the DFC system and concerning the overall performance of the financial sector, the Government has submitted a new reform bill for consideration of the Colombian Congress. This draft legislation proposes measures to better control the operations of financial/industrial groups, to define more clearly the roles of different categories of financial institutions, and to strengthen the powers of the Superintendency of Banks to exercise the necessary controls (details on the status of actions on financial sector reform are contained in Annex TV to this report). 34. Finally, to help DFCs mobilize more resources, the Government decided to promote term transformation (use of short-term deposits to fund medium- and long-term credits). To protect against the risks of term trans- formation, namly (a) the possibility that interest rates paid by DFCs for their 90-day certificate of term deposits (CDrs) would increase over the rates charged on long-term credit outstanding, and (b) liquidity problems caused by transitory fluctuations resulting from deposit withdrawals, the use of floating interest rates bas been introduced. Since January 1984, the Central Bank has periodically been publishing a cost-of-funds index (DTF). This index is calculated on the basis of the average interest rate offered by DFCs on their 90-day certificates of deposit (CDT). It provides a reference rate which permits lenders to charge floating rates of interest in Colombian pesos and constitutes a major innovation in financial sector operations. In particular, it allowed the use of variable interest rates on BR's official lines of credit. To date, this system of floating interest rates based on the CDT has worked well. The only possible limitation to its use is a pro- vision contained In Colombia's Code of Commerce, under which interest rates charged by commercial lenders cannot exceed twice the -ordinary interest rate- as certified by the Superintendent of Banks. Therefore, it is necessary that this -ordinary interest rate- at all times adequately reflects market rates, as otherwise it could become a ceiling on the interest rates that DFCs can cbarge. To this end, the Government has requested that the Superintendent of Banks establish a system to periodically update its certi- fication of this rate. The system would have to be satisfactory to the Bank, and its enactment is a condition of loan effectiveness (Section 6.01 (b), draft Loan Agreement). Should the borrower cease to calculate or publish the DTF at least on a monthly basis, or should the DTF fail to reflect the average interest rate offered by DFCs on their 90-day certificates of deposit, or should any event occur which would make the payment of interest based on the DTF inapplicable, unenforceable or illegal, the Bank would have the right to suspend loan disbursements (Section 5.01 (j) and 5.02 (a), draft Loan Agreement). - 14 - Role of the Bank and IFC 35. The IFC and the Bank bave been workling jointly on sector analysis, and IFC is presently processing proposed investments in tbree DFCs consisting of subordinated loans of US$18 millon to improv2 their capital structure and to permit them to grow at a faster rate than would othervise be possible. The proposed IFC investment and the Bank loan under consideration deliber- ately emphasize the different focus of activities and instruments for financ- ing of the two institutions. While the Bank's work has given priority to sector and institutional issues, IFC has concerned itself more directly with the commercial resource generation ability of the more mature DFCs. The Bank has provided the analytic work to identify sectorwide reforms needed to enhance the role of the financial system in the mobilization of resources tbrough, inter alia, the strengthening of the term transformation functions of DFCs. IFC, in turn, has provided the relevant inputs regarding capital market implications of the recommendations formally outlined to the authori- ties by the Bank. 36. On the operational side, the Bank and IFC have used their proposed operations as instruments to further the policy dialogue and ensure that the measures recommended in the Sector Report are carried out. Thus, the Bank now proposes to proceed with an apex loan through the DFCs to channel medium- and long-term credit towards efficient investmuent projects in the industrial sector and to fortify the financial framework within which the DFC system operates. At the same time, through the US$40 million fourth small-scale enterprise project recently approved (Report No. P-3848-CO presented to the Board on July 10, 1984), the Bank intends to continue supporting a special- ized Government institution which is performing a role that private institu- tions are reluctant to undertake, given the high cost involved in financing very small enterprises. IFC, on the other hand, has been orienting its support to resource mobilization for the three most mature DFCs, and it has also promoted the introduction of more specialized financial instruments (such as leasing operations). Also, the proposed IFC investments have been structured as subordinated loans, so that they will count as quasi equity of the three DFCs. This will allow them to maintain their real level of opera- tiolis until the shift toward market peso long-term lending now being initiated will improve their profitability and further strengthen their capital base for future growth. Therefore, while the Bank loan primarily addresses sectoral concerns and resource transfer, the IFC investment supports the individual DFCs as private profit-making companies. The pro- posed Bank and IFC operations thus complement each other well, with the two institutions focusing on the different areas in which they, respectively, have the greater competence. Previous Bank Lending for Colombian Industry 37. The Bank made its first loan for industrial development in Colombia in 1963 to help Acerias Paz del Rio to carry out a steel mill project. Between May 1966 and May 1980, the Bank made eight loans to Banco de la Republica (BR), totalling US$492.5 million, which were relent, through the DFCs, to private enterprises in the fields of manufacturing, tourism and mining for the establishment or expansion of productive capacity, for tech- nological improvements and for pollution control. These loans were charac- terized by rapid commitment and smooth disbursement, reflecting both the - 15 - strong investment climate during 1966-1980 and the efficiency of the parti- cipating intermediaries. In 1972, the Bank lent US$60.0 million to Colombia for a development and export expansion program, part of which was relent to industrial enterprises. In 1975, 1977, and 1980, the Bank lent a total of US$52.5 million to BR; these funds were relent, through the Government-owned Corporacion Financiera Popular, to privately owned small-scale industry; a fourth US$40.0 million loan for the small-scale industry was recently sub- mitted to the Board. In 1978, the Bank lent US$15.0 million to the Cartagena Industrial and Commercial Free Zone, which is aimed at promoting manufactured exports and expanding employment in a poor region of the country. In the mining sector, the Bank lent US$80.0 million in 1979 (together with US$145.7 million from U.S. Eximbank and a syndicate of private banks) to exploit a nickel deposit and set up refining and smelting facilities for export, and US$9.5 million in 1983 for a coal exploration project. 38. These operations bave contributed both to the expansion and the development of Colombia"s industry. Their objectives included growth, export promotion and diversification, strengthening financial intermediaries specializing in investment lending, and stimulating the establishment and expansion of medium- and small-sized industrial units throughout the country, with the attendant creation of employment. The OED Report on the fifth and sixth DFC projects3/ noted the successful channelling of resources at a rapid rate for economically efficient industrial projects, the increasing maturity of six of the participating DFCs, their capacity to keep up with credit demand and the improvement of their growth and profitability in real terms, and BR's major strides in developing a project appraisal capability. 39. The 1981 OED report also noted, however, that the Bank had only limited success in its dialogue with the authorities on financial and indus- trial policies and, more specifically, in obtaining support for priority activities within the industrial sector. Moreover, BR was found devoting too much time to scrutinizing projects prepared by the DFCs, while its capability to supervise the DFCs' overall performance was still limited. The report recommended greater delegation of responsibility by the Bank to BR on project design and supervision, with a corresponding shift of the Bank's attention to financial and industrial sector issues and stronger DFC efforts to mobilize other resources in the domestic and international markets. In this last respect, the report specifically recommended that the Bank continue the effort it had started in 1978 to set up a system permitting the transforma- tion by the DFCs of short-term deposits into long-term lendable resources. Subject to some modifications resulting from the diversity of the parties involved and the intervening time, all the substantial recommendations of the 1981 Project Performance Audit Report have been adopted in the design of the project described in this Report. 3/ -Colombia - Fifth and Sixth DFCs Projects - Project Performance Audit Report' (&SecM8-430, May 15, 1981). - 16 - PART Iw - UK PROJEcT Project Objectives and Description 40. As noted in Part III of this report, DFCs are currently suffering from difficulties in tapping international capital markets, and the country is redressing the more f%ndamental structural weaknesses of the financial sector that have become evident as a result of the downturn of economic growth. Accordingly, building on the accomplishments of prior Bank loans, which helped several individual DFCs develop into relatively mature term financing institutions, and complementing the Bank's work on financial sector issues, the proposed project has the two-fold objective of: (a) making available medium-term loans to DFCs, that are nou unavail- able to Colombia, to channel term financing toward efficient investment projects in the industrial sector (including manufactur- ing, agro-industry, tourism and mining); and (b) assisting the Government in strengthening the financial sector reforms already undertaken, by (i) helping to develop mechanisms aimed at developing a long-term credit market, (ii) carrying out a program of technical assistance for the staff of the Borrower and of the DFCs in operating the variable interest rate system and related financial management issues, and (iii) carrying out a program of technical assistance for the Superintendency of Banks to enhance its banking supervisory capabilities. 41. The aggregate investment cost of projects potentially eligible for financing out of the proposed Bank loan over the next 24 months (the proposed loan commitment period) is estimated to be on the order of US$350 million equivalent. This estimate is based on current Bank projections of economic growth for Colombia, an enterprise investment survey carried out by BR late in 1983, information on project pipelines of selected DFCs, and the proposed terms and conditions of subloans. The foreign exchange financing require- ments of such investment activity are estimated at US$200 million equiva- lent. After taking into account other probable external sources (i.e., a US$90 million IDB loan and a conservative level of suppliers' credit) a Bank loan of US$90.0 million equivalent is proposed to help fill the sector's estimated foreign exchange gap. Based on data from the BR survey (paragraph 27 above), about 40% of the investment projects can be expected to involve modernization of existing plants and improvements in capacity utilization, 20-25% to support expansions in production capacity for existing product lines, and the remaining 35-40% to help set up new product lines and/or new enterprises. 42. The proposed US$90 million loan would be allocated as follows: (a) US$89.8 million for the credit component which would cover the foreign exchange costs of subloans and equity investments made by DFCs for investment projects involving increases in, or rationali- zation of, productive capacity of enterprises, industrial pollution control or technology development, and for technical assistance required to undertake those projects; and - 17 - (b) US$0.2 million for capitalizing the front-end fee of the loan. A related program of technical assistance for the staff of BR and the DFCs would be financed by BR with its own resources. This program would cover the promotion and evaluation of investment projects, investment and credit port- folio supervision and management, and the operation of the variable borrowing and lending rate system. Also, concomitantly with the proposed project, the Government would carry out a technical assistance program for its banking regulatory agency, the Superintendency of Banks (see para. 49). 43. BR would be the borrower, with the guarantee of the Republic of Colombia, and would onlend the loan proceeds to participating DFCs in accord- ance with subsidiary loan agreements satisfactory to the Bank, entered into as a condition precedent to disbursements with respect to each DFC (Section 2.02(d), draft Loan Agreement). BR itsalf would assume responsibility for the training and technical assistance to DDC's and DFCs' professional staff. The proposed loan would have a 17-year term, including 4-1/2 years of grace. The grace period would be slightly longer than the usual 4 years for Colombian loans to partly compensate the country for the reduction in the repayment period from 17 to 14 years made under the petroleum project. BR would assume the foreign exchange risk between the currency pool obligations incurred under the Bank loan and the currency of BR's onlending to DFCs (i.e., US dollars or Colombian pesos, para. 46). The spreads between BR's onlending rates to the DFCs and the Bank's standard variable interest rate are considered adequate to compensate BR for assuming this risk. In view of the administrative complexities associated with the large number of subloans and investments expected (100-150), the loan would be repaid according to a fixed amortization schedule with equal repayments of principal, instead of a schedule reflecting subloans' amortization. It is expected that the com- posite of subloan repayments and yields of equity investments will be close to the terms proposed for the loans. In any event, it has been agreed that funds repaid to BR prior to the maturities of the Bank loan would be used for purposes similar to that of the loan (see Section 3.02(c), draft Loan Agreement). Credit Component 44. About 90% of the credit component is expected to be used for modernization of equipment and facilities and increases in productive capacity, while technology development, pollution control and technical assistance to enterprises are expected to account for the rest. No special allocation is made for equity investments within the credit component but, based on prior experience, about 5-10% of the component can be expected to be used for this purpose. Subloans and equity investments would cover estimated foreign exchange costs of: (a) fixed assets (machinery, equipment, factory buildings and related civil works and services); (b) permPnent working capital (initial stocks or increases in stocks of imported raw materials, spare parts and components required for increases in productive capacity); and (c) technical assistance services required by industries. 45. No enterprise, including its subsidiaries, shall be eligible to obtain financing out of the proposed loan (in either a subloan and/or equity investment) in excess of US$5.0 million equivalent. Likewise, no investment project shall receive financing (whether from one or more DFCs) in excess of - 18 - US$5.0 million equivalent. Equity investments in a single enterprise (or its subsidiaries) shall be limited to an aggregate maximum out of the proposed loan of US$3.0 million equivalent, regardless of the number of DFCs proposing to make investments therein. These limits are intended to: (a) ensure a reasonable degree of dispersion of loan funds; (b) reduce concentration of credit in the largest enterprises; and Cc) allow a greater concentration of peso-denominated subloans for the relatively smaller enterprises. Unlike previous loans, and reflecting the prevailing difficulties in raising foreign exchange on the international capital markets, a company's size would not limit its access to the proposed Bank loan; however, a company's access to adequate alternative sources of foreign financing has been included in BR's statement of operating policies and procedures as part of DDC's criteria, whereby DFCs' financing to those companies would be ineligible for financing out of the proposed Bank loan. 46. Within these limits, enterprises (and the respective DFCs) would have an option to receive the first US$500,000 equivalent in the form of loans denominated in Colombian pesos or US dollars; any financing in excess of this limit would be denominated in US dollars. Exceptions would be aLlowed in subloans for pollution control, technical assistance and technology development/adaptation, and in loans to DFCs for equity invest- mets, increasing the amount available in peso-denominated loans to the first US$2.0 million of exposure. This arrangement is expected, on the average, to result in relatively higher proportions of peso financing being available to the smaller sized firms. At the same time, it avoids the complications experienced in the past of trying to limit the access to peso-denominated loans on the basis of firm size. It has been statistically observed that the 90-day CDT rate tends to compensate savers for current and expected levels of both domestic inflation and devaluation of the Colombian peso (IBRD Report No. 4444-Co). As a result of the acceleration in the pace of devaluation over the past 18 months, lending rates based on the CDT rate have exceeded the effective cost of borrowing in foreign currency (nominal interest rate plus devaluation). Thus, during the life of the proposed subloans (about eight years on average), the cost to industry of a -peso' subloan should be about the same as a 'dollar- subloan. The purpose of the option to be offered is mostly to meet the perception of risk among the smaller enter- prises, which are generally less at ease with foreign currency movements. For these reasons, this dual system would not entail unreasonable risks for BR, especially since -peso- lending is not expected to exceed 50% of the loan. This limit would be reviewed from time to time between BR and the Bank and could be increased only by mutual agreement (Schedule 4, para. III.3, draft Loan Agreement). Onlendiag Terms 47. Interest rates would be floating in both currencies, adjustable every six months. The rates to the final beneficiaries on subloans denomi- nated in US dollars would be set at the published London Interbank Offered Rate (LIBOR) on 180-day deposits (currently in the 11.0 to 11.5Z range) plus a charge of 2-1/2 percentage points. Peso-denominated subloans would bear rates, also adjustable once every six months, equal to the index of the cost of CDTs (para. 34) plus three percentage points. BR would lend funds to DFCs following the same floating rate schemes, allowing for spreads of 3.0 per- centage points in the case of dollar-denominated subloans, and 4.0 percentage - 19 - points in the case of peso-denominated subloans. Interest rates charged to DFCs by BR on loans for equity investments would be identical to those charged by BR on loans to DFCs for financing subloans in the respective currency (Schedule 4, paras. II. 1-4, and III, 1 and 2, draft Loan Agreement). Maximum subloan maturities would be 15 years, including grace periods of up to three years, except that subloans for pollution control or technology development may have grace periods of up to five years (Schedule 4, para. 11.5, draft Loan Agreement). The exception is justified in view of the longer gestation period involved in some technology improvement programs and the non-productive nature of pollution control investments. 48. All subloans requiring more than US$3.0 million equivalent of Bank funds in the case of Group A DFCs with 'full participation," or more than US$750,000 equivalent in the case of Group B DFCs participating on a -limited basis' (see paras. 59 and 60), would require the Bank's prior approval. Equity investments in excess of US$650,000 equivalent would also require prior Bank approval. Within the above limits, BR itself would delegate part of its review responsibilities to the participating DFCs, depending on the degree of their maturity, as outlined in BR's policy statement. These arrangements should result in prior Bank review of about 10% of the number of investment projects to be financed, accounting for 25-302 of the proposed loan amount. Technical Assistance Component 49. The Government has committed itself to further strengthening of its banking regulatory agency, the Superintendency of Banks. To this effect, it will carry out a technical assistance program, in consultation with the Bank, to enhance the capabilities of this agency to monitor and enforce the regula- tions applicable to the financial sector. This technical assistance package for the Superintendency would include assistance for improvements in the areas of: (a) information systems to select and process data from financial institutions under its control; (b) analysis and interpretation of data received; (c) diagnostic and control techniques applicable to the different categories of financial institutions; and (d) training of the inspectors and financial analysts of the Superintendency. Assurances were received from the Guarantor that a detailed action program to this effect would be presented to the Bank for its comments within six months of loan signing and implemented promptly thereafter (Section 3.01 of the draft Guarantee Agreement). 50. Likewise, to ensure smooth introduction of term transformation in Colombia (para. 34), the staffs of DFCs and BR will need to be trained in the application of the new techniques and their control. This will be done through a special technical assistance component consisting of: training courses and seminars for the professional staff of BR's DDC and of the parti- cipating DFCs, emphasizing promotion and evaluation of investment projects for credit and equity investments purposes, project supervision and term transformation control. Financing for this component would be provided by the borrower. Investment Project Appraisal and Supervision 51. The participating DFCs would be responsible for the appraisal and supervision of investment projects. Appraisals would contain an adequate - 20 - analysis of the organizational, financial, marketing, technical and other relevant aspects of the proposed investment projects. In addition, appraisals of all projects for increases in productive capacity requiring more than US$300,000 equivalent in Bank financing would include a calculation of the project's FRR and ERR following guidelines acceptable to the Bank, and the projects would be financed only if such rates exceed 11% in real terms; for projects involving less than US$300,000 equivalent in Bank financing, only an FRR would be calculated and financing would not be approved unless the FRR equals or exceeds 11% in real terms (see Section 2.03, draft Loan Agreement). Special guidelines for project evaluation would be used in the case of pollution control and technology development sub-projects. They are contained in BR's Development Credit Department's Statement of Operating Policies and Procedures. Each DFC would supervise the projects financed by it to see that subloans or equity funds are utilized for the purpose intended and that the financial and other conditions affecting the project's perform- ance are progressing satisfactorily. BR and the DFCs would have the right to visit the enterprises as necessary and to request from them the relevant information on the enterprise and the project. BR would be responsible for supervising the performance of the participating DFCs and their compliance with the conditions agreed in the proposed loan. To this end, BR would make periodic visits to the DFCs and would receive quarterly reports from them on their financial condition, status of portfolio and performance of loan com- mitments. These understandings, reflected in Schedule 4, para. IV of the draft Loan Agreement, will not be modified without the Bank's consent (Section 5.01(h), draft Loan Agreement). Procurement and Disbursement 52. Procurement procedures would be similar to those under the Seventh and Eighth DFC Projects and conform with standard practice for DFC loans; BR would monitor procurement to be financed out of the proposed Bank loan to ensure that the items are reasonably priced and appropriate for their intended purpose. 53. The loan proceeds would be disbursed against: (a) 100% of foreign currency expenditures for goods supplied from outside the territory of the Guarantor; (b) 100% of foreign currency expenditures (c.i.f.) on imported equipment purchased off-the-shelf in Colombia, or 60% of the reasonable cost of such goods, when the c.i.f cost cannot be ascertained; (c) 40% of the ex-factory cost of domestically manufactured goods and of the reasonable cost of locally supplied services and civil works; and (d) 100% of expenditures for services required for technical assistance, and training. The above percentages reflect estimated average foreign exchange costs of the respec- tive expenditure categories, except in the case of technical assistance, where the proposed disbursement percentage makes no distinction between foreign and local consultants. Only expenditures made within not more than 180 days prior to the date of receipt by the Bank of the corresponding financing requests would be eligible for reimbursement out of the proposed loan-rather than the 90 days customary under the Bank's DFC-type loans, in view of the administrative complexities and time lags involved in the two- tier lending arrangement with participation of a large number of DFCs. The Loan and Project Summary provides an estimated disbursement schedule, which is based on the average disbursement profile for DFC projects in the LAC Region. The closing date would be June 30, 1990. To cover the foreign - 21 - exchange requirements of participating DFCs for investments they will be financing before this loan becomes effective, retroactive financing of up to US$9 million, 10% of the loan amount, has been provided (Section 2.02(d) of the draft Loan Agreement). 54. In order to ensure timely payment of reimbursement claims, as a condition of loan effectiveness, a Special Accounc in U.S. dollars would be established in BR to cover estimated expenditures for thrae months. The Bank would make an initial deposit of US$7.0 million into tbh Special Account. BR would claim reimbursement of the Bank's share of expenditures from the Special Account upon presentation of fully-documented withdrawal applications forwarded to the Bank for replenishment of the Special Account. The Bank would receive from BR a monthly statement of the Special Account which would reflect transactions during the previous month. The Special Account would be subject to the same audit procedures as the other project accounts (see Sections 2.02(c) and 6.02 and Schedule 5, draft Loan Agreement). Accounts and Auditing 55. DFCs participating in the proposed project would be required to maintain adequate records reflecting their operations and financial condi- tion, and to submit annual financial statements audited by independent auditors following principles satisfactory to the Bank. BR would maintain adequate records concerning the progress of the project and to reflect, separately from its other operations, the operations and financial transac- tions of DDC. These accounts would be audited by independent auditors following principles satisfactory to the Bank (see Sections 4.01 and 4.02, draft Loan Agreement). The Borrower 56. Banco de la l rublica (BR), the proposed borrower, is Colombia's central bank. As of DeLember 31, 1983, its paid-in capital and reserves were Col$611.7 billion (US$6.9 billion equivalent). The Board of Directors is composed of ten members, of whom three are appointed by the President of the Republic, another four are appointed by the President upon nominations sub- mitted by, respectively, consumers' groups, manufacturers and distributors, exporters, and the Coffee Growers Federation, while the remaining three are elected by Colombia's private banks. BR's General Manager is appointed by the Board; the rest of BR's senior management is appointed by the Board, upon the advice of the General Manager, and is often drawn from BR's middle management and staff, a generally proficient body of career professionals, now numbering about 1,700. 57. In addition to its central banking responsibilities, BR carries out several development banking activities entrusted to its DDC, which adminis- ters the official lines of medium- and long-term credit available primarily to agriculture and industry (FFAP, FFI, FIP), including Bank DFC loans. DDC has achieved satisfactory proficiency in reviewing industrial projects appraised by the DFCs, owing in part to a Bank-supported training program, and has assigned to this task competent staff in adequate numbers. However, the frequent transfer and promotion of high-ranking personnel in charge of DFCs supervision has often affected its performance. During negotiations, BR has agreed to maintain its unit within DDC which is exclusively concerned - 22 - with the supervision of DFC activities and to carry out the project in accordance with a revised statement of operating policies and procedures (Sections 3.01 and 4.04, draft Loan Agreement). The text of that statement is included as an annex to the Staff Appraisal Report. 58. In the first four DFC loans, BR played a rather limited role: it channeled the loan proceeds to the five participating DFCs and screened the projects to make sure that they conformed to the Govenment's development priorities. The original five DFCs (Colombiana, Nacional, de Caldas, del Valle and del Norte), all counting IFC among their shareholders, conducted their operations under close Bank Group supervision. They have gradually achieved satisfactory standards of project appraisal and follow-up, and of operational decision-making. In the context of Bank lending for the DFCs, BR's functions have become much more substantial during the past ten years. As additional DFCs joined the program, the function of guiding and assisting them became the responsibility of BR, which reviews and approves all projects appraised by the new DFCs and the large projects submitted by the original five DFCs. BR is now intimately associated with the affairs of the particip- ating DFCs, helping the new DFCs that join the program to upgrade their appraisal and supervision capabilities as well as their disbursement procedures. Participating Intermediarie! 59. All 23 DFCs legally constituted in Colombia would be eligible to participate as intermediaries of the proposed loan, provided that they satisfy the following conditions: Group A DFCs - Full Participation (a) ratio of total debt (including debt of the DFC's subsidiaries and contingent liabilities) to equity not exceeding 10 to 1; (b) minimum equity carital of Col$ 500 million; (c) mediumr-4/ and long-term loans plus equity investments accounting for not less than 55% of the DFC's total assets; (d) its Statement of Operating Policies and Procedures- was approved by the Bank; and (e) its assets' composition, portfolio quality, income outlook and technical capacity to appraise and supervise investment projects are satisfactory to BR and the Bank. DFCs which meet all the above conditions would have unlimited access to Bank financing under the proposed project. Initially, seven DFCs are expected to fulfill the above conditions. 4/ Nediur- and long-term loans are defined as the portion of all loans that is not repayable within less than a 12 month period. -23 - 60. In line with the recomudacions of the Financlal Sector Report to enu--rage the gradual evolution of an inceasnrg number of DECs into sound term-lending institutions, DECs which are initially unable to meet the requIrnL ts in para. 59 preceding, but which are interested in complying with them in the future, would be, nevertheless, allowed a lUnited degree of participation (total couit.ents out of the proposed Bank loan not to exceed the lower of two times such DFCs equity or the equivalent of US$10 million), provided they meet all of the following requirements: Group B D?Cs - Limited Participation (a) a ratio of total debt (including debt of the DFC's subsidiaries and contingent liabilities) to equity not exceeding 10 to 1; (b) minimum equity capital of Col$ 300 million, to be increased, at least, to Col$ 500 million within 24 months from the date the DFC is admitted to participate in the project; (c) medium- and long-term loans plus the equity investments accounting for not less than 302 of the DFC's total assets on the date the DFC is admitted to participate in the project; these percentages to be increased to not less than 37%, 44Z and 502 within 12, 24 and 36 montrs, respectively, from such date; (d) its assets' composition, portfolio quality, income outlook and technical capacity to appraise and supervise investment projects are s"tisfactory to BR and the Bank; and Ce) the Bank has approved its -Operating Pblicies and Procedures.- The Bank would annuatly review the progress made by each DFC in this second category after it is admitted to participate in the project. Three Group B DFCs are expected to be eligible at project start. Should any of these DFCs be found in default, the Bank would have the right to suspend or terminate both comitments and disbursements out of the proposed loan to the DFC in question. Adequate arrangements concerning DFCs' participation have been agreed with BR (see Sections 5.01 and 5.02 and Schedule 4, para. I, draft Loan Agreement). Benefits and Risks 61. The credit component of the proposed project would finance effi- cient industrial investment projects and would help fill a gap in term financing needed for increasing or rstionalizing productive capacity in the industrial sector. A total of 100-150 subprojects covering a wide range of industrial activities and involving total investment costs on the order of US$350 million equivalent are expected to be supported through subloans and equity investments to be financed in part out of the proposed Bank loan and in part out on other external sources. Based on past experience, these sub- projects can be expected to have a significant employment impact, directly creating an estimated 7,000-7,500 new job opportunities at an average invest- ment cost of the order of US$45,000-50,000 equivalent per job in 1983 US dollars. The projects financed can be expected to generate annual foreign exchange earnings in the range of US$80-100 million equivalent through - 24 - increases in non-traditional exports. Based on previous experience, most projects are expected to have high economic rates of return in the range of 15-30x. In selecting subprojects for lending, DFCs are guided by satisfac- tory technical, managerial, financial and economic criteria (see para. 51). 62. The tecbnical assistance components of the project would help the Superintendency of Banks, BR and the DFCs to improve their performance in the discharge of their respective responsibilities. The existing tern transform- ation arrangements should help the DFCs to make available an increasing amount of domestic resources for mediumr- and long-term financing of indus- trial investments. Taken togetber, the technical assistance and the strengthening of term transformation under the project would constitute a substantial contribution toward the Government's goal of developing the DFCs into a system of sound and viable termrfinancing institutions. 63. The proposed project presents two risks. The first concerns the possibility that demand for investment financing, although conservatively estimated and in line with moderate economic growth, might be lower than anticipated as a result of macroeconomic developments. In this event, a decision would bave to be taken, in the light of prevailing economic condi- tions toward the end of 1986, on whether to extend the coumitment and dis- bursement periods or to cancel a portion of the loan. The second risk would materialize if one or more DFCs in the second category (para. 60) failed to achieve the agreed upon financial targets on time. The right of the Bank to exclude such DFCs from further participation in the project would constitute an adequate protection of the project's objectives. PART V - LEGAL - A AU7hORM 64. The draft Loan Agreement between the Bank and Banco de la Republica, the draft Guarantee Agreement between the Republic of Colombia and the Bank, and the report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement are being distributed to the Executive Directors separately. 65. Special conditions of the loaa are listed in Section III of Annex ITI. 66. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - 67. I recomend that the Executive Directors approve the proposed loan. A. W. Clausen President Attachments 'ashington, D.C. October 18, 1984 -25- hAIA 1 TABLE 30.8G C TA -SOOAL -IDICAMM -AJ COIUA xzmum G s cvISI
Группа Всемирного банка · Memorandum & Recommendation of the President
Colombia - Development Banking Project
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Memorandum & Recommendation of the President
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Всемирный банк