Tunisia - Export Industries Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 5251-TUN STAFF APPRAISAL REPORT TUNISIA EXPORT INDUSTRIES PROJECT MARCH 20, 1985 Regional Projects Department Industrial Development and Finance 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 otherwisz be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Tunisian Dinar (TD) 1980 1981 1982 1983 1984 TD 1 = $ 2.4691 2.0251 1.6929 1.3695 1.1985 US$ 1 = TD 0.4050 0.4938 0.5907 0.7302 0.8344 List of Abbreviations API Agence de Promotion des investissements BCMA Banque de la Cooperation du Magreb Arabe BCT Banque Centrale de Tunisie BDET Banque de Developpement Economique de Tunisie BNDA Banque Nationale de Developpement Agricole BNDT Banque Nationale de D6veloppement Touristique (formerly (COFIT) BTEI Banque de Tunisie et des Emirates d'Investissements BTKB Banque Tuniso-Koweitienne de Developpement BTQI Banque Tuniso-Qatari d'Investissements COTUNACE Compagnie Tunisienne d'Assurance de Commerce Exterieur EIB European Investment Bank EMI Electro-Mechanical Industries ERR Economic Rate of Return FRR Financial Rate of Return MEN Ministere de l'Economie Nationale SSI Small-scale Industries STUSID Societe Tuniso-Sgoudienne d'Investissements et de Developpement UTICA Union Tunisienne de l'Industrie, du Commerce et de l'Artisanat (Chamber of Commerce)  FOR OMCIL USE ONLY REPUBLIC OF TUNISIA EXPORT INDUSTRIES PROJECT LOAN AND PROJECT SUMMARX Borrower: Republic of Tunisia. Beneficiaries: Banque de Developpement Economique de Tunisie (BDET), Banque Tuniso-Koveitienne de Developpement (BTKD), and Societe Tuniso-Seoudienne d'Investissement et de !4veloppement (STUSID). Amount: US$5G million equivalent. Terms. 17 years, including 4 years of grace, at the standard variable interest rate. Onlending Terms; The Government would onlend $50.0 million equivalent in Dinars of the Bank loan to BDET ($20 million equivalent), BTKD and STUSID ($15 million equivalent each) at the Bank's standard variable interest rate. BDET, BTKD and STUSID would repay their loans to the Government according to a composite amortization schedule of the sub-loans financed out of the proceeds of the loan. The Government '.ould bear the foreign exchange risk. Sub-borrowers would be charged an effective interest rate of at least 11 percent per annum. Project Description: The project would assist the Government of Tunisia in developing Tunisia's export industries through a line of credit to BDET, BTKD and STUSID. The Project also includes the establishment of an Export Promotion Fund and technical assistance to Compagnie Tunisienne d'Assurance de Commerce Ext6rieur (COTUNACE), the Government's newly established export credit insurance company. The project consists of a line of credit of US $50 million equivalent to BDET, BTKD and STUSID to enable these banks to make sub-loans for eligible export projects. I This docment has a rstricted distrbution and may be used by recpients only in the performance of l their official duties. Its cntents may not otherwise be discbosed without World Bank authorization.  (ii, Assistance from bilateral sources and UNDP will finance a $0.15 million equivalent technical assistance package to COTUNACE. The Government is financing from its own resources Export Promotion Fund. The project will increase export earnings and job availability, strengthen three development banks and COTUNACE, and, through the Export Promotion Fund, encourage such marketing and promotion. The project involves no special risks, though some risk is attached to external factors which could depress export possibilities. Estimated Disbursements: (in 9'000) Bank FY FY86 FY87 FY88 FY89 FY90 FY91 Annual 2550 11075 17000 11250 5525 2600 Cumulative 2550 13625 30625 41875 47400 50000  (iii) TUNISIA EXPORT INDUSTRIES PROJECT STAFF APPRAISAL REPORT Table of Contents Page Chapter I. INTRODUCTION ................. .. .......... 1 Chapter II. THE MANUFACTURING SECTOR Structure and Performance ............................ 2 Constraints in the Manufacturing Sector .............. 4 Bank Role in the Manufacturing Sector ................ 5 Chapter III. THE EXPORT SECTOR Structure and Performance *....... ... ...* 7 Plan Objectives and Strategy 8........................ 8 Recent Developments ................................... 9 Fiscal and Financial Incentives ..................... 10 Institutional Framework ...... ....................... 11 Chapter IV. THE FINANCIAL SECTOR Overview ..........**.....*..*. .............. 13 The Financing of Exports ............................ 14 Interest Rates .. ..................................... 15 Review of the Financial Sector ..... .................. 15 Chapter V. THE INSTITUTIONAL FRAMEWORK A. Financial Intermediaries . . . 18 I. Banque de Developpement Econ. de Tunisie (BDET) 18 II. Banque Tuniso-Koweitienne de Div. (BTKD) 24 III. Soci6t6 Tuniso-Seoudienne d'Investissement et de Developpement (STUSID) ............... 28 B. Other Institutions ...................... ........ 31 I. Export-Credit Insurance Company (COTUNACE) ... 31 II. The Center for the Promotion of Exports (CEPEX) 32 Chapter VI. THE PROWECT Project Objectives and Components . . .33 A. Investment Financing of Export Projects . .33 B. Technical Assistance to the Export-Credit Insurance Company (COTUNACE) 36 C. Export Marketing and Promotion . .37 D. Improvement in Procedures related to Exports 37 E. Project Benefits and Risks. 38 Chapter VII. RECOMMENDATIONS Agreements Reached During Negotiations. 39 Conditions of Loan Effectiveness. 40 This report was prenared by Mr. B.H. Pottker on the basis of a pre-appraisal mission that visited Tunisia from October 11-26, 1983, and consisted of Messrs. Pottker, Farsad, Bonnier (Consultant) and Piers de Ravenschoot (Consultant) and an appraisal mission that visited Tunisia from April 9 to April 27, 1984 and consisted of Messrs. Pottker and Hanel (Consultant).  (iv) LIST OF ANNEXES ANNEX 1 Investments in Manufacturing Industries (1980-1983) ANNEX 2 Rates of Growth of Exports 1976-1981 ANNEX 3 BDET table 1 List of Shareholders as of 12/31/84 table 2 Summary of Operations 1980-1984 table 3 Analysis of Approved Operations 1980-1983 table 4 Audited Balance Sheets table 5 Audited Income Statements table 6 Spread Analysis table 7 Loan & Equity Portfolio 12/31/83 table 8 Organization Chart table 9 Forecast of Operations table 10 Projected Income Statements table 11 Projected Balance Sheets table 12 Projected Cash-Flow Statements ANNEX 4 BTKD table 1 List of Shareholders (as of 12/31/84) table 2 Organization Chart table 3 Approvals, Commitments and Disbursements table 4 Analysis of Approved Operations (1981-1983) table 5 Income Statements table 6 Balance Sheets table 7 Forecast of Operations table 8 Projected Income Statements table 9 Projected Balance Sheets table 10 Projected Cash-Flow Statements table 11 Outstanding Loan and Equity Portfolio ANNEX 5 STUSID table 1 List of Shareholders as of 12/31/84 table 2 Organization Chart table 3 Summary of Operations (1981-1984) table 4 Analysis of Approvals (1981-1983) table 5 Forecast of Operations table 6 Actual and Forecast Income Statements table 7 Actual and Projected Balance Sheets table 8 Projected Cash-Flow Statements table 9 Loan and Equity~-Rx-tfolio (12/31/83) ANNEX 6 table 1 BDET - Forecast of Approvals for Export Industry Projects table 2 BTKD - Forecast of Approvals for Export Industry Projects table 3 STUSID - Forecast of Approvals for Export Industry Projects ANNEX 7 Law establishing Export-Credit Insurance Company ANNEX 8 Estimated Disbursement Schedule  I. INTRODUCTION 1.01 This report appraises a project designed to provide financial sssistance to Tunisia's export industries and provide institutional support to an Export-credit Insurance Company, an Export Promotion Fund, and three development banks. It also aims at bringing about improvements in the administrative procedures related to exports. This project was prepared by Bank missions in 1983 and 1984 in response to the Government's desire to give increased emphasis to exports of manufactured products. 1.02 The proposed Bank loan of $50.0 million would be made to the Government of Tunisia which would pass on the proceeds to the three development banks which would utilise the proceeds of the loan to finance eligible export projects in the industrial sector. This amount would be distributed over the three banks as follows: - Banque de Developpement Economique de Tunisie (BDET); US$ 20.0 million; - Banque Tuniso-Koweitienne de Developpement (BTKD): US$ 15.0 million; - Societe Tuniso-S&oudienne d'Investissement et de Dgveloppement (STUSID): US$ 15.0 million.  - 2 - II. THE MANUFACTURING SECTOR Structure and Performance 2.01 Manufacturing industry in Tunisia has been a relatively fast-growing sector of the economy: in real terms the sector grew by 7.4 percent per annum in the 1960's and by an average annual growth rate of 11.5 percent in the 1970's. Growth was adversely affected by the poor economic performance of 1982, reflecting the slowdown in the production of food processing industries, due to weak agricultural output, technical delays in the operation of some manufacturing units, notably chemicals and cement, and the general slowdown of the world economy, particulary in Europe. Growth resumed, however, in 1983 to an annual growth rate of 12% in real terms, bringing the average for 1980-1983 to 7.3%. 2.02 Growth of the manufacturing sector during the 1970's was one of the main sources of growth of GDP which grew in real terms at an average rate of 7.5% per annum for the entire decade. GDP growth slowed down in the last three years to an average of 4.3% but this compares favorably with the growth rates experienced in the other Middle-East and North African countries which averaged less than 2Z. Consequently, the share of the manufacturing sector in GDP increased from an average of 7.5 percent in the 1960's to 10.0 percent in the 1970's and to 14.2 percent in the 1980-1983 period, as can be seen in more detail from the following table: Contribution to GDP of Manufacturing Industries (1971 - 1983) (in million TD at 1980 prices) Av. Growth Rates 1971 1980 1981 1982 1983 1971-81 1980-83 Total GDP 1,594.0 3,036.0 3,206.0 3,238.0 3,442.0 7.3 4.3 GDP manuf. indus. 150.2 415.6 444.0 459.0 514.0 11.5 7.3 GDP manuf. ind/GDP(%) 9.4 13.7 13.8 14.2 14.9 - _ Source: Ministry of Planning 2.03 Tunisia's manufacturing sector is well diversified. Until 1981 food processing remained the most important sub-sector, contributing 25.5% to manufacturing value-added. In 1982, the textile sector became the largest sub-sector mainly because of climatic problems in agriculture. The fastest growing sub-sectors in the period 1971-1981 have been construction materials (18.9% average growth in real terms), miscellaneous industries (14.0%), textiles (14%) and electro-mechanical industries (12.8Z). The table below shows the changing structure of the manufacturing sector since 1971 as a result of these developments;  - 3 - Composition and growth of value-added in the manufacturing sector (in million TD in 1980 prices) Share in total Growth rates 1971 1980 1981 1982 1983 1971 1981 71-81 80-83 Food processing 62.3 101.6 113.4 104.4 113.5 41.5 25.5 6.2 3.8 Textiles 29.2 99.3 108.3 119.0 128.0 19.4 24.4 14.0 8.8 EMI 18.1 54.3 60.2 66.4 75.5 12.1 13.6 12.8 11.6 Construction mat. 11.9 60.0 67.0 72.6 84.0 7.9 15.1 18.9 11.9 Chemicals 13.3 49.5 38.1 32.3 41.0 8.9 8.6 11.1 (6.1) Miscellaneous ind. 15.4 50.9 57.0 64.3 72.0 10.2 12.8 14.0 12.3 Total 150.2 415.6 444.0 459.0 514.0 100.0 100.0 11.5 7.3 Source: Ministry of Planning 2.04 In 1980-83, Tunisia has maintained a high investment level of over 30% of GDP. Investments in manufacturing industry, which constituted 11.7% of total investments in 1971, increased constantly reaching 19.7% of total investments in 1983, as can be seen below: Investments in manufacturing industries (in million TD in 1980 prices) Growth Rates 1971 1980 1981 1982 1983 1971-81 1980-83 Total investments 355.3 982.0 1,110.0 1,170.0 1,180.0 12.8% 6.3% Total investment as % of GDP 22.3% 32.4% 34.6% 36.1% 34.3% - - Investments in manuf. industries 41.5 130.8 186.7 203.8 232.3 16.2% 21.1% Investments in manuf. ind./Total invests. 11.7% 13.3% 16.8% 17.4% 19.7% - - Source: Ministry of Planning 2.05 The public sector has traditionally been a dominant force in the sector with an average of 55% of total investments and has concentrated its investments in chemicals (fertilizers), construction materials (cement) and agro-industries (sugar). Public sector investments are generally capital intensive and have high incremental capital-output ratios. Whereas 45.3Z of total investments in 1980-1983 were in construction materials and chemicals (the two sub-sectors where the public sector dominates) their contribution to manufacturing value-added was only 25.3%. In contrast, the two sub-sectors dominated by the private sector (textiles and miscellaneous industries) accounted for only 19.4% of total investments but contributed 36.8% to total manufacturing value-added during this period. The table below shows investments and value-added in manufacturing by the public and private sector (see also Annex 1):  -4- Investments by activity and sector (1980-1983) (in million TD; current prices) Investments Public Private Total Value Added Amount % Amount Z Aount Z Amount X Agro-Industries 96.8 57.3 72.2 42.7 169.0 18.5 514.8 24.3 Constr. Materials 173.0 69.7 75.1 30.3 248.1 27.2 351.4 16.6 Electro-Mech. Indus. 58.3 38.0 95.2 62.0 153.5 16.8 291.2 13.7 Chemicals 145.7 88.4 19.2 11.6 164.9 18.1 184.1 8.7 Textile & Footwear 18.6 18.8 80.5 81.2 99.1 10.9 504.6 23.8 Miscellaneous 14.2 18.4 63.1 81.6 77.3 8.5 274.8 13.0 TOTAL 506.6 55.5 405.3 44.5 911.9 100.0 2,120.9 100.0 Source: Ministry of Planning 2.06 Employment creation has been one of the main objectives of industrial policy. Between 1975 and 1980 over 30% of total new employment (equivalent to 65,000 jobs) was created in manufacturing industries and the share of employment in manufacturing industries in total employment increased from 17.2Z to 19.1Z. However the 5% annual increase in employment in manufacturing industries remained well below the increase in capital stock in the sector which averaged around 10% per annum during the period 1975-81. The average investment per worker increased from about TD 4,300 in the mid-1970's to TD 6,000 at the end of the 1970's. This higher investment cost was to a large extent due to the very large investments in the chemical and construction industries. Constraints in the Manufacturing Sector 2.07 A significant part of Tunisian industries have developed with import restrictions, price controls, investment licensing and direct subsidies. These measures, which were initially justified for infant industry reasons, have, over time, developed into a system that does not encourage efficiency, productivity and optimal use of installed capacity. This can be seen from the results of the fir.t part of a Bank-financed study under the EMI Project (Loan 2113-TUN) on the protection system, related to the mechanical and electrical industry, which shows that industries with the highest level of protection, serving the domestic market, have the lowest economic and financial rates of return. The same study shows that public enterprises have generally benefitted from the highest levels of protection while showing the lowest rates of return:  Protection, resource use and profitability by market orientation and ownership (EMI-sector) (1980) Domestic Resource Rate of Return Type of Enterprise Effective Protection Cost Economic Financial By market orientation 10OZ dom. market 1.63 1.55 3.52 5.0X Partially exporting 1.45 1.46 6.8X 7.02 lOOZ exporting 0.99 1.14 21.42 9.2Z By ownership Public 1.51 1.37 4.7Z 5.2Z Private 1.34 0.93 14.1Z 13.92 Source: Institut d'Economie Quantitative The Effective Protection Study is being carried out for several other sectors (chemicals, textiles, footwear, construction materials), and further results are expected to be available during the course of 1985. As is illustrated in the above preliminary results, domestic-based industries are clearly significantly less efficient than exporting ones. A rationalisation of the protection system is thus likLely to be an important policy tool for further encouraging the growth of exports. The whole issue of the protection system is now under study and is expected to be addressed in 1985-1986 (para 2.09). 2.08 There are other reasons that account for the low productivity of Tunisian industry. First, wage increases of 232 on average in 1982, and 162 in 1983, have been substantially higher than productivity increases. Together with relatively high social security contributions by employers, the high effective cost of labor is an obstacle to employment creation, particularly if combined with relatively low interest rates. The increase in wages, and its resulting effect on costs and the general price level, has led to restrictions on imports and tightening of price controls in 1983. An Employment Study is presently being carried out with a view to recomend appropriate income and other employment oriented policies. Second, the limited domestic market has meant that for many industries, economies of scale could not be fully exploited. A re-orientation of some of these industries towards exports should help overcome some of the above constraints. Bank role in the Manufacturing Sector 2.09 The dialogue between Tunisia and the Bank on industrial development has been a productive and multifaceted one. It has aimed at addressing the major contraints noted above. Reference was made in para. 2.07 to a study financed by the Bank to assess effective protection and its effect on industrial efficiency. The results of this study will be used by the Bank in its continuing dialogue with the Tunisian authorities to adopt policies more conducive to improving industrial efficiency. In this connection, a high level Bank mission is planned for early 1985 with a view to make recommendations on improving pricing policies, reducing tariffs and  quantitative restrictions, and reorienting public enterprises towards higher productivity and efficiency. The mission will also rely on the results of the employment study as well as the recently completed review of the Financial Sector which is scheduled for discussion with the Tunisian authorities in early 1985 (see para 4.10). 2.10 Through its loans to industry, the Bank aimed at promoting industrial decentralization, labor-intensive industries and financing high priority industries (e.g. EMIs and SSIs) in support of the Government's priorities for industrial development. Bank financing of manufacturing in Tunisia has mostly tonsisted of loans prc ided through BDET which received eight Bank loans totalling $129.2 million (net of cancellations), of which $14.48 million remained undisbursed as of December 31, 1984. Most of these funds financed manufacturing industries. In addition, Bank loans have helped meet BDET's resource requirements while assisting it in strengthening its organization and in improving its performance. Through its representative on BDET's Board, IFC has offered a substantial contribution in this regard. The Project Performance Audit Report of September 1981 on loans Nos. 648-TUN, 798-TUN and 881-TUN, covering the third (1969), fourth (1972) and fifth (1973) loans to BDET, concluded that considerable progress had been made in terms of institution building and management performance, and that these loans have contributed to changing BDET's role from a supplier of equity funds for public sector industries, to that of financier and advisor of private investors. However, BDET's promotion and supervision capacity, and its evaluation of physical and financial contingencies of projects needed strengthening. The seventh loan to BDET (Loan 1504-TUN of 1978) addressed some of these issues, and included a credit line for a pilot Small-Scale Industries (SSI) scheme (Loan 1505-TUN of 1978) which prepared the ground for a $30 million loan to SSI through commercial banks and BDET as intermediaries (Loan 1969-TUN of 1981). The last operation with BDET was Loan 2113-TUN in March 1982 for the financing of Electro-Mechanical Industries. The present project will continue to build upon the last three projects in addressing some of the shortcomings noted in the Project Performance Audit Report. 2.11 The Bank loans have strengthened the leading role that BDET has played, and should continue to play, in the development of medium and small-scale manufacturing industries in Tunisia. The proposed project would represent a continuation of Bank support for Tunisia's industrial development. It would establish credit lines for supporting export generating investments, assist in the establishment of an Export Promotion Fund and help simplify the administrative procedures for exporting. The project would provide further support to BDET and initiate Bank cooperation with two other development banks the Banque Tuniso-Koweitienne de Developpement (BTKD), the Societe Tunisienne SEoudienne d'Investissement et de Developpement (STUSID) as well as with the newly established Export-Credit Insurance Company (COTUNACE).  III. THE EXPORT SECTOR _ Structure and Performance 3.01 In the 1960's industrial development consisted mainly of developing import substitution industries and the public sector was dominant. In the early 1970's, partly in order to overcome the constraints imposed by the small market of six million people, the Government shifted this policy at the same time that the private sector was accorded a more important role. Thus, the Government put greater emphasis on developing export-oriented industries which was reflected in L2'# 72-38, enacted in 1972, which gave important tax, customs and foreign exchange incentives to exports (para 3.10). As a result, manufactured exports increased by an average rate of 14.4% in real terms from 1971 to 1981 (13.6% between 1976 and 1983), leading to a more than four-fold increase in their real value between 1971 and 1983 (from TD 120.0 million to TD 526.4 million). This was substantially faster than the increase in manufacturing value added which increased by 11.5% in the period 1971-1981 (8.4% between 1976 and 1983). At the same time, exports of manufactured products accounted for an increasing share of these products in total exports: manufactured exports (excluding processed food) rose from 32% of non-petroleum exports in 1971 to 79.3% in 1983, as can be seen from the table below: Composition of Exports and the Share of Manufactured Exports in Total Exports (1971-1983) (in million TD at 1980 prices) Growth rates 1971 1976 1980 1981 1982 1983 71-81 76-83 Total exports 240.8 487.4 970.0 1,115.4 940.0 1,003.0 16.6 10.9 Petroleum exports 64.5 206.3 545.6 593.8 430.4 428.8 24.9 11.0 Non-Petr. exports 176.3 281.1 424.4 521.6 509.6 574.2 11.5 10.7 Manuf. exports 120.0 216.0 372.6 462.0 468.8 526.4 14.4 13.6 (o/v proces. food) (63.5) (78.1) (43.1) (73.5) (71.8) (70.8) 1.5 (1.4) Extractive & raw agric. products 56.3 65.1 51.8 59.6 40.7 47.8 0.6 (4.3) Share of manuf. prod. (excl. proces. food) in total non-petro. exports 32.0 49.0 77.6 74.5 77.9 79.3 n.a. n.a. An international comparison of exports of finished products shows that Tunisia's exports grew 2.4 times as fast (35.7% per year in current Us$) as world exports of these products (14.9%) in the period 1976-1981. Tunisia's export performance also compared favorably with that of the mediterranean region where exports grew by an average rate of 17.8% per year 1/. 1/ Morocco, Algeria, Tunisia, Egypt, Turkey, Greece, Yugoslavia, Spain, Portugal. Data compiled from World Bank Trade System (in current US$) (see Annex 2 for details).  - 8 - 3.02 During the 1970's the composition of Tunisia's expo.ts changed substantially. In 1970, 95% of its exports consisted of processed and unprocessed phosphates, foodstuffs and petroleum products. Ihis percentage had fallen to 55% by 1983; and wherea3 52.9% of all manufactured exports consisted of processed foods in 1971, this share fell to below 13.5Z in 1983. On the other hand, textiles and leather increased their share from less than 6% in 1971 to almost 40% in 1981. Over the same period, chemicals almost doubled its share in total manufactured exports to almost one-third of manufactured exports by 1983. Exports of electro-mechanical industries also grew substantially in the second half of the seventies and now represent 9.5% of total exports. The table below shows the changes in the composition of Tunisia's exports between 1971 and 1983: Composition of manufactured exports and their growth (1971-1983) (in percentages) Growth Rates (real) 1971 1976 1981 1983 1971-81 1976-83 Processed Food 52.9 36.2 15.9 13.5 1.5 (1.4) Textiles & Leather 5.7 28.9 39.4 39.3 38.9 18.6 Chemicals 17.8 23.7 31.3 32.4 21.1 18.8 Electro-Mechanical 8.6 6.5 8.0 9.5 13.6 19.8 Miscellaneous 15.0 4.7 5.4 5.4 3.3 15.7 TOTAL 100.0 100.0 100.0 100.0 14.4 13.6 Total value of Manuf. Exports (current TD) 58.4 149.9 502.4 687.5 24.0 24.3 3.03 Tunisia's exports are increasingly oriented to markets of industrialized countries. Exports to the United States, negligible in 1970, represented 21 percent of total exports in 1983. The relative importance of Tunisia's two traditional partners, France and Italy, decreased slightly, from 45 percent in 1970 to 38 percent in 1983, but the overall importanCe of exports sold to the EEC remained about the same, fluctuating between 55 and 60 percent. On the other hand, there was a striking decline in exports to Tunisia's closes neighbours, Libya, Algeria and Morocco. These three countries were absorbing between 10 and 14 percent of exports at the beginning of the 70's but only 3% in 1983. Although exports to Arab countries of the Middle East increased over the period, their importance remains very marginal (1.2 percent in 1983). Plan Objectives and Strategy 3.04 The Sixth Five-Year Plan's (1982-86) main objectives are to ease the growing unemployment problem, to reduce inter-regional income disparities and to maintain the country's long-term social stability and credit-worthiness at a time of growing financial and balance of payments constraints caused by the expected decline in petroleum exports. To achieve these objectives the Plan foresees the need to slow down substantially the growth of private consumption and reduce the high investment rate which was inceasingly financed by foreign savings in the last few years.  - 9 - 3.05 Increased exports of manufactured products are, in the Plan scenario, essential to achieve these objectives. The Plan projects exports to continue to grow at an average rate of 15% per year in real terms. Export-led growth would relieve the pressure on the balance of payments and foster higher growth for the economy. Equally important, export industries are generally relatively labor intensive. In the longer term, traditional exports, such as phosphates-based chemicals and agricultural products, can offer only modest growth prospects. The growth of non-traditional manufactured exports should therefcre become one of the principal instruments for stimulating the growth of the economy and alleviating the balance of payments constraint as well as for creating employment. 3.06 In addition to the well established main export sectors such as textiles and agriculture, which need to be further developed, electrical and mechanical industries are planned to become an important source of new exports. Tunisia has a well trained labor force, whose wages are still well below European levels; it has liberal investment policies with regard to foreign and private investments, is close to Europe and the Arab countries, and has preferential access to the EEC market. This gives the country a comparative advantage in the production of capital, intermediate and consumer goods, in those sub-sectors using labor-intensive and simple or intermediate technologies, where economies of scale are possible at low levels of production. Recent Developments 3.07 During the first two years of the Sixth Plan (1982-86) budgetary and balavce of payments conditions deteriorated sharply, due mainly to a sharp rise in wages, increases in subsidies and budgetary transfers, and increases in the trade deficit. Even though the relative magnitude of the deterioration, as mevsured in relation to GDP, is not as severe as at the start of the last Plan (1977), there is cause for some concern since, contrary to previous years, the contribution of the petroleum sector to the economy is declining and future petroleum price movements are unlikely to restore the favorable financial position which Tunisia enjoyed during the last decade. 3.08 In 1982-83 the drought-related decline in agricultural production as well as the slowdown in external demand for exports and tourism induced the sluggish growth of output. The real growth of output which stagnated in 1982, showed a 4.5 percent growth in 1983. Demand continued to expand rather strongly in 1982-83. Investment exceeded 30 percent of GDP compared to the plan's average target figure of 27 percent. At the same time, the growth of consumption, triggered mainly by the wage increases of the last two years, surpassed the growth of GDP, thus reducing the domestic saving rate from nearly 24 per cent of GDP in 1981 to 20 percent in 1983. The strong pressure of demand translated itself into the unprecendently high inflation rate of 13.6 percent in 1982. Inflation decelerated to about 9 percent in 1983, following the intensification of price controls. 3.09 The current account deficit of the balance of payments also deteriorated in 1981-83. This was due mainly to the decline in net petroleum earnings and an increase in imports. Thus, the current account deficit increased from 7.6 percent of GDP in 1981 to 9.4 percent in 1982. Following  - 10 - the tightening of import controls in 1983, the current account deficit declined slightly to about 8.8 percent of GDP. These emerging external constraints and Tunisia's inceasing debt burden show the importance of fostering export growth, including, in particular, the growth of manufactured exports. Fiscal and Financial Incentives 3.10 In 1972, when the Government's policy changed from one of import substitution to export promotion, a law (Law 72-38) was passed offering attractive incentives to investors who wanted to take advantage of Tunisia's skilled and relatively cheap labor force, its closeness to Western Europe and the well developed industrial infrastructure aLready in place. The law provided the opportunity to establish "off-shore" companies, anywhere in Tunisia, which would not be subject to customs, foreign exchange and fiscal regulations applicable to other companies. The law gives these companies a ten-year corporate tax exemption and reduced rates thereafter, reimbursement of taxes paid on locally procured goods and services, exoneration of all import duties, exoneration of taxes on rented property and reduced rates of registration taxes and on distributed profits. With regards to foreign exchange regulations the law distinguishes "resident" and "non-resident" companies. The latter companies (owned for more than 66% by non-residents) are essentially exempt from all foreign exchange controls but have to execute all their transactions in dinars bought with foreign exchange while resident companies have to repatriate all their foreign exchange earnings. The Investment Promotion Agency (API), created by the same law, advises the Ministry of National Economy to issue the licence, qualifying a company as a resident or non-resident company under the law. Since its passage in 1972, more than 1,050 projects have been approved, including 99 projects in 1983 (58 resident and 41 non-resident). The Law has fostered employment (over 30,000 in 1981) and had a substantial impact on increased exports. However, exporters failed to use more intensively local supplies and the effect has been that there have been insufficient linkages between the export and domestic sectors. It seems that low quality, high price and unreliability of delivery dates are more important obstacles to closer integration of the two sectors than the unwillingness on the part of exporters to use local supplies. 3.11 Aware of the problem of insufficient integration of the export and domestic sectors, the Tunisian authorities passed a second law in 1981 (Law 81-56, as amended in 1983) which gives important advantages to domestic or "non off-shore" companies that export only part of their production and are certified by API. The main advantages for such exporters are the following: (i) a reduced corporate tax of 20% on the part of the production which is exported; (ii) exemption from sales taxes on goods and services bought on the local market and used in the production of exports; and (iii) access to simpler formalities for imports required in the production of exports. This law is recent and it is premature to assess its effect in fostering exports l/. Nevertheless, it is clear that adminstrative procedures related to 1/ Besides the advantages provided to exporters under the above two laws, exporters also have access to credits at the rate of 6.5% per annum to finance their operations .pre-financing) and accounts receivable. Commercial banks providing these credits have access to a preferential discount rate of 4.75% per annum without ceiling or prior approval of the Central Bank.  - 11 - exports remain complex and uncoordinated and therefore limit the effectiveness of the incentives provided by the existing laws and regulations. The proposed project addresses the issue of simplifying export procedures (paras 6.22-6.23). 3.12 Improvements in export finance were also introduced in the last three years following a continuing Bank dialogue with the Government. As a result, several constraints in the financing of exports were removed: (i) to avoid the build-up of stocks of imported raw materials and intermediate inputs, a limitation had been put on pre-financing these imports to 10% of the annual import requirements. This was considered too restrictive and sometimes impeded the uninterrupted production for exports. The Bank recommended that pre-financing should be available for at least 20% of the annual import allocation. This recommendation was subsequently implemented; (ii) Tunisian exporters were limited in their possibility of offering attractive payment terms on their exports, because banks could only discount claims on abroad of a maturity of less than 90 days. This was considered too restrictive and the duration for discounting claims was lengthened to 180 days, to be increased in exceptional circumstances to 360 days; (iii) Tunisian exporters could only keep 3% of their foreign exchange earnings in convertible dinars. This often left exporters with insufficient funds for their marketing and promotion efforts. Recently, the percentage was increased to 4% and exporters are allowed an additional TD 6,000 per year for travel expenditures. This is a step in the right direction but may nevertheless not provide sufficient foreign exchange to allow exporters to explore new markets and, particularly, market new products. Also, and more importantly, it does not cover new exporters which need foreign exchange to market their products abroad. To overcome this problem, the project provides for the setting up of an Export Promotion Fund (paras 6.13-6.17). Institutional Framework 3.13 The Center for the Promotion of Exports (CEPEX), a public organization of industrial and commercial character under the aegis of the Ministry of National Economy, was established by Law 73-20 of April 14, 1973 to contribute to the development of Tunisian exports and to assist exporters by conducting market surveys, providing marketing advice, disseminating commercial information, participating in trade fairs and helping the Government with the formulation of trade policies. CEPEX received financial assistance from the Bank through the Technical Assistance Loan (2197-TUN) which includes a study which has as one of its main objectives to determine how to strengthen the institutions responsible for export promotion and to identify projects and sectors that have export potential. These projects may be financed by the proposed project. The study is underway and is expected to be completed in early 1985. 3.'4 Institutional improvements were also introduced by two new laws passe' in 1984. The most important of these was the approval by Parliament in May 1984 of a law creating an Export-Credit Insurance Company (COTUNACE). The company was estatYlished in September 1984 (see paras 5.48 to 5.50 for further details). The need to establish an export-credit insurance facility was identified by the Tunisian Government and the Bank during missions in 1982 and 1983. The creation of such a facility would complement the favorable credit conditions offered to exporters in the form of export credits at the rate of  - 12 - 6.5% p.a. The objective of export-credit insurance is to cover, through an insurance policy, the majority of losses which an entrepreneur can incur on its export operations because of non-payment by the foreign buyer for commercial or political reasons. Such insurance should eucourage banks to provide loans to exporters with limited collateral. Through the proposed project, the Bank will be closely associated with COTUNACE with a view to monitor its continued sound development. The second law provides for the creation of Export Trading Companies which would benefit from substantial tax, customs duty and foreign exchange facilities. These companies would specialise in selling Tunisian products abroad, especially the products of small- and mediumrsize industries that would otherwise find it difficult to find markets abroad. Licenses for establishing such companies will be issued by the Ministry of National Economy on the recommendation of CEPEX. Conclusion 3.15 The previous sections have outlined the important measures undertaken by the Tunisian authorities in recent years to strengthen fiscal and financial incentives to exporters, simplify administrative procedures and set up and strengthen institutions to foster export growth. Several of these measures were taken in the context of the continuing dialogue between the Bank and the Government of Tunisia and the proposed project builds up on and continues to support many of these initiatives. At the same time, it was pointed out in Chapter II (para 2.07) that the protection framework encouraged inefficiencies and production for the domestic market rather than for exports. The Tunisian Government is aware of this situation and is in the process of undertaking an in-depth study of the protection framework. The results of this work will be reviewed with a Bank industrial sector mission during 1985 and this is expected to initiate a dialogue with the Tunisian authorities on how best to rationalise the protection system in the coming years focusing on pricing, investment licensing and tariffs and quantitative restrictions. At the same time, Tuniria's record of export growth in recent years, and the priority accorded to exports in the current Five Year Plan, as well as the availability of a substantial pipeline of viable export projects and the need to further strengthen export institutions, argues in favor of a project that will support the Government's efforts in this critical area at this time.  - 13 - IV. THE FINANCIAL SECTOR Overview 4.01 Tunisia's financial system consists of the monetary system, other financial institutions and the stock and bond exchange. The monetary system consists of the Central Bank, ten commercial banks and the postal check system. The other financial institutions consist of eight operating development banks, two savings organizations, eight portfolio management companies, eight off-shore banks and five foreign bank representative offices. For the size of the country (seven million inhabitants) and its level of development this is a fairly large institutional framework. In addition, Tunisia has a stock and bond exchange which is not highly developed on which essentially ten-year bonds issued or guaranteed by the Government are traded as well as shares of 44 companies of which nine are banks. The Government is shareholder in 39 of the 44 companies and majority owner in 26 of them. 4.02 The commercial banks, which are essentially deposit-retail banks, are small by international standards. Tie largest bank, Societe Tunisienne de Banque with a share capital of TD 20 million (US $27.6 million) had total assets of just over TD 1.0 billion (US tl.38 billion) at the end of 1982. At that time the total assets of the ten commercial banks did not exceed TD 3.6 billion (US $5 billion). Besides short-term credits, commercial banks can also provide medium-term loans up to a maximum of seven years within limits set by the Central Bank. Loans over seven years can only be provided by commercial banks from special resources (i.e. non-deposits) which have a maturity of more than seven years. However, credits over seven years can be authorised for public enterprises from regular commercial bank resources as long as these credits do not exceed 3% of total deposits of the bank in question. 4.03 The commercial banks are subject to the monetary policy of the Central Bank, its credit controls and particularly the requirement that commerciaL banks invest 43% of their deposits and savings accounts in Government paper (20%), National Home Savings Company (CNEL) bonds (5%) and medium-term loans to industry (18%). This requirement has made the commercial banks important sources for industrial medium-term finance. 4.04 Up to 1980 there were only two development banks: Banque de D6veloppement Economique de Tunisie (BDET) and Banque Nationale de Developpement Touristique (BNDT) which essentially were the only institutions specialized in medium and long-term financing of industry and tourism. Between 1981 and 1983, six new development banks were created. Four of the newly-created development banks were joint-ventures between Tunisia and other Arab countries: the Tuniso-Koweiti Development Bank (BTKD), the Tuniso-Saudi Investment and Development Company (STUSID), the Tunisian and Emirates Investment Bank (BTEI), and the Tuniso-Qatary Investment Bank (BTQI) 1/. In 1/ The other two were the Banque Nationale de Developpement Agricole which finances only projects in the agricultural sector and Banque de Cooperation du Maghreb Arabe which finances only Algerian-Tunisian joint-ventures. Other banking joint ventures are being considered with Libya, Senegal and Italy.  - 14 - comparison with the commercial banks they have relatively large share capitals (BTKD and STUSID: TD 100 million each; BTEI: TD 50 million; and BTQI: TD 70 million) which have been subscribed equally by Tunisia and the respective Arab countries. A main reason for their creation was to attract capital resources from abroad and to channel these resources into productive uses on the basis of financial, economic and technical criteria generally used by development banks. The financing of exports 4.05 (a) Short-term credit. The financing of export and import transactions is strictly controlled by the Central Bank. Exporters are required to repatriate the proceeds of their exports and are allowed a maximum amount (4% of the proceeds) in convertible dinars to pay for incidental expenditures related to their export business. On the basis of agreed import allocations, which have been liberalised progressively, co;amercial banks provide pre-financing credit for imported goods and services required by the prospective exporter. These credits, as well as those to finance claims originating from actual exports, are subject to favorable interest rates (6.5%), unlimited rediscount facility (at 4.75%) and are not subject to prior approval for rediscounting. In future COTUNACE will insure these credits: this will be a significant improvement since credit was often limited by the insufficient collateral of exporters. 4.06 (b) Medium- and long-term credit. Medium-term export credit is provided by the Central Bank through the commercial banks on a case-by-case basis and is tailored to the particular needs of the very few manufacturers who export capital equipment (transformers, railway wagons, metal structures etc.). A medium-term export-credit scheme to finance exports of capital goods is under study. Mediur-term credit (up to seven years) to exporters for investment purposes is available from the commercial banks to a limited extent. However, given their relatively small size and their limited project appraisal capacity tailored principally to smaller projects, commercial banks generally provide mediumrterm finance only in conjunction with long-term credits from the development banks. Commercial banks can only provide long-term credit from long-term resources specifically mobilised for that purpose. Unless these resources have particularly attractive features, for example risk sharing by the Government and provision of low cost resources under the FOPRODI schemes 1/, commercial banks have little incentive to provide long-term finance. Thus commercial banks are principally providers of short-term and medium-term credit which they finance from their short-term and mediumrterm deposits. Long-term lending to industry is essentially provided by the development banks which have been created for this purpose and which have been equiped with organisations and staff to appraise, supervise and promote industrial ventures in all industrial sub-sectors. In 1983-84 development banks financed roughly 60% of MLT credit with 40% coming from commercial banks. In prior years, before the formatioa of the new development banks, commercial banks provided significantly more MLT financing (about 70% of the total in 1981-82). 1/ FOPRODI: Industrial Promotion and Decentralisation Funds (see first Small-Scale Industries Development Project: Loan 1969-TUN).  - 15 - Interest Rates 4.07 Tunisia has a very detailed structure of interest rates which is regulated by the Central Bank. This structure determines all the discount rates of the Central Bank for short and mediunrterm paper. There are different discount rates according to the sector (industry, agriculture, housing, tourism etc.) and purpose (construction, seasonal credit, loans for medium and small-size industry, loans for under-developed regions of the country, exports etc.). Interest rates or loans by commercial banks are also fixed at levels that depend on whether they are discountable or not, the rate of discount as well as the maturity of the loan, the sector and the purpose. Thus for mediumr-term loans (maximum of seven years) to industry for investment purposes, the interest rate is set at between 9.5% (minimum) and 9.75% (maximum) for rediscountable loans and between 10.0% (minimum) and 10.25% (maximum) for non-discountable loans. Development banks are free to determine their own interest rates on long-term loans, which are presently at around 12%. However, for loans below TD 500,000, BDET charges 11.0% in order to remain competitive with the terms on medium-term loans offered by commercial banks. The other development banks do not generally make loans below TD 500,000. The rates of 11-12% on MLT credit compare with an inflation of 9X in 1983. The inflation rate is expected to be 9% through project implemen- tation. Thus local rates are, and are expected to remain over the life of an individual loan, positive in real terms. 4.08 Interest rates on deposits (both sight and term) and savings accounts are also fixed by the Central Bank with rates changing according to maturity (i.e. longer maturities having higher rates), the nature of the saver (individual or corporation), the size of the deposit (small savers have special rates) and purpose (e.g., savings for housing). Typically, term deposits over two years pay 7.75% (after tax) and savings accounts of the same maturity pay 8.75%. 4.09 Periodically the Central Bank revises the general level of the interest rate structure; the last such adjustment took place in April 1981 when interest rates were increased by about 1.5%. This increase was in response to the general rise in interest rates abroad and the experienced inflation rate in the country. The development banks have no access to the rediscount facility of the Central Bank. However, BDET has access to a special facility of TD 8.6 million at 9% (the normal discount rate for mediumrterm loans for industry by commercial banks is 71). Review of The Financial Sector 4.10 A Financial Sector Study (FSS) is currently in progress. It reviews overall monetary and credit policies, the institutional framework and the utilisation of monetary instruments, particularly interest rates, to achieve better mobilisation and more efficient allocation of resources. The FSS concluded that the Tunisian financial sector is basically efficient but can benefit from some adjustments to improve the country's resource and mobilisation efforts and the efficiency of the intermediation process. The FSS proposes an overall upward adjustment in the structure of interest rates together with a simplification and harmonisation of the overly complex existing schedule. While on-lending rates have been positive in real terms,  - 16 - deposits have been barely positive in recent years and well below international levels. It also proposes the introduction of a more flexible system to allow rates to be adjusted more frequently to changes in the liquidity situation, the domestic inflation rate and interest rates abroad. Finally, it proposes that subborrowers bear a share of the foreign-exchange risk on foreign currency loans. Two aspects of the FSS's general recommendations are of relevance to the proposed project and these are discussed in more detail below. More generally, the recommendations of the FSS are relevant to improving the efficiency of the intermediation process in Tunisia and domestic resource mobilisation and allocation. The findings of the financial sector report will be discussed with the Tunisian authorities beginning during 1985 and this will provide the basis for continuing the Bank-Tunisian dialogue on the reform of the financial sector. 4.11 Cost of funds of development and commercial banks. There is a large discrepancy in the cost of funds and lending rates between the commercial banks and the development banks, which is undesirable. The relatively low interest rates on deposits at commercial banks has kept the average cost of funds for these banks at about 6%, taking into account that sight deposits, which constitute between 55% and 60% of banks' resources, are remunerated at the rate of 1% for enterprises and 2% for individuals. Development banks on the other hand are not allowed to accept deposits and are therefore essentially dependent on the international market or lines of credits from bilateral or multilateral agencies. In particular BDET, which raised $60 million in 1983 from the international market, has seen its average cost of borrowing increase to about 8.5% in 1983, while the marginal cost of borrowing increased to over 11%. This rate has since come down to about 10%. Commercial banks make mediumr-term loans to industry at the rate of 9.5% - 10%, which allows them a financial spread of 3.5% - 4%. The average rate on new loan commitments by BDET is presently about 11.5%. The financial margin on its portfolio, 1/ which had declined between 1979 and 1982 because of increases in the cost of borrowing, increased to 2.3% in 1983. This margin is forecast to remain at 2% in the future (see para 6.12 and Annex 3, Table 6) in part because of Government support, which will be phased out, however, at the end of 1986, and in part because of increased interest rates on lending. Nevertheless, BDET's relative position vis-a-vis commercial banks can be strengthened further by upward adjustments in the structure of interest rates (for both deposit and especially lending rates) as recommended in the FSS in order to improve overall domestic resource mobilisation and allocation. This general issue will be pursued in the context of the discussion of the FSS and our general economic dialogue with the Government. While an upward adjustment of interest rates will further strengthen the financial position of BDET which is already and is expected to remain sound, this would only be expected to have a significant effect on BDET's financial position in the medium term. I/ Difference between the average borrowing and average lending rate.  - 17 - 4.12 Foreign Exchange Risk. The Government now carries the foreign exchange risk on the foreign borrowings of BDET and BNDT. Up to 1981 this practice resulted in profits for the Government because of the dinar appreciated in relation to the basket of currencies. Since 1981 the situation has changed, particularly vis-b-vis the dollar which has appreciated. Nevertheless, over a period of ten years, the result has still been positive for the Government. The question of the foreign exchange risk coverage is becoming more important since the new development banks will need to borrow a significant part of their resource requirements abroad. An appropriate foreign exchange coverage scheme should therefore be designed. The FSS has proposed a new basis for subborrowers to cover foreign exchange risks in relation to the risk of devaluation of a particular currency. These principles need to be translated into a detailed scheme. During negotiations agreement was reached with the Government to undertake a study for instituting a suitable foreign exchange scheme on the basis of the principles included in the FSS. The study will be completed and discussed with the Bank by March 31, 1986. This agreement is reflected in the loan documents (Section 4.04 of the Loan Agreement). The Government will continue to bear the foreign-exchange risk under the proposed loan as under previous loans to BDET, until agreement has been reached on an alternative coverage scheme as a result of the study.  - 18 - V. THE INSTITUTIONAL FRAMEWORK A. Financial Intermediaries 5.01 Three financial institutions, BDET, BTKD and STUSID, will be the intermediaries for the proposed project. BDST is the country's leading development bank and has received eight Bank loans since 1966. BTKD and STUSID, two new development banks, were selected as intermediaries in response to the Government's request that the Bank project relies on several channels to support the financing of investments for exports. The inclusion of BTKD and STUSID in the project will significantly add to the number of viable export projects. They have given priority to export projects in the past and the proposed Bank loan has already led them to identify additional viable export projects. The two institutions are financially viable and well managed: they have put in place competent organizations and staff to identify, appraise and supervise projects financed by them. A relation with the Bank is considered important by BTKD and STUSID because of the institutional support the Bank can provide in terms of overall development bank policies and practices and more specifically on appropriate project appraisal/supervision standards. Financial support by the Bank to these institutions is also expected to strengthen their ability to raise resources from international sources. Detailed descriptions and analysis of their operations, financial position, resource requirements and organizational structures are provided in paras 5.23 - 5.34 (BTKD) and 5.35 - 5.47 (STUSID) I. Banque de Developpement Economigue de Tunisie (BDET) 5.02 BDET was created in 1959 and reorganised, with the assistance of the Bank Group, in 1966. Since then the Bank has provided eight loans totalling $134.5 million, representing between 33% and 40% of BDET's total resource requirements. IFC is a shareholder in BDET since 1966 (see list of Shareholders, Annex 3, table 1). The institution is well managed, has a competent staff and has well established procedures for appraisal and supervision. A number of developments have, however, put strains on its operations, financial position, profitability, portfolio and staffing. 5.03 Operations. BDET's approvals almost doubled between 1980 and 1982 (Annex 3, table 2). However in 1983 approvals fell by 35Z mainly for the following reasons: (i) investments in the electro-mechanical industries and tourism sectors returned to more normal levels after the exceptionally high approval levels of 1981 and 1982 reflecting, in particular, large investments in the these two sectors; (ii) competition from the new development banks took away business from BDET; and (iii) demand for financing by SSI 1/ projects stagnated. Although SSI projects remain BDET's most important activity in terms of number of projects, the amounts approved for such projects have decreased in importance in 1982 and 1983. BDET expects approvals to increase by about 10% in the next three years (see para 5.17). BDET's approvals in the period 1980-1983 were mainly for new projects (73%) in the private sector (88%). Its operations were well distributed over the several sectors and regions of the country (Annex 3, table 3). 1/ Defined since 1980 as enterprises having total investment cost of less than TD 500,000. The limit is presently under review and may be increased to TD 750,000.  - 19 - 5.04 Financial Position. BDET's audited balance sheets for the last five years are attached in Annex 3, table 4. During the period 1980-1984 assets increased by an average rate of 21.3Z per year reflecting the general growth of industrial investments in Tunisia. BDET's share capital was increased from TD 10 million to TD 20 million in 1982/83, partly by incorporating reserves. BDET's debt-equity ratio (5:1) on December 31, 1983 remains well below the maximum allowed under previous Loan Agreements (8:1). 5.05 TWo developments in recent years are worth noting: First, the increase in short-term liabilities mainly on account of short-term borrowing. These short-term borrowings, were required to meet BDET's cash requirements for loan disbursements at a time when it was difficult and expensive to raise resources from the capital market. In 1983, BDET borrowed US$60 million in the form of Floating Rate Notes (FRN), which enabled it, among others, to repay about US$ 13.8 million (TD 10 million) of short-term borrowings. Although the terms of the FRN are attractive by international comparison (1/2X above LIBOR, 7-years), the cost of the issue increased BDET's overall resource cost. Borrowing of an additional $60 million on medium-term is planned for early-1985, which should enable BDET to retire the remainder of its short-term borrowings, which had increased again in 1984, and thus further improve its current ratio. 5.06 The second noteworthy development concerns the increase in receivables, which includes TD 10.5 million due by the Government on account of foreign exchange losses incurred on borrowing abroad. These losses have been accumulating since 1981 and concern losses on principal payments only (Interest payments have been substantially paid by the Government-para 5.08). During negotiations the Government committed itself to reimburse BDET before the end of 1985 for outstanding losses on principal incurred up to the end of 1983. A commitment was also obtained from the Government to reimburse BDET for losses resulting from foreign exchange rate fluctuations in 1984 before the end of 1986. The Government will continue to cover BDET's foreign exchange risk until such time as the foreign exchange coverage system may be revised in the light of theresults of the study, referred to in para 4.12. 5.07 Profitabilit. BDET's audited income statements for the period 1980-1982 (Annex 3, table 5) show almost constant net incomes before tax (of about TD 1.55 million) despite an increase of over 50X in assets during this period. The main reason for this development is that the average cost of borrowings increased faster than interest rates on lending. As a result of the dialogue provided for in Loan No. 2113-TUN (EMI project), BDET has increased interest rates on its loans from 9.0% in 1981 to about 11.0% at present for small and medium size industries, to 12.5Z for tourism projects and to 132 for large projects. These increases in interest rates have led to a substantial increase in interest income betweem 1983 and 1984. This was however counterbalanced by the increased cost of borrowing which was largely due to the depreciation of the dinar. Part of this increased cost was however absorbed by the Government compensation for BDET's foreign exchange losses (para. 5.08). Further interest rate increases by 0.5% per year may be envisaged, inter alia in the light of the evolution of the financial sector. The effect of these interest rate increases on income is, however, initially slow since the proportion of higher interest rate new loans in the total outstanding portfolio remains small.  - 20 - 5.08 The cost of borrowing has increased mainly because if the increased debt service on foreign borrowing due to the depreciation of the dinar particularly vis-h-vis the dollar. Foreign exchange losses on account of interest payments on foreign borrowing amounted to TD 1.0 million in 1981, TD 1.6 million in 1982 and TD 2.2 million in 1983. The Government has reimbursed BDET for these losses through its annual compensation payments amounting to TD 1.0 million in 1981, TD 0.5 million in 1982 and TD 2.9 million in 1983. Including these compensation payments BDET's financial margin (difference between the average rate of lending and average rate on borrowing) has been 1.27% in 1982, 2.38% in 1983 and 2.00 in 1984, which is substantially in agreement with the understanding reached during the negotiations for Loan-2113 to assure BDET a margin of 2%. The average return on net worth over the last six years has been 10.7%, permitting BDET to maintain 8% dividend payments. BDET has reduced its administrative expenses in the last four years; in 1983 these expenses fell to below 1% of average assets which is one of the lowest levels of develoment banks financed by the Bank. Reimbursement by the Government of the foreign exchange losses together with che continued increases in interest rates on lending will gradually improve BDET's profitability and permit the phasing out of Government subsidies by 1986 as agreed under the EMI-project (Loan 2113-TUN) (see para 5.18). 5.09 Portfolio. As of December 31, 1983, BDET had a loan and equity portfolio of TD 192.0 million distributed over 680 loans (TD 168.7 million) and 190 equity participations (TD 23.3 million). Loans to industry represented 68% of total loans, the remainder being invested in tourism (21%), and other sectors (transport, services). Loans were well distributed over the several sectors of industries with agro-industries, construction materials, EM