Philippines - Industrial Investment Credit Project

Docunent of The World Bank FOR OFFICIAL USE ONLY 44/ 3/Z7- P Reporlt No. P-5139-PH MEMORANDUM AND RECONMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$65 MILLION TO THE DEVELOPMENT BANK OF THE PHILIPPINES WITH THE GUARANTEE OF THE REPUBLIC OF THE PHILIPPINES FOR AN INDUSTRIAL INVESTMENT CREDIT PROJECT SEPTEMBER 5, 1989 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS (as of November 30, 1988) Currency Unit Peso (P) US$1.0 = P 21.4 P 1.00 US$0.0467 ABBREVIATIONS ADB - Asian Development Bank DBP - Development Bank of the Philippines DTI - Department of Trade and Industry ERL - Economic Recovery Loan FSAL - Financial Sector Adjustment Loan GATT - General Agreement on Tariffs and Trade GDP - Gross Domestic Product GNP - Gross National Product PFI - Participating Financial Institution FISCAL YEAR DBP - January 1 to December 31  FOR OMCIAL USE ONLY PHILIPPINES INDUSTRIAL INVESTMENT CREDIT PROJECT t Loan and Project Summary Borrower: Development Bank of the Philippines (DBP) Guarantor: Republic of the Philippines Beneficiaries: Accredited participating financial institutions (PFIs) and private sector medium and large enterprises. Amount: US$65.0 million equivalent. Terms: Repayable over 20 years, including five years of grace, at the standard variable interest rate. Financing Plan: Subborrowers US$30.0 million Participating Financial Institutions US$15.0 million Technical Assistance Beneficiaries US$ 1.0 million Japan Grant Facility US$ 3.5 million IBRD US$65.0 million Total US$114.5 million Economic Rate of Return: n.a. Staff Appraisal Report: Report No. 7823-PH This document has a restricted distribution and may be used by recipients only in the perfornmance of their official duties. Its contents may not otherwise be disclosed without World Bank author -fi-e; |  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE DEVELOPMENT BANK OF THE PHILIPPINES FOR AN INDUSTRIAL INVESTMENT CREDIT PROJECT 1. The following memorandum and recommendation on a proposed loan to the Development Bank of the Philippines (DBP) for US$65 million equivalent is submitted for approval. The proposed loan would be tor 20 years including 5 years of grace and would carry the Bank's standard variable interest rate. The Government of the Philippines would guarantee the Bank loan to DBP. The proposed Project, which would help finance the development of private sector medium and large enterprises, would be co-financed by the Japan Grant Facility for US$3.5 million equivalent. 2. Background. The remarkable economic recovery of the Philippines in the last two years has been largely led by the industrial sector which accounts for 33% of GDP, 422 of total merchandise exports and 152 of total employment. The sector, which is mostly private, has benefitted from comprehensive structural reforms undertaken by the Government, including a major trade liberalization program and the reform of investment incentives which corrected two major weaknesses of the past, namely, the favoring of import-substituting industries over exports and the favoring of capital- intensive over labor-intensive technologies. As a result, the Philipr.ne economy is now more open and transparent in its regulatory and incentive structure than at any time since 1950. Moreover, the average nominal tariff is now comparable to that of other countries that have also liberalized in recent years. 3. Despite this success, however, GDP in 1988 was barely ahead of the pre-recession (1983) level and gross value added in manufacturing only slightly surpassed the pre-recession peak. This suggests that there is substantial scope for expansion of the industrial sector. The Bank's growth projections for 1989-92, assuming continued good policy performance and a favorable external environment, indicate an average GNP growth of about 6%, with a rate of 8? for industry. Achieving this target will necessitate a gradual increase in the rate of investment, from the 1988 level of 18? of GNP to at least 22%. Industry will need term credit to finance its investment requirements and take advantage of the trade liberalization and incentive reforms already undertaken. 4. The liberalized policy environment has affected various industrial subsectors differently, with firms in some hitherto protected industries needing time to restructure so as to become efficient and internationally competitive. However, the design and implementation of a restructuring strategy has been hampered by insufficient know-how and Government's hesitancy to introduce, at this stage, further policy reforms in some subsectors, out of fear that they would collapse if these reforms were introduced hastily and without proper sequencing. This applies particularly to the capital-intensive processing industries with large, sunk investments. Analysis of the policy and restructuring issues facing these subsectors is therefore needed to assist the Government, industrialists and bankers in the formulation of appropriate subsectoral strategies.  - 2 - 5. Industrial policy reforms in the Philippines have been accompanied by financial sector reforms. In 1980, the Government initiated policies that led to deregulation of interest rates and liberalization of exchange controls. Following the 1983-85 recession and the resulting distress in the financial system, the Government undertook measures for rehabilitating the Philippine National Bank and the Development Bank of the Philippines (DBP), in the context of the Bank-financed Economic Recovery Loan (ERL: Loan No 2787-PH, 1987). With the financial and institutional strengthening of these two institutions substantially completed, and the health of the commercial banks having improved, the Government has embarked on a comprehensive program of financial sector reforms to make the banking sector more competitive and responsive to the needs of the real sectors. This program, with Bank support provided under a Financial Sector Adjustment Loan (FSAL; Loan No. 3049-PH), would be implemented over the next two years. The program consists of measures to (a) improve the supervision and regulation of commercial banks; (b) strengthen the institutional arrangements for protection of insured depositors; (c) reduce bank intermediation costs and, (d) improve the institutional arrangements for the provision of long-term credit through a strategic reorientation of DBP into a wholesale bank that would mobilize and channel funds to the private sector through retail financial institutions. 6. The provision of term credit to industry is currently inadequate, despite the availability of domestic long-term funds from institutional savers like insurance companies, the Social Security System and pension funds. Given the liquidity crises of the past, banks are unwilling to assume the liquidity risk inherent in term transformation, and their present liability maturities are not, nor are they expected to be, long enough to lend long-term. The need for an institution to bring the sources and users of long-term funds together led to the choice of DBP as a wholesale bank, which would play a major role in domestic resource mobilization. Since the local capital market is undeveloped and the Government is likely to continue tapping domestic savings through high-yield Treasury bills, DBP can only assume that role gradually and will have to fund itself to a significant degree through foreign sources in the near future. In this context, DBP has been designated by the Government as a principal conduit for official foreign borrowings, the proceeds of which are to be channeled through retail financial institutions to finance private enterprises. 7. DBP's turnaround in the last two years permits optimism regarding its future prospects as a wholesale bank. Its indicators of capital adequacy, liquidity and earnings performance are sound. It has met and, in some ateas, bettered the targets set jointly by the Bank, the Government and DBP in the context of the ERL. It has a new management that has demonstrated a willingness and an ability to take hard decisions; it has developed a focused strategy and has restructured its organization to implement that strategy; it is implementing improved controls and procedures. Of equal importance, its operations are to be governed by policies designed to ensure that it avoids the mistakes of the past. Its new Policy Statement provides for DBP to have: (a) a private sector orientation with autonomy in decision- making; (b) an interest rate and fees policy that is consistent with prevalent market rates and that ensures full recovery of all its direct and indirect costs, including provisions as required, plus an adequate profit margin; (c) prudent interest rate and maturity match between its assets and liabilities; and (d) a debt-equity ratio not exceeding 5:1. These market-oriented  - 3 - policies, implemented by its now more streamlined organization under new management, should enhance and speed up the integration of DBP into the market-based financial system of the Philippines. 8. Project Objectives. The proposed Project would help improve credit delivery for industry by assisting DBP to cairy out Its wholesale banking function of channeling term funds to retail financial institutions; fill the gap in the supply of term credit to private sector medium and large industrial enterprises; broaden the scope of financial services available to them; help promote development of the capital market by introducing, on a pilot basis, the financing of equity and quasi-equity investments by participating financial institutions (PFIs); support and develop, within DBP and the Department of Trade and Industry (DTI), capabilities to conduct analytical and policy-oriented studies on industrial subsectors; and assist the Government in identifying, in selected subsectors, the policy and institutional framework which would provide the correct signals and support for these subsectors to become internationally competitive and efficient. 9. Rationale for Bank Involvement. The World Bank and the Asian Development Bank have been the two major sources of foreign exchange for term lending in the Philippines, and the Bank's continued involvement is crucial for private industrial investment. The Bank's financial assistance under the proposed Project will (a) help the industrial sector 3xploit the opportunities and meet the challenges provided by the liberalized policy environment and improved socio-political climate; and (b) build upon the restructuring of DBP undertaken under the ERL program. Moreover, by providing funds to DBP to enable it to carry out its wholesale banking role, the Project would complement as well as reinforce the FSAL program. The technical assistance component dealing with industrial subsectors would provide a vehicle for continuation of the Bank's dialogue with the Government on industrial restructuring and lay the groundwork for a program of reforms that may be supported by future subsector operations. 10. Project Description. The proposed Project would have the following components: (a) a Line of Credit to DBP for (i) equipment and working capital financing; (ii) lease financing and (iii) financing of equity and quasi-equity investments. DBP would relend the proceeds of the Bank loan to accredited PFIs in domestic currency at market rates. The PFIs would in turn on-lend the funds to their subborrowers at freely determined competitive rates. The Government would bear the foreign exchange risk in exchange for a market-based fee payable by DBP. (b) Studies, Training and Technical Assistance to DBP and DTI, financed through a US$3.5 million equivalent grant from the Japan Grant Pacility. This component would provide consultant services and training to enhance DBP's and DTI's capability to conduct studies which would (i) provide subsector data and analyses to help financial institutions assess individual projects and (ii) develop proposals for subsectoral restructuring, including measures to improve the policy and institutional framework. 11. The total cost of the proposed Project is estimated at US$114.5 million equivalent with a foreign exchange component of US$68.5 million (60Z). A breakdown of costs and the financing plan are shown in Schedule A. A  - 4- disbursement schedule is presented in Schedule B. A timetable of key project processing events and the status of Bank Group operations in the Philippines are given in Schedules C and D, respectively. The Staff Appraisal Report, No. 7823-PH dated June, 1989, is being distributed separately. 12. Agreed Actions. During negotiations agreement and understandings were reached on the following: (a) DBP would implement its Institutional Development Plan. (b) The Operating Policy Guidelines for the proposed Project would include provisions for (i) a minimum subloan size of US$250,000 and maximum subloan size of US$6 million except in the case of loan syndications, where the maximum is US$8 million; (ii) eligible firms in industrial sectors to have a minimum asset size of P20 million (before financing); (iii) PFIs to contribute from their own funds at least 10? of each subloan and a minimum equity contribution by the subborrower to equal 202 of total project cost; (iv) subprojects to be in compliance with environmental laws; (v) accreditation criteria for PFIs and (vii) exclusion of DBP as a retailer of funds under the proposed Project. (c) The on-lending rate to subborrowers will be determined by PFIs based on market conditions. (d) The relending rate from DBP to the PFIs will be based on domestic market rates and offered to the PFIs on fixed or variable terms. Ce) The foreign exchange risk would be assumed by the Government in exchange for a market-based fee. 13. Benefits and Risks. The Bank loan will increase the long- term resources available for industrial lending. Based on the experience of previous projects, it is expected that the Bank loan would finance about 45 subprojects which would create around 5,300 jobs. The project will also enable DBP to develop the institutional capabilities to embark on the wholesale banking role envisaged for it under the FSAL program. The technical assistance for industrial restructuring studies would assist the Government in designing the reforms that may be necessary for the efficient and competitive development of enterprises in specific subsectors. These studies would also provide the analytical basis for developing subsectoral restructuring strategies. 14. The major risk is that investment demand may not materialize as projected. Commitments could slow down because of slower than expected economic growth or reluctance by financial intermsdiaries in marketing new financial instruments that would be introduced under the proposed Project. To mitigate the impact of these uncertainties, the loan amount has been set in light of conservative demand projections, and the amounts allocated for lease contracts, equity and quasi-equity instruments are relatively small. If this allocation does not match actual demand for leasing and equity investments, the Bank funds would be reallocated for traditional credit operations.  15. Recommendation. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loan. Barber B. Conable President Attachments Washington, D.C. September 5, 1989  Schedule A kepublic of the PhilipDines Industrial Investment Credit Proiect Estimated Costs and Financing Plan Estimated Costs: Local Foreign Total - ----- (USS million)------------ Credit Component 45.0 65.0 110.0 Studies, Training and Technical Assistance 1.0 3.5 4.5 Total 46.0 68.5 114.5 Financing Plan: Local Foreign Total ------(US$ million)--------------- Subborrowers 30.0 30.0 PFIs 15.0 15.0 DBP/DTI (Technical 1.0 1.0 Assistance Beneficiaries) Japan Grant Facility - 3.5 3.5 IBRD 65.0 65.0 Total 46.0 68.5 114.5  - 7. Schedule B Republic of the Philippines Industrial Investment Credit Project Disbursements Category Amount Z to be Financed (US$ million equivalent) Subloans 65.0 1002 of foreign expenditures 602 of local expenditures Estimated Disbursementst IBRD FY 90 91 92 93 94 95 Annual 2.6 15.6 22.1 14.3 7.8 2.6 Cumulative 2.6 18.2 40.3 54.6 62.4 65.0  Schedule C Republic of the Philippines Industrial Investment Credit Project Timetable of Key Project Processing Events (a) Time taken to prepares 1 year (b) Prepared bys DBP with Bank assistance (c) First Bank mission: May 1988 (d) Appraisal mission departure: February 1989 (e) Negotiations: July 1989 (f) Planned Date of Effective ass November 15, 1989  - 9 -4Schedule D Page 1 of 2 THE STATUS OF BANK GROUP OPERATIONS IN THE PHILIPPINES A. STATEMEN4T OF SAWK LOANS AND IDA CREDITS /o An of March 81, 198S Loan or credit Fiscal Amount (leas cencellationo) number Year Borrower Purpose Bank IDA Und,sbursed Seventy-nine loans and five credits fully disbursed 2,912.74 72.98 - 923 1979 Rep. of the Philippines Population II - 34.40 2.39 1809 1980 Rep. of the Philippines Medium-Scale Irrigation ae.93 - 11.34 1814 1980 Rep. of the Philippines Manila Sewerage a Sanitation 46.05 - 1.48 1890 1991 Rep. of the Philippines Watershed Managament 56.64 - 4.72 2030 1981 Rep. of the Philippinva Elementary Educ. Sector Loan 80.50 - 11.12 2040 1982 Rep. of the Philippines Agric. Support Services 22.00 - 8.46 2156 1982 Rep. of the Philippines Natlonal Fisheries Development 2.10 - 0.33 2189 1982 Rep. of the Philippines SMi III 87.46 - 4.47 2173 1982 Rep. of the Philippines Communal Irrigation 61.00 - 24.96 2200 1983 Rep. of the Philippines Education VIII 16.40 - 8.24 2202 1983 Republic of Phil. & PNOC Petroleum Exploration Promotion 8.44 - 1.14 2208 1983 Rep. of the Philippines Water Supply and Sanitation 29.00 - 6.41 2257 1983 Rep. of the Philippines Regional Cities Development 47.00 - 31.31 2360 1984 Rep. of the Philippines Ce-tral Visayas Regional Development 26.80 - 15.89 2418 1984 Rep. of the Philippines Highways V 102.00 - 86.10 2436 1984 Rep. of the Philippines Municipal Development 40.00 - 88.26 2495 1986 Rep. of the Philippines Telecom. Tech. Assistance 4.00 - 1.88 2570 1985 Central Bank of the Phil. Agricultural Credit 100.00 - 48.88 2876 1986 Rep. of the Philippines Manila Water Distribution a8.00 - 23.19 2716 1986 Rep. of the Philippines Rural Roads II 82.00 - 78.35 2787 1987 Rep. of the Philippines Economic Recovery Loan 300.00 - 100.00 2788 1987 Rep. of the Philippines Economic Recovery Loan TA 5.00 - 4.00 2828 1987 Rep. of the Philippines Provincial Ports 32.00 - r2.56 2948 1988 Rep. of the Philippines Irrigation Operations Support 45.00 - 46.00 29568 1988 Rep. of the Philippines Program for Government Reform 200.00 - 126.00 2989 1988 Phtilppine Nat'l Oil Co. Bacon-Manito Geothermal Power 41.00 - 40.83 2909-1 1988 Phil. Nat'l Power Corp. Bacon-Manito Geothermal Power 59.00 - 59.00 2974 1988 Rep. of the Philippines Housing Sector 160.00 - 107.95 Total 4,507.7 107.88 899.65 of which has been repaid 1,081.77 1.90 Total now outstanding 6,555.98 105.48 Amount sold 31.94 Of which has been repaid (third parties) 31.36 - Total now held by Bank and IDA (prior to exchange rate adjustments) 8,524.04 105.48 Total undisbursed 897.27 2.38 899.865 La The status of the projects listed in Part A is described in a separate report on all Bank/IDA-financed projects In execution, which is updated twice yearly and circulated to the Executive Directors on April 80 and October 31.  - 10 - Scebodule D B. STATEMENT OF IFC INVESTMENTS (As of March 81 199) Investment Fi* :DI Lost, Equlty Total number yeir Obligor Type of business (US---. U1 millin)- 67/288 198881978 Privot. Dov. Corp. of the Phillppines Development finance 15.0 4.4 19.4 110 1917 Manila Electrlc Company Utilities 8.0 - 6.0 Il1o/0lo 1967'1989 Meraico Securitles Corporation Utilities 80.0 4.0 84.0 167/899/1091 1970 Phil. Long Dlstance Telephone Co. Utililtl 57.7 0.8 50.6 160/218 1970,'1972 Marlwasa Manufacturing, Inc. Cemnt A constr. not. 0.8 0.4 1.2 165 1970 Paper Industelre Corp. of the Phil. Pulp S paper products - 2.2 2.2 1089/869 1971/1977 Philippine Petroleum Corporation CheNlcale A petroche. 0.2 2.1 8.8 207 1972 Marinduque Mining & Industrial Corp. Mlning 15.0 - 15.0 241 1978 Victoriea Chemical Corporation Chemlcals a petroche. 1.9 0.8 2.2 267 1974 Fillpinas Synthetic Fiber Corp. Textiles & fibers 1.5 - 1.t 272/464 1974/1979 Maria Christina Chem. Ind. Inc. Iron A steel 1.8 0.0 2.2 288 1974 Republic Flour Mille Corp. (RFM) Food A food proceselng 1.2 - 1.2 800 1976 Philippine Polyamide Industrial Corp. Textiles A fiber 7.0 - 7.0 829 1976/1980 Philagro Edible Ollu, Inc. Coconut oil A copra 2.6 0.2 2.8 879/768 1977/1985 Acoje Mining Company, Inc. Mining 2.5 1.2 8.7 874 1977 Sarmionto Industries, Inc. Plywood 8.s - 8.5 423 1978 Cebu Shipyard A Eng. Works, Inc. Ship repairing 2.1 - 2.1 469 1979 General Milling Corporation Food A feod processing 4.0) 1.1 6.1 481/665 1980 PISO Leasing Corp. (All Asia capital) Money A cepital market 11.0 0.2 11.2 480 1980 Venturon In Induetry A Buslno s Money a capital market - 0.8 0.8 Enterprises, Inc. 519 1980 Consolidated Industrial Caeo, Inc. Chemicals A petrochem. 4.1; - 4.5 682 1981 Loans to Seven Corp. for SMSE Money a cepitol market ie.i1 0.6 19.1 568 1981 Phil. Assoc. Smeltin Rofin. Corp. Mining - 5.0 6.0 572 1981 Davao Union Cemont Corp. Cement * constr. mat. 16.0 - 10.0 627 198? NDC-Outhrioe Plantations Palm oil 11.C - 11.0 841 198d Puro Foods Food A food processing - 1.4 1.4 948 1888 BPI Agricultural Development Bank Development finance - 1.0 1.0 1061 1988 Phillfund Money & capital markets - 4.2 4.2 Total Oros Commitments 221.6 80.0 251.6 Leco cold, acquired by others, repaid or concelled 114.4 16.5 180.9 Total Cowmitmonts Now Held by IFC 107.2 18.5 120.7 Total Undisbureed (including participants' portion) 69.0 /a 69.0 /O 814,068.00.