Peru - Industrial Credit Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 9236 PROJECT COMPLETION REPORT PERU INDUSTRIAL CREDIT PROJECT (LOAN 1358-PE) DECEMBER 28, 1990 Trade, Finance and Industry Division Country Department IV Latin America and the Caribbean Regional Office 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 Currency unit - Inti (I/.)* Average Market Rates for Period End of 1976 US$1 = 0.06 Intis End of 1977 US$1 - 0.08 Intis End of 1978 US$1 = 0.16 Intis End of 1979 US$1 = 0.22 Intis End of 1980 US$1 - 0.29 Intis End of 1981 US$1 = 0.42 Intis End of 1982 US$1 - 0.70 Intis End of 1983 US$1 = 1.63 Intis ABBREVIATIONS AND ACRONYMS BCR - Banco Central de Reserva del Peru (Central Bank) BIP - Banco Industria del Peru (Industrial Bank of Peru) COFIDE - Corporacion Financiera de Desarrollo (Development Finance Corporation) CONADE - Corporacion Nacional de Desarrollo EPS - Social Property EnterpriLes ICSA - Inversiones COFIDE S.A. IDB - Inter-American Development Bank PCR - Project Completion Report PDF - Project Development Fund PPS - Public Sector Enterprises with Public Attributes GOVERNMENT OF PERU FISCAL YEAR January 1 - December 31 *Note: The new Government that took office in 1985 changed the currency unit from the Sol (S/.) to the Inti (I/.). One Inti is equivalent to 1,000 Soles.  FOR omaML USE ONLY THE WORLD BANK wasv ton. D.C. 20433 U.S A ONte nt O1feit.ciCGf It Ope,a^uw ivaiMiNim December 28, 1990 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Project Completion Report on Peru Industrial Credit Project (Loan 1358-PE) Attached, for information, is a copy of a report entitled *Project Completion Report on Peru - Industrial Credit Project (Loan 1358-PE)' prepared by the Latin America and the Caribbean Regional Office. No audit of this project has been made by the Operations Evaluation Department at this time. Attachment IThis document hu a tnsted distribution and may be used by oe is onl inthe perlannauc |od theif offciii duties Its contents may not othenne be dbian witbout Worl Bm autb_nso  FOR OFFICIAL USE ONLY PROJECT COMPLETION REPORT PERU INDUSTRIAL CREDIT PROJECT (LOAN 1358-PE) TABLE OF CONTENTS Page No. PREFACE ............................................................. i EVALUATION SUMMARY .................................................. iii PART I. PROJECT REVIEW FROM THE BANK'S PERSPECTIVE .... .......... 1 A. Project Identity . .................................... 1 B. Background ........................................... I C. Project Objectives and Description ................... 2 D. Project Design and Organization ................. 3 E. Project Implementation ............................... 5 F. Project Results ...................................... 6 G. Project Sustainability ............................... 7 H. Bank Performance ..................................... 7 I. Borrower's Performance ............................... 9 J. Project Relationship ................................. 11 K. Project Documentation and Data ....................... 11 PART III. STATISTICAL INFORMATION ................................. 12 1. Related Bank Loans .................................... 12 2. Project Timetable ................ .. .................. 13 3. Loan Disbursements ................ .. ................. 14 4. Use of Bank Resources ................................ 15 ANNEXES 1. COFIDE: Subproject Profile ................................. 17 2. COFIDE: Subproject Description ............................. 19 3. COFIDE: Balance Sheets, 1975-1988 .......................... 22 4. COFIDE: Income Statements, 1976-1983 ....................... 24 5. COFIDE: Financial Ratios, 1977-1983 ........................ 25 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.  PROJECT COMPLETION REPORT PERU INDUSTRIAL CREDIT PROJECT (LOAN 1358-PE) PREFACE This is the Project Completion Report (PCR) of the First Industrial Credit Project in Peru, for which Loan 1358-PE, in the amount of US$35.0 million equivalent was approved on December 27, 1976. The project was imple- mented during a period of recession and macroeconomic instability in Peru and the emergence of the Latin American debt crisis. The loan was closed on June 30, 1983, one year and nine months behind schedule. A total of US$2.9 million was cancelled, mostly reflecting cancellation of subloan commitments by subborrowers. Preparation of this PCR was delayed for two reasons: First, by the time this operation was about to close, the Bank's staff resources were con- centrated on the preparation of two other loans to COFIDE. Second, following the suspension of disbursements, resources for work on Peru were limited. Bank experience in Peru and other countries is that it is usually a mistake to design successive operations without the benefit of a thorough review of the previous operation by a PCR. This PCR was prepared bv the Trade, Finance and Industry Division, Country Department IV of the Latin America and Caribbean Regional Office. Preparation of Part II was requested from the Borrower. But, given the time elapsed since closing of the loan and the fact that many of the Borrower's staff involved in managing the project have retired or moved to new assign- ments, Part II was not completed. Preparation of this PCR has not involved a mission to Peru. It is based, inter alia, on the Staff Appraisal Report, the Loan and Guarantee Agreements, supervision reports, correspondence between the Bank and the Borrower, and internal Bank memoranda. This PCR was read by the Operations Evaluation Department. The draft PCR was sent to the Borrower for comments, but none were received.  - iii - PROJECT COMPLETION REPORT PERU INDUSTRIAL CREDIT PROJECT (LOAN 1358-PE) EVALUATION SUMMARY Obiectives 1. This US$35 million equivalent loan to Corporacion Financiera de Desarrollo (COFIDE), had as broad objectives to help improve production efficiency and overcome Peru's balance of payments constraints by: (i) financing export oriented and efficient import substituting projects from state, private and mixed ownership enterprises; and (ii) strengthening COFIDE's overall effectiveness as a development bank by strengthening its resource allocation and mobilization capacity. The use of economic analysis for Bank financed projects was expected to help COFIDE's resource allocation ability and have a demonstration effect on other Government agencies, thus helping to improve Peru's planning and investment decision making process. Implementation and Results 2. The loan was approved on January 28, 1977 and declared effective on March 30. The actual implementation took longer than planned due to: (i) the economic recession of 1977 - 1979, which caused a slackening in inv'stment demand; and (ii) problems with project design including: reluctance of investors to assume the full foreign exchange risk, and the availability of competing credit lines denominated in dollars at lower interest rates than the Bank loan. Commitments and disbursements accelerated in late 1979 as a result of: (i) a temporary economic recovery; (ii) the exhaustion of alternative sources of foreign resources and higher interest rates on dollar loans that made the Bank loan more competitive (the loan's fixed on-lending rate on dollar denominated subloans had been reduced from 1ll to 9.752 in 1978); and (iii) COFIDE's greater orientation towards the private sector since 1978. The loan was closed on June 30, 1983, one year and nine months later than initially estimated. 3. COFIDE used US$32.1 million in loan funds to finance 78 subprojects, including 15 above the free limit of US$500,000. Seven subloans amounting to 222 of the loan went to state enterprises, with an average loan size of over US$1.0 million compared to US$350,000 for private sector subloans. 4. It is doubtful whether the loan succeeded in its objective of improving industrial efficiency and promoting exports, since the bulk of commitments took place during 1979 - 1981, a period characterized in Peru by macroeconomic instability, declining terms of trade and growing overvaluation of the -hange rate. Moreover, a substantial part of the  - iv - loan went to sELte enterprises, less likely tnan private ones to be managed with efficiency criteria. 3y December 1984, 16 subloans comprising over 402 of the loan amount were in arrears. 5. The most critical shortcoming of the loan was probably its failure tc improve COFIDE's resource mobilization capacity. During the life of the loan, over 952 of COFIDE's resources came from external sources. Offering negative interest rates in real terms, COFIDE's efforts to mobilize local resources through bond issues met with limited success - although they represented 762 of the resources mobilized locally. Between 1977 and 1982, the period of easy access to petrodollars, COFIDE was able to mobilize US$3.1 billion in foreign resources (US$525 million from international organizations). After the onset of the international debt crisis, foreign financing for COFIDE plummeted and with the 1983 crisis in Peru, local resource mobilization also dried up. Findings and Lessons Learned 6. The operation had a major design problem: the selection of COFIDE as the inte-mediary for Bank funds. First, the use of COFIDE as intermediary, to the exclusion of other private and public banks, strengthened the Government's monopoly over term financing. At the time, however, the loan was in line with accepted principles in_the Bank and COFIDE was a prestigious institution with great influence on economic decisions. Second, the use of C;.FIDE as intermediary presented a conflict of interest problem. COFIDE was a holding company for a number of state owned enterprises (thirteen at the time) and the agency in charge of coordinating and guaranteeing the finance of state enterprises. The Bank was, therefore, using as financial iLtermediiry the owner of many of the potential users of the funds. Third, at appraisal, the Bank did not fully assess COFIDE's creditworthiness and relied too narrowly on COFIDE's low debt/equity ratio as proof of financial soundness. The validity of this ratio for public financial enterprises is questionable, when Governments are ready to assume the debts of these institutions. 7. In order to limit the risks of using COFIDE as intermediary, the appraisal mission worked closely with COFIDE on a comprehensive Policy Statement, focussing on COFIDE's development banking functions, and a separate Statement of Operations, Policies and Procedures for the administration of the Bank loan. These statements were designed to isolate the loan from COFIDE's ownership role and tc safeguard its operational autonomy. The Bank was overly optimistic abou-r the capacity of agreed policies and procedures to safeguard the independence of a public financial institution from political influenco~ over its lending decisions. Until 1983, institutional issues remained the main focus of Bank supervision, with less attention paid to the underlying financial strength of the institution. While the Bank made a considerable supervision effort during the implementation of this loan, it had little success in convincing COFIDE to reorient its lending to the private sector and to separate its lending furction from its ownership of state enterprises. Some of the Bank recommendations were implemented in 1981, when a new Government reorganized COFIDE with the support of a follow on Bank loan to COFIDE (Loan 1968-PE).  v 8. Even if the Bank supervision efforts and t... ggreed policies and procedures succeeded in limiting political influence on Bank financed subprojects, these safeguards did not shield the rest of COFIDE's portfolio from political influences. In 1975, when the loan was being-appraised, 95Z of COFIDE's portfolio operations were quasi-fiscal in nature, either as an agent of the state or on its own behalf. By 1982, when the Bank loan was largely committed, 87Z of the operations approved were still quasi-fiscal in nature and COFIDE's portfolio was concentrated on a few state enterprises (loans and guarantees to one state enterprise - Electro-Peru- accounted for 502 of COFIDE's portfolio and were equivalent to 90? of COFIDE's paid in capital and reserves, in violation of COFIDE's operational procedures). By loan closing in 1983, COFIDE's financial situation had become critical as a result of: (i) deterioration of its domestic currency based capital structure under the force of inflation and the growth of its dollar based liabilities structure; (ii) drastic reduction in f;.reign financing; (iii) mounting arrears in its portfolio of state enterprises; and (iv) delays in Government reimbursement of payments made by COFIDE on Government's behalf. 9. This loan shows how difficult it is to convert a public entity. which combines the roles of owner and lender to public enterprises, into an effective financial intermediary with proper financial discipline and independence from political influence. This loan also shows that it is unrealistic to expect that the use of project evaluation techniques in Bank financed loans, would improve investment decision making by Government agencies, which is often based on considerations other than efficiency. 10 In providing this loan, the Bank tried to support a new Government that proposed to relax some of the pervasive controls on the economy imposed by the military revolution since 1968. However, the liberalization policies of the new Government were not far-reaching. In fact, during the life of the loan, the Government maintained its ownership of productive enterprises through COFIDE, kept interest rates administratively fixed and highly negative, and directed credit through a complex system of priorities. This loan shows the futility of supporting with Bank loans half-measures of economic liberalization, in the hope that further liberalization steps would be taken during loan implementation. It also shows that it is difficult for the Bank to react to policy reversals once an operation is being implemented. Proiect Sustainability 10. By the time the loan was closed in mid-1983, the Bank had already approved two other loans to COFIDE: a follow on loan of US$60 million equivalent (Loan 1968-PE) and a US$26 million loan for small and medium enterprises (Loan 2064-PE). These funds allowed COFIDE to continue its operations when external resources began to dry up in 1983. However, unable to mobilize local resources, COFIDE's level of operations continued at a v'ry low level, based on not servicing its external obligations and relending the funds collected from its clients. Meanwhile, continued financial repression, including highly negative interest rates, has prolonged the scarcity of term credit for the productive sector in Peru. The expected benefits of the project are, therefore, not being met.  PROJECT COMPLETION REPORT PERU INDUSTRIAL CREDIT PROJECT (LOAN 1358-PE) PART I. PROJECT REVIEW PROM THE BANK'S PERSPECTIVE A. Proiect Identity 1. Name Industrial Credit Project Loan Number 1358 - PE RVP Unit Latin America and the Caribbean Region Country Peru Sector Finance and Industry B. Backzroundl 2. During the early 19709, industrial sector investment in Peru increased rapidly, spurred by a system of import quotas and generous fiscal incentives, as well as the growing domestic demand stimulated by the income redistribution policies adopted since the 1968 military revolution; Growth of industrial value added averaged 8.6annually in real terms between 1968 and 1974, well above the real GDP increase. However, by-1975, when the loan was being appraised, industrial sector growth had slowed down, as producers were increasingly hampered by shortages of foreign exchange and domestic credit. 3. The major economic objectives of.the:-military government had been to improve income distribution and wealth and- to-decentralize economic activity away from Lima. Based on the-assumption that unregulated market forces would not assure the desired socioeconomic development. the Government assumed an active role in economic management. The State expanded its control of the country's productive resources through the- creation of public enterprises and the control of domestic and foreign investment, and embarked on a fundamental transformation of the ownership and management structures in the economy, through the creation of new schemes of employee participation. In order to foster industrial development, the Government established a complex policy framework involving generous fiscal incentives (up to 852 tax exemptions); import restrictions (import quotas, prior import authorization, and an average nominal protection of 90Z); and concessional financing terms. The incentives were granted on the basis of a priority system in which heavy industries had first priority, other inputs for industry, agriculture and 1/ Based oji: PERU: Policies to Stop Hyperinflation and Initiate Economic Recovery. A World Bank Country Study, April 1989  mining as well as essential goods for mass consumption had second priority, and all other industries were considered complementary. 4. This policy framework stimnulated the development of import substitution