Tunisia - Electrical and Mechanical Industries Project

Documnt of The World Bank FOR OFFCIAL USE ONLY Report No. 9488 PROJECT COMPLETION REPORT TUNISIA ELECTRICAL AND MECHANICAL INDUSTRY (EMI) PROJECT (LOAN 2113-TUN) APRIL 19, 1991 Industry and Energy Divisioni Country Department II Europe, Middle East and North Africa 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 EO'JIVALENTS Name of Currency: Dinar 1982 May 1990 US$1 D 0.59 D 0.89 D US$1.69 US$1.12 ACRONYMS AND ABBREVIATIONS BDET Banque de D6veloppement Economique de Tunisie BTKD Banque Tuniso-Koweitienne de D6veloppement CETIME Centre Technique des Industries M6caniques et Electriques CIDA Canadian International Development Agency EMI Electrical and Mechanical Industry INNORPI Institut National de la Normalisation et de la Proprikt6 Industrielle PERL Public Enterprise Rationalization Loan QR quantitative restrictions SAL Structural Adjustment Loan STUSID Soci6t6 Tuniso-S6oudienne de D6veloppement FISCAL YEAR January 1 - December 31  TH woto DM4S. FOR OFFICIAL USE ONL Waewnon. DC. 204)3 U4SA os2Le of Dtnev-GmvaJ. April 19, 199i MEMONDUN TO THE EXECUTIVE DIpECTOS AND THE PRESIDET SUBJECT: Project Completion Report on Tunisia Electrical and Mechanical Industry (EMI) Project (Loan 2113.TUN) Attached, for information, is a copy of a report entitled "Project Completion Report on Tunisia - Electrical and Mechanical Industry (EMI) Project (Loan 2113-TUN)" prepared by the Industry and Energy Division, Country Department II, of the Europe, Middle East and North Africa Refional Office. No audit of this project has been made by the Operations Evaluation Department at this time. Attachment This document msms a usd, dbuibunou and may be ued by rcpsu only is a e powmce of Sho Ofciul dub. Its mCOnUss May not othems be dfimsd wnt Wor ank as*=monun.  FOR OFFICMiL USE ONLY PROJECT COMPLETION REPORT TUNISIA ELECTRICAL AND MECHANICAL INDUSTRY (EMI) PROJECT (Loan 211.3--TUN) 1 BLE OF CONTENTS PAGE No. PREFACE ........................................................ i EVALUATION SUMMARY .................................................. ii ?ART I: PROJECT REVIEW FROM BANK'S PERSPECTIVE Project Identity ..1........................... Background ........................................................... 1 Project Objectives and Description .. 2 Project Design and Organization .. 3 Project Implementation .............................................. 4 Project Results ..................................................... 7 Project Sustainability .............................................. 9 The Bank Performance ................................................ 10 The Borrower's Performance .......................................... 11 Consulting Services ................................................. 11 Project Documentation and Data ...................................... 12 Lessons Learned .................................................... 12 PART II: PROJECT REVIEW FROM BORROWER'S PERSPECTIVE ................ 13 PART III: STATISTICAL INFORMATION TABLES 1. Related Bank Loans and/or Credits ................................ 20 2. Project Timetable ................................................ 21 3. Loan Disbursemernts: Cum4lative Estimated and Actual Disbursements ............................ 22 4. Project Cost and Financing ....................................... 23 5. Project Benefits ............................ 24 6. Use of Bank Resources ............................ 25 ANNEXES ANNEX 1 BDET's Operations in 1984-88 .............................. 26 ANNEX 2 BDET's Loan Portfolio between December 1984 and September 1989 ........................... 27 ANNEX 3 BDET's Financial Indicators in 1984-1988 ..... ............. 28 ANNEX 4 Income Statements 1984-1988 ............................... 29 ANNEX 5 Balance Sheets 1984-1988 .................................. 30 ANNEX 6 Project Cost, Employment, Investment per Job .... .......... 31 ANNEX 7 Project Analysis by Manufacturing Sector ..... ............. 33 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.  - i - PROJECT COMPLETION REPORT TUNISIA ELECTRICAL AND MECHANICAL INDUSTRY (EMI) PROJECT (Loan 2113-ThLN) PREFACE The Bank approved a US$30.5 million loan in March 1982 to finance priority projects in Tunisia's electrical and mechanical industries (EMI) subsector. prepare a study on the effective protection of manufacturing and design a development strategy for two EMI subsectors. Disbursements of the loan amounted to US$20.9 million (68.6 %) and there was a cancellation.of US$9.6 million. The Bank's Industry and Energy Division, Country Department II, of the Europe, Middle East and North Africa Regional Office prepared Parts I and III of this Project Completion Report (PCR). The preparation of Parts I and III of this PCR is based on the Staff Appraisal and President's reports on the Project, the related Guarantee, Loan and Project agreements and Bank Project files. The Borrower, the Banque de Developpement Economique de Tunisie (BDET) prepared Part II.  ii - 9PSWECT COMPLETION REPORT TUNISIA ELECTRICAL AND MECHANICAL INDUSTRY (EMI) PROJECT (Loan 2113-TUN) EVALUATION SUMMARY Background i. By the late 1970's, the production of Tunisia's electrical and mechanical industries (EMI) sub-sector met only 10X of the local demand for capital goods, one-third of that for intermediate goods and about half the demand for consumer goods. Imports of EMI goods had become an increasing burden on the country's balance of payments. To address this problem, the Government adopted a development strategy for the sector, under the Sixth Plan (1982-86), which gave priority to the diversification and expansion of the capital and intermediate goods subsector (e.g. agricultural and construction machinery) and of a few selected export-oriented lines of production (e.g. mechanical and electrical components). Furthermore, the Government recognized that certain policies hampered the development of the EMI sector (Part I, para. 5 ). The Government, therefore, formulated policies and institutions to help the EMI sector improve its performance (Part I, para. 6). The Bank loan in the EMI sector was part of this overall Government strategy. Project Objectives ii. The basic objective of the ;ect was to encourage the development of EMIs, improve the efficiency and - .oductivity of their operations and increase their production of competitive capital and intermediate goods. At the same time, the Project contained components to improve the development policy and institutional framework of the sector and continue strengthening BDET (Banque de Developpement Economique de Tunisie), the country's development bank. The Project was to achieve these oojectives through a US$30 million loan to BDET approved in March 1982 (Part I, para. 9). Project Implementation ii. The loan became effective in December 1982 and there was a slight delay in effectiveness due to administrative procedures for creating CETIME and INNORPI. Initially, commitments under the loan developed at a pace consistent with that forecast during project preparation and appraisal. However, by mid-1984,commitments of the funds earmarked for EMIs had reached US$8 million only, while commitments of other funds made available to BDET were US$13 million. iii. Initially the slowdown in EMI financing seemed to be temporary, caused by the depressed investment climate in the country (Part I, para. 18).  - iii - In response to the slowdown in commitments, the Bank extended the commitment date for the loan proceeds to end-1988. Neither the Bank nor BDET foresaw the eventual tapering off of demand for investment financing in EMIs. The Bank actually approved a second line of credit for EMIs in March 1985. Since the financial terms attached to this second line were more favorable than those of the first, BDET requested --and the Bank accepted-- that the uncommitted part of the first line of credit be cancelled when the second line of credit became effective. (Part I, Paras. 19 and 20). The amount cancelled under EMI I was USS9.6 million equivalent. Project Results iv. By EMI-1 completion, the Bank loan had financed 18 projects of which 10 were new projects and 8 were extensions. Overall, Bank financing amounted to about 19% of total investment in the related projects (TD 98.4 million). The projects financed created about 2.060 jobs, of which 34% were in new enterprises. Taking into account the cancellation of about one-third of the loan (34.3%, para 20). job creation still fell short of expectations (by nearly 50%) at the time of project appraisal (Part I, para. 28) The average cost per job created was significantly higher than expected, even after accounting for the 1986 devaluation of the TD. This discrepancy may be traced to the fact that initial estimates of the cost per job created were based on investments made in the sector that were not representative of investment opportunities to come. A profile of the projects financed is given in Part I, paras. 26-29. v. The other components of the Project -i.e the institution building of CETIME and INNORPI and the effective protection study were successful but the study undertaken by BTKD on the platewurk subsector was never completed (Part I. paras. 33-36). The Project covenant pertaining to customs tariffs on EMI products was met. BDET was able to improve the management of its client arrears problem and achieve better results in negotiating, with Treasury, tue Government's payments of its losses on account of foreign borrowings, and adjustments to interest rates. In the latter adjustments, the Bank was able to play a significant role, using the results of the 1984 Financial Sector Review. Project Sustainability vi. The general purpose component of the line of credit to BDET proved highly justified, and was sustainable as well as replicable. The EMI component proved to be significantly oversized (paras. 28-31); a component about half the size of that agreed upon would have been more reasonable. The basis of the overestimation was the assumption made, at the time of project preparation and appraisal that the demand in later years would be comparable in magnitude with that existing at the time. Lessons Learned vii. The main lesson the Bank has learned from the Project is to avoid lines of credit that are too specialized, since temporary or permanent changes in the demand for credit in a specialized subsector may result in a  - iv - considerable underutilization of available funds. Instead it would be less risky to define a broader sub-sector such as export industries or small. and medium-scale industries. Substantial changes in a specialized industry within these subsecto i would be less likely to have such a major effect on the progress of the loan. Concerning Project supervision, the Bank should be consistent in its monitoring activities, keep its analytical outlook after project appraisal, note causes of differentials from expectations. maintain awareness of competing lines of credit and help resolve important issues related to supervision by financial intermediaries. Moreover, the Bank should not begin a second operation of the same type in a subsector where commitments have been significantly below the original forecast, without an in-depth analysis of the potential underlying causes.  PROJECT COMPLETION REPORT TUNISIA ELECTRICAL AND MECHANICAL INDUSTRY (EMI) PROJECT (Loan 2113-TUN) PART I: PROJECT REVIEW FROM BANR'S PERSPECTIVE Project Identity: Project Name: Electrical and Mechanical Industry (EMI) Loan Number: 2113-TUN RVP Unit: EMENA Country: Tunisia Sector: Industry Subsector: Electrical & Mechanical Industry Background 1. In the 1970s. the shift to more liberal economic policies in Tunisia, with greater emphasis on labor intensive and export oriented activities, provided generous incentives to foreign and domestic private investors. As a result, during the Fifth Plan (1977-81), manufacturing grew at 10.2% p.a. (from 6.4% in the 1960s), and accounted for 45% of total new employment (from 33% earlier). The manufacturing sector, however, remained concentrated in two traditional subsectors: food processing and textiles which, together, represented about 50% of the sector's total value added and employment and 60% of its exports by 1980. 2. Within the manufacturing sector, the engineering (electrical and mechanical, EMI) industries had experienced a significant development: from almost nonexistent in the early 1960s, they grew at 18% p.a. in the 190i0s and 13% in the 1970s. Yet, they only contributed 1.9% of GDP, showed a value added/output ratio of only a'bout 30% and were the least developed subsectors (about 300 enterprises). By the late 1970s, most of them -about 70%- were small enterprises (less than 50 workers) and were dominated by a dozen large public enterprises (more than 100 workers). 3. While consumer and durable EMI goods were highly protected (with tariffs of 30-100%), all tariffs on capital and intermediate goods (with the exception of steel structure and platework) were lower than 16%. On the latter category of goods, however, generous use was made of import licens'ng or quantitative restrictions (QRs) to protect local manufacturers. The subsector's concentration on end-product assembly resulted in a low domestic VA, poor competitivity of the subsector, and continued significant imports of EMI goods. 4. By the late 1970's, the production of the EMI sector met 10% only of the local demand for capital goods, one-third of that for intermediate goods and  2 about half the demand for consumer goods. Correspondingly, imports of EMI goods constituted an increasing burden on the country's balance of payments. To address this problem, a development strategy for the sector was adopted under the Sixth Plan (1982-86), which gave priority to the diversification and expansion of the capital and intermediate goods subsector (e.g. agricultural and construction machinery) and of a few selected export oriented lines of production (e.g. mechanical and electrical components). 5. The Government, at the same time, recognizea three facts. First, that the development of the EMI settor was hampered by policies -whether protection or pricing related- that did not foster cost effectiveness, rationalization of product mix, or higher productivity. Second, that import duties were levied without an adequate knowledge of the effective protection which resulted for various lines of production. Third, that the absence of standards and quality control was very detrimental to the use of domestic inputs, as well as to the growth of exports. 6. The Government, therefore, decided (a) to reduce a number of customs tariffs in order to incite certain EMI enterprises to improve their efficiency; (b) to undertake a detailed analysis of the effective protection affecting key subsectors (e.g. foundries and steel platework); and (c) to create institutions to establish standards and promote quality control (the Institut National de la Normalisation et de la Propri4t4 Indlistrielle, INNORPI) and to assist EMI enterprises improve their production processes and the use of their machinery (the Centre Technique des Industries M6caniques et Electriques, CETIME). 7. Since a number of the above decisions were made by the Government following investigations carried out by, and discussions with the Bank, the project under review was basically in support of the Government's new approach and strategy as regards the development of the EMI sector. Proiect Objectives and Description 8. The basic objective of the project was to foster the development of EMIs, to improve their efficiency and productivity, and to increase their production of competitive capital and intermediate goods. The project also aimed (a) to improve the development policy and institutional framework of the sector. and (b) to continue strengthening BDET (Banque de Developpement Economique de Tunisie), the country's development bank-. 9. These objectives were to be achieved through a US$30 million loan to BDET approved in March 1982, subdivided in (i) a credit line of US$28 million, of which half was to finance subprojects in priority EMI subsectors agreed upon with the Government, and half to help BDET meet its general resource needs; and (ii ) a US$2 million loan, to be onlent to the Government to help establish CETIME and INNORPI to undertake a study on effective protection of manufacturing, and to design a development strategy for two EMI subsectors. aL The sole such institution in Tunisia until 1981, when another two such institutions were created: Banque Tuniso-Koweitienne de Developpement (BTKD) and Societe Tuniso-Seoudienne de Developpement (STUSID), with a 30% capital participation frorv. Kuwait and Saudi Arabia, respectively.  3 Also, under the project, as interim remedies until the above studies were completed, a series of policy and incentive measures geared to the development of EMIs were to be taken, in the areas -in particular- of customs tariffs, QRs and price controls. These measures were to consist essentially, for a period of 3 years, in maintaining import controls and imposing a maximum price differential between locally produced and imported RMI products: 18% for all subsectors and 21% -exceptionally- for steel struc_.e and platework; beyond this period, import controls were to be gradually lifted. Proiect DesiAn and OrRanization 10. In the te 1970's, the Government recognized the relative importance of EMI products in Tunisian imports, the development and export potential of this sector, as well as the detrimental impact of some of its protection policy and import practices. As a result, the Sixth Plan gave a priority to the development of this sector (para 4-5). Also, the Government agreed, in the framework of th s Bank financed project, to take interim measured aiming at improving the competitivity of the sector, and to undertake studies to design an appropriate policy framework (para 9). 11. Of significant importance to help the development of the EMI sector, was the creation of CETIME and INNORPI. Many industrialists in the sector, aware of inadequacies in their production processes and the need to improve their mastering of technologies, welcomed the creation of CETIME to provide them with technical assistance on a commercial basis. At the same time, some of them were increasingly sensitive to the need to provide clients with formal guarantees of quality. These favored the idea of adopting standards and certification procedures, and they welcomed the creation of INNORPI. Such interests on the part of industrialists in the sector justified that the project include a support to the creation of the above two irstitutions, in the form of financing for technical assistance and purchase of equipment. 12. By the late 1970's, BDET had had access to Bank financing through seven earlier lines of credit, and it continued improving its reliability as a provider of long-term financing for investment purposes. BDET had been successful in mobilizing domestic as well as foreign resources. It was also gaining increasing access to the international capital market; as a result, Bank funds in 1980 represented about 24% of BDET's long-term resources, compared with 37% in 1974. BDET's capital had increased from TD 3 million in 1971 to TD 10 million in 1978, and was scheduled to be increased to TD 30 million by 1985. 13. BDET's organization, management and financial situation were satisfactory. Its portfolio was diversified and sound. Lending to the private sector rose from 85.2% in 1980 to 96.6% in 1990. Industry accounted for about 60% of these approvals, down from 81% in 1977 as tourism financing experienced a significant increase in the 1977-80 period. Total assets amounted to about US$236 million equivalent. Arrears affected 9.7% of total portfolio and debt rescheduling was kept within reasonable limits. Accumulated provisions for risk exceeded the auditors' recommendations by nearly 20%. Its debt-equity ratio remained well below the 8:1 ceiling required by its policy statement and its commitment to the Bank. BDET's spread on foreign currency borrowing was secured through a commitment by the Government to maintain this spread at a level (about 3%) sufficient to provide for appropriate provisions and reserves and an adequate return on capital. However, as the Government was considering  4 a gradual liberalization of long-term interest rates, it was envisaging -in pazallel- reducing its financial support to BDET. It was agreed that, under the prcject, an annual review of the structure of interest rates (to ensure that they remain positive in real terms), Government support and BDET's access to lower cost resources would be carried out in consultation with the Bank. Project Implemencation 14. The loan was declared effective in December 1982, seven months after signature. The delay in effectiveness was modest; it was due essentially to administrative redtape for formally creating CETIME and INNORPI and for nominating their respective directors. 15. The effective protection study was undertaken with only minor delays. Its financing was eventually provided by the Canadian assistance program, CIDA. (Bank funds initially earmarked for this purpose were made available for CETIME and INNORPI). The development strategy study on the foundry subsector was carried out and the platework stu'y was undertaken according to initial plans. 16. CETIME and INNORPI promptly appointed the consultants needed to help design their work program, initiate its implementation and establish their operational procedures. By the end of its second year of operation, CETIME was able to start charging fees close to commercial rates, and demand for its services kept developing steadily. CETIME has reached a finaaLcial situation close to initial expectations: about 85% of its resources to cover expenses other than investments now come from the fees that they charge for their assistance; the remaining 15% still come from the State budget, as CETIME does not charge new client the cost of the first stage of its assistance, as an introductory gratuity. INNORPI, considering the peculiar type of public service that it provides -preparing and edicting standards, and delivering certifications: after products are tested against these standards- is not expected to generate revenues beyond 15% of its financial needs. As of mid- 1989, INNORPI was still receiving a limited number of requests for certification about 16 per year. Howeve , INNORPI organized several seminars on quality control and management, which improved its revenue generation. The end-result, however, is that INNORPI has not yet been able to raise .ignificant revenues: about 8% of its budgetary needs in 1988. 17. Initially, commitments under the loan developed at a pace consistent with forecast made during project preparation and appraisal: by October 1983, the equivalent of about US$6 million had been committed for each of the two components of the BDET loan. However, by mid-1984, commitments of the funds earmarked for EMIs had reached US$8 million only, while commitments of other funds made available to BDET were US$13 million. 18. The slowdown in EMI financing was perceived, at the time, as due basically to the depressed investment climate in the country, as the end of a political era was approaching and uncertainties about the country's future were increasing. It was not seen by the Bank nor by BDET, as a sign of a tapering off of demand for investment financing in EMIs. To take into account the above slowdown, the Commitment Date of the operation was postponed by a year. to end-1988. Had a more careful assessment been made of the sector's evolution at the time the second line of credit was appraised, sufficient signs would have been found of the upcoming dryout of demand for iwvestment  S financing for the sector, as well as of the important difficulties already affecting part of the sector -i.e. SOFOMECA, STIA, CMT-, and the feasibility of following up promptly with a second line might have been questioned. 19. As the earlier use of the line of credit appeared to confirm the appropriateness of the priority given to EMIs in the Sixth Plan, discussions were initiated in early 1984, between the Bank, the Government, BDET as well as BTKD and ST'JSID, on a second line of credit, as a follow-up to that extended under the project. Preparatory work on the new line started in mid-1984, leading to an appraisal in the Fall, negotiations in early 1985 and Board approval in March 1985. 20. As the financial terms attached to this second line were more favorable than those of the first (interest rate was 7.75% against 11.6% for EMI), BDET requested -and the Bank accepted- that the uncommitted part of the first line of credit be cancelled when the second line of credit becomes effective. The EMI 2 line of credit became effective in June 1986. The cancellation made -hen amounted to US$9,6 million equivalent. This amount corresponded to about US$6.3 million still uncommitted by late 1985 (barely lower than that in late 1984), plus funds -in an amount of US$3.3 million- made available between late 1985 and mid-1986 as a result of cancellations of past commitments, for a good part, in the EMI sector. At the time, this situation of under-commitment under the EMI-1 line was explained by BDET, by their wish to keep upcoming EMI projects for commitment under the new line soon to be established. 21. Had the 1984 slowdown in EMI commitment been fully understood, the assessment of the demand for the second EMI operation would have been definitely different. At the time, however, the slowdown was blamed essentially on the temporarily depressed investment climate (para 18), and the ripple effect of the crisis experienced by car assembly in Tunisia. 22. BDET's financial situation started showing signs of a slight deterioration in 1984-85, as a result of (a) significant delays in the Government payments of BDET's losses on account of foreign borrowings, and (b) increasing client arrears. Because of its cash flow problems, BDET had to start bcrrowing expensive short-term funds, which led to a reduction of its profitability. 23. Delays (of more than a year) in Government payments of BDET's losses on account of foreign borrowings were due to the Government's budgetary problems which started developing in the early 1980's. Despite repeated commitments from the Government to catch up with its arrears, these kept worsening. Only in 1988, was the Treasury able to make annual payments to BDET (TD 19.2 million) that exceeded BDET's losses in that year (about TD 15 million), thus beginning to redv_. the Government's cumulated arrears to BDET (TD 34.1 million at end-1987). In the meantime, BDET had to meet the high cost of its short-term borrowings and reduce the dividends paid to its shareholders. The Treasury's commitment to pay its past dues to BDET remains genuine, but forecasts are that, in the foreseeable future, the Government's budgetary situation should remain somewhat difcicult. It is likely, therefore, that the Government will need a minimum of three years to meet its backlog of payments to BDET. In mid-1988, however, in consultation with the Bank under the SAL, a new system of foreign exchange risk coverage was adopted which disengages the Government for post-1988 foreign exchange borrowings. Also, interest rate liberalization -starting with deposit rates- is gradually introduced.  6 24. Client arrears were due to the economic slowdown referred to in para 18. By late 1984/early 1985, client arrears had increased to 15.9 million, from TD 8.1 million at end 1982. Of the total amount of arrears, 85-90 was from 22 clients; of these clients' arrears, about half (among which the largest and longest standing ones) were from about 10 public enterprises (PEs) or institutional projects. A special action program was developed by BDET in early 1985 to address its client arrears problem; it involved adjusting its organization, responsibility assignment, procedures and monitoring for supervisinn. The action program was promptly put into effect in mid-1985. Within the subsequent 18 months, its effects were very favorable, and major arrears from private clientsv started decreasing, a number of cases having led to restructuring (or liquidation) of the enterprise, or transfer to formal litigation procedures. Attempts to reduce arrears from PEs or institutional projects, however, had very limited results, as payments of arrears was -once more- dependent on the Government's budgetary situation (para 23). The gradual reduction of PE arrears should become significant in the near future, as the Government is now addressing the general problem of PEs restructuring, privatization and/or liquidation, with the assistance of the Bank, under the PERL operation. (As of June 30, 1989, client arrears were slightly below rTD 49.4 million] the level reached on June 30, 1988 tTD 51.2 million] and decreased further to TD 38.1 million on December 31, 1989. BDET new management was of the opinion that this situation would improve by the later part of the year, yet was planning to request that the Government take up inter alia the arrears from PEs and institutional projects). 25. In 1988, BDET's overall situation began recovering from the mid-1980's crisis. In the process of overcoming that crisis, however, BDET management grew very cautious about financing PEs. as well as confident in its ability to find solutions with clients in difficulty. Because of its experience with Government arrears, BDET management has also become a strong supporter of financial liberalism, favorable to: (a) leaving intermediaries responsible for mobilizing their resources where they find it feasible, assuming the risk -including foreign exchange related- associated with it and adapting their lending terms accordingly; and (b) gradually reducing the distinction between commercial and investment banks. BDET's financial statements, and financial performance in 1988-89 26. In 1989, despite a still somewhat sluggish economic climate in the country, BDET's financial position kept improving: results would suggest that BDET's net profit/equity ratio would have reached 13.3% (compared with 6.5X in 1988) and its net profit would have reached TD 5.3 million (compared with TD 2.5 million the year before). This was achieved essentially because of: (a) BDET's continued concern (maintained by the new management) for its overall In the meantime, however, arrears from other clients -mostly medium sized- increased significantly, offsetting the gain achieved on the major arrears. This significant increase in new arrears stemmed from the foreign currency controls instituted by the Government from mid-1985 to late 1986 to overcome its foreign exchange shortage, the effect of which was to hamper entreprises -especially new ones- in their purchase of impor-ed equipment or raw materials, and thus to prevent them from operating as planned.  7 arrears situation, and sustained efforts to control it; (b) a significant increase in the tourism sector, which made it possible for important clients of BDET's to resume payments on their loan (c) higher interest rates and; (d) important profits from sales of portfolio. Auditing Performance 27. BDET has its accounts audited annually. Commonly, audit reports reach the Bank by end of June, at the earliest; this is due to the fact that banks in Tunisia close definitely theiz accounts in March only, then call their auditors. This is a local practice that will continue in the foreseeable future. Audit reports have been steadily good, rather detailed and compr:'. fIve; which probably follows in part, at least, from the request made b- e Bank about four years ago that auditors be asked to review BDET's arrep. re gtreater detail. 28. By the time the EMI-1 project was completed. 18 projects (of which 8 in the EMI sector) had been financed through the Bank line of credit. Of these 18 projects, 10 were new projects (of which 5 in the EMI sector), and 8 were extensions. Overall Bank financing amounted to about 19% of total investment (TD 98.4 million). About 76% of Bank financing went to new projets. Approximately 2,060 jobs were created, of which 1,360 -or 34%- in new enterprises. Taking into account the cancellation of about one-third of the loan (34.3%. para 20), this job creation still fell short -by nearly 50%- of expectations at the time of project appraisal. The average cost per job created amounted to 60,800 in new enterprises, and TD 22,600 in extension projects; significantly more than expectations, even after account of the 1986 devaluation of the TD. This discrepancy can be traced to the fact that initial estimates of the cost per job created was based on investments made earlier in the sector that proved to be un-representative of investment opportunities to come. 29. The final allocation of Bank financing was distributed among sectors as follows: EMI, 32.7%; rubber and chemical products, Z5.4%; building materials, ceramics and glass, 18.7%; agroindustry, 10.4%; tex.tile and leather. 7.7%; paper and printing, 5.1%. 30. As regards the general purpose component of the loan to BDET, the project was a success. 31. As regards the EMI component, only about half of the expected demand materialized. The result is that the expansion expected -as a benefit of the project- of the country's industrial base in the sector was not achieved to the extent originally envisioned. Most EMI projects financed through the Bank line of credit had an export orientatior., and imports of EMI goods did not decrease significantly: with the ultimate result of a limited improvement of the balance of payments situation attached to the sector. (As of mid-1989, the EMI sector as a whole had evolved further, with problems affecting in a un-remediable manner three large enterprises -SOFOMECA, STIA and CMT- which eventually had to close).  B Share of EMG Sector in meeting the demand for capital, intermediate and consumer goods. and performance of the sector as regards lmport substitution 32. By a cascade effect, the foundry subsector (e.g. SOFOMECA) was badly affected by the problems encountered by the local production of capital goods (e.g. car engines by Complexe MHcanique de Tunisie), which itself had lost a major client (i.e. STIA. in car assembly) that had collapsed. In these lines of production, local integration (and concomitantly import substitution) failed. In productions of intermediate and consumer goods, results came much closer to expectations, even if for a period of about two years. they suffered--by a ripple effect--from the problems mentioned above affecting another EMI subsector. At present, a number of productions are developing steadily; in particular, under subcontracting arrangements with foreign manufacturers--such as bundles of electric wire for automobiles, car radiators, etc. Also, productions of final products, such as small diesel engines, electric motors, etc. are multiplying; most of the time, with a significant export orientation. For consumer goods, in particular, import substitution was largely achieved. 33. The initial estimate of the demand for investment financing was too optimistic. There appears to be three causes for this oversight. First, the estimate made at the time of preparation and appraisal should have been more conservative; especially regarding the outer years. considering that the sector was still in its early stage of development. 34. Second, the estimate was made after detailed investigations of the structure of existing EMI enterprises and imports, which revealed a number of~ import substitution opportunities and -possibly- attracted excessive interest: from potential investors. Also, the estimate was made after (a) BDET had designed a development strategy for the EMI sector, which had led to the identification of EMI activities (inter alia foundries and electric motors) expected to have a significant "pull" effect on the rest of the sector; and (b) BDET had began seeking -and had found- investors willing to realize some of its project ideas. The analysis of the projects effectively realized shows that (i) investors eventually trusted their own judgement and market assessment more than those of BDET cadres; and (ii) the most successful EMI projects proved to be export oriented and involving some technical/commercial partnership with foreign firms. 35. Third, the above investigations were carried out at a time where Tunisian investors had gathered significant experience in a diversified range of productions and might have developed an excessive confidence in their ability to enter new activities, to master new technologies and to successfully compete with imports. Also, the initial estimate appears to have ignored that a significant fraction of Tunisian investors are, above all, businessmen; and only rarely, fully developed industrialists -which the EMI sector calls for more than most other industrial sectors. Therefore, investments in the EMI sector -it should have been expected- would be realized inasmuch as competing opportunities -in terms either of returns, or lesser technical, commercial/marketing difficulties- remained modest. EMIs proved to be a challenging sector, both technically and marketwise. Investors, as a result, appear to have promptly gone back to more customary activities such as textiles, agroindustry and tourism.  9 36. The other undertakings under the project -i.e the institution building of CETIME and INNORPI and the carrying out of the protection study- were successful. As indicated earlier (para 16), CETIME has established its credibility, is called regularly by EMI enterprises for technical advice and assistance, and is able to charge realistic fees. INNORPI has produced more than 600 norms, has delivered nearly forty certifications and is expanding its activities in the area of promoting quality control, management and monitoring. 37. The development si-rategy study on foundries was completed and its results discussed with the Bank. Most qualifications made at the time were widely confirmed in the last two years by the difficulties faced by this subsector, which were fully exemplified by the collapse of SOFOMECA. 38. The study undertaken by BTKD on the platework subsector was never completed. Following a swift beginning, methodological and technical difficulties soon began hampering its execution. This was compoinded by the unfavorable evolution of that branch of the sector, which justified that the study be suspended. 39. The effective protection study, after a slow start due to delays in the mobilization of foreign (Canadian) experts, developed in a satisfactory manner'. The results of the study were extensively used in the design of the Government's later decisions pertaining to the liberalization of the economy -in particular, those related to the reduction and alinement of customs tariffs-, and in the preparation of the Bank ITPA loan to support this liberalization program. Project Sustainabili 40. The general purpose component of the line of credit to BDET proved highly Justified, and was sustainable as well as replicable. 41. The EMI component proved to be significantly oversized (para 30-34); a component about half the size of that agreed upon would have been more reasonable. This overshooting stems essentially from the assumption made at the time of project preparation and appraisal that the demand in later years would be comparable in magnitude with that existing at the time. Certainly in its most critical phase where the methodology was to be tested and the essential results were to be developed and discussed. Later on, responsibility to duplicate the study on other sectors was passed from the IEQ (Institut d'Etudes Quantitatives) to the CNEI (Centre National des Etudes Industrielles), which proved to be a major error, as CNEI has serious difficulties assembling teams of competent, experienced econo: 'sts to continue the work started by the IEQ.  10 42. The economic covenant pertaining to customs tariffs on EMI products was met. Also, further strengthening of BDET was achievedP as BDET was able (a) to improve the management of its client arrears problem; as well as (b) to achieve better results in negotiating with Treasury the Government's payments of its losses on account of foreign borrowings, and adjustments to interest rates. In the latter adjustments, the Bank was able to play a significant role, using the results of the Financial Sector review carried out in 1984. 43. One objective of the project was to address for the first time in Tunisia, a specific industrial branch, EMIs, and to focus our support to development banking on subsector investment and policies. This approach was one among several attempted by the Bank at the time, to explicitly link its assistance with the resolution of economic policy issues; in the case of Tunisia, the attempt aimed at trade policies. An overall review of this approach would be needed to pass a judgement on its success. In the case of this project, results were mixed: creating CETIME and INNORPI was a success, while the development of EMIs fell short of expectations. 44. The extension of a second EMI line of credit proved premature. Had it been appraised a few months later, clear signs then would have been available of the limits of the demand for investment financing in the sector. In early 1989, a significant fraction of this second line hiad to be cancelled, after it was recognized that the demand was modest and coul.d be met through other existing lines of credit. The Bank Performance 45. During the project implementation period, the Bank contributed significantly to the improvement of the sector policy framework, and to the strengthening of the implementing agency, BDET. The Bank participated in the design of the ITPA program and extended a loan to support it. The Bank also carried out a review of the financial sector and, as a follow-up, participated in the regular review of the country's interest rate structure. In parallel, the Bank undertook a comprehensive review of BDET's organization and operational procedures, which led to a number of recommendations, most of which were adopted and promptly put into effect by BDET's management. 46. In 1985 and 1986. after the negotiation of the EMI-2 operation, the Bank fell short on the supervision of the operation. This prevented the confirmation of the early signs of a shortfall in demand for investment financing for the EMI sector and, as a result, the prompt introduction of the adjustments that were called for. Steadier supervision and proper updating of sector work would have certainly permitted to reduce the misappreciation that was at the base of the launching of the second line of credit. (This second line itself was not subjected to sufficient supervision, which made it The question of feasibility of investing trough BDET was not at the center of this operation. This became an issue in 1984 only, as a result -in part- of the Financial Sector study which w&s carried out that year. This then became a more central question for the Bank subsequent lines of credit. This issue will be a main focus of the PCRs of these operations when they fall due.  11 possible for problems affecting its utilization to last longer than was warranted). The Borrower's Performance 47. BDET failed to develop !n time a full awareness of the fragility of the demand for investment financing for the EMI sectorW. 48. Otherwise, BDET's performance was basically satisfactory. When the loan was made in 1982, BDET's supervision was still weak, in spite of the Bank's urging. With the deterioration of the economic environment, BDET's portfolio deteriorated significantly. By 1985, BDET management was more receptive to the Bank's concern on the worsening arrears situation and was prompt to react in a tangible manner on this issue (para 24). As regards Government arrears, BDET management was able, all along, ' secure from Treasury the maximum payments that the State could afford .o meet its commitments to BDET. BDET increased its capital to TD 30 million, mobilized a larger fraction of its resources through international borrowings (from BEI, DEG, France, Italy, etc) and through issuance of bonds on the local market. The importance of the private sector in BDET's portfolio kept increasing regularly. BDET participated in two privatization operations and has now adopted systematically the practice of arranging with its clients the buybacks of its participation in their enterprise. a.lso, BDET management has established a new strategy to cope with the new economic and institutional context in which BDET has now to operate. Basically. BDET management has clearly decided that, for the years to come, BDET's line of conduct as regards lending should consist of the following: (i) to limit its exposure to new operations with PEs only to the most viable ones; (ii) to give priority to export-oriented projects; and (iii ) to intensify its activities in the tourism sector, focussing, however, on medium size operations. These objectives are in line with the best opportunities available in Tunisia to development finance institutions. Consulting Services 49. Such services were used for technical purposes by CETIME and INNORPI. The consultants hired were LGV and CERLAB/AFNOR, respectively; both from France. Their performance has been most satisfactory, and both CETIME and INNORPI were keen under the EMI-2 operation to obtain financing for the extension of their services. This might have been due to the significant efforts that BDET had made identifying an appropriate way to develop the country's capabilities in that sector (para. 31), and the resulting difficulties that BDET then had acknowledging that investors were not fully convinced of the feasibility to enter this sector.  12 Project Dgcumentation-and Data 50. The data base for this project is basically satisfactory. From late 1984/early 1985 on, the data base is fundamentally the same as that of the EMI-2 operation, as work on each of these two projects was carried out jointly. Lessons Learned 51. The main lesson the Bank has learned from the Project is to avoid lines of credit that are too specialized, since temporary or permanent changes in the demand for credit in a specialized subsector may result in a considerable under-utilization of available funds. Instead it would be less risky to define a broader sub-sector such as export industries cr small and medium-scale industries. Substantial changes in a specialized industry within these subsectors would be less likely to have such a major effect on the progress of the loan. Concerning Project supervision, the Bank should be consistent in its monitoring activities, keep its analytical outlook after project appraisal, note causes of differentials from expectations, maintain awareness of competing lines of credit and help resolve important issues related to supervision by financial intermediaries. Moreover, the Bank should not begin a second operation of the same type in a subsector where commitments have been significantly below the original forecast, without an in-depth analysis of the potential underlying causes.  I 3 PROJECT COMPLETION REPORT TUNISIA ELECTRICAL AND MECHANICAL INDUSTRY (EMI) PROJECT (Loan 2113-TUN) PART II: PROJECT REEW.- FROM BORROWRERS PERSPECTIVE 1. Except for the portion of the loan onlent to the Government (US$2 million)y. Loan 2113-TUN has been used up to 66.4%; it financed 19 subprojects with a total investment cost of TD 98.4m. (US$127m.) and helped create 2.057 jobs. There were 37 subloans for these projects with an average maturity of IO years. including 2 years of grace. 2. The objectives of the loan have been broadly met: - over 3/4 of the amount used of the loan contributed to the financing of pzicects outside Greater Tunis; - 75.7% of the financing concerned new projects; - the financing of priority sectors was distributed as follows: EMI projects which had first priority under loan, received 32,9% of the financing. Next are the rubber industry (25.4%) construction materials (18.7%) and agro-industries (10.4%) (Annex 7 gives the sectoral breakdown of subprojects). 3. The average cost of jobs created is relatively high at TD 47,800. However, excluding STIP and COTREL which are capital intensive, the average cost per job created falls to TD 28,500. BDET EVOLUTION DURING THE 1982-1987 PERIOD 4. In order to increase more significantly its contribution to the objectives of the Sixth Development Plan (1982-1985), BDET increased its equity and its borrowed resources. Equity: BDET share capital which was TD 10 m., at end-I981 was increased to TD 20 m. in 1982 and TD 30 m. in 1984. In parallel, BDET made a special effort to promote foreign investment in Tunisia from industrial enterprises or financial institutions, as follows: 61 The purpose of this component was to finance the cost of technical assistance for INNORPI as well as the study of effective protection in the manufacturing sector.  14 - two participation agreements: first, with the Islamic Development Bank (ID Sm.) and, more recently, with the European Investment Bank (ECU 3m); - joint venture between 4'oreign firms with technical know-how and BDET projects. Borrowings: During the 1982-1987 period, the outstanding amount of BDET resources more than doubled: from TD 93.3m in 1982 to TD 219.6m in 1987. This growth was characterized by: - resource diversification: IBRD's share of BDET resources fell from 20.4Xin 1982 to 9X in 1987. This was offset by borrowings on the international capital markets, which were very small until 1982 but represented nearly half of the total resources at the end of 1987, as well as by borrowings from institutional lenders (EIB. DEG, Italian credits, etc.); - maximization of domestic borrowings: important progress was achieved in issuing bonds on the local market; in 1987, these bonds represented more than one-third of resources used during that year, ie. TD 14.2m. BDET's Policy: BDET's Statutes and General Policy Statement remained unchanged. Staff: BDET has currently a qualified staff of 215 including 50 officers comprising 15 engineers, 25 economists and financial analysts, and I0 legal staff. Industrial Projects Promotion: There are 48 projects identified; 29 are already in operation, and 11 under construction. 5. BDET's Operations between 1982 and 1987 (Annexes I and 2): During the period under review, Tunisia's banking system was characterized by the creation of new development banks. This event placed greater competitive pressure on BDET. It also provided the opportunity for cofinancing new projects, particularly in tourism and in large industrial projects. a. Approvals: During the 1982-87 period, credit approvals reached TD 42.7 m. per year on average. However, these approvals decreased steadily between 1985 and 1987 due to: - the conscious decision in 1985 and 1986 to limit approvals in the tourism sector; - the economic difficulties faced by the industrial sector, stemming frow a decrease in domestic demand and the important increase in project costs resulting from the davaluation of the dlnar.  15 During the 1982-1987 period, the distribution of approvals was the following (see annex 6b): - new protJcts were predominant, representing 2/3 of the approvals; - 701 of approvals were for projects outside the Greater Tunis area; - the private sector remained the principal beneficiary of BDET's financing: its share of total financing was 89.51; - equity parti^ipations represented 6.4% of total financing. With respect to sectoral distribution, three-fourths of BDET's approvals were made to manufacturing. EMI led all other manufacturing branches, thanks to BDET's promotion efforts. As a result, on average, EMI annual approvals represented 20% of total approvals during the 1982-85 period. L L. were followed, in decreasing order of importance, by chemicals and rubber. agro-industries and construction materials which represented respectively 16%. 13.7% and 11% of total approvals. Recent developments: Because of the serious difficulties in the EHI sector (decrease of domestic demand, important foreign exchange losses), investment in this sector has fallen down. Approvals fell from TD 8.1m. in 1986 to TD 0.8m in 1987. At present, the priority is to consolidate and rehabilitate existing projects. It is likely that a revival of industrial investment will require some time. On the other hand, the demand in the tourism sector is very strong. Approvals in this sector have grown to about TD 46m. in 1986, and are expected to remain at a high level in 1989. b. Commitments and Disbursements: Because of the normal lag between approvals, commitments and disbursements, the later two have decreased since 1985, but at a slower rste than the decrease in approvals. 6. Loan and participation portfolio. Over the 1982-87 period, BDET's outstanding loan and participation portfolios have increased at very similar rates: 11.5 and 11.0% p.a., respectively. The loan portfolio increased from TD 139.4 million to TD 239.8 million; the participation portfolio grew from TD 18.0 million to TD 30.3 million. The ratio between the portfolios remained at about 1:10. To improve the revolving of its participation portfolio, BDET now increasingly requires that its privpte partners sign buyback agreements. As of late 1988, such agreements concerned a total of TD 4.9 million, of which TD 2.9 million were guaranteed by drafts backed by the banks of BDET's investment partners. Also, worth mentioning is tihe privatization of two public enterprises which was undertaken in 1987 and concluded in 1988.  16 Provisions are equivalent to 4% of BDET's loan and participation portfolios. 7. Repayments and financial profitability Mi Arrears Client arrears have worsened since 1984. This was due, first, to problems encountered by several large projects, and second, to the difficult economic climate that the country experienced in the last few years. These arrears have evolved as follows: 1982 1983 1984 1985 1986 1987