China - Fourth and Fifth Industrial Credit Projects

Document of THE WORLD BANK FOR OFFICIAL USE ONLY Report No. 16312 PERFORMANCE AUDIT REPORT CHINA FOURTH AND FIFTH INDUSTRIAL CREDIT PROJECTS (LOAN 2783-CHA/CREDIT 1763-CHA AND LOAN 3075-CHA) February 13, 1997 Operations Evaluation Department 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 (annual averages) Currency Unit = Yuan (Y) 1989 US$1.00 Y3.76 1990 US$1.00 Y4.78 1991 US$1.00 Y5.36 1992 US$1.00 YS.42 1993 US$1.00 Y5.73 1994 US$1.00 Y8.50 Abbreviations and Acronyms ABC Agriculture Bank of China BEC Beijing Eastern Chemical Works BOC Bank of China BSD Beijing No. 9 Semiconductor Device Factory CIB China Investment Bank CSCS Copper Strip Corporation of Shanghai DFC Development Finance Company GOC Government of China ICBC Industrial and Commercial Bank of China ICR Implementation Completion Report NBFI Non-bank financial institutions NCM No. I Northwest Cotton Mill of Xian OED Operations Evaluation Department PAR Performance Audit Report PBC People's Bank of China PCBC People's Construction Bank of China PCR Project Completion Report PPAR Project Performance Audit Report SPC State Planning Commission STW Shanghai Transformer Works TFP Total factor productivity Fiscal Year Government: January 1 - December 31 Director-General, Operations Evaluation : Mr. Robert Picciotto Director, Operations Evaluation Department : Mr. Francisco Aguirre-Sacasa Division Chief : Mr. Manuel Pefilalver Task Manager : Ms. Alice Galenson FOR OFFICIAL USE ONLY The World Bank Washington, D.C. 20433 U.SA. Office of the Director-General Operations Evaluation February 13, 1997 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Performance Audit Report on China - Fourth Industrial Credit Project (Loan 2783-CHA/Credit 1763-CHA) and Fifth Industrial Credit Project (Loan 3075-CHA) Attached is the Performance Audit Report on the China Fourth Industrial Credit Project (CIB IV, Loan 2783-CHA/Credit 1763-CHA for US$300 million equivalent, approved in FY87) and Fifth Industrial Credit Project (CIB V, Loan 3075-CHA for US$300 million equivalent, approved in FY89) prepared by the Operations Evaluation Department. CIB IV was fully disbursed and closed one year late, on June 30, 1993; CIB V was fully disbursed and closed as scheduled on December 31, 1994. The main objectives of the two projects were to develop China Investment Bank (CIB) and improve financial intermediation procedures and practices in China. The projects supported investments to modernize and upgrade technology in state- and non state-owned enterprises. Both projects consisted of a line of credit of US$299 million equivalent and a technical assistance component of about US$1 million. The objectives of the loans were partially achieved. CIB IV helped develop CIB as a development finance company, and CIB V supported its conversion into a commercial bank, also adding new financial products and services, encouraging lending to non-state-owned enterprises, and helping CIB to diversify its resource base. The relevance of this achievement was limited, however, because CIB remained a very small provider of long-term funds in China, and its impact on the industrial and financial sectors was minor; China's investment allocation system remained substantially unchanged, limiting the role of financial intermediaries. Moreover, under CIB V, on-lending interest rates on some subprojects, which were supposed to reflect the foreign exchange risk, were revised downward by CIB, without Bank approval or knowledge, well below the minimum level required by the legal agreements. The outcome of CIB IV is rated marginally satisfactory, its institutional development impact moderate, and its sustainability likely; Bank performance is rated as satisfactory. These ratings agree with those of the PCR, except for sustainability, which was then rated uncertain. As the fourth operation in a series, however, more relevant objectives could have been expected. The same is true of CIB V, the outcome of which is also rated as marginally satisfactory. Its institutional development impact is rated as moderate, and sustainability as likely. The failure of supervision to detect the on-lending covenant violation, added to the issue of project relevance, results in a marginally unsatisfactory rating for Bank performance on this project. The ratings of CIB V disagree with those in the ICR, which rated both outcome and Bank performance as satisfactory. The Region believes that the institutional improvements to CIB fulfilled completely the projects' objectives, as stated in the ICR, and that the issue of on-lending rates is not important enough to warrant a marginally unsatisfactory rating for Bank performance. 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. 2 The draft audit report was sent to the Ministry of Finance and to CIB; their comments are attached as Annex 5 and have been noted in the text of the report. Both responses disagree with the report; they assert that the objectives of the projects were fully met and argue that the less than satisfactory ratings are not justified. CIB explains the violation of the interest rate covenants as necessary to make the World Bank funds attractive at a time of gradually declining rates for foreign exchange in the Chinese market; it attributes its lack of attention to the interest rate covenant to staff turnover and organizational changes in CIB. The main lessons from the two projects are that (i) project design should have focused more on improving the quality of financial intermediation and resource allocation in China; (ii) the Bank should have supervised CIB V operations more closely, especially as it was the first project with flexible interest rates; and (iii) the design of future operations in China should take into account the reluctance to use foreign experts and should allow for flexibility in the use of training resources. Contents Preface 3 Basic Data Sheets 5 Evaluation Summary 9 1. Background 15 Macroeconomic Background 15 Performance 15 Reforms 16 (i) Open Door Policy 16 (ii) Market Prices 16 (iii) Devolution of Decision Power 17 Financial Sector 17 Financial Deepening 17 Financial System 18 Financial Policies 19 Recent Reforms 20 2. China Investment Bank Projects 23 Objectives and Design 23 Objectives 23 Design 23 Implementation Experience 25 CIB I-Ill 25 CIB IV and V 26 CIB Performance 31 3. Evaluation and Ratings 35 Contribution to Industrial Sector Development 35 Contribution to Financial Sector Development 35 Institutional Development of CIB 36 Sustainability of Benefits 37 Bank and Borrower Performance 38 Project Outcome 39 4. Lessons of Experience 41 Annexes: 1. The Industrial Sector 43 2. Summary of Main Terms and Conditions 47 3. The Implementation of Credit Training under the Fifth world Bank Credit Line 51 4. List of Subprojects for Fourth and Fifth CIB Projects 53 5. Comments Received on the PAR 65 Alice Galenson (Task Manager) acknowledges with thanks the contributions of: Ashok Khanna and Christian Schmidt (consultants) who audited the project in March 1996 and on whose report the PAR is based; and Geri Wise who provided administrative assistance.  3 Preface This is a Performance Audit Report (PAR) for two projects: the Fourth Industrial Credit Project (CIB IV) (Loan 2783-CHA for $250 million/Credit 1763-CHA for SDR 40.9 million) approved on March 3, 1987 and closed on June 30, 1993; and the Fifth Industrial Credit Project (CIB V) (Loan 3075-CHA for $300 million) approved May 30, 1989 and closed on December 31, 1994. The PAR was prepared by OED and the project PCR/ICR were prepared by the East Asia and Pacific Regional Office. The PAR is based on the PCR/ICR, Staff Appraisal and President's Reports, loan documents, staff files, various Bank working papers and reports and an industrial client survey conducted by CIB. An OED mission visited China in April, 1996 and discussed the effectiveness of the Bank's assistance with CIB and some of its clients. Their excellent cooperation is gratefully acknowledged. The PCR for CIB IV provided a thorough review of implementation experience. The ICR for CIB V was less thorough and did not address the violation of the interest rate covenants. The PAR expands on the analysis in the PCR and ICR by focusing on the projects' relevance to the country assistance strategy and their impact, particularly on CIB and on financial and industrial sector development. The draft PAR was sent to the Borrower for comments; the comments received are reproduced as Annex 5 to the PAR and are also reflected in the text.  5 Basic Data Sheet FOURTH INDUSTRIAL CREDIT PROJECT (Loan 2783-CIA/Credit 1763-CHA) Key Project Data (amounts in USS million) Appraisal Actual or Actual as % of estimate current estimate appraisal estimate Total project costs n.a. n.a. n.a. Loan amount 300.0 300.0 100% Cofinancing - -- - Cancellation Date physical components completed -- -- -- Economic rate of return n.a. n.a. n.a. Cumulative Estimated and Actual Disbursements FY87 FY88 FY89 FY90 FY91 FY92 FY93 FY94 Appraisal estimate (US$M) 15.0 81.0 186.0 255.0 288.0 300.0 300.0 300.0 Actual (US$M) -- 34.3 133.6 213.0 225.0 211.8' 287.2 303.7 Actual as % of appraisal -- 42.4 71.6 83.5 78.1 70.6 95.7 100.0 Date of final disbursement: October 13, 1993 a. $13.2 million reduction represents the refund of its Special Account. Project Dates Original Actual Appraisal 6/86 7/86 Negotiations 1/87 1/87 Board approval n.a. 03/03/87 Signing n.a. 03/16/87 Effectiveness 06/30/87 06/22/87 Closing date 06/30/92 06/30/93 6 Staff Inputs (staff weeks) Total Through Appraisal 131.8 Through Board Approval 50.6 Supervision Total 238.2 Mission Data Date No. of Staff Specializations Performance Types of (month/year) persons days in represented rating problems field Through Appraisal/ 10/83 3 20 Eco, Fin, Eng 2 M Board approval' Supervisionb 07/84 4 13 Eco, Fin, Eng 2 M Supervisionb 01/85 3 15 Eco, Fin, Eng 2 M Supervision 07/86 3 7 Eco, Fin, Eng 2 M Supervisiond 05/87 2 8 Eco, Fin 2 M Supervision' 05/88 2 6 Eco, Fin 2 M Supervisione 10/88 3 5 Eco, Fin, Eng 2 M Supervision' 01/89 2 3 Eco, Fin 2 M Supervisione 10/89 2 3 Fin, Eng I -- Supervisione 09/90 3 3 Fin, Eng 1 -- Supervisione 03/92 1 12 Fin. Analyst 2/3 M/F a. The mission also supervised CIB I. b. Combined mission to supervise CIB I and CIB II. c. Combined mission to supervise CIB 1-III and prepare CIB IV. d. Combined supervision for CIB I-IV. e. Combined mission to supervise CIB I-V. M=Management; F=Finance. Other Project Data Borrower/Executing Agency: People's Republic of China/China Investment Bank FOLLOW-ON OPERATIONS Operation Loan no. Amount Board date (US$ million) Fifth Industrial Credit Project (CIB V) 3075-CHA 300.0 5/30/89 7 Basic Data Sheet FIFTH INDUSTRIAL CREDIT PROJECT (Loan 3075-CHA) Key Project Data (amounts in US$ million) Appraisal Actual or Actual as % of estimate current estimate appraisal estimate Total project costs 460.0 460.0 100% Loan amount 300.0 300.0 100% Cofinancing -- -- -- Cancellation Date physical components completed -- -- -- Economic rate of return n.a. n.a. n.a. Cumulative Estimated and Actual Disbursements FY90 FY91 FY92 FY93 FY94 FY95 Appraisal estimate (US$M) 15.0 96.0 192.0 252.0 285.0 300.0 Actual (US$M) 48.2 101.2 98.5 145.6 207.4 300.0 Actual as % of appraisal 321% 105% 51% 58% 73% 100% Date of final disbursement: April 20, 1995 Project Dates Original Actual Appraisal 01/89 01/89 Negotiations 04/89 04/89 Board approval 05/89 05/30/89 Signing 06/89 07/21/89 Effectiveness 09/89 10/31/89 Closing date 12/31/94 12/31/94 8 Staff Inputs (staff weeks) Total Through Appraisal 69.0 Appraisal to Board 11.7 Board to Effectiveness 1.0 Supervision 123.0 Other _30 Total 207.7 Mission Data Date No. of Staff days Specializations Performance Types ofproblems (month/year) persons infield represented rating Through Appraisal 09/88 3 19 Finance n.a. n.a. 02/89 3 12 Finance n.a. n.a. Appraisal through n.a. n.a. n.a. n.a. n.a. n.a. Board approval Board Approval n.a. n.a. n.a. n.a. n.a. n.a. through Effectiveness Supervision 10/90 3 14 Finance, Civil 1 M Eng Supervision 10/91 3 12 Finance, 1 M Economic Supervision 11/92 2 7 Finance I M Supervision 03/93 1 10 Finance 2 MI/F Supervision 10/94 1 7 Finance 2 IM/F Completion 03/95 1 2 Finance 2 M/F I=Implementation; M=Management; F=Finance. Other Project Data Borrower/Executing Agency: People's Republic of China/China Investment Bank FOLLOW-ON OPERATIONS Operation Credit no. Amount Board date (US$ million) None 9 Evaluation Summary Background 1. China began its reform process in 1979 to transform a centrally planned economy into a market economy. Its progress has been phenomenal. China has recorded the highest rate of GDP growth in the world over the past fifteen years. Industry has been China's fastest growing sector, but state-owned enterprise performance has lagged well behind collective and township enterprises. China's financial sector has also grown rapidly, but the efficiency of financial intermediation has not developed in line with this growth. Government policy has regulated investment allocation and pricing, constraining financial intermediation. The World Bank has supported China's reforms in industry and finance since the early 1980s, with policy dialogue based on sector analysis and with project lending. The Bank made three loans/credits to China Investment Bank (CIB) between 1982 to 1986 to modernize state-owned enterprises and develop CIB as a development finance institution. These projects assisted state enterprises to modernize and spread the use of project appraisal methodology to China's State Planning Commission and other agencies. This report focuses on the Fourth and Fifth Industrial loans/credit channeled through CIB. Objectives and Implementation 2. The basic purpose of both projects was to assist the Government in promoting and implementing technology upgrading and modernization in industry, to build sound institutions and procedures for investment financing, and to improve financial intermediation practices. Specific objectives included institutional strengthening of CIB, financing high priority industrial investment to remove bottlenecks, and expanding and diversifying CIB's resource base. 3. The implementation of sub-projects was satisfactory for both loans. CIB continued to apply World Bank appraisal techniques, adopted under the earlier loans, but its financial position deteriorated, due to the growth in arrears and collection difficulties. Moreover, interest rates charged on subloans under CIB V, which were supposed to vary, based on the World Bank's variable rate plus a minimum spread of 1.5 percent, were often below the required levels, and even below the World Bank rate in some cases. This covenant violation was not noted in the supervision reports or the ICR. Nevertheless, CIB is transforming itself into a commercial bank with diversified sources of funds and products and services. With some financial and internal restructuring, it is poised to become the first truly commercial bank of any size in China, especially if it is permitted to form a joint venture with a major European bank as it and its parent People's Construction Bank of China (PCBC) desire. 4. The CIB IV and V credit lines of US$600 million equivalent helped to expand CIB's resources and provided investment funds for restructuring and modernization of light industry. China was not, however, suffering a shortage of foreign exchange or long-term investment funds 10 during this period. PCBC, China's main long term lending bank, had loan assets more than thirty times those of CIB, indicating substantial long term resources available to lend. CIB IV and V investments were mainly in state-owned enterprises, an enterprise category that has not performed well and is growing much more slowly than the non-state sector. Evaluation and Ratings 5. Contribution to Industrial Sector Development. Overall, the evidence suggests that subprojects achieved the objectives of upgrading technology and modernization and restructuring of light industry. The achievement, however, was in a relatively slowly growing type of enterprise and subsector. Moreover, the projects had to have planning committee approval which, once obtained, often leads to secured funding.2 6. Contribution to Financial Sector Development. By the end of CIB III, CIB had appraised about 300 projects and was judged as performing at an international level in the Project Performance Audit Report. In addition, China's State Planning Commission (SPC) and other agencies had adopted the Bank's appraisal methodology by 1986, one of the major contributions of those projects. Thus, CIB IV and V made little incremental contribution to spreading the use of project appraisal methodology and procedures.4 World Bank project appraisal techniques were applied by SPC and banks mainly to investments in state-owned enterprises, a sector which has not done well (although the appraised investments may have performed better than the average). By some estimates, one-third of state-owned enterprises make losses and another third are marginally profitable. Meanwhile, collective and township and village enterprises' performance is spectacular, and their projects are not appraised. IBoth the Region and the Ministry of Finance disagree with this statement. The Region notes that "foreign exchange reserves and/or FDI ...may not always be substitutable for long-term investment loans. They have a different nature and purpose, and are volatile. FDI in China, in the late '80s and early '90s, was mainly into the service industries..., and highly labor-intensive simple technology manufacturing with short gestation and quick pay-back periods largely confined to South-Eastern China. As regards PCBC, it was until recently a policy bank making loans to large projects in the government's investment plan. CIB was gradually spreading out to the whole country and making loans based on its assessment of project viability. Furthermore, the Bank loans being for longer maturities, provided flexibility to CIB with respect to subloan term." The Ministry of Finance comments that "since 1980s, with high economic growth rate, the economic development and the enterprises modernization in China have needed more foreign exchange, and Bank of China, China Construction Bank (original PCBC) and other banks could not meet the requirements for investments. The World Bank's loans under the CIB IV and V just provided supplemental funds and partially met the requirements of SMEs. The substantial increase of China's foreign exchange reserves is only relevant in the past two years." 2 The Region notes that "All SOE investment proposals above a certain limit have to be approved by a committee comprising representatives of concerned bureaus and commissions, but their decisions are not necessarily binding on the banks. It is also wrong to assume that the approval of projects by planning committees automatically ensures the availability of funds; it only gives a right to approach specialized banks for assistance." 3 World Bank, Project Performance Audit Report, China - First, Second and Third Industrial Credit Projects, Report No. 9945, October 1, 1991. 4 The Region notes that CIB IV and V helped to deepen the appraisal work in CIB and to upgrade its appraisal manual. CIB expanded its appraisals to the borrowing enterprise, not just the subproject; environmental appraisal was added; and new procedures for working capital loans and equity investments were adopted. 11 Nevertheless, state-owned enterprise borrowers voiced appreciation for CIB staff knowledge and input into shaping the final project. 7. CIB IV and V made some contribution to improving financial intermediation practices by requiring subborrowers to take the foreign exchange risk and pay variable interest rates. However, the on-lending rate in CIB V at times fell below the required level, and, at least in some cases, below World Bank lending rates, resulting in a low or negative spread to CIB.5 Most importantly, the investment allocation system remained unchanged. As noted above, projects had to be approved by planning committees before receiving CIB funding. Overall, CIB IV and V's contribution to financial intermediation and investment allocation was limited.6 8. Institutional Development of CIB. Institutional development of CIB was the main objective of CIB IV and V. All the agreed elements of the operational plan in CIB IV were implemented, CIB staff received training under the technical assistance component and World Bank staff put in about 56 weeks of supervision during several missions. In CIB V, CIB diversified its funding base and products and services, received technical assistance for training staff for new functions and funds for purchasing a computer for an information system, and also benefited from 123 staff weeks of World Bank supervision. 9. Bank appraisal and supervision and technical assistance under the two projects played a crucial role in assisting CIB develop as an institution. There was, however, a subtle change in the type of institution CIB was evolving into, from a development finance institution to a commercial Bank. Thus, CIB had made sufficient progress by 1992 to propose to the Government that it convert itself into a commercial bank. Until January, 1994, however, the Government was leaning towards consolidating CIB with PCBC. The Bank's support was instrumental in the approval of CIB's charter as a commercial bank in July, 1994 and its conversion to a limited liability company wholly owned by PCBC, preserving its identity and autonomy. Therefore, the Bank played a pivotal role in CIB's transformation from a development bank to a commercial bank. Since July, 1994, CIB has made a concerted effort to change its liability and asset structure in line with its operations as a commercial bank. 10. On the negative side, CIB's financial performance and condition has deteriorated in recent years. Exchange rate and tax policy changes and increased competition have adversely affected its clients' ability to repay loans. CIB has lost money on the World Bank credit lines, due to the growth in arrears, low collection rates, and small (and even negative) interest rate spreads. At the end of 1994, CIB's capital to asset ratio was about 5 percent and its long-term debt to equity ratio was a conservative 5.6. A restatement of CIB's accounts to conform with international accounting standards would reduce its capital/asset ratio, and CIB will need an infusion of capital. With that financial restructuring, and deregulation of interest rates, CIB's profitability could rise sufficiently for CIB to borrow from international markets in the future on the strength of its balance sheet. Overall, however, the institutional development of CIB has s CIB has explained that the interest rate was reduced for some subborrowers in order to make the funds attractive at a time of gradually declining rates for foreign exchange in the Chinese market. CIB attributes the lack of attention to the interest rate covenant and failure to bring the non-compliance to the Bank's attention to staff turnover and organizational changes in CIB (see Annex 5). 6 The Region argues that the institutional strengthening of CIB improved its project appraisal and resulted in better financial intermediation practices, so the project objective was achieved. OED notes, however, that improvement of financial intermediation practices must include measures to increase the efficiency of resource allocation, i.e. through reforms to the investment allocations and pricing systems. 12 been successful, and in the narrow sense of the institution itself, which excludes policy reform, the institutional development impact of both projects is rated moderate. 11. Sustainability of Benefits. CIB IV and V's main contribution lies in the institutional development of CIB. The sustainability of the projects' benefits hinges on macroeconomic management, financial policy, investment policy and CIB autonomy. China has made progress in developing institutions and instruments to improve macroeconomic management. It is likely that bouts of high inflation will neither recur, nor reach prior levels, alleviating the need for administrative credit restraints that affect bank performance. Interest rates need to be deregulated gradually, starting with interest rate flexibility within a range and more frequent adjustments of rates. Investment policy also needs deregulation, with banks making autonomous decisions for funding fixed asset investments. These policy changes are pre-conditions for the development of a competitive commercial banking system. CIB must also have autonomy. At present, six out of nine members of its Board of Directors are nominated by PCBC. CIB can enhance its autonomy by forming a joint venture with a European bank, a move supported by PCBC and CIB management. The sustainability of the projects' benefits is rated likely. 12. Bank and Borrower Performance. While project design was substantially grounded in the country assistance strategy for China, and the main specific project objectives were also substantially achieved, the project relevance is assessed as low; project design was not appropriate because it did not focus on China's investment allocation and pricing system, the most important reform issues for increasing the efficiency of resource allocation. Although the projects extended appraisals to entire firms rather than just the projects, and also to working capital loans and equity investment, the main contribution to efficient resource use made by the project appraisal methodology had substantially already occurred before CIB IV and V were designed and implemented. 13. Bank and borrower cooperation in the process of project identification, preparation, appraisal and supervision for CIB IV and V appears to have been good, as they were preceded by three projects. The Bank's preparation, appraisal and supervision of these projects was for the most part sound but expensive in staff time in view of a long prior relationship with CIB and few new project components, especially in CIB IV.7 CIB staff indicated their dissatisfaction, along with that of subborrowers, with the World Bank's subproject approval process, and noted that it often resulted in substantial delays. Moreover, supervision of CIB V failed to detect the violation of the covenant concerning on-lending rates. Project implementation by the borrower was satisfactory for CIB IV, although the project had to be extended for one year, mainly because of delays caused by the Tiananmen incident. The borrower complied with most loan covenants, but failed to comply with those for on-lending rates in CIB V. Audit reports and other information were provided in a timely fashion. Supervision of subprojects is close, with regular visits to clients. The borrower's reluctance to accept technical assistance from foreign experts, however, may have affected the quality of training and speed of skill absorption. Overall, while project design conformed with Bank country assistance strategy, and physical project implementation was satisfactory, the project design did not focus adequately on The Region does not agree that these operations were expensive in terms of staff time, given the language, the travel distance to and within China, the prevailing system in China, the size of the loans, the number of above free limit subloans (see para. 18), and institutional development efforts. 8 The Region comments that the Bank's response was normally very prompt, and that an investigation of the one complaint from CIB found that the delay in this case was caused by "late submission of explanations and clarifications by CIB staff to the Bank's comments and queries." 13 investment allocation and pricing, both crucial for improved resource allocation. Despite this shortcoming, Bank performance for CIB IV is rated as satisfactory. Bank performance for CIB V is rated as marginally unsatisfactory, however, in view of the additional supervision shortcomings. Borrower performance is rated as satisfactory for CIB IV and as marginally unsatisfactory for CIB V, in the light of the violation of interest rate covenants in the latter. 14. Project Outcome. The industrial investment objectives of (IB TV and V were met satisfactorily. Based on small samples of projects analyzed in the PCR and ICR, CIB subborrower rates of return were below estimates at appraisal but satisfactory, indicating that the projects were cost-effective. While project contributions to financial and industrial sector development were minimal, the development of CIB as an institution was a salient achievement. The Bank's project design, however, did not focus sufficiently on improving resource allocation beyond the achievements of CIB I-III. Thus, CIB IV and V were of little relevance. In addition, the failure of CIB V to maintain adequate on-lending rates contributed to CIB's declining profitability. For these reasons, the outcomes of CIB IV and V are rated as marginally satisfactory. Summary of Ratings 15. Based on its findings, this audit rates CIB IV and V as follows: CIB IV CIB V Outcome Marginally satisfactory Marginally satisfactory Institutional Development Impact Moderate Moderate Sustainability Likely Likely Bank Performance Satisfactory Marginally unsatisfactory Borrower Performance Satisfactory Marginally unsatisfactory These ratings differ in part from those in the PCR for CIB IV, which rated sustainability as uncertain, and from those in the ICR for CIB V, which rated outcome and Bank and Borrower performance all as satisfactory. 9 The Region believes that the violation of interest rate covenants in CIB V and the failure of Bank supervision to detect the violation are not significant enough to justify the marginally unsatisfactory ratings for Bank and for borrower's performance. More specifically, the Region states "we do not consider [the onlending rate issue] to be a very important factor in the success of the project. We agree that CIB should have consulted with the Bank before deciding to lower the rates and that our supervision on that score was not satisfactory.... Having said that, we share CIB's position that interest rates should respond to market realities, and that CIB could not price itself out of the market at the time of decreased international and BOC rates. We probably would have agreed to CIB's decision to lower rates--which applied to a small number of subprojects and that too for a short period--had it approached us for our no objection. Please also note that CIB has charged higher rates at other times and overall its interest rates are not responsible for deterioration in its financial position." OED notes that according to the tables in Annex 4, 34 of the 43 randomly selected subprojects from CIB V had onlending rates below 8.60 percent, which would have been the minimum required level based on a Bank lending rate of 7.10 to 7.75 percent during the relevant period plus a spread of 1.5 percent. Eleven of these subprojects had rates of 7.50 or below. 14 Lessons of Experience 16. The main lesson arising from these projects is that the project design should focus on sectoral priority needs, which in this case were improving the quality of financial intermediation and resource allocation. Better resource allocation was crucial for the development of China's state-owned enterprise and banking system during the transition to a market economy. Greater flexibility in the choice of subprojects (without requiring planning committee approval) and in pricing (interest rates that reflected risk, for example) would have also made the projects more relevant to these needs. The Bank may have judged at the time that it was not possible to agree with the Government on additional state sector reforms in investment allocation, but in that case, CIB IV and V should not have been undertaken. With little relevance for improving resource allocation, the projects appear to have been channels for achieving high loan/credit volumes to China. The development of CIB as an institution could have been achieved with smaller loans, or even through self-standing technical assistance.10 17. CIB is at a crucial juncture. With PCBC agreement, its commercialization reforms are proceeding. Indeed, PCBC is using CIB as a reform experiment as it has a much better chance of success. It has a smaller and well trained staff of relatively recent vintage and good information technology. While it needs some financial restructuring to conform with international standards, the needs are minor compared with those of PCBC. PCBC and CIB senior management believe that a joint venture with a European bank would help make CIB the first real domestic commercial bank in China. 18. The failure of World Bank supervision to detect the violation of the interest rate covenants for subloans in CIB V, in spite of a relatively high level of supervision, demonstrates the need for the Bank to strengthen its supervision procedures and priorities. After transferring project appraisal capability during the successful CIB 1-111 projects, there was little need for the Bank to require free limits, even for some projects. CIB staff felt slighted and believed that the clearance process was too slow. Supervision missions could have done spot checks on a sample of projects. Loan monitoring should be done by establishing financial and other performance targets, as was done with CIB, and ex post evaluation should replace ex ante controls. 19. Because training programs were agreed ex ante, CIB staff indicated that flexibility to respond to newly perceived needs, such as loan supervision and collections and commercial banking functions, was not adequate. In the future, some training resources should remain uncommitted or periodic reviews should be carried out by the Bank and the Borrower.12 20. CIB's reluctance to use foreign -xperts limited the degree of institutional change under the projects. The design of future operations should take this into account by either eliciting a firm commitment by the borrower agency or not including foreign experts in the technical assistance component. 1o The Region does not believe that this would have been possible. I The Region asserts that since CIB was opening new branches, which were responsible for appraisal, and rapidly expanding staff and operations, the quality of its appraisal was uneven. The head office had inadequate capability to maintain satisfactory quality control, and the free limit was necessary to help branches improve the quality of their appraisals. 12 The Region notes that the training program included substantial supervision-related training and training for new products and services; that the government would not agree to uncommitted technical assistance; and that CIB could and did make adjustments to the program. 15 1. Background 1.1 China began its reform process in 1979 to transform a centrally planned economy into a market economy. Its progress has been phenomenal. China has recorded the highest rate of GDP growth in the world over the past fifteen years. Industry has been China's fastest growing sector, but state-owned enterprise performance has lagged well behind collective and township enterprises. China's financial sector has also grown rapidly but not developed significantly. Government policy has regulated investment allocation and pricing, constraining financial intermediation. The World Bank has supported China's reforms in industry and finance since the early 1980s with policy dialogue based on sector analysis and project lending. The Bank made three loans/credits to China Investment Bank between 1982 to 1986 to modernize state- owned enterprises and develop China Investment Bank as a development finance institution. These projects assisted state enterprises to modernize and spread the use of project appraisal methodology to China's State Planning Commission and other agencies. This report focuses on the Fourth and Fifth Industrial loans/credit channeled through China Investment Bank with the objectives of further developing the institution, assisting state and non-state-owned enterprises to upgrade technology and modernize their operations, and improving financial intermediation practices Macroeconomic Background 1.2 The macroeconomic setting for Bank loans and credits to the China Investment Bank (CIB) and their implementation spans about 13 years, from 1982 to 1995. The first credit was approved in 1982, when China had just begun its reform program. In the pre-reform era, although GDP growth had been respectable, it was achieved at a high cost in investment and other inputs. Investment was dictated by mandatory plan targets and administrative direction. The planned economy provided only basic necessities and the complex bureaucratic controls interfered with the efficient use of resources. China's inward orientation caused it to remain technologically backward. Performance 1.3 Since China began its economic reforms in 1979, it has achieved an average annual growth rate of 9.5 percent in real gross domestic product (GDP; see Table 1.1). Thus, between 1979 and 1994, Chinese real GDP increased from US$150 billion to US$575 billion (1990 prices). China has grown faster than any other economy in the world during this period. Industrial growth has been even faster, averaging about 13 percent per annum, and agricultural growth has averaged a handsome 4.5 percent per annum. Exports and imports have been growing at 15 percent per annum since 1979, about three times faster than world trade. While inflation averaged about 8 percent per annum during the period, several episodes of high inflation led to reform reversals for stabilization purposes. 16 Table 1.1: GDP Growth (percent per year, at 1990 prices) 1984-93 1994 1995 GDP 10.5 11.8 10.2 Agriculture 4.7 4.0 4.5 Industry 13.3 17.4 13.0 Services 12.2 8.2 9.5 Exports 12.4 28.6 28.7 Imports 13.3 8.9 20.0 Source: China: Country Economic Memorandum 1996, World Bank. Reforms 1.4 The three major components of economic reform have been the: (i) "open door" policy; (ii) movement to market determined prices; and (iii) devolution of economic decision power: (i) Open Door Policy 1.5 The "open door" policy opened China's economy to foreign trade, investment and technology. Since 1979, exports and imports have increased almost tenfold, to about US$120 billion each in 1994. During the same period, foreign direct investment and foreign debt increased from virtually zero to US$100 billion. Joint ventures with foreign partners have increased dramatically to about 80,000. In addition, tens of thousands of Chinese students are trained abroad every year. Thus, the open door policy succeeded in introducing modem technology into China. (ii) Market Prices 1.6 Goods Prices. Prior to 1978, all prices for goods and services and the exchange rate, interest rates and wage rates were set centrally, with the market playing almost no role in price determination. Free markets in agricultural commodities were introduced in rural areas in 1978 and state purchase prices of agricultural commodities were significantly increased. Before 1979, most industrial products were distributed through central or local government channels at prices fixed by government agencies on a cost plus mark-up rule. With large variations in costs among Chinese industries, prices varied across regions, even for centrally allocated materials. Price reforms have been implemented gradually and partially by raising some prices, making others flexible within a range andreducing the share of inputs and outputs covered by mandatory planning. In 1981, price flexibility was extended to a large number of inputs and the Government began to allow enterprises to market their products independently. 1.7 By 1985, enterprises were allowed to sell production above their mandatory quota at market prices, formally establishing a dual price system. This system brought about a substantial reduction in the scope of planning and expanded the role of the market. By 1989, about 38 percent of state-owned enterprise output was sold outside the plan and 56 percent of their inputs were purchased at non-plan prices. Although price reforms were halted in mid-1988 due to the emergence of serious inflation, they resumed in 1990. In the past few years, price deregulation has continued and prices of basic goods and services such as grains, energy and transportation 17 have been gradually adjusted to reflect true scarcity costs. Today, prices of more than 97 percent of consumer goods and 80 percent of producer goods are market determined. 1.8 Interest Rates. China has used preferential interest rates and directed credit as key instruments of industrial policy, reflecting the Government's resource allocation priorities. Interest rate policy serves multiple objeztives, resulting in a complex, differentiated and non- transparent structure. Not only do interest rates vary by sector and loan purpose, but deposit and lending rates for identical products can differ by institution. The Government sets about 200 interest rates, some within a band around a reference rate. Even though interest rates have been adjusted from time to time in response to economic conditions, they have not been used as an allocation mechanism. Juxtaposed to these controlled interest rates in the banking sector are market determined rates in the capital market, informal market and Hong Kong. Interestingly, China's interest rates have followed Hong Kong rates in recent years. (iii) Devolution of Decision Power 1.9 Liberalization of product prices and incomplete deregulation of factor prices were accompanied by partial devolution of decision power over investment, production and distribution. In rural areas, the contract responsibility system was implemented at the farm household level. In practice, the new system amounted to a return to private farming. Coupled with price and market reforms, the agricultural sector's productivity grew by about 40 percent in a few years, providing resources and labor for industry. The attempt to extend the contract responsibility system to state-owned industrial enterprises, however, failed to elicit the same improvements in efficiency. Their losses remain a major problem for China. Collective, township and village and private enterprises were permitted, however. These enterprises have been the fastest growing part of the economy. By 1993, township and village enterprises contributed 45 percent to the gross value of industrial production. These new organizations face hard budget constraints, forcing efficient resource allocation. As a result of the non-state sector's much faster growth, the state-owned sector has been contracting in relative terms. Thus, without privatization, the state-owned sector now accounts for less than half of China's GDP, compared with more than 90 percent in 1978. 1.10 Overall, reforms have significantly reduced price distortions in China's economy. Prices of goods and services are now almost entirely market determined. Factor prices faced by the non-state-owned sector, which now dominates China's economy, are also determined by market forces. The still huge state-owned sector, however, remains shackled by regulated wages and interest rates. In addition, other factor market rigidities impede state-owned enterprises from responding to market signals. In spite of reforms, capital is still largely administratively determined. Similarly, labor market reforms have not been sufficiently deep to enable state- owned enterprises to shed excess labor. Financial Sector Financial Deepening 1.11 China's financial sector is deep in comparison with other countries at its income level. China's deposit base has grown rapidly, making its M2 to GDP about 100 percent in 1994, higher than most developing countries. Due to an inadequate range of financial instruments, its gross financial assets (partial count, omitting several small institutions) to GDP was about 241 percent in 1994. China's financial deepening can be explained by a high savings rate of about 38 percent 18 of GDP, partly a consequence of the limited availability of consumer durables and increasing monetization of the economy. Banks account for most of the sector's depth, and, compared with other countries, China's non-bank financial institutions (NBFIs) and capital market are small. Financial System 1.12 Prior to 1979, China had a monobank system similar to most socialist economies, with the People's Bank of China (PBC) acting both as a central bank and a commercial bank. Government and enterprise financing needs were met by the annual budget and credit plans, which directly allocated financial resources. In 1984, PBC assumed the traditional functions of a central bank and its commercial banking business was transferred to the Industrial and Commercial Bank of China (ICBC). Other specialized banks were created or revived: Agriculture Bank of China (ABC) for lending to agriculture; Bank of China (BOC) for foreign exchange transactions; and People's Construction Bank of China (PCBC), established in 1954, to manage budgetary funds for investment. Each of these banks developed a large branch network. In addition, China Investment Bank (CIB) was created in 1981 as a subsidiary of PCBC to handle World Bank and other foreign loans to the industrial sector. 1.13 Since 1986, when reforms began to deepen, the financial sector has grown significantly, with a more diversified structure and a broader menu of financial instruments. Banks have been allowed to handle general banking business and compete for deposits and loans in one another's markets, but all still remain largely specialized. By 1992, in addition to the four specialized banks (ICBC, ABC, BOC, PCBC) with about 148,000 branches and CIB (32 branches), there were two national comprehensive banks (Bank of Communications and China International Trust and Investment Company Industrial Bank with 2,000 branches). These banks are supplemented by commercial banking operations performed by rural credit cooperatives (50,000 branches) and urban credit cooperatives (5,000 branches). Foreign entry into the financial system has been substantial. A number of foreign banks (250 branches), finance and investment companies (11 branches), securities companies (40 branches), and insurance companies (70 branches) had also opened with a limited but expanding business scope. 1.14 In 1994, the specialized and comprehensive banks held over 80 percent of China's financial assets, down from almost 97 percent in 1985. NBFIs, while still accounting for a small fraction of financial intermediation, tripled their share in total financial assets, from 2.8 percent in 1986 to 9 percent by 1994. The nascent securities markets have also grown rapidly during the same period. About 336 shares (A and B) are now listed on the two stock exchanges. 1.15 Reforms have introduced far reaching changes in the way China's financial sector operates, but the desired level of efficiency in financial intermediation has not been achieved. Banks' specialization along sectoral lines was blurred by deregulation, which also led to improvements in the services provided to savers and borrowers. Competition, however, remains at a low level, especially within the banking and NBFI segments. Product-line regulatory barriers continue to limit intra-industry competition for deposits and loans. Price competition does not exist. In spite of the broader range of services offered by China's banks and financial institutions, with the exception of PCBC, their lending is substantially limited to short-term working capital. The dearth of maturity transformation by banks could be a serious constraint for investment financing in the future. While the capital market and NBFIs have increased the availability of long-term finance, their supply capability is limited. The capital market is in an embryonic state and NBFIs are relatively small. 19 Financial Policies 1.16 China has used preferential interest rates and directed credit as key instruments of industrial policy. Even though interest rates have been adjusted from time to time in response to economic conditions, they have not been used as an allocation mechanism. In spite of significant liberalization during the reforms, interest rates are still set administratively by PBC. Administratively determined low interest rates encourage capital intensive investment and excess demand for funds, resulting in credit rationing. This situation tends to favor large state-owned enterprises with soft budget constraints and exclude the smaller but efficient township and village enterprises and private enterprises. Between 1983 and 1988, output of township and village enterprises grew 5.4 times, while lending to this segment grew 3.2 times. Private traders and enterprises have grown to account for 65 percent of retail sales and more than 4 percent of industrial output, but credit extended to them remains minuscule and it was given almost entirely by urban credit cooperatives. Interest rates outside PBC's schedule of rates are free or "negotiated", within limits imposed by PBC. Negotiated rates, which are higher than the controlled rates, apply to the interbank market, primary issues of bonds and enterprise securities. 1.17 Prior to 1979, banks were essentially fiscal agents of the Government, executing and monitoring financial flows required to fulfill the mandatory plan targets. The reforms, which emphasized financial sector development and decentralization, resulted in a sharp decline in government funding of state-owned enterprise fixed investment and a concomitant increase in bank financing. Between 1981 and 1988, budgetary funding of state-owned enterprise investment dropped from 37.7 percent to 13.4 percent and bank financing increased to 20.9 percent. Nevertheless, the Government's role continued to be significant, even for the portion of financing extended by banks. The mandatory investment plan, which includes all projects approved by the State Planning Commission (SPC), is the Government's mechanism for directing investment. Investments that are not in the mandatory plan are included in a "guidance" plan which serves as a basis for decisions at the provincial level. In addition, ceilings are imposed on total provincial loans to collectives and township and village enterprises. Thus, while banks do have a right of refusal and more influence in small projects, virtually all bank credit in China is "directed". 1.18 Such a high level of directed credit inhibits the development of an autonomous banking system which independently screens and monitors investments. In addition, directed lending to support loss-making state-owned enterprises and invest in non-commercial projects results in portfolio deterioration. In 1985, bad loans were estimated to be 12 percent of total bank portfolios. Reports from 1986-1988 estimate the share of overdue and non-performing loans to range from 20 percent to 80 percent in many local bank branches. Non-performing loans have probably risen significantly since due to the retrenchment of 1988-89 and 1994-95 and the continued increase in losses of state-owned enterprises. PBC recently estimated that 20 percent of bank loans are not recoverable. A banking system cannot support such a high proportion of non-performing assets, especially if its interest spread is narrowed by regulation. 20 Recent Reforms 1.19 In November 1993, the Government set the future course for financial sector development in China by announcing reforms to: * transform the People's bank of China into a modem central bank responsible for monetary policy and supervision of the financial system; * separate "policy" lending from commercial lending; * transform specialized banks into commercial banks; * separate commercial banking from securities trading; * allow the controlled development of NBFIs and the capital market; and * modernize infrastructure for the financial sector. 1.20 In the past two years, the Government has: * created three policy banks to separate policy from commercial lending. These banks are now functioning. Although the state commercial banks were supposed to transfer their stock of policy loans to the policy banks, they have not done so. Thus, the State Development Bank of China and the Export-Import Bank of China are starting with a strong portfolio but leaving the state commercial banks with weak portfolios; * granted some autonomy to state commercial banks in lending decisions. Although the credit plan was strictly enforced in 1994 and 1995, the state commercial banks were granted increased autonomy over investment lending decisions within their credit ceilings. They already had full autonomy over working capital loans which account for 60 percent of the credit plan. Gradually, the state commercial banks are gaining independence in pursuing commercial objectives; * allowed CIB to become a wholly owned subsidiary company of PCBC. CIB has remained relatively small in comparison with PCBC. In 1993, CIB's total assets were only 3 percent the size of PCBC's and its branch network was 1 percent as large as PCBC's; * adjusted interest rates more frequently and eliminated some preferential lending rates; and * introduced several banking laws and prudential regulations. 1.21 While these announcements and reforms have been impressive in their coverage, China's financial system still faces deep structural problems. The Government continues to play an unusually important role in determining the allocation of credit by commercial banks. Financial intermediaries in general, and banks in particular, are among the most important pillars of decentralized, market economies. They are the main external financiers of investment in industry, even in countries with developed capital markets such as the U.S. and U.K. They mobilize resources and profitably transform the maturity of short-term deposits into long-term loans. Banks screen potential investments for viability and price their loans according to risk. After loans are disbursed, banks monitor borrowers' performance. Banks' skill in screening and monitoring investments, the quality of intermediation, is among the most important factors for economic development. Using these standards, China's financial institutions would still not be considered full-fledged financial intermediaries. 21 1.22 The Government of China intends to reform the financial system gradually, to keep pace with enterprise reforms. While the Government's reform program is certainly in the right direction and in step with reforms of state-owned enterprises, it may not keep pace with the rapidly growing non-state-owned sector, which is spearheading the development of the socialist market economy. Financial intermediaries need to respond independently and quickly to their clients' investment needs at the branch and subbranch levels as industry spreads throughout the country. Their screening and monitoring function takes on greater importance in a decentralized market economy. For the foreseeable future, banks will remain the main intermediaries for industry in China. Therefore, the development of an autonomous, competitive and efficient banking system is of paramount importance.  23 2. China Investment Bank Projects 2.1 The loans/credit audited in this report formed the latter part of a sequence of five. The objectives, design and implementation performance of these projects should be evaluated in the context of the genesis and evolving relationship between the World Bank and CIB. Thus, a summary review of CIB I-III, extracted mainly from the Project Performance Audit Report (PPAR) for those projects, is presented at the beginning of each section. Objectives and Design Objectives 2.2 CIB I-II. The objectives for CIB I, approved in December 1982, were to: (a) provide needed foreign exchange; (b) improve CIB's ability to design, select and appraise projects; and (c) assist in developing CIB as an autonomous and efficient industrial finance intermediary. The primary objective of CIB II, approved in June 1984, was to continue supporting the first project's objectives including building CIB as an intermediary institution. CIB III was approved in March 1986 and was almost identical to CIB II, basically considered an "interim operation" to assist CIB in meeting its commitments through 1986. CIB I-III loans/credits amounted to US$345.6 million equivalent. 2.3 CIB IV and V. The broad objectives of both projects were to assist the Government in promoting and implementing technology upgrading and modernization in industry, to build sound institutions and procedures for investment financing, and to improve financial intermediation practices. CIB IV, a loan/credit of US$300 million, was approved in March 1987 with the specific objectives of: (a) guiding and assisting CIB in its further institutional development, enabling it to carry out its operations efficiently and perform effectively as a model and catalyst in the ongoing reform of investment design and selection; and (b) continued financing of high priority industrial investments through a general line of credit. CIB V, a loan of US$300 million, was approved in May 1989 with the objectives of: (a) continued institutional strengthening of CIB in its traditional and new activities; (b) expanding and diversifying its resource base; and (c) financing investment to modernize and restructure light industry. Design 2.4 CIB I-II. CIB was created to implement China's new industrial priorities. A development finance company (DFC) with an initial focus on modernization of light industrial enterprises fit with the Government's readjustment strategy. It would improve product quality and expand production, correcting the imbalance between heavy and light industry. The World Bank's first project followed the classic DFC formula. It supported CIB in developing industrial term lending based on thorough project appraisal. Thus, CIB was conceived as helping to fill a gap in foreign exchange, providing long-term industrial finance and improving investment efficiency. 2.5 All projects financed by CIB had to be included in the annual credit plan. Each project in the plan had to undergo a feasibility study covering a wide range of issues, including a technical evaluation. The main investment criterion, however, was consistency with the overall 24 plan and national economic objectives. The feasibility study frequently did not evaluate projects in their sectoral context partly because of fragmented responsibility for individual industries among different ministries and regions. Although economic criteria were supposed to determine project selection, no formal cost/benefit analysis was done, and alternative technologies, scale and location were not sufficiently examined. 2.6 The Ministry of Finance (the World Bank's counterpart agency) selected CIB to improve appraisal methodology. The Ministry of Finance delegated operational supervision of CIB to PCBC but retained overall authority as CIB's supervisory agency. CIB staff, with World Bank and other assistance, drafted a Project Appraisal Manual to make appraisals systematic and comprehensive. In addition, cost/benefit analysis using shadow prices was introduced because of the highly distorted prices prevailing in China's economy. Thus, CIB I included US$1.3 million for subloan feasibility studies and training in addition to US$68.7 million for investment. In effect, CIB became the conduit institution for World Bank funds and PCBC's foreign exchange window, reflecting the Government's reluctance to apply the World Bank's project appraisal methodology to all investments. PCBC remained by far the largest supplier of long-term investment funds in China, and BOC remained by far the largest supplier of foreign exchange to China's enterprises. 2.7 The primary focus of CIB II on institution building resulted from the rapid growth of CIB's project pipeline and branch network. CIB needed to strengthen its staff's appraisal capability, especially in technical, economic and market analysis. These weaknesses had prevented CIB from playing a more significant role at the design stage, earlier in the project cycle. In addition, the World Bank suggested that CIB should begin to appraise larger and more complicated projects. CIB TI had a US$175 million line of credit but did not include a technical assistance component, as most of the US$300,000 for training under CIB I had not been committed. The design of CIB III was the same as CIB II. Indeed, reliance was placed on CIB II's appraisal, reflecting the urgency to meet CIB's need for funds. Thus, the entire US$100 million was allocated for investment, and technical assistance and training were to be financed from amounts remaining from CIB I for that component. The only new understanding under CIB III was that CIB would borrow US$50 million from non-Bank Group sources during the first half of 1986. 2.8 CIB IV and V. CIB had implemented several institutional strengthening measures. It reorganized headquarters in 1985 to establish separate departments for economic, financial and market evaluation, technical appraisal and project supervision. A new Vice-President in charge of lending operations was appointed, and a full-time President came on board in mid-1986. He increased staff and filled vacancies at the head office and branches. A new financial management system was introduced which included medium-term financial planning. Moreover, staff were seconded to financial institutions in other countries for training. Thus, CIB IV was planned in the context of discussions on additional institutional changes, particularly improvements in financial planning. The loan/credit was for US$300 million, mostly for on- lending to small and medium size projects mainly in light industry, with a fixed interest rate on subloans of 8.5 percent. The loan/credit included a small component of $700,000 for training abroad. 2.9 CIB V was designed to support CIB's new development strategy to: (a) diversify its client base by ownership (to non-state enterprises) and by subsector; (b) develop and expand new product lines and services such as working capital loans, equity investments, lease operations, guarantees and loan syndications; (c) diversify its resource base by mobilizing client deposits, issuing certificates of deposit/commercial paper and issuing bonds domestically and abroad; and 25 (d) expand and computerize its management information system. CIB V was a loan of US$300 million with US$299 million for financing small and medium size restructuring projects in light industry and US$1 million for staff training in new products and services and computerization. The industrial credit component was subdivided to include: US$244 million for importing modem equipment and technology; US$50 million for working capital loans; and US$5 million for equity investment and leasing. Interest rates on subloans were to be variable, at a level at least equal to the World Bank's variable rate plus a minimum spread of 1.5 percent. Implementation Experience CIB I-III 2.10 CIB introduced project appraisal methodology to China. It made its project appraisal manual available and offered courses. The approach was adopted by the State Planning Commission by about 1986 and many other financial institutions and planning authorities followed as well. This was an important contribution in an era of highly distorted prices in China. CIB could, however, only lend to projects that had been approved by the local planning and economic commissions and were included in the annual plan. It had no authority to lend for projects not in the plan, but could reject projects included in the plan. CIB was also expected to be involved early in project preparation to influence their design and choice of technology, but it played a limited role because of China's investment approval system. 2.11 Although CIB was supposed to borrow foreign exchange funds from other sources, it basically became a channel for World Bank loans/credits. Indeed, the Government tried to use CIB to absorb any unallocated funds in the Bank's overall China program. This situation arose because the Government would not change PCBC's activities to conform with World Bank requirements, and the Bank would not accept PCBC's funding approach. Thus, CIB was largely created by the Bank in its own image, to emulate the Bank's methods and procedures. The Government initially resisted some of these approaches but acquiesced at the Bank's insistence in order to have the Bank's funds channeled through CIB. 2.12 At the beginning, CIB relied on PCBC for most of its management and staff. Until a full-time President was appointed in mid-1986, the President of CIB was the First Vice President of PCBC on a part-time basis. Similarly, the Presidents of CIB branches were usually Presidents of PCBC branches, acting part-time for CIB. By 1991, most CIB branches had their own Presidents. Nevertheless, the Chairman, Vice Chairman and other CIB board members (appointed by the Government) were from PCBC's senior management. Thus, CIB was still considered a part of the PCBC group. CIB's branches had dual reporting lines: to CIB's head office and the local economic and planning commissions. Branches could and did reject projects in the annual plan and were also gaining autonomy from headquarters in investment decisions. By 1989, five of the older branches were granted decision power over investments up to US$2 million and another 14 branches for investments up to US$1 million. Nevertheless, headquarters retained the final approval over all long-term investments. 2.13 The proceeds of CIB I-III were allocated to 289 subprojects in about twelve industrial subsectors, mainly light industry. Textiles and clothing and electronics account for over half the subprojects by number and amount. Provincial and municipal governments owned 92 percent of the subprojects, with collectives accounting for the remainder. About 46 percent of projects were for modernization, 39 percent for expansion and 15 percent were new enterprises. Subloans were generally small, with over half under US$750,000. Over 70 percent of subloans 26 had maturities of five years or less. The financial and economic rates of return, calculated until the PPAR 1991, suggest that the subprojects were financially and economically well justified. Employment data from subprojects show that about 140 new jobs were created per project. Each project involved importing foreign equipment and, in some cases, installing and operating know- how. Thus, a substantial transfer of technology occurred. 2.14 Cost and time overruns for subprojects were high in CIB I, but were reduced substantially by CIB III. CIB actively provided training for staff either in China or abroad. The quality of CIB appraisals, especially by the older, more established branches, was up to international standards. A comprehensive Project Supervision Manual, prepared with World Bank assistance, guided loan supervision. After repayment of subloans, CIB prepared a Post Appraisal Report for larger projects to learn from experience. 2.15 CIB recorded a profit in every year of operations, although profit before tax as a percentage of total assets peaked in 1986. The profit level by international standards is, however, obscured by different income recognition and bad debt provisioning rules. For example, interest is taken into income when it falls due, regardless of whether it is paid or not, and provisions were restricted to .02 percent of the portfolio until 1988, when it was changed to .2 percent. The portfolio arrears position appeared not to be serious and the PPAR suggested that arrears were caused mainly by discrete macroeconomic events. The portfolio affected by arrears as a percentage of total portfolio was less than one percent in 1987 and around 4.5 percent in 1988 and 1989. This low percentage, however, may be misleading because of rapid portfolio growth of about 60 percent per annum, the grace period given to borrowers and loan reschedulings. Nevertheless, the total arrears of principal and interest in 1989 (the highest during the period) were 67 percent of profits before tax and almost 100 percent in the year to June 1990. Otherwise, CIB's financial and operating position appears to have been conservative and sound: the long-term debt to equity remained less than 3; no contingent foreign exchange exposure existed; the domestic and foreign resource base was diversified after 1986; and activities had also been diversified. CIB IV and V 2.16 Loan Effectiveness and Implementation Schedule. CIB IV was approved in March, 1987 and became effective in June, 1987, within the scheduled date. The original closing date of June 30, 1992 was extended by one year mainly due to the slow down in economic activity after the Tiananmen incident in 1989 (and temporary suspension of disbursements by the World Bank). The Loan Account was closed in October, 1993. CIB V was approved in May, 1989 and became effective in October, 1989. CIB V was closed on schedule at the end of 1994. 2.17 Subprojects. The physical implementation of subprojects by borrowers was satisfactory for both loans, with 63 percent on time for CIB IV and 84 percent on time for CIB V. Changes in project design and tardy delivery of equipment were among the major causes of delay. CIB staff indicated that slow World Bank approval of subprojects also contributed to delays. They said that an entire batch of appraisal reports was lost for several months in Washington. At the time the Project Completion Report (PCR) and Implementation Completion Report (ICR) were completed in 1995, about 40 percent of CIB IV subprojects and 33 percent of CIB V projects were operating at under 70 percent capacity. At this rate of capacity utilization, these subprojects would be breaking even or making losses. Low capacity utilization resulted from declining demand for products because of increased competition and operational difficulties with new equipment. The capacity utilization ratio has since improved. 27 2.18 The profile of subprojects financed by CIB IV and V is presented in Table 2.1, and summary profiles of five beneficiaries visited by the audit mission in Box 2.1. Average subproject size was about US$1 million under CIB IV and increased to US$1.2 million under CIB V, mainly for modernization. The majority of loans still went to state-owned borrowers, although this profile changed somewhat in CIB V, when collectives and joint ventures accounted for 40 percent of funds disbursed by CIB. The textiles subsector continued to attract the largest number of loans. CIB IV subprojects earned a total of US$260 million in foreign exchange, about half of their incremental revenues. The financial and economic rates of return estimated from a sample of subprojects were easily above the project threshold but below estimates at appraisal. Under CIB V, the economic and financial rates of return edged much closer because of reduced price distortions. Lower rates of return were partly due to increased prices of energy and raw materials. About 3 to 4 percent of the companies in CIB's long-term lending portfolio were in arrears, and the total collection rates were about 85 percent, although on-time collection rates were about 75 percent. The arrears position deteriorated for CIB V, however. Arrears in 1994, the year CIB V was closed, grew at a record high of 178 percent over 1993. While arrears were still only 1.6 percent of total assets, this rapid increase is cause for concern. The increase was caused mainly by the exchange rate devaluation, increased competition for state enterprises and a change in tax policy that eliminated repayment of principal as a deduction before tax. 2.19 CIB V also provided funds for working capital, equity investments and leasing projects. It included an allocation of US$50 million for working capital loans which was utilized for 46 working capital loans mainly for state-owned companies in the textile, electronics, machinery and other light industry subsectors. Only one company had difficulty with repayments, while some others were repaying interest due but not the principal. Overall, this component has reinforced the importance of making working capital loans a major financial product for CIB, thus laying a strong foundation for its conversion to a commercial bank. Under CIB V, CIB made two equity investments amounting to US$2.15 million in joint venture enterprises. In one case, World Bank funds were used for the third capital injection in a pre-existing CIB investment. In the other case, World Bank funds were used to invest in a greenfield project. The estimated returns on these investments is below 5 percent per annum. CIB also approved two financial leasing projects under the credit line amounting to US$2.8 million, but the implementation of one has been delayed. 28 Table 2.1: Subproject Profile CIB IV CIB V Total Subprojects 228 197 Type of Project:(percent) Modernization 86 95 New 14 5 Ownership:(percent) State-Owned 92 65 Non-State-Owned 8 35 Subsector:(percent) Textiles 24 19 Light Industry 17 17 Machinery 16 10 Electronics 9 13 Pharmaceuticals 7 2 Construction Materials 5 4 Others 22 36 Average Project Size $1 million $1.2 million Employment Created 16,000 Foreign Exchange Earned $260 million Av.Fin. Rate of Ret.(sample) 21 25 Av.Eco.Rate of Ret.(sample) 28 24 Collection Rates:(percent) Total 87 83 On Time 76 72 Arrears/Amounts Due 13 17 Source: CIB IV PCR June, 1995; CIB V ICR December, 1995; and CIB 1996. 2.20 A survey of 80 subprojects was conducted for this report by CIB at OED's request. Summary data from the survey are presented in Table 2.2 and the details in Annex 4. The results corroborate data obtained from the PCR and ICR in terms of types of projects and ownership and sector distribution. The sample subprojects were functioning at a high level of capacity utilization and most were exporting some of their output, while some were exporting a substantial proportion. The actual profit rates for this sample are, however, considerably lower than the PCR/ICR sample, mainly because of tax law changes. Thus, these data are not comparable with the earlier surveys or estimates at appraisal. Arrears increased from the CIB IV to the CIB V sample mainly because currency devaluation probably affected more CIB V projects. 29 Table 2.2: CIB IV and V Subproject Sample CIB IV CIB V Subproject Characteristics: No. of Subprojects 37 43 Total Subloan Amount $69.70m $90.61m Percentage of Total Subloans 23 37 Average Subloan Size $1.88m $2.45m Purpose of Loan: (percent) Modernization 95 79 New/Expansion 5 21 Ownership: (percent) State 84 60 Collective 8 19 Shareholding 8 5 Joint Venture 0 16 Sector: (percentage) Textile 22 16 Light 19 23 Machinery 16 12 Electronics 8 9 Actual Profit Rate (percent) 14.93 14.99 Estimated Profit Rate 21.66 19.18 Incremental Employment 3675 4107 Arrears $1.074m $2.594m Arrears/Loans (percent) 1.5 2.7 Source: CIB, 1996. 30 Box 2.1: Summary Profiles of Five Loan Beneficiaries Beijing Eastern Chemical Works (BEC). BEC was established in 1978 as the largest acrylic acid producer in mainland China. It now employs about 4,000 workers. BEC received a loan of US$3.9 million in 1988 under CIB IV to produce ethyl acrylate and expand its product range. Project financing included foreign and domestic currency from CIB and domestic currency from PCBC. The overall financing plan was decided by the planning committee which had approved the project. The project upgraded the company's technology but was highly capital intensive, creating only 27 jobs in the control room of an automated process. The loan has been fully repaid despite delays in construction and the project is considered a success by the company. It resulted in technological upgrading, a new product line and increased exports. Beijing No. 9 Semiconductor Device Factory (BSD). BSD is a smaller company employing only 500 workers in three shifts. It has a 20 year history in producing semiconductor devices. The company's exports suffered following the Tiananmen incident. With the approval of its supervisory industry bureau, the company decided to expand its product range by producing SOT-23 slice transistors. A loan of US$300,000 from CIB enabled the company to purchase machinery. Certified under ISO 9002, the products are in high demand and exports have expanded substantially. The company's success attracted a Hong Kong based joint venture partner for new projects. No. 1 Northwest Cotton Mill of Xian (NCM). NCM was established in 1951 and has a current production volume of 110,000 tons of cloth using 886,000 yam spindles, 2,000 looms and 7,200 workers on four shifts. It is among the most advanced state-owned textile mills. A CIB loan of US$4.5 million allowed the company to import 104 sets of air jet looms and 35 sets of high speed drawing frames, warping and sizing machines to produce combed cotton cloth. Over 80 percent of production is exported to Japan and South Korea. The project improved product quality, saved space and energy consumption and improved working conditions. Shanghai Transformer Works (STW). STW builds small and medium sized transformers which are sold to power distribution companies. After planning committee approval, a CIB loan was granted in 1988 to enable the company to make single phase and pole mounting transformers. Because of improved product quality and efficiency, large export orders have received from the Asia region. STW has also entered into a joint venture with Asea Brown Boveri to produce transformers for export. The project affected 26 percent of STW's activities and helped propel it to first place in the national profit per person ranking. Copper Strip Corporation of Shanghai (CSCS). CSCS received the largest loan of CIB IV and V at US$6 million. The project involved purchasing machinery to produce copper coil from local raw materials. The project upgraded quality and facilitated a long-term sales contract for 50 percent of production with a Siemen's joint venture in China. The remaining production is exported. About 200 of the company's total 3,000 staff are employed on the CIB funded project. 2.21 Technical Assistance. Under CIB IV, the technical assistance component was used to provide short-term training courses mainly in bank management and project supervision (see Annex 3). A portion of the CIB V technical assistance component was used to purchase a minicomputer for accounting and the remainder was utilized for continuing staff training in bank management, international finance and settlement. A shortcoming in training for project supervision was perceived, especially in light of CIB portfolio deterioration. Moreover, contrary 31 to earlier agreements, no foreign experts were hired to assist CIB in marketing and financial analysis and environmental and subsector studies. The agreement on using foreign experts should have been firm or should not have been included in the program. CIB Performance 2.22 Appraisal Methodology. Under CIB I-III, CIB had succeeded in adopting World Bank appraisal techniques and spreading their use to other organizations in China, including the planning commission. By the end of CIB IV and V, CIB had conducted over 1,000 subproject appraisals. The recent deterioration in subproject financial rates of return and collection rates is due more to policy changes in China than to faulty project appraisal. Whether these policy changes could and should have been anticipated by CIB is not clear. This situation indicates the importance of mature and seasoned market knowledge and shows that policy direction is as important as an operational handbook in assessing subproject viability. Moreover, CIB did not price the risk of individual subloans under any of the five World Bank operations. While CIB V had floating interest rates, actual on-lending rates were often below the minimum level required. CIB monitors subprojects closely, through regular visits. 2.23 Project Design. CIB has still not achieved full decision power over project selection. Planning committees must still approve all projects before CIB can appraise them and choose whether to fund them or pass. Nevertheless, subborrowers visited by the mission voluntarily mentioned the valuable knowledge and insight provided by CIB staff. 2.24 Channel for World Bank Funds. Over the years, CIB was able to diversify its foreign exchange term lending resources by borrowing from the Asian Development Bank, KfW, other bilateral government loans, government guaranteed foreign borrowings and client's foreign exchange deposits. Primarily, however, CIB remained a channel for World Bank funds. Thus, several other World Bank loans were channeled through CIB including the Shanghai and Tianjin industrial projects (1989-1993), SPARK (1990), Beijing Environment Project (1992), Medium Cities Project (1992), Southern Jiangsu Environment Project (1993) and three recent ozone depletion projects. CIB staff indicated that CIB did not carry the credit risk on these projects, contrary to statements made in the PCR. It acted as a financial agent and was paid for its project appraisals. In some cases, it obtained a counter-guarantee from the local government. 2.25 Management. As mentioned earlier, CIB relied on PCBC for its management staff. Following its new charter as a commercial bank and reorganization as a limited liability company wholly owned by PCBC, it now has a nine member board of directors reporting to PCBC. Six of the nine directors are appointed by PCBC and three are CIB executives. It has no outside directors. CIB made several management adjustments to reflect new operational needs as a commercial bank. A recent organization chart shows new domestic funding, business development and treasury departments. The Shanghai branch has spearheaded branch reorganization to prepare itself for commercial banking. 2.26 Branches. CIB has 32 branches located in major cities across the country. Branches have independent financial statements and are ranked by performance, with Shanghai enjoying the top spot. Each branch has the independence to organize itself within broad outlines provided by headquarters. Branches report monthly accounts by the third day after the end of the month. 13 The Region explains that in some of the projects CIB did take the credit risk and in others it was the agent. 32 Branches do not yet have autonomy over long-term loans, which still need headquarters approval, but they do have free limits for domestic currency working capital loans. Thus, CIB ignored branch free limits under CIB IV and V. 2.27 Interest Rates. Interest rates on subloans under CIB IV were fixed at 8.5 percent, but for CIB V they were variable, based on the World Bank's variable rate plus a minimum spread of 1.5 percent. From the sample of subprojects shown in Annex 4, however, it is clear that on- lending rates for CIB V fell well below the required rate at times, and even below the World Bank rate in some cases. During the period in which CIB V was under implementation, the Bank's variable rate ranged from 7.10 percent to 7.75 percent, which would have resulted in CIB on-lending rates of at least 8.60 percent to 9.25 percent. The subprojects listed in Annex 4, however, had rates as low as 7.125 percent, and many were less than 8.60 percent.14 2.28 Financial Performance. CIB's profitability declined steadily between 1987 and 1994, from an already low net income/equity of 7 percent to 2 percent in 1994 (Table 2.3). Similarly, net income/total assets plummeted from 2.46 percent in 1987 to 0.1 percent in 1994. The decline in profitability has occurred at the same time as an almost ten fold increase in CIB's loan portfolio between 1987 and 1994 funded by successful deposit mobilization from clients and domestic and foreign borrowing. Simultaneously, CIB's financial condition has deteriorated, indicated by a steady decline in the current ratio and a steady increase in the debt/equity ratio. The main reason for the deteriorating financial position is the growth in arrears and collection difficulties. CIB's arrears have grown from Y228 million in 1990 to Y709 million in 1994. While they appear low as a ratio of total assets at 1.6 percent in 1994, they are over six times net income before tax and exceeded accumulated bad debt provisions of Y531 million. Moreover, because interest not received for up to three years is recognized as income (assets are classified as standard for up to 3 years of non-payment), income is overstated by international accounting standards, and the general bad debt provision of 2 percent of long term loan portfolio may be inadequate. Thus, CIB's true financial condition can only be judged if its accounts are re-stated according to international accounting standards. Nevertheless, rising arrears and low collection rates on CIB IV and V loans, combined with a small or even negative spread, indicate that CIB has so far lost money on these credit lines. Collection rates are lower on World Bank funded loans than the rest of the portfolio because borrowers bear the foreign exchange risk. Although many borrowers were hedged against devaluation because they are exporters, currency devaluation from Y3.76/$ in 1989 to Y8.5/$ in 1994 partly explains lagging loan repayments as subborrowers assume the foreign exchange risk. In addition, price reforms increased the prices of inputs, changes in tax policy made loan repayments more expensive and competition for CIB's clients has also increased in recent years. 2.29 Other department heads complain about these losses to the director of the department handling World Bank credit lines. CIB maintains, however, that it will collect its overdues and turn a profit on its World Bank business as it charges a penalty interest for late payment. CIB adopted several measures to improve collections including establishing targets and working groups and pursuing guarantors. The World Bank also contributed by suggesting CIB concentrate efforts on larger arrears that have been overdue for longer periods. CIB's collection performance in 1994 was, however, well below target at about 82 percent. 1 CIB has explained that the interest rate was reduced for some subborrowers in order to make the funds attractive at a time of gradually declining rates for foreign exchange in the Chinese market. Lack of attention to the interest rate covenant and failure to bring the non-compliance to the Bank's attention are attributed to staff turnover and organizational changes in CIB (see Annex 5). 33 Table 2.3: CIB Performance Indicators (percentage) 1987 1988 1989 1990 1991 1992 1993 1994 Net Income/Equity 6.93 4.04 3.65 2.65 2.46 2.66 3.30 2.00 Net Income/T. Assets 2.46 0.91 0.62 0.34 0.26 0.20 0.20 0.10 Admin. Exp/T. 0.56 0.32 0.21 0.16 0.15 0.19 0.15 0.10 Assets Current Ratio 2.13 1.05 1.29 1.44 1.67 1.47 1.12 1.09 LTDebt/Equity 1.38 2.08 2.85 3.78 4.59 5.22 5.02 5.63 AcProv/GrLoanPrtf. 0.13 0.33 0.30 1.20 0.95 1.44 2.00 1.98 Arrears/GrLoanPrtf. N N N 3.28 3.74 4.65 4.41 5.30 Resch/GrLoanPrtf. 1.9 1.6 1.2 0.3 0 Coll.Rte GrLoanPrtf. 113 107 101 97 76 Source: CIB IV PCR June, 1995; CIB V ICR December, 1995; and CIB estimates, 1996. 2.30 Policy and Development Strategy. CIB's policy and development statements were revised as part of the CIB IV appraisal, and served as guidelines for its operations. Under that project, CIB was to remain a specialized bank to raise foreign exchange resources and provide loans to enterprises in the industrial sector. The project reinforced resource and product diversification already undertaken by CIB and included several measures aimed at increasing CIB's autonomy. CIB continued to raise substantial resources from client deposits and domestic and foreign borrowing and provided working capital loans, made equity investments and lease financing agreements and increased its foreign exchange settlement operations. It also essentially implemented all the agreed operational measures to achieve greater autonomy. The strategy to transform CIB into an autonomous and viable financial institution in China was further developed in CIB V. While CIB's operations evolved to resemble a commercial bank, it was not supervised by the central bank until 1994, and could not borrow from it. 2.31 Future Role. During project implementation, CIB's future role in the financial sector surfaced as an important issue for CIB, GOC and the World Bank. CIB, with the World Bank's approval, had submitted a proposal to GOC, PBC and PCBC to become a full-fledged commercial bank. In January 1994, almost a year before CIB V was closed, GOC informed the World Bank of its intention to consolidate CIB into PCBC. The World Bank suggested that an autonomous CIB would conform with GOC's financial sector reform policies to promote competition and commercial operations within the framework of a sound and transparent institutional and regulatory structure. Thus, CIB's proposal conformed with GOC policy, especially as new banks were being licensed, including joint venture and foreign banks. In July 1994, the People's Bank of China (PBC) approved CIB's new charter confirming it as a commercial bank under central bank supervision. The charter permitted CIB to be organized as an autonomous limited liability company, wholly owned by PCBC. CIB became directly responsible for its operations and its branches (which were earlier more responsible to PCBC and Ministry of Finance branches). In 1995, CIB started to implement its "transformation" into a commercial bank starting with the appointment of a new president. It has substantially altered its liability and asset structure and will focus on raising domestic resources from term deposits, improved asset/liability management and intensive collection measures. With PCBC leadership and PBC supervision, CIB's operations are expected to improve. 2.32 Conclusions. The CIB IV and V credit lines of US$600 million equivalent certainly helped to expand CIB's resources and provided investment funds for restructuring and modernization of light industry. China was not, however, suffering a shortage of foreign exchange or long-term investment funds during this period (see Table 2.4). In addition, PCBC, 34 China's main long term lending bank, had loan assets more than thirty times those of CIB, indicating substantial long term resources available to lend. CIB IV and V investments were mainly in state-owned enterprises, an enterprise category that has not performed well (see Annex 1). Table 2.4: China's Foreign Exchange and Investment Indicators (US$ Billions) 1987 1988 1989 1990 1991 1992 1993 1994 Imports 38.9 50.0 52.7 46.6 54.3 73.8 98.3 111.5 Forex Res 16.3 18.5 18.0 29.6 43.7 20.6 22.4 52.9 ForDirInvt - 2.65 3.74 3.77 3.75 4.67 11.29 27.77 33.95 SOEFixInv 62.11 74.68 66.71 56.94 63.74 86.69 123.67 110.06 Source: China: Country Economic Memorandum, 1996. 2.33 CIB staff indicated that the World Bank's subproject approval process often resulted in substantial delays. They pointed out that in a fast moving economy like China, six months can change a project's complexion. After reviewing several hundred subprojects under CIB I-III, it is hard to justify the need for the Bank's approval. By this stage, either CIB was a capable institution worthy of receiving and independently managing Bank credit lines or it was not and should receive no further World Bank funds. 2.34 Physical implementation of the subprojects was successful, and subproject returns are likely to be above the threshold. CIB's profitability has been declining, however, and low or negative spreads for CIB V did not help this situation. On the institutional side, CIB is transforming into a commercial bank with diversified sources of funds and products and services. With some financial and internal restructuring, it is poised to become the first truly commercial bank of any size in China, especially if it is permitted to form a joint venture with a major European bank as it and PCBC desire. The large state commercial banks are encumbered by a huge number of branches and staff, making reforms difficult and very slow. CIB has a country-wide presence but remains a manageable size with a well qualified and experienced staff. It is an ideal choice for a reform experiment that could be replicated later in the larger banks. 1 The Region comments that the Bank's response was normally very prompt, and that an investigation of the one complaint from CIB found that the delay in this case was caused by "late submission of explanations and clarifications by CIB staff to the Bank's comments and queries." 35 3. Evaluation and Ratings Contribution to Industrial Sector Development 3.1 While industrial sector development was not the primary objective for CIB IV and V, both projects included it as a subsidiary objective. CIB IV stipulated the World Bank funds should be on-lent for "technology upgrading and modernization in industry" and CIB V required that funds by used for "investment in the modernization and restructuring of light industry".'6 Two ways of judging the achievement of these objectives exist: first, whether the rates of return on subprojects were above the threshold; and second, whether CIB collection rates indicate project success. As small expansion and modernization projects tend to have high rates of return, it is not surprising that CIB IV and V subproject returns were higher than the threshold. That they were lower than the returns estimated at appraisal is also not surprising, and corroborates analyses of World Bank and other development bank project returns. Arrears and collection rates were reasonable until 1994, when they deteriorated because of the sizable devaluation. CIB expects to collect virtually all outstandings. In any case, loans are either guaranteed or backed by collateral. Moreover, as most loans are to state-owned enterprises, CIB may be able to apply indirect pressure for repayment, especially as its loans are small. Furthermore, in a system where banks and enterprises are state-owned, enterprises may be able to shift the debt to another bank or enterprise. 3.2 The evidence suggests that subprojects achieved the objectives of upgrading technology and modernization and restructuring of light industry. The achievement, however, was in a type of enterprise and subsector that is growing only slowly compared to the rest of the industrial sector. State-owned enterprises and light industry command a shrinking share of industrial output and light industry exports have remained stagnant. Moreover, these investments might well have been made without CIB IV and V, because these projects had planning committee approval. Thus, even though the projects achieved their objectives, they made little incremental contribution to industrial development. Contribution to Financial Sector Development 3.3 This section evaluates CIB IV and V's contribution to financial intermediation and investment allocation in China (CIB's institutional development is discussed separately). CIB IV and V specified "to build up .... procedures for project appraisal and investment financing and to improve financial intermediation practices" as an objective. Building procedures for project appraisal and investment financing started during CIB 1-111 and was supported by substantial technical assistance and World Bank supervision. By the end of those projects, CIB had appraised about 300 projects and was judged as performing at an international level in the PPAR. In addition, China's State Planning Commission and other agencies had adopted the Bank's appraisal methodology by 1986, one of the major contributions of those projects. Thus, CIB IV and V made little incremental contribution to spreading the use of project appraisal methodology 16 As pointed out by CIB, although the President's Report and Staff Appraisal Report refer to "light industry", the Loan Agreement refers only to "industry". 36 and procedures. In any case, this education could have been provided through technical assistance without a credit line. 3.4 Moreover, while appraisal techniques may have prevented some poor investments in an environment of distorted prices, evidence of appraisals leading to successful investment in China is not strong. World Bank project appraisal techniques were applied mainly to investments in state-owned enterprises, a sector which has not done well (although the appraised investments may have performed above average). By some estimates, one-third of state-owned enterprises are making losses and another third are marginally profitable. Meanwhile, collective and township and village enterprises' performance is spectacular, and their projects are not appraised. Nevertheless, state-owned enterprise borrowers voiced appreciation for CIB staff knowledge and input into shaping the final project. 3.5 CIB IV and V may have made a marginal contribution to improving financial intermediation practices by requiring subborrowers to take the foreign exchange risk and, in the case of CIB V, pay variable interest rates. However, the on-lending rates in CIB V were, at least in some cases, below the level required b the legal agreements, and in a number of cases, appear to have been below the Bank's rate itself. Most importantly, the investment allocation system remained unchanged. Projects had to be approved by planning committees before receiving funding from CIB. Whether borrowers had any choice in approaching CIB or other banks for funding is also not clear. Overall, CIB IV and V's contribution to financial intermediation and investment allocation was very small.19 Institutional Development of CIB 3.6 Institutional development of CIB was the main objective of CIB IV and V. CIB IV stated that its objective was to "guide and assist CIB in its further institutional development.. .to effectively perform its role of a model development finance institution..." and CIB V's objective was to "continue institutional strengthening of CIB in both its traditional and new areas of activity... .and prepare itself effectively to meet the changing needs of its clients and operate in the emerging competitive environment". The PCR for CIB IV confirmed that all the agreed elements of the operational plan were implemented, CIB staff received training under the technical assistance component and World Bank staff put in about 56 weeks of supervision during several missions. Similarly, the ICR for CIB V confirmed that CIB diversified its funding base and products and services, received technical assistance for training staff for new functions and funds for purchasing a computer for an information system, and also benefited from 123 staff weeks of World Bank supervision. 7 The Region notes that CIB IV and V helped to deepen the appraisal work in CIB and to upgrade its appraisal manual. CIB expanded its appraisals to the borrowing enterprise, not just the subproject; environmental appraisal was added; and new procedures for working capital loans and equity investments were adopted. is CIB has explained that the interest rate was reduced for some subborrowers in order to make the funds attractive at a time of gradually declining rates for foreign exchange in the Chinese market. CIB attributes the lack of attention to the interest rate covenant and failure to bring the non-compliance to the Bank's attention to staff turnover and organizational changes in CIB (see Annex 5). 1 The Region argues that the institutional strengthening of CIB improved its project appraisal and resulted in better financial intermediation practices, so the project objective was achieved. OED notes, however, that improvement of financial intermediation practices must include measures to increase the efficiency of resource allocation, i.e. through reforms to the investment allocations and pricing systems. 37 3.7 Bank appraisal and supervision and technical assistance under the two projects played a crucial role in assisting CIB develop as an institution. CIB had made sufficient progress by 1992 to propose to the Government that it convert itself into a commercial bank. It would have made even more progress but for its reluctance to accept foreign experts. Until January, 1994, however, the Government was leaning towards consolidating CIB with PCBC. The Bank's support was instrumental in the approval by PBC of CIB's charter as a commercial bank in July, 1994 and its conversion to a limited liability company wholly owned by PCBC, preserving its identity and autonomy. Therefore, the Bank played a pivotal role in CIB's transformation from a development bank to a commercial bank. 3.8 Since July, 1994, CIB has made a concerted effort to change its liability and asset structure in line with its operations as a commercial bank. It has also reorganized branches to support commercial banking operations and promoted staff based on skills and performance. Branches are treated as profit centers with their balance sheets and profit and loss accounts. They compete for a profitability ranking. CIB has recruited staff with appropriate skills and trained existing staff in new products and services. CIB's information system now provides a daily cash position for each branch and for the bank, and enables branches to provide financial statements to headquarters by the third business day after the end of the month. CIB is now probably the best trained and equipped domestic commercial bank in China. For that reason, it is has been chosen by PCBC to undertake further reforms to forge a path for the bigger bank to follow. Its success hinges on its efforts, autonomy from PCBC, reforms in financial policies and institutions and continued World Bank support. 3.9 On the negative side, CIB's financial performance and condition has deteriorated in recent years. Exchange rate and tax policy changes, and increased competition, have adversely affected its clients' ability to repay loans. At the end of 1994, CIB's capital to asset ratio was about 5 percent and the long-term debt to equity ratio was a conservative 5.6. A restatement of CIB's accounts to conform with international accounting standards would reduce its capitallasset ratio and CIB will need an infusion of capital. With that financial restructuring, and deregulation of interest rates, CIB's profitability could rise sufficiently for CIB to borrow from international markets in the future on the strength of its balance sheet. Overall, however, the institutional development of CIB has been successful, and, in the narrow sense of the institution itself, excluding policy reform, its impact is rated moderate for both projects. Sustainability of Benefits 3.10 CIB IV and V's main contribution lies in the institutional development of CIB. The sustainability of the projects' benefits hinges on macroeconomic management, financial policy, investment policy and CIB autonomy. China has made progress in developing institutions and instruments to improve macroeconomic management. It is likely that bouts of high inflation will neither recur, nor reach prior levels, alleviating the need for administrative credit restraints that affect bank performance. Interest rates need to be deregulated gradually, starting with interest rate flexibility within a range and more frequent adjustments of rates. Investment policy also needs deregulation, with banks making autonomous decisions for funding fixed asset investments. These policy changes are pre-conditions for the development of a competitive commercial banking system. CIB must also have autonomy. At present, six out of nine members of its Board of Directors are nominated by PCBC. CIB can enhance its autonomy by forming a joint venture with a European bank, a move supported by PCBC and CIB management. The sustainability of the projects' benefits is rated likely. 38 Bank and Borrower Performance 3.11 Bank Strategy. CIB IV was based on a Bank assistance strategy outlined in the Country Program Paper for China (October, 1985). The main objectives of the assistance strategy were to increase access to foreign technology and practices and increase the efficiency of resource use. In investment finance, the Bank sought to strengthen banks and other financial institutions that provide credit to state and collective enterprises. The Bank intended to continue its involvement with CIB and expand to other financial institutions. CIB IV provided funds to purchase foreign technology, but may not have increased access. In fact, CIB subborrowers could have obtained funds from other sources. CIB IV made no additional impact on China's investment allocation system and efficiency of resource use. 3.12 The Country Strategy Paper dated June, 1988 was the backdrop for CIB V design. Bank assistance strategy objectives included financial sector reform and institution building and rationalization and modernization of productive sectors. The Bank intended to continue large loans to CIB every two years, emphasizing institution building in the broader context of an imminent expansion of competition in the financial sector. It also intended to improve access of non-state-owned industry to formal financial markets. The Bank made only one more loan to CIB to modernize industrial enterprises and provide some access to non-state-owned enterprises. While enterprise modernization might have occurred anyway, lending to non-state-owned enterprises and the institution building inputs into CIB were direct contributions of CIB V. 3.13 While project design was substantially grounded in the country assistance strategy for China, and the main specific project objectives were also substantially achieved, these objectives were not very relevant, and project design was not appropriate. The project design did not focus on China's investment allocation and pricing system in the financial sector, the most important reform issues for increasing the efficiency of resource allocation. Although the projects extended appraisals to entire firms, and also to working capital loans, the major contribution to efficient resource use made by the project appraisal methodology had already occurred before CIB IV and V were designed and implemented. 3.14 Project Identification, Preparation, Appraisal and Supervision. Not surprisingly, Bank and borrower cooperation in the process of project identification and preparation for CIB IV and V appears to have been good, as they were preceded by three successful projects.. Through Board Approval, CIB IV used 182 Bank staff weeks and CIB V used 83 Bank staff weeks. Project supervision was also time intensive, with 56 Bank staff weeks and 10 missions for CIB IV and 123 Bank staff weeks and five missions for CIB V. The Bank's preparation, appraisal and supervision of these projects appear to have been expensive in staff time, in view of a long prior relationship with CIB and few new project components, especially in CIB IV.20 Moreover, supervision of CIB V failed to detect the violation of the covenants on on-lending interest rates. In addition, CIB complained that the Bank's response to subproject approvals was slow, causing problems for CIB and the subborrowers. 3.15 Project Implementation. Borrower implementation of CIB IV was satisfactory. although it had to be extended for one year, mainly because of delays caused by the Tiananmen incident. Audit reports and other information were provided in a timely fashion for both 20 The Region does not agree that these operations were expensive in terms of staff time, given the language, the travel distance to and within China, the prevailing system in China, the size of the loans, the number of above free limit subloans (see Evaluation Summary, para. 18), and institutional development efforts. 39 projects. The borrower's reluctance to accept technical assistance from foreign experts, however, may have affected the quality of training and speed of skill absorption. The borrower generally complied with loan covenants in CIB IV, but failed to comply with the interest rate covenants in CIB V. For this reason, borrower performance in CIB V is rated marginally unsatisfactory. 3.16 Overall, while physical project implementation was satisfactory, the project design did not focus adequately on investment allocation and pricing of credit, both crucial for improved resource allocation. Despite the low relevance of the projects, Bank performance is rated as satisfactory for CIB IV as a whole; it is rated as marfinally unsatisfactory for CIB V, however, in view of the additional supervision shortcomings. Project Outcome 3.17 The subproject lending objectives of CIB IV and V were met satisfactorily. While project contributions to financial and industrial sector development were small, the development of CIB as an institution was a salient achievement. CIB subborrower rates of return were below estimates at appraisal but satisfactory, indicating that the projects were cost-effective. Most importantly, however, project design did not focus sufficiently on improving resource allocation beyond the achievements of CIB I-III. Thus, CIB IV and V were of little relevance. In addition, the low or negative spreads for CIB V, in violation of loan covenants, contributed to CIB's declining profitability during the period of the two loans. The outcomes of both projects are therefore rated marginally satisfactory. 21 The Region believes that the violation of interest rate covenants is not significant enough to justify the marginally unsatisfactory rating for borrower's performance. It also believes that failure to detect the problem is not a sufficient reason to rate Bank performance as marginally unsatisfactory, given the importance of Bank support for other features of the project.  41 4. Lessons of Experience 4.1 The main lesson arising from these projects, which concentrated on building a bank, is that the project design did not focus sufficiently on improving the quality offinancial intermediation and resource allocation. Better resource allocation was crucial for the development of China's state-owned enterprise and banking system during the transition to a market economy. Greater flexibility in the choice of subprojects (without requiring planning committee approval) and in pricing (interest rates that reflected risk, for example) would also have made the projects more relevant to these needs. The Bank may have judged at the time that it was not possible to agree with the Government on additional state sector reforms in investment allocation, but in that case, CIB IV and V should not have been undertaken. With little relevance for improving resource allocation, the projects appear to have been channels for achieving high loan/credit volumes to China. The development of CIB as an institution could have been achieved with smaller loans, or even through self-standing technical assistance.22 4.2 CIB is at a crucial juncture. With PCBC agreement, its commercialization reforms are proceeding. Indeed, PCBC is using CIB as a reform experiment as it has a much better chance of success. It has a smaller and well trained staff of relatively recent vintage and good information technology. While it needs some financial restructuring to conform with international standards, the needs are minor compared with those of PCBC. PCBC and CIB senior management believe that a joint venture with a European universal bank would help make CIB the first real domestic commercial bank in China. 4.3 The failure of World Bank supervision to deteci the violation of the interest rate covenants for subloans in CIB V demonstrates the needj;or the Bank to strengthen its supervision processes and priorities. After transferring project appr.iisal capability during the successful CIB 1-111 projects, the Bank should not have requiredfree limits, even for some projects. CIB staff felt slighted and believed that the clearance process was too slow. Loan monitoring should be done by establishing financial and other performance targets, such as collection rates (as was done in the case of CIB), and ex post evaluation should replace ex ante controls. 4.4 Because training programs were agreed ex ante, CIB staff indicated that flexibility to respond to newly perceived needs, such as loan supervision and collections and commercial banking functions, was not adequate. In the future, some training resources should remain uncommitted or periodic reviews should be carried out by the Bank and the Borrower.23 4.5 CIB's reluctance to use foreign experts limited the degree of institutional change under the projects. The design of future operations should take this into account by either eliciting a firm commitment by the borrower agency or by excluding foreign experts in the technical assistance component. 22 The Region does not believe that this would have been possible. 23 The Region notes that the training program included substantial supervision-related training and training for new products and services; that the government would not agree to uncommitted technical assistance; and that CIB could and did make adjustments to the program.  43 Annex 1 The Industrial Sector Industry is China's largest productive sector, accounting for 52 percent of GDP (1990 prices) in 1994 and contributing over 70 percent to GDP growth. The sector comprises more than eight million enterprises, mostly not state-owned (see Table I below). These enterprises provide 140 million people with full-time employment. After 1950, China pursued industrial development vigorously and has transformed an agrarian state into a modern industrial economy. Its industrial development strategy can be broadly divided into two periods: 1950 to 1979 and 1979 to the present. During the period before 1979, China's centrally planned system favored industry over agriculture. It relied on domestic savings and technology to invest in state-owned heavy industry. A monobank system allocated resources administratively. Industries were located across the country based on provincial autarky and a defense strategy called the Third Line Program. The dispersion of industry provided some of China's remote provinces with a nucleus of industry, an infusion of skills and rudimentary infrastructure. Trade was controlled by the state--domestically through the materials distribution system and externally through the foreign trade corporations. Goods were exported mainly to finance imports. Industrial output grew at an impressive rate of nearly 10 percent per annum during 1957 to 1979. This rapid growth, however, was financed by rising investment rates that increased from between 31-34 percent during 1970 to 1976 to nearly 37 percent in 1978. Economic efficiency deteriorated significantly, as indicated by a 18.5 percent rise in the economy-wide capital output ratio between 1966 and 1975, and technology became obsolete. These weaknesses were exacerbated by mandatory planning, institutional rigidities and controlled and distorted prices. Over-emphasis on regional self-sufficiency led to fragmented markets and reduced domestic competition. Dispersion of production resulted in a failure to realize economies of scale and benefits of specialization. Moreover, poor infrastructure, inadequate R and D and little vocational training in modern technology also retarded industrial development. Shortages of foreign exchange limited imports of raw materials and spare parts, adding another constraint. Market oriented reforms began in 1979. In the following decade, the role of central planning declined. The emphasis shifted to the non-state-owned sector and light industry.24 The Government undertook reforms in exchange rate and trade policies, price and distribution controls, banking, labor policies, taxation, enterprise governance, etc. China's "open door" policy spurred foreign trade and investment, especially in the coastal provinces. Industrial growth averaged over 10 percent per annum until 1988 and has accelerated since. Manufactured exports grew at an even faster rate and increased their share of total exports from 50 percent in 1980 to 84 percent in 1994. Total factor productivity (TFP) in industry increased in both the state and non-state sectors. Most estimates place TFP growth in the collective sector to be twice A Light industry includes leather products, footwear, wood products, pulp and paper, and light engineering goods. 44 as high as in the state sector. "Other" enterprises recorded the highest TFP growth at about three times the average for industry as a whole. Table 1: Industry Data (percent) 1985 1990 1994 Type of Ownership State 64.9 54.6 34.1 Collective 32.1 35.6 40.9 of which: Township 7.8 10.2 14.8 Village 6.8 10.0 15.7 Joint 1.6 2.3 3.4 Individual 1.8 5.4 11.5 Other 1.2 4.4 13.6 Type of Industry Light 47.1 49.4 44.0 Heavy 52.9 50.6 56.0 Exports Manufactured 49.0 74.0 84.0 Light Industry 16.0 20.0 19.0 Note: Light and heavy industry data under 1994 are for 1993. Source: China: Country Economic Memorandum, 1996. Subsector Performance While light industry output grew rapidly in the early period of the reform process, its performance reversed at the turn of the decade and the output of heavy industry has grown faster. Thus, despite rapid growth in output and trade, the distribution of output between light and heavy industry has remained stable. Even at a disaggregated sectoral level, changes in output shares have been modest. This stability is even more remarkable in view of the substantial changes in shares output between state and non-state-owned enterprises. A possible explanation is the continued use of investment approvals to control resource allocation. Investible resources have been divided among broad sectors in fixed proportions instead of being channeled into the most efficient uses. Export shares have, however, changed substantially, with light industry's share of manufactured exports declining from 33 percent in 1985 to 23 percent in 1994. State Enterprises Unsurprisingly, state-owned enterprises' output grew at a slower pace than output from other ownership forms. Individually owned and "other" categories of enterprises grew fastest. State-owned industry consists of 73,000 enterprises with 43 million workers. About 15,000 enterprises are large or medium sized and a few employ as many as 100,000 workers. Despite their falling share of output, these firms retain a central position in China's industry, supplying key raw materials and intermediate and capital goods. They are also an important market outlet for collectives and other firms. While state-owned enterprises are widely regarded as inefficient with obsolete equipment, bloated inventories and surplus labor, they include elements of strength. Their productivity has risen steadily since reforms began and, despite a withdrawal of subsidies, their exports have grown between 15-20 percent per annum. 1993 data show that large and medium firms contributed 43 percent to output but accounted for 72 percent of pre-tax 45 profits and about 70 percent of new product sales and exports. In addition, reported results suffer from the departure of strong state-owned firms to joint ventures and shareholding corporations. At the same time, numerous loss-making state enterprises exist. They routinely continue operations while accumulating massive debt. A part of their weak financial condition reflects the social burden they carry in the form of surplus labor, housing and other social services. Nevertheless, state-owned enterprise losses have mounted in the past few years and infected state commercial bank portfolios. As a consequence, at least 20 percent of bank portfolios are estimated to be non-performing. Since 1991, the pace of enterprise reform accelerated because state-owned firms continued to incur large and growing losses. Primarily, these reforms focused on separating formally ownership from management rights and functions, and clarifying erstwhile ambiguous property rights by converting state enterprises into limited liability and joint stock companies. Independent decision powers were specified in the "Regulations on the Transformation of the Operating Mechanisms of State Owned Enterprises" and the rules for conversion to companies were outlined in "Provisional Regulations on Joint Stock Companies" and similar regulations for limited liability companies, all issued in 1992. By 1994, about 4,000 enterprises have been converted into limited liability and joint stock companies with an average 85 percent ownership by the state. In spite of these reforms, supervisory authorities continue to intervene in enterprise operations and enterprise governance remains essentially unchanged. Collective Enterprises Collective enterprises date back to the 1950s. The reforms of the 1970s and early 1980s ignited agricultural growth and raised rural demand for industrial goods. The simultaneous removal of barriers to collectives obtaining resources and marketing in urban areas spurred a boom in rural industry. Although collectives are owned by local governments, managers are given autonomy and have to meet agreed targets. Above target earnings remain with the enterprise, often distributed as bonuses. Output of collectives has risen explosively and now exceeds that of state-owned enterprises. By 1992, these enterprises employed almost 100 million people. Rural firms have emerged as a major engine of China's export thrust, with foreign sales soaring from US$3.9 billion in 1985 to US$40 billion in 1994. Growth of collectives has also provided competition for the state sector and reduced profit margins. An important factor in their success has been the freedom from controls and social obligations that burden state enterprises. Their growing importance has encouraged the Government to eliminate some of their special cost advantages such as low taxation. Increasing competition among collectives has, however, lowered their profitability and threatened the survival of many firms. Reports indicate the beginning of a shake-out as labor costs rise and the demand for higher quality products increases with higher incomes. The upper tier collectives are pushing towards national and international level competitive industrial production with modern management and technology. Joint Ventures and Private Enterprises The balance of industrial output is from a variety of enterprise types, with joint ventures and private domestic firms as the most important. Joint ventures between overseas firms and usually a state-owned enterprise have grown rapidly partly because of the substantial tax and regulatory relief provided by the Government. A recent report records about 80,000 joint ventures which contribute about 7 percent of industrial output. Most joint ventures are in duty- free export zones and produce for export. China's private sector is booming even though 46 entrepreneurs have to build their businesses on intricate arrangements and are easy targets for informal tax levies. About 8 million "individual" enterprises (less than 8 workers) and several thousand private enterprises exist. Most private firms are tiny, however. Only one private firm is classified as medium or large. In 1993, exports of private firms amounted to only US$182 million or 0.2 percent of total exports. While China's reforms have brought rapid industrial growth, the transition to a market system is incomplete, especially for the state-owned enterprise sector. The inherent weakness in enterprise governance stemming from state ownership remains unaltered. Budget constraints on these enterprises have not been hardened and recourse to the state banking system is still available for loss-makers. Moreover, the enforceability of property rights and commercial agreements is still suspect. Nevertheless, about 65 percent of industrial output produced by the non-state sector now responds to market prices and competition, with remuneration based on performance. 47 Annex 2 FOURTH INDUSTRIAL CREDIT PROJECT Summary of Main Terms and Conditions Loan Amount: US$300 million equivalent (IBRD loan: US$250 million equivalent; IDA credit of SDR 40.9 million or US$50 million equivalent) Borrower: People's Republic of China Term: Loan: 20 years, including 5 years of grace, at standard variable rate; Credit at standard terms Loan Effectiveness: Conditions of effectiveness included: (1) signing of Subsidiary Loan Agreement satisfactory to IBRD/IDA; (2) State Council approval of the Development Credit Agreement and the Loan Agreement. Allocation: 100 percent of funds to be used for subloans to small and medium-scale industries. Subsidiary Loan: Description: A loan from the Borrower to CIB, denominated in US dollars. The Borrower assumed the exchange rate risk between the US dollar and (a) the currency pool index (for the Bank loan portion) and (b) the SDR (for the IDA credit portion). Term: 20 years, including 5 years grace, with CIB allowed to roll-over funds. Interest: The Borrower charged CIB a fixed interest rate of 7 percent p.a. and the Bank and IDA commitment charges, thus bearing the variable interest risk as under earlier loans/credits to CIB. CIB would on-lend the loan proceeds to the final borrowers at a fixed interest rate of 8.5 percent p.a. The subsidiary loan to CIB and the subloans were denominated in US dollars valued at the date of withdrawal. The subborrowers would carry the foreign exchange risk between the US dollar and the Yuan. CIB and the Bank agreed to exchange views prior to making any changes in interest rates. Free Limit: Free limits related to each branch as in earlier 48 loans to CIB. The free limit for this project was set at $2.5 million for Shanghai, Tianjin and Jiangsu branches and at $1.5 million for Hebei, Hubei, Fijian, Liaoning, Anhui and Zhejiang branches. All other branches (10) would have a free limit of $1 million. The aggregate free limit was US$150 million. The first three subprojects proposed to be financed by a new branch, regardless of size, would be treated as above free limit and would need the prior approval of the Bank/IDA. Supervision: CIB submitted to the Bank/Association (1) detailed reports on its operations and financial results; (2) progress reports on all subprojects under implementation and a list of subprojects in the pipeline; (3) an annual audit report on CIB's accounts and Special Account and Statements of Expenditure audited by independent auditors acceptable to the Bank/Association within 6 months of the end of each fiscal year; and (4) a project completion report within 6 months after completion of disbursements of the loan/credit. Semiannual reports would also be submitted to the Bank on completed subprojects during the first three years of subprojects' operations. Documentation and Subproject Eligibility: All subprojects to be financed under the loan/credit would meet the following criteria: (1) subprojects will pertain to the manufacturing subsectors; (2) subprojects in heavy industry would be only for modernization and energy/material saving; (3) the beneficiary enterprises would have a satisfactory projected financial situation; and (4) the subprojects would have a minimum financial rate of return and economic rate of return of 12 percent. In addition, CIB may on-lend in foreign exchange up to $15 million for an individual subproject. Disbursements would be made against standard documentation for 100 percent of (a) foreign expenditures on goods and services for subprojects; (b) the ex-factory price of locally manufactured equipment procured through ICB; (c) interest during construction on subloans payable by an investment enterprise; and (d) expenditures on overseas training. Disbursements for contracts of or above $200,000 would be made against full documentation. Disbursements for contracts of less than US$200,000 and for overseas training would be made against statements of expenditures, with the full documentation held by CIB for review by Bank supervision missions. 49 FIFTH INDUSTRIAL CREDIT PROJECT Summary of Main Terms and Conditions Loan Amount: US$300 million equivalent Borrower: People's Republic of China Term: Loan: 20 years, including 5 years of grace, at standard variable rate Loan Effectiveness: Conditions of effectiveness included: (1) signing of Subsidiary Loan Agreement satisfactory to IBRD; (2) State Council approval of the Loan Agreement; and (3) ratification by the Board of Directors of CIB of its revised development strategy statement and the statement of operating and financial policies, as agreed with the Bank. Allocation: US$299 million equivalent of funds to be used for subloans to small and medium-scale industries. US$1 million equivalent to be used for technical assistance to CIB. Subsidiary Loan: Description: A loan from the Borrower to CIB, denominated in US dollars. CIB assumed the exchange rate risk between the US dollar and (a) the currency pool index. Term: 20 years, including 5 years grace, with CIB allowed to roll-over funds. Interest: The Borrower charged CIB a variable interest rate equal to the Bank. CIB would on-lend the loan proceeds to the final borrowers at a fixed interest rate of the Bank rate plus a minimum spread of 1.5 percent p.a. and would carry the foreign exchange risk between the Bank's currency pool and the yuan. Subborrowers with a loan of less than US$1.0 million would have the option of carrying the foreign exchange risk between the US dollar and the yuan only, subject to payment of an appropriate fee, in addition to the interest rate, to CIB for carrying the foreign exchange risk between the currency pool and the US dollar. The fee would not be less than 0.5 percent p.a. and CIB would have the right to increase the fee up to 2 percent p.a. if necessary. CIB 50 and the Bank agreed to exchange views prior to making any changes in interest rates. Free Limit: Free limits related to each branch as in earlier loans to CIB and ranged from $1 to $4 million. The aggregate free limit was US$150 million. The first three subprojects proposed to be financed by a new branch, regardless of size, would be treated as above free limit and would need the prior approval of the Bank/IDA. Supervision: CIB submitted to the Bank/Association (1) detailed reports on its operations and financial results; (2) progress reports on all subprojects under implementation and a list of subprojects in the pipeline; (3) an annual audit report on CIB's accounts and Special Account and Statements of Expenditure audited by independent auditors acceptable to the Bank/Association within 6 months of the end of each fiscal year; and (4) a project completion report within 6 months after completion of disbursements of the loan/credit. Semiannual reports would also be submitted to the Bank on completed subprojects during the first three years of subprojects' operations. Documentation and Subproject Eligibility: All subprojects to be financed under the loan/credit would finance small and medium-sized restructuring projects in the light industry sector and would support the removal of the sector's operational bottlenecks. In addition, CIB may on-lend in foreign exchange up to $20 million for an individual subproject. Disbursements would be made against standard documentation for 100 percent of (a) foreign expenditures on goods and services for subprojects; (b) the ex-factory price of locally manufactured equipment procured through ICB; (c) interest during construction on subloans payable by an investment enterprise; and (d) expenditures on overseas training. Disbursements for contracts of or above $500,000 would be made against full documentation. Disbursements for contracts of less than US$500,000 and for overseas training would be made against statements of expenditures, with the full documentation held by CIB for review by Bank supervision missions. 51 Annex 3 The Implementation of Credit Training Under the Fifth World Bank Credit Line Training Course Time Place Persons Expenditure Banking Management July-Sept., 1993 USA 14 $131,839 International Settlement June-July, 1993 USA 2 $13,517 Financial Seminar November, 1993 Japan 1 $1,070 International Finance February, 1994 Japan 4 $11,122 Financial Seminar July, 1994 Japan I $2,597 Financial Seminar October, 1994 Spain 3 $14,159 Asian and Pacific Capital October, 1994 Japan 3 $12,288 Markets International Finance Oct.-Nov., 1994 USA 2 $9,535 Project Management Oct.-Nov., 1994 Denmark 10 $5,000 Computer Oct.-Nov., 1994 USA 4 $16,430 Seminar on Development Oct.-Nov., 1994 Japan I $5,052 Banking Management November, 1994 Germany 1 $6,026 International Settlement November, 1994 Hong Kong 1 $3,356 Economic Seminar Nov.-Dec., 1994 Singapore, 2 $6,293 Hong Kong SWIFT Training December, 1994 Hong Kong 3 $11,195 Banking Management December, 1994 Singapore 1 $4,213 Engaging Foreign Experts January, 1994 UK 2 $46,529  53 Annex 4 ―郡：:_ China Vourth Industrial Credil PrøjecLs In USI) Ten Thousand Appendix WIR,.1 Nallle of Lwal inn Dilte 01 F.,d IOWIlership svel ør ýilblt>ilii A111011111 fipc 01 lý)illt of 11>illi kl r(-,I l Å 66 81v1.1 lill? -liiioiiiii» 19511 Nlide 4 18,00 Vi xed Investmeøl 11.ra) l WH klødel iiiz,t(i()il WHK, 11 06 Jiiltl!Yill 8 Parts Jiatlesu I M State Machinery 92,00 Vilted lit%,estiiieitt 8.500 1991 klo(lei.i)iziitioil 00( 11 61 Wiixi Silk A- Ihing lianesti 1958 State TexIde 1116,09 Fixed Investmeni B.SW 1992 klodei-iii-i.alioil 0 W ll 108 liiiiiitil! GIOLlcose Jiaiiýsu 1959 State Ilbarmaccutical 151.fig Fixed Investinent 8.500 1992 Vor Expansion 0 (x: Å ILý 1)Oii2fallý Chemical 1,1 lkijin,« 19m State Chemical 3Mý112 Fixed Investment 8.500 1990 Modernizilhoo offl. Å 61 lk,iiiii! No.:ý liciiiiit 1961 Slate liglil 202,00 Fixed Investunent 8.500 1992 kw(!$-lliz;llioll 0 M Å 09 Witsliiiiý mil(ýli Ikijing l!)ýÅl State liklit Ififix) ý'ixeýi liiveslilitýiit 11.500 MT> 39 Zllilliliitllý Guangdon. 1966 klm-hinery 1611,1X 1.,ixe(i Inves1111c111 11 SN 1995 \1 od ý.- 1, 11 iz,l l i o] 1 0 0(1 Å 11) ýllitoýii;iii Tøol 1,1iklil Guall!!dong 1970 -MMe Miieliiii(!ry 119,111) hud liivtslllt(!111 8 5(x) l99,5 11)Il 000 Å 5., 1 lill!ý ý'iii Hvet corp Gllikogdong 19117 ýlate ý:lecti-ollie 4,35,30 1,ixcd Investillent 11.5(x) 1.991 1) OP A :Il GlfillizIlou 110s Guanýdong 19117 Share holding, Robber 1911.08 ý'ixed Inveshnent 8.5W 1991 Modernizatioii OAW A 52 ýýooleii klill Dl Tdona Min 1956 State TexIfle 164,00 1'ixed luvestinent 8.500 1992 ýloderiii-i.iitioii 0 NI li (19 Milt Guafløgxi 1965 ýtale Pharmaccuticat 4 120 Vixed Investmen( fl.500 1990 Modei iii-ial ioii 0 00 il 17 IJII4m1 Gualløki IWI 26.M ViXed liiv(!5111ýeiil 8. N X) IMN) Mod(.1 Iliml Ion 0 (k) 11 711) lýil1)1H.I of Ilcki 19(Wi ýtiite 10:1IK) ý,ixr(l InveA111c111 l 1. 'Å X) 1992 M (x Ic r i i ivi l I i o i i (MNI l l 7 \iýilisli,til 11181 S '1.11(ýiiiiiig 1986 klitelliliery 50,00 Fixed InvestInent 11 SW 1991 Modernimlion 0.00 11 37 Iktillen Produ 19711 Colleekve lýeliL 40,00 ý'ixed InvesImeffi 11.500 1990 Modernizatioll () M Å M CotIon Te\t 1.11cjlitllaý l 967 81 ate TexIfle 21M.60 fixed Inyrstment 11.swl i fm klo(l(.l«liizi%l ioll 12(Kj ,A 21) Dollagnille liýlilýlill, Cl! i gf)f) llililtilligD illilltýi-i 240.211 Fixc<l litv(..%tiiieiit O.M N data not avaflable China -- Fourth Industrial Credit Projcls Inii n T hn lltousand Appendix 1W4H1 rMer l \tt il I:ilpså Kales ilen l6port uf kul äl ýali (*apacciitN .llilizi.atmt Tigill No. u IIIpys N u 1ous Efpjimpl-d Nali ol TI li of 1 sI \rl vs \ul vsl. AtA. Vsl. l Act V. Avt. - 26 luzbui Bertrl - nr ?0005 972( 0 0 l(K) (( 235 265 5 10 fmancial gcnsoucv lili pit o»v impilvd 11 14 In. i laher aIc I500 2122 100 100 100 100 5M 6:30 350 481 fainacial coiistiaio uch I oudii<:tii prok- s impiosvd \ 25 S.a1.1c11i11 Coppe-o Var t 5431 120(0 10 40 100 110 236 25 20 la TecikFia c nsuiiltiiri riducIIImn pi piess miuo d A 46 Sainhli.ii SM l 1.r7o 1000 2517 t] 0 100 ff5 N 347 N 200 TechIkIi,a constimllafiy Pii iiimn proi vSS impimked A 75 Shan,i x(:1 Iljeick 52160 5777 5 45 t0 100 360 360 m 2 Techia rcoultimics 1,1d11li11 pi es 1simed IS 61 Sliane11i liiiusehcodl C 248111 3100 19 )25 100 100 910 950 N 45 lerkkhina cn aciäiN 4mW riitil cess cu1nmd IS 65 Shanilca1 Daih1 CIim1 7551.3 7100 26 :30 100 l00 900 100 N 450 Temichkusma consulknci i oclnh ciiic es imr med-YN 11 68 Shaliajii Då 7hi De Ilot) 1352 1821 92 92 100 90 421 646 l 322 Techm&f'ina cosullauics rodcltioinici prcwes imimp oed 11 104 leasli IRiililr Plant 3790 4913 70 75 500 100 1100 1260 528 64:3 I'inaiaiiil consutanet Priodulbo proces.s uimpeuxed 1 67 Ali 1an riderv 25540 3210 B0 8 100 95 200 200 N 550 financial consultancy flioduction process filmrled 41 01 Zsbo Tonels Mill 5680 3318 80 65 100 500 133 240 N 2700 Financial consultancy Production process inproid 4 65 Vailai Iiroadelotht a 363 2d67 80 60 100 100 1468 1738 M 1054 Financial consultancy Production process improrud A 63 0 otllcst lertriw 2169 2965 60 10 100 100 570 570 M 123 Teh&ina coisultancy Production process improted A 51 golm Silk Afill 2275 2915 5 35 100 100 290 232 N 195 TeIh&flina coisullancy Production process intproved I fil 0.411.1n1 stisitim 670 2400 100 90 100 100 744 631 N 450 Tch&fina ëéonsultiny Proucidchon process imimp ou d 1l 9K wo-iul Ko i Ph1milca 192.3 3211 60 71 100 90 1600 183O 913 165 Techlkfjina consullaim I oducti.o pm r ii e us i l 12 \% 1 liadio Kuctois 3764 5721 0 0 100 95 635 687 N 200 Tech&ina consuiai, lProdurlion pvi-ss im idm A3 77 äimdwiinarn i i nemi 2995 3404 0 0 L00 85 816 5055 N 250 Teci&fina consiRanei Produi<loi procs uicand N data nol avilable China Vourth Industrial Credit Projects I 1U1 Ten Tiousand Apåeivik rge. 52 No mie of s:niise a lm. a Yxl#ort to Total Sa.les% p ililiay.ioniwi Total No of inplovces NO. omen .i Eislovml Nal ure of[ T si of II EI All. Est. Ärl. Fs AVl. Est. c Es. A40. A 66 ins. 5 elte 2293 3:200 0 0 100 100 844 M5 m 74 Tecl&Fina consuilltaice Produciol proer s olmpnmed iS 06 lkanflin 5 Paris 595 679 im 18 <00 100 272 270 40 80 TechL-mia consiltaiiie Producbon prx-ocess kipr ed 11 61 luxi ilk & Osin 6778 5000 10 35 100 100 1230 1550 800 1020 1cfinila consoffluin Plroduibon pi orry oipi o ged S1 Ipijolanc Culo.se 5950 2000 50 70 100 95 1736 t500 900 950 Te.CIBL-Fina consullann h oduchl ion process llfiloled A 35 k)o-,iii (hemiaitl i 27 0 3250 500 100 100 100 29 29 6 0 TecI&Fina coisulit inc Produclion process iipmed A 61 Wielinc o : 4295 564 N N 100 80 120 103 Nm 31 TechkFälj na 1 consuiialtana 11Amelin Pllroces I s Im jomed A 69 Ik-qin G.Sinll 1.h 6578 6510 7 10 100 70 973 900 N 350 Tech&Fina coisuiltancy Production process imlpromd A 39 %II.Imiinil tie uimmeii 716 1140 0 0 100 5100 296 2152 101 112 Terhlfinla »<ulvaISnety Profi 11[llm process 1m i[bmed%»1 A 5 Simuemi 1005 Planolt 02 1023 100 96 100 95 42 30 251 18 Tech&Fina consultancy Production proess bmprmoid 4 55 m1110 \tile 1 C1orp1 174 6500 70 93 100 100 :0 552 8 277 Tecli&fioa constlutitncy Producion process iltmtOed A 31 Gnanyhou Ruhlm-i 11o 5m 2549 25 52 100 1 00 150 2119 m 42 Tech&Fina consulanssy bodInSillionl no m esy ämrl14d A 5 1olen 11Mil of Taona 7604 555S 45 65 100 66 3000 3135 M 1711 Tecl&Fina consultansc Production proces imlrmed 11 09 Mviria måennce tiv t 90 35 15 N 100 57.5 24 43 N 27 TeCil Ina consullanev I ne-tj<lttt-liton pio res' unplllli)ke-d 55 17 ljuiou Phaare «r 8 50 N N 100 505 100 115 m 65 r(chkFill coisiIlv 11 i>tlliI51oni p1x-css im1pil m ed 0 75 Ruhllkwr Vactus or Si 26112 3177 0 0 l0X 70 1450 1500 700 750 Tecl&finla conlsuållaney Modutelioll w11 occss iiprkr1d 55 7 'mos>an insi S f s 550 22n 100 90 100 34 40 30 M 18 Tech&illa consuHilanie> 5 Poduclion proms'1 implmed fi 37 Ihllen Iafle j odu 2520 63) 95 65 100 2at 0 45 m 129 Tetl&fina consultalce 5>5 hJIcIonI p>cebss iiil>fmdi A *0 Mhami"u Cotlon Tmt 2181 7170 95 50 100 500 3406 4500 N 3151 Techifina consultane Producion picess impred IL20 lmoing Buiding Ce , 2657 3607 19 40 100 100 945 945 N 320 Tech ina consullancj Produclion prorcss 1iprme N data ist avaidable China rourth Industrial Credit ProjecLs in RII Ten Thusamd Appendix kl: Pag. 3 l %0 (dn o51 e:leiprb:e Total \ssL,cs melk In /skökse Ternl lkbit/Euity lIRR Tutal Proj -e (* E1 uity • 11W 144. lo,tias _ - 1. .\r. INV. FSI. Avt. N. Ac. Kl. h-. fin.s tl !M A i slo ElvtIi ire il ffiZ> 1 6i1 122 090 0.45 31.60 211.50 fuk 91? 4) 16 11 :3 30 3 ff 14 Fuim ici Far 1200 150 2 7 11.10 000 060 26.50 23.70 _ 62 M2 20 20 22 22 l i i A 25 shacngIhai co wr fav 7651.1 14100 1500 26.06 079 047 21.10 2250 2929 6271 330 33 649 _692 191 191 A 46 :anchai SaI v Razo 194 2300 7.60 020 0.37 20.90 16.30 _195 _2209 63 63 323 :1 60 197 697 A 75 LAmchi N.3 llvricle 2619.4 3326 30.32 2522 N 0.79 17.35 22.00 2686 _:617 0 0 545 4!00 669 669 11 61 SInchai Ilousehold C 4281.6 5322 21 66 17.61 000 0.50 55.50 44.00 66M _ 661 25 25 27 27 515 545 l 65 Samla Dåls Chemi 1792.5 2607 8.19 1.06 0.00 0.66 22.42 20.) 687 l1 1:39 5:19 110 _110 14 1 45 lI 68 Zhain<giai Da '/.i lic too 1775 2360 14.79 l1.50 0.99 0185 24.00 1G.90 845 174 29 29 a5 85 50 500 11 104 shnhi Rubber ,1iPan 1187 1522 13.90 12.70 0.13 0 15 481.80 18.30 481 624 41 146 67 32 209 300 4 67 1hi DOi moider>it( :0<52 4::11M 15.21 55.50 0.40 070 30.00 21A.0 1112 15o 100 l00 164 164 402 40 A 01 /io Toe.- Vill 2070 7219 22.73 18.50 0.00 0.60 29.40 22.00 1455 2331 122 300 241 26:3 4355 4:31 A 65 anlai Iroadclothi Fa 5842 6152 23.52 5701 0.30 . 23.28 19.50 1600 3134 134 170 327 32? 34? 250 A 6,3 Sou1tICest Iletric 5100 7500 2627 17.00 0.73 0.60 39.07 19.50 1300 1500 200 210 200 149 250 100 A 51 Wisuu Silk Miill 3672 655 16.16 14.60 .00 0.89 24.00 11.80 2302 3975 150 605 327 327 1050 610 I II l?altamt Sus11n 834 1320 12.00 1300 1.00 0.80 21.00 15.60 187 2M5 60 75 22 22 45 45 55 90 Iizli.ot No l PhScarmma 2525 4076 2895 2 1.10 32.00 1100 799 1002 50 50 67 67 500 SM0 11 22NO Radia Fieleory 2952 770 5. 530 1.17 0.74 34.00 9 5511 9 70 70 148 148 50 50 A 77 Simdon01 inuen Cevir 3309 6191 24.4 19.54 0.31 O.M 25.61 16.00 1610 3308 681 393 150 150 370 1670 M dala not available 1011)/IA in ISSI ten thousand China -"ourth industrial Credit Projec.s in 111111 Teo Thomsand Appendix III1 Vage 3 2 No N,t , ineipns Totil Assels Nel lucajnte/Safed Term Ikmko.<¡uity 1I<I( Total ProietCosis Fapäly v I D \1 Ole håens u____________ lS f5.., l 1 ,51. Est, Avt. Est. Act. l f A& rmi. lAct. l S,t 44 ENVt V A 66 Utsban Iel gift i o 521 25 må 60.3 26j00 i wi mo m7i -mw sxgi - ri 1 ö im n f 1t <f6 fialill 5 1ai1 760 12PÅ)9 21.69 17.40 (_60 0. 31.110 6.7) bifi 534 «46 W 93 93 Imj 70 1I 61 lxm Stjk k ilvmi 6714 11023 9 35 12.1 0.41 1.11 21.18 19.111 2269 24139 900 I080X 236 236 N 40 0 308 iiiae Glov<_os 3248 _6100fi 25.25 l930 074 063 22103 20.50 2944 _,02 1921 419 152 154 459 503 A lim n hemiilj I, 2962 t7ff 24 76 23,12 N 0.95 24.211 19.WI 3704 4461 755 780 3Off 3l S 1 922 533 A 61 lkijiim. N0326 _69,6m 1.70 7.11 3.24 0i :34191 211.41 1465 2100 126 .9) 202 212 9 1) 19 A 69 iåse s larl 4=11 9121 11.19) 9.6 0 29 0.41 49.62 jVO.?0 101 _lIPAJ 119 3X0 ti4 I M 0 3 A 39 /1aain II_I.Sil 10811 571) 42.46 912 0.45 0.67 28.99 19.81 759 1140 138 200 16 168 0 (3 A 15 fiho Saniiiii ToI0ll'amt 593 91 30.71 12.50 OI 0.46 31.62 19.22 494 950 100 100 120 120 1713 1711 A 55 ij Ynj Werl Corp 1595 5149 50.91 18.95 0.51 028 42.40 22.23 __ 5 __K271 0 200 435 14 123 20 A 31 tnaiinzntl Rubber tios 3865 6961 570 5.65 0.13 0.51 47.74 14.18 1020 3400 0 1100 198 1911 90 59% A 52 _0o1e1 11i11 of Tiåo11, 5920 8196 12.81 669 0.14 0.93 40.45 21.12 1656 6 180 180 165 77 600 61 Il 09 lej an liee e at 20 413 37.74 22.54 0.12 0.35 32.56 19.80 209 245 20 21 41 41 N 20 I 17 Itim _lnikroffic 576 600 14.11 24.73 N 0.00 30.00 22.36 271 2m 100 _ 100 26 26 __3 3 It 75 Rjubber Vigel i y or Sh 2760 491t( 45.75 1:2 0.60 0.111 33.40 20.14 546 560 &1 65 <3 ffi 40 40 I1 7 \mosha l S N Fiast :151 I(l: 22.10 950 0.45 0.27 24.10 13A0 371 410 25 95 50 50 110 211) 11:37 Iamen Iritii'r fli 1067 2313 11.10 4.70 0.62 0.16 23.20 13.15 290 4 2 22 40 26 43 I1) A 3 tocil Cotin TMI 5775 IrmmA) 17.1 lMX)3(.23 1.431 <7.40 1310 24V 30 211 212 64 6 A 20 kmfnin. BHuildiig Ce 1767 177 56.00 22 40 N 0.2A 42.65 2103 1764 363 N 1 400 240 240 760 11S N data not available IIIH)/IDA in USI) tent thousand China Fifth Industrial Credit ProjecIs Iii USD Tenl Thoosand Appendix 9 V05 Pagc l l 4 A.nne Vi o:te prise. 14ljolbn a1e 1i Eso OIInriip setr Sthloani Amglogiffl Type of Inall Inaies Re( 1a1un poi o la \um i ml 3 0 hen.:hen Ti l it Guanidoni 1989 Tim.L Voiharet oldlit e r 287.50 1ixed inve:tment 7.125 93 i> 33 epnion (0K I1 >64 lan Ttile i (t in 1H11iua 1966 Stit. Texb le 147.76 Vixed livest meff 7.175 1991 \I odeyr16,ioi 12 CA lH 160 finilin No Plastii Tianifi M966 Staie Plastie 69.00 fixed investment 7.750 1996 Mne( mzailon11 0.0c t 1,59 Twiijin No 21 Plasi ir Tiänjim 956 oUri åe PMasi 27.5) Kx-d invesmelingii 7.750 1% Modec niiialiion 0 f 11 152 Ti.iiin Må ho N'i.vse Tianjin (985 Jii lt tl,sile 40. ixe) K invesltmieil 7.75) I1A \l oerinn OAX) H122 IV hIanichai vov lin f.e Mhanlghaä 195 S ale ah 241 ff) Fixed Investimvin 7.250 1997 iodcitit on 00 Il 120 01tia No.1 Pcocil Shaighiiai 959 Stlate lighl 49.40 Fixed Invesinent 13.500 1995 ooruiion 000 A 36 .iimeh Tri nrmer Shajutlhai 1921 SlIte machinery 430 U xed nvestmen 7250 196 lit nizi 1o11 000 A43 :lisholn A110u1i9rar Ö 'i ory lubej l9M0 State Afiomobile 233.00 fixed invesliteni 8500 >999 Nel M Kv etterpiis 0,f) 11 87 QIuM m hfleifcrr Shandon-g (951 Coljelive light 128.00 Fixed hmivestm<eit 7.125 l995 \kffi odeinizt log 21 M A 23> i,>iia iir Shiaditontti 1903 Share holding Liehlt 371.00 Fixedt tinvestimiet 7.125 l995 l'ar expansionl 11 1 l 16 Iaml Ik-I flon- 'inul C Sinnuilmton I992 Joinjt. Vett>1nire FoWd 65114 mxed linvesinent 7.25 (997 Nen illersläm. 4 txi A 2 \ %Iipu lfahlit Aid shandong 1919 State rexiile 600.30 fixed linvestumelt 7250 1916 Montiz gilm lon 5 Ix 11 135 11 7.han No.3 k I-lion, Shandonk 1991 joint ventiure lightt 123.80 fixell ivesitmeal - 7.250 1995 Moderniziation 0.M Il >18 l i hn ine (hatt!il Seiean 1>990 Joini Ventire Packing 40.20 Fixed ivestieni 9.375 l993 fo f:\ptisioi offl l 75 11i11h0n <etromtagn daliIn 1986 State machiilery 30.00 fixed Investment 7.375 19(93 odei fmition 0.AI j 10< Vintekoo ChFmicalib jaonning 1976 State Textile 42000 fixed hnvestmnent 7.600 1999 oUditrniz.dtioni 000 i lo'> i HIotl!un tten Glass Jianjastå 1967 Collective I.1i1. 121.10 Fixed investmnent 9.690 19% ioderiiztliot 0 00 11 m Suzhoi Prujcion Tih Janesu 1966 State £leetrottie 127.18 Vixed Investnment 1.580 1994 Modetnmiztlion 000 >1 36 Iii hiu terfion Jianvsu 1958 State pachinerr 29.60 fixed Investment 9810 I997 modernizalion 000 31 l anmiubwm IlBladet jiannum l958 Colleie extile 47.00 lixed h1vest.1men1 7.800 l995 f oi fixpatsion 0 0 15,1 Dci im KnO Svii- l Miin >969 ileri rtic 15: Fixed stment 770 >90v N immsz.uli-o 7^ 1 A In lidan intertlnainl Ilaian >9>9 Joutå <enti i ht 20vl9Ctixe havestmen, 9.25. >992 Ne1 Eiderpris 0E d dala nl arailab*. flufl Ii IIdI l iii Ce(11. (;( o (!(.s lit IJTSI) Teo Thiolisand .\llAppendix 111C S Pae. 1 2 \.AM-me of (lipoi l.oiabon Dll o s( j tsing secl or Sliloan Atoloiil_ Type of Loall liliel kt il klit ii v I'urpflo of V.oan \ i cl ?i75 kmimi .11x p rl flo Guandoni 19111 Slitig Light 149AX)00 ieled 1w311mcA iol 7870 l 19 V \loiIi iiIi ion t) M l 2l \mmi ll r Gu1anttedoni 1970 Slale (emical (57.70 Fixed iivest mieigt 770 1994 \loteri ho (0 A in lushIan No -5 Iådio 1 Guaindon, 1969 State tectronlic 257.40 fixed Investmetii 7.870 199 ModemInzai on 0 09 H1 56 Olhhna Tragt Aelee G;uandol 1989 Joint venture jehlt 75.49 fixed livestment 7.870 1992 \e E:flerprise 0 00 A 211 :;aiiiii_iouå Sinj Mil Guanledoig 1956 State M3allukrgical 550.00 Fixed Investmlelt 7.9:0 1990 kloderialion 0i (00 3 47 Ove ietory Jiln 1956 State Clenical 74.00 Fixed Investment 8 500 1994 \lodernizalion 01) 00 1l 42 Chall-, Clu Eleelite åin 1%6 State lachiinery 95.60 fixed Inves mnent 9.560 1994 Moderlizalionl 0.00 A 41 Cuilm i e Factory Guoanxi 1969 State ltubber 297.00 fixed investmenl 7813 1998 ModernizMJon 0f0 A i 3r/ho 11111m Cakr Gungi 1961 State Nml3 omohelil 210.)0 Fixed nvestmMenI 7g13 9e4 \ 1ode1 y1 ion ( 00 4 50 lim Cooth Grl \lil Id Sianlxi 1995 Jolit Venu r Voodll 153.70 Vixed investimenl 7 5A 1997 Ne l nrie 4 0_ lit A 29 Cott oll lit sli;&.iianxi l952 St ate lextile 200.00 Hxel liiesiimtetil 7250 1996 Moderi1,t on < (Xl A 27 (Iii lil iiiac a llan 1917 CoCiflle henical 3199.70 rixed hivestnien 7.97 1997 ionderain 000 A 1 \Iiig Gruclid 1len1an 1966 State Textile 268.60 fixed Inveslment 7.810 1996 Mlidhemyalol 70 00 I3 7 1o1 III 'tiiii ('ha mae Ilt-hvi 3950 Satc Paik rn ilc uIica l 192.31 Fixed Investnent 9.3l) 1994 \lodirnizio3 län ( I0 11 291 incelin f.mligidriy leiej 984 Colleelive ,iht 29.60 Iixed ivestmbken 9.750 1993 kxli nizatin 0(K) 1l 16 lLodins No2 Ch lii lebei 1952 State (lhenical 300.90 fixedi nvestlenl 7.500 1995 \l,dertiza(;on 6000 A :l TWneshn Coldm. Varl ftlåvi 1970 State lalalellurnical 5413.0 Fixed ilnvesmnirni 79!33 1999 \ldemiii-h on 0i0) o 1:19 ilnchou, Souithast C llejian 11943 State Chemical 212.60 Fixed livestient 7.750 1997 \lodinization 0.00 13 2 i a , 1zh o S i l S Ier n Z i ! ji a n g 9 2 7 S t a e e x l e I .0 0 F i x e d li v e s t i i ie n t 7 .6 1 0 1 9 9 3 l W o d e i j x a li o n i )0 0 Ai 53 Iixi l.ilii Indut. ry Zh(ejiaiing 1912 i igh 674.80 Fixed haivestmie.ntl H.750 1999 Modernizatiolnl 0 0l N dltla fot available China Vifth Industrial Credit Projeels tn K(lII Teng iousaiid Appendix X#K5 Per 2 l \u \ame ttonti pise Sai(. hic 1pu tf TuLl Sales: Capacity lizaiun: Tut it No Sv kmBirest-- No of wmgon en tmpljto.f Namv fi , Re-iull (4 11 1.,1 rl 1 t. ttl. KA . e4 s. Arlt Äl. Acl S0 14.14uin T1.111,1 yl( v 8526 C2) 95 lut tIR 102 320 579 50 litfi 1mnuitml, consutatit s odu tm11 1 ot 4» imopi.d tt 164 kui\uun Tetilr run11 20260 29 5 60 20 l00 75 7200 6194 N 3620 mnia cosullm f. a ty omb ltht mn opintrl.ll.di t l 1 t;lipn NU 7 Plat e 21411 2100 30 30 1 IX) 1W 460 467 m 155 Tech&Vinå coslitlln Podui- 11o pioess 11m1p10wd t 1in1 Nu 21 PLIsc ll 4-00 0 0 100 100 776 776 N 270 Tei&Fm consin-6 Pdur m11i otlttpIni nd l '15 Ti.tm lIn Da 1 s1.st. fi f t I mi 116 1 3> 0 1 0ill l0l 121 90 20 )3 Tehmu Tuuisulte Producol lroess I un u ned I1 tt 12 2 i.t- 1 J flir 96lil tt2 W 41 t 100 M 05 1:144 t7911 N 692 TPloguit- iisutanplott'clducn ioss unpon0d l 1ä tinnm No l tevil 3956 4963 29 6 296 l00 100 919 1000 N 470 T coksin l cnsuita Pjuut lion piocess impio id A 36 :i;angbat Tiiansformer 6175.6 7.126 26 26 l00 0 0% N 925 11 t e1 chkima consultanc Pi urol pme.,ss i impi o kedt A 43 :1nshoum1 Autorirt Vari< 2950 3'27 0 0 100 95 780 795 30 36 Techlmeal consultalne l oduhonltl pi oess impitm ed tt 87 (Iitecipo Etchie 11900 350 50 5 100 100 N 670 N 200 Finjanecial consutllncy Pi oductiol process uinprowCd 4 23 Tsiniettao eicer 6000 10500 50 49 1ffi 100 N 1205 N 465 Financial consultancy Production process mjupriviei Il 169 Taian Iet Honc Yood C 1378 1545 50 0 100 B5 N 460 8 66 financial comsultancy Production process improswed A 21 \utmiii Fabrit And 5950 10325 0 20 100 100 500 501 N- 270 tinancial consultaoev Production process imprmedui tt J3:i %hao No3 k Ilvig 129 40W4 10f 100 1 20 133 462 N 221 Finlancial consultancy Plodurlitn process impim u ed tf Il 4*honetinm g m (thanialnc 10201 1665 31) 40 t00 100 135 150 N 22 finanecial consutä anc Po durtlon proccs imred i 75 buhlu 1lchoman >324 1450 100 100 100 100 240 240 N 63 Trci&Finia ionsuflänt- Proetulilion process ipitml Il 11 1n1eku l tmuk ica Ii 19341 22211 0 0 1 00 90 6435 6500 N 2500 Tvcl&Via consultane Mjodtuln piocess impluitt tt #u: 103 Wilioiigeag GLIss 0 1 03i 20 l0 _ l0 90 402 402 N _5_ Tch&mna conösullane, Produvehon rocess imupiutti _6(1 zM lhoie 1'trujetion Tul 43S5 Stt 50 50 100 100 1201 30 N1 45 Financial consultamipl mgothlon procs: Ing i vil t 3f6 #Alm 1t 11i 11011 2000 _45 LK 00 _ __m 43217 597 rumncial costillancy Imudiwi prorm iimutl t 31 tlancllu Illankel 420 61 10 5 100 85 600 650 350 420 Tech&Vina consiltant Produrion process impimeid I1l1 Ik-iiin ko 9 _-när. 474 _92 75 _ 1_ _ 00 100 46 >30 m en T11'> dm&fwa xiflim iflm k Inirm iloitiii I lImnan IuhmnamaI 2016 4172 100 0 I00 100 1100 1151 N 60 Techtfina consullaic r'otltm-ionm pMUcss improul t data mat avaiable China Vi11h1 Industrial Credit Projecls lin Ifil Tena Thousaiid Apl)en.diix #11(5 Vage 2 2 \ i.am of I:nSe prise S ltes Eae po I(Ttaf Sales. Capivit titilizitionl% Total No. o Emilployes No. o Wooren .pioyd Ni uiire of 1' lisull ol T\ si. A,t. -st Act. .s. Art. yst A,t. v.s. AcL 175 \mti mipel VIvo 10®0l 1142 :W 1) 100 1 00 2o 4a N 157 Thrl i consultt a 111Prodhlmli pcesm 1up1 med 11 21 \m4m [ r 2118 3069 0 0 100 100 338 410 N 187 Techina consul ProltkmPrdutlion pr oress impi os· et A In Ius.bim No å liRtdio r 63050 46997 410 11 100 72 1000 10110 N 586 cM:ik-mmma coansumllimr litilmi mm i lirocess mnlmoumd 14 56 flim Trltift emc 5506 6266 100 100 100 100 2910 294 N 214 Tech&Fina consu ilainPdimnlm proces imrimd A 28 (;mmum5zmanhui Sill) vmill 20400 14509 N N 100 75 600 600 N 190 recht&Fimia consultme, Produlcion inmoces im med il 47 Diet mLory 36950 512m 20 0 100 100 6544 6610 N 710 TelikFina ronsuiallivpo lraitmmmlmmmim iiimm<ess imiikvill il 42 lanc 1,h111m P.lit, 2977 3W69 25 10 o 0 1400 1451 m 601 TechLV&inla vonlisullant. ltimlit n iems impirou-o.,l A 44 Gmfin Tire famrlmm y 3312 4812 15 15 90 90 250 250 101 10 Teclh&Filla conisulal i oni prf(immlmamm imocs mmmixmimld A a inlim ilmi Car 2:161 2540 M N 10( 1 05 48 35 N 12 Tehma conlsula rlimi i Plon procesms mniou- A 50 il Uomli G1m snl 1644 <057 133 0 100 65 60 71 N 24 Techm&lfina iconlsultant PlV <oduchon press m imipmed A 29 o i <oltonl Mill 14841 37279 97 73 100 130 7266 7702 M 5391 Teclh&Fina consillant Production promcm improtu-t) A 27 lili ctemial im lo 3960 4522 N N 100 83 178 290 N 70 Tclöffina constillmn Production proces i miplikdl A 34 imang Gelmnl 6592 5281 16.8 75 100 70 154 2ff5 N 171 Tech&Tinia consulanr Production pjroicss inpiimmed I 71 Nm lIm ina rharm 41160 5230 0 I1f 100 97 120 til N 81 Tech&Finla conmasult anom mdlimiol prvos nmel)mmo mmd 11 29 ilchln I.mrmrtmit.t v 92 1«192 0 0 <00 60 50 44 39 39l Thrlina constltam imblriion rtomr-ss impii-> l 16 .llim No 2 Chemi> 20701 2500 50 22 10(1 64 05 <035 N 424 consultanlt. ll t tt tducioni prot-css imilm l A 3: Tanmmmbanm lmiiVm el <«1070 19625 N N l0I0 70 1201) 19091 N 526 TchbA-Finsa consikiltan laiiion priic n up impmi i 139 limit te t mmffl C 4441 70If5 20 0 100 70 250 3110 N 1711 Tchci&iniia consunt<mi Ilmoduliion pmrocess impmitisd2 11 2 111,111c-iou Slik Serven 2imm 3193 100 80 100 100 1470 150 N 981 TchkllFina consultalnmmc Pl uducion pl,ocess _imipiu'd,m A 51 jfixi lieli Industri_ 1 191481 19636 53 60 100 70 200 224 N 93 Tehkiga consultane Porodumion process.imp irmm m data not avaitable ChiA VAih Industrial Credit Projects In 1(111 T'en Thousand Appe,ndiu # KI5 ac 3 1 \a vme ol ln1c1pIise ToIl \ssel NIe) lcoiic/'Sals% Terin) lqily flVI% Toal Pro,l Cosis U<piil IHR1/I I olliv ltomns EsA. Acl tl Vl1. EsI. Al .Es. AvI Vsi. ,\H-. lA Avl LM VI 1 , .kl A3 M entvono, i 6M735 93N0 1543 1230 11 >0 0.6 26.40 20R 223 2561 lp2N. I Ifi 2811 2ii 1:39 15 li 16fi laollu,m TeI ie l'i 2l593 30722 N 6" N 1.10 29 (X) HUX 956 1242 N :30 N 148 N W IlI 160 'h,njin No? P,stiv 600 1180 1000 <000 <.45 1.07 2900 9.00 574 574 30 30 19 89 N N I 159 Tin11m1 No 2l 1l1a 2115 2500 13.78 121K1 (.01 0.97 2200 11II 225 225 20 20 28 28 N N f ,52 Tian m æh ful i 1 1 17 )00 <f75 900 0 l 1 0.45 17.(X) 14.20 376 376 211 211 40 401 lffi 16 Il 122 11.1iIt ur.lieI 1621.9 20XK 7 23I t 10 000 1.20 19.23 1650 1622 2000 0 0 24< 241 0 0 I l20 I n(aliili NoI'eld 17676 2200 42A2 2560 000 0.43 s364 4500 144 3Z i i 39 :3 t 0 A :W6 .niu,iq<ii, T,a,nsol im'r I060 2327.7 25.52 21 00 0.61 0.95 2091 <820 4311 4311 it Ift 49 49 122 1122 A 4: .4 oi 11lorIrl l'actol 3000 5665 2371 1850 0.40 0.51 21.60 1760 2110 254 300 300 20:1 2313 :00 300 <i «7 (m d leri i6355 22170 371.W 27.00 0.50 0.65 39.00 2600 064 1711 259 259 121 1211 200 'I A 2:1 Timida lii 15840 25632 30.18 2960 0.50 0.91< 42.9:1 24.:0 2114 4339 600 600 321 :71 0 i 400 lI t61 Tmii <kn liiun I,ood C 3541 7200 30 0 17.90 000 30 2500 15.70 9:12 2174 379 <031 66 661 0 597 A 21 \Iol Iobiic ·\td 422 111092 15.6 60 0 31 0.97 28.00 21.00 4221 9W5 940 840 525 600 N N Il 135_ 1 7.hau No 3 11linf 1982 8U00 3 411 5 M.50 . 02 0.05 2700 26.50 <545 <9ß9 521 521 124 124 349 320 I loni< <i 'ohan'u 250) 2855 <.56 <5.60 000 0.6 _ 29.00 (6750 24? _ 26 26 46 4G 0 (1 li 75 linzbou i:lecroman 1291 <70 20.00 111.501 <20 1.00 22.00 21.00 466_ 695 100 150 10 _30 _10 280 1 1 \UB miekiou (1veicali 3Fi 142 56520 20.m 19.:30 0.95 062 27.00 220 -.00 4555 77J 1069 420 420 0 0 i l03 liu I<ou>iuan' Qass 2374 3642 68.10 4047 0.52 0.17 20.10 1920 732 1317 121 253 121 125 4<1 4(1 I 6l :z.hon Propredion Tub N 31115- 23.00 11.10 N 0.38 66.00 :1.00 1440 204 725 75 127 127 105 201 11:6 3G uii uel Iindeeion 6036 l430i 290M 1020 0.319 017 17.50 16.40 3360 3782500 500 299 299 1751 28413 I 3:11 lnihu Illadel 6100 703 45.:5 17.79 0.76 0.50 12AX) 1400 427 CS 9< 98 47 41 N N I15 I-ilIII! No 9 Se9iiico 301 912 19.92 I 689 N 0.1 28 4:1 21.11 285 317 43 80 32 32 7 0 A 1< 1iio ulnkialtional F >02j 3a586 l5.4:1 8.2. 000 0.72 42.<0 7 l <950 2142990 1000 204 204 0 0 N dal not available 11R/I10DA it LSD en thnousmand China Iifth Industrial Credit Projcts lit Oll Tvin flhotesatid Ap MaICS KIg e I \' bille f Euler pilse lial Assels Ncl TlCi11/Sales v Tnn tt/)e ity f(9 Totai Proeri Vos5 ä lty Imil), I1) o\ hLoan V51______________ : cl V- Avt «______ EI,) A kl ( Esl. Avi s. At. Esi Ar3 l Cs( \v I ,,i 3 Ii3175 \1111t1 Ca pel Vad 9203 11424:. 17.61 1007 0 05 061 35 9 130(k 2 2211 333 2M0 149 l419 107 (000 i 21 \Ifflio hhne 2996 41179 911 974 :11 22.Il 3 220 21 169 l IS? 44 15o 1 13 1 1 (x) 41(x A_ 11cliall 4\5679 _50(M78 9) 5.27 0 IS 0 39 61 3) 1I 12 l4i13)4 J:m 226 1(Iff 257 261 10:19 721 f 5 0 (h1n, T1ic \!!(,lv « 1620 36)7 (394 -8.20 0 55 0:19 25.70 391(1 120 142) 32( IwM) 75 76 7 200 2 _3 (U.&ii31 S11111 Mill 23001 _19212 (443 3333 050 0 7 1932 37111 31104 1m72 12fm) 151(0 644 550 7235 7,397 1 47 )leo y 27328 124111 116? 11 1l 037 0.20 N 4M 574 60 ih0 73 74 0 0 11 42 Chotic (6lom Evr) i 2M34 34511 (7 4: 7() 0_01 034 23,00 1720 3480 119 IM 2,1) 92 92 9M X) _4 4 änil Tu c Vadlje 43779 5013 N _ ,193 0 26 0511 11 mo(0 211 2EYl 3W 340 297 297 N N A_8 1.mt11n1 5411 h av r 403 1 25.29 2362 N 055 20.00 2000 11)3 511 SIX) 4111) 2 1 213) N N A_ 5 1.1o atukti fiai A 2443 2940 22.26 6.30 093 10 _20.00 3.50 3743 1579 .261' 6 54 156 600 4317 A 29 \o l Clton klil 36117 40569 _3358 (332 0.42 . 2500 1850 3736 353(3 04 3000 200 207 570 320 A 27 li hilal Facto SI1 5662 2553 22.22 0.6 0.50 _'17.13 70 2710 5936 11113 220 401 02 610 2220 A_ 34 xi,imx<t G:eneril 37925926 2.94 2.10 0.15 1.59 3.90 22 52 (77 164 269 2m 6ij aw .. 71 Nu.th Oli.a I.i.!rnliifC 5288:1 78453 1.99 _ 320 0333 024 _3690 31 0( 1297 I935 :,96 400 (92 39( (336 424 l3 29 _N,iei_i!boile _ 460 510 11.11 6.04 _090 1,20 24_30_ 20.12 321 3156 40 405 :1 m o 0i) 1 16 fland ol NO f hemiv 1144 _4927 _1635 ___TI N _ .29 2. l0 13.21 377y 3617 406 12 2i 2611 1 ) A 33 Linhn (Voking Vort 26199 4(072 16.46 (288 0)0 074 19.12 16(0 11 559 3943 703 93) 544 544 1 (3 3311 lCangln utheasl ( 9664 18951 21.12 9 lå 0.1I 027 20440 13 4f 2902 4,1))) 522 1 sm0210 21: 13 31 IL 2 slraev.:hu,Si Ikvme 6913 10N2 9(42 5.73 04) (365 229X0 V575 1i l075 221) 221 l( ili 231 2:31 A 51 ( 1tltet l(u11s1 ry 16204 28249 9.1 fi 63 0111 075 :32)0 23 201 624) 11043 1:1X) IM) 522 76 100 mi* N dala nio av;ilabile 1I3(I)/Il)A in USI) ten thousand 65 Annex 5 Comments Received on the PAR The attached comments were received from the Borrower on the draft PAR. Please note that the footnotes were prepared by OED and have been added to the text to respond to the Borrower's comments.  67 Mr. Manuel Penalver Division Chief Country Policy, Industry and Finance Operations Evaluation Department World Bank August 29, 1996 Fax No.: 001-202-522-3124 Draft Performance Audit Report for Fourth and Fifth Industrial Credit Project (CIB IV and V) Dear Mr. Penalver, We have received your letter and the attached draft Performance Audit Report for CIB IV and V projects (PAR) both dated July 12, 1996. With regard to the PAR, we have the following comments: 1. Performance Ratings. In general, the evaluation and rating for CIB V in the PAR is unfair and unacceptable. We do think that the implementation of CIB V is generally satisfactory, and it is unreasonable to lower the project rating only due to some temporary issues in the implementation such as onlending rate. 2. Project Objectives. The objectives of CIB IV and V have been fully reached. At the same time, the project has materially contributed to conversion of China Investment Bank (CIB) into really commercial bank since the objectives of the projects were designed in accordance with actual progress of China's financial sector reform and specific situation of CIB itself at that time. Currently, the World Bank is preparing a Financial Sector Development Project (FSDP) for China and aims to facilitate commercialization of China Construction Bank (CCB) through the project. CIB, as a wholly owned subsidiary of CCB, has been autonomously undertaking its commercialization reform under its own initiative and is in the forefront of financial sector reform in China. In this regard, the CIB IV and V projects financed by the World Bank have created a favorable condition for the reform process. In addition, since late 1980s, China has been beginning to undertake its enterprise reform, and most of enterprises needed funds to improve and modernize their facilities in the process. In this case, the projects have largely contributed to improvement and modernization of small and medium-size enterprises in China during the past years. Therefore, original objectives of the projects were fully justified and relevant to the stage of industrial and financial development in 1988/89.' 1 The basic purpose of both loans included the improvement of financial intermediation practices. However, the projects did not focus on improving China's investment allocation and pricing systems, both crucial for improving the efficiency of resource allocation. This issue is discussed in paras. 3.13-3.16. 68 Considering the reasons mentioned in the paragraph I and this paragraph, the CIB V project should be rated as "satisfactory" accordingly. 3. Access to Foreign Exchange. The PAR stated that "China was not suffering, a shortage of foreign exchange ..." and "it had substantial ... foreign exchange reserves which would have been available through the Bank of China." (para 3 of ES). However, since 1980s, with high economic growth rate, the economic development and the enterprises modernization in China have needed more foreign exchange, and Bank of China, China Construction Bank (original PCBC) and other banks could not meet the requirements for investments. The World Bank's loans under the CIB IV and V just provided supplemental funds and partially met the requirements of SMEs. The substantial increase of China's foreign exchange reserves is only relevant in the past two years. 4. SOEs. SOEs is a main category of Chinese enterprises and critical force of China's economy. It is true that some SOEs have "not performed well" (para 3 of ES), but the category is not declining. In order to strengthen its viability in the context of China's economic development, it is important and necessary to restructure and modernize SOEs to facilitate the transition process toward socialist market economy. This is one of reasons for CIB IV and V's investment "in state-owned enterprises" (para 3 of ES). 5. Content, Description and Evaluation. There are a lot of incorrect judgments in the Report and its ES. The following are main and important examples: A. The sub-paragraph (c) of the first paragraph of the Schedule 2 to the Loan Agreement for CIB V project clearly describes that one of the objectives for the project is "to finance investment in the modernization and restructuring of industry". Please note that it is "industry" not "light industry" as mentioned in the para. 2.32, 3.1, 3.2 and the ES (para. 3), etc.2 Accordingly, the related description and judgment in the paragraphs is incorrect and should be corrected. B. There are some detailed issues concerning judgment and evaluation of the projects in "Evaluation and Ratings" of the ES and Chapter 3: (i) In para. 4 of the ES (reference to para. 3.2 of Chapter 3), the description and judgment of " it is highly likely that these investments would have been made without CIB IV and V, because these projects had planning committee approval...." and "...they did not make any substantive incremental resource allocation contribution to industrial development" is incorrect. In fact, in accordance with China's investment approval system, any project to be financed by any resource must have been approved by relevant governmental authority or agency before the investment is to be made. The approval means that the project be authorized to proceed with funding either from domestic or foreign sources, including the World Bank. However, as a matter of fact, given the tight credits available from domestic banking system, the indicative borrowing itself from the World Bank as submitted to the Chinese authorities was an important factor for the approval. Accordingly, the above-mentioned judgment in the PAR is obviously misunderstanding and incorrect. Similarly, the judgment in para. 6 of the ES (para. 3.5 of Chapter 3) that 2 This is accurate. However, the President's Report and StaffAppraisal Report both describe the objective as financing "investment in the modernization and restructuring of light industry.... " 69 "the menu of projects for potential CIB funding was pre-determined by these committees" since "projects had to be approved by planning committees before assessment by CIB for funding" as well as related evaluation in this paragraph are also incorrect. (ii) In para. 5 of the ES (reference to para. 3.3 of Chapter 3), it is stated that "...China's State Planning Commission (SPC) and other agencies had adopted the Bank's appraisal methodology by 1986, perhaps the major contribution of those projects (i.e., CIB 1-111) Thus, CIB IV and V did not make any incremental contribution io spreading the use of project appraisal methodology and procedures. In any case, this education could have been provided through technical assistance without a credit line...." The description and the judgment are unacceptable to us because it is not proper and responsible to use the word "perhaps" for judging the contribution of the projects and infer the CIB IV and V not making any incremental contribution from the "perhaps" in the PAR.4 Furthermore, the CIB IV and V as the follow-up projects of CIB 1-111, in fact, did make its incremental contribution to developing the project appraisal methodology and procedures and particularly spreading their use further. In summary, there are confusing, inevidential and incorrect descriptions and evaluation for the projects in the Report is incorrect. We do not think that the judgment, evaluation and rating for the projects, especially for CIB V is objective, fair and reliable. Therefore, we would like to suggest that the Report be rewritten or significantly revised. Yours Sincerely /s/ Zhu Xian Acting Director World Bank Department Ministry of Finance, P. R. China Text ofPAR has been revised Text of PAR has been revised  71 To: World Bank Attn: Mr. Penalver/Ms. Galenson From: YANG Guangdou, General Manager China Investment Bank, Int'l Dept. 2 Date: August 7, 1996 Total pages: 4 Re: Performance Audit Report (PAR), CIB Fourth and Fifth Industrial Credit Projects Dear Mr. Penalver and Ms. Galenson, With reference to said PAR, kindly take note of our following comments: 1. The overall evaluation of PAR on CIB IV and V is unjustifiable, the evaluation is made without regard to the historical background nor to stipulations of the Loan Agreement. (1) Project Objectives. According to the Loan Agreement, the objectives of CIB IV was "to assist CIB in financing such productive facilities and resources in China as will contribute to the economic and social development of the country and to develop sound institutions for project appraisal and investment financing and improve financial intermediation practices." The objective of CIB V was "to continue institutional strengthening of CIB, in existing and new areas of operations, to expand and diversify CIB's resource base and to finance investment in the modernization and restructuring of industry". CIB IV & V achieved the prescribed objectives which were agreed by the World Bank, MOF and CIB at the time the credit lines were prepared. The fact that PAR changes the original objectives or adds new objectives in its assessment, and therefore, its conclusion are unacceptable.1 (2) Criteria of Project Selection. The stipulations of CIB IV & V Loan Agreements required CIB make "the Subsidiary Loan Agreement" with MOF. According to Subsidiary Loan Agreement (IV), CIB IV should finance export-oriented small & medium-sized projects which are urgently needed for national economic construction & capable of bringing good economic returns. The Subsidiary Loan Agreement (V) stipulated that projects should be selected from such sectors as chemical industry, electronics, metallurgy, building materials, light industry, textile, etc. The basic purpose of both loans included the improvement offinancial intermediation practices. However, the projects did not focus on improving China's investment allocation and pricing systems, both crucial for improving the efficiency of resource allocation. This issue is discussed in paras. 3.13-3.16. 72 Obviously, projects selected by CIB conformed to the requirement. Furthermore, there was no such clause in the Subsidiary Loan Agreement that loans should be directed to economically backward areas. It is inappropriate for PAR to base its judgement of project selection and regional distribution merely on the performance of the few sub-borrowers visited by Post-appraisal delegation of the World Bank, Mr. Khana and Mr. Schmidt.2 (3) In the case of appraisal methodology, the two credit lines helped CIB to utilize the experiences it gained in processing CIB I-III and to further improve its appraisal work. The appraisal system has ever since served as an example followed by all other Chinese banks. We feel unable to agree with the comment that "CIB IV and V did not make any incremental contribution to spreading the use of project appraisal methodology and procedures. "3 (4) The relationship between CIB and the State Planning Commission (SPC) is clear in respect of project approval. CIB should comply with the state industrial policies in selecting projects, but this does not mean that projects approved by SPC must necessarily be implemented by CIB. The misunderstanding of PAR in this respect is mainly due to its ignorance of China's social & economic system.4 2. Chapter 1 describes China's macroeconomic performance without direct relevance to CIB IV & V. The long discussion makes the reader wonder where exactly PAR places emphasis 5 on. 3. The same problem appears in Chapter 2. Much attention is devoted to CIB 1-III, other projects on-lended by CIB, branch network of CIB, the relationship of CIB and PCBC. The few statements relevant to IV & V, such as "physical implementation of the subprojects was successful, and subprojects returns are likely to be above threshold" seem inconsistent with "Summary of Ratings" in "Evaluation Summary" and makes the reader confused. 4. Most of Chapter 3 is a repetition of ES.6 What puzzles the reader is that, if such conclusions as "the physical objectives of CIB IV and V were met satisfactorily" hold water, then how can PAR, which is aimed to assess CIB IV & V, make a totally different overall evaluation? 5. May we conclude that the many mistakes, inconsistencies and meaningless repetitions in PAR indicate that the writers, before they set out to write, did not bother to fully understand CIB IV & V, China and World Bank policy to China or that they have obvious prejudice against what they write about? We request that, for the benefit of CIB's future development and WB's business growth in China, the inaccurate evaluations, wrong judgements and conclusions be conscientiously amended or rewritten. 2Text ofPAR has been revised Text of PAR has been revised The PAR states simply that the menu of projects for potential CIB funding was pre-determined by the planning committee. Chapter I has been revised Some material has been moved to Annex 1. 6 The Evaluation Summary focuses heavily on Chapters 3 and 4, which include the main conclusions of the PAR. See also footnote I above. 73 6. According to usual practice, a round-up talk is held between CIB and WB officials after the post-evaluation to inform each other of relevant views and conclusions. Mr. Khana and Mr. Schmidt refused our proposal of a round-up talk during their visit to China in April. It appears to us such style of work runs counter to standard practices of WB. Best regards, /signed/ YANG Guangdou Cc: 1. MOF 2. Jane Loos 3. Austin HU/Naiqin LU, WB Resident Mission in China The mission held a round-up talk with CIB before leaving Beying. It was agreed at that time that an additional round-up meeting would be held following the mission's visits to other cities only if those visits led to any revised or additional conclusions. As the mission's conclusions remained unchanged, no further meetings were necessary.  75 To: the World Bank Attn: Alice Galenson Date: July 17, 1996 Reference: Interest Rate issue of subprojects from Industrial Loan under CIB V. Dear Ms. Galenson: Soon after I received your EM dated June 22, 1996, I got my dept. people to go thoroughly through the subprojects financed with the CIB V. Here below is the detailed description on the interest rate concerned. I. The interest rate specified in the appraisal report of each subproject was in conformity with the requirement of the Loan Agreement. 2. During the early years of subprojects, CIB stuck to the stipulations of the Loan Agreement and abide by the schedule of appraisal reports, and set more than 1.5% interest rate margin of relending. 3. Being due to: (1) the exchange risk of Currency Pooling System, there was the 1.5% margin of relending that make things worse for the subborrower to suffer. In this regard, many subborrowers request CIB by reflecting to the Central Bank to lower the relending interest rate; (2) Facing the gradually lowering lending rate of foreign exchange in the chinese market since 1993, CIB had to adjust the interest rate temporarily for some of the subborrowers in order to lend out the committed loan as much and quick as possible, as well as to decrease the commitment fee payment. But from now on, CIB will resume the scheduled 1.5% margin step by step. 4. As for other subborrowers who were financially in better conditions and had stronger repayment capabilities, CIB, to its own favor, assumed the scheduled 1.5% margin all the time. 76 5. In the strive to relend the loan under CIB V, there happened somewhat personnel transfer as well as organization reform, leading to a less attention to the stipulation on interest rate in the Loan Agreement and belated report thereafter to your esteemed bank. For all these, we would like to make up in our future implementation. Yours Truly /signed/ Yang Guangdou General Manager International Dept. 2 China Investment Bank Cc: Jane LOOS Zafar Khan (EA2IN) World Bank Resident Mission in China Ministry of Finance of China    IMAGING Report No.: 16312 Type: PPAR