Philippines - Third Development Corporation Project

RESTRICTED FILE COPY Report No. P-721 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE PHILIPPINE NATIONAL BANK FOR A THIRD DEVELOPMENT CORPORATION PROJECT WITH THE GUARANTEE OF THE REPUBLIC OF THE PHILIPPINES June 10, 1969  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOI1iENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE PHILIPPINE NATIONAL BANK FOR A THIRD DEVELOPEMENT CORPORATION PROJECT WITH THE GUARANTEE OF THE REPUBLIC OF THE PHILIPPINES 1. I submit the following report and recommendation on a proposed loan in various currencies equivalent to $25 million to the Philippine National Bank (PNB) for relending to the Private Development Corporation of the Philippines (PDCP). PART I - HISTORICAL 2. PDCP was established in February L963 with the Bank Group's assistance. The proposed loan, if approved, would be the Bank's third for PDCP; the first loan (331-PH) of $15 million was made in February 1963 and the second (467-PH) of $25 million in September 1966. As in the case of the first two loans, the proposed loan would be made to PNB, a Government owned institution, with the guarantee of the Government, and PNB would relend the proceeds of the loan to PDCP; under existing law the Government is unable to guarantee a Bank loan directly to a private corporation. 3. In December 1968, with the agreement of the Government and PNB, PDCP asked the Bank to consider making a third loan in an amount of $25 million to replenish its foreign exchange resources. A Bank mission appraised PDCP's operations in March 1969. 4. In M@ay the Government informed the Bank that in connection with the proposed loan it would require an explicit understanding between PDCP and the Government that the proceeds of the loan would be used in conformity with the Government's economic development policies, programs, and priorities. As this is consistent with its corporate policies and objectives, PDCP was quite ready to conform. We have reviewed the proposed agreement between the Government, PNB and PDCP, in which this understanding is expressed, and have found it acceptable (the text appears as Annex 5 to the attached appraisal report). 5. Negotiations were held in Washington from Hay 23 to 29, 1969. The Government was represented by His Excellency Ernesto V. Lagdameo, Ambassador to the United States, and Mr. Cesar Virata, Chairman of the Board of Invest- ments; PNB by Hr. Arturo R. Cruz, Vice President; and PDCP by Mr. Roberto T. Villanueva, Chairman and President, Hir. Vicente R. Jayme, Executive Vice President and Hv1r. R. M. Jalandoni, Attorney.  - 2 - 6. The proposed loan would be the twelfth in the Philippines and it would increase the total amount lent to $183.2 million, net of cancellations. The following is a summary statement of Bank loans to the Philippines as at May 31, 1969: Loan Amount (US$ million) No. Year Borrower Purpose Bank Undisbursed 183 PH 1957 National Power Corp. (wPC) Power (Bi.nga) 18.4 - 290 PH 1961 R.epublic of the Phi- lippines Dredging 7.4 - 297 PH 1961 NPC Power (Angat) 33.5 - 325 PH 1962 NPC Power (Haria Cristina) 3.4 - 331 PH 1963 Philippine National Relending to the Pri- Bank (PNB) vate Development Cor- poration of the Phi- lippines (PDCP) 14.8 - 386 PH 1964 National Waterworks & Sewerage Authority (HWv1SA) Nianila Water Supply 20.2 4.5 393 PH 1964 Republic of the Phi- Education (College lippines of Agriculture) 6.0 2.6 432 PH 1965 Central Bank of the Philippines Agriculture 5.0 - 467 PH 1966 PNB Relending to PDCP 25.0 12.4 491 PH 1967 NIPC Power (Bataan) 12.0 10.2 607 PH 1969a/Central Bank of the Philippines Agriculture 12.5 12.5 Total (net of cancellations) 158.2 of which has been repaid to Bank and others 15.3 Total now outstanding 142.9 Amount sold 12.0 of which has been repaid 7.4 4.6 Total now held by Bank 138.3_/ Total undisbursed 42.2-/ a/ Signed in June 1969; not yet effective. b/ Including $12.5 million not yet effective.  - 3 - 7. Although project implementation in the public sector has improved, a number of difficulties still remain with Bank-financed projects as explained in my Report and Recommendation (No. P-697), dated Niay 15, 1969, in connection with the Second Rural Credit Project. The Bank will continue to press the Government and the Borrowers (NWSA and NPC) to take the necessary actions. 8. A loan of $35 million for the Upper Pampanga River Irrigation Pro- ject has been appraised and is expected to be ready for the Executive Direc- tors' consideration in the next few months. A Grain Storage Project requiring a loan of about $15 million is also being appraised and may be ready for the Executive Directors' consideration later in the year. 9. IFC's loans and investments in the Philippines consist of an equity investment of P800,000 (equivalent to $205,000) in PDCP, which has since been sold to other investors; and an equity investment of $4 million equivalent and a loan of $8 million in the 1M1anila Electric Company, of which IFC now holds $3.6 million and $9.3 million, respectively, for its own account. IFC is appraising two projects for loan and share investments - Philippine Long Dis- tance Telephone Company ($4.5 million) and iIariwvasa Aianufacturing, Inc., a ceramic tile plant ($1,150,000) - and expects to submit these projects to the Executive Directors for consideration in July or August. PART II - DESCRIPTIONI OF THE PROPOSED LOAN 10. Borrower: Philippine National Bank. Guarantor: Republic of the Philippines. Beneficiary: Private Development Corporation of the Philippines. Amount: In various currencies equivalent to $25 million. Purpose: The loan is to be relent by PNB to PDCP to finance foreign exchange costs of specific projects undertaken by private productive enterprises for the economic development of the Philippines. Amortization: The initial amortization schedule provides for repayment over 17 years, including a grace period of two years, through 31 semi-annual instalments beginning July 1, 1971 and ending July 1, 1986, subject to amendment from time to time to conform substantially to the aggregate of the amortization schedules for loans and other investments financed out of the proceeds of the loan.  -4 - Interest Rate: 6Ng per annum. Commitment Charge: 3/4 of 1% per annum. E-,elending terms: PNB would relend the proceeds of the loan to PDCP at the Ban.c's interest rate plus a service charge of .443" per annum. Prior Approval All loans for projects requiring more than of Projects: $500,000 in foreign exchange and all equit-r investments are subject to the Bank's prior approval. PART HII - THE PROJECT 11. A report entitled "Reappraisal of Private Development of the Philippines" (No. DB-51a), dated June 10, 1969 is attached. 12. At the time PDCP was established in February 1963, IFC made an equity investment in PDCP of P800,000 (about $205,000) which has since been sold to other investors at a profit and PDCP obtained a peso loan of P27.5 million (about $7.1 million) from USAID, in addition to the first Bank loan for PDCP of $15 million. PDCP's other borrowings consist of two foreign exchange loans - a second Bank loan of $25 million and an Asian Development Bank (ADB) loan of $5 million. 13. By the end of Hay 1969, PDCP had had access to total resources amounting to over $61.3 million equivalent. These consisted of share capital, reserves and retained earnings which totalled about $9.7 million equivalent, and the four loans totalling $52.1 million from the Bank, USAID and ADB. 14. In its five and a half years of operations to the end of 1968, PDCP had made 158 loans totalling $51 million equivalent for 99 projects for modernization and expansion of existing enterprises and for new ventures. Of these, 85 loans totalling $36.6 million were in foreign exchange. 15. PDCP's share investments and underwritings have been modest. But there are prospects that PDCP will have increased opportunities to expand these activities in the future. 16. At the end of June 1969, PDCP is expected to have uncommitted foreign exchange resources of about $4 million. On the basis of proposals in various stages of investigation, PDCP estimates that during the two years from July 1969 it will be able to commit for loans and other investments a total of about $36 million equivalent, of which about $29 million will be in foreign exchange. PDCP will therefore need new foreign exchange resources of about $25 million for the two-year period to mid-1971. PDCP expects to raise additional peso resources through portfolio sales and peso borrowing.  17. PDCP has now completed nearly six years of operations. It has continued to be a well-organized and smoothly functioning development finance company. Its management is able and experienced,- its staff is competent, and the quality of its project appraisal is good. 18. PDCP's financial performance is good. Net profit after taxes has increased steadily and amounted to P4.9 million at the end of 1968, represent- ing about IV, of net worth. Net profit is expected to rise to P7.6 million by the end of 1971 or about 16% of net worth. An annual cash dividend of 10% has been paid for the last four years, while adequate allocations have been made to reserves. At the end of 1968, reserves and retained earnings totalled P11.3 million, representing about 5, of its share capital and 11% of its portfolio. PDCP's P10 shares were traded at between P14.75 and P15.75 in 1968. PDCP's financial position is satisfactory; its investment portfolio is sound; and its prospects are good. PDCP should be able to meet debt service payments on the proposed loan and other borrowings, as well as to main- tain satisfactory dividend payments and adequate allocations to reserves. 19. PDCP is the largest private industrial finance company in the Philippines. Its impact on the economy has so far been modest3 PDCP estimates that its financial assistance accounted for only 4% of total private industrial investment in 1968. However, this figure underestimates PDCP's irnportance, given the care with which it selects projects. Pioreover, its significance should increase in future, if it can comm,and adequate resources. PART IV - LEGAL INSTRUIiENTS AND AUTHORITY 20. The draft Loan Agreement between the Bank and PNB, the draft Guarantee Agreement beuween the Republic of the Philippines and the Bank, the draft Project Agreement between the Bank and PDCP, the Report of the Comnittee provided for in Article III, Section 4(iii) of the Articles of Agreement of the Bank and the text of a draft Resolution approving the proposed loan are being distributed to the Executive Directors separately. 21. The draft loan documents contain provisions norraally used for development finance company projects and follow the same pattern of the documents used for the previous two loans made by the Bank to PNB for relending to PDCP. The Subsidiary Loan Agreement to be entered into by PNB and PDCP containing the terms and conditions of such relending has been approved by the Bank and cannot be amended without the agreement of the Bank. 22. In addition, the debt limitation covenants in the previous two pro- ject agreements are amended to conform with the new debt limitation covenant set forth in the draft Project Agreement (Sections 2.09, 3.01 and 3.02).  - 6 - PART V - THE ECONC4Y 23. An Economic Report on IrThe Current Economic Situation and Pros- pects of the Philippines" (No. 138a, dated May 24., 1968) was distributed to the Executive Directors on June 3, 1968 (R68-90). Plore recent developments were described in my Report and Recommendation (No. P-697), dated May 15, 1969, in connection with the Second Rural Credit Project. 24. As emphasized during presentation of the above menticned project, we are satisfied that the Government has made significant progress in dealing with the major long-term problems confronting the economy. This applies particularly to progress in increasing public savings in order to strengthen the economy's infrastructure. Despite the progress made in augmenting Government revenues, these are still considerably below the requirements of the economy. The Government is fully aware of this and has placed addi- tional tax bills before Congress. This being an election year, Congressional reaction to these is uncertain. We will continue to support and encourage the Government's efforts to raise additional revenues. 25. There has also been a considerable improvement in the policy framework to facilitate the channeling of private sector resources into areas and activities which are most conducive to economic growth. Of particular significance for the proposed loan, which will be used by the private sector, is the enactment in 1967 of the Investment Incentives Act and the setting up in 1968 of the Board of Investments (BOI) to im- plement that Act. The BOI is required to select those industrial activi- ties which have high economic priority but which are unlikely to go forward at the required pace without the tax incentives provided by the Act. The BOI is also charged with the responsibility of determining within each industrial field the specif'ic projects that will qualify for these incen- tives. While the provision of incentives to industry is not a new develop- ment in the Philippines the detailed and systematic analysis of the BOI is relatively novel. It is particularly encouraging that the BOI is determined to avoid the problems created in the 1950's by the indiscriminate estab- lishment of industries with heavy protection. By the end of April 1969, the BOI had approved 107 projects entailing a total investment of more than $300 million, of which about $180 million is in foreign exchange. 26. Despite a short term debt problem brought about by current balance of payment difficulties, the longer term external indebtedness of the Philippines is relatively low and the Philippines should be able to service an increasing inflow of long term capital for the financing of economically productive investments, including the proposed loan. PART VI - COMPLIANCE V4ITH ARTICLES OF AGREEMENT 27. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank.  - 7 - PART VII - RECOiNdIE1EDATION 28. I recommend that the Executive Directors approve the proposed loan. Robert S. MicNamara President Attachment WTashington, D.C. June 10, 1969