Colombia - Fifth Development Finance Companies Project

DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1266-CO REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO BANCO DE LA REPUBLICA WITH THE GUARANTEE OF THE REPUBLIC OF COLOMBIA FOR A FIFTH DEVELOPMENT FINANCE COMPANIES PROJECT May 18, 1973 This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CURRENCY EQUIVALENT2 / Currency Unit - Colombian Peso (Col$) US$1.00 - Col$23.38 Col$1.00 - us$.0o43 Col$1,000,000 - US$44,150 Colombia's Fiscal Year - January 1 to December 31 1/ May 11, 1973.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO BANCO DE LA 2EPUBLICA hITH GUARANTEE OF THE REPUBLIC OF COLOMBIA FOR A FIFTH DEVELOPMET FThANCE COMPANIES PROJECT 1. I submit the following report and recommendation on a proposed loan to the Banco de la Repfiblica (BR) - the Central Bank of Colombia - with the guarantee of the Republic of Colombia, for the equivalent of US$60 million, the proceeds of which would be made available to eight Colombian private development finance companies (Financieras). The term of the loan would be a composite of the terms of individual investment projects which will be up to 15 years, including grace periods not expected to exceed three years. The interest rate would be 7-1/4 percent per annum. The proceeds of the loan will be relent at 1O-3/4 percent interest if taken in foreign exchange or at 20 percent interest if taken in pesos, as long as the inflation rate in Colombia stays between 12 and 16 percent. If the rate of inflation departs from the aforementioned range, new terms of relending in.pesos will have to be agreed upon between the Bank, the Borrower, and the Government. PART I: THE ECONOMY 2. The Bank's most recent economic report (Economic Position and Prospects of Colombia) (R 72-21) was distributed to the Executive Directors on May 18, 1973. 3. ColombiA's econony is characterized first, by the problems resulting from poverty and population pressures both in rural and urban areas and secondly, by the foreign exchange constraint caused mainly by dependence on one crop - coffee - for the majority of export earnings. Concentration of land ownership, technical backwardness and poverty as well as severe underemployment characterize most rural areas, with the exception of certain enclaves of successful commercial farming. In urban areas, the pressures of population growth, compounded by heavy migration from the countryside, create a severe unemployment problem, In these urban areas, building and other construction, and industry create substantial numbers of productive new jobs but the speed at which this is possible cannot keep pace with the rapid increase of urban population. Thus, many newcomers to the labor market have had to find jobs in the service sector where underemployment is high, and a large part of the rest remain unemployed.  aL. A substantial measure of success has been achieved in coping with Colombia's foreign exchange constraint through policies to encourage non- traditional exports. Although Colombia has not freed itself from its dependence on coffee exports, the rapid growth of non-traditional exports, if continued, will achieve this result in the foreseeable future. 4ith regard to the other major structural problems - rural poverty and urban unemployment - no comparable success has been achieved so far. Recent Government ardministrations have reacted to these basic problems in a more systematic fashion than in the past but much remains to be done to alleviate unemployment and poverty. In spite of the passage of an Agrarian Reform Law in 1i961 and the creation of the Agrarian Reform Institute (INCO.A), also in 1 961, only modest results have been achieved in the battle against rural poverty. Also, until recently, no coherent policy frameworlc had been deveioped to cope with urban problems, particularly unemployment. However, evidence suggests that economic growth, as such, over the past ten years has been sufficient to avoid a large increase in urban unemployment. But it may prove difficult to maintain this situation if growth projections for urban labor supply prove correct. To cope with this situation, the Government has begun to shift the emphasis of its development strategy, giving among other things far more emphasis to urban development, particu- larly housing. Through this program it hopes to stimnlate a pattern of demand that will maximize employment. The most recent Bank economic report discusses this new strategy in detail. 5. The near term outlook for the Colombian economny is somewhat un- certain. Output growth is strong and was somewhat above 7 percent in real terms in 1972. Coffee prices are high and shipments are moving well. Non- coffee exports continue to grow rapidly and their total value approached the value of coffee shipments in 1'?72. Merchandise export earnings in 1972 were over US$500 million, some US$150 million above 1971 receipts, and net inter- national reserves of the Bank of the Republic reached nearly US$477 million (a historic high) at the end of March 1973. However, on the negative side, the rate of price inflation has accelerated with consumer prices estimated to have risen by about 11.4 percent during 1971 and 13.5 percent during 1972, as compared with a 7.5 percent average increase for the 1967-70 period. In these circumstances it is particularly importaint that Colombia continues her policy of frequent exchange rate adjustments, in order to maintain the momentum of non-traditional export growth. 6. For the medium-term future two other developments could make the management of Colombia's balance of payments more difficult. First, in response to high prices, world coffee supply might increase substantially, which would force coffee prices down. Second, it seems inevitable that by 1'975 or 1976 Colombia will have to begin importing crude petroleum on a substantial scale since dormestic requirements for petroleum products are rising far more rapidly than new oil reserves are being discovered in the country. Thus, it remains crucially important for Colombia to maintain the agricultural and industrial export drive to the fullest extent possible.  -3- 7 lDuring the five year period 19)66-72 current revenues of the national governriment have risern at an average of 10 percent per anmnum in real herms, and in 1'972 the national government generated some l)) percent of Dublic sector current revenue. Public investment is heavily (dcpendent u1pon support from the national governmer]t, which in 1,72 financed 35 per- cernt of the total public sector investment program, principally through capital transfers to the decentraliz.ed agencies. A combination of new fiscal measures and high coffee prices is expected to resulL in hig.h currerit revenues during 1 973, and1 tlhe cuLrrent surplus of the national gover,nrent is projected to rise 17 percent in real terms. This project,ion is based on a presumed cof'fee price of 64 cents in New York, which in present circumstances mav be considered conservative. ftinanciaI support for the public sector investment program should therefore be strong. Beyond 1973 the strength of the national goverrment finances will dependt upon new fiscal measures to maintain the momentum of current revenues. E'ven within the frameworlk of existing tax legislation, however, the current surplus of the national government is projected to rise by 5 percent in real terms during 1974. 8. Colombia's public debt service ratio is not high (1L4.6 percent in 1972), relative to many other developing countries. If accelerated economic growth continues, this ratio will rise and can be expected to peak at about 26 percent in 1d83. Public long-term external debt repayable in foreign currency amounted to US42.2 billion at the end of 1972, or US$1.4 billion excluding undisbursed commitments. Should real growth of the economy continue at roughly 7 percent per year, which appears feasible, and should this be accompanied by a further strong expansion of non-coffee exports and progress toward wider employment opportunities and an improved distribution of personal income, Colombia should merit a considerable and sustained inflow of long-term development capital. PART II: BANK GROUP OPERATIONS IN COLOMBIA 9. The proposed loan, whiclh would be the fifty-third made to Colombia, would bring the total amount of Bank loans to Colombia to US$967.7 million (net of cancellations). Of the foregoing amount, US$781.1 million is now held by the Bank. IDA has made one credit of US$1 9.5 million for highways in Colombia in 1961. 10. Disbursements have been completed on 30 loans and the one IDA credit. Of the 23 loans with undisbursed balances, progress is generally satisfactory, although problems are encountered in various projects. IFC has made investment and underwriting commitments in 27 enterprises in Colombia, totalling about US$20.0 million of which IFC how holds US$10.2 million. Annex II contains a summary statement of Bank loans, the IDA credit, and IFC investments as of March 31, 1973, and notes on the execution of ongoing projects.  1 1 . Bank disbursements as a percentage of total annual disbursements by official lenders to Colombia are expected to peak at about 40 percent in 1973-74 and then decline. The Bank's share of total debt service is also projected to peak at about 31 percent in 197b-75, and the Bank group share of total debt disbursed and outstanding is likely to fall from 28 percent in 1972 to 24 percent in 1978. 12. Prospective Bank loans in an advanced stage of preparation are a third education, a sixth railway and a water suppl;y project. Over the past few years, Bank lending in Colombia has expanded and become increasingly diversified and the Bank has assumed greater responsibilities as head of the Consultative Group for Colombia. Increasingly, projects involving loans in agriculture, industry and the social sectors were developed. While so far our efforts in these sectors have been mainly production-oriented in support of economic growth and related export expansion objectives, we are now seekcing to develop projects in such a way as to combine increasing output with maximum benefits in terms of employment and improving the income of the poor, particularly in rural areas. Such further shift in emphasis of Bank lending, however, will require a new approach in many instances and hence, project preparation and appraisal are likely to be more time-consuming. Also, at least in the initial stage, such projects are likely to be of much smaller size than the tradi- tional large infrastructure projects. 13. We expect over the next several years to make an increasing con- tribution to the agricultural and industrial sectors, with perhaps as much as 60 percent of our total lending in those two sectors. In evaluating the suitability of projects for Bank lending, four major objectives would be pursued: efficient growth of output; creation of employment; improvements for the lower income groups; and potential contribution to foreign exchange earnings or savings. 14. The other major focus of our activities would be in such social sectors as education and water supply, as well as in other project areas such as the traditional sectors of Bank lending - electric power and transportation - whenever important institution-building objectives can be achieved. In addition, in formulating conditions for lending, the Bank would continue to cooperate with the Government in its efforts to improve the fiscal system and in developing institutions capable of increasing public savings. 15. The operations of external lenders in Colombia are shown in Annex I, page 3. While IBRD, IDB, and AID provided about four-fifths of the total external financing to Colombia in the 1961-71 period, their share decreased to 53 percent in 1972. This reflects the Government's decision to diversify its sources of external financing mainly through medium and long-term borrowing from commercial banks and by issuing bonds abroad. The IDB has assisted  projects in low-cost housing, university education, agrarian reform, ports, electric power, water supply, transportation, and industry. AID has shifted the emphasis of its lending in recent years from program to sector loans, particularly for education, urban development, and agriculture. PART III: INDUSTRY IN COLOMBIA 16. Over the last decade, industrial development in Colombia has made good progress. Manufacturing (excluding handicraft) has slowly increased its contribution to GDP from about 14 percent in 1960 to about 17 percent in 1971, and industrial growth continues to be somewhat faster than overall economic growth. Originally, industrial development policy was oriented entirely toward import substitution, but in recent years industry has begun to contribute substantially to the rapid increase in non-traditional exports, which partly reflects the fact that Colombia has an active entrepreneurial class; and its industry, in spite of protection, has managed to achieve a reasonable level of efficiency in many subsectors. 17. Colombia has an urban and regional structure which is unique in Latin America. The centers of development are widely dispersed throughout the country because, until recently, Colombia's difficult geography enforced the semi-isolation of regions and led to the growth of decentralized urban centers. In contrast to the monocentric urban structure of many Latin Ameri- can countries, Colombia has four major centers (BogotA, Medellin, Barranquilla, and Cali) of over 500,000 inhabitants each, and 100 urban centers with over 10,000 inhabitants. Industrial production in Colombia, unlike that in other Latin American countries, is distributed among the four major urban centers and several smaller industrial cities, and thus the direct effect of industrial- ization and its multiplier effects reach a larger share of total population than in developing countries with only one predominant industrial center. 18. Industry's direct contribution to increased employment, however, has been modest, i.e. the rate of increase in industrial employment Just kept pace with the overall increase of employment in all sectors excluding agricul- ture. Its indirect contribution, particularly to employment growth in the modern part of the service sector (banking, wholesale and retail trade, trans- port, repair and maintenance, etc.) has probably been substantial, although statistically unmeasurable. At any rate, judging from experience in the majority of cities in the developed countries, it seems that in the longer run the urban unemployment problem cannot be solved without rapid industrialization. 19. Until recent years, Colombia's industrialization policies were limited largely to a few standard policy measures to encourage import substi- tution. These included import licencing, tariff protection for domestic industry and some tax incentives, which have been largely ineffective. In recent years, a number of export promotion measures, such as a tax credit certificate (15 per- cent of fob export price) and exemption from tariffs of imported inputs for export products, have been added. On the other hand, the credit system has traditionally been regulated in favor of agriculture, housing and the public  -6- sector. Thus, industry and commerce pay substantially higher interest rates than other sectors. These regulations have developedl as a result of an almost constant shortage of capital and have reflected the absence of comprehensi-ve policies to develop the capital market. I'he high concentration of wealth and share ownership, the heavy competition for savings combined with effective official ceilings on interest rates, and the large share of their assets that financial institutions must invest in certain govermnent prescribed sectors have all contributed to restrict the development of a functioning capital market. 20. The extent to which industrial investment has suffered from this situation, as well as from the frequent shortages of foreign exchange is dif- ficult to determine but available evidence suggests that serious shortages oL funds, both for short and long-term purposes, have occurred fairly frequently. Although smaller firms have been affected. most by these shortages, the speed with which external loans to this sector have been comritted indicates thiat demand has far outstripped supply throughout the whole sector. 21. 'rhe Bank 's involvement with industrial financing started in, 1 16, wnen the Bank supported the creation of the Private Investment itnd (PIF) wibhiri the Barnco de la Rep