Afghanistan - Industrial Development Bank Project

FILE COPY DOCU1MENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION Not For Publc Use Report No. 66a-AF APPRAISAL OF A FIRST PROJECT TO ASSIST THE INDUSTRIAL DEVELOPMENT BANK OF AFGHANISTAN April 6, 1973 Development Finance Companies Division Europe, Middle East and North Africa Region | This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Baok Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report.  CURRENCY EQUIVALENTS Prior to Feb. 12, 1973 US $1.00 - Af 80 AS 1,000 - US $12.50 Since Feb. 12, 1973 US $1.00 = Af 71.55 Af 1,000 = US $13.98 (Approximate Free Narket Rates) FISCAL BAR March 21 - March 20 This report was prepared by Henry B. Thomas on the basis of a visit by Douglas Gustafson, Raj Krishna and Henry B. Thomas to Afghanistan in July 1972 and of an earlier visit by Douglas Gustafson and Peter Mbdeen in January 1972.  APPRAISAL OF A FIRST PROJECT TO ASSIST THE INDUSTRIAL DEVELOPMENT BANK OF AFGHANISTAN Table of Contents Page No. SUMARMY .......,,.,...,,, .,, ..... i-ii I. INTRODUCTION ....... ........ ,. . 1 II. THE ENVIRONMENT ..................... . . , 2 General Background ...2... ... 2 Private Sector Manufacturing Activity ...... 3 The Financial Environment ................ 5 Conclusion 00..o.. 7 III. THE PROPOSAL ...................... , 8 Legal Basis .......... .. 8 Ownership ............. ... 0....... 8 Objectives and Powers .. ....... .......... 8 Policies ......... ... ........... 8 Resources ,.... .* .... 9 Board of Directors and Executive Committee 11 Management and Staff ..... .............. 12 UNDP Technical Assistance .... 12 Application of FDPIL ............... ........ 12 Audit ......... . ., ..,.13 IV. BUSINESS PROSPECTS AND FORECASTS o................... 13 V. CONCLUSIONS AND RECOMMENDATIONS... 14 Conclusions ......... , 14 Reconmendations .15   LIST OF ANNEXES 1. Members of the Sponsoring Committee 2a. Law of Industrial Banks in Afghanistan 2b. Regulations for Obtaining Loans for the Industrial Development Bank of Afghanistan 3. Summary of the Foreign and Domestic Private Investmeni: Law 4a. Afghan Subscribers to the Share Capital 4b. Prospective Foreign Subscribers to the Share Capital 5. Policy Statement 6. Members of the Board of Directors 7. Assumptions Relating to Financial Projections 8. Projected Cash Flow Statements-Optimistic Assumption 9. Projected Profit and Loss Statements-Optimistic Assumption 10. Projected Balance Sheets-Optimistic Assumption 11. Projected Cash Flow Statements-Conservative Assumption 12. Projected Profit and Loss Statements-Conservative Assumption 13. Projected Balance Sheets-Conservative Assumption 14. Schedule of Estimated Disbursements of the Proposed Credit   SUMMARY i. The proposal to establish the Industrial Developmernt Bank of Afghanistan (IDBA) has been under consideration since 1963. The enactment in 1967 of the Foreign and Domestic Private Investment Law (FDPIL) has provided a setting sufficiently conducive to private industrial investment to support such an institution. The passage in 1971 of the Law of Industrial Banks in Afghanistan (the IDBA Law) provided the legal basis for IDBA's establishment. ii. Since the FDPIL came into effect, making financial incentives available for approved projects, there has been an upsurge in private investment activity, although the present level of about $7 iLllion a year can only be considered moderate. However, there is at present: essentially no institutional source of long-term capital in Afghanistan; this lack has certainly inhibited investment as most projects have had to rely completely on owners' capital. The IDBA is designed to fill this gap, as well as to provide technical assistance and to act as a catalyst in deveLoping new projects. iii. It is proposed that the IDBA be established with a share capital of Af 240 million ($3.4 million equivalent), 40% of which will be held by foreign investors including a proposed investment of about $250,000 equiva- lent by IFC, and 60% by local investors (mainly private). The IDBA Law pro- vides for a Government loan to the IDBA of Af 560 million ($7.8 million equiv- alent) on concessionary terms. iv. An IDA credit of $2 million is proposed; it would be made available to the Royal Government of Afghanistan which would on-lend it to the IDBA at 7-1/4% p.a. interest for 18 years including three years grace. This credit is expected to cover the foreign exchange cost element of projects the IDBA finances during its first two years. It (and IDBA's local currency resources) will be relent by IDBA at 10%, with the foreign exchange risk being covered by IDBA's borrowers. The Government feels, however, that with foreign ex- change loans, because the risk is being passed on, the 10% rate would be too high for small-scale industries. As a matter of policy, therefore, the Gov- ernment, through rebates to small-scale borrowers, will bring the effective interest rate on foreign exchange loans down to 8%. v. The IDBA will be able to provide both debt and equity financing and to underwrite and guarantee credit from other sources. Initially it is expected to focus on the private industrial sector, though it will not be precluded from assisting Government enterprises or enterprises in other sectors such as mining or tourism. It will be guided by a Policy Statement similar in most respects to policy statements adopted by other development finance companies. vi. The Board of Directors of IDBA is responsible for general policies and procedures. An Executive Committee deals with all investment proposals. The President is Dr. Nour Ali, a prominent Afghan citizen. A UNDP technical  - ii - assistance grant has been arranged to cover the cost for up to five years of an expatriate General Manager, financial manager and engineer; arrangements have been made to fill these positions. The World Bank has agreed to be the Executing Agency for this project. vii. Forecasting the level of business the IDBA is likely to receive is difficult. However, it seems reasonable that the IDBA should be able to commit the equivalent of about $2 million in the first year, with the amount increasing gradually in subsequent years. With the low operating costs prevalent in Afghanistan, the UNDP assistance and the concessionary Government loan, the IDBA should be profitable from the beginning and be able to give moderate returns to shareholders.  I. INTRODUCTION 1. Since 1963 the possibility of establishing a development finance company in Afghanistan to provide long-term finance to soundly based manu- facturing enterprises has been periodically explored by the Royal Government of Afghanistan (RGA), Afghan private investors and the Chase Manhattan Bank (Chase). The Bank Group was associated with this endeavour in the early years but could not see its way to support the proposal as it then emerged and ceased to be actively interested in 1966. The other sponsors pursued the idea. In 1967 a Law of Industrial Banks in Afghanistan was proposed to Parliament authorizing the establishment of development finance companies, and in particular, through special provisions within the Law, of the Indus- trial Development Bank of Afghanistan (IDBA). At the same time a Sponsoring Committee of Afghan businessmen was formed (the membership is; given in Annex 1), the framework of a development finance company proposal was developed and local subscriptions to the share capital were invited. Consideration of the proposed Law by Parliament, however, became quite protracted, and as a result the Sponsorlng Committee became inactive. 2. The proposal was reactivated in August 1971 by the passage of the Law (hereinafter referred to as the IDBA Law). 1/ In October 1971 the Association was invited to re-examine the prospects for the proposed company. The Government also requested that Chase, due to its historical interest in the project, re-examine the situation. An Association mission visited Afghanistan in January 1972 to undertake this examination. Preparatory work for this mission was carried out in Afghanistan by Dr. Mohammed Aman, former Minister of Finance and Chairman of the Sponsoring Coimmittee, with the assistance of a number of foreign advisors. Following that mission, discussions were held with Chase and agreement was reached on a general proposal for the establishment of IDBA. This proposal was sent to the interested Afghan parties and the Government. Chase also presented this proposal to a group of potential foreign investors. A second Association mission, together with a representative of Chase, visited Afghanistan in July 1972 to discuss the proposal with the Afghans. General agreement was reached by all parties during that visit that the proposal represented a suitable basis for establishing the IDBA. 3. On the basis of this agreement, Chase received firm expressions of interest from four other foreign banks to subscribe to part of the share capital of the IDBA. IFC also considered the proposal and agreed to consider an equity investment if the Association decided to proceed with the proposed credit. Local subscriptions had already been obtained by the Sponsoring Committee. On March 3, 1973 the IDBA was incorporated with the Afghan in- vestors paying in their portion of the share capital (60%). Negotiations for the proposed IDA credit were held in Washington D.C. from March 12 to 21. 1/ An unofficial translation of this Law is given in Annex 2a.  -2- II. THE ENVIRONMENT General Background 4. The level of manufacturing activity in Afghanistan is small and substantial increases in industrial output face serious obstacles. 1/ To cite a few parameters, per capita GNP is estimated to be about $80 (there are no national accounts). In a country of some 15 million people cement con- sumption is below 100,000 tons. Cotton cloth consumption is slightly above 100 million meters. Total imports of consumer, intermediate and capital goods are only about $70 million per annum. These low levels of consumption reflect a population that is still struggling to meet its most basic needs rather than one that has begun to enjoy, in any significant way, expansion of incomes. Given its landlocked position, a difficult internal communication system, relative lack of exploitable raw materials, plus an agricultural economy still highly dependent on the vagaries of weather, it is not surpris- ing that the manufacturing sector of the economy is small. 5. The RGA's attitude toward industrialization has also had an impact on the sector's development. Private initiative was active in the pre-World War II ear and private sector enterprises, some with monopoly powers, did extrenely well. So well, in fact, that one result was a reaction against private enterprise. During the 1950's some private firms were nationalized and the RGA undertook substantial new investments in manufacturing facilities. In many cases the RGA made these investments because it felt that private initiative would not undertake the projects. Many mistakes were made, the most serious being that, with one or two notable exceptions, government companies suffered, and continue to suffer, from very poor management. Few government enterprises even have balance sheets; most are undoubtedly losing money--how much no one really knows. 6. The RGA now operates, among others, firms making cement, metal tools and forgings, cotton textiles, ginned cotton and bakery goods. By 1970 public sector enterprises accounted for about 75% of the investment and about half of the sales and employment of all manufacturing enterprises employing 50 or more workers. The Government has let the private industrial sector expand but rarely allowed private investments in industrial sectors where it is heavily involved. 7. The private sector has also made mistakes. Business failures have not been uncommon. Indeed, the only major manufacturing investment made by the RGA in the last two years was necessitated when a new private textile mill defaulted on loans guaranteed by the RGA (it was built without a power supply--now due two years later than planned), and consequently the RGA had to take it over. 1/ For a description of the economic condition and prospects of Afghanistan see IBRD Report No. SA-29a; February 1, 1972.  -3- 8. In recent years, however, the problems of the past and the lack of Government resources appear to be dampening the RGA's interest for going into those manufacturing activities which could be undertaken by the private sector. In 1967 the Foreign and Domestic Private Investment Law (FDPIL) 1/ was passed, making possible a range of import duty and tax relief incentives for approved investments. In the Fourth Five Year Plan (1972/73-1976/77) now under consideration, there are no firm plans for new manufacturing investments by the RGA and the climate for private sector investment is probably as good now as it ever has been in Afghanistan. Indeed, there is evidence that the RGA in some cases may have been overly generous in its incentives to new private manufacturing facilities. Competitiveness has not been systematically used as a test, the screening of projects for fiscal incentives has not been very vigorous and all available incentives under the FDPIL have been given to projects approved by the Investment Committee 2/ irrespective of their relative economic worth. Recently, however, new investment criteria were established with a view to avoiding creation of over-capacity and balance of payments problems. The Investment Committee has started to heed these criteria. Private Sector Manufacturing Activity 9. There is little reliable data for employment or output of private, very small-scale manufacturing activities, traditional in Afghanistan, which include such activities as rug weaving, some textile production, shoe-making, furniture making, metal houseware goods, basic processed foods, etc. Most of these activities are primitive household-type production and, unless put on a more organized basis, are not the sort of activities which offer much scope for development with inputs from financial institutions. Exceptions, however, are two sub-sectors that could assume increasing importance, partic- ularly in terms of their export potential, namely embroidered cloth and leather garments and related handicraft items and carpets. 10. Data is, however, available on private sector firms employing more than 50 workers. A review of this data gives a good picture of the existing larger scale manufacturing units in the private sector. A convenient way to review this sector is to consider those projects established before the FDPIL and then to consider those established subsequently. There are about twelve private companies employing more than 50 workers that pre-date, and therefore do not have the privileges extended by, the Law. The twelve include a tex- tile mill, a sugar mill, a cement plant, four cotton ginning firms, two wool product plants and three small workshop-type enterprises. Within this group the Afghan Textile Company is dominant. A Bank Millie enterprise (see para- graph 18), it has a capacity of 85 million meters and employs 6,400 people; this is about 38% of total private sector manufacturing employment in firms employing 50 or more. These twelve "old" companies have total (depreciated) 1/ The main provisions of this Law are summarized in Annex 3. 2/ The Committee consists of the Ministers of Finance, Commerce, Planning, Mines and Industries, and Agriculture.  - 4 - assets at present of about $18 million equivalent. The textile company accounts for about 70% of this total. Interestingly, almost all of the above companies are currently experiencing difficulties. Most are operating substantially below capacity due to raw material supply problems, lack of demand, or poor managerial and marketing skills. 11. As to the firms operating with approved status (and virtually every significant new investment made since 1967 is an approved project under the FDPIL), the number is larger although the magnitude of invest- ment is smaller than that represented by the twelve older firms. From the passage of the FDPIL through September 1972 some 175 projects have been approved by the Investment Committee. Of these, about 120 have been or are being implemented. (Some of the remainder are not likely to be implemented as in many cases more projects were approved in a given line of business than demand warranted.) From an analysis of the data on these projects it is possible to get a rough idea of private manufacturing investment in the last few years. In the 1967-1969 period it was very modest, but it seems to have totalled about $6 million in both 1970 and 1971 and probably totalled about $7 million in 1972. This excludes whatever investment took place in firms not enjoying approved status, but this is probably not a significant exclusion. 12. The approved projects that are now operating, some 80 ventures, cover a wide field of activities. On the export side, a number of raisin cleaning and packing plants have been established. Also, plants for the initial phases for processing casings and skins have been set up. Some tanning facilities have also been established, although this activity is still at an early stage of development in Afghanistan. Finally, a few leather and embroidery goods manufacturers have expanded and are beginning to enjoy favorable export results. On the import substitution side there has been a rash of rayon weaving plants based on imported yarn, plus sundry plastic and metal goods assembly and manufacturing plants. The most sizeable projects in the last few years include a pharmaceutical plant, a cotton textile mill, a soft drinks plant, a soap factory, a shoe factory and a lubricating oil plant; in advanced stages of implementation are a viscose rayon yarn plant, a match factory and an electronic data processing installa- tion. 13. Of the approved projects that have been, or are being, implemented, almost one-quarter involve foreign investors, often in partnership with local investors. Pakistanis head the list of foreign investors and Indian and Pakistani firms are likely to be the major foreign investors (by number if not by amount of investment) in the foreseeable future. Foreign investment prior to 1967 was almost non-existent. 14. In considering the level of private manufacturing investment there are two related questions that are difficult to answer. First, to what extent has the absence of the possibility of borrowing long-term capital been a brake on the expansion of business activity? Second, what sort of invest- ment trend is reasonable to forecast for the future? As to the first question,  - 5 - it is a common complaint that many Afghan companies depend completely on owners' capital and are capital-starved. (Some larger firms have had access to suppliers' credits.) Quantification of this problem in terms of the amount of good banking business that is not being done is well-nigh impossible. However, by and large it would be true to say that the lack of long-term loan capital has been an inhibiting factor for investment. 15. As to the level of future investment, the scanty data base makes quantification even more difficult than the determination of past investment. However, there is investment potential. One area is import substitutioni activities. For example, in the textile sector some of the cloth varieties locally consumed are not produced in Afghanistan. Additional rayon spinning capacity is required to supply the several rayon weaving plants that have been established and which now depend on imported yarns. Agricultural pro- cessing possibilities, including export opportunities, are fa,r from being fully exploited. Processing of meat, vegetables and other perishable products is almost non-existent. Further processing of skins is likely to become more important with the organized development of the livestock sub-sector that the Government is now implementing. Industry based on livestock slaughtering and products is another area which has been almost totally neglected. (The recently approved livestock development project will begin to develop this industry in Herat province). The quality of the products of the existing dry fruit processing plants is inadequate and quality improvement could raise Afghanistan's exports substantially. Fruits and nuts accounted for $29.3 mil- lion or 35% of exports in 1970/71. As noted earlier, handcrafted products such as coats and other leather items and carpets represent good potential for exports if quality and design standards are improved and if these can be transformed from the present small "household-type" activities. The scope for trucking business, and hire-purchase facilities for it, has also increased as Afghanistan has recently become a party to the International Road Transport (TIR) convention, the first step to obtaining trucking transit rights in other participating countries' territories. (The RGA has agreed, in conjunction with the livestock development project, to complete the other steps needed for obtaining transit rights within a year.) In short, while it is not justified to project a rapidly rising curve for private manufacturing investment, there are reasonable prospects for the level of recent private industrial investment activity to be at least maintained, if not to grow moderately in the immediate years ahead. The surge of applications following the passage of the FDPIL, and the applications presently in the pipeline, indicate that there is invest- ment interest. The availability of term financing should contribute to the realization of that interest, and in fact kindle the realization of some proj- ects that would otherwise not go ahead. The Financial Environment 16. There are three commercial banks In Afghanistan which provide finance to the private sector. 1/ Their activities are supplemented by bazaar money- 1/ While there is a Commercial Code, there is no legislation related to banking as such other than the IDBA Law. Each bank's policies are based on its Articles of Incorporation and historic practices.  -6- lenders, although the magnitude of the services of the bazaar bankers is not quantifiable. Of the three banks, the Governiment-owned Da Afghanistan Bank is by far the largest with assets of about Af 40 billion. This bank also acts as the bank of currency issue. However, although it serves in part as a Central bank, it has no powers of credit control vis-a-vis the other two banks. The great majority of its business is related to government activities. Its total credit to the private sector has fluctuated around Af 1 billion in recent years and most, if not all, of it is short-term trade credit. The amount of credit which it proposes to channel to the private sector each year is subject to Cabinet approval. Its operations with new manufacturing firms have so far been inconsequential, and becausq of the support the Government gives the IDBA proposal, this is unlikely to change. 17. The other two banks are of about equal size, each having assets of about Af 2 billion. One of these, the Pashtany Tejaraty Bank (PTB) is controlled by the RGA (65% of the shares) and was set up about 17 years ago to specialize in the financing of exports, particularly the karakul trade. Its other shareholders are largely trading firms, although Bank Millie (see below) is also a shareholder and is represented on its board. In principle, it is more amenable to financing light manufacturing enter- prises than the Da Afghanistan Bank, although its credit is normally short- term. In a few instances it has taken minority equity participations in manufacturing enterprises, but this is rather exceptional. It is plausible to expect that it will continue to be a bank that primarily provides short- term credit to importers, exporters and traders. 18. The third bank, Bank Millie, is a private bank that was established in 1930. It has about 2,000 shareholders. The largest shareholding group is the Zaboli family, which founded the bank, although it does not now have a controlling interest. One major difference between Bank Millie and the other banks is that its net worth is about equal to its liabilities, and of its assets, equity investments (Af 640 million at cost) are almost as large as its outstanding loans. Its major investments (direct and indirect) are in the Afghan Textile Company, Baghlan Sugar, Jabulseraj Cement, a bus transport firm and two government-controlled firms, Jangalak Foundry and Spinzar Cotton. In some of the above companies Bank Millie has the major and controlling interest. Its equity portfolio has not expanded to any significant extent in the last six years and thus, while it remains, in aggregate terms, the dominant equity owner in the private sector, its importance is declining as most of the new manufacturing enterprises coming on the scene in Afghanistan are outside the Bank Millie group. 19. Interest Rates. Because there is little or no medium- and long- term credit available from institutional sources, there is no empirical base for determining the interest rate for such funds. Neither is there a good basis for determining the opportunity cost of capital in Afghanistan. Commercial banks pay 6% for deposits (tax free) and their short-term loans bear an effective cost of 10-13% for normal facilities for financ$ng trade. The cost is 8% for special government-supported activities such as financing the cotton crop. These rates have been applied for many years. They have  -7- to be viewed in the context of stability of prices for non-food items over the past 10 years and substantial fluctuations in food prices induced by the variations in the volume of cereal crops. The present deposit rate is inadequate to attract substantial increases in private deposits. The bazaar rates are very different from the commercial bank rates. Bazaar credit, which in any case is not medium- or long-term credit of the type needed for industrial investment, costs from 18% to 36% per annum. No one knows the amount of funds mobilized in the bazaar, but bazaar lenders certainly pay higher rates for deposits than do the banks. Thus it would not be surpris- ing if their mobilization of private resources has exceeded that of the banks in recent years. The bazaar moneylenders are very skillful and they maintain close connections with Afghan and foreign banks. 20. An additional indicator of "market" values is the price at which shares are traded in the bazaar. To the extent that it can be determined, these shares are all currently traded at prices below par ancd which give net dividend yields (after the 20% withholding tax) of 10-12%. This dividend yield has been typical for several years, although there is no detailed data available on the volume of trading or price movements. One other indicator of the current cost of credit is that the Agricultural Development Bank (reorganized in 1970 in conjunction with IDA credit No. 202-AF) charges 8% for term loans financing farmers' capital investments and 10% for short-term working capital loans. 21. In short, it is difficult to determine what would be an appropriate interest rate for medium- and long-term loans to industrial enterprises in the Afghan context. From the available data it would appear that a rate of about 10% would be reasonable, at least for medium and large-size enterprises, and would ensure that resources are not misallocated. During negotiations it was agreed that this subject would be reviewed after the market for these funds is established and tested (see paragraph 33). Conclusion 22. It is in this context--a lack of medium- and long-term institutional finance while interest in private manufacturing investment has been stimulated by passage of the FDPIL--that all parties concerned in Afghanistan, private and public, are anxious to see the long discussed IDBA proposal realized. There is no institution existing in Afghanistan with sufficient experience to enable it to undertake, without an uneconomic effort, efficient term financing functions like those envisaged for IDBA. On balance, a new institution re- presents a more satisfactory solution. The IDBA would provide emerging Afghan entrepreneurs with both capital and advice; it would also play an important role in promoting and crystallizing new project ideas. Through proper project appraisal the IDBA would assist in identifying those projects that have good potential for making a long-term contribution to the development of the coun- try. As discussed later, it seems reasonable to expect the IDBA to be able to commit about $2 million equivalent, including about $1 million in foreign exchange, during its first year of operation, with this level rising modestly in future years.  -8- III. THE PROPOSAL Legal Basis 23. The IDBA Law provides for the establishment of the IDBA, under the Commercial Code, as a legal entity with its own Articles of Incorporation. This Law defines the purposes and powers of institutions such as the IDBA (see Annex 2). IDBA's administration is determined by its Articles of Incor- poration. The Articles were prepared by the Afghan Sponsoring Committee in consultation with the Bank Group. They were adopted at the first meeting of shareholders held on March 3, 1973. Ownership 24. The initial share capital of the IDBA will be Af 240 million ($3.4 million equivalent) of which 60% is now held by Afghans (mainly private) and 40% will be held by foreign investors, including, it is proposed, the IFC with an equity investment of approximately $250,000, provided the Association approves the credit proposed in this report. According to the IDBA Law, no single in- terest can hold more than 15% of the shares and foreign investors as a group cannot hold more than 49% of the shares. Afghan shareholders comprising in- dividuals, business enterprises and banks have already paid in their subscrip- tion (Annex 4a). Chase and four other foreign banks (Annex 4b) have agreed to invest in the IDBA if the IFC also invests. Objectives and Powers 25. It is expected that IDBA will provide finance to a wide range of business enterprises. It will focus on the development of the private sector, though it will not be precluded from investing in Government enterprises; it will also undertake to act as a catalyst in developing new project proposals. It will be able to provide both debt and equity financing as well as to under- write securities and guaranteee credit from other sources. Policies 26. IDBA'a operations will be in accordance with its Policy Statement (Annex 5), which was drafted in consultation with the Bank Group and adopted by IDBA's Board of Directors at its first meeting, held on March 4, 1973. This Policy Statement will not be changed without prior consultation with IDA. It conforms in most respects to policy statements adopted by other develop- ment finance companies. According to it, the IDBA will normally limit its total financial assistance to a single enterprise to 20% of its own share capital and free reserves. Its equity investment in an enterprise will normally not exceed 10% of its own share capital and free reserves, and its total equity holdings will not be greater than its share capital and free reserves. It will normally not hold more than 20% of an enterprise's share capital. IDBA will normally finance only up to 50% of the cost of a project, including working capital.  -9- Resources 27. In addition to its share capital of $3.4 million equivalent, the IT)BA has a local currency loan of $7.8 million equivalent from the Government for use in its operation. It is also proposed that an IDA credit be made available at the outset. These are dealt with below. 28. Government Loan. As established in the IDBA Law, the IDBA will receive a loan from Da Afghanistan Bank (see paragraph 15) of Af 560 million ($7.8 million equivalent). Af 60 million was paid in upon IDBA's establish- ment: the remainder will be paid in five annual instalments of Af 100 million each. Each tranche will be repaid over a 20-year period including 10 years of grace. The interest rate is 2% p.a. The loan is subordinated to other debt obligations of IDBA. An agreement, satisfactory to the Association, covering this loan was entered into by Da Afghanistan Bank and the IDBA on March 7, 1973. 29. The local currency resource endowment is a carry-over from judgments made in 1967, at the time the Government first proposed the IDBA Law to Parliament. Chase and the local sponsors felt it necessary to ensure that sufficient local currencY resources were available at the outset to meet the institution's needs for about five years or so. That approach was reflected in the share capital subscriptions that were pledged in Afghanistan in 1967 and in the size of the Government loan proposed to Parliament at that time as a part of the IDBA Law, and which was approved in 1971. When the Association was invited to re-examine the IDBA proposal in 1971, it had to face the re- ality that the size of the Government loan was established by Law. On reflection, the large size of that loan was acceptable in view of the diffi- culties that had to be overcome in having the Law passed. Also, in order to have the IDBA maintain a reasonable debt-equity ratio, it was felt necessary to keep the share capital at the level of $3 million equivalent. 30. Proposed IDA Credit. A $2 million IDA credit is also envisaged to help the IDBA cover the foreign exchange cost element of the projects it finances during its first two years of operations. The credit would be granted to the RGA on normal IDA terms and relent to the ITBA on terms satisfactory to IDA. These terms include an interest rate of 7-1/4% p.a. and a repayment period of 18 years, including three years grace. This amortization schedule would be amended from time to time to conform substan- tially to the aggregate of the amortization schedules of loams and investments made by the IDBA. Because the IDBA will be a new institution with no prior experience in project appraisal, a low free limit of $50,000 would be estab- lished, with an aggregate free limit of $500,000; for the same reason the ratio of IDRA's long-term debt to its net worth has been set at a maximum of three. A commitment fee of 3/4 of 1% would be payable by the IDBA to the RCA, but would apply only when IDA authorizes a sum for withdrawal with res- pect to a specific project, and only to the amount so authorized; this con- forms to normal World Bank policy in respect to first credits to a new devel- opment finance company. The IDBA would charge its borrowers a similar commit- ment fee. A draft Subsidiary Loan Agreement between the RCA and IDBA, reflect- ing the above terms, has been prepared and is satisfactory to IDA. IDA would have to be satisfied with the standard terms of the loan agreement IDBA will enter into with its borrowers.  - 10 - 31. IDBA intends to charge all of its borrowers an interest rate of 10% p.a. on all funds it lends, regardless of their source, and to pass any foreign exchange risk on to its borrowers. Such loans will have a maximum term of 15 years. As mentioned in paragraph 19, there is no empirical base for determining what should be the most appropriate interest rate for IDBA to charge. In view of the fact that borrowers will be accepting the foreign ex- change risk on IDBA's foreign exchange loans, the 10% rate in general appears reasonable. 32. The RGA feels, however, that this rate on foreign exchange loans (not local currency loans) is too high when the borrower is a small-scale industry 1/ because the foreign exchange risk is also being passed on. They believe that such a rate with the foreign exchange risk might act as a dis- incentive for the establishment of small-scale enterprises for which there is potential and which deserve encouragement. Because of the lack of any comparable lending experience in Afghanistan, and in view of the manifest need to encourage Afghan entrepreneurs, who are mainly traders, to enter industrial pursuits and make long-term investments in productive enterprises, the Government's argument has strength. As a matter of policy, therefore, RGA has decided to assist such borrowers (regardless of from whom they borrow) by reducing their effective interest expense to 8% by rebating to them any excess interest above 8% that they pay. As a matter of administrative con- venience, the RGA proposes to appoint IDBA as its agent for making such re- bates to small-scale industries which borrow from IDBA. 33. IDBA's management will review its policies regarding interest rate and foreign exchange risk coverage, and the effect of RGA's policy of assist- ing small-scale industry, in the light of experience gained during the first year of IDBA's operations. This review will focus on the effect of the in- terest rate level and the foreign exchange risk coverage arrangements on IDBA's business prospects and on the need to safeguard IDBA's financial position as well as on the effect of governmental assistance in promoting small-scale in- dustry. During this review a judgment will be reached as to a suitable cost of capital for industrial development in Afghanistan. The results of this review, together with any recommendations for changes in these policies, will be made available to the RGA and the Association, with any changes to be agreed upon by the RGA, the Association and IDBA. Satisfactory assurances on the cost of IDBA's lending were obtained during negotiations. 34. Under the IDBA Law and the Regulations for Obtaining Loans for the Industrial Development Bank of Afghanistan (Annex 2b), the RGA is authorized to borrow on behalf of the IDBA. The matter of parliamentary authorization of the proposed credit is appropriately covered under the IDBA Law and the Regulations. 1/ A small-scale industry is defined as an enterprise where the investment in equipment and installations (fixed assets other than buildings and land -- the value of buildings and land varies greatly from one part of Afghanistan to another) is less than $100,000 equivalent.  - 11 - Board of Directors and Executive Committee 35. The Board of Directors will be responsible for general policies and procedures. The Articles provide for a Board of between seven and 15 members; at the first meeting of shareholders the number was set at nine. The Articles also provide that the President and General Manager are ex officio members with the same rights and obligations as other Directors. They are in- cluded with other Directors in determining the size of the Board. The Afghan shareholders will be represented by four Directors and the foreign shareholders, by three. Cumulative voting procedures will be used for elections. 1/ An under- standing has been worked out among the prospective foreign shareholders that for the first few years IFC will designate one of the foreign Directors, with the other two rotating among the other foreign shareholders. In accordance with the IDBA Law, so long as any part of the government loan is outstanding, the RGA will have an observer on the Board. The observer will not have voting rights. All Directors of IDBA were elected at the first meeting of shareholders (see Annex 6). Mr. Kyaw Myint, the Bank's resident representative in Afghanistan, was elected to the Board seat which the shareholders would like to be filled by an IFC nominee if IFC's Board approves the proposed investment. 36. The IDBA Law also provides that all Directors be elected for four- year terms. The Articles provide for an election every four years unless a vacancy occurs, in which case the new Director will serve out the term of the Director he replaces. Retiring Directors may stand for re--election. 37. It is expected that the Board will meet once or twice a year. A majority, present in person or by proxy, will constitute a quorum. Board decisions will be taken by a simple majority vote of those present except for (a) amendment of the Policy Statement, 2/ (b) election of and delegation of power to the Executive Committee, (c) appointment of and delegation of power to the President and General Manager and (d) elections to fill vacancies on the Board, in which cases a two-thirds majority of all members of the Board will be required. 38. The Articles provide that the Board shall elect from among its mem- bers an Executive Committee. This Committee, which was elected at the first Board meeting (see Annex 6), has five members: the President, the General Manager, two local Directors and one foreign Director. The Director from Chase is the initial foreign member. The Board delegated to the Executive Committee power for day-to-day management including the power to approve all investment projects. It will meet more often than the Board, perhaps once a month. 1/ Under cumulative voting each shareholder is entitled to as many votes as are equal to the number of shares he owns multipled by the number of directors to be elected. He may cast all these votes for one candidate or distribute them among the candidates in any way he sees fit. This procedure prevents shareholders representing only a bare majority from electing the entire Board. 2/ If an IDA credit is made, such an amendment would also need the approval of the Association.  - 12 - 39. The Articles provide that members of the Board and of the Executive Committee can appoint alternates, and that members unable to attend a meeting in person can vote by mail or cable. Management and Staff 40. The President. As specified in the IDBA Law, the President of the IDBA is an Afghan citizen. He is a full-time officer of the company and its chief executive. At the first Board meeting Dr. A.J. Nour Ali was appointed the first President of IDBA. Dr. Nour Ali is a former Minister of Commerce and a former representative of the Afghan Trading Company in New York and London. He is well regarded by those in the Bank who know him. 41. General Manager. It is recognized both within and outside Afghanistan that there is no Afghan available with the required experience to manage a new development finance institution like IDBA. It has therefore been agreed that in the initial years there will be an experienced expatriate General Manager with, in a practical sense at least, executive powers. His detailed responsi- bilities and authority, satisfactory to the Association, were established by IDBA's Board at its first meeting. Mr. Varadachari Srinivasan, an Indian national and until recently a member of the World Bank staff was appointed the first General Manager at the same time. Before joining the World Bank, Mr. Srinivasan organized and managed the successful State Industrial and Investment Corporation of Maharashtra. 42. Staff. Initially only a small professional staff will be required. Given the need to train Afghans for development finance company work, three other experienced expatriate staff, in addition to the General Manager, will be employed during IDBA's early years. One would be a financial manager responsible for appraising the financial and economic aspects of projects and for supervising investments. The second would be an engineer responsible for appraising the technical aspects of projects. Arrangements have been made to fill these two positions. The third would be the chief accountant. In addition to the four expatriates, it is expected that about ten other profes- sional staff would be required during the first two years. UNDP Technical Assistance 43. Given the small income base for the IDBA, and the relatively high cost of foreign personnel in Afghanistan, the RGA has requested, and the UNDP has agreed to make, a technical assistance grant to cover the cost to IDBA of the General Manager, the financial analyst and the engineer for up to the first five years of operation. The a:countant is not included in the re- quest to the UNDP. The Project Document was signed in February 1973. The Bank has agreed to be the Executing Agency. Application of FDPIL 44. The RCA's Investment Committee approved IDBA's sponsors' applica- tion for approved status under the FDPI]. on February 28, 1973. Approved status means that, like most other new enterprises in Afghanistan, the IDBA  - 13 - will be exempt from income tax for its first five years of operation and that dividends will be tax exempt in the hands of the recipient for five consecutive years if distributed within eight years from receiving approved status. 1/ Under the FDPIL dividends can be freely repatriated and the foreign capital investment plus capital gains may be repatriated after five years at the rate of 25% per annum. Audit 45. The IDBA has hired Coopers and Lybrand, an experienced firm of auditors satisfactory to the Association, to audit IDBA's accounts annually in accordance with generally accepted accounting standards. IV. BUSINESS PROSPECTS AND FORECAStS 46. Forecasts were prepared in Afghanistan by IDBA's sponsors against the background discussed in paragraph 15. They assumed an eaverage annual growth of about 18% p.a. in manufacturing investment and that the IDBA would finance up to 20% of the total. There is not adequate evidence that this rate of growth is achievable. There is, however, reason to believe that, given the virtual absence of institutional long-term finance for industry, the IDBA could in fact provide 20% of the capital required for new industrial investment. A majority of the entrepreneurs who have received approved status or who are seeking it have indicated that they would welcome loan capital if it were available. 47. Two sets of projections have been prepared, one based on the average 18% p.a. growth rate assumption of the Sponsors and a second on a more modest 10% p.a. growth rate. These two assumptions result in the iEollowing rates of commitment by IDBA: ($ million equivalent) Years 1 2 3 4 5 6 7 Optimistic 2.0 2.5 3.0 3.5 4.1 4.7 5.4 Conservative 2.0 2.2 2.4 2.7 2.9 3.2 3.5 1/ Normally, IDBA would have to pay a 5% gross receipts tax and 20% on earnings after (a) provisions for losses, (b) the 5% gross receipts tax and (c) cash dividends. Dividends would normally be subject to a 20% withholding tax.  - 14 - These projections do not include estimates of financing in sectors such as tourism and transport that could materialize in modest amounts in the next few years. The projections assume that IDBA's lending rate will be 10% p.a. and that liauid funds will be temporarily invested at the general deposit rate of 6% p.a. They also assume that commitments will be half in foreign currency and half in local currency which may understate the need for financing the importation of capital equipment. Ilowever, there is no material disadvant- age in using this assumption for the purposes of this exercise. The detailed financial results based on these commitment rates, plus more details on the assumaptions used, are given in Annexes 7 to 13. 48. The profitability of the IDBA under both projections is about the same: net profit to share capital in years three to five averages about 14%. Profitability under the conservative projection is not that much less than uiider the optimistic projection because of several factors: income is still earned on the local currency funds not invested in projects, though at a lower rate; interest expense is less as less foreign currency funds are drawn dowm; and the provision for doubtful debts is lower. 49. A dividend of 6% is not an impossibility in the third year, and an 8% or even a 10% dividend in the fifth year may be possible. The debt to equity ratio under either projection increases to only about 3 to 1 in the seventh year due to the buildup of retained earnings; these amount to about 50% of share capital in that year, after assuming a 6% dividend in the third year, a 7% dividend in the fourth year, and an 8% dividend yearly thereafter. The project will therefore give moderate returns to shareholders. V. CONCLUSIONS AND RECOMMENDATIONS Conclusions 50. There is a need in Afghanistan for a development finance company, albeit a moderately sized one in keeping with the present stage of development in the country. Its establishment would make institutional iong-term finance available to the private sector for the first time. A privately controlled comapany, vis-a-vis a government institution, has great advantages in Afghanistan in terms of the quality of management and staff that can be mobilized and the efficai&cy of operations that is likely to be achieved. 51. The proposed IDA credit and IFC equity investment would enable wt-, BiaiV Gro.p to make a significant contribution towards the successful establishment of the IDBA and, through it, the expansion of the industrial and service sectors, and thus over time the diversification of the economy zr&wav fron thte preponderant agricultural sector. This contribution would be through providing not only capital but also, and perhaps more importantly in the early stages, guidance. The proposal set forth in this report represents a suitable basis for commencing IDBA's operations.  - 15 - Recommendations 52. The proposed IDA credit would be lent to the Government of Afghanistan on IDA's standard terms. In turn, the proceeds of the IDA credit would be relent to the IDBA on agreed terms as detailed in paragraph 30. The IDBA will enter into a Project Agreement with the Association containing those provisions, other than those relating to the making and repayment of the IDA credit, normally applied to Bank loans to developmerLt finance com- panies and as further detailed in paragraph 30 of this report. The proceeds of the proposed credit would be used to finance the cif cost: of imported goods. 53. An undertaking was received from IDBA during negotiations that its management will, during the first year of operation, review IDBA's interest rate policies and foreign exchange risk coverage, and the effect of RGA's policy of assisting small-scale industries. Any recommendeci changes would have to be agreed upon by the Association, RGA and IDBA (paragraph 33). 54. The effectiveness of the credit would, in addition to the standard provisions relating to IDA credits, be conditioned on: (1) the payment by the foreign shareholders of their share capital subscription; and (2) submission by IDBA to the Association of the draft loan agreement, satisfactory to the Association, which IDBA would conclude with its borrowers (paragraph 30). 55. On the basis of the above arrangements, an IDA credit of $2 mil- lion and an IFC equity investment of Af 18 million (about $250,000 equivalent) are recommended to assist in the establishment of the IDBA iand to meet its foreign exchange requirements for the first two years of its operations.   ANNEX 1 THE INDUSTRIAL DEVELOPTMEfT BANK OF AFGHANISTAN Members of the SponsoringL Committee Dr. Mohammed Aman Former Minister of Finance and Chairman of the Sponsoring Committee Dr. A. J.Nour Ali- London Manager, Trading Company of Afghanistan. Former Minister of Commerce. Mr. Abdul Njadjid Zabuli Founder and Chairman of the Board of Bank Millie 4r. Jana3t Khan Gharwal-/ President, Pashtany Tejaraty Bank Mr. Abdul Rahim Hatif Private Businessman 2/ Mr. Said Murtaza -' President, Omaid 'Textile Co. Mr. Mohammed Jaafar Mukhtar-Zadeh President, fifghan Textile Co. Mr. Haji Habibullah Kandahari Private BusinessmnEn Mr. Haji Aziullah President, Chamber of Commerce - Herat 1/ Now the President of the IDBA 2/. iNow Directors of the IDBA EMENA/DFC March 26, 1973   ANNEX 2a THE INUSTRIAL DEVELOPMET BANK OF AFGHANISTAN Page 1 of 6 Law of Inudutrial Banks in Afghanistan Chapter One General Provisions Art. I Any industrial bank established in conformit,y with this law shall be a legal entity and be represented by the President of the bank. Art. II Industrial banks shall be established for the following purposes: (1) To assist in the establishment, expansi(Dn and modernization of industrial enterprises in Afghanistan. (2) To advise and encourage foreign and domestic persons to participate in industrial enterprises in accordance with the Foreign and Domestic Private Investment Law of Afghanistan. (3) To facilitate the acquisition of industrial securities through private investment in industrial enterprises concerned with manufacturing and assembly. Art. III Industrial banks shall have the following rights and obligations: (1) To provide medium and long term loans for industrial enterprises. (2) To purchase bonds and convertible securities issued by industrial enterprises and to issue bonds and convertible securities. (3) To guarantee the sale of shares and to underwrite the purchase of bonds, convertible securities and other securities issued by industrial enterprises. Participation of the bank in industrial enterprises is allowed for the purpose of reselling the shares. The bank's shares shall not exceed twenty percent of the total capital of the enterprise in question. (4) To guarantee loans and other obligations of industrial enterprises in case these loans and obligations are provided from other investment sources. (5) To cooperate in obtaining managerial, technical and professional assistance of industrial enterprises.  ANNEX 2a Page 2 of 6 (o) To make short-term loans of less than one yearts maturity. (7) To accept securities on moveable and immovable property in conformity with the bank's objectives and to sell the securities according to the provisions of the law when fulfillment of the obligations is postponed, or in case when suc[l rights are given to the bank on the basis of mutual agreement. (b) To cooperate in preparing useful industrial projects and to assist in organizing industrial enterprises with the Government's consent. (9) To provide consulting services for borrower and non- borrower industrial enterprises. (10) To conduct research and study possibilities and to publish information of interest to investors and probable borrowers in accordance with objectives of the bank. (11) The bank may accept grants, unconditional assistance and possessions. Grant assistance of foreign institutions can be accepted with Government approval. (12) To sue and defend in the bank's name. (13) To have a bank seal. (14) To make contracts and incur liabili-ties in the bank's own name in accordance with the objectives of the bank. (15) To appoint and employ officials, foreign and domestic representatives and employees of the bank in accordance with the pertinent laws and regulations. In selection of officials and employees, the bank shall give preference to employment of Afghan nationals. In addition to good performance,, the training of Afghan nationals shall be provided by the bank. The bank shall attempt to replace, as soon as possible, foreign officials and employees by Afghans who are capable of performing the duties. (16) To determine all other duties relative to the bank's objectives, according to the Articles of Incorporation of the bank within the provision of law. Art. IV Authorized capital and the mode of payment shall be determined by the Articles of Incorporation of the bank. Art. V Tax exemptions of the bank shall be determined in accordance with the Foreign and Domestic Private Investment Law of Afghanistan.  ANNEX 2a Page' 3 of 6 Art. VI The bank shall establish suitable conditions in accordance with its objectives in each loan agreement or service contract, within the limits of the law. Art. Vll If the following conditions are met, the bark may request a debtor to repay all liabilities: (1) If substantial inaccurate information is posted on the loan application. (2) If the borrower does not observe the conditions set forth in the loan agreement. (3) If the insured property, given to the bank as a security, has not been inisured sufficiently or the security loses its value so that additional security is needed while such security is not provided. Art. VI13 The bank's accounts shall be kept in accordEance with the Commercial Code and banking practices. Art. IX The account to the bank shall annually be audited by a firn, in accordance with the ForeiEp and Domestic Private Investment Law. Such an audit shall be performed by an organization with international standards, elected annually by a majority vote of shareholders in general meetings. Such an organization must be licensed in Afghanistan. Art. X If transactions of the bank are contrary to law, the government is obliged to take legal action. Art. XI Participation by foreign stockholders in the issued capital of industrial banks shall not exceed forty-nine percent of that capital. LTo one person, family, entity or units of common interest can hold more than fifteen percent of the issued capital of the bank. This limitation shall be applied with respect to allocation and registration of shares transferred to a person in any manner of ownership. Art. XII For the purpose of this Law, units of common interest are as follows: A. A person affiliated with a legal entity or business enterprise in which such person acts as President, ownier, director or manager. B. Two or more entities or business enterprises the ownership or management of which is substantially the same.  ANNEX 2a Page t of 6 Chapter Two A aini stration of' Industrial Banks Art. )Jl1 The acuinistration of industrial banks shall be determined by the banks' Articles of Incorporation in accordance with thleir juridical nature. The banks' Articles of IncorporatioD shall not be contrary to the text and spirit of the laws of Afghani stan. Chapter Three Special Provisions Art. XIV (1) In the first stage, an industrial bank shall be established by the name of Industrial Deve'oprment Bank, in. accordance with the provisions of this Law. (2) Da Afghanistan Bank shall give a loan of five hundred and sixty million Afs to this bank. The repayment of each installrent, as mentioned below, shall be postponed for the first ten years of the loan disbursement and begiining with the eleventh year of disbursement the repayment of' the loan shall be made in ten ecqual installments. Sixty million Afs shall be paid to the bank when it is established. The remaining five hundred million Afghanis shall be paid to the bank gradually, within five years. The interest rate of Da Afghanistan Bank loan shall be two percent per annum from the time the loan is given to the Bank. (13) In case of the (lissolution or liquidation of the bank, the repayment of' tihe government loan and of' other creditors shall be prior to rights to shareholders. (4) Up to the time of full repayment of the governmert loarn, the govenmient shall appoint its representatives as an observer on the Board of Directors of the Industria] Development Bank. The observer shall not have voting rights. (5) Concerning interest rates, the bank is obl.iged to f'ollow the policy of the governmient with respect to average interest rates f'ixed for such banks. Art. XV 'The Goverrinent oII the basis of this Law and on the basis of conditions and liun-.tations that it may establish, can guarantee the loans to the Industrial Development Bank of Afghanistan. Such loans and the relatted guarantees as well may be designated in foreign currency.  ANNEX 2a Page of 6 Art. XVI As long as tLle Da Afghanistan Bank loan, given to the bank according to Art. XlV is outstanding, the bank shall annually allocate 10 percent of its profits to a special reserve. Allocating of profits to the special reserve shall continue until this reserve equals the outstanding amount of Da Afghanistan Bank loan. Whatever part of the profits allocated for other reserves (not more than fifteen percent of the annual profilts) and, also, the amount allocated for the special reserve mentioned in this Article with regard to tax exemptions is subject to the Forei.g and Domestic Private Investment Law of Ufghanistan. Art. XVII The bank shall be established only when the following conditions have been met: (l) Sixty percent of the authorized capital has been subscribed and allocated. (2) One-half of the subscribed capital has been transferred into a special account in one of the Aflghan banks. (3) A general meeting of the shareholders has been held and the bank's Articles of Incorporation have been approvJed by two-thirds of the shareholders or their legal agents. The Board of Directors also shall be seLected in this meeting. (4) A written memorandum certifying the above items (1, 2 and 3) of this Article has been forwarded to the concerned legal registration authority. Art. XVIIJ. If' a shareholder fails to pay any part of his subscribed shares, he shall be given a grace period of 60 days to complete payment. Such a shareholder shall be informed by registered mail. If after this period he still fails to pay, his earlier payments shall be accepted as shares and he shall lose the right to buy the remaining part of his shares. Artl. XIX it is not necessary for the Board of Directors of the barik to own shares. The Board of Directors shall be elected for four years. Trhe composition of the Board shall be deterndned in the bank's Articles of Incorporation. The President of' the bank shall be appointed by the Board of Directors according to the bank's Articles of Incorporation. lIe shall be an Afghan national. .rt. XX All foreign exchange transactions of the bank shall take place through the Da Afghanistan Bank, on the basis of the free rate of Da Afghanistan Bank on the day of the transactions. Da Afghanistan Bank shall provide the required amounts of foreign exchange needed by the bank to meet its liabi.lities  ANNEX 2a Page 6 of 6 to foreign creditors, distribution of payable dividends and the proceeds from the sale of shares of foreign share- holders in accordance with the Foreign and Domestic Private Investment law. The purchase price of shares belonging to foreign shareholders shall take place only on the basis of freely convertible foreign exchange. The bank is obliged to sell its hard currency throughl Da Afghanistan Bank at the free market rate. Art. XXI Idithin a period of six months after the close of the fiscal year, a condensed annual balance sheet together with a profit-and-loss statement, shall be published in Pashtu, )ari. and in one foreign language. Art. XXII If the bank becomes a plaintiff or a defendant in) Afghanistan, the case shall be decided by a competent court of Afghanistan in accordance with the provisions of law. A -rt. XXIII If disputes on legal cases arise between the bank and its foreign shareholders, it shall be referred to an arbitration committee in Kabul provided both sides agree. In respect to foreigp creditors, the arbitration place shall not be limited to Kabul. The decision made by the arbitration committee shall be final and both sides will have to honor it. This decision, in order to be executed, shall be sent to the concerned authorities. Chapter Four Miscellaneous Provisions Art_. XXIV Provisions concerned with private enterprises shall not prevent, in this law the establishment of industrial banks in the form of government enterprises or any other form of' companies in which the goverrment holds more than fifty percent of the shares. , > t. .<,- lMatters not covered by this law shall be regulated by the Commercial Code, the Foreign and Domestic Private Investment Law, Government Enterprises Law and other Laws. Art. .XVI . This law shall be effective after completion of its legislative stages. December 29, 1972.  ANNEX 2;b Page 1 of 2 THE INDUSTRIAL DEVELOPMENT BANK OF AFGHANISTAN Regulations for Obtaining Loans for the Industrial Development Bank of Afghanistan ARTICLE I The regulations based upon Article 94 of the Constitution of Afghanistan and pursuant to Article 15 of the Industrial Banks Law of Afghanistan are enacted and regulated by the Royal Government of Afghanistan as follows: a) The Industrial Development Bank of Afghanistan shall, prior to raising any Loan from any source from outside Afghanistan, obtain the agreement of the Royal Government of Afghanistan that such Loan shall be used for productive purposes and for the economic development of Afghanistan. b) The Industrial Development Bank of Afghanistan shall repay the principal of, interest and other charges on, the Loan punctually. c) To enable the Industrial Development Bank of Afghanistan to meet its obligations under paragraph (b) of Article I, the Royal Government of Afghanistan shall make available or cause to be made available to the Industrial Development Bank of Afghanistan, whenever necessary, such foreign currencies as shall be required for the Industrial I)evelopment Bank of Afghanistan to discharge its obligations. d) The Industrial Development Bank of Afghanistan shall carry out all its obligations under any agreement or arrangement the Royal Government of Afghanistan may enter into with the Industrial Development Bank of Afghanistan for the guarantee of any such Loan. e) The Industrial Development Bank of Afghanistan shall carry out all its undertakings, covenants or agreements entered i-nto with any foreign person, agency or institution or international organization which shall have provided such Loan to the said Bank. f) Loans may be obtained directly by the Industrial Development Bank of Afghanistan in accordance with the provisions of the Industrial Banks Law of Afghanistan. lWhenever it is considered necessary and desirable by the Royal Goverment of Afghanistan and the Industrial Development Bank of Afghanistan so to do the Royal Government of Afghanistan may borrow for, or on behalf of, or for the purpose of or use by, the Industrial Development Bank of Afghanistan, on such tenms and conditions as the Royal Government of Afghanistan may detenmine, provided, however, that it shall be deemed as if the loans so raised were loans obtained by the Industrial Development Bank of Afghanistan and the Royal Government o:F Afghanistan were the Guarantor thereof pursuant to Article 15 of the Tidustrial Banks Law of Afghanistan; provided, furthermore, that nothing contained herein  ANNEX 2b Page 2 of 2 shall be so construed as to affect in any way whatsoever any rights or financial or other obligations of the Royal Government of Afghanistan under any agreement entered into by it based upon Article I with any foreign lender. AP.TICLE I The term "industry" wherever used in the Industrial Banks Iaw of Afghanistan shall include manufacuturing, assembly, agricultural processing, mining, tourism and related service industries. AR'TICLE III The Regulations shall upon publication in the Official Gazette enter into force. EMENA/DFC January 11, 1973  ANNEX 3 Page 1 of 2 THE INDUSTRIAL DEVELOPIENT BANK OF AFGhIANISTAN Summary of the Foreign and Dcmestic Private Investment Law 1. Scope Explicitly eligible to receive the incentives under the law are the following sectors: industry, mining, agriculture, tourism. The Investment Committee (IC) may include other service sectors under the scope of the law and has done so, e.g. in the case of transportation, computer activities, and dry cleaning. 2. Tax Benefits (a) Exemption from all income taxes for the first five years of operation. (b) Exemption from import duties on capital goods and replace- ment parts for the approved investment and on raw materials and components for production resulting from the invest- ment for five years from approval by the IC. (c) Exemption from personal income tax and corporate tax on dividends for five consecutive years if distributed within eight years of approval by the IC. (d) Exemption, without time limit, from personal income tax and corporate tax on interest on foreign loans to finance part of an approved investment. (Nlormally, such interest is subject to a 20% tax.) (e) Exemption from export duties for products of approved invest- ments for ten years. 3. !epatriation Rights (a) Payment of principal and interest on foreign loans and dividends on foreign investments may be freely repatriated. (b) Foreign capital investment and reinvested profits may be repatriated after five years at the rate of 25% p.a. of the foreign capital invested. (c) Licensing fees for patents or know-how may be repatriated in accordance with licensing agreements approved by the IC. L. Audit T'he accounts of enterprises with investments approved under the law have to be audited by auditors of international standing and licensed to operate in Afghanistan.  ANNEX 3 Page 2 of 2 .Foreign Onership There is no limitation on foreign ownership in enterprises with investments approved under the law. 6. Activities Outside the Scope of the Law (a) Afghan nationals whose investments do not qualify under the law may carry on business in accordance with the Commercial Code and other relevant laws. (b) Foreign nationals whose investments do not qualify under the law may be licensed to do business pursuant to the "Licensing Regulations for Private Foreign Traders and Firms in Afghanistan". EMENA/DFC Duecember 29, 1972  ANIIEX l-a THE INDUSTRIAL DEVELOPMENT BANK OF AFGHANISTAN Afghan Subscribers to the Share Capital Af 1000 Percent of Total Equity Pashtany Tejaraty Bank 36,000 15.O Bank Millie group 36,000 15.0 Chaimber of Commerce 25,000 lO.4 "ement I.Factory, Jabulsaraj 10,000 14.2 About 200 companies and individuals, each less than AF3a,500,000 37000