Philippines - Shipping Project

Report No. 437a-PH Appraisal of a FILE COPY Shipping Project Philippines September 26, 1974 East Asia and Pacific Projects Department Not for Public Use Document of the International Bank for Reconstruction and Development International Development Association 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 It may not be published, quoted or cited without Bank Group authorization.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 EQUIVALENTS Currency Unit = Philippines Peso (Ps) 1 Peso (Ps) = US$0.149 Ps 1 million - US$149,000 US$1.00 = Ps 6.729 WEIGHTS AND MEASURES 1 Kilometer (km) = 0.62 Mile 1 Nautical Mile (knot)- 1.85 Kilometers (km) 1 Nautical Mile = 1.15 Miles GLOSSARY OF ABBREVIATIONS BOI - Board of Investments BPW - Bureau of Public Works CISO - Conference of Inter-Island Shipowners and Operators DBP - Development Bank of the Philippines DPH - Department of Public Highways DPWTC - Department of Public Works, Transportation and Communications dwt - Deadweight Ton (a measure of weight-carrying capacity) Epp - Export Priorities Plan GRT - Gross Registered Ton (a measure of total cubic capacity) IMCO - Inter-Governmental Maritime Consultative Organization IPP - Investment Priorities Plan MIA - Maritime Industry Authority NEDA - National Economic Development Authority NRT - Net Registered Ton (a measure of net cubic capacity) PAL - Philippine Air Lines PCG - Philippine Coast Guard PNR - Philippine National Railways GOVERNMENT OF THE REPUBLIC OF THE PHILIPPINES FISCAL YEAR July 1 - June 30  PHILIPPINES APPRAISAL OF A SHIPPING PROJECT TABLE OF CONTENTS Page No. SUMMARY AND CONCLUSIONS .................................. i-ii I. INTRODUCTION ............................................. 1 II. BACKGROUND ............................................... 2 A. General ............................................. 2 B. The Transport Sector ................................ 2 C. Transport Planning and Coordination .... ............. 4 III. ORGANIZATIONS INVOLVED IN THE PROJECT .................... 5 A. Overall Government Coordinating Agencies .... ........ 5 B. Maritime Industry Authority (MIA) ................... 5 C. Development Bank of the Philippines (DBP) .... ....... 7 D. The Philippine Coast Guard (PCG) .................... 8 E. The Shipowners of the Inter-Island Fleet .... ........ 9 IV. THE PROJECT .............................................. 10 A. Project Description ................................. 10 B. Demand for Funds .................................... 10 C. Procurement ......................................... 11 D. Disbursement ........................................ 12 E. Project Execution ................................... 12 V. ECONOMIC EVALUATION ...................................... 14 A. General ............................................. 14 B. National Economic Development and Inter-Island Transport ......................................... 14 C. Economics of Inter-Island Shipping .................. 16 VI. FINANCIAL EVALUATION ..................................... 18 A. Inter-Island Shipping Companies ..................... 18 B. Financial Position and Operating Costs .... .......... 19 C. Effect of Investment in New Ships ................... 20 VII. AGREEMENTS REACHED AND RECOMMENDATION .................... 20 This report was prepared by Messrs. G. F. Bain, J. Burns and 0. Rahkonen.  -2- ANNEXES 1. Inter-Island Shipping and Traffic 2. Maritime Industry Decree 2(a) Memorandum of Agreement between Maritime Industry Authority and Philippine Coast Guard 2(b) Presidential Letter of Instruction to Philippine Coast Guard 3. Outline of Technical Assistance Required for Marine Inspection Services 4. DBP Statement of Operating Policies and Procedures 5. Terms of Reference for Technical Assistance to Development Bank of the Philippines 6. Inter-Island Shipping Companies Investment Program 7. Foreign Exchange Composition of Project Cost 8. Economics of Improvements in Inter-Island Shipping TABLES 1. Operating Results for Six Major Inter-Island Shipping Companies, 1972/73 2. Operating Results for FS Type Vessels (925 Dwt) 1972 MAP IBRD 11009 - Philippines Transport System  PHILIPPINES APPRAISAL OF A SHIPPING PROJECT SUMMARY AND CONCLUSIONS i. The Bank has been asked to help finance the replacement and repair of vessels in the inter-island fleet as part of the Philippine Government's plans for the integrated development of the maritime industry and to provide for the economical and efficient shipment of goods and passengers. ii. Ports and shipping have in the past played a dominant role in the transport sector of the Philippines and continue to provide an essential means of inter-island transport and communications. In 1971 the inter- island fleet had 130 vessels of over 1,000 GRT totalling about 280,000 GRT, and some 300 vessels of 1,000 GRT and under; more than 65% of this fleet were 20 or more years old. Some are poorly maintained, built to obsolete standards and ill-suited to modern cargo-handling methods. There is also a poor record of safety. iii. The proposed project consists of the acquisition of new and used vessels to replace ships over 20 years old, the major repair of ships up to 16 years old, the provision of technical assistance and the formulation of a maritime industry development program. iv. New ships will be acquired on the basis of international competi- tive bidding, in accordance with Bank Guidelines. In the case of Philippine built ships, evaluation of bids will include a 15% preference or the amount of import duties whichever is lower. Used ships will be obtained through the services of shipbrokers. The specialized nature of ship repairs and small ship conversions would make international competitive bidding procedures impracticable. v. The Bank would provide some 60% of the foreign exchange component of the funds required and the Government would make available any additional foreign exchange required for the shipowners' contribution. The funds lent to the Government would be relent to shipowners through the Maritime Section of the Industrial Department of the Development Bank of the Philippines (DBP), a state-owned banking institution. These loans, suitably secured by mortgages on the borrowers' ships and other appropriate assets, would be repaid over a period of 16 years including two years' grace in the case of new ships, over eight to 12 years with six months' grace for used ships, and up to five years with one year's grace for repairs. The first 10 shipping sub-loans would be subject to Bank approval before disbursement. Subsequently, based on experience, a free limit would be agreed upon between the Bank and DBP. vi. DBP, which will receive technical assistance for this project in the form of two shipping experts to be financed by the United Kingdom under the Colombo Plan or, failing this, through the proposed loan, would be  - ii. - competent to appraise and supervise the sub-loans. The organization has been carefully examined by the Bank Group over the past two years, resulting in changes in administration and operating procedures. Measures to strengthen DBP's Industrial Projects staff and audit system were agreed during negotia- tions for a US$50 million industrial loan; operating Policies and Procedures for industrial lending were also reviewed and agreed and subsequently approved by DBP's Board of Governors on May 29, 1974. vii. The Government has decided that supervision of the maritime industry requires coordination and to this end has promulgated a Maritime Industry Decree, the general content of which is acceptable to the Bank. The Maritime Industry Authority (MIA) set up by the Decree will prepare a ten-year Maritime Industry Development Program which will be updated annually and approved by the President. A memorandum of Agreement as to ship inspection services, satisfactory to the Bank, has been signed by MIA and the Philippine Coast Guard (PCG). -jiii. The PCG with the assistance of the MIA will continue to be responsible for ship registration and inspection. Technical assistance and training for improving ship inspection services may be sought on a bilateral basis, using a recognized international classification society. Funds to cover the required technical assistance have been included in the loan on a contingent basis. ix. The economic rate of return will be determined from the examination of sub-projects and present indications are that this return will be about 27% for the newer, larger vessels replacing unsafe and obsolete fleet units. x. The proposed project provides a suitable basis for a Bank Loan of US$20.0 million equivalent to the Government of the Republic of the Philippines for a term of 18 years including a four-year grace period.  PHILIPPINES APPRAISAL OF A SHIPPING PROJECT I. INTRODUCTION 1.01 The Government of the Republic of the Philippines (the Government) has requested the Bank's assistance in financing the replacement and repair of vessels in the inter-island fleet. The estimated total cost of the proposed project is US$34.0 million of which US$20.0 million equivalent will be financed by a Bank Loan. The Project will consist of: (a) the acquisition, conversion and repair of vessels in the inter-island fleet; (b) technical assistance for various organizations involved in the project; and (c) the formulation of a maritime industry development program. The loan would be made to the Government for a term of 18 years, including a four-year grace period. Most of the proceeds of the proposed loan would be relent to shipowners through DBP's Maritime Section. The proposed loan would also finance technical assistance to DBP and MIA should bilateral assistance not materialize. 1.02 Four loans have been made for transport infrastructure in the Philippines, two for highways, 731-PH in 1971 for US$8.0 million and 950-PH in December 1973 for US$68.0 million, and two for ports, 290-PH in 1961 for US$8.5 million and 939-PH in December 1973 for US$6.1 million. Experience in the first port project, Loan 290-PH for the procurement of dredging equipment, was unsatisfactory due to failure to operate and maintain the dredgers in an efficient manner and some US$1.1 million was cancelled. Due to civil disturbances in the project area and rapid price escalation, progress of Loan 731 PH (the first highway loan) has been slower than anticipated but is now improving; US$4.9 million has been disbursed at August 31, 1974. The total cost of the second highway project (Loan 950 PH) has increased by about 60% as a result of the rise in costs of basic construc- tion materials and fuel. Several proposals to assist offsetting some of the additional cost are under consideration. In these loans, the Bank's objec- tive is to bring about organizational improvements. 1.03 In total the Philippines has received 26 Bank loans and three IDA credits totalling US$572.0 million, net of cancellation. About half of this total has been for priority infrastructure projects; the remainder has been divided between agriculture and industry. 1.04 This report is based on the findings of an appraisal mission composed of Messrs. G. F. Bain (maritime specialist), J. Burns (financial analyst) and 0. Rahkonen (economist) which visited the Philippines in January 1974.  -2- II. BACKGROUND A. General 2.01 The Phili3pines consists of some 7,000 islands with a land area of about 300,000 km (roughly the same size as Italy). Luzon, on which Manila is situated, and Mindanao are the two largest islands, making up about 70% of the land area. They also account for about three-quarters of the 39 million population. The annual population growth rate, 3% during 1960-70, is one of the highest in the world. 2.02 Agriculture, the basis of the economy, generates about 32% of the Net Domestic Product (NDP), accounts for about 70% of export earnings (coconut, forestry products and sugar), and employs about 48% of the labor force. About 33% of the land area is cultivated (primarily rice and corn) and about 48% is commercial forest. Manufacturing accounts for about 21% of the NDP, considerably more than in Malaysia, Thailand and Indonesia. The Philippines has abundant natural resources, with particular potential for tropical agriculture, forestry and mineral development (copper, gold, iron, chrome and nickel). B. The Transport Sector (Map 11009) 2.03 Ports and shipping have, in the past, played a dominant role in the transport sector of the Philippines and continue to provide an essential means of transport and communication between the islands of the archipelago. In recent years, however, an expanding network of highways, particularly on Luzon, has provided access to the interiors of the larger islands, and road transport has played an increasingly important role. The relatively short inland distances have limited railways to a small fraction of the total traffic. 2.04 Difficult terrain, heavy rainfall and unfavorable soil conditions have been natural obstacles to the provision of transport infrastructure but lack of funds and poor planning and organization have compounded the problem. The lack of finances has made it impossible to maintain or improve transport facilities to an adequate level. Since the imposition of martial law in 1972, there has been a notable increase in the amount of funds made available for infrastructure investment and maintenance. 2.05 The highway network consists of about 16,000 km of paved roads, 38,000 km of gravel, and 20,000 km of unimproved roads. The highways of Luzon and Mindanao comprise three-quarters of the entire system, most of the rest being on the main islands of the Visayas. The condition of the road system is generally poor, with even the national primary and secondary roads in a deteriorated condition, because of inadequate maintenance.  -3- 2.06 The Government-owned Philippine National Railways (PNR), has about 1,000 km of main line and 1,000 km of branch lines on the island of Luzon. About 760 km of PNR's track was relaid during the 1960's with the aid of Japanese reparations. The remainder is in very poor condition. Management of the railway has been weak, maintenance of facilities inadequate and opera- tions inefficient and unprofitable. The main line is paralleled by highways for most of its length and it is difficult to visualize the railway ever being competitive with trucks and buses without Government subsidy. However, since PNR is an important employer, it would be difficult for the Government to close it down, and the Government's present objective is to improve its operations to the point where it is covering all cash costs. In FY 1974 PNR expects an operating surplus as a result of increased traffic, an increase in tariffs and improved cost control. 2.07 Manila, the only international airport in the Philippines, is served by 15 major international airlines, as well as by the Philippine Air Lines (PAL), which has both international and domestic services. An extensive network of domestic airports is served by PAL. Domestic passenger traffic has been increasing at about 17% per annum with PAL carrying more than two-thirds of the traffic up to the end of 1973, when the two other major domestic airlines were taken over by PAL. Despite the high traffic growth, PAL has encountered increasing financial difficulties over the last two years, partly because of an ambitious expansion program. 2.08 There are some 90 national and 390 municipal ports throughout the Philippine archipelago, plus numerous private piers and wharves. Most of the public ports are small and the Government envisages the gradual elimination of the less economic ports from the national system. This will be achieved through the concentration of investment at selected locations, a process which should yield economies of scale. Most of the public ports are poorly maintained and have not been designed for modern cargo-handling techniques. Sheds are often lacking, although private warehouses are usually available nearby. Cargo-handling is generally in the hands of private companies, and many ports lack equipment. Manila, much the largest port, accounts for about 70% of all imports and 5% of all exports. Private port facilities handle most of the dry cargo exports and oil imports and by comparison with the public ports are modern and efficient. 2.09 The Phllippine merchant fleet totalled approximately 1.6 million gross registered tons (GRT) in 1971. This includes 130 ocean-going vessels totalling 830,000 GRT and 130 inter-island vessels of over 1,000 GRT totalling about 280,000 GRT, the remainder being craft of under 1,000 GRT each. About 65% of the inter-island fleet and 41% of the ocean-going fleet were 20 or more years old in 1971. Some vessels are poorly maintained, built to obsolete standards and ill-suited to modern cargo-handling methods and the safety record is poor. In 1968, seven new cargo/passenger vessels, of 7,000 deadweight tons each, were bought with aid from the Federal German Republic for inter-island services. More recently, a few tankers and cargo vessels have been acquired through private financing.  -4- C. Transport Planning and Coordination 2.10 As a result of the continuing Government reorganization, transport planning will in future be the joint responsibility of the National Economic and Development Authority (NEDA), and other agencies such as the Department of Public Works, Transportation and Communications (DPWTC), the Department of Public Highways (DPH), the proposed Philippine Port Authority (PPA) and the Maritime Industry Authority (MIA). Each agency will have a Planning Service responsible for transport planning within their respective jurisdic- tions. The Philippine National Railways (PNR) is responsible for planning railways development. Exclusion of the highways, railways, ports and ,hipping from the jurisdiction of the DPWTC militates against effectiveness of the latter as an instrument of overall transport coordination, which is now left to NEDA. NEDA is, however, setting up an information/monitoring system where transport planning agencies will be informed of their respec- tive functions and where transport data will be centralized. 2.11 Rates and Fares for inter-island shipping are set by the Board of Transportation (Annex 1) in accordance with policies prescribed by the MIA. MIA has been given regulatory powers in respect of the growth of the naritime industry. The main objective in exercising these powers is to rcvide better coordination, rather than increased control, of the develop- men: of the maritime sector, conducive to improved efficiency and economic growth within that sector. The Bank supports this objective. The present regulatory functions for shipping will continue with the Philippine Coast Guard (PCG) with the assistance of MIA particularly in the classification and inspection of vessels. 2. +' The Government's four-year public infrastructure program for highways ant ports (1974-77) calls for a very substantial increase in public investment, and a large number of transportation projects have been identified. This emphasizes the importance of the role of the Planning services of the various Government agencies in establishing priorities amongst competing projects under the coordination of NEDA, since the Government will not be able to implement all the proposed projects within this period. DPWTC is already receiving technical assistance, financed by the UINDP, in its physical planning studies. In addition, to make its studies meaningful, a general improvement in the quality of basic data is required. Steps have already been taken to improve highway project planning and implementation capabilities. A similar improvement in the field of ports is essential and during negotiations for the second port loan the Government agreed to strengthen, before the end of 1974, the Port Programm- ing and Planning Branch of the Bureau of Public Works (BPW) with a view to organizing the collection of statistics and improving the preparation of projects for all National Ports. The MIA will collect data for shipping consistent with the port data to be collected. A Philippine Ports Authority ~s in process of being established with responsibility for developing a national policy for ports and with general jurisdiction and control over all port districts; it will become fully operational by January 1976.  III. ORGANIZATIONS INVOLVED IN THE PROJECT A. Overall Government Coordinating Agencies 3.01 NEDA is supported by the Board of Investments (BOI) which is now attached to the Department of Industry in coordinating investments and development plans, including export promotion, within the private and the mari- time sectors. Insofar as the project is concerned, NEDA and BOI will be assisted in planning and coordination by the MIA (para 3.05). 3.02 NEDA is the overall coordinator of national policies on fiscal, budgetary, monetary, credit, tariff, investment, price, production, manpower and trade matters. It provides policies which serve as the broad framework for the investment and financial policies, plans and programs of Government financial institutions and corporations attached to the Authority. NEDA also reviews the Investment Priorities Plan (IPP) and the Export Priorities Plan (EPP) prepared each year by BOI. 3.03 The BOI was formed in 1967, to administer the Investment Incentives Act. This act affects investments in manufacturing, agro-industries and mining, but not service industries including transportation. About one-half of total industrial investment has gone into projects registered with BOI. BOI attempts to determine needs for additional capacity to meet domestic and/or export demands. It approves projects in harmony with the IPP and EPP and discourages investment in overcrowded industries by refusing incentives. Its project evaluation usually contains a comprehensive economic analysis including the calculation of the economic rate of return and is of high quality. The Development Bank of the Philippines (DBP) does not consider any projects and loan applications which have not been registered with BOI. B. Maritime Industry Authority (MIA) 3.04 The Government has recognized the urgent need for coordination of maritime industry development and supervision, which was hitherto allocated among many Departments and other organizations. In order to accomplish the required restructuring of responsibilities, a Maritime Industry Decree (Annex 2), the general content of which is acceptable to the Bank, has been promul- gated. 3.05 The Decree provides for a MIA having jurisdiction over the develop- ment of shipping, shipbuilding and repair, stevedoring and freight forwarding, and with general coordination functions regarding marine training. The Board of MIA is charged inter alia, with providing policy guidance for the promotion and development of maritime industry; prescribing promotional development rules and standards for the effective regulation of shipping enterprises; setting policies for freight and passenger rate regulation to be followed by the Board of Transportation in its rate-fixing function.  -6- 3.06 The MIA is charged with responsibilities in both planning and operations. It will prepare a ten-year Maritime Industry Development Pro- gram, for approval by the President within two years of its inception, and the Bank will assist in the preparation of the initial Program. Considera- tion will be given to the introduction of standardization to the extent possible. The Program, which will be updated annually by MIA by forecasting demand and the capital needs of the industry and by proposing appropriate patterns of shipping operations and solutions to shipping problems, will provide the basis for a more rational and coordinated approach to the mari- time sector. 3.07 In operations, the MIA will be responsible for the issuance of Cer- tificate of Philippine Registry for all vessels being used in Philippine waters, including fishing vessels; conducting continuing research and develop- mental programs on the expansion and modernization of the merchant fleet and supporting facilities; undertaking studies to determine present and future requirements for port development including navigational aids; implementing the rules and regulations issued by the Board of Transportation with respect to maritime shipping; and the inspection of the safety of stevedoring equip- ment. In addition, MIA will coordinate marine training; recommend measures to regulate the importation and exportation of vessels, their equipment, and spare parts; assist the Philippine Coast Guard (PCG) in the classification and inspection of vessels; assist in settling labor disputes; prescribe and enforce anti-pollution regulations and a data collection system for the shipping sector which will be consistent with that of other parts of the maritime sector. These powers, together with the planning functions of MIA, are adequate to ensure a rational development of the maritime sector. 3.08 Organizational changes will be made transferring certain powers and functions of the Department of Trade and Bureau of Transportation to MIA. These relate, inter alia, to freight studies and supervision of shipping. The PCG will retain its present functions relative to maritime matters with the provision that within two years of the issuance of the Decree the President may transfer the regulatory functions of the PCG to the MIA (paras 3.17 to 3.19). 3.09 MIA's operational division, which will be set up within four months of the promulgation of the Decree, will become the nucleus for promoting the development of the Maritime Industry. After a transitional period MIA will become the focal point of the ship inspection service. During this period the training of ship surveyors will take place within the PCG, while MIA will be the recipient of the technical assistance proposed for improving ship inspection in the Philippines. This technical assistance and training is based on recommendations contained in the report of an expert provided by the Inter-Governmental Maritime Consultative Organization (IMCO) under UNDP finance. The report included the preparation of a 17-volume revision of Philippine Merchant Marine Rules and Regulations and a strong recommenda- tion for the creation of a civilian ship inspection service. It also set out the technical assistance and training program required, an outline of which is given in Annex 3.  - 7 - C. Development Bank of the Philippines (DBP) 3.10 A detailed report on the institutional aspects, resources, operations and financial position of DBP is contained in the Bank's Appraisal Report No. 424a-PH of May 5, 1974. During negotiations for an Industrial Loan of US$50.0 million, the Bank and DBP reviewed DBP's plans and progress in strengthening the staff of the Industrial Projects Department and the steps by which the Bank will assist in strengthening DBP's existing audit system (para 4.16). The Bank and DBP also reviewed and agreed upon operating Policies and Procedures for industrial financing which were approved by DBPs Board of Governors on May 29, 1974 (Annex 4). 3.11 DBP is by far the largest development bank in the Philippines. DBP's total financing to date amounted to Ps 14.3 billion (US$2.1 billion) for 260,000 clients and accounted for about 10% of total investment in the Philippines; its industrial financing, for about 20% of total industrial investment. It is proposed that DBP be the recipient of Bank loans for use in the industrial sector. In appraising DBP the Bank has found that DBP has some organizational problems but its overall technical capability and in particular that of its industrial department is adequate. 3.12 DBP has lived through a recent period of difficult times in which many of its guarantees were called and in which many borrowers defaulted partly as a result of sharp exchange rate changes. The effects of this period are being overcome through tighter control by the Central Bank of the terms on which private suppliers' credits are incurred and by the financial reorganization of the companies concerned. 3.13 In preparation for increased lending in shipping required to improve the sector, DBP has formed a Maritime Section as part of a general reorganization of its industrial lending activities. Industrial loans are now handled by three Departments - I for large industrial loans, II for small loans, and III for public utilities including shipping. The Maritime Section in Industrial Department III will have a staff of 21 including a marine engineer and a naval architect, 5 financial analysts, 5 technical analysts and other support personnel. The staff is generally of good quality and experience. Three of the technical staff have received on-the-job training in the United Kingdom at shipyards and banks. 3.14 At December 31, 1973 the Maritime Section had a shipping portfolio totalling some Ps 150.0 million consisting of 14 loans totalling Ps 83.0 mil- lion and six guarantees totalling Ps 67.0 million. Nine loans and five guarantees had been in arrears (principal and interest) for more than one year; this reflects both a past weakness in DBP's appraisal and supervision standards and the effects of the revaluation of the Deutsch Mark, the currency of denomination for several large loans. The portfolio has been reviewed and legal action taken for recovery in two cases where the vessels financed have sunk. Two other loans have been rescheduled.  - 8 - 3.15 DBP is prohibited by law from lending proceeds of loans from international institutions to corporations which are in arrears for more than three payments. This prohibition increases the financial pressure on companies in arrears and should lead to improvements in the organization, operation and capital structure of the shipping industry. As a result of the reorganization of the Industrial Department, DBP will now take sustained action to insure not only the repayment of loans but also the realization of projects' expected contribution to the national economy. It will exercise much closer control and supervision of projects. 3.16 While DBP's loan appraisal and supervision techniques are adequate, some assistance will be required for maritime lending operations. Technical assistance consisting of a maritime finance expert and a maritime technical expert, each for two years to act as advisers to the manager of Industrial Department III, will be secured by DBP. Terms of reference for these experts have been agreed between the Bank and DBP (Annex 5). It also appears desirable to secure modest advisory services in Admiralty law for DBP. This technical assistance would consist of a retainer fee for an Admiralty lawyer for about 12 months plus the cost of a library. D. The Philippine Coast Guard 3.17 The Coast Guard, staffed by officers and men of the Navy, is responsible for navigational aids; police functions in Philippine waters; the approval of construction, repair, and conversion plans; ship inspection; registration, documentation, and certification of ships; and operating procedures of vessels, their equipment and appliances. It also investigates marine casualties and accidents. It registers and licenses marine officers, pilots, and seamen and supervises and controls nautical schools. 3.18 While the functions and powers relative to maritime affairs are retained by the PCG, the MIA decree provides that MIA will assist the PCG in the performance of its functions especially in the classification and inspection of vessels. It also provides for coordination between the PCG and the MIA in supervising and regulating operations of water transport utilities. 3.19 Complementary to the above provisions (para 3.18), a Memorandum of Agreement has been signed by the PCG and the MIA (Annex 2a), reinforced by a Presidential Letter of Instruction (Annex 2b) to PCG, setting forth the requirements for providing ship inspection services and providing for adop- tion of the revised Merchant Marine Rules and Regulations referred to in para 3.09 by June 1, 1975. The physical work of ship inspection will be carried out under the overall supervision of the marine surveyors secured under the technical assistance and training program outlined in Annex 3. These arrangements are satisfactory to the Bank and an early improvement in the quality of inspection is anticipated, particularly in connection with repairs and the issuing of certificates of seaworthiness for old ships.  - 9 - E. The Shipowners of the Inter-Island Fleet 3.20 The Philippines inter-island fleet is entirely privately owned. Government records are inadequate with respect to the number, type, size, and condition of the fleet. Most of the records were destroyed by fire in 1971. An attempt is currently being made to reconstruct these records. From an extension of 1971 data, it appears that the 1973 fleet totalled about 1.6 million GRT, of which 0.4 million GRT represented the inter- island fleet. 3.21 The inter-island fleet seems to consist of about 430 ships of which about 70% by number and 30% by gross tonnage are ships of under 1,000 GRT. About two-thirds of the ships are over 20 years old, with one-fifth over 30 years old. Most of this latter group consists of wartime-built ships. These are now badly deteriorated and most are unseaworthy and in dangerous condition. Following several recent serious accidents involving loss of life, the Government has ordered the removal from the fleet within the next four years of all ships over 30 years of age. 3.22 The Conference of Inter-Island Shipowners and Operators (CISO) consists of 18 companies which together own about one-third of the gross tonnage thought to be in the inter-island fleet. Fifteen of these companies were questioned and/or interviewed by the mission to discover their investment plans. This group alone had plans to acquire over US$50.0 million equivalent of ships within two years (Annex 6). Much of the demand is likely to be realized because the larger of the companies appear to be creditworthy or will become so through financial reorganization. All of the CISO members have some old, small ships requiring replacement. Limited data exist about the small companies based in and outside of Cebu and Manila which own and operate ships. Two of these are, however, current borrowers from DBP and appear to be sound financially. 3.23 During the project identification stage, many companies were questioned about their ability to provide the increased equity required to support acquisition of new ships. In most cases the answers were positive. In addition, the managerial abilities and the financial expertise of many companies appeared to be adequate for administering the expansion or changes planned. For the balance of companies, DBP has a well developed program of financial advice and managerial training to assist its borrowers. 3.24 Among the ships likely to be acquired are used and new passenger and cargo ships, roll-on/roll-off ships to serve trunk routes, and high- speed smaller ships for secondary routes. Such acquisitions, because they will introduce modern equipment with lower operating costs and provide effi- cient and reliable service, will be encouraged by DBP in its development role. There may be other innovative and cost effective projects involving larger specialized vessels which DBP will also attempt to finance such as side port loading for palletized cargo and container ships.  - 10 - IV. THE PROJECT A. Project Description 4.01 The project consists of: (a) the acquisition, conversion and major repair of vessels of the inter-island fleet, with emphasis on replacement of ships over 20 years of age and the major repair of ships of up to 16 years of age; (b) the provision of technical assistance to DBP and MIA; and (c) the formulation of a maritime industry development program (para 3.06). The Project will be implemented by DBP and MIA, with assistance from the PCG. 4.02 The Bank will make available up to US$20.0 million equivalent in foreign exchange for the acquisition, conversion and major repair of inter- island ships through a loan to the Government. The Government will relend the loan proceeds to DBP which will, in turn, relend the funds to shipowners on terms detailed in para 4.14. The Government has confirmed that shipowners will be able to obtain any additional foreign exchange required for their contribution. 4.03 The United Kingdom has given an undertaking that it will provide the required funds for technical assistance to DBP's Maritime Section under the Colombo Plan. The advisers to be selected will be approved by the Bank and it is expected that recruitment will have been completed by December 31, 1974. 4.04 The Government may request the technical assistance and training involved in improving the marine inspection services from bilateral sources using a recognized international ship classification society. Terms of reference for the marine surveyor experts are to be prepared and agreed with the Bank. The Government has agreed to secure the required technical assistance by December 31, 1974. 4.05 Funds to cover the required technical assistance outlined in paragraphs 4.03 and 4.04 have been included in the loan on a contingent basis. In the event that bilateral aid is forthcoming, these funds will be reallocated or cancelled if not required. B. Demand for Funds 4.06 As of December 31, 1973, DBP had pending shipping loan applications amounting to about US$5.0 million equivalent. During appraisal the mission  made a survey to assess the likely demand for DBP loans, covering companies owning about one-third of the estimated gross tonnage in the inter-island fleet. This survey indicated that over US$45.0 million equivalent is likely to be invested in purchasing vessels (Annex 6). 4.07 Although it is not possible to be precise, the cost of project components, including shipowners' equity assumed to be about US$13.6 million equivalent, is estimated to be as follows: Pesos Million US$ Million Local Foreign Total Local Foreign Total New and Used Ships 5.4 198.6 204.0 0.8 29.2 30.0 Major Repairs and Conversions 8.2 12.2 20.4 1.2 1.8 3.0 Technical Assistance 0.7 4.7 5.4 0.1 0.7 0.8 Training 0.7 1.3 2.0 0.1 0.2 0.3 Total 15.0 216.8 231.8 2.2 31.9 34.1 The Bank would finance US$20 million or just under 60% of the cost of the shipping project (see Annex 7). C. Procurement 4.08 It is anticipated that a wide variety of sizes and types of new and used ships will be procured mainly from Japan and Europe. Bids for new ships shall be invited on the basis of international competitive bidding, against owners' outline specifications which will have been approved by DBP's Maritime Section. Contracts shall be let under procedures consistent with those set forth in the Bank Guidelines. For ships built in the Philipp- ines, evaluation of bids will include a domestic preference of 15% or the amount of import duties, whichever is lower. Contracts for used ships shall be awarded after DBP has secured quotations for ships of an appropriate size and type from international shipbrokers, account being taken of the price delivery times, the cost of having such ships classified by an international classification society and ocher relevant factors. In deciding whether to purchase a new or a used ship, the shipowner will employ appropriate investment appraisal techniques with assistance from DBP's maritime advisers. 4.09 The specialized nature of ship repairs and small ship conversions, the small number of parts to be secured from specific manufacturers at any one time, and the limited size of repairs - say a maximum of about US$200,000 equivalent as against a small ship replacement value of about US$1.2 million - would make international competitive bidding procedures impracticable for repairs and conversions. Contracts for repairs and conversions shall, however, be awarded in accordance with regular commercial practice, and, where applicable, a domestic preference of 15% or the amount of import duties, whichever is lower, will be used in bid evaluation.  - 12 - Repairs and conversions will be carried out according to the technical standards of an international classification society. Materials for ship repairs and conversions will be procured from local commercial sources where international suppliers are widely represented. Repairs and conversions are unlikely to be undertaken abroad in view of the competitive position of Philippine shipyards. A review of procurement and technical standards will be undertaken by DBP's Maritime Section prior to disbursement in order to ensure that costs are competitive and that appropriate procedures have been followed. D. Disbursement 4.10 The Bank will reimburse DBP as follows: (i) 100% of the sub loans for new ships (80% of the procurement cost); (ii) 100% of the sub loans for used ships (50% to 60% of the procurement cost, depending on age); and (iii) 75% of the suo loans for major repairs or conversions (60% of the cost, repre- senting the estimated foreign exchange cost in an average domestic repair or conversion). Disbursement will be made against appropriate documentation indicating that DBP has fully disbursed its loan or that payment for work done was due under contract terms. DBP may require a shipowner to make payment out of his own funds prior to DBP's disbursement. For consultants' services, disbursement will be on the basis of the actual foreign exchange cost. It is estimated that DBP will commit the Bank's loan within two years and that it will be fully disbursed within four years. E. Pject Execution DBP Lending Terms 4.11 DBP's lending criteria for loans for inter-island ships will be based upon: (a) operating Policies and Procedures for Industrial Financing agreed upon by the Bank and DBP (Annex 4); (b) an adequate survey of the vessel to be acquired, converted, or repaired; (c) a study and appraisal of specifications for new ships; and (d) the acquisition, conversion and major repairs mainly of ships of about 1,000 GRT and under, and the setting of technical standards for ships to be acquired or repaired.  - 13 - 4.12 With the technical assistance proposed, DBP's Maritime Section would be capable of adequately appraising loan applications. Nevertheless, the first 10 shipping loans will be subject to Bank approval prior to disbursement. Subsequently, on the basis of this experience a free limit will be agreed upon by the Bank and DBP. All project appraisals will be sent to the Bank for information or approval and for disbursement, and will contain certain other data of interest to the Bank. 4.13 Vessel surveys will be undertaken prior to lending for the acqui- sition of used ships or for repairs and conversions. They will be carried out by DBP's staff, by a classification society, or by such other competent marine surveyor as DBP may approve. DBP will require evidence of the satis- factory completion of repairs or the registration of ships in the Philippines prior to releasing funds, although contract progress payments may be made according to normal commercial banking practice. DBP security will include, among other things, a first mortgage on the ship and such other security as DBP may require to obtain 130% coverage for its loans including the right to attach the ship's revenues and to manage it, if necessary. Adequate insurance of the ship or of a company's fleet will be required in order to secure DBP's position. Ships will be classified by a recognized classification society. DBP loan conditions provide for representation by two regular directors on any borrower's board and, where necessary, the appointment of a controller. 4.14 DBP's lending terms will extend up to 16 years, with two years' grace, for new ships and from eight to twelve years for used ships, includ- ing six months grace. For conversions and major repairs, loans will be available for up to five years with one year's grace. DBP will lend to shipowners at 12%, the maximum legal rate for such loans in the Philippines; this rate and spread of 4% are similar to those negotiated for the Bank's US$50.0 million industrial loan. As agreed between the Government and the Bank, the foreign exchange risk on the currency of procurement will be borne by the shipowner, while the risk on the currencies of obligation will be borne by the Government. 4.15 DBP's lending will conform to the policies set by MIA for the maritime sector and an understanding was reached between the Bank and DBP dealing with this and other criteria (para 4.11). Audit 4.16 The Philippines Government's auditing system, which includes DBP's auditing Department, is in the process of being reformed. The Bank has discussed and agreed with DBP specific steps for improving DBP's audit, par- ticularly with regard to a detailed examination of DBP's portfolio and including the assistance of an auditing expert and staff training. In respect of the proposed shipping loan, DBP will furnish the Bank within a specified time all information that the latter reasonably requests concerning the operations and transactions of the Maritime Section of the Industrial Depart- ment III.  - 14 - V. ECONOMIC EVALUATION A. General 5.01 The evaluation of the economic feasibility of the project involves a two-fold assessment of its impact on the economy. The first, a macro-economic one, takes into account overall national needs and develop- ment programs; the second, the internal economics of inter-island shipping. The evaluation in this appraisal is mainly assessed on the latter. 5.02 The project has several specific features which have implications for the economic evaluation and make it different from most public sector transport projects. The most important of them are: (i) the project does not represent a single, lumpy investment in creation or improvement of a single facility, but is composed of a number of sub-projects (individual ships) which have similar general characteristics, although different in special features; (ii) investments in ships do not represent assets, which once created, are fixed in place like infrastructure investments; ships can be sold on the market and can be put into alternative use; (iii) the use of ships is not tied to specific infrastructure facilities except at terminal points; so there is complete freedom of route selection and congestion problems are not experienced except again at terminal points; and (iv) alternative modes do not exist, as for most of land transport, to fulfill inter-island transport demand except for some high unit- and time-value transport where air transport facilities are available. The implications of these features will be outlined in subsequent paragraphs. B. National Economic Development and Inter-Island Transport 5.03 Regional dispersal tendencies resulting from overall population and economic growth, combined with specific agricultural and industrial development, generated fairly rapid growth in inter-island transport in recent years. These trends may be summarized as follows: (a) Luzon, and particularly Manila, has become a deficit area of domestically consumed agricultural products and other primary commodities due to a rapid increase in population, unfavorable physiographic conditions (typhoon-prone area) and limited availability of undeveloped land areas. (b) Similar circumstances prevail in the most developed and densely populated islands in the central Philippines, particularly in Cebu.  - 15 - (c) These deficits have increasingly been supplied from Mindanao, which has large agricultural and forestry surplus potentials due to lower population densities, more favorable physiographic conditions and large tracts of undeveloped land. (d) A reverse flow of manufactured products is taking place particularly from the Manila area, which has dominated industrial production in the Philippines because of availability of capital and skilled labor and proximity to the most important local market with considerably higher than average per capita incomes. 5.04 As a result, the inter-island traffic, which at the beginning of 1960's was estimated at about 2 million tons of cargo and some 1.5 million passengers, had by 1972 increased to some 3.5 1/ million tons of freight and the same number of passengers, indicating an average annual increase of about 5% for freight and about 7.5% for passenger traffic. Although these estimates are subject to a considerable margin of uncertainty, they indicate a substantial growth particularly in passenger traffic, with Manila and Cebu as the main inter-island ports handling together about 30% of both the freight and passenger traffic. Indicative of the deficits in these two centers and their immediate influence areas is that in 1972 about 1.85 million tons were discharged in these two ports, while only 1.05 million tons were loaded. Further details on the inter- island traffic are provided in Annex 1. 5.05 No significant changes are expected in these development trends in future; in fact, it may be expected that the imbalance in trade flows will continue to increase. The reason for this is that Mindanao will, with its vast potentials, continue to be the major agriculture and forestry development area in accordance with the Government's regional development policies and thus continue to act as a source of supply to the major urban and other deficit areas, while Manila will decrease in importance as a supplier of manufactured products (para 5.06). The deficits are expected to increase due to population growth and the limited agricultural development potentials close to these centers. The economic growth of Mindanao is expected to be about 7 to 8% p.a. over the next ten years, somewhat above the national average (para 2.02). 5.06 Government regional development policies imply a gradual dis- persion of the concentration of the industries from the Manila area. This policy is consistent with the attempts to promote and diversify economic growth of the outer islands. Such development is already taking place at present in the outer islands, mainly based on locally produced raw materials from agricultural and forestry activities with the expectation of a gradually increasing processing level and product variety. This will result 1/ Estimated base on total in- and outward port traffic volumes divided by two.  - 16 - in a decreased dependency on Manila as a source of supply of manufactured products and it will also decrease, in relative terms, the outflow of goods from Manila. Passenger traffic is expected to show a similar growth trend as in the past, due to increased urbanization and transmigration and higher income levels with continued strong contacts with the "home provinces" typical for the Philippines. As a result, passenger traffic will gradually increase its relative importance measured in the number of passengers compared with tons of freight. This development is indicated on the major routes, where the shipping companies have gradually been replacing their fleets from basically freighter type vessels to combined cargo-passenger carriers. 5.07 Expected future annual growth rates of inter-island freight and passenger traffic of 5% and 7.5% respectively would imply some 5.25 million tons of freight and 6.25 million passengers by 1980 implying some 2.5 bil- lion ton-km and 3.0 billion pass-km with an average transport distance of about 250 nautical miles (almost 500 km). According to information given by the shipping companies, the growth rates have been considerably higher during the past two years than those above, but these are believed to be only temporary and the result of the recent improvement in the internal conditions Ln the country. ,.ns As outlined above, inter-island shipping is of essential importance .cr the continued overall economic development in the Philippines. It is difficult, if not impossible, in the absence of an alternative mode of transport to estimate the detrimental effect on the national economy of not improving the inter-island shipping. It would result not only in lost value added from inability to transport considerable volumes of domestic production but also in a gradual disintegration and stagnation of the national economy. C. Economics of Inter-Island Shipping .09 Because of the nature of the project, the economic return on the project investment can be established more firmly only after all requests for sub-loans have been evaluated and those with the highest economic and financial returns have been selected by the DBP and the Bank and the loan has been fully committed. This will involve a period of about two years, while the final assessment will require an additional period of actual operation. Therefore, the results of the economic evaluation undertaken as part of this appraisal represent only indicative estimates of the eco- nomies which can be obtained through a gradual modernization of inter-island shipping in the Philippines. The results are, however, representative for the project, because the evaluation has been based on actual ship acquisition plans submitted to the DBP by the shipowners and because the cost and opera- tional data used in the evaluation are based on actual operations.  - 17 - 5.10 An economic evaluation has been undertaken for two typical cases: (1) introduction of a 5,000 GRT, modern, although second-hand, roll-on-roll-off (ro-ro) type vessel on the main inter-island shipping route Manila-Cebu replacing a number of con- ventional passenger/cargo vessels, which in turn will replace a number of old FS-type 1/ vessels on some of the secondary (feeder) routes. It is assumed that the FS-type vessels, which are about 30 years old will be scrapped; and (2) scrapping and replacement of a number of FS-type vessels with newer conventional type passenger/cargo vessels on secondary routes only, while the operations on the main route Manila-Cebu remain essentially unchanged. 5.11 Both cases involve a substantial improvement in the inter-island shipping operations and enable a simultaneous scrapping of old and less suitable vessels of which many have for years represented a serious safety hazard with yearly fatal accidents taking place. However, case 1, the introduction of a ro-ro vessel, represents a far more advanced technology than case 2, which is more typical of the current practice in the Philippines. The ro-ro case was chosen because (i) there exist sufficient passenger and freight volumes on the Manila-Cebu route to make the operation of such a vessel a financially and economically viable project; (ii) some Philippine shipowners already have plans for acquisition of such vessels, which are readily available either second-hand or new; and (iii) they are at present extensively used elsewhere, particularly in Europe, on the Baltic, the North Sea and the Mediterranean. These ships require, however, fast turnaround times in order to be economically viable. This means in practice a minimi- zation of port times, because vessel cruising speeds can be increased only to a limited extent and at high cost because of steeply increased fuel consumption. .5.12 The results of the economic evaluation are presented in Annex 8. The results indicate that the economic return for case 1, involving a initial investment of Ps 30 million (US$4.5 million equivalent net of duties and taxes), would be about 30% over a project life of 25 years. As indicated above, the result is sensitive to the estimated port times of the ro-ro vessel. These were assessed conservatively at about double those typical for present European operations, but a further doubling of the port times would still give an economic return of about 20%, which is highly satisfactory. 5.13 The economic rate of return for case 2, involving an initial investment of Ps 20 million (US$3.0 million equivalent), has been estimated at about 27%. A reduction in the operating efficiency of 20% for the passenger/cargo vessels replacing the FS-type vessels would still give an economic rate of return of about 21%, which is very satisfactory. The 20% 1/ The F. S. type is a World War II landing craft design converted for cargo/passenger service on feeder and distribution routes to small outlying ports.  - 18 - reduction in operating efficiency implies a 35-40% increase in the assumed port times. 5.14 One of the main reasons for the high economic returns is that in both cases, it has been assumed that the ships were procured secondhand at a substantially lower cost than corresponding new ships. This has, how- ever, been considered to be economically and technically sound, because of (i) the high cost of new ships; and (ii) the availability on the market of a substantial number of second-hand ships less than 12 year old, which are reliable in operation but no longer financially viable in their present area of operation because of obsolesence (e.g. 5-10 year old ro-ro vessels, which are being replaced by a newer generation of highly specialized vessels, either for freight or high standard passenger travel.) If new ships were used, in- stead of secondhand, there would not be any further substantial improvement in operational efficiency under Philippine conditions. However, if new ships were used, the economic return for the ahove two cases would be about 12%. 5.15 The economic cost (including capital costs) of carrying one traffic unit (one passenger or freight ton) between Manila and Cebu (390 nautical miles or 720 km) is estimated to be at present Ps 25.00 (US$3.70 equivalent). This cost would be reduced to about Ps 21.50 (US$3.20 equivalent), or by about 15%, by use of the modern ro-ro vessel. There would be a similar percentage reduction on the secondary routes as a result of replacing FS-type vessels with conventional passenger/cargo ships. These reductions are minor in relative terms and are not expected to be passed on to the traffic users in the short term. However, this is expected to be accomplished in the longer term in the form of avoided increases in rates and fares. Without replacements, increases would occur in the real cost of ship operation because of obsolesence and increased repair requirements. VI. FINANCIAL EVALUATION A. Inter-Island Shipping Companies 6.01 The inter-island shipping companies are all privately owned, mostly by family interests. The smaller companies and operators are wholly in shipping while the larger companies are part of larger diversi- fied family interests. 6.02 The most important companies in the inter-island fleet are William Lines, Carlos A. Go-Thong, Sweet Lines, Aboitiz Shipping and Cia Maritima, the last being the major line operating out of Manila. Negros Navigation concentrates almost wholly on high-speed passenger services in which trade Sweet Lines is also an important factor.  - 19 - 6.03 Management of the major shipping companies is of high quality and all have sophisticated accounting systems, including detailed opera- tional costs in voyage accounts and audited annual accounts. The control of repair and maintenance costs is adequate which explains the continued satisfactory operation of older ships in these companies. b.04 Most shipping companies expressed dissatisfaction with the existing procedures for granting freight rate increases, which are a variant of the United States' system where tariff increases are referred to the Interstate Commerce Commission. The basic tariff structure is outdated and obsolete for many categories of traffic. The approach adopted by the Government in establishing rate making policy in MIA and having the Bureau of Transportation establish rates based on that policy, is favored by shipowners. B. Financial Position and Operating Costs 6.05 It has not been possible to undertake any extensive analysis of financial data for the inter-island sector of the industry. However, it was possible to obtain recent financial data for six major companies, which are summarized in Table 1. 6.06 Apart from Cia Maritima, all the companies are in a sound financial position and are able to meet their debt service requirements. Cia Maritima's DBP loans are at present being reviewed for possible reschedul- ing. Ships have been revalued at fair market value based on the prevailing foreign exchange rate at December 31, 1972. 6.07 An analysis of operating costs of ships of various sizes and ages has been made based on data supplied by two of the companies, which operate fleets of 12 and 16 vessels respectivelv and which range from modern cargo/passenger vessels to World War II FS type ships. This fleet is representative of the various kinds of vessels operating in the Philippines though the proportions differ from those in the fleet as a whole. These figures provide a basis for assessing the economics of the ships and of their replacement. 6.08 A breakdown of operating costs is given in Table 2 for ten 30-year-old vessels of 925 Dwt. The operating ratios reflect the high load factors and range from 41% to 71%, despite the high cost of maintenance and fuel oil. 65.09 These data indicate that substantial cash flows are being generated from these operations and that shipowners, given the availability of foreign exchange, will be able to replace these ships by larger, newer vessels of about 1200 Dwt.  - 20 - C. Effect of Investment in New Ships 6.10 With the demand for shipping space, new vessels with lower operating costs can yield a return of 21% on the capital investment, provide sufficient cash to meet loan amortization and give the shipowner an adequate return on his equity as indicated below for a 1200 dwt vessel: PS'000 Operating revenues 6,381 Operating costs 2,433 Depreciation 897 Overhead expenses 121 Net operating profit 2,930 Capital cost 17,950 Debt service requirement 2,172 Operating ratio 51% Return on capital 21.2% Return on equity (20%) 46.1% Assumptions 1. Fuel costs have been estimated at January 1974 prices. 2. Depreciation has been taken at 5%. 3. Loan terms 16 years including 2 years' grace at 12%. VII. AGREEMENTS REACHED AND RECOMMENDATION 7.01 Agreement has been reached on the following matters: (a) preparation of a Maritime Industry Development Program within two years of MIA's inception (para 3.06); (b) technical assistance and a training program for the ship inspection service will be available by December 31, 1974 (paras 3.09 and 4.04); (c) measures for strengthening Industrial Projects staff and audit system, as agreed for DBP's industrial loan, (paras 3.10 and 4.16); (d) technical assistance for DBP's Maritime Section wxvll be se zured by December 31, 1974 (paras 3.16 and 4.03); (e) shipowners will be able to obtain the foreign exchange required for their contribution (para 4.02);  - 21 - (f) lending criteria for sub-loans for inter-island ships (paras 4.11); (g) first 10 loans to be approved by Bank and free limit established thereafter (para 4.12); and (h) loan proceeds to be relent to shipowners by DBP at interest rates similar to those negotiated for DBP's industrial loan (para 4.14). 7.02 The proposed project is suitable for a Bank loan to the Government of US$20.0 million equivalent for a term of 18 years including a four-year grace period.   ANNEX 1 Page 1 PHILIPPINES APPRAISAL OF A SHIPPING PROJECT Inter-Island Shipping and Traffic A. General Characteristics 1. Inter-island shipping in the Philippines is defined to consist of freight and passenger transport which is undertaken by licensed, self- propelled vessels operated to provide public transport on a commercial basis comparable to operation of trucking and bus companies. This definition does not exclude small, one vessel owner-operators, but the thousands of small sailing and other privately owned vessels mainly engaged in fishing and local transport are excluded. According to the Coast Guard, the number of all kinds of registered, domestically operated vessels alone was about 3,850 at the end of 1973, with an average tonnage of less than 50. On the other hand, the number of vessels licensed for commercial operations was 434 (Appendix 1) or only about 11% of the number of those registered. Even this definition is slightly too broad because many of the licensed vessels are quite small - 40% less than 500 GRT (Appendix 1) - and engaged in coast-wise and bay transport only. 2. The main characteristic of the inter-island shipping industry is that, unlike land transport, the operators are free to establish and/or clhange their schedules and routes without prior authorization by a regula- tory body; there is also a complete freedom of entry, because the commercial license is not related to a particular operation and is issued to the ship, not the owner or operator. Moreover, the operators are not obliged to provide any information about their routes or traffic carried, which creates additional difficulties in obtaining a reliable and accurate picture of the industry. However, the larger inter-island shipping companies, which carry the major part of the traffic, maintain fairly regular published schedules. In addition, most of the traffic is carried between a limited number of major regional centers. However, only limited information is available on the origin and destination of traffic and estimated traffic volumes are subject to considerable uncertainty. Therefore, one of the main purposes of the project is to bring about a simultaneous improve- ment in management, operation, planning and data collection of the shipping industry. This institutional aspect is clearly important, although the probable effects cannot be quantified. 1B. Fleet 3. Inter-island shipping is undertaken by some 65 companies, most of them registered at Manila or Cebu, the latter being the main regional, center for inter-island trade. The larger shipowners, who may control  ANNEX 1 Page 2 more than one company, have formed the Conference of Interisland Shipowners and Operators (CISO). The following tabulation indicates the distribution of the inter-island fleet between conference members and other operators as of December 1973: No. of Companies No. of Ships Tonnage, GRT Conference 17/ 98 132,000 - 7 largest members (10) -2 (73) (117,000) - other (7) (25) (15,000) Non-Conference operators 45/3 306 173,700 Total 63 404 305,700 /1 Excluding one member with two inter-island oil tankers (8,600 GRT). /2 Two members control more than one company. /3 Excluding Luzon Stevedoring Corporation, which operates some 28 oil tankers with about 76,800 GRT. 4. A considerable part of the fleet is relatively old, about 30% eing more than 20 years old (Appendix 2). This applies both to larger ind small operators, although the larger ones have newer ships, while Lhe small owner-operators generally own the oldest ones, in many cases purchased from the larger companies. Most of the older ships are less than 1,000 GRT in size and represent war-built, FS-type surplus vessels obtained from the United States Government through the provisions of the Rehabilitation Act of 1946. Many of these ships have been legthened to provide additional cargo capacity and have been modified by extension of superstructures in order to provide deck space and a few cabins for passengers. As modified, the FS-vessels average about 750 GRT per vessel and take up to 200 passengers and 400 tons of cargo. They have high-speed engines, which require the more expensive HS diesel oil and provide a speed of about 11 knots. 5. The FS-type vessels represent the only large standardized group of vessels; the others are of varying origin and type, ranging from war- time landing craft to large, 6000 GRT combined passenger/cargo vessels. The great majority of these vessels have been purchased second-hand abroad. Only few large vessels have been imported new, while some smaller ones have been built in the Philippines. Compared with most of the fleet, the FS and other war-time vessels are more expensive to operate principally because of (a) higher fuel consumption; (b) the higher-cost fuel required; and (c) the relatively small space, even after modification, available for cargo. These higher operating costs may however be compensated by lower initial capital costs. The age distribution of the inter-island fleet is shown in Appendix 3.  ANNEX 1 Page 3 C. Operations 6. There are 93 national and about 390 municipal ports in the Philippines. Inter-island shipping of some significance, however, takes place only between some 40 of them on a commercial and regular basis, because all the municipal ports and 35 of the national ports are open for coastwise and bay trade only, while another 15-20 national ports authorized for inter-island shipping are of no importance because of insignificant volumes of traffic. 7. The 40 inter-island ports are served by the CISO-members on a regular basis with about 60 scheduled routes. In addition, less regular tramper services are mainly provided by. small, owner-operators, which also serve a number of small municipal ports scattered over the whole archieplago. About 10 of the 60 routes are of major inter-regional importance; the main trunk route connects Manila with the main centres on the Visayas (Cebu, Bacolod, Iloilo) and northern coast of Mindanao (Cagayan de Oro, Butuan, Surigao). The other routes are either extensions to this route (Zamboanga, Davao) or connected with Manila or one of the other major centres along this route. Characteristic for the operations of the routes is that, except for the Manila-Cebu-Mindanao trunk route, the competition between the major companies is limited; several of them operate a number of secondary routes independently and the companies appear to be reluctant to engage in any "cut-throat" competition. They maintain that the small traffic volumes and the low tariff level would be damaging for the whole industry which operates on a narrow financial return margin. This situation is expected to change gradually with lower cost, nore efficient, ships being introduced. D. Operating Efficiency 8. Compared with modern cargo liner operations the efficiency of Philippines inter-island shipping is low, on average about 3,500 ton-km per DW4T a year, which is about one third that achieved by an ocean-going cargo-liner. The ratio per employee is even less favorable because of the size of the crew. However, several adverse external factors contri- bute to this low effiency level, wlhile the large crews, which have a positive employment generating effect, are possible because of the rela- tively low wages paid. The adverse external factors are: (i) the com- paratively short distances between ports of call, which increases the proportion of time spent in port; (ii) the port times are additionally increased by excessive times spent at port, either waiting for berthing space or at quay because of generally disorganized port operations; and (iii) on minor routes, which connect small local ports, an additional factor is the physical limitation of the ports, restricting the size of ships. As a result of these factors, the time spent in port exceeds the sailing times except for the main trunk route Manila-Cebu-Mindanao; even on this route delays are frequent, particularly at the Mindanao ports. The high share of port time is the most important single factor in the reluctance of shipowners to acquire new, capital-intensive vessels,  ANNEX 1 Page 4 the use of which would further increase the proportionate share of port times without a significant shortening in total operating times. Therefore, taking into account the adverse operating conditions, the performance of inter-island shipping is satisfactory with generally competent management and crews. The load factors have also been high, from 70% to 95% during the past two years reflecting a general upturn in the economic activity. E. Tariffs 9. The inter-island rates and fares are based on a tariff pre- scribed by the Public Service Commission in 1928. The tariff has not been significantly revised or updated since then, except for a series of across-the-board percentage increases, which on a cumulative basis amount to 310% for freight and 180% for passenger traffic. The latest increase was in November 1971 and amounted to 30% for both main traffic categories 1/. The Board of Transport (BOT) is at present considering a request for an additional increase of about 30% for freight and 25% for passenger traffic, mainly because of increases in capital and fuel costs. l'OT has plans to undertake a comprehensive review of the tariff, although no date for completion of such review has been set. It has to be preceded by studies on the economics of inter-island shipping to be undertaken by MIA in connection with the preparation of the 10-year Maritime Industry D)evelopment Program. 10. The freight tariff is expressed as: (i) specific point-to-point rates for named routes; and (ii) class rates, other wise applicable, related to a classification of commodities into four groups. When ship- ments are transported between ports for which specific rates are not published, the charges per manifest ton, weight or space, are calculated on the following bases (as of 1973): Distance Rate Commodity Basic Rate, per naut. mile, Increment ClassLI Pesos Centavos % A 8.20 4.1 30 B 6.15 4.1 30 C 4.10 3.1 30 D 24.60 4.1 30 /1 Class A: e.g. beer, liquors, medicines, instruments textiles, imported canned goods. Class B: e.g. cardboard, cement, coconut oil, grains, machinery. Class C: e.g. bananas, iron and steel products, sand, cane sugar. Class D: logs, timber and lumber only. TFie previous increases were in 1946 (70%), 1950 (10%), 1961 (10% freight, 5% passengers), 1965 (18%, freight only) and 1969 (30%'0 freight, 10% passengers).  ANNEX 1 Page 5 The above calculation bases result in freight rates equivalent to USe0.7, 0.6, 0.4 and 1.1 per ton-km respectively for A, B, C and D classes on a typical distance of 400 nautical miles (Manila-Cebu). The prescribed freight rates cover only receipt and delivery of cargo at ship side. The shipowners are allowed to charge at current prices for extra services such as storage for more than five days, lighterage, insurance, overland transportation, etc. In addition, the shipowners are authorized to charge prescribed surcharges for transit cargo, heavy consignments and storage up to five days. The present freight rates appear to be fairly high if compared with ocean-going shipping, but reasonable in view of the special operating features of inter-island shipping in the Philip- pines; recent and expected cost increases may justify some of the requested increases in freight rates (para 9). 11. Passenger fares, related to first, second and third class ser- vices are, as for freight, based on point-to-point fares for specific main routes, while the fares between other points are calculated on the following bases: Distance, Rate, Centavos Increment Class naut. miles per naut. mile % 1 0-100 28.0 15 101-300 25.2 15 Over 300 22.4 15 2 70% of first class fares 3 40% of first class fares The fares include the price of meals during voyage and correspond to US42.1, 1.5 and 0.8 per pass-km for first, second and third class passengers respectively on a typical distance of 400 nautical miles. The present pas- senger fares reflect the level of service provided, although recent increases in fuel prices may require an upward adjustment as requested by the shipping lines. Compared with freight rates, the passenger fares appear however to give a slightly higher financial return. This applies in particular to additional marginal traffic increase. F. Traffic 12. The quality of the available inter-island traffic statistics is unsatisfactory for planning purposes. One of the main reasons for this deficiency is that no government agency has been given the responsibility of planning and coordinating the development of the maritime industry, including collection of basic data for this purpose. At present, statistical information is collected by the Bureau of Customs, which compiles data for each of the national ports on the basis of ship manifests. The main purpose of these statistics is to provide a basis for collecting a 2% tax on the gross receipts of public carriers. The statistics are, however, inaccurate and do not provide information on the origin and  ANNEX 1 Page 6 destinations of the traffic. Individual shipping companies are not obliged to keep or provide detailed information about the traffic they carry or about cost of their operations. Such information is however available on special request; most of the companies responded very positively to the appraisal mission questionnaires. 13. Improvements in the statistical bases will in future take place in two different areas, supplementing each other: (a) On the Government side, the recently established Maritime Industry Authority (MIA), (para 3.04), will be the sole agency responsible for planning and coordinating the deve- lopment within the maritime sector. In respect to collec- tion and analysis of maritime traffic data, MIA will work closely together with the Philippine Ports Authority (PPA) to be established shortly (para 2.12). The Port Programming and Planning Branch of Bureau of Public Works (BPW), which is responsible for port planning until establish- ment of the PPA, is being strengthened and is collecting statistical data on shipping and ports on a mutually accept- able basis. (b) On the maritime industry side, the shipping companies seeking loans from DBP are already at present obliged to provide fairly extensive information about their present operations and future plans. With development of appraisal techniques under the technical assistance to be provided to DBP (paras 4.03 and 4.14), it is expected that this information will be further developed to include data on origins and destinations by type and volume of traffic, supplemented by inform- ation on sailing and port times. This information may be used, in addition to evaluation of loan apolications, to cross-check the data collected by MIA and PPA. 14. According to the Bureau of Customs, the total inter-island traffic (inbound and outbound) amounted to about 7 million tons of freight anid the same number of passengers. The actual volumes were, however, only one half, because the traffic was recorded both at port of loading ancl unloading. Compared with 2 million tons of freight and 1-1/2 million passengers in the begining of 1960's, the above volumes imply an annual compounded growth rate of 5% for freight and 7-1/2% for passengers. These growth rates are expected to be maintained in future because of continued expansion of inter-island trade (para 5.07). These estimates are to be considered conservative, because the development of iiindanao and other outer islands may take place at a more rapid rate than the Dast trend indicates. This has been the case during the past two years ,-ut is mainly explained by an improvement in the internal situation in the  ANNEX 1 Page 7 15. The following tabulation provides a break-down of inter- island traffic (excluding fuels) through the 40 more important national ports in 1972/73: Passengers, Freight, Ports by thousand thousand tons Size Inbound Outbound Inbound Outbound Two largest (Manila, Cebu) 1,318.2 936.6 1,842.0 1,063.4 % of total 36.6 32.0 42.9 39.3 1- 6 2,167.9 1,562.3 2,783.0 1,748.8 , of total 60.2 53.4 64.9 64.6 1 - 16 2,749.1 2,103.2 3,648.6 2,368.4 AZ of total 76.4 71.9 85.0 87.5 Total 3,599.7 2,926.2 4,290.0 2,707.5 1 - 40 100.0 100.0 100.0 100.0 As mentioned in para 12, the traffic data are not accurate and have to be reviewed with some reservations; however, they indicate the right order of magnitude of the traffic. 1(. No accurate statistics are available on the composition of ireight traffic, but according to a more detailed study made in 1967 and recent port development studies the percentage composition of freight in two typical inter-island ports, Manila (deficit) and Cagayan de Oro, Mindanao (surplus), was as follows: Commodity Manila Cagayan de Oro Group Inward, % Outward, % Inward, % Outward, % Grains, flour 17 6 2 52 Otlher agr. products 27 8 15 12 Processed foodstuffs 16 34 35 17 Other consumer goods 7 5 10 5 Machinery & Vehicles metals 3 23 7 3 lther goods 30 24 31 11 Total 100 100 100 100 Inward as % of outward 150 65 Soturce: Bank Staff. September 1974  ANNEX 1 Appendix 1 PHILIPPINES APPRAISAL OF A SHIPPING PROJECT The Philippine Maritime Fleet (1971) Ocean-Going Vessels - Tonnage 820,000 Gross Tons Number 130 ships Inter-Island Vessels Tonnage 390,000 Gross Tons Number 434 ships Ocean-Going Vessels Inter-Island Vessels Breakdown Breakdown Breakdown Breakdown Size Range by by by by (GT) Gross Tonnage Number Gross Tonnage Number Up to 500 0.01% 0.90 7.61% 40.17% 501- 1,000 0.18 1.82 21.03 32.90 1,000- 2,000 0.60 2.73 14.42 10.25 2,001- 5,000 18.20 35.46 43.38 14.96 5,000-10,000 50.79 46.36 4.74 0.86 10,000-20,000 19.62 10.91 8.82 0.86 More than 20,000 10.60 1.82 - - Total 100.00% 100.00% 100.00X 100.00% Source: Philippines Coast Guard, 1973. March, 1974  ANNEX 1 Appendix 2 PHILIPPINES APPRAISAL OF A SHIPPING PROJECT Distribution of Inter-Island and Ocean-Going Vessels According to Age (1971) Breakdown Breakdown by by Age Number Gross Tonnage Inter-Island Vessels 30 years and over 17.X0% 7.52% 20 - 29 years 50.85 46.78 10 - 19 years 15.39 22.64 Less than 10 years 16.66 23.06 Total 100.00% 100.00% Ocean-Going Vessels 30 years and over 9.09% 5.64% 20 - 29 years 32.72 25.47 10 - 19 years 36.36 40.90 Less than 10 years 21.83 27.99 Total 100.00% 100.00% Source: Philippines Coast Guard, 1973. March 1974  PHILIPPINES APPRAISAL OF A SHIPPING PMOJ3O? Breakdown of Vesela by Ae Over 11000 GItT only {.) ~ ~ '- .',RT iz .n