Romania - Otelinox Special Steel Project

CIRCULATING COPY . ... t... u MTO BE RETURNED TO REPORTS DEF1" DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Not For Public Use Report No. P-1 4O0a-R.Q REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXCECUTIVE DIRECTORS ON A PROPOSED LOAN To THE INVESTMENT BANK, ROMANIA WITH THE GUARANTEE OF THE SOCIALIST REPUBLIC OF ROMANIA FOR THE OTELINOX SPECIAL STEEL PROJECT June 24, 1974 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 It may not be published, quoted or cited without Bank Group authorization.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 pr completeness of the report.  CURRENCY EQUIVAlENTS 1,. Official Rate lei 4b97 = US$1.00 lei 1 = US$0.20 2. Tourist Rate lei 14.38 US$1.00 lei 1 = US$0.07 Conversion Rate for Traded Goods lei 20 = US$1.00 lei 1 = US$0.05 Fiscal Year -- January 1 - December 31  INTERNATIONAL BA\K FOR RECONSTRUTCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE INVESTMENT BANK, ROMANIA, WITH THE GUARANTEE OF THE SOCIALIST REPUBLIC OF ROMANIA FOR THE OTELINOX SPECIAL STEEL PROJECT 1. I submit the following report and recommendation on a proposed loan to the Investment Bank, Romania, with guarantee of the Socialist Republic of Romania, for the equivalent of US$70 million to help finance the foreign ex- change cost of a special steel project. The loan would have a term of 15 years, including 5 years of grace, with interest at 7-1/4 percent per annum. The Otelinox enterprise would be the beneficiary of the Bank loan, and the cost of the loan to the enterprise would be 9 percent per annum including a guarantee fee of 1-3/4 percent per annum. PART I - THE ECONOMYf 2. Romania joined the Bank on December 15, 1972. The first economic mission visited the country in March/April 1973 and its report, entitled "The Economy of Romania" (R73-274), was issued to the Executive Directors on Novem- ber 30, 1973. An updating mission just returned from Romania and will complete its report later this year. The first basic mission is scheduled for 1976. Social and economic country data are given in Annex I. 3. Since the founding of the People's Republic of Romania in 1948, which in 1965 was reconstituted as the Socialist Republic of Romania, eco- nomic management has been organized along socialist principles which have included state and cooperative ownership of almost all productive resources, and the absence of private enterprise. Economic activity is directed by means of administrative development planning, coordinated by the central authorities. Productive enterprises operate within the framework of the development plan which defines the scope of their activity, the outlines of their production and investment goals and their targets for operating efficiency. The Plan is elaborated within a five-year time frame, each year having a separate Annual Plan. The country is presently in the fourth year of its Five-Year Plan for the period 1971-1975. 4. The technical and functional Ministries are the State's chief agents for the administration of economic activity. They are assisted by subordinate units known as Centrals, which coordinate and supervise activities within a common branch or industry without being directly engaged in production. Sub- ordinate to the Centrals are the productive enterprises whose principal task is meeting production targets. Production enterprises generally are not au- thorized to engage directly in foreign trade. For this purpose they use spe- cial foreign trade enterprises.  -2- 5. Economic development is of paramount concern to the Romanian Govern- ment. Rapid industrialization is a major objective with priority being given tc heavy industry including steel, machine tools and chemicals. To achieve their growth objectives the Romanian authorities have made considerable efforts to mobilize domestic resources for development and to maintain a high rate of capital formation. In the present Five-Year Plan planned and actual investment rates of around 30 percent of GNP have been the norm. As a consequence, con- sumption has been restrained, and the development of the consumer goods indus- try has been less strongly emphasized than that of heavy industry. In 1972, heavy industry (led by machine tools, chemicals and ferrous metallurgy) ac- counted for about 70 percent of industrial production. 6. As a result of this strategy, a marked change has been achieved in the structure of Romania's economy. Rapid industrial growth, which over the last decade has averaged more than 13 percent per annum, has expanded the share of the labor force employed in industry including power and construc- tion to 35 percent in 1972, from about 14 percent in 1950. During the same period, agricultural output almost tripled while the share of the labor force engaged in agriculture declined from 74 percent to around 45 percent. 7. Romania's population growth is around 1.0 percent per annum. Thus, the impact of rapid economic growth on per capita incomes has not been substan- tially diluted by the population increase. In the last decade, GNP growth has been 9.0 percent per annum on average, implying a growth of about 8.0 percent per annum of per capita GNP. The latest World Bank Atlas estimates GNP per capita for 1971 at $740. 8. The organizatior. of production in both the urban sector and in agri- culture is such that all labor is actively employed and there is no open un- employment. There is, however, some labor surplus. Income distribution is also relatively equal. In 1972, average monthly wages were 1,498 lei (about $75 equivalent). Almost 80 percent of all monthly wages were within the range of 900-2000 lei and less than 6 percent were under 900 lei. Minimum wages are guaranteed by the State; they were raised to 1,000 lei per month for full-time workers in September 1972. Prices for essential consumer goods and services such as basic foodstuffs, rents and urban transport are relatively low and most social services, notably education and health care, are provided with- out charge. Continuous efforts are made to increase the standard of living. Romania also pursues a positive regional policy which has sought to bring a balanced development of both human and natural resources to all parts of the country. 9. The official exchange rate of lei 4.97 per US$1.00 is used only for accounting purposes. The rate used for invisible and capital transac- tions is lei 14,38 per US$1. Under a newi system introduced in January, 1974, the prices of all traded goods are converted at a uniform rate of lei 20 per US$1.00, a rate which is considered by the Romanians as being representative of the cost of convertible foreign exchange. For imported goods, the domes- tic lei price is found by adding to the converted foreign price a tariff rate which varies for different types of goods. The rate of lei 20 per US$1.00 has also been used to convert national income statistics from lei to dollars.  Consequently, this rate has been used as the base rate for calculations in the appraisal. Recent Developments 10. Since the National Party Conference of 1967, which set the stage for major qualitative advances in Romania's economic and social development, there have been important new emphases in Romania's economic management. Measures were taken to improve the institutional basis of planning (e.g. by creating the Centrals to assist in plan administration), to increase the ef- ficiency of economic management and to improve upon the quality of production in industry. In agriculture efforts were made to raise productivity and sta- bilize growth through irrigation, mechanization and the expanded use of chem- ical fertilizers. To expand upon the growth of foreign trade and technical- economic cooperation the Romanian Government has concluded trade and coopera- tion agreements with a wide range of countries. In this context also, Romania has made positive efforts to expand its multilateral external relations and to pursue full cooperation with the international agencies, including UN, UNCTAD, UNESCO, FAO, UNIDO and GATT. 11. One result of these efforts is that foreign trade has expanded quite rapidly in recent years both in volume and in regional diversity. There has also been a tendency to move away from trade on a bilateral barter basis to- wards trade involving multilateral payments. During the period 1965-72, total foreign trade grew at about 12 percent per annum in current prices. In 1972, imports and exports each totalled about $2.6 billion, about 45 percent of which represented trade with non-socialist countries. Overall trade deficits have generally remained small. During 1968-72 the total annual trade deficit aver- aged about $75 million, i.e. less than 8 percent of average exports. However, the results varied as between different trade regions. Imports from East European Socialist countries were slightly lower than Romania's exports to that region. In Romania's trade with Western industrialized countries, on the other hand, exports were much less than imports. These deficits have sometimes been increased by deficits on the invisibles account with Western countries. 12. The Romanian economy has not escaped the impact of recent world de- velopments affecting the energy sector, even though the country depends only marginally on imported fuels. At present Romania is a net importer of crude oil and a net exporter of petroleum derivatives. In 1973 Romania imported about 4.0 million tons of crude oil valued at around $80 million, out of a total crude consumption of around 17 million tons. Valued at 1974 prices, this volume of imports will cost over $200 million which represents a sig- nificant increase in required foreign exchange. These imports, however, are used mainly as chemical feedstock. Exports of derivatives in 1973 were aDoul 5.0 million tons valued at about $140 million. To the extent petroleum deriva- tive prices rise in response to recent changes in crude oil prices, there will be gains in export earnings to offset the rise in the oil import bill. The extent to which this will occur, however, is still uncertain. In November 1973, the Romanians embarked on a stringent program of economy in the use of fuels, which included rationing of gasoline and fuel oil, in order both to minimize the import drain and maximize the supply available for export; ration- ing ended in March 1974 following an increase in the selling prices of these fuels.  -4- External Assistance 13. The expansion of Romania's trade with the non-socialist industrial countries has led to an increased need to obtain convertible currencies to pay for imports from those countries. Romania has met this need both by borrowing abroad and by mounting a major effort to expand exports and tourism. Gross inflows of convertible currency capital were US$542 million in 1973, hav- ing grown from US$276 million in 1967. Romania's access to convertible finance, however, has been almost exclusively confined to financial and suppliers' cred- its with relatively short repayment periods. The net inflow of convertible capital in 1973, therefore, was only US$238 million. 14. As part of its effort to expand its foreign trade and cooperation relationships, Romania has also taken active steps to attract long-term pri- vate capital. A regulation passed in 1972 defines the conditions under which foreign firms can establish joint ventures with domestic enterprises, prefer- ably in foreign exchange earning/saving industries. Romania has also estab- lished two joint banks, one in France and the other in the United Kingdom, in an effort to expand the availability of credit from European countries. Prospects 15. The current Five-Year Plan (1971-75), whose original targets in most sectors appear likely to be exceeded, reflects Romania's continued strategy of rapid growth. The targets contained in the Annual Plan for 1974, for example, include a 16.7 percent growth in industrial production, 14.6 percent growth in national income, an investment rate equal to 35 percent of national income and a 41 percent expansion of foreign trade. The Plan also lays stress on a range of qualitative aspects of development including technical improvements and diversification in industry and foreign trade, improvements in capacity utilization, development of the nation's human resource potential and a con- tinued emphasis on regional development. 16. Romania has good potential for further economic growth. Endowed with important natural resources - fuels, some minerals, timber, rich soils and a favorable climate both for agriculture and tourism - and located con- veniently with respect to its major international markets in the East and West, the country has built a broad industrial infrastructure (power, metal- lurgy, chemicals) which will serve as a base for the expansion of secondary manufacturing sectors such as machine building and consumer durables. Above all, Romania has a hard-working and increasingly skilled population devoted to the achievement of the country's development objectives. 17. Economic growth and structural change call for the introduction of new industrial technologies, improvements in the quality of products, more economic use of materials and factor inputs, and reductions in production costs. The increasing diversity and complexity of Romania's economic struc- ture require continuing improvements in the efficiency of economic planning and coordination and further refinements in industrial management. To keep up with these changes and requirements large programs of education and man- power training have been mounted, and efforts are being made to strengthen technical cooperation with industrialized countries and international organ- izations.  -5 - Creditworthiness 18. At the end of 1973 Romania's total medium and long-term external debt amounted to $1,519 million. Most of these debts ($1,404 million) were denominated in convertible currencies, the major creditor countries being Germany, France, UK and Italy. While the total debt does not appear exces- sive in relation to the volume and growth of external trade, average maturi- ties are relatively short and convertible debt service payments are estimated to be in the order of $340 million a year during 1974-75. The convertible debt service ratio was approximately 19 percent in 1973, reflecting the unfavorable terms of foreign credits available to the country. 19. The organization of economic activity in Romania and the pursuit of a development strategy involving high investment/saving rates and rapid income growth ensure the ava-lability of domestic resources sufficient to service reasonable amounts of foreign debt. Moreover, the country's major efforts to expand exports (particularly to convertible currency areas), to attract private joint venture capital and to seek other forms of bilateral converti- ble currency financing are increasing the foreign exchange available for debt service. Convertible earnings rose from $585 million in 1967 to $1,902 mil- lion in 1973. The preferential trade status accorded to Romania by the EEC in June 1973 should facilitate the further expansion of such exports as could the granting of most favored nation status by the U.S. Last year, the Govern- ment also restricted the use of short-term credit facilities from western sup- pliers in an effort to improve the structure of the country's external debt. Assuming a continuation of present export and debt management policies it can be expected that the debt service ratio will gradually decline during the sec- ond half of the 1970's. The country's present outward-looking posture, the success of both its domestic growth and foreign trade policies, and its po- tential for continued development, all support the judgment that Romania is creditworthy for substantial Bank lending. 20. When Romania joined the Bank, most pre-war foreign debts of the country had been settled. The only settlements which were still under dis- cussion at that time concerned claims in the United Kingdom and in the United States. The Romanian authorities have repeatedly assured the Bank of their intention to settle these old claims, and have from time to time advised the Bank staff of progress towards settlement. As far as the US claims are concerned, there have been several meetings between both parties. The most recent meetings between a Romanian delegation led by the Deputy Minister of Finance and representatives of the US bondholders took place on June 10, 11 and 20 in Washington; the next meeting is planned for early July during which both sides expect to agree on procedures for formal registration and validation of outstanding bonds. The Romanian authorities have ex- pressed confidence that final agreement on a compensation formula will be completed no later than August 1974. The UK claims are larger and more complicated. The most recent meetings were held in London on June 6 and in Bucharest on June 18. Both sides aim to exchange specific proposals during the next few weeks, and the Romanian authorities have expressed confidence that final agreement will be reached by September.  -6- PART II - BANK GROUP OPERATIONS IN ROMANIA 21. Documents for the first loan to Romania, the Tecuci Fertilizer Project, were distributed recently to the Executive Directors. In addi- tion to the proposed project, documents are also now distributed for the proposed Turceni Thermal Power Project. 22. It will take time to build up detailed knowledge of the economy which would allow a sharper focus on the outstanding development problems. At present, foreign exchange, especially in convertible currencies, appears to be a major constraint. During the early phase in the Bank's relations with Romania, therefore, one of the major objectives of Bank lending will be to help alleviate the country's shortage of foreign exchange by provid- ing long-term external capital and by financing projects which will expand foreign exchange earnings or savings. Bank lending will also aim at support- ing the Government's efforts to introduce new industrial technologies, to im- prove the quality of products, to make more economic use of materials and factor inputs and to reduce production costs. Market aspects and marketing, especially for export goods, will also be emphasized. Special attention is also being given to agriculture where productivity levels are still relative- ly low. The Government is aware of this situation and has stepped up efforts to develop the agricultural sector as evidenced by the rapid expansion of ir- rigation, the increasing use of fertilizer and the continuing pursuit of in- stitutional improvements in this sector. The Bank will assist the Government in implementing plans in this field. 23. In furtherance of these objectives of Bank lending, loans for an irrigation project in the area of Giurgiu-Razmiresti and an agricultural credit operation to develop agricultural production within the recently com- pleted Sadova-Corabia irrigation system are envisaged within the next year. Also being proposed for Bank consideration is a multi-purpose power and irri- gation project on the Lower Olt River and a pulp and paper project. 24. In addition to significant help with the preparation of projects for Bank financing, the Bank (through EDI) has assisted in establishing a project appraisal training course for Romanian officials (held in Belgrade in October 1973). The preparations for additional such courses in Romania are underway. 25. Romania is not yet a member of IFC but preliminary contacts have been made to discuss Romania's cooperation with IFC. 26. The projects in the pipeline would represent only a small propor- tion of Romania's total need for external financing, and of its total dis- bursed convertible debt. However, they would provide a substantial net ad- dition to the present inflow of convertible currency finance and hopefully set a pattern for obtaining finance on longer repayment terms. The disbursed debt outstanding to the Bank is not expected to constitute more than 10 percent of Romania's total projected convertible currency debt in FY79; the Bank's share in Romania's debt service payments in FY79 would be less than 4 per- cent.  - 7 - PART III - ME INDUSTRIAL SECTOR IN ROMIIA Industrial DevelopEent 27. Romanian development policy during the last 25 years has emphasized industry in general and producer goods in particular. The aim has been to transform a nation that once specialized in the exportation of raw materials into a country with an integrated, self-sufficient and diversified industrial structure. Since the mid-1950's investment in industry has averaged 50 per- cent of total investment and around 60 percent of this total has been in fuel, chemicals, metallurgy, engineering and metal working. The 1971-75 Five-Year Plan calls for a continued emphasis on heavy industry and stresses technical improvement, product diversification and increased capacity utilization. 28. Thus, industry is playing an ever increasing role in Romania's eco- homic growth. Gross industrial output grew at an average annual rate of al- most 13 percent between 1960-71 and is scheduled to grow at 11-12 percent per annum during the 1971-75 Five-Year Plan. In 1955, industry, including power and construction, accounted for 45 percent of national income, 17 per- cent of employment and about 20 percent of exports. By 1972, these percent- ages had grown to 66 percent for national income, 35 percent for employment and over 60 percent for exports. 29. In developing various branches of heavy industry, Romania has to some extent already introduced foreign technology and equipment in expanding its heavy industry exports in recent years (the share of machinery and chem- icals in total exports having increased from 7.4 percent to 33.1 percent in 1972). Despite these achievements, however, the quality of product and ancil- lary services offered in these branches is still such that competition remains difficult in the markets supplied by the world's most advanced producers of these goods. Steel Industry 30. Crude steel production grew at an annual rate of nearly 14 percent throughout the 1960's, increasing from 1.8 million tons in 1960 to 6.5 mil- lion tons in 1970 and is projected to grow at about 10 percent per year during the present decade, reaching 17 million tons by 1980. According to its plans, Romania will become in 1980, for the first time in its history, a net exporter of steel, with steel consumption equal to 682 kg per capita. Plans call for more diversified and higher quality steel-based end products. Alloy steel production is planned to rise from 525,000 tons of crude steel equivalent (or 7 percent of total steel production in 1973) to about 2.0 million tons (equal to 12 percent of total production in 1980). Market for Alloy and Stainless Steel 31. Rapid growth is foreseen in the sectors which consume alloy and stainless steel. They include consumer goods, machine tools, motor vehicles,  -8- railway rolling stock, electronic and electrical equipment, construction ma- chinery and equipment for food processing, chemicals, paper, textiles, ship- building and power generation. In particular, between 1970 and 1980, the demand for metal-processing equipment is planned to increase 8 times, for food processing equipment 6.5 times, for power generating equipment 5 times and equipment for the chemical, petroleum refining and paper industries 4 times. Based on previous success in heavy industry, these targets are likely to be met. It is only through the availability of locally produced raw mate- rials, some of which the project will provide, that such high rates of growth will be possible. Industrial Organization 32. At present ten industrial ministries are responsible for the Romanian industrial sector. Subordinate to each Ministry are several foreign trade en- terprises, research and design institutes and a number of Centrals, which in turn direct the activities of a group of related enterprises. The work on overall design and supervision of projects is delegated by the Ministry to one of its research and design institutes; in the case of Otelinox, it is IPROLAM, the research and design institute for steel rolling mills, within the Ministry of hetallurgical Industries. The enterprises, Centrals and design institutes, which have not been authorized to trade abroad, conduct their foreign business indirectly through the foreign trade enterprises which belong to the same Ministry. Similarly, the Otelinox enterprise would deal with METAROM in regard to the procurement of foreign equipment. The Borrower 33. The Borrower for the proposed loan would be the Investment Bank which is the specialized agency under the Ministry of Finance for investment projects in all sectors of the economy except agriculture (including water resources) and food processing. It has a large technical and economic staff with branch offices in all districts of the country. The Investment Bank's involvement in investment projects commences in the preparation phase; its staff appraises all major investment projects technically and financially and recommends ap- proval or otherwise when their financing is considered by the Council of Min- isters. When a particular project and its financial plan have been approved by the Council of Ministers, all major funds (budget allocations, deprecia- tion funds, share of planned benefits) are channeled through the Investment Bank in accordance with the approved financial plan. All payments in Lei for the execution of a project have to be authorized by the Investment Bank which keeps separate accounts for each category in the financial plan for every enterprise. It is the Investment Bank's obligation to ensure that a project is executed according to the financial and technical data included in the final technical and economic study as approved by the Council of Ministers. Its inspectors check whether the project is proceeding according to the schedule approved in the Plan. 34. While the Investment Bank's supervision and control function is thus rather strong during the implementation phase of project, its functions are much more limited during the operation phase of a project. Although it has  - 9 - the right and obligation to verify that the enterprise is meeting the invest- ment targets set in the Plan, it has no legal authority to influence the man- agement of the enterprise or to force the enterprise to take operational ac- tions which it considers necessary. In practice, however, it can request such actions very effectively by reporting through the Ministry of Finance to the Government. In order to reflect this factual situation and yet to ensure that the Otelinox enterprise meets the requirements specified in Article IV of the Loan Agreement concerning the operations phase, the Guarantor has agreed that it shall cause the enterprise to comply with such requirements (see Section 2.03 of the Guarantee Agreement). 35. As mentioned above, the Investment Bank is the channel for all sources of major domestic investment financing, but its own funds are still relatively small. Its prime source of funds is the State Budget. The Guarantee Agree- ment, therefore, includes a provision (Section 2.02) that the Guarantor shall provide all necessary funds for the implementation and operation of the proj- ect. The Guarantor would also provide sufficient funds to the Investment Bank to ensure that it can meet the debt service on the Bank loan (see para. 43 below). In view of the status of the Investment Bank within the government system, it is considered sufficient to rely in this respect on the Guarantee Agreement (Section 2.01). PART IV - THE PROJECT 36. In early 1973, the Romanian Government submitted a list of possible projects to the Bank including the Otelinox Special Steel Project. IPROLAI4 delivered a preliminary technical and economic study for Otelinox to the Bank in June 1973. A pre-appraisal mission in August 1973 was followed by an ap- praisal mission in November 1973. Negotiations were held during April/May 1974 in Washington. The Romanian delegation was led by Mr. Mihai Diamandopol, President of the Investment Bank. Project Description 37. The project is important for the development of the Romanian metal processing and machine building industries. Otelinox represents the second stage in the development of a specialty steel complex in Tirgoviste, and will be the only domestic manufacturer of stainless steel sheet and strip and one of the few domestic producers of small sizes of alloy bar and rod products. Its detailed analysis, first in the form of a preliminary and later in the form of a final technical and economic study, as well as the initiation of construction is included in the 1971-75 Five-Year Plan. Its completion and attainment of full capacity will be part of the 1976-1980 Five-Year Plan. 38. A Loan and Project Summary is attached as Annex III. The Appraisal Report entitled "Appraisal of Otelinox Special Steel Project (No. 359a-RO) dated May 21, 1974, is being distributed separately to the Executive Directors. The project will include:  - 10 - (a) engineering and construction of a cold rolling mill complex designed to produce about 30,000 tons per year of stainless steel sheet and strip from hot-rolled coils; (b) engineering and construction of a rod and bar rolling mill complex designed to produce about 120,000 tons per year of alloy steel rod and bar products from billets; (c) training of staff in the application of special production processes and techniques and in plant management and opera- tion; and (d) studies on the end use of Otelinox's products, on the feasi- bility of the establishment of intermediate warehouse facil- ities and steel service centers, and on the export potential for Romanian special steel products. Project Execution 39. The responsibilities for project execution have been delegated to several different agencies, but the Otelinox enterprise shall have overall responsibility for the coordination of project execution and of the project- related activities of the other agencies involved (see Section 3.01 of the Loan Agreement). IPROLAM, with many years of experience, is responsible for basic design and engineering, and the technical evaluation of bids; moreover, it provides technical assistance to the Otelinox enterprise in the supervision of construction. NETAROM, the foreign trade enterprise engaged for a number of years in the buying and selling of equipment and know-how for the metallurgical industry, will undertake the commercial eval- uation of bids and handle contracts with foreign suppliers; goods and serv- ices required for the project and to be supplied from within Romania will be procured directly by the Otelinox enterprise witn the guidance of IPROLAM. Actual construction and erection will be performed by either the Industrial Construction Trust under the Ministry of Industrial Construction or a con- struction trust under the Ministry of Metallurgical Industries. The former trust is presently engaged in the construction of Stage I of the Tirgoviste complex. The construction of both mills is expected to be completed by June 197S and they are scheduled to reach full production in 1980. Project Operation 40. Otelinox is one of the nine enterprises in the Steel Central which is part of the Ministry of Metallurgical Industries. The organization and functioning of Otelinox will be in accordance with the 1971 law on the or- ganization of State production units. This law provides for a general manager of the enterprise (appointed by the Ministry of Metallurgical Industries) who, assisted by a management committee, decides on and supervises the daily opera- tions of the enterprise. Under. the Romanian system of collective decision- making the organization of the enterprise further includes an Assembly of Working People in the enterprise, which meets twice yearly to determine  - 11 - matters of broad policy interest, and a Committee of Working People (formed from the Assembly) which determines operating policies at monthly meetings. All decisions of these bodies must be made within the framework of the na- tional plan. This decision-making process seems to work well in practice. Project Cost 41. The total costs of the project including working capital but ex- cluding interest during construction ($11.1 million) are equivalent to US$174.2 million with a foreign exchange component of US$86.6 million or about 50 percent of total costs. The local cost component, based on fixed Romanian prices, is unlikely to change significantly; 1/ foreign costs con- tain a 10 percent contingency per annum for price escalation. In addition, a physical contingency of 10 percent has been added to total fixed costs. The project consists of two separate units; a cold mill with a foreign ex- change cost of $39.9 million representing 47 percent of its total cost of about US$85.1 million (excluding interest during construction) and a bar mill with a foreign exchange cost of $46.7 million representing 54 percent of its total cost of about US$89.1 million (excluding interest during construction). Financing 42. The proposed Bank loan of US$70 million would be sufficient to fi- nance about 73 percent of the total cost of equipment imports and engineering, know-how and technical assistance for the project and is intended to cover 100 percent of such cost for the cold mill and about 65 percent for the bar mill. The remainder of the foreign exchange requirements, as well as interest on the Bank loan during construction (amounting to about US$9.2 million) and the small foreign exchange component of working capital, would be met by the State. However, an understanding has been reached that any undisbursed loan portion as a result of cost savings would be used to finance part of interest during construction on the Bank loan. Budgetary advances totalling lei 1,790 million will be channeled through the Investment Bank and the National Bank 2/ and will cover all lei expenditures (including financial charges during con- struction) that are required for the Otelinox project for the items not fi- nanced by the Bank loan; it would also cover a deficit of lei 99.5 million in the first year of Otelinox's operation. 1/ The overall effects of a forthcoming revision of prices, the extent and direction of which are not yet known by the Bank, may cancel out on bal- ance. No revision of prices of local goods required for the project is expected to take place before orders will be placed concerning the proj- ect. Romanian practice is to keep producer prices fixed for relatively long periods (see the Economic Report on Romania, pp. 5-7). 2/ Only advances for working capital are channeled through the National Bank.  - 12 - Lending Terms 43. The proposed loan to the Investment Bank would be guaranteed by the Government and would be for a term of 15 years including 5 years of grace at an interest rate of 7.25 percent per annum. In accordance with the financing mechanism for projects in Romania, which is described in detail in Annex 5-3 of the Appraisal Report, the Investment Bank would not actually relend the Bank loan to the enterprise. However, the enterprise would be the beneficiary of the Bank loan and the cost of the loan to the enterprise, inc'Ludinig a guar- antee fee of 1-3/4 percent, would be 9 percent per annum. The an.nual transfer of funds to the State Budget and Investment Bank by the enterprise would be sufficient to cover the lei equivalent of the debt service on the Bank loan (Section 4.01 (h) of the Loan Agreement). Financial Analysis 44. Enterprises in Romania cannot determine their general level of pro- fitability because production targets and the broad product mix are set in the plan and both input and output prices are set by the central authorities. Given the output target and these prices, the enterprise has a planned bene- fit set each year which the enterprise may over- or under-fulfill depending on the extent to which it meets the productivity and efficiency goals stipu- lated in the pian. Actual benefits are not a guide for future investments, which are determined by the State. However, they are not irrelevant to the financial analysis of an enterprise, because, since 1971, there has been an attempt to increase the role of enterprise self-financing over the use of State Budget funds. 45, Moreover, any shortage of funds within a Romanian enterprise mnust be covered by transfer payments through the respective Centrals, budgetary allocations, and/or bank credits. In this context, standard financial indica- tors, such as debt/equity ratios and debt service coverage hav7e limited signi- ficance; however they are satisfactory except for the first year of operations. As mentioned in para. 42 above, the funds to cover the entire investment fi- nancing of the Otelinox project, part of which would represent the lei cost of the foreign assets financed by the IBPD loan, will be provided from the State Budget. After commissioning, working capital will be financed by trans- fers through the National Bank. After the first year of operations, internal cash generation should be sufficient to cover all expenses including interest on and principal of the IBRD loan. The project would provide for a suitable financial return of about 13 percent, in constant value terms. Audit 46. Romania has a well developed system of internal and external audit- ing primarily to ensure that the activities of enterprises conform to state plans. Any deviations are brought to the attention of higher authorities. The Steel Central, Ministry of Metallurgical Industries and the Ministry of Finance periodically audit financial statements prepared by the enterprise, and the Bank will receive annual audits of the enterprise and the Borrower  - 13 - carried out by the Ministry of Finance (Section 6.01 (e) and (f) of the Loan Agreement). This arrangement would adequately meet the Bank's information requirements in this respect. Procurement 47. Procurement of the items to be financed by the proposed loan will follow international competitive bidding in accordance with the Bank's pro- curement guidelines. The major facilities for the project together with engineering, know-how and technical assistance will be grouped in two large single-responsibility contract packages - one for the cold mill and the other for the bar mill. There will be a staged bidding procedure for these packages: first, following prequalification, preliminary technical offers will be sub- mitted, by consortia which are expected to be led by foreign suppliers, and discussed at a pre-bid meeting to answer any technical and any other question which the suppliers may have; second, firm technical proposals and separate priced bids will be submitted followed by consultation and modification of the technical bids to achieve reasonable uniformity among the final techni- cal bids; and third (and only at this stage), will the original price bids be opened accompanied, where necessary, by supplemental price bids to reflect the technical changes (Schedule 4 to the Loan Agreement). The Romanian equip- ment which will not be included in a foreign bid but will form part of the two mills and be covered by the performance guarantee of the consortium leader, will be prescribed to all foreign bidders alike. IThile no Romanian supplier is expected to be prequalified as consortium leader for either of the two contracts, Romanian sub-suppliers for the bar mill package are possible. The selected procedure is considered appropriate and efficient under the circum- stances and consistent with Bank guidelines. The procedure to ask for firm price bids represents a departure from previous Romanian practice which was to procure by inviting tenders from selected manufacturers and then negotiat- ing a supply contract. Civil construction, to be carried out by a specialized Romanian construction firm, will not be part of the bid packages. Some addi- tional specialized expertise may become necessary to assist the Romanian ex- perts in the evaluation and comparison of the technical aspects of the bids (including equipment selection) for the cold mill, the first of its kind in Romania. A letter supplemental to the Loan Agreement to be delivered by the Borrower will provide that consultants will be employed for this purpose unless the Borrower and the Bank agree that such assistance is not needed. Disbursements 48. The Bank loan would be disbursed against 100 percent of total ex- penditures under the two contracts and 100 percent of foreign expenditures for the procurement consultants. This procedure has been selected also for disbursements against expenditures under the bar mill contract; however, dis- bursements would be limited by the loan amount which, as mentioned in para. 42 above, is sufficient only to finance about 65 percent of the total cost of equipment imports and engineering, know-how and technical assistance for the bar mill. The loan would become fully effective when the Romanian Council of Ministers approves the main indicators of the technical and economic study for the project as a whole. However, to permit early loan disbursements on  - 14 - account of down payments under the two contract packages for the project, the Loan and Guarantee Agreements may become effective if the Romanian Council of Ministers authorizes the conclusion of one of the two contract packages (cf. para. 47 above - Sections 8.01 and 8.02 of the Loan Agreement); however, dis- bursements under either contract may not exceed $3 million equivalent, i.e., the estimated amount of down payment, until the Council has approved the main indicators of the technical and economic study for the project as a whole (see para. 4(b) of Schedule 1 to the Loan Agreement). Disbursements would take place over five years from the end of 1974 through 1978. A schedule of estimated disbursements is given in the Loan and Project Summary (Annex III). Markets 49. Otelinox's markets appear well assured. Domestic consumption of special steel, which grew at the rate of 23 percent per annum in 1965-70, is planned to increase from 668,000 tons in 1970 to 2 million tons in 1980, implying a yearly growth rate of 14 percent throughout the present decade. Most of the major consumers of Otelinox's products, such as producers of equipment for food processing, chemicals, agriculture and construction, as well as producers of road vehicles, rolling stock, consumer durables, and electrical equipment, are targeted to grow at rates in excess of 15 percent per year during the 1970's. There will be only very limited competition among special steel producers in Romania not only because their production is fully planned but also because their product mix and dimensions largely differ, with Otelinox concentrating on the smaller, and thus more difficult to produce, dimensions of higher-grade steels. Prices for special steels have been held fairly stable by government control at levels roughly com- parable to world market prices for the total product mix. Given the state trading monopoly, foreign imports will not be permitted at the expense of unsold domestic production. Even if exports of stainless steel sheet and strip products were not to materialize as predicted, the domestic market should be able to absorb most if not all of the excess. Environment 50. Otelinox, being basically a rolling operation, presents fewer eco- logical hazards than an integrated steel plant. The enterprise will arrange to neutralize acids released by pickling in a special facility and to remove oil, grease, suspended solids and scale from liquid effluents prior to dump- ing. Since the final selection of the processes for the project has not yet been made, the possible ecological hazards are not yet known exactly. However, enviromental factors are covered by rather strict and detailed legislation in Romania at the present time and Otelinox would fully comply with this legis- lation. Moreover, the Borrower has agreed specifically that the project will include facilities adequate to protect the plant's environment from potentially harmful effects of the operation of the plant and that the facilities estab- lished under the project will be operated with due regard to ecological and environmental factors (Part A3 of Schedule 2 to, and Section 4.01 (a) of the Loan Agreement).  - 15 - Labor Force 51. At full capacity, the Otelinox project is expected to utilize more than 1600 employees. The recruitment plan has been worked out in detail, re- quiring about 750 graduates of technical and secondary schools, 300 transfers from existing steel plants, 342 craftsmen transferred from various industries and 200 plant trainees. Justification 52. The economic rate of return for the total project would exceed 14 percent. The calculation of basic raw material costs and the value of final output is based on world market prices in 1973. Operating cost estimates are converted from lei into dollars at the rate of US$1 = lei 20 (see para. 2 above). Even under foreseeable adverse conditions the rate of return exceeds 12 percent while it would be 18 percent if a conversion rate of US$1 = lei 25 was used. 53. The project is inportant for the rapid development of Romanian in- dustry and well in line with the Government's policy both of reducing import dependence and of quality improvement and technical innovation in production. Limited foreign exchange resources would not permit the importation of all high-grade raw materials necessary for the construction of a wide range of equipment, machinery, electrical devices, road vehicles, and other facilities. Without this equipment, many other industries such as food processing, chemis- try, paper, and agriculture could not continue their rapid growth. 54. The provision of up-to-date technology, equipment and technical ex- pertise will enable Romania to embark on some industrial processes hitherto not undertaken in the country. The Romanian labor force is well-trained and experienced and the domestic supply of appropriate raw materials is assured. The demand could very well exceed supply during the rest of this decade in the international market for steel products in general, with the possible exception of stainless steel, Tirgoviste is an acceptable location, being near most of the future customers and the suppliers of billets for the bar mill while relatively low tonnages of the higher valued hot-rolled band to be used in the cold mill would be transported 270 kilometers. The net for- eign exchange savings resulting from the project would be about US$60 million per year after the project achieves full production in 1980. PART V - LEGAL INSTRUMENTS AND AUTHORITY 55. The draft Loan Agreement between the Bank and the Investment Bank of Romania, the draft Guarantee Agreement between the Socialist Republic of Romania and the Bank, the report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement and the draft resolution approving the proposed loan are being distributed to the Executive Directors separately. The special features of the loan documents are described above.  - 16 - 56. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VII - RECOMMENDATION 57. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments Washington, D.C. June 24, 1974  ANNEX I Page 1 of 2 pages COUNMR DATA - ROMAIIA AREA POPUIATION DENSITY 2'7,500 kn2 20.253 million (nid-1970) Per km2of arable land SOCIAL INDICATORS Reference Countries Romania Yugoslavia Sxico Italy 1960 1970 1970 197 0 1970 GNP PER CAPITA US$ (ATLAS BASIS) , 330 /a 740 /a 650 670 1,760 DEMIC.jAPphI, CrWudebrth rate (per thousand) 19 21 18 44 16.8 Crude death rate (per thousand) 9 10 8 9 9.7 Infant mortality rate (per thousand live births) 75 49 56 67 29.2 Life expectancy at birth (years) 66 69 65 62 71.1 Oross reproduction rate#2 0.6 /b 0.9 /c 1.3 3.1 0.9 Population growth rate 1.1 1o0 1.0 3.5 0.8 Population growth rate - urban 3.8 /d 3.4 /d 3.3 5.0 0.7 /e,f Age structure (percent) 0-14 28 /b 26 /c 2b 46 24.3 15-64 657W 66 7c 64 50 64.9 65 and over 77W 8 7 8 4 10.7 De-andancy ratio /4 0.5 7 0.7T7 0.8 /a 1.6 /a 1.0 Urban population as percent of total 32 /d 41 /d 35 59 93 /e,f Fanily planning: N. of acceptors cumulative (thous.) .. .. No. of users (% of married women) .. .. EMPLOYENT Tota=abor force (thousands) 9,580 9,920 9,600 15,900 19,600 /h Percentage employed in agriculture 66 49 52 47 17 Percentage unemployed 0 0 8 .. 3 INCiME DISTRIBUTION Percent of salaried workers earning less than 1,100 lei .. 24.3 13.55 /i.q Percent of salaried workers earning more than 2,500 lei . 6.3 13.1 /) li DISTRIBUTION OF LAND OWNERSHIP % otned by top 10% of owners .. .. a cwned by smallest 10% of owners 'EALTH AND NU'TRITION Population per physician 740 /o 680 /o 1,C0O 1,850 /q 55C Population per nursing person 300 200 790 /q Population per hospital bed 140 120 180 55C Sq 100 /c Per capita calorie supply as % of requirements /5 110 110 125 / 1C8 /q 118 /s Per capita protein supply, total (grass per day7/6 82 82 92 7q 66 7W 8b 75 Of which, animal and pulse 24 28 29 75 28 7i 42 7s Death rate 1-4 years /7 5/b 3/c 3i 977 1.1 7 EDUCATION AdJusted /8 primar' school enrollment ratio 97 107 94 /c 71 107 AdJusted 7W secondary school enrollment ratio 42 62 45 77 19 59 Years of schooling provided, first and second level 12 12-14 12 12 13 Vocational enrollment as % of see. school enrollment 54 /w 56 /c,w 59 /c 23 /; 26 /c Adult literacy rate % .. .. 85 76 91 7ii,v HOUSING Average No. of persons per rooa (urban) .. 1.3 /x 4.1 /k,l 2.5 1.1 /u,k Percent of occupied units without piped water 52 75 63 51 38 Access to electricity (as % of total population) .. 49 77,y 98 / .. 96 7;,y Percent of ,ural population connected to electricity . 27 .. CONSUMPTION Radio receivers per 1000 population 109 152 164 276 218 Passenger cars per 1000 population *- *- 35 25 190 Electric power consumption (kwh p.c.) 520 1,730 1,140 /c 530 /c 2,188 /c a Newsprint consumption p.c. kg per year 2.1 2.8 4.3 3.1 5.3 Notes: Figures refer either to the latest periods or to accotnt of environmental temperature, body weights, and the latest years. Latest periods refer in principle to distribution by age wnd sex of national populations. the years 1956-60 or 1966-70; the latest years in prin- /6 Protein standards (reqoirsaebts) for all countries as estab- citle to 1960 and 1970. lished by USDA Economic Research Service provide for a minimum T 'he Per Cspita SNP es imte ti at market prices for allowance of 60 grams of total protein per day, ant 20 graDLs of vr-t oth,r than 1960,calculated by the oame conversion animal and pulse protein, of which 10 grams should be animal technique as the 1972 World Bank Atlas. protein. These standards are somewhat lower than those of 75 1 Averaget number of daughters per woman of reproductive grams of total protein and 23 grass of animal protein as an age- average for the world, proposed by FAO in the Third World Food /1 Population growth rates are for the decades ending in Survey. 1960 and 1970. /7 Some studies have suggested that crude death rates of children R a:tio of under 15 and 65 and over age brackets to ages 1 through 4 may be used as a first approximation index of those in labor force bracket of ages 15 through 6I,. malnutr.tion. 5 FAO reference standards represent physiological re /8 Percentage enrolled of corresponding population of school age quirements for norrmal activity and health, taring as defined for each oountry. la Tn 1971 US$ converted at the rate of 20 eli per uSI; /b 1962; /c 1969; /d Cities, towns and 13 other localities having urban socio-economic characteristics; /e 1971 census; /f Population over 2,00C; /B Ratio of population under 15 and 65 and over to total labor force; /h Over 10 years old; /FPercentage of national income received by lowest 20 percent; / Percentage of national income received by highest 5 percent; /k Urban and rural; /1 Data refer to dwellings; /m 1968 households; /n 1969 households; /o Include dentists; /p 1967; /q 1968; /r 1964-q; /s 1968-69; /t 1964-67; /s 1961; / Population over 15 years; /w Full-time education only; 7x 1966; 7y Percenaage of total dwellings with electrical lighting; /I Percentage of rural dwellings with electrical lighting. R4 May 31, 1974  ANNFX I Page 2 of 2 pages ECONOMIC INDICATORS GROSS NATIONAL PRODUCT IN 1971 ANNUAL RATE OF GRChlll (Z, constant Prices) US$ Mln. 7 1961-65 1966-70 1971 GNP at Market Prices 15,213 100 9.0 L 7.7 LL 12.8 /1 Gross Fixed Domestic Investment 4,400 29 11.3 11.2 10.5 Exports of Goods 2,102 14 9.0 /2 10.9 /2 13.5 /2 Imports of Goods 2,102 14 10.7 /2 12.7 /2 7.3 2 LABOR FORCE IN 1972 GOVERNMENT FINANCE Min. % General Government (lei Bill.) Z of NNI 1 Agriculture 4.4 44 1971 1971 1969-71 Industry 3.4 35 Services 2.2 21 Current Receipts 138.6 58.6 65.2 Current Expenditure 100.5 42.5 47.4 Total 10.0 100 Current Surplus 38.1 16.1 17.7 Capital Expenditures 33.7 14.2 16.0 BALANCE OF PAYMENTS (Mln. US $) RETAIL PRICFS 1969 1970 1971 1972 1967 1971 1972 1973 (1966 = 100) 100.6 101.0 101.6 101.6 Exports of goods 1,396 2,102 2,592 3,667 MERCHANDISE EXPORTS (AVERAGE 1970-72) Imports of goods 1,546 2,102 2,615 3,424 US $ Mln. Z Trade balance -150 0 -23 +243 Capital goods 517 24 Net services -6 -23 -31 -107 Consumer goods 404 18 Foodstuffs 283 13 Balance on goods and services -156 -23 -54 +136 Intermediate goods 232 11 Raw materials 748 34 Net MLT capital 152 5 22 83 Industrial (426) (19) Disbursements 317 350 464 589 Agricultural (322) (15) Amortization -165 -345 -442 -506 Total 2,184 100 Residual balance -4 -18 -32 -219 EXTERNAL DEBT. DECEMBER 31. 1973 RATE OF EXCHANGE US $ Ml. Total 1 519 Official rats: Tourist rate: of which convertible currencies 1,4C' US$1.00 = ',i 497 US$1.00 =lei 14.38 Lei 1.00 = US$0.20 lei 1.00 = US$0.07 DEBT SERVICF RATIO FOR '973 National income conversion rate: Convertible currencies only 19 US$1.00 = lei 20 lei 1.00 US$0.05 IBRD/lDA LEN3TNG, Mav 1974 (Million US $): IBRD IDA Outstanding incl. U'ndisbursed ^ L1 Net National Income June 3, 197h L2 Current prices. E?&DZA Region  ANNEX II There are no previous Bank Group operations in Romania.   ANNEX III Page 1 of 3 pages ROMANIA - OTELINOX STEEL PROJECT LOAN AND PROJECT SUMMARY Borrower: Investment Bank Guarantor: Socialist Republic of Romania Beneficiary: Otelinox Special Steel Enterprise Amount: US$70.0 million, equivalent, in various currencies. Terms: Amortization in 15 years, including 5-year grace period, through semi-annual installments beginning September 1, 1979 and ending March 1, 1989. Interest rate, 7-1/4 percent per year; cost to the Otelinox enterprise, 9 percent per year. Project The project would comprise: Description: (a) engineering and construction of a cold rolling mill complex designed to produce about 30,000 tons per year of stainless steel sheet and strip from hot- rolled coils; (b) engineering and construction of a rod and bar roll- ing mill complex designed to produce about 120,000 tons per year of alloy steel rod and bar products from billets; (c) training of staff in the application of special production processes and techniques and in plant management and operation; and (d) studies on the end uses of Otelinox's products, on the feasibility of the establishment of intermediate warehouse facilities and steel service centers, and on the export potential for Romanian special steel products. Financing Plan: US$ million Local Foreign Total Loan Funds IBRD - 70.0 70.0 State Funds For: Fixed Capital 79.8 26.4 96.2 Working Capital 7.8 0.2 8.0 Interest during construction 1.8 8.0 9.8 89.4 94.6 184.0  ANNEX III Page 2 of 3 pages Expenditures to be Total expenditures under the contract for the cold mill Financed by Loan: facilities (US$39.8 million) and about 65 percent of ex- penditures under the contract for the bar mill facilities (US$30.2 million) as well as foreign expenditures for procurement consultants. Estimated Cost: US$ (millions) Local Foreign Total Percent Equipment and spares /1 19.1 62.4 81.5 44.3 Engineering, know-how and Technical Assistance 6.1 5.1 11.2 6.1 Construction and Installation 45.3 - 45.3 24.6 Supervision and Start-Up 1.7 - 1.7 0.9 Pre-operating Expenses 0.7 0.2 0.9 0.5 Contingencies: Physical 6.9 7.4 14.3 7.8 Price - 11.3 11.3 6.1 Total Fixed Assets 79.8 86.4 166.2 90.3 Working Capital Requirement 7.8 0.2 8.0 4.4 Total Project Cost 87.6 86.6 174.2 94.7 Financial Charges /2 During Construction 1.9 9.2 11.1 5.3 Total Financing Required 89.5 95.8 185.3 100.0 /1 CIF plant site. /2 Financial charges are attributable exclusively to the Bank loan. The foreign component represents 7-1/4 percent interest during construction, while the domestic component contains the 1-3/4 percent guarantee fee. Estimated Disbursements: Calendar Year Amount (US$ million) 1975 12.65 1976 15.94 1977 27.46 1978 13.95 70.0  ANNEX III Page 3 of 3 pages Procurement Two single-responsibility packages -- one for the cold Arrangements: mill, and the other for the bar mill -- would be procured through international competitive bidding in accor&,aje with Bank guidelines and following a staged bidding pro- cedureQ Technical Staff training would be provided by a member of the winning Assistance: consortium for each bidding package. Consultant services for the technical evaluation of bids for the cold mill would be supplied by a foreign firm. Economic Rate of Return: Exceeding 14 percent. 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