Bolivia - Banco Industrial Mining and Industrial Credit Project

FILE COPY' Document of The World Bank International Finance Corporation FOR OFFICIAL USE ONLY Report No. P-1867-BO REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS OF THE BANK AND TO THE BOARD OF DIRECTORS OF THE CORPORATION ON A PROPOSED LOAN BY THE BANK TO THE REPUBLIC OF BOLIVIA FOR THE BENEFIT OF THE BANCO INDUSTRIAL, S.A. AND AN INVESTMENT BY THE CORPORATION IN THE BANCO INDUSTRIAL, S.A. June 22, 1976 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS (As of June 1, 1976) Currency Unit = Bolivian Peso ($b) US$1 = $b20 $bl = US.o0.05 .$bl,000 = US$50 $bl,000,000 = US$50,00O GLOSSARY OF ABBREVIATIONS BISA Banco Industrial S.A.  FOR OFFICIAL USE ONLY REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS OF THE BANK AND TO THE BOARD OF DIRECTORS OF THE CORPORATION ON A PROPOSED LOAN BY THE BANK TO THE REPUBLIC OF BOLIVIA FOR THE BENEFIT OF THE BANCO INDUSTRIAL, &A AND AN INVESTMENT BY THE CORPORATION IN THE BANCO INDUSTRIAL, S.A. 1. I submit the following report and recommendation on a proposed loan to the Republic of Bolivia for the benefit of the Banco Industrial, S.A., (BISA) for the equivalent of US$10 million to assist BISA in its financing of private mining and industrial enterprises, and an IFC investment of up to $bll million (Us55o0,000 equivalent) in the share capital of BISA. The interest on the loan would be 8.85% per annum. Amortization would confonm substantially to the aggregate of the amortization schedules applicable to the sub-loans financed out of the proceeds of the loan, and would not exceed 18 years. PART I - THE ECONOMY Introduction 2. An economic report entitled "Current Economic Position and Prospects of Bolivia" (786a-BO) dated July 28, 1975, was distributed to the Executive Directors. An updating economic memorandum will.be distributed to the Executive Directors in the near future. Country data sheets are attached as Annex I. Background 3. Despite the increasing importance of petroleum and natural gas exports, as well as significant mineral deposits, Bolivia remains one of the poorest countries in South America. The majority of the population is engaged in tra- ditional agriculture. Only a small part of the labor force is employed in the modern sectors.. The infrastructure is primitive and the road and rail networks cover only a fraction of the country. The combination of strong traditional ties within the Indian communities and geographic, health and educational obstacles to population mobility has perpetuated the demographic concentration on the barren, windswept and dry 10-15 thousand foot plateau, the Altiplano. About half of Bolivia's population lives a physically, culturally and economi- cally isolated subsistence existence in this inhospitable region which is rich in mineral deposits but limited in agricultural potential. 4. The 1952 revolution sought to put an end to the dual structure which characterized Bolivia's economy since colonial times and to deprive the landowning and mining oligarchy of its economic base. This objective was only This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  partially achieved. Progress was made in eradicating feudal relations, dis- tributing the land and eliminating obstacles to social mobility. The agrarian reform and the nationalization of large mines however, were followed by falling production. GDP declined in the 1950s and did not recover to its pre-1952 level until 1961. During the subsequent decade, output increased steadily at an average annual rate of about 5%, providing for average annual per capita income increases of 2.5%. As a result, GNP per capita which had fallen by 24% in the 1952-60 period had recovered by 1970, to the 1952 level and was more equally distributed. However, the momentum of economic growth was again lost in 1970/71 because of political instability associated with declining private investment and deteriorating public finances. Ihe deterioration of public finances reflected a structural flaw in the economy. Bolivials public sector is proportionately one of the largest in South America and a source of livelihood for a sizeable segment of the population. With the scarcity of employment opportunities in the private sector, pressures to expand the ranks of public servants proved difficult to resist. Increased expenditures on wages and salaries, combined with a weak tax system, left few resources for investment. Moreover, the inability of the public sector to generate adequate savings limited its capacity to utilize external assistance. 5. On coming to power in 1971, President Banzer faced the need to provide jobs forthe unemployed and to revitalize investment and output growth. This need was initially faced in the context of a sharp deteriora- tion in Bolivia's terms of trade which produced a weakening in the balance- of-payments and a further deterioration in public finances and eventually resulted in a substantial devaluation in 1972. At the same time, however, more rational economic policies were put into effect. To establish a more favorable climate for private investment, new laws offering guarantees and incentives to private investors were promulgated and claims arising from earlier nationalizations were settled. The Government also improved public administration and the pricing policies of some public undertakings. Ihese policies were successful in increasing private investment and ilk bolstering the rate of growth. Fecent Economic Developments and Prospects 6. The most important events affecting recent economic performance have been the substantial improvement in the terms of trade in 1974 and the subsequent deterioration last year. Ihe sharp increases in petroleum and mineral prices in 1974 allowed a simultaneous and large expansion of both consumption and investment and brought about an unprecedented improvement in public finances and the balance-of-payments. After current deficits in 1970-73 the Central Government achieved savings equivalent to one-third of its capital expenditure in 1974. For the public sector as a whole, savings in 1974 exceeded 10% of GDP and covered nearly 90% of capital expenditure. On the balance of payments side, the terms of trade gain in 1974 was equivalent to about 11% of GDP and the trade surplus exceeded US$150 million. There was a current account surplus of some US$50 million and net capital inflows approached US$90 million, nearly four times their 1973 level, as a result of substantially higher loan disbursements to the public sector and  - 3 - increased foreign investment associated with hydrocarbon exploration. The net foreign reserve gain in 1974 -- US$125 million -- brought total reserves to US$156 million, equivalent to 3.7 months of imports, a high point in Bolivia's recent economic history. 7. After the terms-of-trade related financial improvement in 1974, a deterioration took place in 1975 -- caused by a worsening of the terms-of- trade and the impact of the world wide economic recession. Mineral exports fell by well over 20C. There was a decline of mineral prices approximating 13%, on weighted average, and the volume of sales of most minerals fell as a direct result of the recession and unloading of speculative stocks accumu- lated during the commodity boom of 1973/74. Efforts by the International Tin Council to sustain prices by imposing export quotas did not produce the expected results. Exportable surpluses of crude petroleum were signi- ficantly reduced for the second year in a row due to falling production and rapidly rising domestic consumption of hydrocarbon derivatives. A signi- ficant price increase for natural gas was obtained from Argentina, but this could not compensate for the overall decline in export earnings. Based on preliminary estimates, merchandise exports in 1975 declined by 18% while imports rose by nearly one-third in the wake of the start-up of a new public investment project and the liberalization of imports for consumer durables and motor cars earlier in the year. The current account deficit approached US$211 million and despite substantially increased disbursement of medium term loans to the public sector, there was a loss of net foreign exchange reserves of some US$60 million. Reserves declined to US$100 million, or about two months of imports. 8. Bolivia's terms of trade are expected to again improve in 1976 and beyond. Mineral prices appear to have bottomed out in 1975 and hydro- carbon prices have resumed their rising trend. Furthermore, with gradual economic recovery in industrialized countrieq mineral export volumes should increase. Recent Government measures to increase prices of domestically consumed petroleum products, especially of gasoline, should improve exportable surpluses. The outlook for 1976, therefore, is for somewhat accelerated growth and an improved fiscal and balance-of-payments position. 9. Economic growth prospects over the medium- to longer-term depend on the Government's ability to increase savings and stimulate investments, particularly those for developing the countryts hydrocarbon, mineral and agri- tural resources. Government measures designed to broaden the revenue base have begun to show results. The firm wage policies that have been applied since 1974 have resulted in a reduction of inflation to an annual rate well below 10%. Investment in mining and hydrocarbons is accelerating. Intensified exploration for hydrocarbons by the state-owned petroleum company and private foreign companies is underway and may lead to significantly increased production and export of crude petroleum and natural gas which would stimulate an acceleration of economic growth towards the end of the decade.  -4 - Debt Service and Creditworthiness 10. Service on external public debt in 1975 amounted to 16.8% of exports of goods and non-factor services net of investment income abroad. Average terms of the external debt outstanding have remained soft, reflecting the high proportion of concessionary aid channeled to Bolivia. Average interest in 1975. was 4.4% and average maturity about 22 years. 11. This position is bound to change, however, as it can be expected that lending terms will become harder and the share of loans on conventional terms will increase. Of new loans attracted during 1974 and 1975, over 40% were financial and suppliers' credits. With substantial disbursements envisaged during the next five years, the service on external public debt will move well above its historical average (12.8%) by 1977/78. However, as a result of growing exports, the debt service ratio should decline in sub- sequent years. In view of the nature and growing size of Bolivia's debt, prudence in selecting and utilizing external capital will have to become an essential element of debt management. 12. Bolivia enjoys a substantial resource base in agriculture, minerals and hydrocarbons which has to be developed to sustain rapid economic growth and, in particular, rapid expansion of export earnings in the foreseeable future. If production in the export sectors can be increased as planned and prices for the country's major export products (oil, gas, minerals) are adequate, Bolivia can be considered creditworthy for substantiallv increased amounts of external lending on conventional terms. Nevertheless, some additional lending on soft terms is justified by Bolivia s poverty and its large and continuing external capital requirements. The country will require substantial external financing of investment to supplement the domestic savings effort at least until the early 1980s. While the Government is making a serious effort to mobilize domestic resources and prepare a development program, implementa- tion of this program will require external assistance well in excess of the foreign exchange component of suitable projects presently available for inter- national financing. Although substantially increased suppliers' and financial credits will probably become available, they should prudently cover not more than 35% of the public capital inflows required during 1975-80 for meeting a GDP growth target of 6-7% annually. The remainder should be obtained on softer terms, preferably from international development financing agencies, including an expanded Bank lending program. PART II - THE BANK GROUP OPERATIONS IN BOLIVIA 13. Bolivia is an original member of the Bank but it did not obtain Bank Group resources until 1964. Bank Group assistance to Bolivia has been limited by the country's tight budget and restricted capacity to service external debt. Until 1975, lending to Bolivia was in the form of IDA credits, except for a Bank loan to help fin-nce an "enclave" project. Because of the narrow scope for private investment, the first IFC investment, amounting to US$400,000 in a cable-and plastic products enterprise, was not made until  1973. With the recent expanding opportunities for private investment, IFC is) together with its proposed investment in BISA, planning to invest up to US$337,500 in the Banco Hipotecario Nacional to assist in the development of mortgage banking and the establishment of a local market for long-term securities. Annex II con- tains a summary statement of the status of Bank Group operations in Bolivia as of April 30, 1976, and notes on the status of ongoing projects. 14. The proposed loan would be the Bank's fifth and the sixteenth Bank Group operation in Bolivia. Net of undisbursed balances, Bolivia's debt to the Bank and IDA in 1974/75 represented 8.3% of its external public indebtedness and the share of the Bank Group in total debt service is now about 4%. Both figures are expected to increase marginally by 1980. Although the Bank Group has ranked below the US Government and the IDB as a source of financial assistance to Bolivia, its role has been expanding. 15. Future Bank lending will continue to give emphasis to supporting Government efforts to expand production while simultaneously improving the distribution of the benefits of economic growth. Many Bank activities will focus on helping the less developed regions of the Altiplano and the inter- mediate Valleys which contain the majority of Bolivia's rural and urban poor. 16. In the social sectors, additional agricultural projects are being considered which will be designed to meet the needs of the poorer farmer and an education project for the improvement of rural and vocational education.is in an advanced stage of preparation. A water and sewerage project has also been prepared and will be presented to the Board in the near future. In mining, the next Bank-financed project will be directed to assisting the development of smaller mining enterprises, through a credit program administered by the state-owned mining development bank. Ihe financing of further economic infrastructure is also contemplated in the transportation and power sectors. In transportation, project preparation is underway for a project to-provide access to remote areas of the country through a program of airport development and continued support for the railway rehabilitation program is planned as well. PART III - SECTORAL BACKGROUND A. The Mining Sector 17. Mining has traditionally exerted a dominant influence on the Bolivian economy. Despite difficult terrain, which makes mining costly, it is an important sector in which Bolivia has a comparative economic advantage, and accounts for about two-thirds of merchandise exports. As a capital- intensive activity, mining employs only about 3% of the labor force, but several hundred thousand Bolivians depend on it for their livelihood. 18. Mining operations are carried out by public and private sector enterprises, the latter consisting of medium and small mining firms. The public sector includes all the largest mines, which belong to the Corporacion Minera Boliviana (COMIBOL) and which account for over 50% of mineral experts and 40% of employment. COMIBOL is beset by serious problems of over-centrali- zation, inefficiency, and excessive welfare expenditures, the resolution of which would require difficult political decisions.  - 6 - 19. Medium mining consists of 29 private firms, both local and foreign owned, which form an Association of Medium Miners. Its members must have share capital of at least US$100,000 and a certain minimum monthly production. The rest of the private sector is referred to as small mining. It includes some 2,000 operating mines, varying in size from family operations to companies approaching the size of medium mining enterprises. 20. As a group, medium miners are the most efficient segment of the sector; they account for 22% of the mining exports and 28% of mining taxes. Their mines are relatively modern and capital intensive. Thus, they employ relatively less labor than the public. or small mining subsectors, but pro- vide their workers with better working and living conditions. While some larger firms are gradually becoming diversified corporations with holdings in agriculture, industry and banking, the number of medium mining companies has been and will be increasing as the larger and more efficient units of the small mining subsector continue to develop. This natural process would be greatly accelerated through a small mining development project, which is being considered separately by the Bank. 21. Recent developments in the mining sector have been disappointing. Even apart from temporary adverse effects of deteriorating market conditions for major minerals since 1975, the sector's contribution to GDP has been declining for some time, reflecting the existence of deep-seated structural problems. These include inadequate exploration, undercapitalization and inadequate maintenance of the existing mines, especially small ones, and an excessive dependence on tin mining. Past political instability, anti- quated mining policies and a virbual lack of long-term credit have dis- couraged mining investment and have been mainly responsible for the present situation. 22. The present Government is determined to resolve some of these problems by initiating better planning and new policies aiming at more equitable mining taxes, establishing a central fund to finance exploration, and opening of public lands for joint exploitation by public and private interests. The gradual change from the production tax -- which under- or over-charges the miners, depending on market conditions, and discourages efficient mining -- to a profit tax is expected to induce private investment to modernize and expand existing operations and to search for new mineral reserves. Opening of public lands to joint exploitation and the creation of an exploration fhnd should facilitate expansion of known mining areas and induce the formation of joint ventures between foreign and local investors, private or public, thereby bringing in foreign oapital, tech- nology and administrative know-how. 23. Bank g~roup assistance, based on the recommendations of the 1972 sector report,li is focused on the provision of term credit for private mining, but it also contains a substantial technical assistance component. 1/ The Mining and Metallurgical Sector, Report No. Pl-14, dated Decer`btr 7, 1972  - 7 - The first IDA Credit, No.455-B0, provided term credit for medium miners through Banco Industrial (BISA) and financed technical assistance, includ- ing studies of mining taxatior and the possibility of creating an exploration fund. It also partially covered costs of the initial phase of the survey of small mines, which is a prerequisite for a small mining development project which is presently under preparation. The credit portion of the first IDA Credit is about 60% coimmitted and should be fully committed by September of this year. The other components of the IDA Credit are proceeding as scheduled. The proposed project is designed, among other things, to expand the scope of medium-size mining investment and to further strengthen BISA, thus consolidat- ing the gains made with the first IDA Credit. Also, a Government proposal for Bank participation in an exploration fund is expected shortly; consideration would be subject to prior consultation with the Executive Directors. 24. Mining subloans of BISA to be financed under the proposed Bank loan would be used primarily to increase the efficiency of the existing medium-size mining operations with resulting high economic benefits. In addition, BISA as the largest private development finance institution, is expected to play an active role in implementing the Government 's new mining policies and particularly in promoting joint mining ventures. Also, it would be expected to give special attention to subprojects producing metals other than tin and to evaluate carefully the economic viability of tin subprojects (para. 47). B. The Industrial Sector General 25. Industry contributes about 10% to GDP, as compared to 11% by mining, but employs almost three times as many workers, about 8% of the labor force in 1974. This is because industrial activities are largely carried out in. small plants and workshops which are labor intensive. With the exception of petroleum and metal refining, most industrial firms are privately owned. It is expected that the present share of industry in GDP would increase, in response to investment expenditures which have risen substantially since 1972 and which are likely to remain strong in coming years. 26. The principal problem for industrialization is the smaU size of the internal market which is further reduced by the high cost and difficulties of internal transportation. This and the distances from world markets and the lack of a Bolivian-owned port provide natural protection to local industry and make it difficult to sell in the international market. 27. Processing of locally produced agricultural and mineral raw materials accounted for over three-fourths of industrial output and employment in 1973. Imports satisfy about half of the domestic demand for industrial goods. Imports of goods competitive with those produced by the processing sectors accounted for 28% of total imports in 1973, suggesting that there is still room for additional efficient import substitution in processing  - 8 - industries. Given Bolivia's natural resource base, it appears that industry has been developing along the lines of comparative advantage. 28. Reflecting the low level of financial development in Bolivia, a severe shortage of term credit limits investment mostly to retained earnings and other savings of a small group of entrepreneurs. As a result, investment projects are often undertaken on too small a scale or not at all. Most credit extended by the banking system is to finance working capital at short term, but it is nevertheless inadequate for Bolivian industry, which, due to diffi- cult transport, has to carry exceptionally large inventories. Firms could grow faster if more term credit for investment and working capital were avail- able. The current rapid development of the financial sector should thus stimulate industrial development. Policy 29. Tariffs are low and provide a fairly even amount of protection to all sectors, thereby allowing relative profitability to be determined by economic efficiency. In October 1975, in response to a decline in inter- national reserves, the Government increased the number of items subject to import quotas and prohibitions, but they still apply only to about 4% of the items in the tariff schedule. Thus, Bolivian industry is still largely free of the distortions created by widespread trade controls. The benefits to Bolivia of belonging to the Andean Common Market may be offset by the very high Cormmon External Tariff which might finally be negotiated. 30. The Investment Law encourages private investment in both new and existing enterprises, principally in industry. While successful in pro- moting investment, the Law grants benefits, mainly exemption from import duties, that stimulate most those industries which use the highest propor- tion of imported raw materials and capital goods and which are capital rather than labor intensive. 31. Income taxes in Bolivia are low but numerous national departmental and municipal excise taxes are levied at each stage of processing. In effect, highly processed goods are taxed more than less processed goods. This is particularly damaging as Bolivia's comparative advantage lies principally in processing industries. 32. If Bolivia follows trade, investment, and taxation policies which allow its comparative advantage to be realized, the processing industries should continue to grow faster than industry as a whole. In addition to maintaining low and uniform protection, authorities should search for new means of promoting industrial investment which do not favor import-intensive and capital-intensive industries. Measures are also needed to eliminate excess taxation of highly processed goods and to offset the burden of excise taxes and import duties on exports, for example by a comprehensive rebate in the form of a transferable credit note. Ihese measures could contribute significantly to the promotion of non-traditional exports. Sound, rapid industrial growth will be facilitated by recent changes in interest  _ 9 _ rates that should encourage financial intermediaries to attract savings and make longer term loans for industrial investment (para 35). The need for improvements in both industrial and financial policies was discussed with the Bolivian authorities during preparation of the project as part of the Bank's ongoing dialogue with the Government on economic policy. C. Financial System 33. The financial system in Bolivia, which consists of the Central Bank, commercial and specialized banks, and other financial institutions, is at an early stage of development. Nevertheless, rising incomes, greater political stability, and more consistent government policies have recently sparked accelerated financial development, resulting in the formation of some new banks and financial companies. Financial develop- ment has been reinforced by the increase in the share of total credit going to the private sector. Tis increase has resulted from rising public revenues due to higher oil prices which have reduced the need for deficit financing. However, although commercial bankst resources and their total volume of lending have increased, the average lending term has been actually shortened to less than one year following the full commitment of concessionary funds derived from foreign assistance grants and loans. The result is that short-term working capital credit is now easier to get, but the scarcity of term financing for investment and permanent working capital remains severe. BISA, the major domestic source of medium- and long-term financing for industry and mining, has been unable to satisfy the fast-growing demand of private industries, while its mining lending, made possible through IDA credit No. 455-B0, has not reached more than a modest number of medium-size projects. 34. Real interest rates in Bolivia have generally been positive since the 1959 stabilization program. Inflation, fluctuating in a range of 3 to 39% per annum since 1960, made real rates negative for about 18 months during 1973 and 1974, following the 68% devaluation in 1972. Since mid-1974, however, real rates have again turned positive as the November 1974-November 1975 rate of inflation dropped to 7. 5%. 35. Interest rates on savings deposits in commercial banks were raised from 9% to 10% in 1974, and the Central Bank started to guaranteed the dollar value of the savings deposits of individuals. In August 1975, the dollar guarantee was extended to time deposits, whose interest rates were raised to 10-1/4% for 90-day deposits and to 11-3/,4% for 360-day deposits. Commercial banks pay up to 9% per annum on US dollar time deposits. Central Bank regulations permit commercial banks to charge nominal interest of up to 15% per annum on loans made from their own resources. Because of taxes, cormissions, and the prepayment of the interest normally required by banks, the effective rate to the borrower may exceed 23% on short-term peso "productive" loans and 33% on personal and commercial loans. In comparison to commercial banks, the cost of  - 10 - term loans made by development institutions such as BISA is much lower. There are no taxes or employees benefit fee on development loans and they are usually denominated in US dollars. Funds from international organizations, which are principally available for longer term lending, may not be relent at more than 12% per annum in foreign currency and after lending fees and commissions their cost to the borrower is about 13% per annum. On January 8, 1976, the maximum lending rate on development banks own resources, which are usually loaned on terms not exceeding three years, was raised from 13% to 15% per annum to conform to the maximum nominal rate of commercial banks. Including a closing fee, the effective cost of these loans may now reach 16% per annum. However, despite the equality in nominal lending rates as between commercial and development loans, sizeable differences continue to exist in their comparative effective costs due, on the one hand, to the foreign exchange risk inherent in dollar denominated loans for development and, on the other hand, to the taxes, commissions and requirements for pre- payment of interest attaching to peso denominated commercial loans. 36. Ihe need for an increase in the development banks' lending rate was discussed with the Central Bank during project preparation and the January increase may be an important breakthrough in the mobilization of domestic resources for investment purposes. For the first time in recent yearss, BISA and other development finance institutions should be in a position to offer an interest rate on term funds in excess of the rate paid on commercial bank time deposits and still have an adequate interest spread on relending the borrowed funds. 37. Development Prospects and Constraints. Although notable advances have been made, the Bolivian financial system still suffers from a number of structural weaknesses. A foremost weakness is the lack of a reasonable term structure of interest rates. The present interest rate structure does not set a differential between short and longer term loans and therefore discour- ages term lending, since it offers commercial banks no incentive to pay higher interest rates to mobilize longer-term savings. A second weakness is that much of the recent advancement in the financial system nas relied on US dollar guarantee of individuals' savings instruments. This would endanger the effectiveness of monetary policy in the event of a devaluation. Instead an adequate interest rate differential between guaranteed and non- gruaranteed instruments should be established. 38. Despite these weaknesses, the financial system should be able to mobilize increasing amounts of resources and to make a modest beginning in lengthening the average term of both assets and liabilities. The re-establish- ment of positive real interest rates has set the stage for healthy develop- ment of the financial system and made feasible the initiation of a modest capital market which would aid in the efficient allocation of investment funds throughout the economy.  - 11 - 39. Project Implications. Thus far, BISA has played a minor role in the mobilization of domestic resources, largely because of the previous ceiling of 13% per annum on lending from its own funds. The recent interest rate adjustment, which allows development banks to charge 15% per annum on their own resources, should enable BISA to initiate the issue of one- to two-year dollar bonds at corpetitive interest rates. BISA's issue of bonds would be facilitated by the prospective establishment of an over-the-counter securities market. A successful issue of bonds by BISA would set a precedent for other financial institutions, thereby stimulating the development of the capital market and facilitating investment in mining and industry. PART IV - THE PROJECT Background and Objectives 40. The proposed project, consisting of a Bank loan and an IFC invest- ment, would represent the second Bank Group financing of BISA. Unlike the 1974 IDA Credit, which was restricted to the mining sector, the proposed loan would provide scarce long-term funds to both private mining and industrial projects, including projects of small industrial enterprises. Ihe proposed IFC investment, which was first discussed during the appraisal of the IDA Credit in 1973, would consist of a subscription to BISA's share capital. The project would contribute to the further development of BISA as the principal term-lending institution to the private mining and industrial sectors in Bolivia, and would incorporate some features designed to help develop the Bolivian capital market. 41. The loan and investment summaries are provided in Annex III. The pro- posed project was appraised in November/December 1975. Negotiations were held in Washington in May 1976. The Government of Bolivia was represented by the Economic Counselor in its Washington Embassy, Jaime Delgadillo. BISA was repre- sented by its General Manager, Jorge Lop'8z Pacheco. The Staff Project Report (No. 1132-BO and dated June 4# 1976) is being circulated under separate cover to the Executive Directors. Banco Industrial, S.A. (BISA) 42. BISA, established in 1963 as a private development bank, was set up primarily to provide term financing to the private industrial sector. Since its participation in the IDA Credit, it now also finances the private mining sector. BISA is presently implementing a plan for geographic and functional expansion that would transform it into a truly national development finance institution. Other private development banks in Bolivia are much smaller and relatively ineffective, while the record of Governmernt-owned institutions has thus far been poor. Therefore, the growth and development of BISA has important implications for the overall development of the private mining and industrial sectors in Bolivia.  - 12 - 43. OTinership ana Board of Directors. BISA's shareholders include the most important groups in the Bolivian private sector. Shareholders are grouped into four categories: private Bolivian banks (21% of share capital), industrial firms and individuals (32%), foreign investors (32%), and medium mining enter- prises (15%). The biggest shareholder is ADELA Investment Company, with about 23% of share capital. No other shareholder accounts for more than 7%. Each shareholder category has two directors, a system that gives BISA an eight-mnember Board with a good balance of skills. BISA's Board, which includes several prominent bankers and businessmen, is effective in setting policy and takes an active interest in BISA's operations. hlj.. Management and Staff. BISA has competent and experienced management. Its general manager is well qualified and has headed BISA since 1969. BISA has built up an able staff of 19 professionals. It recently opened a branch office in Santa Cruz to help develop the considerable agro-industrial potential of the western region, and a representative office in Tarija to cover the southern provinces of Bolivia. 45. Policies and Procedures. The quality of BISA's appraisal work is generally satisfactory. Technical evaluation and financial analysis are acceptable. Economic analysis includes the economic rate of return (ERR) for all subloans requiring more than US$50,000 equivalent, which account for close to 90% of total approval amount. Supervision is acceptable. Prncurement and disbursement procedures are satisfactory. h6. BISA recently drafted an integrated policy statement which serves as a guide to operations. During negotiations, BISA agreed to modify its policy statement so that it would (i) reduce the total amount of its exposure, as a percentage of its equity, in any single client from 35% to 25% by 1978 in step with its growth in equity and (ii) institute more efficient operating policies which should result in satisfactory profitability, increased dividend yields and thereby facilitate the mobilization of the necessary equity resources to assure BISA's sound financial growth. 47. As a guide for subsequent project supervision by the Bank Group, BISA's future operational strategy was discussed and agreed upon, in principle, during negotiations. Points covered, inter alia, were BISA's geographic expansion plans, capital market development efforts and overall operational targets, including loans to small-scale enterprises. It is BISA's intention to give special attention to subprojects producing metals other than tin in support of the Government's policy of diversification in the mining sector, and to examine carefully those subprojects producing tin or goods whose importation is prohibited. Bolivian industrial policies have important implications for BISA. Because of the recent increases in import restrictions, BISA should evaluate carefully the economic viability of subprojects producing goods whose importation is prohibited. These implications were discussed during negotiations and BISA has agreed to adopt-reasonable para- meters for the shadow pricing of labor and foreign exchange.  - 13 - 48. Past Operations and Results. While still a relatively small institution with total assets of about US$11 million, BISA has already established itself as a major source of scarce term financing for the private industrial and mining sectors. Since 1963 BISA has approved a total of 862 loans for about US$35,000 average. The processing industries in which Bolivia appears to have comparative advantage, such as food products and textiles, account for more than half of the total amount approved. Though recently started, mining already represents 10% of total approvals. Firms in the La Paz area continue to absorb the bulk of BISA's funds. This does not indicate a reversal of BISA's efforts to diversify operations geographically, but rather results from the financing of mining projects sponsored by firms with headquarters in La Paz but with operations elsewhere. A considerable lengthening of average loan term, and a much greater percentage of loans now financing fixed assets rather than working capital, indicate the growing maturity of BISA as a term-lending institution. Also, while BISA has not been very promotional in terms of equity investments, it has been active in financing the creation of new enterprises, which accounted for 23% of total approval amount since inception. 49. BISA also provides credit to small-scale enterprises having no more than US$50,000 in equity and employing not more than 50 people. In 1975, these loans, made in amounts not exceeding US$30,000 equivalent, accounted for about half of the total number of loans approved and for about 8% of total approval amount. Active participation of commercial banks as channels for part of these loans has resulted in wide geographical distribution of this type of credit. BISA expects that about 10% of its future lending, including a part of the pro- posed loan, would be made to small enterprises. During negotiations it was agreed that BISA would institute a system of management controls for loans to small-scale enterprises which would assure that appraisal standards would be more evenly applied and subproject implementation more closely supervised. 50. Loan approvals increased five-fold from $b40 million in 1973 to about $b216 million in 1975, while the total portfolio grew by about 60% in 1974 and 1975, reaching an estimated $b230 million. BISA's earnings have now recovered from the decline in the earl;y 1970s, and it plans to resume a minimum 5% yearly cash dividend (based on share capital) out of 1975 earnings. As a result of a doubling of assets from $blO9 million in 1973 to about $b211 million in 1975, the debt/equity ratio rose from 3.5:1 at year-end 1973 to 4.9:1 at year-end 1975, although BISA retained all earnings during this period. This is still within its contractual limit with IDA of 6:1. As an incentive for BISA'S capital market develop- ment efforts, the Bank and IDA have agreed that the sale of domestic bonds up to an amount equivalent to BISA's equity would not be counted against the basic debt/equity ratio.(Section 3.05 of the Project Agreement). This is justified by financial and institutional improvements in BISA since the appraisal of the IDA Credit. 51. BISA's loan portfolio is adequately secured with guarantees. Arrears over three months represent about 7% of outstanding loans and recovery pros- pects of these loans are relatively good. Total loss reserves are currently 1.2% of BISA's total portfolio. BISA has agreed that the current reserve for portfolio losses is barely adequate and has agreed to increase the provision annuallyr, so as to reach 3% by 1980.  52. Projected Operations. BISA should have no difficulty in attaining its target for approvals through 1980 at a conservatively projected growth rate of about 12% per year. Due to large increases in approvals in 1974 and 1975, BISA's assets would triple by 1978 from the year-end 1975 base of $b211 million. Profitability should also increase significantly to reach a 15% return on average equity from 1978 onwards, which should make BISA's shares more attractive. 53. This projected growth rate would require additional forei&.