Tanzania - Tanzania Investment Bank (TIB) Project

Document of - < , The World Bank FOR OFFICIAL USE ONLY Report No. P-2606-T. REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE TANZANIA INVESTMENT BANK WITH THE GUARANTEE OF THE UNITED REPUBLIC OF TANZANIA AND A PROPOSED CREDIT TO THE UNITED REPUBLIC OF TANZANIA July 12, 1979 t This document bas 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 Currency Unit = Tanzania Shilling (TSh.) US$1.00 = TShs. 8.30 TSh. 1.0 - US$0.12 (As the Tanzania Shilling is officially valued in relation to a basket of currencies, the US Dollar/ Tanzania Shilling exchange rate is subject to change. Conversions in this report were made at US$1.00 to TShs. 8.30 which is close to the 1979 average exchange rate.) ABBREVIATIONS AND ACRONYMS BIS = Basic Industrial Strategy EADB = East African Development Bank EEC m European Economic Community NBC - National Bank of Commerce NDC = National Development Corporation NIC = National Insurance Corporation SIDO = Small Industries Development Organization SSI = Small-Scale Industries TDFL - Tanganyika Development Finance Company, Ltd. TIB = Tanzania Investment Bank TRDB = Tanzania Rural Development Bank FISCAL YEAR Government: July 1 - June 30 TIB : July 1 - June 30  FOR OFFICIAL USE ONLY TANZANIA TANZANIA INVESTMENT BANK PROJECT LOAN, CREDIT AND PROJECT SUMMARY BORROWER : TanzaLnia Investment Bank (TIB) for IBRD loan and United Republic of Tanzania for EEC Special Action Credit GUARANTOR : United Republic of Tanzania for loan AMOUNT : US$25 million equivalent loan US$15 million equivalent Special Action Credit TERMS : Loan to TIB would be repayable substantially in con- formity with the aggregate amortization schedule for sub-loans and investments for which withdrawals from the loan account are approved or authorized. The interest rate would be 7.9 % per annum. Special Action Credit would be on standard IDA terms to Government; it would be onlent to TIB under a subsidiary loan agreement on terms equivalent to the IBRD loan. RELENDING TERMS TIB would relend the proceeds of the loan and Special Action Credit at an interest rate of 11% per annum. The maximum maturity of sub-loans will be 15 years including adequate grace periods. The exchange risk would be assumed fully by sub-borrowers. PROJECT DESCRIPTION The purpose of the proposed project is to meet part of TIB's foreign exchange requirements for investments in rnedium and large scale industrial, agro-processing, and tourism development projects through June 1982. FINAL DATE FOR PROJECT SlJBMISSIONS: Banlk Loan - June 30, 1982 Special Action Credit - June 30, 1981. CLOStNG DATE : Bank Loan - June 30, 1984 Special Action Credit - December 31, 1981 DEBT COVENANTS : Maximum debt/equity ratio of 3:1. RISKS : There are no major risks associated with this Project. This document has a restrictecl distribution and may be used by recipients only in the performance of their official duties. Its contients may not otherwise be disclosed without World Bank authorization.  - ii - DISBURSEMENT ESTIMATES: (US$ million) FY80 FY81 FY82 FY83 FY84 IBRD Loan: Annual 0.2 2.0 5.8 9.0 8.0 Cumulative 0.2 2.2 8.0 17.0 25.0 EEC Special Action Credit: Annual 0.8 7.7 6.5 Cumulative 0.8 8.5 15.0 APPRAISAL REPORT: Report No. 2400-TA, dated June 22, 1979.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE TANZANIA INVESTMENT BANK WITH THE GUARANTEE OF THE UNITED REPUBLIC OF TANZANIA AND A PROPOSED CREDIT TO THE UNITED REPUBLIC OF TANZANIA 1. I submit the following report and recommendation on a proposed loan to the Tanzania Investment Bank (TIB) with the guarantee of the United Republic of Tanzania for the equivalent of US$25 million and a proposed EEC Special Action Credit of $15 million equivalent to the United Republic of Tanzania for onlending to TIB to help finance the foreign exchange component of investm[ents by this development finance company in Tanzania. The interest on the loan would be 7.9% per annum and its amortization will conform sub- stantially to the aggregate of the amortization schedules applicable to the specific investment projects financed out of the loan. The credit would be made to the United Republic of Tanzania from the EEC Special Action Account in accordance with the terms of the agreement of May 2, 1978 between the Associa- tion and the European Economic Community (EEC). Credit funds would be onlent from the Government to TIB on terms equivalent to the IBRD loans. PART I - THE ECONOMY I/ 2. A Basic Economic Mission visited Tanzania in August 1976. The Basic Economic Report was distributed in December 1977 (Report No. 1616-TA). A summary of social and economic data is in Annex I. Profile of the Economy 3. Tanzania is one of the 30 least developed countries in the world with a per capita income in 1977 of US$200. The economy is still heavily dependent on agriculture: 90% of the labor force is engaged in agriculture and approximately 45% of GDP and two-thirds of total exports are derived from agricultural production. The industrial sector is still small, producing about 10% of GDP, approximately the same percentage as 11 years ago. The service sector has also remained at about 40% of GDP in current prices but has risen to 46% in 1966 prices (with agriculture falling to 38% in constant prices; thus a price shift has offset the real growth of the service sector). Overall population density is low, though a few areas are considered over- populated. Population growth is estimated at 2.7% per annum with both fertility and mortality at relatively high levels. 4. Since the Arusha Declaration in 1967 Tanzania has pursued a socialist development strategy. Banking, insurance, and most large-scale enterprises in manufacturing, plantation agriculture, and wholesale trade are under state control. Controls are used extensively to direct economic activity, including import licensing, foreign exchange control, price control, the reservation of some activities to the state or cooperative sector, and detailed Government I/ This section is esserLtially the same as that of the President's Renort on the Tanganyika Development Finance Company, Limited (TDFL) project dated June 8, 1979.  -2- investment planning. The second major feature of Tanzania's development strategy is its strong emphasis on rural development and social programs to benefit the poor. This is reflected in ambitious programs for the provision of rural water supplies and health services and in its decision to achieve universal entry into primary education. Long Term Economic Trends 5. In the decade 1967-77 real GDP at factor cost grew at an annual average rate of 4.6%, or about 1.8% per annum per capita. While economic growth was severely disrupted by the economic crisis following the failure of rains and large increases in import prices in 1973 and 1974, the economy has recovered well, with annual growth of 5 to 6% for 1976 through 1978. 6. The Government has an impressive record of domestic resource mobilization. Between 1966-67 and 1976-77 the share of recurrent revenue rose from 14.3% to 20.2% of GDP. This has been achieved through a combina- tion of highly progressive direct taxes and proportional or moderately progressive indirect taxes. Except during the economic crisis in 1974-75, the rate of national savings has also been high: gross national savings fluctuated at around 16-17% of GNP from the mid-1960's through 1973, fell to half that level during the crisis years and recovered to the pre-crisis level in 1976-77. These are extremely high levels of savings for a country at Tanzania's income level. 7. Some progress has also been made in achieving the Government's objective of a more equitable income distribution. Between 1969 and 1975 the average urban-rural gap remained approximately constant, halting the trend of an increasing gap in the early 1960s. It is likely that the gap has been slightly reduced since 1976 due to continued recovery of agricultural produc- tion and higher producer prices. Regional income differentials in rural areas have tended to widen slightly. Within the urban sector there has been a dramatic narrowing of the post-tax income differential between the highest- paid government officials and minimum wage earners from 50 to I in 1961 to 8 to 1 in 1975. However, the overall formal urban sector earnings structure has remained relatively stable while a large informal sector has emerged com- prising large numbers of unemployed and underemployed workers with earnings significantly below the official urban minimum wage. The policies of wage restraint and higher producer prices pursued since 1975 should have a bene- ficial impact on almost all dimensions of income distribution and the basic needs oriented programs in rural water and health and in universal primary education (para. 4 above) are resulting in a significant redirection in public expenditures toward the rural poor. 8. Despite satisfactory performance on growth, domestic resource mobil- ization and income distribution, there are other areas in which performance has been less satisfactory. The most worrying long-term trend is the slow growth of agricultural production. In the period 1967-77 agriculture grew at an annual rate of 2.7%, the same as the rate of growth of population. In the -t three years agricultural growth has been higher, but this was primarily a reflection of the recovery to the long-term trend from the drought years  - 3 - 1973-74. In addition, the recovery has been limited to subsistence agricul- ture; monetary agricultural production was only 2.2% higher in 1977 than in 1972. 9. Slow agricultural growth has been largely responsible for a second problem, the disappointingly slow growth of export volume -- the volume of exports of goods alone was actually 35% lower in 1977 than in 1966. While increaLsed levels of foreign assistance and service receipts as well as high coffee prices mitigated the worst effects of the decline in export volume in 1976 and 1977, with the end of the coffee boom export performance has again become a serious problem. Recent Economic Performance 10. The economy contintLed its recovery in 1977 and 1978. Total GDP increased by 5.9% in 1977. There was no significant change in export volume but the boom in coffee prices helped raise commodity export receipts from TSh. 3,828 million to TSh. 4,585 million. Preliminary data show a GDP growth rate of 5.6% in 1978. International reserves rose to US$280 million at the end of 1977 and import restrictions were relaxed. However, with the fall of coffee prices in 1978 and increased import levels, reserves have fallen rapidly; by January 1979 they had fallen to less than $100 million, equivalent to about one montlh of imports at the 1978 level. 11. The Government has continued to adhere to the principal elements of the policy package introduced at the time of appraisal and negotiation of the Program Loan (No. 1063-TA) in late 1974. These include reallocation of investment in favor of directly productive sectors, higher agricultural pro- ducer prices, constraints on wages and salaries, and price and tax increases to restrain private consumption. In the fiscal years of 1977 and 1978 the Government also succeeded in bringing Government spending under control and relaxed. import controls. Because excessive Government spending and borrowing from the banking system were threatening to undermine financial stability and the entire program of recovery in early 1976, a program of budgetary control was developed by the Government and supported by IMF assis- tance and a Program Credit (No. 688-TA) in early 1977. Through the imposition of new budgetary control measures and the reimposition of a progressive tax on coffee exports, the Government was able to reduce Government debt to the banking system and in 1977-78 hold bank borrowing to nearly zero. The Program Credit was also designed to support selected relaxation of import controls in order to provide needed imports of spare parts and raw materials for increased capacity utilization. After some delays, the availability of essential main- tenance imports has increased. However, the recent fall in expgrt receipts (particularly coffee) and the subsequent decline in reserves will lead to large cuts in even high priority imports of raw materials, spare parts and caDital goods unless additional external balance of payments assistance can be obtained. In addition, while the growth in Government revenues was reduced by the decline on coffee prices (upon which there is a sharply graduated export tax), Government expenditures began to grow rapidly again in early 1978. The fall in customs and excise revenue resulting from a short-fall in projected imports will also  - 4 - force the Government to increase its borrowing from the banking system. Finally, the conflict with Uganda has further strained both the budget and the balance of payments. As a result of these trends Tanzania is again facing a balance of payments crisis. To begin to address this the Government announced a 10% devaluation in January, 1979 and reached an agreement with the IMF for the use of the first credit tranche and drawings under the trust fund and export compensatory facility. The problem of increasing Government expendi- tures has been the prime focus of the budgetary review for FY 1980. 12. In recent months the Government has experimented with measures to increase labor productivity. These have included layoffs of some redundant workers,trial incentive schemes at the firm level and consultancy studies of the operational problems of individual firms. Of potentially greater importance, in the Budget Speech in June 1978 the Finance Minister called for the adoption of a payment-by-result wage system to stimulate productivity; discussions on this matter are now in process between the Ministry of Finance and the other involved ministries. 13. Tanzania continues to attract large amounts of foreign assistance on concessional terms. Because of the very concessional terms on which aid has been given to Tanzania and the Government s reluctance in the past to use higher cost commercial loans and supplier's credits, the overall debt service ratio has remained low. Including a notional 40% share of the debt of the East African Community Corporations, it was less than 8% in 1977. Future debt service developments will depend on how the balance of payments difficulties (para 11) are resolved. Assuming the Government's increasing use of modest amounts of commercial funds continues, the debt service ratio is projected to increased to about 15% by 1985; this development is being closely monitored. In 1977 the Bank held 14% of Tanzania's external debt (for the Bank Group, it was 26%) and received 27% of Tanzania's debt service (29% for the Bank Group). We were projecting these to remain at about 30% through the 1980s, but the recent decisions of many donors to switch to grant terms and to forgive past debts will lead to a somewhat higher level of Bank exposure unless the Govern- ment turns to more significant commercial borrowing and supplier's credits. However, with the Bank debt service ratio at only about 3%, this is not expected to be a problem. 14. Tanzania has a well conceived development program which will require resources in excess of domestic savings and external capital made available solely to finance the foreign exchange costs of projects. Given the Govern- ment's efforts to mobilize domestic resources and in view of our support for its increased emphasis on local cost intensive rural investments, the Bank Group will continue to finance a high proportion of total costs including, in appropriate cases, a portion of local costs. East African Community (EAC) 15. The recent developments in the East African Community were outlined in a report to the Executive Directors dated December 19, 1977 (R77-312). Dr. Victor Umbricht, the independent mediator appointed by the Partner States, has visited East Africa on numerous occasions and has now prepared reports to the Partner States on the results of his fact-finding work on the EAC Corpora- tions and the General Services. The next phase of the mediator's work will be  - 5 - to make recommendations on the allocation of these assets and liabilities. The mediator's reports and recommendations on the future structure of the East African Development Bank (EADB) have been accepted in principle by the Partner States and he is now preparing to revise EADB's Charter to reflect the agreed r_ ommendations. 16. The de facto breakup of the Community has had some impact on Tan- zania's budget as new national corporations take over the services formerly provi-ded by the EAC Corporations. A major development related to the EAC difficulties was the closure of the border with Kenya. Kenya was a major trading partner of Tanzania and considerable adjustments have had to be made in locating new suppliers for some items and developing alternative outlets for some manufactured goods and agricultural products. PART II - BANK GROUP OPERATIONS IN TANZANIAY' 17. Tanzania joined the Bank, IDA and IFC in 1962. Beginning with an IDA credit for education in 1962, 38 IDA credits and 18 Bank loans, of which two are on Third Window terms, amounting to US$722.0 million have so far been approved for Tanzania. In addition, Tanzania has been a beneficiary of 10 loans totalling US$244.8 million which have been extended for the developmenl: of the common services and development bank operated regionally by Tanzania, Kenya and Uganda through their association in the East African Community. IFC investments in Tanzania, totalling US$4.7 million, were made to the Kilombero Sugar Company in 1960 and 1964. This Company encountered financial dlifficulties and in 1969 IFC and other investors sold their interest in the Company to the Goverrment. An IFC investment of US$1.75 million in soap manufacturing in Mbeya was approved by the Executive Directors on June 8, 1978 and ain investment of US$1.5 million in metal product manufacturing was approved on May 10, 1979. Annex II contains summary statements of Bank loans, IDA credits and IFC investments to Tanzania and the East African Community organizations as of May 31, 1979 and notes on the execution of ongoing projects. 18. To support Tanzania's overall development strategy Bank Group lending operations are incresasingly focusing on the rural sector and directly productive projects. While up to the end of FY 1972 Bank Group operations were directed mainly on infrastructure, the overwhelming majority of the operations approved since FY73 have been for directly productive projects. Furthermore, a number of recent Bank Group supported infrastructure projects have been closely linked with specific productive activities. For example, the Urban Water Supply Project (Loan No. 1354-TA) approved in January 1976, will support the Industrial Complex in Morogoro (Loans No. 1385-T-TA and 1386-TA) and the Morogoro Textile Project (Loan No. 1607-TA and Credit No. 833-TA). Directly productive projects recently approved include the Second Cashewnut Development Project (Credit No. 801-TA), the Tobacco Handling Project (Credit No. 802-TA), the Mwanza/ Shinyanga Rural Development Project (Credit No. 803-TA), the Mufindi Pulp and Paper Project (Loan No. 1650-TA and Credit No. 875-TA) and the TDFL Project (Loan No.1745-TA). In addition, 1/ This section is essentially the same as that of the President's ReDort on the TDFL Project dated June 8, 1979.  a Tourism Rehabilitation Project (Credit No. 860-TA), a Sixth Education Project (Credit No. 861-TA) and a Fifth Highway Project (Credit No. 876-TA) were approved by the Board in FY79. Projects which have been appraised include a Second Urban Water Supply Project, a line of credit to the Tanzania Rural Development Bank (TRDB), a Smallholder Tea Consolidation Project, a Foodgrain Storage and Milling Project, and a Harbours Project. A rural development project in Mara, an education project, a small scale industries project, an urban project, a coconut project and an agricultural services project are also under preparation. 19. Although the comparatively high undisbursed proportion of loans and credits, detailed in Annex II, is in large part a result of the recent approval of many of these projects, it also reflects the fact that overall project implementation has been slower than was projected. It is clear in retrospect that both the Bank Group and Tanzania have been optimistic re- garding Tanzania's absorptive capacity. The causes of the difficulties in implementation are varied. Some stem from the scarcity of suitably trained and experienced manpower, some reflect the problems in identifying agronomic input packages appropriate to the needs of smallholder farmers while others result from the strains associated with attempting a "frontal attack" on poverty. These problems have been compounded by frequent and drastic admi- nistrative changes, which -- though potentially the source of long-term benefits -- have certainly disrupted orderly execution of projects and made parts of earlier project concepts obsolete. In general, difficulties have been most severe in agriculture, particularly in the smallholder rural sector. As our lending program has increasingly concentrated on this sector, these problems have become correspondingly more apparent and severe. By contrast, the "modern" sector projects have tended to fare better: the Tanzania Investment Bank, Mwanza Textile, and Morogoro Industrial Estate Projects, for example, are proceeding well. 20. As the Bank Group's lending program has expanded, increasing attention has been given to measures designed to improve project implementa- tion. A course was conducted in Dar es Salaam in 1973 and again in 1978 on Bank Group procurement for relevant Government officials. A special project implementation unit was set up in the Ministry of Agriculture and nine Agricultural Development Services staff have been assigned to Bank Group financed projects in agriculture and rural development. The need to establish a close and continuous working level dialogue between responsible Tanzanian officials and Bank Group staff on implementation problems was one of the prime reasons for the expansion of the Resident Mission to two profes- sionals in October 1976. In February 1977 a regular Government/Bank Group review of project implementation was established. Monthly discussions on the Bank Group program chaired by the Ministry of Finance and attended by Bank Group staff and officials from implementing agencies deal in detail with individual problem projects and problems which are affecting project imple- mentation across a number of sectors. As a result of these efforts, there has been a noticeable improvement in project implementation. Actions agreed to during the reviews have been completed relatively fast and coordination and communication between the Ministry of Finance and the various ministries and agencies responsible for project implementation has improved markedly. 21. The Government has become increasingly conscious of the importance of effective implementation. In addition to fully supporting the project  implementation review system, the Ministry of Finance has set up a unit to oversee project performance. Furthermore, there have been more consistent responses to Bank suggestions and a willingness to openly discuss project problems raised by Bank Staff. As a consequence, the disbursement records of Bank Group financed projects have improved somewhat over the last two years, and a recent analysis indicated that the Tanzanian disbursement performance is about equal to the Bank-wide average. While there is still a potential for further significant improvements, the Government is implementing its invest- ment program, including Bank Group and other foreign aided projects, more effectively than in the past. PART III - THE INDUSTRIAL SECTOR General Backrground 22. At Independence Tanzania had an extremely limited industrial sector dominated by private firms. Three major features have characterized the sector sinces that time: rapid expansion, a diversification in output and a major shift in ownership from private to public hands. The share of manufac- turing in G:DP rose from just under 4% in 1961 to 10% in 1970, and has remained around this level since. Secondly, Tanzania's industrial structure has under- gone a change from a rudimentary structure producing a very limited range of goods to a more diversified structure, producing a larger variety of food and non-food consumer goods, intermediate goods and some capital goods. Finally, following the Arusha Declaration of 1967, the Government systematic- ally transferred the control and ownership of a number of large private and foreign-owned industrial enterprises to Government-owned parastatals. By 1976 parastatals accounted for 53% of the value added and 48% of the employment in the industrial sector. Notwithstanding the rapid growth of public enterprises, the private sector has remained an important participant in industry. Performance and Problems 23. The industrial sector grew fairly rapidly in the sixties but later experienced. a decline in its rate of growth. Value added in manufacturing grew at an average rate of 10.8% between 1965 and 1969, but the growth rate fell to 7.4% between 1970 and 1973. After a virtual stagnation in production in 1974 and 1975 because of the economic crisis in those years and its attendant supply problems for a wide range of industrial inputs, output has recovered, showing a growth rate of about 6.4% in 1976 and 5.4% in 1977. 24. Tle overall decline in the industrial growth rates from the high levels in t:he late sixties reflects a number of factors. Most important, the Government has not yet developed the administrative capability to monitor and coordinate effectively the operations of the control system which was instituted along with the irncreased public ownership of manufacturing enter- prises. Major components of this control system include centralized decision making on investments, detailed allocations of foreign exchange through import licensing, an extensive regime of price controls and rules of procedure  - 8 - operated by the National Pricing Commission, and wage-setting by the Permanent Labor Tribunal and the Government. While the Government feels these controls are needed to achieve its development goals, their effect has largely been to insulate public enterprises from the discipline of market forces; this is particularly serious as performance indicators consistent with the macro systems and clear guidelines for evaluating performance are still lacking. In addition, there is a scarcity of trained managerial personnel and skilled labor, and most enterprises have to live with periodic shortages of other key inputs. 25. The Bank Group has raised these issues in its discussions with the Government on general economic work and in specific projects in the indus- trial sector; the Government is aware of the problems, and is making efforts to resolve them. It has acknowledged the problems of low labor productivity and low capacity utilization, and is stressing the need to improve per- formance. While decisions on major policy changes relating to incentives, price and import control systems, and the oversight of parastatals will take time because of the importance and breadth of the issues involved, the future policy on incentives is under active discussion at present (para. 12). In addition, a number of improvements have already been made at the firm level. These include some cases of retrenchment in over-manned parastatals, better discipline among workers mainly due to improved relations between managers and the labor union,greater worker participation in certain aspects of decision-making, introduction of incentive systems in a few firms and relaxa- tion of limitations on recruitment of expatriate experts. In particular, the National Development Corporation, the largest parastatal holding company, hired a firm of consultants to advise on operational efficiency in some of its subsidiaries. Some parastatals have also commissioned studies under the IDA Technical Assistance Credit (No. 601-TA), with a view to identifying causes for low capacity utilization and improving overall operational efficiency. 26. The emphasis on productivity and capacity utilization has had the effect of increasing confidence in the industrial sector and improving the overall investment climate. Furthermore, the Government has clarified, at the highest level, that the Arusha Declaration did not preclude private investment in industry, and that such investment would be encouraged in all areas not specifically reserved for full Government ownership. This has been followed in practice by increased licenses for the importation of spare parts and raw materials for private industries. The effect of these actions has been a marked increase in private sector investment in industry over the past year. While the recent developments in the balance of payments have already led to some fall in import licenses, the expansion in investment activity by the private sector has been maintained. Basic Industrial Strategy and the Third Five-Year Plan 27. The Government's present strategy for the development of the industrial sector is based on the Basic Industrial Strategy (BIS) which was adopted in 1974. The two main goals of this strategy are structural trans- formation and self-reliance; it emphasizes the use of domestic resources for domestic needs. Priority will be given to industries which cater for the basic needs of the majority of Tanzanians, such as food, shelter and health, and to the development of heavy industries, such as iron and steel. By using  -9 - local resources and producing for the local market, the BIS envisages a struc- tural transformation of the etconomy through a system of backward and forward linkages. Although the BIS stresses the domestic market, the Government also recognizes the need to expand export-oriented agricultural processing industries to increase the foreign exchange earning capacity of the country. The major potentia.l problem with the BIS is that attempts to restructure the economy too quickly during a period of resource stringency may ultimately frustrate both growth and structural change. A too-rapid expansion of the metals sector (especially steel production) may lead to excessive reliance on external finance, know-how and markets and the massive investment coordination required by the strategy may overburden the country's already weak planning capacity. 28. The Third Five-Year Plan (1976 - 1981), currently under implementa- tion, incorporates the first phase of the BIS. Under this Plan, the specific objectives are to improve the efficiency and capacity utilization in existing industries and to expand and establish industrial capacity for production to meet basic needs. The targeted growth rate for the industrial sector is 9.3% per annum compared to an overall GDP growth target under the Plan of 6%. While reasonable growth in industrial production was achieved during the first two years of the Plan (as noted above), it did not match the targeted growth rate. In line with the important role which industry plays in the Plan, a total of TShs. 5,147 million (24% of the total investment allocation in the Plan), has been earmarked for public investment in the sector. Small-Scale: Industry 29. Although it is difficult to accurately isolate the performance of small-scale industries (SSIs) due to the lack of data, SSIs appear to be concentrated in those areas associated with early industrialization, for example, grain milling, bakeries, clothing and furniture. As the share of SSI production in manufacturing appears to be declining, the Government has decided to promote the development of SSIs. In 1972, it established the Small Industries Development Organization (SIDO) to have primary responsibility for planning, promoting and providing all kinds of assistance to small-scale industries. SIDO's major activities are the setting up of industrial estates and training-cum-production centers for imparting skill and craft training. Its other activities include preparation of feasibility studies, provision of hire-purchase finance, marketing, and other technical assistance. The Govern- ment has resquested the Bank Group to assist SIDO and a Bank mission recently visited Tanzania to identify a suitable project. The Financial Sector 30. Tanzania's financial institutions are relatively well developed for a country of its size. In addition to the Bank of Tanzania (the central bank responsible for overall monetary policy), there are nine other financial in- stitutions: a State-owned ,commercial bank, a State-owned insurance corpora- tion, a national provident fund, four development banks (three dealing with the modern sectors of manufacturing, transport, etc., and one with rural development), a savings bank and a housing bank. Of these, the commercial,  - 10 - savings and housing banks are authorized to accept deposits from the public. Tanzania has no active private capital market and the bulk of equity invest- ments is provided by the Government through the budgetary process. Overall, the respective roles and functions of the financial institutions are clearly defined and there is no costly duplication of effort. 31. The three development banks dealing with the modern sectors are the East African Development Bank (EADB), the Tanganyika Development Finance Company, Limited (TDFL) and the Tanzania Investment Bank (TIB). EADB, an East African Community Corporation, whose majority shares are held by the Govern- ments of Kenya, Tanzania and Uganda, is directed by its charter to make 38.75% of its investments in Tanzania. With the dissolution of the East African Community, EADB's role has diminished considerably because of the uncertainty surrounding its future. TDFL, which is jointly owned by TIB and bilateral aid agencies of the U.K., West Germany and the Netherlands, has a relatively small equity base and provides funds mainly to medium-size private enterprises. TIB, discussed in detail below, provides medium and long-term finance primarily to parastatals in the industrial sector. Although there is some overlapping of functions between TDFL and TIB, their respective roles are well defined, with TIB concentrating on larger and public enterprises. Furthermore, as TIB owns 30% of TDFL's share capital and appoints two directors on its Board, reasonable coordination of operations of the two organizations is assured. In FY78 the average TIB loan was TShs. 13 million compared to TShs. 2 million (TShs. 3 million including equity investments) for TDFL. Bank Group Experience in Industry 32. The Bank Group has been extensively involved with TIB since 1974, and has made one IDA credit and two Bank loans for a total of US$36 million. Progress on these operations has been satisfactory as TIB has developed into a well organized institution and an efficient allocator of medium and long- term funds to the industrial sector. The Bank Group is expanding its assis- tance to Tanzania through financial intermediaries; a loan of US$11 million to TDFL was recently approved and an appraisal for a credit of US$10 million to TRDB is being completed. 33. The Bank Group has also provided US$143 million to four industrial projects. Two investments totalling US$60 million have been made in the textile sector through the National Textile Corporation, the first to expand an existing operation, the second to set up a new integrated polyester textile mill. The Bank Group also approved US$23 million for an industrial complex at Morogoro in 1977, wherein a canvas mill and a shoe factory will be set up with the primary objective of exporting their output. Early this year the Bank Group approved a total of US$60 million for the Mufindi Pulp and Paper Project. The project consists of the establishment of an integrated pulp and paper mill with an initial capacity of 60,000 tons per annum of paper and board as well as 1,400 tons of pulp for sale outside the mill. The Bank Group has also provided an IDA credit of US$6 million for a Technical Assistance Project. In the SSI sector, IDA has approved a US$1.4 million component as part of the Second National Sites and Services Project which will  - 11 - provide assistance to small-scale industries in Tabora and Tanga. The program will provide infrastructure for industrial clusters, credit for equipment and management and technical assistance to selected small enterprises. In view of the reemergence of the private sector, IFC has approved investments of US$1.75 million in soap manufacturing and US$1.5 million in metal project manufacturing (para. 17) and is studying other project possibilities. PART IV - THE PROJECT 34. The proposed loan would be the Bank Group's fourth line of credit to TIB; the first was an IDA credit (No. 460-TA for US$6 million) approved in 1974, the second and the third were IBRD loans (No. 1172-TA and No. 1498-TA for US$15 million each) approved in 1975 and 1977, respectively. TIB also administers the IDA Technical Assistance Credit of US$6 million (No. 601-TA). A report entitled "Appraisal of the Tanzania Investment Bank", dated June 22, 1979 is being distributed to the Executive Directors separately. The project was appraised in ODctober/November 1978. Negotiations were held in Washington in June 1979 and the Tanzanian Delegation was led by Ernest Mulokozi, Principal Secretary, Ministry of Finance and Planning. A Loan, Credit and Project Summary is at the front of this report, and a Supplementary Project Data Sheet is in Annex III. Ownership and Role 35. Established in 1970, TIB is wholly owned by the Tanzanian Govern- ment. It has an authorized capital of TShs. 200 million of which TShs. 100 million was paid-in as of December 31, 1978. The Government holds 60% of the paid-in capital, the National Bank of Commerce (NBC) 30% and the National Insurance Corporation (NIC) 10%. Both NBC and NIC are wholly owned by the Government. Within the system of financial institutions in Tanzania, TIB's main role has been to finance projects in the directly productive sectors in the form of medium and long-term loans. As almost all sizeable projects are now promoted and implemented by parastatals, equity financing is usually provided directly through the; budget. Through its independent appraisal and investment decision-making process, TIB has provided a critical independent check on the technical, financial and economic feasibility of parastatal investments which are presented to it for financing, thereby improving the quality of resource allocation in Tanzania. Having built up its capacity and gained the confidence of the industrial sector, TIB is gradually extending its activities from loan financing to project identification and promotion. As the intermediary for channelling funds under IDA's Technical Assistance Project, TIB has been assisting parastatals to carry out (i) pre-investment and feasibility studies in respect of several new project ideas and (ii) capacity utilization and effiLciency studies in respect of projects facing operational problems. Board of Directors, Management and Organization 36. TIB's Board is chaired by its Managing Director, who is appointed by the President, and has ei,ght other members. They include the Commissioner of Sectoral Planning of the M4inistry of Finance and Planning, a senior  - 12 - economist in the President's Office, a representative of the labor union, the General Manager of NIC, the Director of the Institute of Finance Management and three representatives of NBC. TIB's Board is actively involved in TIB's work with the sole power of approving loans and equity investments. A General Manager assists the Managing Director in overseeing TIB and its organizational structure consists of four departments: Operations, Planning and Development, Finance, and Secretary's and Administration. Tanzanians head all these departments. As of December 1978, TIB's total professional staff numbered 43, of which eight were expatriates. TIB has developed an excellent training program for its staff, and is making good use of overseas training programs and its expatriate staff in training Tanzanians. Operations and Portfolio 37. TIB's operations have grown rapidly since its founding in 1970. The level of TIB's loan approvals increased from 9 loans for TShs. 29 million in FY72 to 23 loans for a total of TShs. 285 million in FY78. TIB's cumulative loan approvals for ordinary operations as of March 31, 1979 amounted to 137 loans for TShs. 1,119.5 million. In addition, it has made equity investments in thirteen enterprises for TShs. 64 million. TIB assists a broad range of economic sectors and most TIB-assisted projects utilize domestic raw materials. The most important sectors are food and food processing, transport, chemical and rubber products, tourism development, textiles and metals. Projects approved during the fifteen months ending September 1978 are expected to create 9,135 new jobs at an average investment cost per direct job created of about US$13,400 which is reasonable given TIB's primary focus on medium and large-scale industry. These projects have an average estimated financial rate of return of 20% and economic rate of return of 23%. The growth of commitments and disbursements has kept pace with approvals; as of March 31, 1979 about 73% of TIB'S net approvals by amount and 91% by number had been committed and over 70% of the committed amount had been disbursed. By improving its follow-up during project implementation, TIB has increased its disbursement rate appreciably in recent years. 38. As of December 31, 1978, TIB's loan portfolio amounted to TSh. 476 million for 81 projects of which TShs. 135 million (28%) in 32 projects was affected by arrears of over three months. While this represents an improve- ment from the level outstanding at the time of the third TIB line of credit (39%), it does not fully reflect the emphasis TIB has placed on addressing its portfolio problems. Over the past two years, TIB has considerably strengthened its follow-up capacity. It has conducted comprehensive reviews of each problem project, made specific recommendations for resolving the causes of the problems and used its influence as a financier to ensure that appropriate steps are taken in response to these recommendations. These actions have yielded good results; of the six projects identified as problem projects at the last TIB appraisal, one is already profitable and three others have shown improved operating results. During appraisal, TIB's efforts in problem follow-up were assessed in detail and were found to be adequate. In addition, as noted above, TIB has begun actively to promote use of the IDA Technical Assistance Credit for studies of capacity utilization problems. Finally, the size of the arrears affected portfolio does not fully reflect  - 13 - the quality of TIB's loans because about 30% of the portfolio in arrears over 3 months involves projects which have temporary problems where arrears are likely to be collected in the near future and 28% of the arrears affected projects are under implementation, requiring extensions of grace periods due to delays in project completion. The remaining ten projects were facing technical and marketing problems; while five of these are classified as havirng moderate problems with a reasonable chance of overcoming their difficulties, the others (involving TIB loains of TShs. 23 million) are in poor condition and TIB nxi,y 1-se? a portion of its investments in them. Since all these problem projects are parastatals, there are good prospects that TIB will recover most of the amounts due from the r,elevant holding companies. 39. TIB's equity portfolio was TShs. 37.8 million as of December 31, 1978 including investments in the common stock of 5 companies (TShs. 12.8 million) and the preferred stock of nine companies (TShs. 25 million). Its major investment (TShs. 30 million) is in the common and preferred stocks of TDFL. While TDFL has been paying interest on its income notes, TIB's other investments yield no return because the projects involved are expe- riencing various problems or are under implementation. Financial Condition 40. As a result of the rapid growth of its operations, TIB's total assets increased from TShs. 156 million in 1974 to TShs. 697 million by June 30, 1978. This increase has been financed mainly through grants from bilateral donors, long-term borrowings, and increased equity. TIB's net worth during this period increased from TShs. 78 million to TShs. 466 million, mainly due t:o grants (TShs. 309 million) and increased paid-in capital and retained earnings. This rapid increase in TIB's equity base has resulted in an improvement of its long-term debt to equity ratio from an already sound position of 1:1 in 1974 to 0.4:1 in 1978. The return on TIB's average net worth, as of June 30, 1978 was only 3.6%; however, in view of the low leverage in its capit:al structure this is adequate. TIB's administrative expenses were reasonable at 0.9% of the total assets. TIB's liquidity situation continues to be sound and the debt service coverage at 2.6 is adequate. TIB carried out a project-by-project review at the time of the 1978 audit and made provisions of TShs. 8.4 million which were satisfactory to its auditors. Considering its strong equity base, TIB would continue to be creditworthy even if it were necessary to write off av sizeable portion of its investments facing difficulties. Bank Group Experience with TIB 41. Since its formation, TIB has developed rapidly into a well organized and professional financial intermediary. Its pragmatic willingness to iden- tify and resolve institutional problems and its continuous efforts at increas- ing its effectiveness in guiding Tanzania's industrial development has earned it considerable respect withiin Tanzania and with bilateral and multi-lateral agencies. TIB's project appraisal work has considerably improved and it now has the ability to undertake comprehensive financial and economic analysis of investment proposals. In response to implementation and operational difficul- ties with SDme of its investments, TIB has expanded and improved its follow-up activities.  - 14 - 42. The Bank Group has supported TIB since its founding and has worked closely with TIB in developing its ability to be a key participant in Tanzania's industrial development. Under the previous three lines of credit, TIB has financed twenty six sub-projects including projects in leather tan- ning, textiles, garments, cement, plastics, glassware, soap, vehicle spares, aluminum, oilseeds, hotels, transportation, soft drinks, farming and marketing of navy beans and cashewnut processing. Eight of these sub-projects are in operation and only one project (navy beans) has operating problems; TIB is following this up closely. The first two lines of credit and about US$12 million of the third are committed. The sub-projects financed under the Bank Group's lines of credit are estimated to have an average economic rate of return of about 31% and upon completion will provide employment for almost 10,000 persons. TIB's Future Strategy 43. In formulating its investment strategy, TIB has been guided by the Third Five-Year Plan's investment priorities (para. 28). Over the medium- term TIB's strategy is: (a) to increase its share of financing public investments in the industrial sector from 20 to 25%, particularly by financing the types of projects recommended in the Basic Industrial Strategy; (b) to pay more attention to the operational problems of projects it assists and to make funds available for studies aimed at identifying and resolving technical problems of operating companies; (c) to help improve project implementation by parastatals; (d) to build up an adequate cadre of technical staff by recruit- ing and training engineers in different specialties; (e) to reduce portfolio arrears by improving debt-collections and communications with parastatals; (f) to mobilize resources from commercial sources abroad to meet its growing financial requirements. 44. We consider this strategy appropriate for TIB; it is consistent with the Government's development priorities, fits well into TIB's role in the Tanzanian economy and is within TIB's administrative capability. Projected Operations, Resource Requirements and Financial Results 45. TIB's level of lending is expected to increase by 6% in FY79 and 15% in FY80; thereafter, a constant level in nominal terms is assumed until FY83. TIB is expected to approve about TShs. 1.9 billion in loans and TShs. 10 million in equity investments in various subsectors from FY79 to FY83. Of the expected loan commitments of about TShs. 2.1 billion during  - 15 - this period, about TShs. 1.7 billion will be disbursed. These medium-term operational targets are withirL TIB's administrative capability and imply that it will finance about 25% of Tanzanian industrial investment. 46. TI:B's projected commitments in foreign currency from May 1979 through June 1981 are TShs. 703 million (US$84.7 million). To meet these requirements TIB will utilize TShs. 109 million presently available for commitment and it has been assured of additional foreign resources from bilateral sources equivalent to TShs. 110 million. This will leave a gap of TShs. 484 million (about US$58 million), of which it is proposed that the Bank would provide US$25 million and the EEC Special Action Account $15 million. TIB is making efforts to raise the remaining amount from its traditional sources and from commercial sources in Europe. TIB is also expected to face a local currency gap of TShs. 114 million. It anticipates obtaining adequate local funds from the Tanzanian Government or the Bank of Tanzania. 47. TIB's return on average net worth is expected to increase from 3.6% in 1978 to about 5.6% by 1983. This level of profitability would enable it to consider dividend payments to shareholders after 1981 when its retained earnings will exceed TShs. 100 million, the level which must be reached according to TIB's Charter before dividends can be declared. TIB is projected to hold its administrative expenses below 1% of its average total assets although its; financial expenses are expected to rise as TIB resorts to in- creased borrowing. The projected return on TIB's equity is rather modest owing to the large equity base. TIB's long-term debt to equity ratio of 0.4:1 in 1978 is expected to increase to 0.9:1 by 1983. Unless the Bank Group agrees otherwise, TIB's long-term debt to equity ratio would not exceed 3:1 (Section 4.06 of the draft Loan Agreement and Section 3.05 of the draft Special Action Project Agreement). Interest Rates 48. It: is TIB's policy to charge an interest rate which substantially reflects the cost of capital in Tanzania. Its policy statement has set this rate at a mLnimum of 10% per annum. The general aim of TIB's financial policy is, inter aLia, to maintain the value of its capital and to achieve a profit margin which would enable it to cover its administrative costs, build up adequate provisions and reserves and remunerate its share capital. Following these policy guidelines, TIB increased its lending rate three years ago to 11% for all its ordinary operations. Recently TIB has charged 12% on some of its loans to the private sector. TIB also charges a flat 1% commission on the loan amount and another 1% oni the undisbursed commitments. Furthermore, since TIB passes on the exchange r:Lsk on its foreign borrowings to the sub-borrowers, the effective rate on its loans is higher than 11%. Indeed with the current Balance of Payments difficulties forecast (see para. 11) this may add greatly to the effective interest rate. 49. TIB's rates are among the highest on medium- and long-term loans to productive sectors in Tanzania. Although the nominal rates were not positive in real terms during the last three years given Tanzania's inflation rate, they were considered by the Bank Group as acceptable because (i) they provided an adequate spread to IIB, (ii) the effective cost of capital to the ultimate 'borrowers  - 16 - (including the unquantified exchange risk) was the highest in Tanzania, (iii) other development banks in the country were charging comparable or often lower rates on medium/long-term loans, (iv) TIB passes on the foreign exchange risk to its borrowers, and (v) there were expectations of a decrease in the inflation rate in the future although the war with Uganda and recent oil price increases will delay this. Within the overall structure of interest rates in Tanzania, TIB's are adequate but this structure is expected to be a topic of discussion with the IMF and the Bank. The interest rate on all subprojects financed under the loan and Special Action Credit will be 11% (Section 2.10 of the draft Loan Agreement and Section 2.08 of the draft Special Action Project Agreement). Terms of the Loan and Special Action Credit 50. Procurement for the subprojects financed under the loan and the Special Action Credit would be in accordance with TIB's normal procedures, which have been reviewed and found acceptable. Disbursements under the Special Action Credit would be limited to expenditures in local currency or for goods and services supplied from the nine EEC countries or any developing country which is a member of the Association and potential recepients of a Special Action Credit (Section 2.01(b) of the draft Special Action Credit Agreement). The proposed loan and the proposed Special Action Credit would be disbursed against foreign exchange requirements, i.e. 100% of the foreign cost of imported goods and services, 60% of the local cost of goods previously imported and 40% of the costs of civil works (Section 2.02(b) of the draft Loan Agreement and Section 2.02(b) of the draft Special Action Credit Agree- ment). 51. The IBRD loan to TIB would be repaid according to a flexible amort- ization schedule conforming to the aggregate amortization schedules of TIB sub-loans, which have a maximum maturity of 15 years including adequate grace periods (Section 2.08(b) of the draft Loan Agreement). The Special Action Credit to the Government would be on standard IDA terms. It would be onlent to TIB under a subsidiary loan agreement between the Government and TIB on terms and conditions satisfactory to the Association (Section 3.01(b) of the draft Special Action Credit Agreement); these would include terms consistent with those of the IBRD loan (Section 2.08(a) and (b) of the draft Loan Agree- ment). Execution of this subsidiary loan Agreement will be a condition of effectiveness of the Special Action Credit (Section 5.01 of the draft Special Action Credit Agreement). 52. TIB will not require the Bank Group's prior approval of projects using less than US$1 million from the proposed loan or Special Action Credit but it will not be able to approve more than an aggregate of US$8 million equivalent through this procedure under the loan or more than an aggregate of US$5 million equivalent under the Special Action Credit (Section 2.02(c) of the draft Loan Agreement and Section 2.02(c) of the draft Special Action Credit Agreement). Under the last IBRD loan the individual project limit was US$800,000 and the aggregate limit was US$7 million; the proposed increases are in recognition of TIB's continuing improvement in appraisal work.  - 17 - Project JustiLfication and Risks 51. TIB is a well organized and competently managed institution which is making positive contributions to the economic development of Tanzania through the selection and financing of economically justified, financially viable and technically feasible projects. In the past few years, it has directed increasing attention to problems which have arisen in the industrial sector. In particular, it has increased its technical assistance to operating firms through seminars and increased follow-up work and assisted project preparation through the Technical Assistance Project. It has an appropriate medium-term strategy involving, among other things, increased lending to the productive sectors in accordance with the Basic Industrial Strategy. Further- more, it is helping improve the operational efficiency of parastatal enter- prises by its willingness to fund consultants to carry out efficiency studies and to provile training opportunities under the Technical Assistance Project. To meet its lending targets TIB will need foreign resources; the proposed loan and Special kction Credit wou:Ld help meet part of its foreign resource require- ments through June 1981. There are no major risks involved in lending to TIB. It is a mature and creditworthy development financing institution, having the support of the Government and a number of bilateral and multilateral financing institutions and performing a well-charted role within the framework of the country's development plan. The only risk is that it may not be able to mobilize in time all the foreign resources on acceptable terms necessary to meet its operational targets; this could somewhat reduce TIB's level of operation and projected profitability. In view of TIB's past performance in mobilizing resources, this risk is not viewed as excessive. PART V - LEGAL INSTRUMENTS AND AUTHORITY 52. The draft Loan Agreement between the Bank and the Tanzania Invest- ment Bank, the draft Guarantee Agreement between the United Republic of Tanzania and, the Bank, the draft Special Action Credit Agreement between the United Republic of Tanzania and the Association (acting as Administrator of the Special Action Account), the draft Special Action Project Agreement between the Association (acting as Administrator of the Special Action Account) and the Tanzania Investment Bank, the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement of the Bank and the recommendation of the Committee provided for in Article V Section 1(d) of the Articles of Agreement of the Association are being distributed to the Executive Directors separately. The draft agreements conform to the normal pattern for development finance company operations. 53. Special features of' the draft legal agreements are reflected in Part III of Annex III. As a condition of effectiveness of the Special Action Credit, the Government and TIB must enter into a subsidiary loan agreement satisfactory to the Association.  - 18 - 54. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and that the Special Action Credit would comply with the criteria established by the Agreement of May 2, 1978, between the Associa- tion and the European Economic Community. PART VI - RECOMMENDATION 55. I recommend that the Executive Directors approve the proposed loan and the proposed Special Action Credit. Robert S. McNamara President Attachments Washington, D.C. July 12, 1979  ANNEX I - 19- Page 1 TAJLE 3A TANZANIA -