Zambia - Second Development Bank Project

Document of The World BankhoB0% FOR OFFICIAL USE ONLY Report No. 3202-ZA ZAMBIA STAFF APPRAISAL REPORT OF A SECOND LINE OF CREDIT THE DEVELOPMENT BANK OF ZAMBIA (DBZ) October 20, 1980 Eastern Africa Projects Department Industrial Development and Finance Division 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 US$1 = K 0.80 K 1 = US$1.25 ABBREVIATIONS ADB - African Development Bank AFC - Agriculture Finance Corporation BOZ - Bank of Zambia DBZ - Development Bank of Zambia DEG - Deutsche Entwicklungsgesellschaft EEC - European Economic Community EIB - European Investment Bank GRZ - Government of the Republic of Zambia INDECO - Industrial Development Corporation IMF - International Monetary Fund MAWD - Ministry of Agriculture and Water Development NCCM - Nchanga Consolidated Copper Mines Ltd. NSCB - National Savings and Credit Bank PPD - Planning and Promotion Department RCM - Roan Consolidated Mines Ltd. RDC - Rural Development Corporation RUCOM - Rural Commercial Properties SIDC - Small Industries Development Corporation SSE - Small Scale Enterprises TNDP - Third National Development Plan (1979-1983) ZADB - Zambia Agriculture Development Bank ZIMCO - Zambia Industrial and Mining Corporation ZNBS - Zambia National Building Society ZNCB - Zambia National Commercial Bank ZNPF - Zambia National Provident Fund ZSIC - Zambia State Insurance Corporation FISCAL YEAR Government: January 1 - December 31 DBZ: April 1 - March 31  FOR OFFICIAL USE ONLY THE DEVELOPMENT BANK OF ZANBIA (DBZ) STAFF APPRAISAL REPORT Table of Contents Page No. BASIC DATA .*..................................................... i-iv I. THE ENVIRONMENT ........................... 1 -A. The Industrial Sector ........ . . ...... ........... ........ . . 1 Manufacturing ...... ............. ... ............ 1 Mining ................. * ...........-........ 3 Small-Scale Enterprises (SSEs) ............... 4 Government Industrial Objectives and Policies . 7 Bank Experience and Strategy in the Sector .... 8 B. Agriculture and ARro-Industry ...................... 9 Cr. The Financial Sector ...... . . . . . .............................. . 11 Financial Institutions ...... . .. ................ 11 Domestic Credit .... * ........ ............ ....... . 13 Inflation ...... .............................................. 13 Interest Rates ................ ................ 14 II. THE INSTITUTION . ............ .......... . . ................ 14 A. Institutional Aspects ...... . . . . . ........................ * .... 14 Background and Role .................... ....... 14 Ownership ............ . ..................... .* . 15 Board of Directors -* .. ......... o ............... . 15 Management . .... ....... ......... O--*........... 15 Organization and Staff ..** .................. - 16 Operating Policies . ............... ............ . 17 Interest Rates ................................... 17 Procedures ......... .......... ......... ......... .. 18 * Appraisal ................................ 18 Project Supervision ................... ... 18 * Procurement and Disbursement ............. 18 Strategy .. ... .. *. 18 Promotional Activities. 19 Auditors ........... .19 B. Operatigns.. ..... . ...... I .. .. . ..... 19 This report was prepared by Messrs. Philippe Beuzelin, Godfrey Tumusiime and Michel Cramer on the basis of their visit to Zambia in November 1979. r This documenl hu 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.  - ii - Page No. C. Financial Condition ......... .................... .. 21 Portfolio ................................ 21 Resources ......... .. . . ........ 22 Financial Position . .............. . . 22 Financial Results .................. ........... 22 D. Prospects *. . .......................... 23 Forecast Operations ........... 23 Resource Requirements ......... ..... .... 23 Projected Financial Condition and Performance . 24 III. THE PROJECT ....... .... o.....................sees................ 25 Ao Objectives o..o ............................... ....o... 25 B. Description of the Proposed Loan to DBZ ............ 25 Terms and Conditions ..o.. ..*.*. * * * * . ........ ....*.*.. 25 Project Cost Financing o....................... 26 C. Project Implementation *................ ........ 27 Reporting Requirements ..... ........... ....... 27 Procurement * . .*........... ..... -* .. . 27 Disbursements ... .see.... . .. .. *..... .. * ......... 27 D . Benefits and Risks ... - .................. 28 IV. AGREEMENTS TO BE REACHED AND RECOMMENDATIONS ...... 28  LIST OF ANNEXES Page No. 1. ZAMBIA - Interest Rate Structure .......... .. ............ 30 2. DBZ - Strategy Statement ................................ 31 3. DBZ - Analysis of Loan Approvals as of March 31, 1980 ... 33 4. DBZ - Summarized Balance Sheets (1974-1980) .... ......... 34 5. DBZ - Summarized Income Statements (1974-1980) .... ...... 35 6. DBZ - Project Pipeline as of November 15, 1979 .... ...... 36 7. DBZ - Actual and Projected Approvals, Commitments and Disbursements (1976-1984) .... ............... 38 8. DBZ - Assumptions for Financial Projections .... ......... 39 9. DBZ - Projected Balance Sheets (1981-1984) .... .......... 42 10. DBZ - Projected Income Statements (1981-1984) .... ....... 43 11. DBZ - Projected Cash Flow Statements (1981-1984) ........ 44 12. DBZ - Actual and Projected Financial Ratios (1975-1984) 45 13. DBZ - Estimated Disbursement Schedule .... ............... 46 14. DBZ - Selected Documents and Data Available in the Project File ............................. 47  U d  BASIC DATA On DEVELOPMENT BANK OF ZAMBIA (DBZ) (in K'000) Year of Establishment: 1973 Ownership: (As of March 31, 1980) Shareholders: Class A: The Government of the Republic of Zambia (through Ministry of Finance) 4,500 Bank of Zambia 500 Zambia National Provident Fund 500 National Commercial Bank Limited 200 Zambia National Building Society 150 Zambia State Insurance Corporation Ltd. 150 Total Authorized and Subscribed Class "A" 6,000 Class B: German Development Company (DEG) 1,500 European Investment Bank (EIB) 550 International Finance Corporation (IFC) 350 Group of Yugoslav Banks (eight) 300 Barclays Bank of Zambia Limited 400 Standard Bank Zambia Limited 200 African Development Bank 150 Grindlays Bank International (Z) Limited 100 Bank of America 100 Banca Nazionale del Lavoro 100 Bank of Tokyo and Five Other Banks 200 Den Norske Kreditbank 50 Total Authorized and Subscribed Class "B" 4,000 Total Authorized and Issued Shares, Class A and B 10,000 Class C: Bank of Zambia 4,425 Zambia State Insurance Corp. Ltd. 1,000 Other Unsubscribed Class C Shares 4,575 Total Authorized Class C Shares 10,000  - ii - Historical Operational Data (in K'000) (Year ending March 31) 1975 1976 1977 1978 0979 1980 Approvals 1/ Equity Investments - - 312 150 *90 250 Loans in Local Currency ) 600 6,234 4,447 3,940 5,753 9,633 Loans in Foreign Exchange 6,00 1,348 997 5,140 6,193 11,636 Total Approvals 6,600 7,582 5,756 9,230 12,036 21,519 Commitments Equity Investments - - 82 380 90 250 Loans in Local Currency ) 300 9,004 2,487 5,723 4,925 6,167 Loans in Foreign Exchange 4,00- 1,545 2,274 7,195 10,609 Total Commitments 4,300 9,004 4,114 8,377 12,210 17,026 Disbursements Equity Investments - - - 282 148 8 Loans in Local Currency ) 800 5,622 3,549 4,098 2,537 5,337 Loans in Foreign Exchange 3 - - 206 2,323 4,505 Total Disbursements 3,800 5,622 3,549 4,586 5,008 9,850 Operating Results (in K'000) (Year ending March 31) 1975 1976 1977 1978 1979 1980 Gross Income 398 800 1,292 1,659 2,100 3,106 Administrative Expenses 283 375 445 576 751 896 Financial Expenses 19 156 374 536 ...686 782 Profit 70 236 438 500 618 1,374 Profit/Average Net Worth (%) 1% 2.9% 4.5% 4.8% 5,5% 9.1% Financial Position (in K'000) (Year ending March 31) 1975 1976 1977 1978 1979 1980 Total Assets 7,154 13,253 17,270 18,409 21,-879 2/ 28,214 2/ Net Worth 7,016 9,252 10,240 10,741 11,909 2/ 18,243 2/ Term Debt/Equity 0.01 0.4 0.7 0.7 0.8 0.5 1/ Net of cancellations. 2/ Excluding Special Funds.  - iii - Interest Rates and Other Charges (per annum) Interest Rates: 12.5% Commitment Charge: 3% on foreign currency loans and 2% on Kwacha loans on signing of contract and on the undisbursed amount on the anniversary of contract signing. Foreign Exchange Risk: DBZ passes on to its borrowers the foreign exchange risk on loans denominated in foreign currencies. Resource Position (in K'000 as of March 31, 1980) Resources Local Resources Foreign Resources Total Share Capital (paid-in) 15,425 - 15,425 Reserves and Retained Earnings 2,818 2,818 Long-Term Borrowings 2,675 16,632 19,307 Total Resources 20,918 16,632 37,550 Uses Net Fixed Assets 1,607 - 1,607 Loans and Equity Investments Outstanding 19,196 6,111 25,307 Undisbursed Loan and Equity Commitments 8,527 11,922 20,449 Total Uses 29,330 18,033. 47,363 Resources Available for Disbursements (8,412) (1,401) (9,813) f  - iv - Basic Data on Bank Loan 1210-ZA A. Status of Loan Million US dollars Status as of September 5, 1980 Rate Date of of Amount Out- Board Interest Amorti- of Com- Dis- stand- Approval Signature Effectiveness to DBZ zation Loan mitted bursed ing 2/10/76 2/18/76 4/23/76 8.5 18 years 15.0 14.5 9.3 6.9 1/ B. Summary of Special Features of Loan (a) Foreign exchange risk: Is passed on by DBZ to its borrowers (b) Closing date for subproject submission: 9/30/80 Closing date for loan disbursements 9/30/81 (c) Free limit for individual subprojects ($ 000) $250 (d) Aggregate free limit ($ 000) $3,000 Basic Data on IFC Investment Approved on February 10, 1976 Held and paid by IFC as of May 2, 1980: K350,000 Par value per share: K10,000 Market price per share: Not listed Membership of Board: One 2/ 1/ As of April 14, 1980 2/ IFC and the African Development Bank (ADB) have a one-year rotation arrangement for representation on DBZ-s Board.  ZAMBIA THE DEVELOPMENT BANK OF ZAMBIA (DBZ) STAFF APPRAISAL REPORT I. THE ENVIRONMENT A. The Industrial Sector Manufacturing 1/ 1.01 Background. Until independence in 1964, Zambia's manufacturing sector was constrained by the competition of imports from South Africa and Southern Rhodesia and contributed less than 7% to GDP. In the decade fol- lowing independence, the sector showed a rapid and steady growth, facil- itated by high protection from imports, availability of foreign resource surpluses from copper exports for covering imports of manufacturing equip- ment and supplies, and the high degree of urbanization due to a modern mining sector. Between 1965-1974, manufacturing value-added at constant prices grew at an average rate of 10% p.a., about five times faster than the rest of the economy. In more recent years, however, value-added at constant prices has declined, mostly due to external constraints (para. 1.10). 1.02 Contribution to the Economy. For an African country, Zambia has a large manufacturing sector 2/ which, in 1978, was estimated to contribute K 394 million or 17% to the country's GDP, and employ 50,000 people or 14% of total formal employment. However, activities in the sector have tended to concentrate on the final stages of consumer good production requiring large imported inputs, and contribute only 1% to Zambia's exports. This concentra- tion may be attributed to: (i) a rather strong currency supported by copper exports, which disadvantaged manufactured exports; and, (ii) low or zero duties on intermediate goods, which advantaged manufactures with higher import contents. In recognition of this problem, the Government now plans to give priority to manufactures based on local resources through its import licens- ing (para. 1.30). 1.03 With a value-added per employee of US$10,600 p.a., labor produc- tivity in manufacturing is rather high compared to other African countries, and about six times higher than in the rest of Zambia's labor force. On the other hand, the sector has a relatively high capital-intensity, and in its 1/ Does not include mining which is dealt with separately. 2/ By the share of national GDP, it was the fourth largest in 1977 among African countries, after the Republic of South Africa, Egypt and Zimbabwe.  - 2 - large public subsector net fixed assets per employee reached US$22,500 in 1979. The Government is concerned about this high capital-intensity and recently started to take corrective measures, including: (i) increasing tariffs on capital goods from 7.5 to 10%; and, (ii) a tax exemption of K 500 per year for three years, for each job created by existing enterprises. 1.04 Structure. In 1978, the formal manufacturing sector was estimated to comprise 722 establishments including a rather high proportion (45%) of larger firms having more than 50 employees. The sector - particularly larger firms - showed a high and persistent concentration around the line-of-rail and Lusaka, due to poor infrastructure facilities and a low disposable income in rural areas. In 1977, the Copperbelt Province and the Central Province (in- cluding Lusaka) each accounted for 40% of manufacturing employment, and the other six provinces together for only 20%. With a view to contain the high migration towards cities, however, the Government recently gave priority status to rural enterprises (para. 1.26) and further granted them an income tax rate of 30%, lower than the norm of 48%, during their first five years of operations. 1.05 In 1978, the manufacturing sector's value-added mostly came from: beverages and tobacco (31%), rubber and chemicals (17%), metal-products and machinery (16%), textiles (12%), and food (11%); with the fastest growth at constant prices since 1970 in textiles (12% p.a. on average) and rubber and chemicals (5.5% p.a.). Due to a shortage of qualified Zambians, expatriates still held about one-third of managerial positions and accounted for 5.7% of manufacturing employment. 1.06 To accelerate investments and reduce foreign control after indepen- dence, the Government has gradually expanded its ownership in manufacturing during 1968-1975, with an emphasis on large-scale, technically advanced manufacturing. In 1977, Government-controlled enterprises accounted for 45% of manufacturing employment and more than half of manufacturing value-added. 1.07 INDECO. INDECO, a large holding company grouping all Government equity participations in manufacturing, is wholly owned by the Zambia Indus- trial and Mining Corporation (ZIMCO), an apex holding company for parastatals placed under the Ministry of Finance. INDECO has large autonomy in conducting its activities but refers major investment and pricing decisions to the ZIMCO Board chaired by the President of the Republic. In principle, INDECO's role is to accelerate through ownership control the implementation of Government policies in the manufacturing sector, such as Zambianization, employment gen- eration, economic diversification and rural development. In 1979, INDECO had 31 subsidiary companies and employed 24,800 people. Its subsidiaries produce all the sugar, beer, fertilizer and cement, and most of the maize/wheat food, cotton products and edible oil in the country. 1.08 Although INDECO is intended to operate on a profitable basis, it has suffered from: (i) difficulties in retaining competent staff because of Gov- ernment salary limitations; (ii) excessive debt-financing of fixed investments;  and, (iii) Government price control on a few basic consumer goods. As a result, consolidated profit has been low since 1975 and, in FY79, INDECO made a loss amounting to 2% of total assets; its ratio of long and short-term' debt to equity reached 5:1. To correct this situation, the Government accepted major increases in controlled prices (except for maize/wheat meal) in 1979. Furthermore, it intends in the future to set these prices at levels allowing INDECO to finance its expansion and plans to consolidate INDECO-s equity basis, although it lacks the necessary resources at present. 1.09 Role of Private Enterprises. The private manufacturing sector is still important with 55% of manufacturing employment. Private firms are gen- erally smaller, more labor-intensive, more concentrated in the Copperbelt and Lusaka, and using more expatriate staff. Private entrepreneurs had firs t-been apprehensive, following Government 1968 pronouncements for state control of industry and INDECO's subsequent expansion. In more recent years, howeveK, the Government has clearly recognized the useful role of private enterprise, particularly in rural and small-scale industries, as reflected in the Indus- trial Development Act and the policy objectives of its Third Plan (paras. 1.26 and 1.28). Entrepreneurs appear to have regained confidence and showed increas- ing initiative in the last 2-3 years. This resulted in particular in a swift increase in the proportion of private investments proposed to DBZ for loan financing (para. 2.23). 1.10 Constraints and Prospects. The major weakness of the manufacturing sector is its high dependence on imported supplies and raw materials, com- pounded by the long distances from sea-ports to landlocked Zambia. The sector was thus particularly affected by: (i) the severe restrictions on imports of industrial supplies following the sharp fall in copper prices in 1974; and, (ii) the closure of the Rhodesian border in 1973, and subsequent transport rerouting through the congested port of Dar es Salaam. As a result, manufacturing value-added at constant prices fell at an average rate of 8% p.a. during the three years 1975-1977. Since then, however, increased efforts have been made to expand the capacity of alternative trading routes while progress was being made towards a Zimbabwe settlement, and copper prices have increased substantially (para. 1.15). 1.11 Now that these constraints are being relieved, prospects for'a mod- erate recovery of the manufacturing sector appear reasonably good, particu-, larly considering: (i) the high growth rate achieved in 1965-74 (para. 1.01); and, (ii) Zambia's large untapped resources in mineral deposits, arable land and forests. In 1978, manufacturing value-added was estimated to have in- creased again by 6%. Mining 1.12 Contribution to the Economy and Structure. During the period 1964 to 1974, the mining sector and especially copper accounted for an average of 35% of Zambia's GDP, 45% of Government revenue and 95% of export earnings. Although the sector's overall contribution to the economy~-declined after the  - 4 - 40% fall in world copper prices, mining retained a dominant place in the economy through the 1970's. In recent years it still accounted for about 15% of total GDP and over 90% of Zambia's exports. Apart from copper which is by far the most important product accounting for over 90% of the sector's export value, Zambia produces significant quantities of cobalt (20,000 metric tons In 1978), lead (12,000 tons), zinc (40,100 tons) for export and coal (677,300 tons) for local consumption; and is prospecting for uranium in the southern province. 1.13 Most of Zambia's mining operations are located in the "copperbelt" area in the north-central part of the country bordering Zaire. Mining oper- ations are dominated by two major companies, Nchanga Consolidated Copper Mines Ltd. (NCCM) and Roan Consolidated Mines Ltd. (RCM). The Zambian Govern- ment, through its parastatal holding company - Zambia Industrial and Mining Corporation (ZIMCO) has, since 1970, held 51% of the shares in each company, the other major shareholders being the Anglo-American Corporation and Roan Selection Trust. 1.14 Constraints and Prospects. In recent years, copper production has stagnated and remained constantly below the peak of 748,000 tons achieved in 1969. This has been due to several factors, the most important being a lack of sufficient self-generated funds for new investment programs, a growing shortage of skilled mine workers due to a high turnover of expatriate personnel (resulting from a deterioration in benefits and incentives offered by mining companies), and increasing difficulties in mining the ore from underground deposits from which as much as 70% of Zambia's copper is obtained. Copper sales of 582,000 tons in 1978 were not only lower than the year's production of 657,000 tons but also declined 13% below the 670,000 sales volume achieved in 1977. 1.15 In addition to the above production difficulties, the decline in the value of copper sales followed from: (i) slow recovery in copper prices on the world market, leading to scarcity of foreign exchange. In 1976, copper prices were K 800/ton as compared to K 1950/ton in 1974. Recently, however, prices have significantly improved to an average of K 1900/ton during 1979; (ii) transportation bottlenecks on the country's export routes. As a result of a breakdown in external routes especially during the second half of 1978, Zambia accumulated large stocks of copper and failed to take advantage of firmer prices. 1.16 Prospects for the mining industry for the future appear sound in view of forecast increases in world copper prices (Bank projections in con- stant US dollars are US$2,300/ton in 1980, US$2,700/ton in 1982 and US$3,890/ ton in 1985), and greater possibilities of Zambia finding access to adequate export routes following expected improvements in the Zimbabwe situation. Small-Scale Enterprises (SSEs) 1.17 Structure of the Sector. The structure and extent of SSE activity in Zambia as a whole is not fully known as no comprehensive study of that sec- tor has been undertaken. Data gathered in the few brief SSE surveys conducted  -5- in the last five years are extremely sketchy and unreliable. However, a recent Bank review of the sector indicates that there are three broad categories of SSE in Zambia. First, there are about 300 small enterprises 1/ servicing the mining industry particularly in the Copperbelt. The majority of these firms, initially set up by expatriate technicians and now increasingly being bought by Zambian entrepreneurs, carry out repairs of mining equipment and produce a wide range of essential mining goods such as ducting for air vents, steel balls, steel welded pipes, etc. They vary in size from small, specialized workshops employing about 25 people to establishments with up to 100 workers. Capital investment in these firms ranges from K 50,000 to about K 200,000. 1.18 Beyond these, there are about 1500 small enterprises engaged in retail trade or in the production of miscellaneous goods - window frames, carts, furniture, clothing, jewelry and providing various services such as printing, catering, etc. These activities are dominant in the major urban centers particularly along the line of rail and are largely owned and man- aged by Asian enterpreneurs. Most of these firms have capital investments of K 25,000 to K 100,000 and employ 5 to 25 workers each. The proportion of African owned enterprises in this category has increased in recent years but is still low - probably no more than 20%. 1.19 The third category comprises an estimated 10,000 much smaller retail operations and artisan industries in the rural areas. These are exclusively owned by Africans and range from very small one-man or family establishments engaged in retail trade, bicycle and radio repairs and production of handi- crafts, utensils, etc. using basic hand tools to some sizeable retail shops and workshops producing furniture, tinware, clothing, etc. using power tools and some machinery. Capital investment in these small artisanal activities is usually no more than K 10,000. 1.20 Needs of SSEs. The development of SSEs in Zambia has been con- strained by two major problems: lack of institutional support and lack of adequate raw material supplies and spares. At present there is no institu- tion at the national level responsible for planning and promoting SSEs. Rural Commercial Properties Ltd. (RUCOM) - established in 1961 to promote the development of small industries in rural areas by providing premises and technical assistance to rural entrepreneurs no longer assists SSIs. When the Government in 1976 issued directives to all parastatal enterprises to be more profit oriented and less reliant on Government subsidies, RUCOM underwent a total re-orientation of its previous policies and changed from a subsidized p,romotional institution to a purely commercial operation. About 10 initially successful rural industries that RUCOM had helped set up eventually col- lapsed largely due to lack of continued technical and managerial support. 1/ Defined as enterprises with the following features: (i) the entrepreneur is an owner/manager who fulfills most management functions in running the business without employing specialized managerial staff; (ii) employ- ment of 5 to 100 workers; and (iii) total capital invested in the enter- prise does not exceed K 200,000.  -6- 1.21 Another institution, the Village Industries Service (VIS), set up in April 1978, promotes simple, labor-intensive rural industries with the view of providing work for school leavers, and thus preventing rural-urban migration. VIS is not a state organization and is funded with voluntary contributions. Because of lack of resources (initial budget of K 500,000) its scope and effectiveness are limited. So far VIS has operations in only one province. 1.22 Although Zambia has a variety of financial institutions, none is committed to providing working capital finance and term credit particularly to small Zambian entrepreneurs. The Industrial Finance Corporation established in 1969 partly to fill this gap went into liquidation in 1977, due to mis- management and financial difficulties. The only assistance of any magnitude to small businesses has been by Barclays Bank, through its Zambian Development Loans Scheme (ZAMDEV) introduced in 1974. As of December 1977, Barclays had approved 798 loans for a total of K 1.7 million. Performance under the scheme was disappointing. About 18% of the amount lent out was lost in bad debts. The main reasons for the failure of the scheme were: (i) poor entre- preneur selection by Barclay's local branch managers who lent out money indiscriminately without adequate inquiry into the suitability of the borrowers; (ii) the maximum loan amount of K5,000 was too small and was often used up before the enterprises became fully operational; and (iii) profit margins of most borrowers (retail traders) were very small - no more than 3% as prices of their commodities were controlled. 1.23 The second major problem confronting SSEs has been a shortage of adequate raw materials and spares due to: (a) lack of or inadequate produc- tion in Zambia of essential raw materials and spares hence the need to import supplies; (b) failure or delays in obtaining foreign exchange allocations and import licenses; and (c) transport bottlenecks particularly in rural areas. 1.24 Policy Framework. The Government has recognized the need for a con- sistent policy on small-scale industry (SSI) development - now designated as one of the priority objectives in the Third National Development Plan (TNDP). To facilitate SSI development particularly in rural areas, the Government has proposed the establishment of a Small Industries Development Corporation (SIDC) that will provide consultancy, financial, procurement and marketing services to small entrepreneurs. In its present form, however, with a Managing Director, two Controllers, six General Managers and nine branch managers, the proposed SIDC appears too large and complex an organization in relation to the stage of development and size of the SSI sector about which little is known at the moment. 1.25 Prospects. The designation of small rural industry promotion as a priority objective in the TNDP is a significant step towards SSE development in Zambia. Nevertheless, prospects for a successful SSE development program on a national scale appear weak at the moment due to various constraints (para. 1.23) that seem unlikely to be alleviated in the near future. In the short term, SSE development efforts would be more appropriate and effective on a selective, pilot level, that would eventually be used as a basis for a wider program. During the preparation of this project discussions were held with the Government and DBZ to envisage such a pilot SSE component to be included  - 7 - in the line of credit to DBZ. However, the Government was not prepared to assume the foreign exchange risk on IBRD funds that would have been allocated for SSE assistance. Hopefully these initial discussions will pave the way for future IBRD assistance to SSEs in Zambia. DBZ is planning to set up a special unit to identify, appraise and monitor loans to SSEs (Strategy State- ment: Annex 2). Government Industrial Objectives and Policies 1.26 The Third National Development Plan. One of the Government's main objectives as defined in the TNDP is to reduce the economy-s dependence on the copper mining sector and to promote the development of manufacturing. The strategy essentially aims to promote import substitution and export devel- opment by establishing industries making maximum use of domestic raw materials, linked with each other, with agriculture and with the mining industry (back- ward and forwards linkages). It also gives priority to the establishment of small industries particularly in the rural areas; to the fullest utilization of existing industrial capacities and to a more even geographical distribution of manufacturing activities in the country. 1.27 On the basis of these objectives, a number of priority industries for public or private investments have been selected for emphasis during the Plan period (1979-1983). These include agro-industries such as maize milling, edible oils, sugar, stockfeed, meat processing, fruit and vegetable processing, leather goods; products of copper and brass, fertilizers, sulphuric acid, mining equipment, agricultural tools and implements, cement, ceramics and prefabricated building elements. These sensible policies may be difficult to implement because they imply basic changes in the structure of the indus- trial sector (para. 1.04). 1.28 The Industrial Development Act. The Act, drafted in conjunction with the TNDP, was enacted in October 1977, well before launching the Plan in 1979. It spells out the intentions of the Government with regard to private investment by both local entrepreneurs and overseas investors. Its main objectives are to encourage investment in the country, from all sources but mainly by the private sector, by providing incentives to enterprises considered priority on the basis of the objectives of the TNDP for the sector (para. 1.26). These incentives include preferential import license allocation, rebates from duties, relief from taxes and the possibility to set off training expenditures against income taxes. Furthermore, the Act authorizes foreign investors to remit dividends and profit and assures them fair treatment in case of nationalization. 1.29 The Act also regulates the granting of manufacturing licenses for setting up new or expanding existing enterprises. An Industrial Investment Committee, consisting of the Permanent Secretaries of all major ministries, advises the Minister responsible for industry on individual applications. The Act has one shortcoming, namely that the incentives are stipulated in rather vague wording, and that their granting depends not only on the Ministry of Industry, Commerce and Foreign Trade but also on the Ministry of Finance, whilst the rules for co-operation between the two ministries in this respect have not been clearly spelled out. So far, the impact of the Act on industrial investment has not been very significant in part due to the weakness mentioned above and also to the general economic conditions of the country.  1.30 Import Licensing and Foreign Exchange Allocation. The import control system, introduced in February 1978, is designed to allocate scarce foreign exchange according to priorities defined in accordance with the TNDP by the Import Licensing Committee attached to the Ministry of Industry, Commerce and Foreign Trade. On the basis of the forecasts of the Bank of Zambia regarding the prospective available resources of foreign exchange, import licenses are granted to cover six-month needs of enterprises. However, an import license does not guarantee foreign exchange as the Bank of Zambia allocates these resources on the basis of their availability. 1.31 Prices. Prices in the economy are controlled by the Government, mainly as an anti-inflationary device. The controls are implemented either directly, via administrative mechanisms or indirectly via the pricing policies of Government controlled firms which compete with the private sector. The result is that few prices acurately reflect demand and supply conditions. Recent moves by Government suggest an awareness of these pricing problems. Expansion of the scope of ZIMCO's powers over price setting was a first step. ZIMCO has subsequently circulated instructions to its subsidiary companies that prices should be established at levels which more accurately reflect costs of production and which will allow, eventually, a ten percent financial return on net assets. The Government's acceptance of an ILO's recommendation to establish a Prices and Incomes Committee (PIC) to implement economic pricing is also significant. However, implementation of economic pricing will depend significantly on how economic prices are defined and on the extent to which sufficient expertise and administrative capacity will be made available to calculate and revise prices in a timely fashion. Bank Experience and Strategy in the Sector 1.32 The World Bank assistance to the industrial sector has been mainly through DBZ which has received a Bank loan (No. 1210-ZA) of US$15 million and in which IFC made an investment of about US$544,000 (No. 324-ZA). In addition, IFC has made three investments in the following manufacturing firms in Zambia: Century Packages, Bata Shoe Company and Nchanga Consolidated Copper Mines. 1.33 To assist DBZ's clients that were experiencing difficulties in obtaining imported raw material and spare parts because of the country's lack of foreign exchange, the Bank agreed, on an emergency basis, that some of its first loan to DBZ be used to finance such items (para. 2.27). 1.34 The major new emphasis in industrialization strategy proposed in the Third National Development Plan (TNDP) is to reduce the economy's dependence on the copper mining sector and to promote industries making maximum use of domestic raw materials. It also gives priority to the establishment of small industries, particularly in the rural areas and to the fullest utilization of existing industrial capacities. The policy measures proposed to implement the strategy will take effect only gradually, because of the present structure of the Zambian industry and existing macroeconomic constraints. However, they deserve the Bank's support and the proposed loan to DBZ will contribute to their implementation.  - 9- B. Agriculture and Agro-Industry 1.35 Agriculture. The agricultural sector in Zambia is markedly dual- istic. On the one hand, there is a relatively small modern sector of about 800'heavily-capitalized farmers (mainly, but steadily decreasing, of European origin) contributing about half of marketed production and a small number of state farms and ranches, mainly under the Rural Development Corporation (RDC), a parastatal. On the other hand, there are about 600,000 farm families on land held under traditional tenure, the majority of whom cultivate less than 2 ha using hand- or ox-cultivation and are oriented towards subsistence production. This extreme dualism has been modified In recent years by two developments. Firstly, a number of medium-scale Zambian farmers ("emergent farmers"), mainly along the line of rail, have developed mechanized farms geared to the commercial market. Secondly, an increasing number of small farmers, particularly in the Southern, Central and Eastern Provinces have begun to produce crop surpluses for market. 1.36 Although agriculture provides a livelihood for about 60% of Zambia's population, it accounted for only 16% of GNP in 1978. In real terms, agricul- tural output has grown only at an average annual rate of 3% over the period 1970-78, somewhat less than the rate of population growth, and since 1976 overall agricultural production has stagnated. The development of agricul- tural exports has historically been very limited. Tobacco and confectionary groundnuts are the only regular exports, but they account for less than 1% of total exports. In some years of surplus production, limited quantities of maize have been exported to neighboring countries. Imports of agricultural commodities have shown an increasing trend during the 1970's, reaching K 48 milllon (about 9% of total imports) in 1978. The major items imported have been vegetable oils and oilseed cakes (32% of 1978 agricultural imports), cereals (22%), and dairy products (9%). 1.37 Agriculture Development Objectives and Strategy. The Government of the Republic of Zambia (GRZ) has, in its statements of development objectives, consistently given priority to rural development in general and to increased agricultural production in particular, emphasizing the achievement of higher levels of self-sufficiency in staple foods, the provision of raw materials for domestic agro-processing industries, the exploitation of export potential where this exists, and hence an increase in rural incomes and levels of living and a reduction in the high urban-rural disparity. 1.38 The priority accorded to agriculture and rural development has been reflected, particularly in recent years, in the proportion of the GRZ develop- ment budget allocated to agriculture which, after declining from 20% in 1970 to only 11% in 1974, has since risen to over 30% in 1978 and 1979. The re- sources have been invested in parastatal production enterprises (which have proved to be inefficient) and in a number of highly subsidized smallholder development schemes (mainly involving resettlement) which have benefitted a few farmers at a high cost and which have produced only small returns in terms of increased production. GRZ now fully recognizes the importance of improving the efficiency and output of the smallholder sub-sector, and is according priority to investment in much broader-based regional agricultural and rural development projects, of which the Eastern Province Agricultural Development  - 10 - Project to be financed by IDA is the first. Similar projects are currently being prepared, for external donor financing, in the Southern, Western, North-Western and Northern Provinces of Zambia. 1.39 The agricultural sector has not, however, been allocated recurrent budgetary resources commensurate with its stated importance. The Ministry of Agriculture and Water Development (MAWD) receives only about 3% of the recur- rent GRZ budget to finance its support services to the agricultural sector. These allocations have during the 1970's failed to keep pace with inflation. Furthermore, an increasing proportion of these funds have been earmarked for salaries, and the sums available to meet other operating costs have become increasingly less adequate to enable MAWD staff to perform their duties effec- tively. In the context of its current review of the sector, the Bank intends to assist GRZ to rationalize its overall allocation of recurrent budgetary resources. 1.40 Agro-Industry. Agro-industry plays a significant role in the Zambian manufacturing sector where it accounts for 38% of value added and 33% of employment. There are 147 agro-industrial establishments, i.e. 20% of all the total number of enterprises in the formal manufacturing sector. 1.41 Main Characteristics. The subsector is largely controlled by para- statal companies under INDECO, in dairy, beer, sugar, tea, coffee, ricde, animal feed, oilseed crushing, and cashew processing. The private sector plays a more important role in the processing of fruit, fish, maize, cattle, pigs and poultry, confectionary and bakery products. As most manufacturing activities, agro-industrial enterprises are heavily concentrated along the line-of-rail in the Central, Copper Belt and Southern Provinces although raw material supplies are found in various parts of the country (para. 1.04). 1.42 Furthermore, agro-industrial production is often concentrated in a limited number of large factories. For instance, dairy processing and sugar manufacturing are each centered in one large plant; animal feed processing, cotton ginning, oilseed crushing and cattle slaughtering capacity are centered in two or three large plants. There are however small-scale operations pri- marily in rice milling, bakery products, pig slaughtering, confectionary products, beverages, grain milling and brewing. 1.43 At present, very little of Zambia's agro-industry is export oriented: tobacco, maize, confectionary groundnuts. As mentioned earlier, some agro- industrial activities depend on imports of raw materials for their operations. Furthermore, other agro-industrial potential remains unexploited while. the country-s needs are met by imports: vegetable oil, soybean meal, wheat, rice, coffee, fruit juices, honey, yeast for animal feed, bags for maize, vegetable seeds. 1.44 Constraints and Opportunities. One of the main constraints to the development of agro-industry is the difficulty in starting new operations off the line-of-rail while raw materials come from outlying areas and products from line-of-rail operations need to be distributed in these areas as well. This results from difficulties in finding good management and skilled labor outside the line-of-rail and also from the lack of adequate transportation and communications facilities within outlying areas and between outlying regions and the line-of-rail.  - 11 - 1.45 Another major problem affecting the growth of agro-industry is the insufficient volume of production of agricultural products for processing although the potential exists. As a result, some agro-industrial activities depend upon imports for their critical raw material requirements, especially dairy and animal feed processing. 1.46 Opportunities exist in the following activities: vegetable oil pro- duction from maize germ and soya beans, fodder yeast and alcohol production from molasses, fruit and vegetable processing, fish processing, freezing and distribution, kenaf fiber production and processing, cashewnut production and processing. C. The Financial Sector Financial Institutions 1.47 Zambia has a fairly well developed financial system which, in addi- tion to the Central Bank, includes four commercial banks, and six specialized financial institutions. The latter have played a major role ii meeting a sizeable proportion of the country's total domestic demand for credit as their combined financial assets equal about 40% of the total assets of commercial banks. 1.48 The Bank of Zambia (BOZ). The Central Bank regulates commercial banks and establishes and administers national monetary and credit policies through the use of the discount rate, reserve requirements and direct controls such as ceiling on lending rates. BOZ also manages Zambia's international reserves and is in charge of the country-s foreign exchange control system, which it administers in cooperation with the commercial banks. 1.49 The Commercial Banks. There are four commercial banks with 100 branches throughout the country. The state-owned Zambia National Commercial Bank (ZNCB), established in 1969, handles the bulk of commercial banking busi- ness of parastatal organizations and other Government agencies. Its assets exceeded K 320 million as of September 30, 1979. The three private banks are subsidiaries of Barclays, Standard and Grindlays. As of September 30, 1979, Barclays had assets of over K 410 million, Standard K 390 million and Grindlays K 104 million. The commercial banks play an important role in mobilizing deposits from the public through their large network of branches. As of September 30, 1979, total commercial bank deposits amounted to over K 685 million of which both Barclays and Standard held 33% each, ZNCB 27% and Grindlays 7%. 1.50 The commercial banks provide short- and medium-term (up to 5 years) credit, leaving long-term credit to specialized institutions. During 1978, about 30% of commercial bank lending went to agriculture; 25% to manufacturing; and 20% to commerce. Mining, transport and construction each received about 5%. About 60% of lending by the private commercial banks goes to the private sector. The bulk of ZNCB lending is directed to the public sector and parastatal organizations. Lending to the private sector accounts for only about 20% of its loan portfolio.  - 12 - 1.51 Specialized Institutions. The five specialized institutions other than DBZ are: the Zambia National Provident Fund (ZNPF), the Zambia State Insurance Corporation (ZSIC), the Zambia National Building Society (ZNBS), the Agriculture Finance Company (AFC) and the National Savings and Credit Bank (NSCB). They fall under the control of the Zambia Industrial and Mining Corporation (ZIMCO) -- the apex holding company for all state-controlled enterprises. Three of these specialized institutions - ZNPF, ZSIC and ZNBS - hold shares in DBZ. 1.52 Zambia National Provident Fund (ZNPF) is a Government-owned body which administers a mandatory retirement savings scheme for non-civil service Zambian employees. The funds are subsequently channelled into productive investments mainly through credit to the public sector. As of December 31, 1978, the Fund held members contributions of K 208 million of which K 99.5 million were invested in direct loans to the Government, Government stock and treasury bills. Lending to parastatals and local Government authorities and municipalities amounted to K 100 million during 1978. ZNPF has no appraisal capacity and has shown interest in financing large projects jointly with DBZ. It has made two loans to DBZ amounting to K1.8 million at an interest rate of 7-1/2% p.a. 1.53 Zambia State Insurance Corporation (ZSIC) was formed in 1971 after the merger of all existing insurance companies. As of December 31, 1978 the Corporation-s resources totalled K 127 million of which about 80% were invested in Government bonds, loans (including mortgages) and in various industrial and commercial investments. In 1976, ZSIC set up a revolving fund of K 3.3 million for loan investments in agriculture. At the end of 1978, 90 farmers had been granted loans from the fund. The scheme has not been successful mainly because of a very low recovery rate (40% of the payments due). 1.54 Zambia National Building Society (ZNBS) was formed after the national- ization of three private societies in 1971. It obtains funds through savings shares and deposits from the general public and institutions. As of March 30, 1979 its resources totalled K 112 million, of which 83% were invested in mort- gage loans mainly for residential properties. ZNBS has lent K 70,000 to DBZ at an interest of 8-1/2% for 14 years. 1.55 Agriculture Finance Company (AFC) was established in 1970 as a sub- sidiary of the Rural Development Corporation, a parastatal holding company under the Ministry of Rural Development. Since its formation, AFC has lent about K 100 million, 70% of which has been for seasonal loans. The remainder of its loan portfolio consisted of medium-term agriculture financing and real estate loans, the latter for the purchase of farms. AFC charges an interest rate of 9% on most of its loans. AFC has had various problems including a very high rate of default on its loans. As of December 31, 1978 about K 31 million of the K 100 million lent out since 1970 was overdue. It is expected that AFC will be liquidated soon. 1.56 In April 1979, Parliament passed an Act establishing the Zambia Agriculture Development Bank (ZADB). This new institution is expected to take over the activities of AFC but will operate under a new charter and management.  - 13 - ZADB will have an authorized capital of K 75 million and will provide finan- cing for agricultural and fishing projects. The Government has not spelled out the relationship between ZADB and DBZ with regard to financing agriculture. There are indications, however, that the two institutions would be expected to play complementary roles in promoting agricultural development. 1.57 National Savings and Credit Bank (NSCB), known as the Post Office Savings Bank until 1973, is the most widespread financial institution in Zambia with over 150 agencies. The bank caters for the smallest saver especially in the rural areas where no other banking facilities exist. NSCB pays 4.25% on deposits. At the end of 1978, its total assets amounted to K 25 million, half of which constituted long-term loans to the Government and parastatals. The remainder was held in form of deposits with the Building Society and Zambia National Commercial Bank. 1.58 Overall, the structure of Zambia's financial sector is adequate. Except for their lack of commitment to assisting SSEs, the various financial institutions have played an important role in mobilizing savings and allo- cating resources. While the institutions have well defined primary roles, most operate freely with substantial flexibility, particularly with regard to medium and long term lending. Domestic Credit 1.59 Domestic credit in Zambia over the last two years has been signifi- cantly affected by the stand-by arrangement agreed between the IMF and the Zambian Government in March 1978. This arrangement, which expired on April 25, 1980 was designed to support a comprehensive stabilization program of which the main objectives were to diminish gradually the overall balance of pay- ments deficit, reduce inflationary pressures, ensure resumption of economic growth, and set the basis for the diversification of the economy through a more efficient allocation of resources. A tight monetary policy, adopted in 1978 and so far strictly adhered to, aims at restricting deficit financing of the Government budget and commercial bank lending. 1.60 Performance under the stabilization program has been satisfactory. Inflation tapered off (para. 1.61) and the financial position of the Government showed a considerable improvement, with the overall deficit financing declining from the equivalent of 11% of GDP in 1977 to 3% in 1979. Total commercial bank lending which had increased by 40% in 1976/77 declined by 49% to K 438.9 million in 1978 while lending to the Government decreased 73.2% during 1978. During 1979 and much of 1980, the liquidity of commercial banks increased due to lack of outlets for surplus funds. Inflation 1.61 During the years 1976, 1977 and 1978 inflation rates in Zambia were respectively 19%, 20% and 17% p.a. The high rates of inflation in these years resulted from several factors including rapid expansion of domestic credit, the depreciation of the Kwacha by 20% in 1976 and 10% in 1978, and increases in direct taxation and a reduction in consumer subsidies. As a result of the stabilization program (para. 1.59) the rate of inflation  - 14 - declined to 11% in 1979. Bank projections Indicate that, if the restrictive monetary and credit controls are maintained, Inflation will be about 12% during 1981 and 1982 and decline to about 10% in 1983. Interest Rates 1.62 The present structure of interest rates In Zambia, presented in Annex 1, is part of the IMF Stand-by Agreement with Zambia and has been in effect since May 1, 1978. Commercial bank lending Interest rates range from 9.5% for seasonal agricultural loans to 11% paid by most borrowers; while their deposit rates vary from 4-1/2% on short-term deposits to 9% on long-term deposits of three years and above. ZNBS pays Interest rates varying from 4% to 9% on deposits depending on their term and charges 12% on its mortgage loans for commercial and industrial properties and 9% for housing. ZNPF's loans whose maturities range from 10 to 20 years carry interest rates between 8% and 12%. Up to March 31, 1980, DBZ charged 11-1/2% to 12% p.a. on long-term funds, plus a 1.5% commitment fee on all loans at commitment dates and undis- bursed balances at anniversary dates. Recently its Board approved an increase in DBZ's interest rates to 12.5% and an increase in commitment fees to 3% on foreign currency loans and 2% on Kwacha loans at commitment dates and on undisbursed balances at anniversary dates. These increases, effective on April 1, 1980, will improve DBZ's forecast financial performance. DBZ also passes on to its borrowers the foreign exchange risk on the foreign currency component of their loans. There is no interest rate differentiation on the basis of size of borrowers. The maximum lending rate for all financial Institutions (apart from DBZ) is 12%. 1.63 The prevailing interest rates appear appropriate as far as DBZ's foreign exchange lending is concerned but may be on the low side for Kwacha loans given the inflation rate estimated at 12% in 1980. The possibility of raising interest rates was discussed during the mission. Both the Ministry of Finance and the Bank of Zambia, however, consider existing rates adequate for resource allocation and, in light of future inflation expectations, see no need for increasing interest rates. The lending institutions have felt no need for higher rates as the existing structure has enabled them to maintain sufficient margins on their loan portfolios. This is further discussed in paragraphs 2.12 and 2.13. II. THE INSTITUTION A. Institutional Aspects Background and Role 2.01 The Development Bank of Zambia, established as a statutory corpora- tion by an Act of Parliament in 1972, started operations in 1974. Its main objectives are to provide medium and long-term loans and equity financing for projects in industry, agro-industry, engineering, construction, transport, power, tourism, mining and large-scale agriculture. DBZ is also authorized to  - 15 - provide technical assistance and advisory services and to administer Special Funds (para. 2.11). Within its first six years of operations, DBZ has become the major source of term financing for productive investments inZambia and, despite the country's economic difficulties, it has remained a sound institution. Furthermore, a significant Government participation in its share capital has not prevented DBZ from maintaining a large degree of autonomy in its investment decisions and the management of its operations. 2.02 The World Bank Group assisted the Government in establishing DBZ by participating in a study that led to its creation and by granting a US$15 million loan to DBZ in 1975 (paras 2.24-2.27). Furthermore, the International Finance Corporation (IFC) was instrumental in attracting foreign shareholders and made an equity investment in the institution (para. 2.03). Ownership 2.03 Initially DBZ had an authorized share capital of KIO million con- sisting of 600 "Class A" shares and 400 "Class B" shares of K10,000 each. In April 1979, Parliament authorized DBZ to increase its share capital by issuing a new class of non-voting preference interest bearing shares, desig- nated "Class C" shares. DBZ's Board of Directors has put a ceiling of K1O million on these shares. The "Class A" shares are reserved for the Government and its agencies and the "Class B" shares are reserved for private local and international institutions while there are no limitations on the "Class C" shares. The list of DBZ's shareholders is presented in the Basic Data at the beginning of the report. As of September 15, 1980, DBZ's paid-in share capital amounted to K15.4 million of which K350,000 had been subscribed by the IFC (1.75% of total authorized share capital). Board of Directors 2.04 DBZ's Board consists of ten members, one of whom is the Managing Director of the institution. The Government appoints six Directors, inicluding the Chairman while the "Class B" shareholders appoint four Directors. The Government has appointed the Permanent Secretary of the Ministry of Finance and Technical Cooperation, DBZ's Managing Director, the Special Assistant to the President on Economic Affairs, the Governor of the Bank of Zambia, the Director of the Zambia National Provident Fund and a private businessman. The "Class B" shareholders have appointed only three representatives: IFC-s Regional Representative for Eastern Africa 1/, the General Manager of Barclays Bank of Zambia Ltd, and a manager of DEG. Board members do not have alternates. The Board which meets four times a year approves all loans and investments that DBZ makes. Overall, DBZ's Board has played its role in an acceptable manner. Management 2.05 DBZ's present Managing Director joined the institution .in 1977 as General Manager and took over his present position toward the middle of 1978. Previously he had been Managing Director of the Zambia National Commercial 1/ IFC and ADB have a one-year rotation arrangement for representation on DBZ's Board.  - 16 - Bank and has also occupied a managerial position at the Central Bank. The General Manager is an expatriate who has been recruited recently. This position had not been officially filled since mid-1978 but an expatriate manager who had been several years with DBZ de facto acted as General Manager until his departure from DBZ in April 1979. 2.06 In contrast to the situation which prevailed when DBZ was appraised for a first loan in 1975, most managerial positions at DBZ are now occupied by Zambians. Although they are still learning their managerial functions, the results obtained so far are quite satisfactory. DBZ's management is competent. Organization and Staff A 2.07 DBZ s organization structure comprises eight departments responsible respectively for planning and promotion, industrial projects, agricultural projects, project supervision, finance, legal, personnel, secretarial and administration. The structure is well designed and quite suited to DBZ's work and objectives. 2.08 DBZ presently employs a total staff of 95 persons of whom 8 are in managerial, 29 in professional and 58 in secretarial and general services position. Two of the managers and 7 of the professionals are expatriates. To pursue the expansion of its operations, DBZ intends to recruit 3 additional Zambian professionals. In addition 7 expatriates provided under bilateral assistance from Germany, Canada, Britain and the European Economic Community have been recuited and are expected to join DBZ soon. They include a chief Economist and Training Coordinator, a Senior Agricultural Economist, the Finance Manager, a Senior Engineer and two Senior Projects Officers. When the new recruits join DBZ, its managerial staff will total 10, of whom 3 expatriates, and the professional staff will total 34 of whom 14 expatriates. This staffing is adequate for the level of operations expected during the next 2 to 3 years. 2.09 The Zambian staff is dedicated but still generally inexperienced. DBZ has made efforts to develop its staff by sending for training abroad the most promising members. It also had some in-house seminars on topics related to its activities. However, this needs to be improved and systematized. One of the main tasks of the newly recruited Training Coordinator will be to design and implement a comprehensive and sustained training program. In terms of specializations, the number of staff is well balanced among the various disciplines required, although there is a certain weakness regarding the engineering function which will be remedied when the two expatriate engineers join DBZ. 2.10 A major problem affecting DBZ had been its salary structure which was in accordance with the regulations designed to limit the salaries of parastatal employees. The structure was inadequate as it did not properly differentiate between the levels of responsibility and was out of line with the salaries paid by other financial institutions. This had affected nega- tively staff morale, caused DBZ to lose one of its most qualified Zambian staff and was not conducive to attracting experienced Zambians. Recently  - 17 - however, DBZ obtained its board and Government's approval for a general salary increase, ranging from 20% to 50% effective as of June 1980. The new salary structure is considered adequate at least for the next two years. Operating Policies 2.11 DBZ's operating policies are defined by its Establishment Act of 1972, and a Policy Statement adopted by its Board in 1975 after consultation with the Bank. They were satisfactory, subject to two qualifications: (i) The policy statement placed no limit on DBZ's exposure in any individual project. It has been agreed that DBZ will not normally finance more than 75% of any single project's total capital costs including permanent working capital. Exceptions to this rule would be determined by the particular nature and merits of a project. DBZ's policy statement has been amended accordingly. (ii) the Act allows DBZ, apart from its normal business, to administer any Special Fund creating "no charge or lien upon DBZ's funds". DBZ has two Special funds under bilateral grants: K3.8 million for small low-interest loans to high-risk Zambian- owned rural projects, and K650,000 for consulting services in project preparation. Special Funds could in principle allow DBZ to engage in many activities outside the scope of its agreed Policy Statement with the risk of complicating administra- tion and diverting staff capabilities. DBZ has therefore agreed to include in its policy statement, a provision, acceptable to the Bank, specifying the conditions under which new Special Funds will be administered (para 4.02 (c) (l). Interest Rates 2.12 In March 1980, DBZ's Board increased DBZ's maximum interest rate and commitment fees, in order to improve DBZ's profitability (para. 1.62). DBZ now charges interest rates of 12.5% on all loans 1/; plus a "commitment" fee of 3% on foreign currency loans and of 2% on kwacha loans at commitment dates and on undisbursed portions at anniversary dates. By comparison, the Bank estimates local price inflation at 12% p.a. in 1981-82 and at about 10% in 1983, and international inflation at 9.5% in 1980 and 7.6% in 1981-85. Thus regarding loans whose repayment obligation is expressed in foreign currency - including subloans financed under the proposed line of credit - DBZ's interest rates will be positive in real terms, since DBZ passes on the foreign exchange risk to its borrowers. 1/ DBZ can, at its discretion, charge 11.5% on agricultural loans.  - 18 - 2.13 Regarding loans in local currency, DBZ's current interest rates would appear marginally positive in real terms but current inflation projec- tions for Zambia are particularly uncertain at this time. DBZ has agreed to review annually its interest rate structure and to take all measures necessary to maintain positive interest rates in real terms. Procedures 2.14 Appraisal. DBZ's project appraisal is adequate. After manage- ment's clearance of a project brief, detailed appraisal is undertaken, and the appraisal report is reviewed before Board presentation by a Loan Committee grouping department heads and management. DBZ uses check-lists for data collection and has just issued in consultation with the Bank an improved appraisal manual for its staff. Earlier deficiencies in the appraisal of project management and technical aspects have been gradually corrected with the building-up of DBZ's staff experience and technical capabilities. Some recent appraisals lacked a calculation of the economic rate of return. DBZ has agreed in principle to make this calculation for all its project financing above K200,000. 2.15 Project Supervision. DBZ had focussed on project appraisal in its early years, and started developing its project supervision only recently. It began to generalize supervision visits in 1977, created a separate Super- vision Department in 1978, and sent its first reporting form to clients in 1979. First efforts have been rightly directed to those projects plagued with serious arrears or management problems. There has been lack of emphasis on supervision planning and on preventive supervision techniques. In order to formalize and improve its system of supervision procedures, DBZ has recently prepared a comprehensive supervision plan and procedure manual which have been reviewed by the Bank and found to be satisfactory. 2.16 Procurement and disbursement procedures are appropriate. DBZ asks its private enterprise clients to obtain quotations from at least three suppliers among whom one is selected in consultation with DBZ. DBZ-s client public enterprises broadly follow the Government Central Tender and Supply Board's procurement procedures and these normally satisfy DBZ's requirements. For supplies of goods not exceeding $1.25 million only local bidding, widely advertised in the local press is required. For procurements above $1.25 million, however, public enterprises normally advertise invitations to bid in Zambian papers and among various embassies/trade missions resident in Zambia. The latter, in turn notify potential suppliers in their respective countries. In all cases, a minimum of three quotations is required for each procurement. For the INDECO group of companies, the ultimate supplier is selected by a centralized procurement committee; for other public enterprises, suppliers are selected by individual enterprises. DBZ makes disbursements against evidence of payment, invoice, or architect certificate for local construction. Strategy 2.17 DBZ strategy for coming years is defined in a statement, presented as Annex 2. This statement which is in line with the TNDP specifies that: (1) DBZ will concentrate its project financing in a few key sectors and subsectors such as agriculture, agro-industry, transport and engineering industry; (2) within these priority sectors and subsectors, DBZ will put  - 19 - the emphasis on projects which utilize mainly local raw materials and develop linkages within the manufacturing sector and with agriculture and the mining industry; (3) DBZ will give priority to export oriented enterprises and to projects that are likely to contribute significantly to employment creation and will, to the extent possible, assist its clients in selecting technologies that are labor intensive; and (4) DBZ will create a special unit to identify, appraise and monitor loans to small-scale entrepreneurs. DBZ's pipeline of projects is consistent with its strategy. The strategy statement which was discussed with DBZ management, was reviewed and formally agreed upon during negotiations and has been approved by DBZ-s Board of Directors. Promotional Activities 2.18 DBZ's promotional activities are carried out by the Planning and Promotion Department (PPD) which is presently staffed with one manager and four professionals. The approach mostly used by PPD is to find project ideas and prepare investment opportunity studies for those that seem to be promising. Such studies were conducted for a steel re-rolling mill, collapsable tubes and the manufacture of zinc oxide in Zambia. A Planning and Promotion Committee has been created under PPD to review prefeasibility studies and the terms of reference of feasibility studies and to decide whether the studies should be submitted for financing under the Special Fund for Technical Assistance which PPD manages. The Special Fund for Technical Assistance has received bilateral funding of K650,000 equivalent from Norway, Germany, and Sweden. Until now four project feasibility studies (pork processing, ceramic, wooden furniture) have been commissioned. DBZ-s promotional effort is satisfactory and con- sistent with the institution's strategy. Auditors 2.19 DBZ has appointed Coopers and Lybrand as its auditors. Their reports are comprehensive and adequate. B. Operations 2.20 DBZ's operations as of March 31, 1980 are summarized in Annex 3. DBZ's loan approvals averaged about K7 million/year in the period 1975/78 before growing rapidly to over K10 million during FY79 and FY80. In real terms, they grew at a low average rate of about 6% due to extensive economic and financial crises that have prevailed in Zambia over this period. While DBZ's commitments have kept pace with approvals, its loan disbursements have lagged behind because of long delays in its project implementation. As of March 31, 1980 undisbursed commitments amounted to K20.4 million. 2.21 Slow disbursements result from delays in finalizing collateral arrangements, from difficulties in obtaining clients' contributions and from shortages of working capital financing. DBZ has taken measures to resolve these problems. A Legal Department has now been created to pursue and finalize security arrangements before project approval and to expedite pending legal matters. In addition, DBZ now requires its clients to: (i) deposit their contribution in a blocked account; and, (ii) obtain commercial bank assurances for financing of working capital requirements before the project is approved. As a result, the disbursement rate has substantially increased since the beginning of FY81. DBZ expects that about 80% of present undisbursed commitments would be disbursed by November 1980.  - 20 - 2.22 As of March 31, 1980 DBZ had approved a total of 139 loans for K57.0 million and also had equity investments of K439,500 in seven companies. The total investment cost of projects approved by DBZ exceeded K310 million. Most of the loans, 79 in number but only 16% in value were for amounts less than K250,000. While large loans over Kl million were only 12% of the total number, they accounted for 49% of loan approvals by amount. The average loan size was K410,000. About 54% of the loan amount carried an interest rate of 11% and above. Over 95% of the loans by both number and amount had maturities between 5 and 12 years. DBZ operations are spread over a variety of sectors, with manufacturing accounting for 65% of loan amounts, agriculture and forestry 20%, distribution 4%, tourism 3%, transportation and mining each 3%. 2.23 Of the 139 loans, 52 were for new projects, 67 and 8 respectively for expansion and modernization of existing projects. In terms of location, DBZ's projects, like other industrial, commercial and agricultural activities in Zambia, are concentrated along the line of rail. Over 75% of DBZ's invest- ments by number (80% by amount) were in Lusaka, the Copperbelt and southern provinces. The economic rate of return of DBZ financed projects varied between an estimated 6% on an INDECO project and 50% on several projects. The average rate of return was at a satisfactory 28%. The average investment cost per job for new projects was about US$26,298, which compares favorably with the overall average of US$28,600 for other dfcs in Eastern Africa. A large proportion (57%) of DBZ's loans (by amount) went to the private sector. The proportion of DBZ's approvals for the private sector increased significantly in FY80 when it reached 76% of total approvals. 2.24 The First World Bank Loan To DBZ. The first Bank loan to DBZ, of US$15 million, took much longer to commit than was expected at appraisal, as DBZ's approvals increased at a slow annual rate of 10% p.a. versus a projected rate of 25% p.a. The discrepancy was essentially due to the economic situation in Zambia. The loan has now been almost entirely committed and is about 60% disbursed. 2.25 DBZ used the Bank loan to finance 40 projects in the following five sectors: % of total Number of financing projects (amount) Manufacturing 21 62 Agriculture 15 25 Transportation 2 9 Distribution 1 3 Tourism 1 1 TOTAL 40 100 A large proportion of projects financed under the first loan were for the creation of enterprises (61% in value), followed by expansion (34%) and modernization (5%). These projects had a total investment cost of K26.4 million and created about 1,200 jobs at a cost of US$28,500, which is close  - 21 - to the average in the Eastern Africa Region. The cost per job on World Bank-financed project was somewhat higher than the average cost per job for the total portfolio (para. 2.23). This was due to fact that DBZ submitted for financing the larger projects which were also somewhat more capital- intensive. 2.26 In general, the projects submitted to Bank financing were well conceived and worthwhile supporting. Their economic rate of return ranged from 11% (farming) to 45% (packaging) and the average rate was at a satisfac- tory 27%. It is expected that, when the projects are fully in operation the annual value of their output will be about K40 million and that they will contribute to net annual foreign exchange savings of about K9 million. 2.27 To alleviate the needs of DBZ's priority clients that were facing the danger of serious financial difficulties because they were unable to obtain foreign exchange from the Bank of Zambia to import raw materials and spare parts, IBRD agreed to finance, on an emergency basis, part of their requirements. This financing was limited to assisting the enterprises to increase their capacity utilization at cash break-even level plus a 10% margin. A total of US$2.1 million has been lent for that purpose. The possiblity of including in the proposed-second loan a compnent for financing working capital had also been considered in detail. Since end-1979 however, the availability of foreign exchange for working capital has improved, follow- ing the copper price increase and a national effort in foreign resources mobilization. In a March 1980 survey, DBZ found that all the enterprises importing raw materials in its portfolio were operating profitably. The proposed component was thus cancelled at DBZ s request. C. Financial Condition 2.28 Portfolio. As of March 31, 1980, DBZ held a portfolio of K21.5 million, with 98% in loans and 2% in equity investments. The share of the portfolio in subsidiaries of INDECO was 47%, but should decrease rapidly given the lower proportion of Government projects in recent approvals and in the pipeline (para. 2.23). 2.29 The loan portfolio is of acceptable quality, but it has suffered from: (i) national economic difficulties; (ii) DBZ-s limited project super- vision (para. 2.15); and (iii) earlier deficiencies in DBZ's project appraisal (para. 2.14). As of August 3, 1980, loan arrears of more than three months totalled K 449,431 and affected 22 projects. The arrears affected portfolio accounted for 15% of total outstanding portfolio. Eighty percent of these arrears were due to two larger state projects: (i) a producer of ballast and limestone found to lack critical equipment after project appraisal, and expected to resume repayments in 1982; and, (ii) a battery producer which just had its faulty machinery replaced by suppliers, and should resume rapid repayments by end-1980. Both companies have encountered implementation delays beyond their control, possibly justifying loan rescheduling. Other arrears come mostly from small farms with inexperienced management, for which legal action is being taken.  - 22 - 2.30 With the projected supervision efforts (para. 2.15) and appropriate loan reschedulings, the rate of arrears is expected to improve rapidly. Losses on loans are very unlikely because DBZ has kept a high security coverage, most often exceeding 200% of the loans, and subject to a standard minimum of 125%. Thus DBZ's auditors have advised to make no specific provisions for losses on loans aside from its general reserve (para. 2.32), which is justified. DBZ's recent equity portfolio seems to have low prospects for rapid dividends, but it is too small (K 439,500) to affect DBZ's overall profitability. 2.31 Resources. As of March 31, 1980, DBZ had mobilized long-term resources totalling: (i) K 20.9 million in local currency including K 12.8 million in its A and B shares and reserves, K 2.7 million in loans at 6-8% interest mostly from ZNPF and Government, and non-voting preference "C" shares subscribed in 1979 by Bank of Zambia for K 4.4 million at 7% interest and by ZNIC for K 1 million at 8.5%; and, (ii) K 16.6 million equivalent in foreign currency consisting of loans committed by ADB in 1973 (K 1.9 million at 6%), IBRD in 1976 (K 12.1 million at 8.5%), and EIB in 1978 (K 2.6 million at 5.45%). At that date DBZ's resources' position (Basic Data, page iii) showed gaps of K 8.4 million in local currency and of K 1.4 million in foreign currency. This position had resulted from an unexpected reduction in Bank of Zambia's proposed C share subscription (K 10 million) and the sudden accelera- tion in DBZ's operations in 1979 and 1980. As a result of a strong resource mobilization effort, DBZ's resource situation has improved. ZNPF has agreed to invest K 1.5 million in Class 'C shares. Local commercial banks have committed themselves to taking up DBZ-s promissory notes for a total of K 11 million. These promissory notes which will be guaranteed by the Government will be issued as need for the funds arises. 2.32 Financial Position. DBZ's financial statements and ratios for FY74-80 are presented in Annexes 4, 5 and 12. DBZ's total assets have increased at an average rate of 27% per year since FY74 to K 29 million in FY80. DBZ has constantly kept a strong financial position, mostly due to its large equity funding and sound financial management. According to the audited accounts of March 31, 1980, DBZ had a low long-term debt to equity ratio of 0.5:1 and a high debt service coverage ratio of 3.6:1, indicating a large potential for further borrowings. Its liquidity position was satisfactory with a current ratio of 3.3:1. Although losses on the portfolio are unlikely (para. 2.30), DBZ had built-up its non-distributable legal reserve to March 31, 1980 K 823,000, which represented 3.8% of portfolio. Audited accounts as of March 31, 1980 show a strong financial position (Annex 5). 2.33 Financial Results. DBZ-s profit is exempt from tax by its Act and has been increasing rapidly to reach K 1.37 million in FY80. However, the return on equity (7.5%) was only moderate when compared to current local in- flation. This moderate return resulted mostly from: (i) DBZ's low leverage; (ii) the present lag in DBZ-s disbursements (para. 2.21); and, (iii) a modest average spread of 3% between its portfolio income and its costs of debt. As a percentage of total assets however, DBZ's gross income in FY80 was 12.4% and its profit was 5.5%, which is acceptable and DBZ management has proposed a K 466,000 dividend.  - 23 D. Prospects Forecast Operations 2.34 DBZ's project pipeline is presented as Annex 6. It includes forty- nine projects: 25 in manufacturing, 19 in agriculture, 2 in tourism, 2 in transport, 1 in public utilities. Within agriculture and manufacturing, the projects are well diversified: mixed farming, dairy farms, ranching, crop cultivation, fishing, pharmaceuticals, plastics, chemicals, milling, plastic containers, textiles. The total investment cost of these projects is expected to amount to about K 65 million (US$81.2 million) of which K 36 million (or 55%) for local purchases and K 29 million (45%) for imported materials. DBZ expects to provide total financing of K 33 million, i.e., about 51% of total project costs, of which K 12 million for local purchases (36% of total DBZ financing) and K 21 million for imported materials (64% of total DBZ financing). 2.35 In agriculture, individual project cost is expected to vary between K 65,000 and K 2.5 million, the average project cost being K 664,000, while in manufacturing, average project cost will amount to K 1.8 million. DBZ's average size of loans will be K 451,000 in agriculture and K 815,000 in manufacturing. However, about 41% of all loans will be less than K 350,000. The majority of projects to be financed are privately owned: 86% of the number of projects and 64% of DBZ-s total project financing. 2.36 DBZ-s forecast of approvals, commitments and disbursements is presented in Annex 7. Approvals are projected to increase in current terms from K 21.9 million in FY81 to K 37.6 million in FY84, i.e. at an average annual rate of 20% in current terms. In real terms the growth is likely to be about half that rate. Such expected growth is reasonable considering DBZ-s large project pipeline and the evolution of its activities in FY79 and FY80. Resource Requirements 2.37 DBZ-s commitments during the period March 31, 1980 - March 31, 1982 are expected to amount to K 25.3 million in foreign exchange and K 16.8 million in local currency. Furthermore, at the end of 1980 DBZ had a shortage of funds for commitments totalling K 8.4 million in local currency and K 1.4 million in foreign currency. 2.38 DBZ-s resource needs over the period can be expected to evolve as follows (in K -000):  - 24 - March 31, 1980 - March 31, 1982 (K 000) Resource Needs Local Foreign Total Expected commitments during the period: * Loans 16,493 25,047 41,540 * Equity investments 300 300 600 Sub-total 16,793 25,347 42,140 Resource gap for undisbursed commitments at 3/31/80 8,412 1,401 9,813 TOTAL 25,205 26,748 51,953 Sources of Funds Internal cash generation during the period 9,000 - 9,000 Resources to be obtained: * Zambia National Commercial Bank 1,205 - 1,205 * Zambia State Insurance Corporation 2,000 - 2,000 * Zambia National Provident Fund 3,000 - 3,000 * Barclays Bank of Zambia 5,000 - 5,000 Standard Bank (Z) Ltd. 5,000 - 5,000 * DEG - 2,542 2,542 * African Development Bank 8,206 8,206 * IBRD - 12,000 12,000 TOTAL 25,205 22,748 47,953 Resource Gap - (4,000) (4,000) 2.39 DBZ's total resource requirements during the period are expected to amount to K 51.9 million (US$64.9 million) of which K 26.7 million (US$33.4 million) in foreign exchange. A World Bank loan of US$15.0 million would represent 23% of DBZ-s total resource needs during the period and about 45% of its foreign exchange requirements. DBZ has mobilized adequate local resources to finance its opeations. The K 4.0 million foreign currency gap is expected to be covered by borrowing from the European Investment Bank (EIB). Negotia- tions for the second EIB Loan are expected to take place in April 1981. Projected Financial Condition and Performance 2.40 The forecasts of DBZ's financial results for the period 1981 and the assumptions underlying them are shown in Annexes 8 through 12. DBZ's earnings are expected to grow steadily as a result of a loan portfolio expan- sion. Loan income is projected to increase from 12.0% to 12.5% of average total assets over the forecast period. As DBZ increases borrowings, its  - 25 - financial expenses as a percentage of average total assets increase from 3.1% in FY80 to 6.7% in FY84. Administrative expenses do not exceed 2.9% of average total assets throughout the four-year period. In spite of a small spread on its loan portfolio, DBZ's profitability is projected to increase as a result of a higher level of operations (para. 2.36) expected improvements in the volume of disbursements (para. 2.21) and a higher leverage of debt/equity (para. 2.41). Profit as a percentage of average equity increases from 8.5% in FY81 to 14.6% in FY84. 2.41 DBZ's long-term to debt-equity ratio which was around 0.5:1 in FY80 is projected to increase to 2.7:1 by FY84 due to a large increase in borrow- ings but little change in the equity base. This will be below the ceiling of 4:1 agreed with IBRD under the first loan and to be maintained (para. 3.03(f)). DBZ's debt service coverage remains very satisfactory throughout the period improving from 3.6 times in FY80 to 5 in FY84. In view of its high security coverage on most loans (para. 2.30) DBZ has made no provisions against specific doubtful debts; however it does have a general provision for losses. III. THE PROJECT A. Objectives 3.01 The main objective of the proposed project would be to assist in the development of the industrial, agro-industrial and agricultural sectors in Zambia, by providing resources for the expansion of existing enterprises and the creation of new ventures in these sectors. In line with the objec- tives of the Third National Development Plan, the emphasis will be on assisting enterprises that are priority either because they contribute significantly to employment creation or because they use mostly local raw materials and are likely to be foreign exchange savers. In addition, by continuing a close working relationship with DBZ, the Bank will contribute to strengthening the institution. B. Description of the Proposed Loan to DBZ 3.02 The proposed US$15 million Bank Loan to DBZ would finance the foreign exchange component of the fixed capital investment of medium and large-scale subprojects approved by DBZ in the industrial, agro-industrial, and agricultural sectors. This would represent about 23% of DBZ's projected resource needs to finance these sectors during the period March 1980 to March 1982 (end of the fiscal year), and about 45% of its foreign exchange needs during the period. 3.03 Terms and Conditions. The proposed second line of credit to DBZ would carry the following terms and conditions:  - 26 - (a) Onlending Rate by DBZ and Foreign Exchange Risk. DBZ will onlend to subborrowers at a minimum of 12%. This rate will be reviewed periodically in light of prevailing inflation to ensure that it remains positive in real terms. DBZ will pass on the foreign exchange risk to all subborrowers. (b) Free Limit. Under the first line of credit to DBZ the free limit was US$250,000 and the aggregate free limit US$3 million. In recognition of the quality of DBZ's appraisals the free limit will be raised to US$400,000 and the aggregate free limit to US$5 million. This will still permit the Bank to review about 60% of projects financed by the Bank loan, which is adequate. (c) Amortization Schedule. The proposed loan to DBZ would have a flexible amortization schedule conforming to the aggregate amortization schedules of DBZ's subloans, none of which should, in principle, exceed a maximum period of 15 years. (d) Commitment Fees. As a change from the first IBRD loan for which DBZ had concessionary treatment, standard commitment fees would be charged on the proposed loan. (e) Guarantee Fee on the World Bank Loan. It is now Government, policy to charge a 2% commission on loans it guarantees for parastatals. Considering that DBZ's spread of 3% is already low, the Government has agreed to waive the guarantee fee. (f) Debt/Equity Ratio. As under the first Bank loan the ceiling would be retained at 4:1. 3.04 Project Cost Financing. The total cost of projects that DBZ is likely to finance from March 31, 1980 to March 31, 1982 is expected to total about K 77.7 million. DBZ's contribution to these projects would amount to K 51.9 million of which the foreign exchange component is estimated at K 26.7 million. 3.05 DBZ's financing plan for the period March 1980 to March 1982 is as follows:  - 27 - Financing Plan March 1980 - March 1982 (K million) Local Foreign Total Total commitments 16.8 25.3 4-2.1 Resources available for commitments as of 11/15/79 (8.4) 1.4 (9.8) Total resource needs 25.2 26.7 51.9 To be financed by: Local currency Cash generation 9.0 - 9.0 Borrowings from local institutions 16.2 - 16.2 Foreign exchange DEG - 2.5 2.5 African Development Bank - 8.2 8.2 European Investment Bank 1/ - 4.0 4.0 World Bank - 12.0 12.0 Total 25.2 26.7 51.9 The Bank would, therefore, provide about 45% of DBZ's foreign exchange require- ments and about 23% of its total resource requirements between March 1980 and March 1982. C. Project Implementation 3.06 Reporting Requirements. As under the first line of credit DBZ would be required to submit quarterly reports which would include financial state- ments, resource position, statement of arrears and notes on subprojects encountering serious operational difficulties. DBZ will also continue to submit audited annual accounts prepared by qualified accountants along with DBZ's annual report. 3.07 Procurement. Procurement for the subprojects refinanced under the loan will be in accordance with DBZ's procurement practices (para.'-2.16). 3.08 Disbursements. The proceeds of the proposed line of credit would be disbursed on DBZ's subloans as follows: 1/ The EIB loan, which has not yet been appraised, is projected to be only partly committed by March 1982.  - 28 - (a) 100% of the c.i.f. cost of imported goods or services into Zambia; (b) 75% of the local cost of goods previously imported into Zambia through normal trade channels; (c) 60% of the local cost of equipment produced in Zambia substantially from previously imported components or raw materials; (d) 40% of the cost in local currency of construction works included in subprojects. 3.09 The loan is expected to be fully disbursed by June 30, 1987. D. Benefits and Risks 3.10 By providing foreign exchange resources that are in critically short supply in Zambia the project will assist in maintaining and expanding the productive capacity of the country in manufacturing, in agro-industry and in agriculture. Of particular importance-will be the development of agricultural and agro-industrial firms that will help the country toward self-sufficiency In food production. The proposed loan will directly contribute to total investments of about US$48 million and create about 1,800 new jobs at an estimated average cost of about US$27,000 per job while under the previous line of credit, the average cost per job created was US$28,500. This results from DBZ's increasing activities in labor-intensive enterprises. Furthermore, the project will assist in strengthening DBZ as an institution. 3.11 The risks associated with the project are mainly related to the general economic conditions of the country. A deepening of the economic crisis could result into a considerable slowdown of investments in the sectors concerned by the project; in which case commitments and disbursements under the loan and credit could be considerably delayed. IV. AGREEMENTS REACHED AT NEGOTIATIONS 4.01 This report recommends a Bank loan of US$15 million on the terms and conditions specified in para. 3.03. 4.02 During negotiations, agreements were reached on the following: (a) With Government and DBZ, that DBZ will onlend to subborrowers at a minimum of 12%. This rate will be reviewed periodically to keep it positive in real terms. DBZ's subborrowers will assume the full foreign exchange risk.  - 29 - (b) With Government that: (i) it will exempt DBZ from the 2% guarantee fee on the Bank loan (para. 3.03(e)). (c) With DBZ, that: (i) it shall, no later than January 31, 1981 include in its Policy Statement, a provision acceptable to the Bank, specifying the condition under which it will administer new Special Funds (para. 2.11(ii); (ii) appraisal reports of projects for which DBZ's financing will exceed K 200,000 will include the calculation of an economic rate of return (para. 2.14); (iii) it will implement a comprehensive supervision plan (para. 2.15).  - 30 - ANNEX 1 INTEREST RATES STRUCTURE IN ZAMBIA (Effective May 1, 1978) 1. BANK OF ZAMBIA % p.a. (i) Bank Rate 6.50 (ii) Treasury Bill Rate (Maximum) 3.50 tq 4.50 2. COMMERCIAL BANKS - DEPOSIT RATES (Minimum) (i) Savings Accounts 7.00 (ii) Short Term Deposits: Up to 15 days 4.50 10 - 45 days %4.75 46 - 90 days 6.00 91 - 180 days 6.00 (iii) Long Term Fixed Deposits: 6 - 9 months 7.00 9 - 12 months 7.50 12 - 24 months 8.25 24 - 36 months 8.75 36 months and above 9.00 3. COMMERCIAL BANKS - LENDING RATES (Minimum) (i) Overdrafts Agricultural sector 9.50 Manufacturing sector 10.00 (ii) Bill Finance Drawers' Bills (up to 120 days) covering exports 9.50 Drawers' Bills (more than 120 days) 10.00 Drawers- Bills (covering imports) 10.00 4. BUILDING SOCIETY (i) Deposit Rates (Minimum) Savings shares 4.00 Investment shares 6.50 Deposits up to 60 months 8.25 (ii) Mortgage Rates (Minimum) Residential, private 7.50 Commercial and industrial 9.00 5. MAXIMUM LENDING RATE: 12.00 EAPID September 1980  - 31 - ANNEX 2 THE DEVELOPMENT BANK OF ZAMBIA STRATEGY STATEMENT The following principles will serve as a guide for DBZ's activities, during coming years. They constitute DBZ's strategy to provide maximum assistance to the economic development of Zambia and supplement DBZ's general objec- tives as expressed in its Statutes and Operations Policies. After its approval by the Board of Directors, this strategy will be widely publicized within the institution so that staff are fully aware of it and become fully committed to its implementation. It will be reviewed from time to time in the light of developments occurring in Zambia's economy. 1. In line with the objectives of the Third National Development Plan, DBZ will concentrate its projects financing in the following prior- ity sectors; agriculture, agro-industries, transport and engineer- ing, construction and export oriented enterprises. Areas for financ- ing will primarily include dairy and cattle farming, mixed farming, maize milling, edible oils and fats, stockfeed, meat processing, fruit and vegetable processing, manufacture of agricultural machines, implements and tools, textiles and clothing utilizing loca-lly produced cotton. DBZ promotion efforts will be concentrated in identifying investment opportunities within these areas through sectoral studies and contacts with possible investors. 2. Within the key sectors selected, DBZ will place emphasis on the identification and financing of projects which will utilize mainly local raw materials and develop linkages within the manufacturing sectors. 3. DBZ will also pay particular attention to financing projects which are labor-intensive and, therefore, likely to result in large employment. As a guideline, project investment costs per job created up to a level of K 16,000 to K 20,000 (about US$20,000 to US25,000 equivalent) would be considered as acceptable range. To be eligible for financing by DBZ, projects with investment costs per job exceeding K 24,000 (about US$31,000 equivalent) would have to be justified on the basis of very large other other economic benefits. To the extent possible, DBZ will assist its clients in selecting technologies that are labor-intensive. 4. During coming years, DBZ will make a special effort to assist worthwhile Zambian entrepreneurs in manufacturing, agriculture and possibly trade. This is considered a very effective way of creating employment and developing in the long run, the industrial base of the country. To that effect, a special unit will be created within DBZ to identify, appraise and monitor the loans to small-scale entrepreneurs. As the loan amounts are  - 32 - ANNEX 2 likely to be below the present minimum of K 25,000 authorized for DBZ loans, financing of small-scale enterprises will necessitate an amendment to DBZ's Act allowing the Bank to extend loans below that level within the framework of special programs. DBZ will develop special appraisal, accounting and supervision procedures for lending to small-scale enterprises.  - 33 - ANNEX 3 DEVELOPMENT BANK OF ZAMBIA Analysis of Loan Approvals as of March 31, 1980 (Amounts in K'000) Number % Amount / A. SIZE K1 - 49,999 10 8 280 1 K50,000 - 99,000 25 18 1,850 3 K100,000 - 249,999 42 30 6,585 11 K250,000 - 499,999 28 20 .9,045 16 K500,000 - 999,999 17 12 11,341 20 K 1 million & above 17 12 27,945 49 139 100 57,046 100 B. SECTOR Agriculture 55 40 11,830 20 Manufacturing 63 45 37,178 65 Distribution 2 1 2,500 4 Mining and Quarrying 6 5 1,589 3 Forestry 5 4 919 2 Tourism 6 4 1,860 3 Transportation 2 1 1,170 3 139 100 57,046 100 C. TYPE OF PROJECT New 62 45 25,615 45 Expansion 69 50 26,624 47 Modernization 8 5 4,747 8 139 100 57,046 100 D. OWNERSHIP Private 115 83 35,068 61 Public 24 17 21,978 39 139 100 57,046 100 E. LOCATION Lusaka 52 37 20,959 37 Luapula 1 1 319 1 Central 12 9 4,899 9 Copper Belt 33 23 15,419 26 Northern 6 5 886 1 Northwestern 1 1 175 1 Southern 21 15 9,783 16 Western 3 2 273 1 Eastern 10 7 4,333 8 139 100 57L246 100 EAPID September 1980  DEVELOPMENT BANK OF ZAMBIA (DBZ) Summarized Balance Sheets, 1974 - 1980 (in K'OOO) . . .... A -u. d i t e d. Year ending March 31 1974 1975 1976 1977 1978 1979 1980 ASSETS Cash 1/ - 76 13 6 334 341 1,123 Short Term Investments 6,395 2,500 2,500 3,210 - - - Accounts Receivable 93 1o6 209 305 288 3 447 3 974 Total Current Assets 26,82 2,722 3,521 3 3,= 5,097 Loan Portfolio 1/: Local Currency _ 3,839 9,426 12,650 16,108 14,147 14,483 Foreign Currency - - - - 188 2,323 6,588 - 3739 12,650 16,296 16,470 21,071. Equity Investments - - - - 282 431 439 Net Fixed Assets 298 633 1,105. 1,099 1.209 1,191 1,607 TOTAL ASSETS 6,786 7,154 13,253 17,270 18,409 21,880 28,214 =w LIABILITIES Current Liabilities 90 63 79 79 168 930 1,520 * Borrowings: Local Currency - 75 3,922 6,951 7,293 7,289 2,675 Foreign Currency - - 207 1,751 5,776 Total Borrowings - 75 3,922 6,951 7,500 9,040 8,451 Share Capital 6,650 6,900 8,900 9,450 9,450 10,000 15,425 Legal Reserve 12 29 88 198 324 479 823 Other Reserves 34 87 264 592 967 1,430 1,995 Total Equity 1/ 6,696 7,ol6 9,252 10,240 10,741 11,909 18,243 TOTAL LIABILITIES 6,786 7,154 13,253 17,270 18,409 21,880 28,214 SPECIAL FUNDS Cash - - - - - 471 1,048 1/ Excluding Special Funds EAPID S.eptember 1980  DEVELOPMENT BANK OF ZAMBIA (DBZ) Summarized Income Statements, 1974 - 1980 (in K'OOO) A u d i t e d Year ending March 31 1974 1975 1976 1977 1978 1979 1980 INCOME Loan Income - 79 606 1,o67 1,558 1,947 2,8131/ Other Income 202 319 194 225 101 153 2942- Total Income 202 398 800 1,292 1,659 2,100 3,107 EXPENSES Administrative Expenses 135 283 375 445 576 751 896 Financial Charges 14 19 156 374 536 686 782 Depreciation 7 26 33 35 47 45 54 Total Expenses 156 328 564 854 1,159 1,482 1,732 Profit 46 70 236 438 500 618 1,375 '1/ Including a penalty of about K 300,000 for a,large early repayment. 2/ Including the first equity investment dividend received by DBZ. EAPID September 1980  DEVELOPMENT BANK OF ZAMBIA (DBZ) Project Pipeline As of November 15, 1979 Financing Working Type Project Cost DBZ __ Additional Capital 3/ Owner- Date Economic of Foreign Foreign Inter- Employment Foreign Promoter ship Received Activity Project Local Exchange Total Local Exchange Equity Total nal Created Ex.Req't Luangwa Industries Pu. 1/ 8/79 Bicycles New 5,959 2,100 8,059 1,000 - - 1,000 7,059 370 - Gamma Pharmaceuticals Pr. 2/ 6/78 Pharmac. New 740 245 985 220 245 - 465 520 41 730 Sambro Pr. 6/79 Knitwear Exp. 190 310 500 350 - - 350 150 58 - Zambia Motor Assemblers Pr. 3/79 Mixed Farming New 1,000 1,300 2,300 - 1,300 - 1,300 1,000 45 90 C. & K.Farm Ltd. Pr. 8/79 Mixed Farming New 168 27 195 143 27 - 170 25 20 - Chilenga Farm Ltd. Pr. 8/79 Mixed Farming New 65 - 65 50 - - 50 15 7 - Chipongwe East Estates Pr. 5/79 Dairy Exp. 106 40 146 75 40 - 115 31 10 - Athol Plastics Pr. 6/79 Plastics Exp. 81 109 190 - 109 - 109 81 7 55 Sodium Silicate Pr. 8/79 Chemical Exp. 503 105 608 125 105 - 230 378 23 253 Zinc Oxide Pr. 7/79 Chemical Exp. 372 132 504 199 114 - 313 191 12 - Chibote Farms Ltd. Pr. 2/79 Dairy New 200 500 700 l0OO 400 - 500 200 15 _ Natala Ranch Pr. 6/79 Mixed Farming Exp. 160 - 160 130 - - 130 30 15 _ Kampasha Farm Ltd. Pr. 7/79 Mixed Farming Exp. 100 - 100 86 - 85 15 11 - Wakefield Farms Ltd. Pr. 8/79 Ranching Exp. 83 - 83 68 - - 68 15 5 _ Sub-total 9,727 4,868 14,595 2,546 2,340 _ 4,885 9,710 639 1,128 1/ Pu.: Public 2/ Pr.: Private 3/ Estimated requirement to cover one year production at break-even capacity utilization m EAPID x ,iay 1980 o I -~  DEVELOPMENT BANK OF ZAMBIA (DBZ) Project Pipeline As of November 15, 1979 (K '000 ) Financing Working Type Project Cost DBZ Additional Capital 3/ Owner- Date Economic of Foreign Foreign Inter- Employment Foreign Promoter ship Received Activitv Project Local Exchange Total Local Exchange Equity Total nal Created Ex. Req't Kingstone (Z) Ltd. Pr. 2/ 10/79 Mixed Farming New 300 200 500 150 200 - 350 150 33 Katende Farms Ltd. pr. 9/79 Mixed Farming New 70 30 100 80 - - 80 20 11 Sibetta & Sons Ltd. Fr. 10/79 Mixed Farming New 100 50 150 100 - - 100 50 15 Curray Ltd. Pr. 10/79 Mixed ll Farming Exp. 20 70 90 80 - - 80 10 10 Mpongwe Dev. Co. PidtPr. Mixed 10/79 Farming Exp. 1,300 1,200 2,500 800 1,200 - 2,000 500 278 Bonanza Tobacco Co. Pr. 10/79 Mixed Farming Exp. 90 120 210 80 120 - 200 10 22 Lukulu Coffee Pr. 9/79 Crops New 1,000 500 1,500 550 200 250 1,000 500 200 Chibote Farms Ltd. Pr. 10/79 Wheat New 700 800 1,500 500 600 - 1,100 400 83 E.C. Milling Ltd. Pr. 11/79 Milling New 525 400 925 200 400 - 600 325 78 Mubuyn Pr. 4/79 Dairy New 150 260 410 - 260 - 260 150 54 Sunlake Fisheries Pr. 8/79 Fishing New 150 300 450 50 300 - 350 100 40 Hybrid Poultry Pr. 7/79 Hatchery Exp. 1,060 400 1,460 500 400 - 900 560 40 Copperbelt Afroplast Pr. 9/79 Plastic Containers Div. 101 170 271 - 170 - 170 101 1 Plastic Closures Pr. 9/79 Plastic Closures New 166 250 416 - 250 - 250 166 43 175 Mutende Safaris Pr. 7/79 Teurism New 1,030 - 1,030 600 - - 600 430 27 Art Engineering pr. 7/79 Wire Galvn.Div- 742 528 1,270 222 528 - 750 520 33 Kapiri Maize Mill Pr. 9/79 Maize Milling New 397 243 640 111 243 - 354 286 22 Kitwe Maize Mill Pu. 1/79 Maize Milling New 5,470 3,642 9,112 2,000 - - 2,000 7,112 103 Townap Pr. 8/79 Terry Tex. New 676 732 1,408 168 732 - 900 508 148 975 Lake Tanganyika Safaris Pr. 9/79 Tourism Exp. 100 50 150 100 50 - 150 - 5 Zambia Nat.Wholesale & Marketing pu, 5/79 Transport Reh. 250 400 650 - 400 - 400 250 n.a. Footwear Holdings Pr. 3/79 Footwear New 1,122 470 1,592 391 470 - 861 731 260 150 Refined Oil Prod. Pu. 2/79 Soap Exp. 300 2,000 2,300 300 2,000 - 2,300 - n.a. Zambia Paint Pr. 10/79 Paint Reh. 130 20 150 80 20 - 100 50 - Chromium Co. Pr. 10/79 Chrome P1. New 380 20 400 180 20 - 200 200 34 Mulambo Transport Pr. 3/79 Transport Exp. 150 300 400 - 300 - 300 150 n.a. Central African Power Pu./Pr. Corp. 10/79 Power Dist.Exp. 4,100 1,500 5,600 1,500 1,500 - 3,000 2,600 n.a. Swarp Ltd. Pr. 6/79 Textiles Exp. 705 1,875 2,580 - 1,420 - 1,420 1,160 140 Muki,ba Textiles Pr. 8/79 Textiles New 500 1,200 1,700 - 1,200 - 1,200 500 100 Copper Weaving Mills Pr. 9/79 Textiles New 578 1,429 2,007 - 1,429 - 1,429 578 107 Poly Packers Pr. 9/79 Plastics Exp. 330 450 780 133 415 - 548 232 9 Lead Pencils Pr. 5/79 Pencils New 436 185 621 205 185 - 390 231 51 44 Wooden Furniture Pu. 4/79 Furniture New 1,204 902 2,106 305 902 - 1,207 899 124 Bata Shoes Co. Pr. /79 Footwear Exp. 250 275 525 118 275 - 393 132 15 Waste Paper Recycling Pr. /79 Paper New 1,912 2.932 4.844 - 2.592 - 2.592 2.252 121 TOTAL 36,221 28,771 64,942 13..Q49 21,121 250 33,419 31.573 2,846 2,472 I / Pu .: Public