Honduras - Second Industrial Credit Project

Document of j i :; 8 ; $ The World Bank FOR OFFICIAL USE ONLY Report No. 3596b-HO HONDURAS STAFF APPRAISAL REPORT SECOND INDUSTRIAL CREDIT PROJECT November 23, 1981 Projects Department Latin America and the Caribbean Regional Office 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$1.00 = 2.00 Lempiras (L) L1.00 = US$0.50 GLOSSARY OF ABBREVIATIONS ATLANTIDA Banco Atlantida BANADESA National Agricultural Development Bank BANCAHSA Banco Capitalizadora Hondurena BCH Central Bank of Honduras CAAFIID Central American Agreement on Fiscal Incentives to Industrial Development CABEI Central American Bank for Economic Integration CACM Central American Common Market CDI Industrial Development Center CET Common External Tariff COHDEFOR National Forestry Corporation of Honduras CONADI National Industrial Development Corporation CONSUPLANE National Planning Council D/E Ratio Debt to Equity Ratio DFC's Development Finance Companies EFF Extended Fund Facility FONDEI National Industrial Development Fund GDP Gross Domestic Product ILO International Labor Organization IMF International Monetary Fund INFOP National Institute for Vocational Training S&Ls Savings and Loans Institutions SMI Small and Medium Industry SOGERIN Banco Sogerin SSE Small Scale Industrial Enterprise UNDP United Nations Development Program UNIDO United Nations Industrial Development Organization Fiscal Year January 1 to December 31  FOR OFFICIAL USE ONLY HONDURAS SECOND INDUSTRIAL CREDIT PROJECT STAFF APPRAISAL REPORT TABLE OF CONTENTS Page No. I. THE INDUSTRIAL SECTOR .................................. 1 A. Economic Setting .. 1 B. Main Features and Structure . . 2 - Industrial Growth and Structure. 2 - Industrial Imports and Exports. 3 - Manufacturing Employment. 4 - Size and Distribution of Enterprises. 6 C. Industrial Policy .. 8 - Industrial Development Strategy ................ 8 - Industrial Incentives . . 8 - Tariff Policy and Protection. 9 - Export Promotion .10 - Outlook for Industrial Growth and Investment 11 - CACM. . 12 II. THE FINANCIAL SYSTEM ................................... 13 A. Banking System .. ................. 13 - BCH ................... 13 - BANADESA ..................... 13 - Commercial Banks . .14 - Other Financing Institutions .17 B. Monetary Policy and Mobilization of Resources 17 - Background and Objectives .17 - Interest Rates and Financial Resources .18 - Interest Rates .18 - Deposits .19 - Internal resources .20 - Rediscounts .20 C. Financing of Industry .20 D. Industrial Investment and Credit Demand .22 - Industrial Investment .. 22 - Credit Demand .23............................. 23 This report is based on the findings of an appraisal mission which visited Honduras during April-May 1981. The mission comprised Messrs. M. Alonso and G. Faillace (both of the Bank). 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.  Table of Contents (Continued) Page No. III. THE PROPOSED PROJECT .............................. 24 A. Institutional Structure and Project Objectives .... 24 - Background .............................. 24 - Project Objectives ....................... 24 B. Fondo Nacional de Desarrollo Industrial (FONDEI) 25 - Establishment, Organization and Management 25 - Policies and Regulations .26 - Statement of Policies and Industrial Regulations .26 - Nature of subprojects to be financed 26 - Terms and limits of financing .26 - Interest rate .28 - Subproject Appraisal and Supervision .28 - Operations ........................ 30 - Financial Position .32 C. Financial Intermediaries . .33 - Commercial Banks ............................... 34 - CDI ...................................... 34 - COHDEFOR .35 - CONADI .36 D. Guarantee Fund .37 E. Cofinancing ....................................... 38 IV. THE PROPOSED LOAN ..39 A. Project Cost and Financing Plan .39 B. Proposed Loan ...................................... 40 - Amount and Terms .40 - Relending Terms and Conditions .41 - Technical Assistance .41 - Procurement .42 - Commitment and Disbursement .43 - Accounting, Auditing and Reports .43 C. Project Benefits and Risks .44 V. AGREEMENTS AND RECOMMENDATIONS ..45  LIST OF ANNEXES ANNEX 1 FONDEI: Organization Chart ANNEX 2 FONDEI: Draft Statement of Policies and Industrial Regulations ANNEX 3 Regulations of the Guarantee Fund for the Promotion of Small-Scale Industry ANNEX 4 Supporting Tables: T-1 Structure of Industrial Value Added T-2 Manufactured Imports T-3 Manufactured Exports T-4 Manufactured Goods--Trade Balance T-5 1980 Balance Sheets -- Finance Companies and Public Banks T-6 1980 Balance Sheets-Commercial Banks T-7 Consolidated Financial Statements--Financial Intermediaries T-8 Financial System Interest Rates T-9 Industrial Fixed Investment--by Industrial Products T-10 Industrial Fixed Investment--by Type of Goods T-ll FONDEI: Subprojects Approved as of March 31, 1981-- Loan 1659-HO (By Year, Intermediary and Size of Enterprises) T-12 FONDEI: Subloans Approved as of March 31, 1981-- Loan 1659-HO (By Size and Term) T-13 FONDEI: Subprojects Approved as of March 31, 1981-- Loan 1659-HO (By Total Assets of Enterprises) T-14 FONDEI: Subprojects Approved as of March 31, 1981-- Loan 1659-HO (By Type of Enterprises, Subsector and Location) T-15 FONDEI: Subprojects Approved as of March 31, 1981-- Loan 1659-HO (By Investment Item) T-16 FONDEI: Socio-economic Results of Subprojects--Loan 1659-HO T-17 FONDEI: Balance Sheet T-18 FONDEI: Income Statement T-19 FONDEI: Cash Flow T-20 FONDEI: Commitment Status -- Loan 1659-HO T-21 CONADI: Balance Sheet T-22 CONADI: Income Statement T-23 CONADI: Portfolio T-24 CONADI: Cash Flow T-25 Estimated Schedule of Disbursements for the Proposed Loan ANNEX 5 Selected Documents and Data Available in the Project File MAP   I. THE INDUSTRIAL SECTOR A. Economic Setting 1.01 Honduras is one of the poorest countries in the Western Hemisphere with a per capita income of US$565 in 1980. Although the population density of 30 per square kilometer is low, the population is growing at a rapid rate of 3.4% per year. A large number of the 3.7 million Hondurans live in poverty, particularly in rural areas, and about one-half of the population is without safe water and three-quarters without electricity. The adult literacy rate is 57%. The economy is still based predominantly on agriculture and forestry, which contribute one-third of Gross Domestic Product (GDP) and four- fifths of exports, and provide two-thirds of the employment. The country's extensive pine forests, which are the largest in Central America, are one of its most important resources, but the lax control of their exploitation has resulted in some depletion of these resources. 1.02 The long-term growth of the economy has been slower than in other Central American countries. However, while the Honduran real GDP growth of 3.7% annually 1/ during 1950-75 was inadequate to substantially raise the living standards, it has shown a remarkable growth rate in the last few years, reaching 7.7% p.a. during the 1976-79 period. The most important growth factors were exports and investment; the former resulted mainly from the recovery of banana production after the 1974 hurricane and an increase in the value of coffee exports, and the latter from rapid expansion of private investment, and the large and aggressive government development and investment programs, which laid the basis for much improved longer term growth prospects. 1.03 In 1980, however, the Honduran economy slowed down. Real GDP growth is estimated at 2.5% a year because real exports and investment lost their dynamism. Transitory difficulties with banana production, a slower expansion of coffee production, and a continued decline of lumber exports explain the deceleration of the growth rate. Private investment was adversely affected by political events in Nicaragua and El Salvador, high interest rates abroad, and tight credit. The consumer price index rose at an annual rate of 18.8%, compared to 8.8% in the previous year, with above average increases in the price of beans and corn, which are the basic foods of the poor. The sharp acceleration of inflation eroded real wages, in spite of a 1980 increase in the minimum wage and general wage increases. In addition, the current account of the balance of payments 2/ showed a deficit of over US$300.0 million in 1980, or 12% of GDP. Import growth significantly exceeded export growth, mostly due to a 55% increase in the value of imported oil and large imports of capital goods. Net official foreign exchange reserves declined by about US$60.0 million to US$110.0 million (about one month of imports CIF), in spite of large inflows of foreign official capital. l/ This was only slightly above the 2.7% rate of population growth in the 1950-75 period. 2/ The balance of payments position of Honduras traditionally depends on the exports of a few commodities (bananas, coffee, lumber, beef, sugar). Recently, coffee exports have become as important as bananas, and the share of total exports represented by bananas has dropped from 75% in 1950 to 25% in 1980.  1.04 The government's financial position also deteriorated in 1980. Current expenditures of the central government increased by about 30%, effec- tively offsetting the revenue impact of a 1979 tax reform. Furthermore, some public enterprises confronted serious financial difficulties, because they followed lax wage and expenditure policies, failed to take appropriate tariff or price actions, and/or became involved in unprofitable activities. These difficulties created additional financial pressures on the central government in 1980, which are expected to continue in 1981. Weak public finances brought about a large increase in the use of domestic credit by the public sector and a tightening of credit to the private sector. 1.05 In the next few years the government is likely to continue its aggressive development policies and programs, and a relatively favorable growth scenario is possible for the 1980s. Although the outlook for 1981-82 is less optimistic, real GDP growth could be about 4-5% a year during 1981-85. The government-s strategy is to support both industrial and agricultural growth with large infrastructure investments and expanded credit availability, and accelerate the implementation of social projects. However, for these plans to be implemented, the government needs to strengthen the financial position of the public sector and restore private sector confidence. In April 1981, the government took measures to improve its finances by increasing sales and import taxes. In addition, the government plans, under the renewed Extended Fund Facility (EFF) arrangement with the IMF, to restrict current expenditure growth, improve tax administration, raise rates for services of public enterprises, reduce the size of the overall public sector deficit, and reduce Central Bank (BCH) credit to the government. Furthermore, BCH freed interest rates on savings deposits (the only deposit interest rate which remained fixed), and provided commercial banks with adequate spreads for loans financed with foreign credit. B. Main Features and Structure Industrial Growth and Structure 1.06 Manufacturing accounted for about 17% of GDP at factor cost and employed about 12% of the working force in 1979. Moreover, it expanded rapidly, averaging 9.6% annually during 1975-79, which sharply contrasted with the slow real growth (3% per year) of the 1960-75 period. During the 1960s, import-based industries (including some new industries producing detergents, cosmetics, metal products and plastic) developed at a faster rate than the local input-based industries. However, this trend did not continue into the 1970s, and traditional consumer goods industries, such as food products, beverages, tobacco, footwear and apparel, and intermediate goods, such as lumber and cardboard boxes, are now leading industrial growth. The production of heavy intermediate and capital goods remains minimal (Annex 4, Table 1). 1.07 During the 1960s, industrial value-added grew by only 3.8% a year, at approximately the GDP growth rate. This resulted from the small size of the domestic market, lack of infrastructure, and the inability of domestic firms to take full advantage of the opportunities offered by the creation in 1961 of the Central American Common Market (CACM). While CACM intra-regional  -3- trade, the bulk of which was in manufactured products, increased rapidly from US$30.0 million in 1960 to US$252.0 million in 1968, Honduran exports to the CACM only grew from US$8.0 million to US$30.0 million, and the Honduran share of intra-regional trade dropped from 27% to 12%. Honduras withdrew from the CACM following the conflict with El Salvador in 1969, and in 1973 signed bilateral agreements with each CACM country, except El Salvador. The bilateral agreements, which provided for partial restoration of free trade along CACM lines, have offered certain advantages to Honduras, which was permitted to charge tariffs on some manufacturing goods from CACM countries. 1.08 Reduced competition from other CACM imports coupled with the renewed granting of industrial investment incentives, which triggered a process of modernization and expansion of industrial capacity, led to faster industrial growth (6% p.a. in value added during 1970-74 and 9% p.a. during 1975-79). This growth rate, however, decreased to about 6% during 1979-80 because of political uncertainties in the region. In spite of the advances of the 1970s, Honduran industry is still at a relatively early stage of development. Traditional consumer goods account for a large share of value added (55% in 1960 and 64% in 1980), but some consumer durables products are being manufac- tured. Capital goods still contribute minimally to industrial value added. Industrial Imports and Exports 1.09 With its relatively small industrial base and small domestic market, Honduras has to import a wide range of manufactured products for which local production would not be economic. In 1960, approximately 41% 1/ of the domestic demand for manufactures was met by imports, with consumer goods, intermediate goods, and capital goods and transport equipment, representing each about one-third of total manufactured imports. By 1980 consumer goods imports represented about 17% of manufactured imports, intermediate goods 40% and capital goods and transport equipment 43% (Annex 4, Table 2). Although Honduras was succesful in substituting some imports of consumer goods, the shift in relative shares is explained also by the increased value of inputs of intermediate products, which resulted from the sharp increase in petroleum prices, and by the large increase in capital goods imports associated with the rapid expansion of private and public investment during 1976-79. 1.10 Manufactured exports (which include processed agricultural products) in constant 1966 lempiras, grew at an average annual rate of 13.6% p.a. between 1960 and 1970, at 14.6% between 1970 and 1974, and at 13.3% between 1975 and 1979. During the 1970s, the proportion of consumer goods exports in total manufactured exports (mostly processed foods, and in particular processed meats, sea foods and refined sugar) increased significantly. On the other hand, the share of intermediate wood products (particularly sawmill products) dropped from 42% in 1970-74 to 29% in 1975-79. This downward trend continued in 1980 when intermediate wood products represented only 18% of 1/ This ratio increased to about 55% during 1970-1980 as a result of large growth in domestic demand for intermediate and capital goods and for consumer durables not manufactured in Honduras.  -4- total manufactured exports (Annex 4, Table 3). With the completion of two large government-owrned sawmills in the Olancho area during 1982-1984, however, this trend should be reversed. lo1L The proportion of manufactured exports in domestic manufacturing productioni increased from about 10% in 1960 to about 27% average during 1970-74, and again to an average of about 38% during 1975-79. As a result, the trade deficit for traditional manufactured consumer goods decreased significantly during the period and became a surplus in 1980 mainly because of increases in exports of processed foods. 1.12 The proportion of HonduranL manufactured exports to other CACM countries remained approximately constant, at about 25%, during the 1960s. However, following the withdrawal from the CACM in 1969, the proportion of Honduran manufactured exports to CACM averaged less than 5% between 1970 and 1974. After 1974, the first year in which the bilateral agreements with Nicaragua, Guatemala and Costa Rica became fully operational, manufactured exports to the CACM increased substantially, to over 20% in 1976-79. In addition, a major structural transformation has taken place. Once a major supplier of agricultural products to the rest of the region, Honduras slowly became an exporter of manufactured products, which by 1979 represented over 80% of Honduran exports to the CACM. Currently, however, Honduras is facing difficulties to export to some CACM countries because of their economic and political situation. ManufacuigEpomn 1.13 Structure, Employment grew faster than the Honduras population growth rate between 1960 and 1980. During 1960-1970, employment in firms with five or more employees (the factory sector) increased from 14,900 in 1960 (or 2.8% of the total labor force) to 25,500 in 1970 (or 3.6% of the labor force), equivalent to a growth rate of about 5.5% p.a. However, employment in firms with less than 5 workers grew at an annual rate of only 3.5%; as a result, the overall manufacturing employment grew by about 4.3% a year, somewhat above the country's population growth rate. During 1970-1980, employment in firms with five or more employees increased more rapidly than in the previous decade, with employment growth averaging 7e3% a year. As a result, total employment in these firms doubled to about 51,600, or about 5% of the total labor force. Growth in employment in firms with less than 5 workers, however, continued to be slower (4.3% per annum), so that the overall growth rate of employment averaged about 5.6% a year, which is significantly above the country's popula- tion growth rate. 1.14 The subsectoral composition of factory employment changed somewhat during the 1960s and early 1970s, reflecting the shifts in industrial production. Based on the latest industrial survey, which was taken in 1975, the categories which contributed the most to employment were: food processing, beverage and tobacco (35.0%); wood and paper products (19.1%); and textiles, clothing and leather (16.9%). Approximately 52% of all manufacturing employ- ment creation took place in large faLctories with over 100 workers, which are large for Honduras, compared with only 30% of employment creation which took place in factories with less than 50 employees.  1.15 Labor Force Training. Compared to the other CACM countries, the labor force in Honduras is less skilled, partly because the adult literacy rate is only 57%, but also because vocational training systems, despite the program being undertaken by the National Institute for Vocational Training (INFOP) (para. 1.16), are not highly developed. On the other hand, wages in Honduras are low relative to its major trading partners (Table 1.1). These relatively low labor costs, coupled with political stability in the last few years and comparatively good management-labor relations, help to keep Honduras reasonably competitive in the CACM context, and may be a key consideration for promoting manufactured exports to third market countries. Table 1.1: INTERNATIONAL COMPARISONS OF WAGES IN INDUSTRY 1/ (In US$) Ranking 2/ on Basis of 1977 Average Wages Per Month GDP Per Capita (1977) USA 8762 983 Japan 6069 748 Venezuela 2910 336 Brazil (1976) 1570 266 Philippines 510 257 Mexico 1290 249 Panama 1290 238 Costa Rica 1540 168 Nicaragua 840 158 Hong Kong 3040 149 Singapore 3260 147 Taiwan 1400 144 Korea 1160 143 El Salvador 600 108 Honduras 480 3/ 105 Colombia 870 102 Guatemala 910 100 1/ Includes basic salary and wage payments. Conversions are made on average length of work week and based upon average exchange rates during the year. 2/ If social charges are included, ranking could change appreciably. Honduras' social charges, as a percentage of wages, are the lowest in Central America (about 23%). 3/ US$565 in 1980. Sources: ILO, Yearbook of Labor Statistics, 1977; IMF, International Financial Statistics, April 1979, and Philippines NCSO; IBRD Atlas.  -6 - 1.16 Formal technical training in the manufacturing sector is carried out by INFOP, while some informal training is provided by several secondary vocational schools. The Bank has been instrumental in assisting Honduras to develop its vocational training system through INFOP. Under the First Education Project (Loan 954/Cr.452-HO) approved in December 1973, two vocational training centers were built and equipped in Tegucigalpa and San Pedro Sula. The basic objective of the two vocational training centers is to complement the skill training program of INFOP with major emphasis on the industrial sector. The training centers offer courses at apprenticeship, basic skill and skill upgrading levels, as well as in-plant training. Additionally, to promote in-plant training, the Tegucigalpa center identifies training needs, plans and implements the programs, institutes certification techniques and establishes a placement service. INFOP's annual output in these centers has increased from 333 graduates in 1973 to 8,548 in 1979, of which about 60% represented in-plant training graduates. Size and Distribution of Enterprises 1.17 Most industrial enterprises are relatively small. The 1975 indus- trial census lists 849 firms with more than 5 employees (the factory sector), which generated about 80% of total manufacturing value-added and employed 37,000 workers. Out of the 849 firms in the factory sector, about 10% had more than 100 employees, accounted for 54% of output, and 52% of factory employment (Table 1.2). An additional 34% of the firms provided 40% of the output and contributed 35% of employment. The remaining 56% of the firms accounted for just 6% of the output, but contributed 13% of employment. Total fixed assets per firm for the latter group is less than US$50,000. The proposed loan contains features to ensure that these firms would be benefited by the project (paras. 3.38 and 4.02). Table 1.2: CHARACTERISTICS OF ENTERPRISES Size Enterprises Eployment Value Added Factory Output (by employees) Number % Number % Millions % Millions % of Lempiras of Lempiras Small (5-19) 478 56 4.6 13 17 7 60.5 6 Medium (20-49) 196 23 6.3 17 31 13 14.4 12 Medium-Large (50-99) 94 11 6.7 18 48 20 273.0 28 Subtotal 768 90 17.6 48 96 40 457.9 46 Large (over 100) 81 10 19.4 52 144 60 528.2 54 849 100 37.0 100 240 1/ 100 986.1 100 1/ At factor costs. Source: 1975 Industrial Census  1.18 Of the 849 firms with 5 or more employees, 56% had less than 20 employees, and about 90% had less than 100; almost two-thirds were family- owned and only 20% were incorporated. Most of these firms were located in the country's two largest cities, Tegucigalpa (32%) and San Pedro Sula (39%). Artisan and very small enterprises (employing less than 5 workers each) con- tributed US$25.0 million to total manufacturing value-added. Although they employed some 37,000 workers, a large proportion of them worked in family concerns without formal remuneration. 1.19 A significant modernization of productive capacity and the establish- ment of larger and more efficient factories took place in the 1960s and 1970s, which resulted in a reduction of the share of firms with less than five employees in manufacturing value-added from 42% to 20% between 1960 and 1975. These trends have been accompanied by significant rises in labor productivity in the food, beverages, tobacco, textiles, and clothing subsectors, where a six-fold increase in value-added has been achieved with only a doubling of the work force. This trend towards larger factories and higher productivity is partly a consequence of diversification into more capital intensive products and the growth of export-oriented industries, such as meat packing, sugar, and textiles, which have to be quite large in order to be competitive. Neverthe- less, the average capital intensity of the Honduran factory sector (capital per worker ratio of US$7,500 equivalent in 1975) is low by Latin American standards. Data on 210 firms covered by the Central American Agreement on Fiscal Incentives, representing over 60% of industrial value added, show little change in the composition of the industrial sector in 1977 compared to the 1975 industrial census. Approximately 39% of all enterprises had net worths of less than US$200,000, and only 29% had net worths of over US$800,000 (Table 1.3). Table 1.3: HONDURAN INDUSTRIAL SECTOR - DISTRIBUTION BY SIZE Size Range 1/ Enterprises Cumulative (US$) (Number) (%) (%) Less than 25,000 8 3.8 3.8 25,001 - 50,000 10 4.8 8.6 50,001 - 200,000 64 30.5 39.0 200,001 - 400,000 45 21.4 60.5 400,001 - 800,000 22 10.5 71.0 800,001 - 1,600,000 30 14.3 85.2 1,600,001 - 3,200,000 19 9.1 94.3 3,200,001 - 6,400,000 7 3.3 97.6 6,400,001 - 12,500,000 4 1.9 99.5 over 12,500,000 1 0.4 100.0 210 100.0 1/ Capital plus retained earnings. Source: Central Bank 1977, Census of firms covered by Central American Agreement on Fiscal Incentives  C. Industrial Policy Industrial Development SSrLtgye 1.20 The National Planning Council (CONSUPLANE), in consultation with the Ministry of Economy and the Central Bank, has prepared an Economic Development Plan for 1979-83. This plan, which aims at maintaining a fairly high rate of economic expansion coupled with an improved balance of payments performance and a better distribution of economic benefits to the poorer groups of the population, envisages continuing heavy public investment in infrastructure and in the social sectors while giving more emphasis to rapid yielding investment projects in the productive sectors. Industry has been assigned a leading role in achieving rapid growth of value added, exports, and employment. These overall objectives are still maintained in the updated 1981-82 program. 121 The primary targets established in the 1979-83 Economic Development Plan for industry are: (i) real growth in industrial value added of 9% p.a., whereby industry would increase its contribution to GDP from about 17% in 1977 to 19% in 1983; (ii) manufactured exports growing by 15% p.a. in current US dollars with the proportion of domestic value-added in exports progressively increasing; and (iii) more rapid development of labor-intensive small- and medium-sized enterprises. To achieve these targets the plan envisages: (i) a more selective import-substitution strategy focusing on efficient industries in the intermediate goods and metal working fields; (ii) increased promotion of exports outside the CACM; (iii) promotion of industries in which Honduras has a comparative advantage, in particular those which use raw materials from forestry and agriculture; and (iv) increased credit and technical assistance to small- and medium-sized industry (SMI). The latter objective would receive special emphasis under the proposed loan. 1.22 A law to promote the development of small-scale and artisan industry, which was enacted in 1978, extended to small enterprises the benefits of the industrial incentive legislation, and confirmed the government's intention to provide financial and technical assistance to the sector. Subsequently, the government has upgraded its Centro de Desarrollo Industrial (CDI), which has been providing technical assistance largely to artisans, in order to enable CDI to provide such services to small-scale enterprises (SSEs) in the future. The First Industrial Credit Project provided financial and technical assistance to a number of SSE's through CDI and some commercial banks (paras. 3.20 and 3.31). Industrial Incentives 1.23 By far, the most important policies affecting the manufacturing sector since 1960 have been those determined by Honduras participation in the CACM. The main policy instruments have been the Central American Agreement on Fiscal Incentives to Industrial Development (CAAFIID) and the Common External Tariff (CET). Both of these instruments were designed to support a strategy of regional import substitution within the CACM. After its withdrawal from the CACM in 1970, Honduras reduced or cancelled some of the investment incentives, but they were largely restored after Honduras signed bilateral agreements with all CACM countries except El Salvador. Under the CAAFIID, which superseded industrial incentive legislation enacted separately by the  CACM countries shortly before 1960, qualifying industrial firms were granted exemptions for up to 10 years from income taxes and from tariffs on imported equipment and raw materials and other inputs. 1.24 Maximum benefits were provided to Group A companies that produce industrial inputs and capital goods, as well as consumer goods industries that use raw materials and intermediate products, at least 50% of which are of Central American origin. Lesser benefits were provided to Group B companies producing high domestic value added products, but depending to a significant extent on imported inputs. Lowest benefits comprising a 3-year exemption from tariffs on imported equipment and raw materials, were provided for Group C companies, which are those not qualifying as Group A or B but judged to be economically desirable in view of their domestic value added, balance of payments and employment impacts. Various modifications have been made to the incentive package during the 1960s and 1970s, but the basic characteristics remain the same. 1.25 While the effect of the incentives program in encouraging industrial investment has been important overall, there appears to be a growing consensus among CACM countries that in addition to the high cost of the present fiscal incentive system (much of the investment would very likely have taken place anyway), there are basic weaknesses with this approach to industrial develop- ment. 1/ The Bank's 1980 study 2/ of industrial development policies in the CACM, highlighted the following weaknesses: (i) the incentive system has tended to encourage investment in industries not appropriate to the resource endowment of the region, with low value added and high import and capital intensity; (ii) the basic operational characteristics of the systel, a contract providing tariff exonerations on imported inputs to a specific firm for a fixed period of time while its output is protected from external competition, does not encourage the establishment of industries with long-term economic viability; (iii) vested interests are created to find means to perpetuate these diseconomies, as can be seen from the experience with the numerous extensions of exonerations. Under the proposed project, the subproject review process would pay particular attention to the economic efficiency of invest- ments contemplated, regardless of the incentives they might receive. Tariff Policy and Protection 1.26 Tariff policy in Honduras is closely related to liberalization of intra-regional trade and the establishment of the Common External Tariff (CET). With the exception of certain agricultural products and some consumer durables, all of the CACM imports from outside the area are included under the CET. The tariff for each item has two parts, one ad valorem and the other specific by unit of measurement; while the full ad valorem equivalent of the 1/ While this problem is recognized in Honduras, pending a revision of the regional system, the authorities have been reluctant to take action because of strong competition for investment by the other CACM member countries. 2/ Bank report No. 2325b-CA entitled "Central America Special Report on the Common Market," dated September 29, 1980.  - L0 - tariff is related to actual price levels, recent inflation has probably substantially reduced the overall tariff system impact since the second compo- nent of the tariff has not been adjusted. The CET followed the basic structure of national tariffs in the region with higher nominal protection for final consumer goods than for capital and intermediate goods. 1.27 Although nominal tariffs for industrial inputs vary substantially between products, with subsector averages ranging from 10% to 150%, average tariffs for most subsectors are below the 35% level. The average nominal protection rate 1/ of about 22% (weighted by the gross value of domestic production by subsectors) in Honduras is quite low, and somewhat lower than those of the other CACM countries. Effective protection rates are somewhat higher, particularly for those subsectors with high nominal rates of protection (i.e. luxury items, processed agricultural products, seafood, wood products, clothing, textiles, soaps and detergents). However, most of these same subsectors are responsible for much of the increase in manufactured exports (para. 1.10), indicating that available protection has not been utilized in many instances. With some exceptions Honduras' tariff structure has not encouraged production of goods on an uneconomic scale and at prices which are substantially above international levels. The bulk of industry is still based on the processing of local inputs, some of which are exported in the world market, and competition within the region and the restricted purchasing power in the domestic market have largely prevented industry from taking undue advantage of protection levels. Export Promotion 1.28 The bias towards regional import substitution in the CACM trade policy is one of the most important constraints on the growth of industrial exports outside the area. The structure of CET, combined with the granting of duty exonerations under the industrial incentive agreement, has resulted in a pattern of protection which is excessive for traditional consumer product industries and discriminates against those producing intermediate and export goods. Thus, traditional industries (such as textiles, clothing, shoes and leather) recorded substantial output increases in the first years of the CACM development, but did not establish external export markets during this time. 1.29 This emphasis on import substitution, while valid in the initial stage of industrial development in the region, has encouraged individual enterprises to produce a broad range of products in accordance with regional demand patterns, rather than a few items, which could be produced in large amounts and thus be competitive in the international markets. In addition, an important consequence of the emphasis on import substitution has been the lack of export marketing skills, necessary for export promotion. While there has been a recent mood of protectionism in the industrialized countries, there 1/ In April 1981, the Government (for fiscal purposes) raised import tariffs by 5% of CIF prices for most intermediate and capital goods and 10% for consumer products, including goods from CACM countries with which Honduras has bilateral trade agreements.  - 11 - has been also a growth in their imports of consumer goods. Honduras and the remaining CACM countries have not participated in this growth to the extent possible under their current conditions of production. Moreover, there appears to be considerable scope for the CACM countries to penetrate into international markets even where quotas are imposed. 1.30 Even during the period of maximum intra-regional trade expansion in the early 1960s, various CACM officials had recognized the need for broad export development strategies. However, partly as a result of the post-1969 CACM difficulties, a program for formulating a common regional export incentive policy was discontinued and it was decided to leave these programs to national initiatives. At present, all countries except Honduras have established export promotion agencies to assist exporters of non-traditional products to find markets and to attract foreign investors who would produce for export. In addition, other CACM countries provide export incentives which are more generous than in Honduras (such as tax credits to exporters). All CACM countries and Honduras reimburse duties paid on imported inputs for the manufacture of export products--duty draw-back. However, such a measure has limited usefulness as an incentive, since it essentially provides exporters a supply of inputs at the same prices that their external competitors pay. The administrative complexities of the operation of the draw-back system are another reason for the low degree of its effectiveness in the CACM countries. 1.31 The Honduran Government is presently attempting to establish a more systematic approach to export promotion. In view of Honduras' current economic situation (increasing balance of payments deficit and decreasing international reserves), and the apparent unwillingness of CACM countries, at this time, to formulate a common regional export incentive policy, the imple- mentation of an effective national export promotion strategy has become increasingly important. The government has prepared an initial draft of an export promotion law which the Bank, in close cooperation with the IMF, has reviewed and given comments. The current draft law needs to be improved in several areas including: (i) the fiscal incentives are based on the FOB value of the increments of exports rather than on value added; and (ii) the negative impact on central government's finances, which would put in jeopardy the Extended Fund Facility (EFF) arrangement with the IMF. Furthermore, there is a need to properly address one of the most critical aspects of export promotion which is the scarcity of export financing. During loan negotiations assurances were received from the government that before taking any action concerning incentives for the promotion of exports, the government shall afford the Bank all reasonable opportunity for exchanging views on such incentives. Outlook for Industrial Growth and Investment 1.32 Favorable overall growth prospects are foreseen for Honduras in the 1980s. The large government investment effort is expected to greatly accel- erate growth by the mid-1980s, and together with the good prospects for increasing exports, particularly in food products, wood 1/ and paper products, 1/ It is anticipated that wood products would double in volume once the two new sawmills become fully operational in 1982 and 1984.  - 12 - significant growth rates of about 7-8 percent p.a. in value added may occur in the mid to late 1980s. The near-term outlook, however, is less optimistic, because of the political climate in the region, the decline in coffee prices, the limited liquidity of the banking system, and high interest rates. Private investment is the most uncertain element for the next few years. On one hand, the limited increase in domestic credit during 1980 was mostly siphoned to the public sector; this, together with a reduced exposure in Central America by foreign commercial banks, high interest rates abroad, and political uncertain- ties in the area, had negative effects on private investment in 1980. Addi- tionally, the government's industrial investment corporation (CONADI's) support for large private projects may have peaked since most of them have been completed and CONADI's severe financial difficulties effectively limit its capacity to enter new operations on a sound basis (para 3.35). On the other hand, the government's program for 1981-82 under the EFF arrangement (para 1.05) should help increase credit availability for the private sector (if public finances strengthen), increase investor confidence and provide the right environment for private sector growth. Greater participation of the private sector is essential in the medium term because the expansion of the public sector in the last few years is taxing its personnel and finances. Nevertheless, it must be recognized that the industrial outlook will continue to be influenced for the next few years by the political situation in Central America, and private investors are likely to remain relatively cautious. CACM 1.33 With respect to the future of the CACM, recent political upheavals in the area have clearly affected trade relations among countries. These events raise serious questions concerning the political viability of the integration movement. However, it can be argued that strong economic interests in the CACM have been created which are likely to continue to exercise pressure to maintain, in some form at least, these arrangements. It is necessary to devise an industrial strategy for the countries of the CACM, which would stimulate production and export of manufactured products (particularly of resource-based items) to markets outs:ide the region. In this regard, the revision of the policy instruments of CACM is essential to permit them to play a proper role in this process. While there is growing support among the CACM countries for a reappraisal and revis-ion of policies and strategies, it may take some time for firm decisions to be taken. In the interim, investment would be directel zo those accivities in which the CACM countries have compara- tive advantages and can be individual:Ly comDetitive. 1.34 While the precise nature of the gains from the current stage of integration are difficult to measure, it is clear that there has been a substantial increase in the degree of interdependence among the CACM countries. A series of positive results from the regional integration efforts can be identified: an expansion of market size has made possible the growth of a number of local industries which individual national markets could hardly have supported, and has encouraged some degree of intra-industry special- ization; encouragement to the development of technical and managerial skills which can provide the basis for further growth; and important improvement in regional infrastructure which has in turn generated better national links.  - 13 - II. THE FINANCIAL SYSTEM A. Banking System 2.01 The banking system in Honduras is comprised of BCH, 15 commercial banks and financieras, 1/ 3 development banks (CONADI, Banco Nacional de Desarrollo Agricola--BANADESA, and Banco Municipal Autonomo--BMA), 9 specialized credit institutions (mostly mortgage banks), CDI and Corporacion de Desarrollo Forestal (COHDEFOR). Of these entities, all except BANADESA, BMA and the specialized credit institutions are involved at present in financing industry. BCH 2.02 BCH was established in 1950 as the government's central bank and fiscal agent, with responsibility for formulating and implementing monetary policy and for supervising the banking system. The BCH is generally regarded both within and outside Honduras as a professional, well-managed and adequately staffed organization. In recent years, BCH has taken an active role in economic development, policy formulation, planning and financing. 2/ It is operating a guarantee fund for small-scale industrial lending (para. 3.37) and an export rediscount line. In addition, BCH has assumed responsibility for administering the Bank Group's four Livestock and Agricultural Credit Projects, as well as the First Industrial Credit Project and the tourism credit component of the Tourism Development Project. Under the proposed project, BCH would continue its role in channeling term financing to the Honduran industrial sector (paras. 3.03 and 4.02). BANADESA 2.03 BANADESA (formerly Banco Nacional de Fomento, BANAFOM) with assets of L288.0 million as of December 31, 1980, is the second largest bank in Honduras (Annex 4, Table 5) and until 1977 was virtually the country's only source of industrial term credit to SMI. Founded in 1950 mainly as an agricultural bank, it became involved in industrial financing and in operating agricultural marketing and storage facilities as part of its agricultural price stabiliza- tion activity. By 1975, the bank had acquired an industrial portfolio of L12.6 million (out of a total portfolio of about L131.9 million), mostly of medium- and small-size loans, of which about one-third were in arrears. Most of the small loans had been guaranteed by BCH's small industry guarantee fund (para. 3.37). In early 1977, the BCH, on behalf of the government and along with BANADESA's new management, undertook a review of the range of the insti- tution's activities and capabilities. As a result, it was decided that BANADESA should focus its resources on its expanded agricultural development responsibilities and phase out other activity. Thus, the bank's industrial lending activities ceased in July 1977 and a phase-out was begun of all 1/ Including Financiera Hondurena (Banfinan), which went bankrupt in 1980. 2/ Along with the Ministers of Finance, Economy and Natural Resources, the President of the Central Bank serves on the National Economic Council, which formulates economic policy.  - 14 - agricultural marketing and storage functions. BANADESA provides a major portion of Honduras's institutional financing for agriculture and for small- scale farmers. BANADESA's total portfolio was about L198.0 million as of December 1980, and it currently has financial difficulties mainly because of a high level of portfolio arrears and limited efforts to collect. Commercial Banks 2.04 The 15 commercial banks and financieras (3 of which are foreign owned) form the core of Honduras' financial system. As of December 31, 1980, they held 66% of the financial system's assets (excluding the BCH) of L1.5 billion and accounted for almost two-thirds (L191.0 million) of total new industrial credit. In the past three years, industrial credit, on average, accounted for about 20%. of the commercial banking system's outstanding total loan portfolio. Commercial banks are engaged mainly in short-term lending activities. In 1970, loans for less than 18 months accounted for more than 67% of resources loaned while longer term loans with maturities of 4 years and over accounted for only 17% of the total (Table 2.1). By 1975, this situation had changed appreciably and loans of over 4 years represented 26% of total lending. The trend has continued with the increased availability of longer term resources to commercial banks, such as under the First Industrial Credit Project. Table 2.1: COMMERCIAL BANKING SYSTEM - TERMS OF NEW CREDIT (in percentages) Loan Terms 1970 1975 1980 Less than 18 months 67 57 48 1-1/2 to 4 years 16 17 14 Over 4 years 17 26 38 100 100 100 Source: Central Bank of Honduras 2.05 Several large banks, of which the largest and most important are the Banco Atlantida (ATLANTIDA) and Banco Capitalizadora Hondurena (BANCAHSA), have traditionally dominated commercial banking activity (Annex 4, Table 6). However, in recent years, reflecting BCH's efforts to increase competition in commercial banking, important changes have occurred giving the banking system a broader base, an enlarged clientele, and an improved geographic spread. As a result, the number of commercial banks has increased by 40% (three specialized credit institutions became commercial banks in 1971 and 1976, a new commercial  - 15 - bank was established in 1974, and a second one in 1979), the system is channel- ing an ever-increasing amount of resources into the productive sectors (agri- culture and industry) (Table 2.2), and the smaller banks have grown at a faster rate than the larger ones. These changes within the banking system, even in a short period, are quite significant. Thus, between 1975-80, while ATLANTIDA's overall industrial lending had increased substantially, its share of the market declined from 35.7% to 14.7% of total industrial lending. Two other large banks, BANCAHSA and Banco Financiera Hondurena also experienced a large market share decline (from 25.1% to 5.0%) during the same period, as did the three banks with foreign ownership, whose industrial lending share fell from 19.5% to 13.5%. 1/ Seven smaller banks and one financiera are rapidly growing in importance and have increased their share of new industrial lending from 10.8% in 1975 to 22.0% in 1980. With high competitive pressure and relatively low lending limits, 2/ the commercial banks have actively sought to broaden their SMI clientele. 1/ The importance of the larger banks, particularly of one of the three foreign owned banks, is underestimated since they also provide a substan- tial amount of guarantees for dollar financing of industrial clients by foreign banks. 2/ Commercial banks are not permitted to have loans outstanding to a single enterprise greater than 20% of their equity. Thus the maximum size loan for the smaller 8 of the 15 commercial banks (including Banfinan) ranges from US$270,000 to US$990,000 equivalent, with an average for all the commercial banks of about US$1.0 million equivalent, as of December 31, 1980.  - 16 - Table 2.2: Industrial and Total Financing by Intermediaries (1975 and 1980) (new loans in millions of current US$) Industrial Total 1975 1980 1975 1980 I/ Amt. % Amt. % Amt. % Amt. % Commercial Banks Atlantida 17.4 35.7 23.6 14.4 74.4 19.0 111.2 14.7 Honduras 4.3 8.8 6.4 3.9 33.8 8.7 33.6 4.4 Occidente 1.1 2.3 5.3 3.3 15.6 4.0 40.1 5.3 Londres y Montreal 3.1 6.4 8.2 5.0 19.7 5.0 30.1 4.0 El Ahorro Hondureno 2.7 5.5 12.5 7.7 43.2 11.0 67.0 8.9 Bank of America 3.3 6.8 8.9 5.5 29.9 7.6 42.7 5.7 Los Trabajadores 0.3 0.6 1.3 0.8 17.4 4.4 55.3 7.3 BANCAHSA 5.4 11.1 7.0 4.3 33.9 8.7 72.4 9.6 Del Comercio 3.1 6.4, 4.9 3.0 19.0 4.9 38.4 5.1 Continental 0.7 1.4 2.9 1.8 7.6 2.0 18.6 2.5 Hipotecario Sogerin 0.3 0.6 2.9 1.8 8.7 2.2 36.8 4.9 Fuerzas Armadas - - 3.2 2.0 - - 25.0 3.3 Mercantil - - 4.0 2.5 - - 14.5 1.9 Financiera Hondurena 6.8 14.0 1.1 0.7 51.4 13.1 19.4 2.6 Financiera Centroamericana 0.2 0.4 3.4 2.1 - - 21.4 2.8 Public Banks CONADI - - 67.3 41.2 4.8 1.2 76.8 10.2 BANADESA - - - - 32.2 8.2 52.0 6.8 TOTAL 48.7 100.0 162.9 100.0 391.6 100.0 755.3 100.0 1/ Preliminary data to October 1980, annualized. Source: Central Bank of Honduras.  - 17 - Other Financing Institutions 2.06 Other institutions financing industry in Honduras are CDI, COHDEFOR, and CONADI which are discussed in paras. 3.30 to 3.36, and the Central American Bank for Economic Integration (CABEI). CONADI, the government indus- trial development institution created in 1974, has become the most important source of financing to the industrial sector, accounting for about 41% of industrial lending and 10% of total lending of the financial system. Currently CONADI has financial problems and its lending level for the next 1-2 years is expected to be very modes:i (paras. 3.34 to 3.36). CABEI, although not part of the Honduran banking system, has been active in financing Honduran industry. CABEI was founded in 1961 as the bank for economic integration of the Central American region, with headquarters in Tegucigalpa. Since its inception, it has made 72 loans totaling US$36.5 million to the manufacturing sector in Honduras, for projects with a total cost of US$123.8 million. The subprojects financed are large, with an average loan size of about US$500,000, and an average subproject investment of about US$1.7 million. For the next 2-3 years, CABEI's industrial financing in Honduras is expected to be modest, taking into consideration also that larger private subprojects requiring CABEI financing are not ready for implementation. B. Monetary Policy and Mobilization of Resources Background and Objcctives 2.07 Following the rapid expansion of export earnings in 1976, increased domestic savings were supplemented by substantial foreign borrowings, resulting in a significant rise in credit during the 1976-1978 period. This favorable situation, however, changed in mid-1979. The growth of financial savings weakened, partly as a result of political uncertainties and low domestic interest rates. Foreign medium- and long-term borrowing from commercial banks was limited by the desire of foreign commercial banks to limit their exposure in Central America and by sharply rising foreign interest rates, thus eliminating or reducing considerably the spread with which domestic banks could operate. As a result, the banking system found itself in a liquidity squeeze, which led to a decline in credit to the private sector. By 1980 total credit growth became negative in real terms. This reduction in real credit adversely affected private sector activities. However, the situation is expected to improve as a result of the program agreed with the IMF (para. 1.05) and the new Central Bank's policy on interest rates (para. 2.09). 2.08 Monetary policy in Honduras has traditionally focused on three principal objectives: (i) maintaining the stability of the lempira within a system of free-currency convertibility; (ii) seeking to achieve equilibrium in the balance of payments; and (iii) keeping the domestic inflation rate at or below the level in the US, Honduras principal trading partner. These objectives have been pursued by modifying legal reserve requirements on deposits, regulating the percentage of commercial bank lending for a particular purpose, limiting discount and rediscount facilities mainly to agricultural crop and export financing, and levying surcharges on imports of non-essential  - 18 - items. Partly as a result of these government policies, the historical rate of inflation in Honduras, as measured by the consumer price index, has been low compared to many other Latin American countries, and the US dollar-lempira exchange rate has remained at 2:1 for the past two decades. The annual average increase of the consumer price index rose from 3.4% in 1970-1973 to 7.7% in 1976-1979. In 1980, inflation rose to 19% as a result of the substan- tially higher prices of imported goiods, triggered in part by the new round of oil price increases, and because production of basic grains has not kept pace with rising demand. Interest Rates and Financial Resources 2.09 Interest Rates. While in the 1960s interest rates were modified infrequently, in the 1970s interest rates have played a more important role in monetary policy. The maximulm interest rates on productive loans, 1/ which were constant between 1967 and 1971, were raised substantially from 8% to 11% in two adjustments (in 1972 and 1974) and were changed again in 1980 and 1981. Interest rates on loans for consumption or commerce, however, had been increasingly restricted sinc-e 1974 when the free market rate was replaced by a 13% ceiling interest rate. In the face of a 66% increase in banking liquidity between 1975 and mid-1977, the BCH raised legal reserve requirements on all bank deposits, from 25% to 30%, thereby increasing the cost of resource mobilization by the banking systesm, and reducing incentives to raise long-term funds. In 1978, 1979 and 1980, the lending rates were raised (Annex 4, Table 8). Ceilings of 11% and 14% established in 1978 and in 1979, respectively (which in practice were much lower), on deposit interest rates, hampered the mobiliza- tion of domestic resource. In addition, a lending rate ceiling (16% prior to March 1980 and 19% thereafter) caused difficulties to local commercial banks in obtaining foreign commercial borrowing. As part of the financial program developed with the IMF, interest rates were freed on saving deposits (the only deposits with fixed rates), and a maximum spread of 3.5% above the external borrowing cost was allowed on loans of commercial banks which were financed with foreign credit (Table 2.3). 1/ Loans to expand or improve output of agriculture and industry, which must constitute not less than 70% of commercial banks' lending, while lending for commerce and trade or consumption may not be more than 30%.  - 19 - Table 2.3: SUMMARY OF MAXIMUM ANNUAL INTEREST RATES 1/ Rates for Loans over L5000 1980 May 1981 Loans for any purpose 19% 19% 2/ (provided bank paying between 7%-8% on at least 51% of savings deposits in local currency) Loans for any purpose 16% 16% 2/ (when above condition not met) Deposit Rates Savings Deposits (in banks) 8.0 FREE Savings Deposits (in S & Ls) 9.0 FREE Time Deposits 8-14 3/ FREE 1/ Above interest rates do not apply when specified in loan agreements with international/bilateral agencies. 2/ Loans financed with foreign funds allowed a maximum spread of 3.5% above external contracted rate. 3/ Special rates for large deposits. Source: Annex 4, Table 8 2.10 Deposits. The government's past policy of setting interest rates for time deposits to yield savers positive returns on average, together with an effective resource mobilization by the commercial and housing banks, was successful particularly in 1974-78 when deposits, in nominal terms, grew at about a 22% annual rate. A substantial part of this high growth was due to increased time deposits (with maturities of three months to one year), which grew at about a 25% annual rate (Annex 4, Table 7). Mobilization of deposits denominated in foreign currencies during this period also grew at about 32% p.a. However, the growth rate of domestic currency deposits dropped substan- tially (to 11%) during 1979-80, as a result of the negative interest rates (in real terms) paid on deposits, the political uncertainty in Central America and higher interest rates paid abroad. In addition, the mobilization of foreign medium- and long-term financial resources by the system 1/, which, in real terms, had declined by 18% between 1978-79 continued to decline by 6% in 1979-80, further reducing the availability of resources. Foreign borrowings by domestic commercial banks declined by 51% in 1978-79 and 38% in 1979-80. Central Bank credit, however, increased by 58.3% annually during this period providing some liquidity to the banking system. Approximately 31% of this Central Bank credit was provided to Financiera Hondurena for emergency financial assistance, with an additional 40% of the credit equally divided between BANADESA, SOGERIN and Occidente, mostly to cover required reserve deficits with the Central Bank. 1/ Excluding BCH.  - 20 - 2.11 Short-term foreign borrowing by domestic banks is strictly limited to the short-term financing of exports of coffee, cotton, tobacco and other major agricultural or seafood products. With previous authorization from BCH, banks could have obtained long-term resources abroad, but were (until May 1981) restricted to the stipulated interest rate lending ceilings. This, in the context of the unusually high irLterest rates prevailing during the past year in the international markets, discouraged commercial banks from borrowing abroad, which partially explains the sharp decline of foreign bank borrowing of 38% between 1979-80 by local c:ommercial banks. It is expected that the new measures taken by BCH (para. 2.09) will assist the banking system in mobilizing both domestic and foreign resources. 2.12 Internal Resources. Internally generated resources of the banking system have been progressively declining in importance as deposits have expanded. Capital and reserves of the banking system amounted to L103.1 million (20% of total resources) in 1971 and L293.5 million (13%) in 1980. However, commercial banks and other financial institutions are providing an important part of CONADI's capital, since, in addition to the government's capital contribution, CONADI receives contributions from each bank and insurance company in an amount equal to 10% of their capital and reserves. These contributions receive preferred 6% shares in CONADI. In addition, as quasi-equity, CONADI receives an anrnual contribution of 10% of total import duties or income taxes exempted by the government from industrial enterprises. Contributing industries receive non-negotiable 6% interest-bearing certificates repayable by CONADI in 20 years, with 3 years of grace. 2.13 Rediscounts. The BCH