Tunisia - SOGITEX Textile Rehabilitation Project

Document of FILE COpy The World Bank FOR OFFICIAL USE ONLY Report No. P-3068-TUN REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF TUNISIA FOR A TEXTILE REHABILITATION PROJECT May 11, 1981 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 Currency Unit - Tunisian Dinar (D) Tunisian milliames 1,000 - D 1.000 The exchange rate of the Tunisian Dinar is floating. The rate used in the President's and Staff Appraisal Reports, which approximates the current rate, is: US$ 1.00 - D 0.400 D 1.000 = US$ 2.50 D 1 million = US$ 2.5 million FISCAL YEAR January 1 - December 31 WEIGHTS AND MEASURES 1 Metric Ton - 1,000 Kilograms = 2,2C4.6 Pounds 1 Meter (m) = 1.0936 Yards = 39.37 Inches 1 Square Meter (m2) = 1.2 Square Yards = 10.76 Square Feet PRINCIPAL ABBREVIATIONS AND ACRONYMS USED BDET - Economic Development Bank of Tunisia EOE - Export Oriented Enterprise MFA - Multi-Fiber Agreement SITER - United Textile Industries Inc. (Societe Des Industries Textiles Rgunies) SITEX - Textile Industry Inc. (Societe Industrielle Des Textiles) SOGEX = Accounting, Management and Auditing Inc. (Societe Fiduciaire d'Expertise Comptable, d'Organisation Generale et d'Audit). SOGITEX General Textile Industries Inc. (Socigte Generale Des Industries Textiles) SOMOTEX - Textiles of Monastir Inc. (Socigte Monastirienne Des Textiles) SSI Small Scale Industry TISSMOK = Societe de Tissage de Moknine toe - tons oil equivalent  _ FOR OFFICIAL USE ONLY TUNISIA TEXTILE REHABILITATION PROJECT Loan and Project Summary Borrower; Republic of Tunisia Beneficiaries: SOGITEX Holding and its four main production subsidiaries--SITEX, SITER, SOMOTEX and TISSMOK. Amount: US$18.6 million equivalent Terms: 15 years including a grace period of three and one half years at an interest rate of 9.6 percent per annum. Relending Terms: The proceeds of the Bank loan would be onlent to SITEX (US$14.4 million equivalent) and to SOGITEX Holding, SITER, SOMOTEX and TISSMOK (US$4.2 million equivalent), for 15 years including a grace period of three and one half years at an interest rate of 10.6 percent per annum. The beneficiaries would bear the foreign exchange risk. Project Description: The proposed project will assist the Government in implementing the first phase of the rehabilitation and modernization requirements of the SOGITEX Group. The objectives of the project are to expand and improve SITEX's production so as to enhance the competitiveness of the company in export markets and prepare the ground for the rehabilitation of SITER, SOMOTEX and TISSMOK. The proposed project comprises the following components: (i) expansion and improvement of SITEX's production by reconditioning spinning and winding equipment and upgrading service facilities at Sousse, by expand- ing and upgrading the existing weaving and finish- ing facilities at Ksar Hellal, and by providing essential incremental working capital; (ii) balancing of the existing production facilities as well as overhauling of selected equipment and provision of essential spare parts and accessories to SITER, SOMOTEX and TISSMOK; and (iii) technical assistance to help SITEX prepare and implement its rehabilitation and expansion program, to upgrade the management and accounting systems of SITEX, SITER, SOMOTEX, TISSMOK and the holding company, and to strengthen marketing capabilities and prepare future investment plans for SITER, SOMOTEX and TISSMOK. 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.  Benefits and Risks: Upon project completion in 1983, SITEX's annual yarn and finished denim production would reach 13,250 tons and 26 million square meters respectively, a 65 percent increase over 1980 levels. This, together with the improved quality of production, would increase substan- tially SITEX's revenue earning potential. The main risks are those normally associated with textile proj- ects in general (low profit margin) and export projects in particular. However, SITEX's output mix is flexible and the company is competitive in the EEC market due to its relatively low labor and freight costs and high quality of production. The investments proposed for SITER, SOMOTEX and TISSMOK, together with technical assistance, would improve equipment and operations in these three companies while preparing for a full rehabilitation to be implemented in a second stage. Estimated Costs: Local Foreign Total -------US$ million--------- SITEX Equipment and spares 0.9 9.3 10.2 Installation and start-up 0.1 0.4 0.5 Engineering, Consulting Services, and Training 0.2 0.4 0.6 Base Cost 1.2 10.1 11.3 Physical Contingencies 0.1 1.0 1.1 Price Contingencies 0.1 1.1 1.2 Subtotal 1.4 12.2 13.6 Incremental Working Capital 3.7 7.2 10.9 Interest during Construction 0.2 2.6 2.8 Total SITEX 5.3 22.0 27.3 SOCITEX Holding, SITER, SOMOTEX, TISSMOK Equipment and spares 0.2 2.6 2.8 Consulting Services 0.1 0.8 0.9 Base Cost 0.3 3.4 3.7 Physical and Price Contingencies 0.1 0.8 0.9 Subtotal 0.4 4.2 4.6 Interest during Construction 0.1 0.9 1.0 Total SOGITEX Holding, SITER, SOMOTEX, TISSMOK 0.5 5.1 5.6 Grand Total 5.8 /1 27.1 32.9 /1 Includes US$0.3 million of local taxes.  - iii. - Financing Plan: Local Foreign Total - US$ (million)------- Government Equity 5.8 4.0 9.8 Swiss Credits - 4.5 4.5 IBRD - 18.6 18.6 Total 5.8 27.1 32.9 Estimated Disbursements: Bank FY: 1982 1983 1984 -------US$ (million)------ Annual 10.7 7.4 0.5 Cumulative 10.7 18.1 18.6 Rate of Return: about 30 percent Appraisal Report: 3369-TUN dated May 7, 1981 Map: IBRD 15613   INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF TUNISIA FOR A TEXTILE REHABILITATION PROJECT 1. I submit the following report and recommendation on a proposed loan for the equivalent of US$l8.6 million to the Republic of Tunisia, to help finance the foreign exchange cost of a Textile Rehabilitation Project. The loan would have a term of 15 years, including 3 and one half years of grace, with an interest rate of 9.6 percent per annum. US$14.4 million equivalent would be relent to Societe Industrielle des Textiles (SITEX) and US$4.2 million equivalent to Societe Generale des Industries Textiles (SOGITEX), Societe des Industries Textiles Reunies (SITER), Societe Monastirienne des Textiles (SOMOTEX) and Societe de Tissage de Moknine (TISSMOK) for 15 years including 3 and one half years of grace with interest at 10.6 percent per annum. The beneficiaries would bear the foreign exchange risk. The financing plan for the project includes US$4.5 million equivalent from the Swiss Govern- ment (US$l.5 million equivalent, interest free, for 15 years including 10 years' grace) and Swiss commercial banks (US$3 million equivalent at an interest rate of 6.7 percent per annum, for 10 years including 3 years of grace). PART I - THE ECONOMY 1/ 2. The last economic report entitled "Economic Position and Prospects of Tunisia" (No. 2201-TUN) was issued on November 16, 1978. An economic mission visited Tunisia in June 1980 and this part reflects its findings. Country Data sheets are attached in Annex I; present economic projections are provi- sional and strongly depend on the outcome of an ongoing study on the future of domestic oil production and energy demand and on the economic policies that will be adopted for the Sixth Development Plan (1982-86). 3. Tunisia is rather poorly endowed with natural resources. Much of it is arid or semi-arid. The limited areas where dry-land agriculture is possible are subject to severe year-to-year fluctuations in rainfall. The adverse effects of climatic fluctuations are alleviated by expanding irriga- tion. Tunisia's most important raw materials are phosphates, petroleum, and natural gas; however, the known exploitable reserves of oil and gas are small, and phosphate deposits are of relatively low quality. There is considerable tourism potential, and efforts have been made to develop it rapidly over the last decade. 4. Since independence in 1956, Tunisia has undertaken a massive effort towards development of its human resources, paying special attention to educa- tion and training as basic prerequisites for modernization. As a result, the adult literacy rate has increased from under 15 percent at the time of 1/ Part I is substantially unchanged from that in President's Report No. P-3063-TUN for a Health Project distributed to the Executive Directors on May 8, 1981.  - 2 - independence to 55 percent by 1980; the health and nutrition status of the population improved, average calorie supply per capita increased from about 80 to 112 percent of requirements, and life expectancy at birth increased from about 48 years in 1960 to 57 years in 1978. 5. Tunisia's economy depends on rural activities to provide employ- ment, but on petroleum and phosphate exports to provide foreign exchange earnings. Manufacturing is rapidly becoming important in both respects. The relative sectoral composition of GDP shows a diversified economic structure. From the employment point of view (the country's most pressing social problem), Tunisia remains an agricultural economy, with the rural sector providing work for about one out of every three Tunisians in the labor force. The direct employment effects of petroleum extraction, phos- phate mining and tourism are small, although these sectors make a vital contribution to GDP, public revenues, savings and exports. From the export point of view, Tunisia is largely a petroleum and mining economy with those two activities providing 37 percent of the country's foreign exchange earn- ings; all manufacturing activities and tourism together provide another 43 percent. The Main Economic Sectors in 1979 (in percent) GDP /1 Employment Exports /2 Agriculture 16.2 35.0 6.8 Energy/Mining 12.1 1.8 37.1 Manufacturing 12.1 21.8 22.5 Tourism 4.8 1.5 20.2 Construction and Services 41.2 25.4 13.4 Government Administration 13.6 14.5 - 100.0 100.0 100.0 /1 At factor cost. /2 Goods and non-factor services. Recent Economic Developments 6. Tunisia's economy has grown relatively fast in recent years. GDP, in constant prices, increased at an average annual rate of 6.5 percent from 1976 to 1979. Although this is somewhat less than the 8.6 percent growth rate for the 1969-76 period, Tunisia's GDP growth of 8.0 percent for the entire decade 1969-79 places it among the top 10 middle-income countries; it also marks a substantial improvement over the relatively low growth (4 percent per annum) experienced during the 1960s. GNP per capita reached $1,120 in 1979, which, in constant prices, is about 73 percent above the 1969 level.  7. The impressive growth achieved from 1969 to 1976 was largely attributable to changes in economic management introduced at the beginning of this period. In agriculture, stronger Government efforts to stimulate production, reoriented towards promotion of individual farming, together with favorable weather conditions, resulted in a near doubling of produc- tion, a remarkable turn-around from the slow, but continuous, decline in agricultural production during most of the 1960s. In manufacturing, the degree of Government control declined, and more incentives were given to private initiative. An increasingly export-oriented investment strategy, coupled with a dynamic marketing effort, led to a rapid growth of produc- tion, particularly in textiles, while tourism was promoted with marked success. 8. During the second half of the 1970s, the situation was quite different, not so much in terms of overall growth (which slowed down slightly), as in terms of the underlying growth factors; output in agri- culture has virtually stagnated since 1976, partially as a result of bad weather conditions; textile production declined in 1978, and tourism development slowed down because of the 1977 slump in the European tourist market. By contrast, petroleum production and, to a lesser extent, phos- phate processing expanded making these two sectors the main engine of economic growth over the 1976-79 period. After an exceptional low level in 1976, oil production increased by over 12 percent per annum up to 1979; more important, however, were the large profits reaped by Tunisia from the successive increases in crude oil prices, starting in 1974. These large additional foreign exchange earnings enabled the country to increase its investments, from an average of slightly over 20 percent of GDP before 1975, to nearly 29 percent thereafter, and expand its public services at a rapid rate. These two factors, in turn, triggered a rapid growth in the construction industry and in local manufacturing of construction materials. 9. In spite of the considerable increase in domestic demand, particu- larly in investments, the balance of payments situation remained favor- able. Even in constant prices, exports grew marginally faster than imports. In addition, the terms of trade improved significantly, due to higher export prices for oil and low import prices for grain. As a result, the resource gap remained relatively small, and domestic savings financed on average over 72 percent of the greatly increased investment effort. The current account deficit of $500-600 million (1978/1979) was easily financed; grant aid and private investments accounted for about 30 per- cent, while the remainder was covered by long-term foreign borrowing. The increase in lending to Tunisia from public sources allowed it to reduce borrowing from financial markets and suppliers' credits. During the 1970s, therefore, total foreign debt disbursed increased little relative to GDP and the debt service ratio improved (para. 18). Net foreign exchange reserves increased in seven out of the last ten years, but still repre- sented only 1.5 months of imports at the end of 1979. 10. Since independence, the public sector has played a major role in mobilizing and redistributing domestic resources. General budgetary  - 4 - revenues were equivalent to one-third of GDP in 1978 and 1979, one of the highest shares among middle-income countries. Over one-fourth of these revenues were saved, and public savings financed close to two-thirds of total government capital expenditures. This comfortable public finance situation has led to a fast increase in subsidy payments to private con- sumers and public enterprises. Such transfers have nearly doubled over the last four years, accounting for 16 percent of total current budget outlays, or 4 percent of GDP. This level of subsidies, to cover the increasing operational deficits of public enterprises may not be sustainable in the long term; similarly, consumer subsidies for basic necessities will have to concentrate more systematically on the needy. Medium-term Prospects 11. The objectives of the Fifth Development Plan (1977-81) have a good chance of being achieved, except for the employment creation targets. The actual GDP growth will be just short of the planned rate of 7.3 percent per annum, while the investment objective of $9.8 billion in current prices, or 30 percent of GDP, will be fully met. Completion of some large projects in the public sector (steel, cement, expansion of the oil refinery) will, how- ever, be delayed. Private sector investments, both foreign and national, are likely to exceed Plan targets. The Government welcomes this shift from large capital-intensive projects in the public sector to medium-scale industries as a means to speed up employment creation. Open and hidden unemployment is currently considered the most serious problem for the Tunisian economy. During 1977-79, the domestic non-agricultural economy could only absorb three-fourths of new job seekers. In view of this, and of the fact that migration to Libya and Europe is decreasing rapidly, the overall unemployment and underemployment rate, estimated at between 20 and 25 percent, has not declined markedly. 12. The Sixth Development Plan (1982-86) is presently in preparation. Employment generation, food self-sufficiency, and more rapid growth in the three most backward regions of the country (North-West, Center-West, and South) are likely to be among its major objectives. The outlook for over- all economic growth during this period and beyond, will depend upon future developments in the oil and natural gas sector. Based on known reserves, it is generally expected that oil production will decline after 1981 from its present level of 5-6 million tons per annum and will come to an end during the late 1990s. The possible exploitation of some of the smaller fields that may soon become profitable will not delay the declining produc- tion trend by more than a few years. Some off-shore fields cannot be exploited for the time being, because they are located in areas disputed by Libya. Gas production in presently exploited fields (385,000 tons of oil equivalent--toe--in 1979) is expected to cease around 1990. Royalties from the Algerian/Italian pipeline will provide an additional supply of natural gas, rising from 200,000 toe in 1982 to 800,000 toe in 1986 and there- after. Negotiations with Algeria on the purchase of additional quantities of natural gas are proceeding, but have so far been inconclusive. The Government is therefore considering the exploitation of the off-shore gas  field of Miskar, despite its high production cost. The optimal use of all these resources is being studied with foreign assistance, within a compre- hensive long-term policy framework. 13. While detailed macroeconomic growth projections beyond the mid- 1980s will have to wait for the outcome of these studies, there can be little doubt that--except in the unlikely case of large new oil discoveries--Tunisia will face the consequences of a decline in oil and gas production over the next 10-15 years, and become a net importer of hydro- carbons, perhaps as early as 1987-88. The Government is fully aware of these developments. It agrees that the situation will require significant policy changes in the near future and is analyzing the areas where these changes will have to take place in the context of the preparation of the Sixth Plan. Unlike many other developing countries, however, Tunisia has enough lead time to introduce these changes gradually until the mid-1980s. This will reduce the associated economic and social strains, and should avoid major balance-of-payments problems. Assuming that the necessary measures will be implemented, it is reasonable to expect an overall GDP growth of about 7 percent in constant prices, until at least 1985. 14. The expected decline in oil production and exports is likely to have an impact on external debt and domestic savings, particularly public savings. Changes in demand management will thus be required to avoid balance-of-payments difficulties and maintain satisfactory economic growth. In the public sector, the necessary restraint in current budget expenditures will require a reassessment of present price and subsidy policies, in particular for energy, basic foodstuffs, and transportation. Considering the complexity and the pervasiveness of the present subsidy system, and the impact its dismantling will have on domestic inflation and on the standard of living (particularly on the 17 percent of the population still living in absolute poverty), the introduction of changes into the system will be a difficult endeavor, but ought to be initiated without delay. As part of this effort, the subsidies to public enterprises, to a large extent stemming from managerial inefficiencies, ought to be phased out. In addition, interest rate and fiscal policies will have to be used more effectively to restrain final consumption, particularly of imports, and to stimulate savings. Finally, wage and salary policies will have to keep labor cost increases in line with productivity increases, particularly since Tunisia will have to stimulate tourism and make a greater effort to improve its competitiveness in international markets by promoting exports of manufactured goods other than textiles. 15. A successful and timely implementation of these policy changes, however, cannot prevent a decline in the domestic savings rate. This, in turn, will require a corresponding adjustment in the investment rate below the present average of 29 percent of GDP, so as to maintain a manageable spread between domestic savings and investments. More resources will have to be allocated to labor-intensive projects, particularly to small and medium manufacturing enterprises, in order to ease the unemployment problem and reduce income disparities, between rural and urban areas as well as  within each of these areas. While investments in education, health, hous- ing and water supply will have to continue, they should be focussed more on the most needy income groups, provided at lower costs (health, shelter), and made more relevant to the needs of the economy (education, training). Social Issues 16. In general, Tunisia's social performance has been impressive. Since independence, the country has come a long way towards meeting the basic needs of its population and reducing absolute poverty. About 16 per- cent of GDP is now devoted to social programs, although too many of the benefits still accrue to the upper income groups. Education expenditures rank first among budgetary outlays. The comprehensive education system provides free access for all students, and the gross enrollment rate has reached 100 percent for primary education and 22 percent for secondary education. The performance of the system, however, could be improved by: (a) expanding vocational training programs and improving their relevance and coordination with labor demand; and (b) catering more to poorer and rural groups. Public health services are second among social expenditures, and their overall beneficial effect is reflected in the improvement of the vital statistics (para. 4). There remain, however, regional disparities in the availability of hospital beds, doctors, and nursing personnel and the medical referal system is not properly functioning. As a result, the rural poor are often excluded. Closely linked to nutritional deficiencies, infant mortality is still high. So far health services have concentrated largely on curative medicine. To achieve better and faster results, the Government is planning to allocate more resources to preventive medicine and nutrition education. Finally, Tunisia faces a difficult housing situation. Subsidized housing, the cornerstone of public intervention, has not reached the most needy groups. The housing demand from households above the poverty limit should be satisfied by the private sector; to this end, adequate incentives need to be provided. 17. Absolute poverty still affects one out of every six people in Tunisia. Over the last fifteen years, the overall number of absolute poor remained stable but declined in rural areas as a result of internal and external migration. Most of the poor are unskilled seasonal workers in agriculture and industry, small farmers, and artisans. Income differen- tials between the coast (East) and the interior (West) widened, in part because the system of price controls and subsidies, as well as the tax system and budgetary expenditures, had a weak redistributive impact. The Government is using the preparation of the forthcoming Plan as an occasion to focus on basic needs and poverty alleviation, with a view of abolishing absolute poverty before the end of this century. Maintaining a low popula- tion growth rate will be an important factor for a significant alleviation of poverty. External Assistance and Foreign Debt 18. As mentioned above (para. 9), foreign borrowing remained limited during the second half of the 1970s, and a growing share of foreign funds  was provided by public sources at relatively soft terms. During the 1976-79 period, foreign loan commitments averaged about $670 million per annum, two-thirds of which in the form of Official Development Assistance (ODA--$450 million or some $75 per capita). About 70 percent of ODA com- mitments came from bilateral sources, chiefly France, the Federal Republic of Germany and Canada, but also some oil-surplus countries, whose contribu- tions averaged about one-fourth of total bilateral ODA. About 17 percent of total ODA was committed by the Bank Group, and some 13 percent by other multilateral sources. Borrowing terms were favorable, averaging 6.1 percent interest and 18 years maturity, including a grace period of 4.8 years. At the end of 1979, debt outstanding and disbursed was estimated at about $2.9 billion, or one-third of GDP; debt service was 10.7 percent of exports of goods and services, as compared with 17.8 percent in 1970. Direct foreign investments were small during most of the 1970s, but have gained momentum during the last five years in line with increased activi- ties in the petroleum sector and new incentives offered to foreign in- vestors in manufacturing. Such investments have increased from less than $20 million in 1969 to more than $100 million in 1976 and $165 million in 1979. 19. The balance-of-payments outlook remains favorable, at least up to the mid-1980s. Thereafter, much will depend on the policy measures initiated during the next few years (para. 14). The main risk would be for Tunisia to attempt to continue its policy of high investments and high current social outlays in spite of the expected decline in foreign exchange earnings and domestic savings. Pressures to that effect will certainly exist. The new Government formed in the spring of 1980, however, is aware of this danger and recognizes the need for change. Considering its long record of prudent and skillful balance-of-payments and external debt management, there is every reason to assume that Tunisia will formulate and implement the necessary reforms and, thus, will continue to remain credit- worthy for future Bank lending. PART II - BANK GROUP OPERATIONS IN TUNISIA 20. Between 1962 and March 31, 1981 Tunisia has received forty-one Bank loans and eleven IDA credits amounting respectively to $765.6 million and $70.1 million (net of cancellations) of which fifteen loans and nine credits have been fully disbursed. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of March 31, 1981, and notes on the execution of ongoing projects. Project implementation is generally satisfactory. In a number of sectors, important institutional improvements have been achieved, and autonomous agencies have been created or strengthened to ensure the efficient management of the related sectors or subsectors. 21. The Bank's lending strategy in Tunisia aims at supporting Govern- ment efforts to: (a) increase employment; (b) encourage more balanced  growth and distribution of income among regions and income groups with particular emphasis on rural areas; (c) promote export-oriented policies and investments; and (d) provide selective support for the development of basic infrastructure and for institution building in key public services. An important feature of this strategy is to support the Tunisian authori- ties in the timely and well-coordinated preparation of projects through missions and advice by Bank staff, the assistance of the IBRD/FAO Coopera- tive Program and the use of the Bank's Project Preparation Facility. The Bank is also supporting the Government in its efforts to increase the mobilization of domestic resources, and to secure cofinancing for the projects it assists. The latter is particularly important in view of the extent of Tunisia's external resource needs. 22. Within this broad framework, past lending emphasized support for long-term investments in infrastructure and social development. Lending for urban and social development, including water supply, sewerage, educa- tion, family planning, urban low-cost housing, and the Tunis planning and public transport project has accounted for 28 percent of Bank/IDA commit- ments in Tunisia since 1971. Lending for transport, power and tourism infrastructure has accounted for 36 percent. Agriculture and fisheries have received 22 percent, and industrial and hotel financing, mostly through the Banque de Developpement Economique de Tunisie (BDET), 14 per- cent of total commitments. 23. In line with its lending strategy, the Bank will pursue its efforts in key sectors of the economy that offer prospects for economic and social development. It will also assist projects which enhance regional integration and help reduce the gap between income groups, and between urban and rural areas. Particular attention will be paid to employment creation and institution building. In addition to the proposed textile rehabilitation project, the lending program includes projects in various stages of processing in the agricultural sector, in industry, highways, urban development, and education. 24. The Bank's economic and sector work will continue to focus on strengthening the macro-economic and sector base for our lending program; it will be more centered in the future on the analysis of economic issues and policies related to the necessary adaptation process from a petroleum exporting to a petroleum importing country including appropriate interest rate policies (paras. 12-14). Two major reports in 1980 on the mechanical and electrical industries and on the social aspects of development provided a better knowledge of the country's industrial development base and pros- pects in these sub-sectors, and a better understanding of income dispari- ties by evaluating the Government's social policies aimed at poverty alleviation. Future reports will include a review of pricing and subsidy policies in the rural sector, of the Sixth Plan (1982-1986), and of the agricultural, education and training, urban and energy sectors. 25. The Bank and IDA accounted for about 12 percent of total public commitments to Tunisia during 1970-1979. Their share in total debt out- standing and disbursed at the end of 1979 (including loans from private  sources) was 10 percent and their share in debt service during 1979 was 11 percent. The Bank's and IDA's share in Tunisia's disbursed external debt by 1986 is expected to decrease to about 7 percent, and their share in the debt service would increase to about 16 percent. 26. IFC has invested in NPK Engrais (a fertilizer plant), BDET (a Tunisian development finance company), in Compagnie Financiere et Touristique (COFIT, a company to promote and invest in tourism projects), in Societe Touristique et Hoteliere RYM (a large hotel development), in Industries Chimiques du Fluor, which produces aluminium fluoride from local fluorspar for export, and in the Sousse-Nord integrated tourism development project. IFC's net commitments in Tunisia total $12.8 million, as of March 31, 1980. PART III - THE MANUFACTURING SECTOR Background 27. Manufacturing is a leading sector in the Tunisian economy in view of its ability to generate employment (74,000 new jobs in 1977-80), to export tD 370 million, or 40 percent of commodity exports in 1980), and to attract foreign investment (D 50 million during 1972-78, or 18 percent of total investment in manufacturing). The Government has played an important role in promoting the industrial development of the country. In the 1960s it invested heavily in capital intensive activities such as construction materials, chemicals and steel, to promote import substitution, while in the 1970s it oriented its investments more towards labor-intensive activi- ties. During the last decade, industrial development objectives also shifted to focus more on private investment and exports. As a result of strong Government incentives, supplemented by protection against competi- tion from imports, manufacturing growth accelerated from 6.4 percent per annum in real terms during the 1960s to close to 10 percent during the 1970s, and its share of GDP increased from about 10 percent in the 1960s to about 12 percent in the 1970s. Private investment, encouraged by Govern- ment incentives increased from D 25.8 million during 1969-72, to D 151.6 million during 1973-1976 and D 235 million during 1977-80. 28. Despite these achievements, the sector suffered from a number of weaknesses. First, weak management capability and employment creation beyond efficiency levels resulted, after 1972, in deteriorating produc- tivity in public sector companies in the construction materials, food, and chemical industries. Productivity was, however, maintained in electro- mechanical industries, and it increased in private Tunisian textile enterprises, especially in those with foreign participation (para. 29). Second, although exports increased on the average by over 20 percent per year during the 1970s, export diversification was constrained by the Government's pricing and protection policies.  - 10 - The Textile Industry Subsector 29. The textile industry has played an important role in the real- ization of Tunisian development objectives because of its low capital intensity, and good export potential. In the 1970s, textiles were the second largest contributors to value added in manufacturing (after food processing) and led the manufacturing sector in exports and job creation. During 1973-78, textiles generated about 40 percent of all new jobs in manufacturing and accounted for about 30 percent of industrial exports, while absorbing only about 10 percent of industrial investment. By 1979, the country was producing about 52 percent of its yarn and all of its fabric consumption. Until its recent restructuring into a holding company and four main production subsidiaries 1/ (para 39), Societe Generale des Industries Textiles (SOGITEX), was the only public sector textile company. In 1979, it accounted for about 50 percent of all yarn and fabric manufac- tured in Tunisia, and for almost all fabric exports. The private sector consists of about 60 textile companies engaged mostly in weaving, knitting and fabric production for the local market. There are also some 130 enterprises jointly owned by foreign and local private interests, and specialized in garment manufacturing for export. These export-oriented enterprises (EOEs) operate in "Free Zones" and import capital goods, spare parts, and raw materials in bond for further processing in Tunisia prior to export, mainly to the EEC. Tunisia does not produce natural or synthetic fibers--with the exception of small quantities of wool--so virtually all raw materials are imported. Recent experiments to grow cotton have been encouraging, and a pilot project is being considered to grow cotton in southern Tunisia. 30. Consumption of yarn in Tunisia grew from about 21,500 tons in 1974 to 34,900 tons in 1979, and that of fabric from 34.7 million meters in 1974 to 47.5 million meters in 1979. During the same period production of yarn and textile fabric increased from 10,600 tons and 43.1 million meters in 1974 to 18,200 tons and 56.8 million meters in 1979, respectively. Indus- trial production of garments for the local market is not well developed in Tunisia, and in 1979 about two thirds of the woven fabrics were sold over- the-counter for home sewing. While domestic production satisfied 98 per- cent of the demand for new garments, it accounted for only about 50 percent of the total consumption of all garments, the difference being imported used clothing, the use of which is wide-spread in Tunisia because of its low cost. Because of the importance of these articles in the low-income family budget, the Government has allowed such imports to increase more rapidly than the total demand for textile products, and there is now con- siderable pressure from textile manufacturers and trade unions to curb these imports, which they feel constrain the growth of the domestic textile industry. Projections of future demand and supply of textiles indicate 1/ The Holding also owns a fifth small subsidiary, SOPIC, which is engaged in the production of jeans, shirts and sportswear, for both the domestic and export markets.  - 11 - that by 1985 the demand for textile yarn and woven fabrics will exceed supply and by 1990 the deficit is forecast to reach about 11,000 tons of yarn and 4,300 tons of fabric. 31. Exports of textile products from Tunisia increased rapidly in the 1970s, and the growth rate accelerated with the establishment of the EOEs. Between 1973 and 1979, textiles increased their share in manufactured exports from 10.7 percent to 35.6 percent. Out of the total D 139.5 million exported in 1979, about D 109 million represented garments mostly produced by the EOEs from fabrics imported in bond, with the balance (D 30.5 million) being largely cotton fabrics and carpets. Denim--a sturdy fabric traditionally used for the manufacture of blue jeans--accounts for the bulk of Tunisia's exports of cotton fabrics followed by work cloth. 32. Societg Industrielle des Textiles (SITEX)--a subsidiary of SOGITEX and the main beneficiary of the proposed project (paras 40-42)--is the only manufacturer of denim in Tunisia. Production started in 1976 on the basis of an agreement between SOGITEX and Swift, S.A. of Switzerland (a sub- sidiary of Dominion Textiles Inc. of Canada), which provided technical assistance and marketing arrangements as well as necessary equipment. EEC countries represent the major market for SITEX's denim production. By 1980, SITEX was exporting about 15 million square meters to the European market, including 6 million square meters of denim converted into jeans by the EOEs. This successful export performance was due to geographical proximity, a growing market in the EEC (denim consumption in Europe increased from negligible quantities in 1974 to about 220 million square meters in 1980), duty-free entry subject to quota restrictions, and a competitive price for a relatively high quality product. 33. Imports of textile products into the EEC are currently governed by the Multi-Fiber Agreement (MFA) for 1978-1981. In 1980 Tunisia utilized 66 percent of the quota for cotton fabrics, and 75 percent of that for trousers; in France, where SITEX currently sells about 57 percent of its production, half of the quota for cotton fabrics was utilized. EEC markets other than France, Benelux countries and Italy are virtually untapped to sales of SITEX's denim fabric and jeans. The quotas for 1982-1986 are still under negotiation. However the annual increases under the next MFA for Tunisia are not expected to exceed 3 percent for fabrics and 5 percent for garments, in view of the current recession in the EEC textile industry. Bank Role in the Manufacturing Sector 34. To date, Bank financing of manufacturing industries in Tunisia has been limited to loans provided through financial intermediaries. The Economic Development Bank of Tunisia (BDET) has received seven loans from the Bank totalling $95.8 million (net of cancellations), of which $6.5 million remained undisbursed as of March 31, 1981. Most of these funds were used to finance manufacturing industries, although lending for hotels also took a large share, especially in the early years. The Bank's rela- tionship with BDET has been most fruitful. It helped meet BDET's foreign  - 12 - resource requirements while contributing at the same time to strengthening the bank's organization and operating procedures. At the end of 1979, BDET held about 40 percent of all long-term industrial credit outstanding to industry in Tunisia, and about 30 percent of private industrial credit. 35. Several textile projects have been financed by the Bank through BDET. Among the objectives pursued by the Bank through its loans to BDET for the development of the industrial sector there were the promotion of: (i) export-oriented activities; (ii) industrial decentralization towards less developed areas; and (iii) low-cost investments in relation to the number of jobs created or maintained. The seventh loan to BDET (Loan 1504- TUN of January 1978) of $30 million included $2 million earmarked for financing the expansion of Small Scale Industries (SSIs). Simultaneously with this loan, the Bank provided $5 million to the Government (Loan 1505- TUN) to be used exclusively for lending to new SSIs through commercial banks, as well as BDET, as intermediaries. The purpose of the Bank's SSI pilot scheme was to strengthen the ongoing initiatives in the field of financial and technical assistance to SSIs, and to prepare the ground for a full-fledged Bank operation for the development of SSIs. On April 14, 1981, the Executive Directors approved a $30.0 million loan to support the Government's program for SSIs. About 130 SSIs will benefit from the proj- ect and about 5,200 new jobs will be created at an average cost of $11,000. 36. The proposed project would represent a continuation of the Bank involvement in Tunisia's manufacturing sector. The projected increase in output would require only about one third of the investment needed to generate such production from a new operation of similar type and size, while it would contribute greatly to promoting exports and maintaining employment. The project is expected to result in an about turn in profit- ability in SITEX, thus reducing Government subsidies to the industrial sector, while enhancing management capabilities in the public-sector textile industry in general. PART IV - THE PROJECT 37. The Government has requested the Bank to assist in financing a project which represents the first phase of a rehabilitation program for the public-sector textile industry. The project was identified by a Bank mission in June 1979; feasibility studies were prepared by consultants under UNDP financing, and revised with Bank assistance in May/June 1980. The project was appraised in November 1980, and negotiations were held in Washington, D.C. in April, 1981. The Tunisian delegation was led by Mr. Habib Ben Cheikh, President Director General of SOGITEX Holding. The Staff Appraisal Report (No. 3369-TUN, dated May 7, 1981) is being distributed separately to the Executive Directors. A Loan and Project Summary is provided at the beginning of this report; a Supplementary Project Data Sheet (Annex III) and a map showing the location of the plants benefitting from the project are attached.  - 13 - Project Objectives 38. The proposed project represents the first phase of the Govern- ment's rehabilitation program for its textile industry. The project aims at (i) expanding and improving the quality of SITEX's denim production for export; (ii) debottlenecking and overhauling certain production lines in Societe des Industries Textiles Reunies (SITER), Societe Monastirienne des Textiles (SOMOTEX), and Societ4 de Tissage de Moknine (TISSMOK)--three other subsidiaries of SOGITEX--to improve their technical and financial positions; (iii) upgrading the management and accounting systems of the SOGITEX Group; (iv) analyzing the market potential and developing a market- ing strategy for SITER, SOMOTEX and TISSMOK; and (v) preparing detailed investment proposals for the rehabilitation of SOMOTEX, SITER and TISSMOK to be implemented during the second stage of the rehabilitation program. Beneficiary: The SOGITEX Group 39. SOGITEX was created in 1967 through amalgamation of five existing plants. In January 1979 it was reorganized into a holding company with three main operating subsidiaries--SITEX, SITER and SOMOTEX. Although the 1979 restructuring of the Group was intended to give the subsidiaries a large degree of autonomy, SOGITEX retained overall responsibility for marketing and pricing of the subsidiaries' products. The marketing and selling role of the holding company did not, however, prove to be effective and constituted a source of continuing conflict with the subsidiaries. To remedy this situation the Government decided to transfer all marketing and sales activities to the subsidiaries as of January 1980. Further, it soon became apparent that SITER's weaving and finishing facilities did not form an integrated and manageable entity in either geographical or production terms, and in January 1981, the weaving mill was spun-off to form a fourth main operating subsidiary--TISSMOK. 40. SITEX. SITEX is the largest operating company of the Group and would be the main beneficiary of the proposed Bank loan. It is an inte- grated cotton spinning, weaving and finishing operation producing mainly denim, for export to the EEC. It operates two plants, one at Sousse (spinning) and one at Ksar Hellal (weaving and finishing). These facili- ties were not originally designed for the production of denim and the changes introduced to convert the mills to denim production created imbalances, particularly in spinning. Moreover, the low quality of yarn produced and the use of narrow shuttle looms resulted in a relatively high proportion of SITEX denim being of low quality, and therefore, penalized on export markets. Although capacity utilization is relatively high (96 percent in spinning and 86 percent in weaving in 1980), operating efficien- cies are only 60-70 percent of Western European standards, mainly because of unbalanced production facilities, worn-out and/or outdated equipment and shortage of accessories and spare parts. The problem of inadequate produc- tion facilities is compounded by: (i) inefficiencies in accounting, inventory management and cost control; and (ii) low labor productivity due to overstaffing in indirect labor and administrative services.  - 14 - 41. To overcome some of the difficulties resulting from low denim quality and loss of production due to imbalances, in 1980 the company started a modernization program in its spinning plant. The new equipment (mainly financed through Swift--para. 32), was erected during the fourth quarter of 1980, and commissioned in March 1981. Because of these invest- ments, SITEX's yarn production is expected to reach 10,000 tons per year (22 percent above the 1980 level), starting from 1981. However, the full benefits of these investments will not materialize unless the remaining old spinning and winding equipment is reconditioned and service facilities are upgraded in the Sousse plant, and the existing weaving equipment in the Ksar Hellal plant is upgraded and new looms installed to produce broader fabric widths. 42. SITEX's staff is generally capable and competent. Most of the company's senior and middle management are graduates from technical schools in France and Belgium. However, in the absence of a long industrial tradi- tion, there is only a limited background of industrial business management experience in Tunisia to provide the necessary guidance for achieving productivity and profitability targets. For this reason, expatriate operating assistance is still needed, and will be included under the proposed project. At the supervisory level the company has enough staff who have gained experience while working in textile mills in Europe. Labor is in general well motivated and trained, and capable of matching the production performance of Western Europe, if given the benefits of equal standards of equipment, raw materials and production organization. Future training requirements will be determined by the consultants to be recruited under the project (para. 46), and a training and staffing program will be prepared and submitted to the Bank by June 30, 1982 (Project Agreement, Section 5.05). 43. Other Subsidiaries. SITER operates a relatively modern processing plant at Bir Kassaa engaged in commission bleaching, dyeing, printing and finishing of woven textiles. The plant contains a large variety of equip- ment offering versatility of processing for a wide range of products. Utilization of several items of equipment is very low, and on average the plant operates at less than 50 percent of its capacity. Due to past neglect of effective maintenance and shortages of spare parts, some equip- ment has deteriorated to such an extent that complete overhauling is urgently required. In addition, marketing and financial management need to be upgraded. 44. SOMOTEX operates three facilities for spinning and weaving in Monastir. This company is primarily engaged in the production of heavy work cloth for both the domestic and the export markets, as well as of furnishings and suitings for local sale. The recent replacement of part of the equipment has created imbalances in spinning operations, while in the weaving plant some of the looms are very old and need replacement, as spare parts are no longer available. In addition, management and accounting systems, and marketing need to be upgraded.  - 15 - 45. TISSMOK operates a weaving mill at Moknine, primarily for the production of light-weight apparel fabrics for domestic use. In recent years, production has suffered from shortages of spare parts and acces- sories, and low labor productivity; this has been compounded by inadequate market research and organization, and substandard financial management and accounting systems. Project Description 46. The proposed project comprises the following components: (i) Physical Investments in SITEX. These will consist of recondition- ing of the spinning and winding equipment and service facilities at the Sousse plant, and upgrading of the existing weaving equip- ment and service facilities and installation of some 60 extra-wide shuttleless looms to produce wide denim at the Ksar Hellal plant, as well as the associated investment in incremental working capital. These measures will complement the ongoing investments in spinning (para. 41) and enable SITEX to absorb a portion of its redundant indirect labor through adequate training. No new labor will be hired and an agreement has been reached with the labor unions to operate the new weaving equipment on four shifts, as is currently done in the spinning plant. Although the mill is specialized in the production of denim, the new looms will be equipped with accessories capable of producing other types of fabric, such as corduroy, shirting and sheeting, thus giving SITEX the flexibility to absorb fluctuations in denim demand, or to meet market requirements for other fabrics. Modern but conventional technology, appropriate for Tunisian conditions, will be used for the proposed project with the exception of the new looms which will be of the shuttleless type. These technologically advanced looms are essential to achieve maximum quality standards required for export markets. It will not be difficult for SITEX to operate the new looms since only a small number of operators (20 persons) will need to be trained, and the company has demonstrated in the past its ability to deal with advanced technology and will con- tinue to receive operating assistance. Moreover, shuttleless technology is not new in Tunisia. This type of loom has been used in SOMOTEX for 15 years, and the equipment is still in good condi- tion. (ii) Physical Investments in SITER, SOMOTEX and TISSMOK. In addition to the provision of essential spare parts, the project will provide for: (a) renovation of scouring, bleaching, washing and dyeing equipment, and acquisition of auxiliary equipment to improve operating performance at SITER's plant; (b) balancing of production lines, installation of traveller cleaners on spinning frames, reconditioning of existing looms, and acquisition of auxiliary equipment for SOMOTEX; and (c) reconditioning of looms and provision of auxiliary equipment for TISSMOK.  - 16 - (iii) Technical Assistance. About 120 man-months of consulting services will be provided, under two separate contracts, to assist SITEX, SOMOTEX, SITER and TISSMOK as well as the holding company in various areas. For SITEX, technical assistance (about 34 man- months) will include: (a) preparation of detailed project design including equipment specifications; (b) preparation of tender documents and evaluation of bids; (c) assistance during erection, start-up and initial operation of new equipment; (d) assistance in the preparation and implementation of a training program for plant operators and technicians--who will be required for the new equipment--as well as for training of production management and supervisory personnel abroad; (e) development of appropriate systems for financial management including cost accounting, planning and budgeting, internal auditing and management reporting and control; and (f) development of a project monitoring and reporting system. For SITER, SOMOTEX, TISSMOK, and the holding company, technical assistance (about 86 man-months) will include: (a) development and implementation of financial management systems including cost accounting, planning, internal auditing and manage- ment reporting, according to the requirements of modern mill operations; (b) assessment of SITER's, SOMOTEX's and TISSMOK's market potential, and improvement of their marketing capabilities; and (c) preparation of investment proposals for SITER, SOMOTEX and TISSMOK, to be implemented during the second phase of the rehabilitation program. Project Cost and Financing Plan 47. The total cost of the project is estimated at D 13.2 million ($32.9 million), of which D 10.9 million ($27.1 million) is in foreign exchange. Physical contingencies have been calculated at 10 percent of the base cost estimate. Price escalation on local costs has been estimated at 7 percent per year on average for 1981-1983, while foreign costs are expected to increase by 9 percent in 1981, 8.5 percent in 1982 and 7.5 percent in 1983. Engineering and consulting services have been estimated at $12,000 per man-month, including all expenses. The cost for the rehabilitation of SITEX is estimated at about $24.5 million (excluding interest during implementation). While the installed cost per annual incremental meter, as a result of the proposed project, is estimated at only $1.40 (as compared to $4 per annual meter for a new operation of the same type and size), working capital costs are independent of whether the incremental output is derived from a new or rehabilitation investment. As a result, incremental working capital requirements ($10.9 million) repre- sent a large share of total financing required for SITEX. About $4.6 million represent physical investments and consulting services for the other companies of the SOGITEX Group. Interest during project implementa- tion is estimated at $3.8 million in total.  - 17 - 48. The foreign cost of the new looms for SITEX ($5.0 million) will be financed through $4.5 million equivalent of credits from the Swiss Govern- ment ($1.5 million equivalent, interest free, repayable over 15 years including 10 years of grace) and Swiss commercial banks ($3 million equiv- alent, at an interest rate of 6.7 percent per annum, repayable over 10 years including 3 years of grace) made to the Government and onlent to SITEX, and a Government equity contribution of about $500,000 for the 10 percent downpayment on this equipment. The proposed $18.6 million Bank loan will finance the balance of the foreign exchange for equipment, and the foreign exchange component of consulting services and incremental work- ing capital requirements. The Government will finance interest during implementation and all local costs ($9.3 million). Fulfillment of all conditions precedent to the disbursement of the Swiss credits would be a condition of effectiveness of the Bank loan (Loan Agreement, Section 6.01(c)). 49. The proposed Bank loan would be made to the Government which would onlend $14.4 million to SITEX, and $4.2 million to SOGITEX Holding, SITER, SOMOTEX and TISSMOK. The Government would receive these funds at a 9.6 percent interest rate for a period of 15 years including 3 and one half years of grace, and would pass them on to SITEX and the other companies on the same repayment terms, but at an interest rate of 10.6 percent. A longer grace period than project implementation has been allowed in the light of SITEX's sensitivity to possible delays in implementation, decline in revenues, or increases in operating costs. The companies would bear the foreign exchange risk. All Government contributions to the project would be in the form of equity. During negotiations, the Government confirmed its proposed equity contributions to the project (Loan Agreement, Section 3.01(b)(i)). Execution and ratification of two Subsidiary Loan agreements between the Government and SITEX, and between the Government and SOGITEX Holding, SITER, SOMOTEX, and TISSMOK for onlending the proceeds of the Bank loan, and receipt of (a) legal opinion(s) relating thereto, would be condi- tions of effectiveness of the proposed Bank loan (Loan Agreement, Sections 6.01(a) and (b), and 6.02(b) and (c)). Project Implementation 50. The project will be implemented over 2 and one half years, and is expected to be completed by the end of 1983. SITEX's management will be responsible for all aspects of the project relating to this company. SITEX's technical assistance requirements will be provided under one contract. Terms of reference have been discussed and agreed upon between SITEX and the Bank, and a contract is currently being negotiated with Swift. SITER's, SOMOTEX's and TISSMOK's managements will be responsible for implementation of the physical investments envisaged for these companies, while the technical assistance package for these three sub- sidiaries and the holding company (to be provided under another contract) will be implemented under the responsibility of the management of SOGITEX Holding, in collaboration with the managements of SITER, SOMOTEX and TISSMOK. Terms of reference were agreed upon with the Bank and proposals  - 18 - invited from a number of qualified firms are being evaluated. During nego- tiations, SITEX, SITER, SOMOTEX, TISSMOK and the holding company agreed to furnish to the Bank all reports and recommendations prepared by their con- sultants, and to exchange views with the Bank prior to implementation of these recommendations (Project Agreement, Section 5.06). In order to ensure that the operations of SITER, SOMOTEX and TISSMOK are upgraded with- out delay--a necessary condition for successful implementation of future rehabilitation efforts--it was agreed during negotiations that recruitment of consultants would be a condition of disbursement for the portion of the Bank loan to be onlent to SOGITEX Holding, SITER, SOMOTEX and TISSMOK (Loan Agreement, Schedule 1, para. 2(c)). Disbursement and Procurement 51. Disbursement under the Bank loan would be made against 100 percent of foreign expenditures. No local bids are expected. Proprietary items, including components needed for overhauling of equipment and spare parts (about $5.2 million) would be purchased from original machine suppliers; accessories (about $0.5 million) would be purchased after limited inter- national tendering; new machinery and equipment for expansion and debottle- necking (about $4.2 million) would be procured through international competitive bidding, or limited international tendering for items costing less than $100,000 and not exceeding $0.5 million in total. The imported component of incremental working capital requirements (about $7.3 million) would be procured through the main commodity markets (cotton), or from qualified manufacturers (dyes, chemicals and spare parts for stock-piling) using, whenever possible, limited international tendering procedures. About $1.4 million would be disbursed for engineering and consulting services. Marketing 52. Marketing of SITEX's denim for export is governed by an agreement with Swift (para. 32), under which Swift retains exclusive rights for the marketing of SITEX's denim with the exception of up to 0.5 million meters per annum that SITEX is allowed to sell on its own on the local market. The present arrangement has distinct advantages for SITEX as it allows it to dispense with costly marketing functions while establishing a good repu- tation in the EEC market for its production. Swift also derives benefits from the arrangement. Although it is responsible for all costs of market- ing and distribution, as well as of technical assistance and depreciation of the equipment it has provided to SITEX, it markets the denim in the EEC where Tunisia has associated status with duty free access. SITEX's price to Swift is based on the average US ex-factory price adjusted, pro rata, for width. The price of denim in the EEC market, on the other hand, includes both higher freight rates than for Tunisian denim, and a 14 percent import duty. As a result, the EEC market price is about 17 to 20 percent higher than the US ex-factory price, enabling Swift not only to recoup the aforementioned costs, but also to generate reasonable profits. For SITEX to set up its own marketing and distribution system in Europe  - 19 - might cost less than Swift will make on the anticipated sales, but Swift's experience and close marketing connections with the major European jeans manufacturers are very valuable, particularly when additional volumes need to be marketed. Both parties feel that they have established a good rela- tionship, and although the existing contract expires in 1983, both expect to continue their cooperation. During negotiations, it was agreed that SITEX will consult with the Bank before modifying existing arrangements or entering into new ones for the sale or marketing of a substantial portion of its production (Project Agreement, Section 5.04(b)). 53. Upon completion of the proposed project, SITEX's yarn and denim production would reach 13,250 tons per annum and 26 million square meters per annum--an increase of about 50 percent over the 1980 levels. No diffi- culties are expected in exporting to the EEC SITEX's production of wide denim (10.5 million square meters from 1983, as compared to 8.5 million square meters of narrow denim alone exported in 1980). Given the high quality of the fabric (SITEX's denim would be within the upper quartile of the EEC denim market), and SITEX's competitive edge, the whole production is expected to be easily absorbed even if the EEC fabric quotas for Tunisia were frozen at the 1980 level and sales of denim continued to be limited to France, Benelux and Italy (para. 33). Regarding the narrow denim, the export oriented enterprises (EOEs) have been using increasing quantities of SITEX's denim in their production of trousers. In 1980, the EOEs exported about 5.5 million pairs of denim jeans to the EEC, 3.2 million of which were made from SITEX's denim. While the use of narrow denim is less desir- able in the high-labor-cost EEC countries, it can still be profitably con- verted into jeans in Tunisia. The EOEs are therefore expected to take advantage of the increased local supply of denim and substitute it for imported fabric. 54. However, to absorb almost all of SITEX's narrow denim production by 1983, the EOEs' production of denim jeans will have to increase more rapidly than that of other cotton trousers. If the required acceleration does not take place, SITEX could find itself with some excess narrow denim production in 1981-1983. These amounts are estimated not to exceed 1.3 million square meters of narrow denim in 1981, 2.9 million square meters in 1982, and 1.2 million square meters in 1983. To insure against such an eventuality, SITEX and Swift are developing a number of alternative market outlets. The first is to cut the narrow denim into trousers at SITEX, the pieces being converted into trousers by EOEs with spare capacity, on a commission basis, for marketing by Swift to minor European jeans manufac- turers, which are too small either to undertake the investment involved in establishing their own EOE in Tunisia, or to contract for manufacture by existing EOEs. At least 1.6 million square meters of narrow denim per annum could be absorbed in this manner. Another outlet would be to increase export sales to neighboring countries where low labor costs also prevail. It is estimated that at least 2.2 million square meters of narrow denim per annum could be absorbed by such markets. Finally, SITEX and Swift are actively developing light-weight pocketing that could be sold to European jeans manufacturers, as well as to EOEs, in a package with SITEX's denim.  - 20 - Financial Performance 55. As mentioned in para. 39, until January 1, 1979 SOGITEX's sub- sidiaries were operating units of SOGITEX and therefore all historic data on financial performance prior to 1979 relate to the Group as a whole. As a single company, SOGITEX was not financially successful. By 1971, the company had cumulative losses of D 2 million, which were written off by the Government in 1972, together with about D 3 million of short term debt. SOGITEX continued, however, to face financial difficulties and the mills frequently found themselves without essential raw materials, accessories and spare parts. Furthermore, financial management systems were inade- quate. As a result, after breaking even in 1972-1974, SOGITEX's financial situation began to deteriorate once more. With the reorganization of 1979, the mills acquired independent status, but their financial situation did not improve since the financial restructuring of the Group--which was intended to parallel the Group's organizational restructuring--was not completed until April 1981. In 1979 and 1980 all subsidiaries and the holding company incurred losses amounting to D 1.1 million and D 1.4 mil- lion, respectively, on a consolidated basis. 56. Since the proposed investments in SITER, SOMOTEX and TISSMOK are small and include a substantial element of technical assistance, detailed financial projections have not been prepared for these entities. However, as a result of the increased availability of funds following completion of the financial restructuring, as well as the investments and technical assistance included in the proposed project, these entities might approach the break-even point in 1981 and possibly generate some profits in 1982-83, when major physical investments are envisaged for their full rehabilita- tion. On the other hand, with the proposed project, SITEX's financial performance is expected to improve substantially. Sales revenue is pro- jected to increase from D 15.8 million in 1980 to D 28.3 million by 1983, and SITEX would be able to pay dividends of at least D 1 million per year from 1983 onwards, without the current ratio falling below 1.5 or the debt/equity ratio exceeding 45:55. This would represent an annual return of 30 percent on new equity financing for the project or 9 percent of total Government share capital. From 1986 onwards, dividends could increase to D 1.5 million without the current ratio falling below 1.7 or the debt/ equity ratio exceeding 32:68. The above dividends would represent a 13.5 percent return on share capital or 44 percent on project equity financing. The projected profit margin will range between 4.5 percent in 1984 and 14.2 percent in 1993, and is considered normal for the industry. The projected break-even point is reached at a production of 21.2 million square meters of fabric, compared with an anticipated production of 26.0 million square meters at full capacity. 57. To protect SITEX's profitability, and to prevent the holding company from using profits generated by each individual company to sub- sidize the operations of the other subsidiaries, it was agreed during negotiation that, during the life of the Bank loan, the holding company and its subsidiaries will (i) not borrow additional funds if, as a result,  - 21 - according to projections acceptable to the Bank, their respective debt/ equity ratios would exceed 60:40 or debt service coverage fall below 1.3; (ii) not enter into any major new investment (exceeding $2.0 million per annum for SITEX; $1.0 million per annum for each of the other companies) without prior agreement of the Bank; and (iii) maintain a current ratio of at least 1.2 at all times, whilst taking no action, such as distribution of dividends or prepayment of debt, if such action would reduce the current ratio to less than 1.5 (Project Agreement, Section 6.03). Auditing and Reporting 58. The Group has only recently started to audit its accounts. Audits have been made by a Tunisian accounting company (Societe Fiduciaire d'Expertise Comptable, d'Organisation Generale et d'Audit--SOGEX), with which the Group has established a good professional relationship. During negotiations, SITEX, SITER, SOMOTEX, TISSMOK, and the holding company agreed that annual audited financial statements will be prepared, in a form satisfactory to Bank, and will be submitted to the Bank not later than four months after the end of each fiscal year (Project Agreement, Section 6.02). It was also agreed that SITEX, SITER, SOMOTEX, TISSMOK, and the holding company, as the case may be, will prepare and submit to the Bank periodic reports on the progress of work and, upon project completion, a final report assessing the results achieved (Project Agreement, Sections 2.05(b)(iii) and (d), and 3.05(b)(iii) and (d)). Ecology 59. The project does not pose ecological problems while it would improve the working environment in the companies through major modifica- tions of the air-conditioning systems in spinning and weaving plants. Similar to the existing steam boilers, the boiler for SITEX to be procured under the proposed project will be equipped with automatic regulating devices to restrict the discharge of carbon monoxide in the fuel gases to acceptable levels. Assurances were obtained during negotiations that the companies will operate their facilities with due regard to ecological con- siderations and occupational hazards (Project Agreement, Section 5.03). Project Benefits 60. The financial rate of return for SITEX is estimated at about 20 percent. Both the financial and the economic analysis are based on the assumption that, if the project were not implemented, SITEX would be closed down and its existing assets sold off. Since the proceeds of this sale would represent the opportunity value of the existing assets, they were added to the cost of the project (net of debt outstanding in the case of the financial calculations). For the economic analysis, since without the project SITEX's labor force would be laid-off, labor costs were shadow priced at 66 percent of their financial value and all local duties and taxes were netted out from cost and benefit streams. Since all cotton would be imported and the bulk of SITEX's projected sales would be exported, no adjustments were warranted in raw materials and sale prices.  - 22 - On this basis, the economic rate of return for SITEX is estimated at about 30 percent. 61. Regarding the proposed investments in SITER, SOMOTEX, and TISSMOK it is possible that they will not suffice to restore profitability, but they are expected to halt the progressive deterioration of the technical and financial situations of these companies, while preparing the ground for a full rehabilitation to be implemented under a follow-up project. The sizeable technical assistance component included under the project would permit not only the formulation of detailed investment proposals for the rehabilitation of SITER, SOMOTEX, and TISSMOK but also the upgrading of the Group's accounting and management systems to the requirements of modern textile operations. Project Risks 62. Given the small size and the nature of the investments proposed for SITER, SOMOTEX and TISSMOK, project risks have been assessed only with regard to SITEX's expected performance. The sensitivity analysis indicates that this project component faces relatively low risks from a production point of view. A 10 percent increase in capital cost would only reduce the economic rate of return of the proposed investments for SITEX to 28.7 per- cent and is deemed unlikely to occur since the price of a major portion of the new equipment (i.e. the looms to be financed through the Swiss credits) is contractually fixed. Regarding the operating costs, raw cotton repre- sents 56 percent of total production costs and changes in the price of cotton are normally reflected in the sale price of denim. The other major cost components (labor, dyes and chemicals) represent relatively small shares of total production costs and are not closely correlated. A 10 percent increase in total independent operating costs is, therefore, unlikely to occur, and would only reduce the economic rate of return to 22.7 percent. The major risks of the project relate to marketing. As mentioned above (paras. 53 and 54), the projections are based on the assumption that the EOEs will absorb the bulk of the narrow denim produced by SITEX either directly or on a commission basis. If SITEX's and Swift's efforts to increase their market share in the EEC, through sales of jeans manufactured on a commission basis by the EOEs, do not prove successful, the EOEs' own production of denim jeans will have to increase more rapidly, from 1981 to 1983, than that of other cotton trousers so as to absorb the increased production of narrow denim. Should this not occur, SITEX would find itself with excess production in 1981-83 (para. 54). Besides changing the output mix (both existing equipment and that to be provided under the project would allow flexibility), SITEX could reduce narrow denim produc- tion, and sell the excess yarn on the local market. This would reduce the economic rate of return to 28.6 percent.  - 23 - PART V - LEGAL INSTRUMENTS AND AUTHORITY 63. The draft Loan Agreement between the Bank and the Republic of Tunisia, the draft Project Agreement between the Bank and SOGITEX, SITEX, SITER, SOMOTEX and TISSMOK, and the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement are being distri- buted to the Executive Directors separately. Special features of the draft Loan Agreement are referred to in the text, and listed in Section III of Annex III. Special conditions of effectiveness are (i) execution of two Subsidiary Loan agreements between the Government and SITEX and between the Government and SOGITEX Holding, SITER, SOMOTEX and TISSMOK and receipt of (a) legal opinion(s) relating thereto; and (ii) fulfillment of all condi- tions precedent to disbursement of $4.5 million equivalent of Swiss credits made to the Government and onlent to SITEX (draft Loan Agreement, Sections 6.01 and 6.02(b) and (c)). Recruitment of consultants for the holding company, SITER, SOMOTEX, and TISSMOK will be a condition of disbursement for the portion of the Bank loan to be onlent to SOGITEX Holding, SITER, SOMOTEX and TISSMOK (draft Loan Agreement, Schedule 1, para. 2(c)). 64. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 65. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President Attachments Washington, D.C. May 11, 1981  - 24 - ANNEX I TABLE 3A Pago I o f 6 TUNISIA - SOCIAL INDICATORS DATA SHEET TUNISIA REPERENCE GROUPS (EIGHTED AVE,SCES LAND AREA (THOUSAND SQ. KH.) - h E ST RECENT ESTIMATE)- TOTAL 164.0 NTWU INCOME AGRICULTURAL 76. 6 MOST RECENT NORTH AFRICA 6 MIDDLE INCOHE 1960 /b 1970 /b ESTIMATE lb MIDDLE EAST LATIN AMERICA A CARIBBEAN GNP PER CAPITA (US$) .. 360.0 1120.0 818.5 1562.9 ENERGY CONSUMPTION PER CAPITA (KILOGRAMS OF COAL EQUIVALENT) 190.0 261.0 543.0 545.0 1055.9 POPULATION AND VITAL STATISTICS POPULATION, MID-YEAR (MILLIONS) 4.2 5.1 6.0 URBAN POPULATION (PERCENT OF TOTAL) 36.0 43.5 50.1 45.7 63.4 POPULATION PROJECTIONS POPULATION IN YEAR 2000 (MILLIONS) 9.0 STATIONARY POPULATION (MILLIONS) 14.0 YEAR STATIONARY POPULATION IS REACHED 2075 POPULATION DENSITY PER SQ. KM. 26.0 31.0 37.0 40.7 28.1 PER SQ. KM. AGRICULTURAL LAND 55.0 67.0 78.0 598.6 81.7 POPULATION AGE STRUCTURE (PERCENT) 0-14 YRS. 43.3 46.2 42.6 44.0 41.4 15-64 YRS. 52.5 50.0 53.8 52.5 54.7 65 YRS. AND ABOVE 4.2 3.8 3.6 3.5 3.9 POPULATION GROWTH RATE (PERCENT) TOTAL 1.8 /c 1.9/c 2.0 2.6 2.7 URBAN *- 3.6 3.9 4.5 4.1 CRUDE BIRTH RATE (PER THOUSAND) 49.0 42.0 32.0 41.6 34.8 CRUDE DEATH RATE (PER THOUSAND) 21.0 15.0 12.0 13.7 8.9 GROSS REPRODUCTION RATE 3.1 3.4 2.2 2.9 2.5 FAMILY PLANNING ACCEPTORS, ANNUAL (THOUSANDS) .. 29.2 73.5 VSERS (PERCENT OF MARRIED WOMEN) .. 8.0 18.0 16.2 FOOD AND NUTRITION INDEX OF FOOD PRODUCTION PER CAPITA (1969-71-100) 97.0 98.0 126.0 93.5 106.9 PER CAPITA SUPPLY OF CALORIES (PERCENT OF REQUIREMENTS) 80.0 88.0 112.0 103.6 107.4 PROTEINS (GRAMS PER DAY) 50.0 57.0 73.0 69.8 65.6 OF WHICH ANIMAL AND PULSE 12.0 14.0 22.0 17.5 33.7 CHILD (AGES 1-4) MORTALITY RATE 29.0 20.0 15.0 17.5 8.4 HEALTH LIFE EXPECTANCY AT BIRTH (YEARS) 48.0 54.0 57.0 54.4 63.1 INFANT MORTALITY RATE (PER THOUSAND) 148.0/d 135.0 .. .. 66.5 ACCESS TO SAFE WATER (PERCENT OF POPULATION) TOTAL .. 49.0 70.0 62.5 65.9 URBAN .. .. .. 82.9 80.4 RURAL .. .. .. 45.1 44.0 ACCESS TO EXCRETA DISPOSAL (PERCENT OF POPULATION) TOTAL .. .. .. .. 62.3 URBAN .. .. 30.0 *- 79.4 RURAL .. .. .. .. 29.6 POPULATION PER PHYSICIAN 10000.0 5950.0 4800.0 4688.7 1849.2 POPULATION PER NURSING PERSON .. 730.0 1070.0 1751.5 1227.5 POPULATION PER HOSPITAL BED TOTAL 373.0/e 410.0 439.0 635.5 480.3 URBAN .. 280.0 RURAL .. 930.0 ADMISSIONS PER HOSPITAL BED .. 24.1 HOUSING AVERAGE SIZE OF HOUSEHOLD TOTAL .. 5.1 /f 6.0 URBAN .. 5.1 7f 5.8 RURAL .. 5.1 7? 6.1 AVERAGE NUMBER OF PERSONS PER ROOM TOTAL .. 3.2 /f URBAN .. 2.7 7 -* RURAL .. 3.6 7r ACCESS TO ELECTRICITY (PERCENT OF DWELLINGS) TOTAL .. 24.0 /f URBAN .. .. RURAL .. ..  - 25 - ANNEX I Page 2 of 6 TABLE 3A TUNISIA - SOCIAL INDICATORS DATA SHEEZ TUNISIA REFERENCE GROUPS (WEIGHTED AVE%AGES - MOST RECENT ESTIMATE)- MIDDLE INCOME MOST RECENT NORTH AFRICA & MIDDLE INCOME 1960 /b 1970 /b ESTIMATE /b MIDDLE EAST LiATIN AMERICA * CARIBBEAN EDUCATION ADJUSTED ENROLLMENT RATIOS PRIMARY: TOTAL 66.0 100.0 100.0 76.4 99.7 MALE 88.0 120.0 118.0 92.2 101.0 FEMALE 43.0 79.0 81.0 59.9 99.4 SECONDARY: TOTAL 12.0 23.0 22.0 33.3 34.4 MALE 19.0 33.0 28.0 41.9 33.5 FEKALE 5.0 13.0 15.0 24.2 34.7 VOCATIONAL ENROL. (X OF SECONDARY) 24.0 12.0 17.0 9.8 38.2 PUPIL-TEACHER RATIO PRIMARY 61.0 48.0 40.0 39.2 30.5 SECONDARY 16.0 28.0 23.0 25.1 14.5 ADULT LITERACY RATE (PERCENT) 15.5 24.0/f 55.0 39.7 76.3 CONSUMPTION PASSENGER CARS PER THOUSAND POPULATION 11.0 13.0 18.3 15.3 43.0 RADIO RECEIVERS PER THOUSAND POPULATION 40.0 74.0 138.0 139.6 245.3 TV RECEIVERS PER THOUSAND POPULATION 0.1 10.0 35.0 29.0 84.2 NEWSPAPER (-DAtLY GENERAL INTEREST-) CIRCULATION PER THOUSAND POPULATION 19.0 16.0 33.0 22.2 63.3 CINEMA ANNlUAL ATrENDANCE PFR CAPITA 2.0 .. 2.3 2.8 LABOR FORCE TOTAL LABOR FOkCE (THOUSANDS) 1137.9 1214.8 1533.5 FEMALE (PERCENT) 6.1 7.7 8.0 9.6 22.2 AGRICULTURE (PERCENS) 56.0 49.8 45.0 47.0 37.1 INDUSTRY (PERCENT) 17.6 21.0 24.0 23.8 23.5 PARTICIPATION RATE (PERCENT) TOTAL 27.0 23.7 23.7 26.1 31.5 MALE 50.2 4.2 46.0 47.4 48.9 FEMALE 3.3 3.6 6.0 4.7 14.0 ECONOMIC DEPENDENCy RATIO 1.4 1.8 1.8 1.9 1.4 INCOME DISTRIBUTION PERCENT OF PRIVATE INCOME RECEIVED BY HIGHEST 5 PERCENT O} HOUSEHOLDS .. .. 17.0 HICGEST 20 PERCENT OF HOUSEHOLDS .. .. 42.0 LOWEST 20 PERCENT OF HOUSEHOLDS .. .. 6.0 LOWEST 40 PERCENT Or HOUSEHOLDS .. .. 15.0 POVERTY TARGET GROUPS ESTIMATED ABSOLUTE POVERTY INCOME LEVEL (USS PER CAPITA) URBAN .. .. 204.0 262.5 RURAL .. .. 97.0 140.4 190.8 ESTIMATED RFLATIVE POVERTY INCOME LEVEL (USS PER CAPITA) URBAN .. .. 193.0 202.1 474.0 RURAL .. .. 193.0 122.2 332.5 ESTIMATED POPULATION BELOW ABSOLUTE POVERTY INCOME LEVEL (PERCENT) URBAN .. .. 20.0 22.1 RURAL .. .. 13.0 33.1 Not available Not applicable. NOTES /a The group averages for each indicator are population-weighted arithmetic means. Coverage of counktries among the indicatora depends on availability of dat. end it not uniform. /b Unless otherwise noted, data for 1960 refer to any year between 1959 and 1961; for 1970. between 1969 and 1971; and for Most Recent Estimate, between 1974 and 1978. /c Due to emigration population growth rate is lower than rate of natural increase; /d 1960-65 average; /a 1962. /f 1966. Most recent estimate of CNP per capita is for 1979, all other data are as of April, 19a0. October. 1980  - 26 AN- Page 3 of 6 cEkf1INOtOtIOf SOCIALIJNIICA:los Notee; Although th. dat -ar ran t o nNa dta1 cged the ust authoritaive and reliahie, It should elan he noted that they say not be te.e-- naIoaly opaahc oaucof I. . -odardle-d defolnLoti. and concpts -sd h: diffIntent co-tien to collectlug the data. The data are,noe thelens oseho r. oecr rOo ,tcac.fc.d.odi,an trends, and char.ct-ir- certaIn -aIor differences he.t ...n nattee.. The refernc grcope arc c t h, ...e cont- ge-p of the.ulo conrend cI). .a..tr group n th so.se,hen higher 1orgslonn than the cannery gep ot the euh) eo -n-cr e0.-pc for- pcl opu oil fpr c roa ohre "MIddle Inco- North Africa an d Kiddle tEst" Is chase- bn.aaeeof etrengee e_lo-ulcra H toen,