Mexico - Industrial Technology Development Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 5925-ME STAFF APPRAISAL REPORT MEXICO INDUSTRIAL TECHNOLOGY DEVELOPMENT PROJECT July 11, 1986 Industry Department Energy and Industry Staff Tlis 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 autborization.  FISCAL YEAR (FY) January 1 - December 31 Exchange Rates (average M$ per $) 1980 22.9 1981 24.5 1982 57.2 1983 135.2 1984 176.5 1985 257.0 LIST OF ABBREVIATIONS AND ACRONYMS ACF - Index of Average Cost of Funds, the Bank's acronym for CPP CPP - Costo Promedio Porcentual CONACYT - Consejo Nacional de Ciencia y Tecnologia DGN - Direccion General de Normas (SECOFI) DGPI - Direccion General de Promocion Industrial (SECOFI) FOMIN - Fondo Nacional de Fomento Industrial FONEI - Fondo de Equipamiento Industrial FONEP - Fondo Nacional de Estudios y Proyectos GDP - Gross Domestic Product GIRA - General Interest Rate Agreement nMIT - Instituto Mexicano de Investigaciones Tecnologicas INFOTEC - Servicio de Informaion Tecnologica ITD - Industrial Technology Development LANFI - Laboratorios Nacionales de Fomento Industrial LDC - Less Developed Country NAFINSA - Nacional Financiera, Sociedad Nacional de Credit& NIC - Newly Industrialized Country PVP - Sistema de Pagos al Valor Presente (Present Value Payment Scheme) R&D - Research and Development SECOFI - Secretaria de Comercio y Fomento Industrial (Ministry of Commerce and Industry) SHCP - Secretaria de Hacienda y Credito Publico (Ministry of Finance and Public Credit) SPP - Secretaria de Programacion y Presupuesto (Ministry of Planning and Budgeting) UNESCO - United Nations Education, Science and Culture Organization TDU - Technology Development Unit (FONEI)  FOR OmCLc USE ONLY MEXICO INDUSTRIAL TECHNOLOGY DEVELOPMENT PROJECT Table of Contents Page No. I. LOAN AND PROJECT SUMMARY ......................................... 1 II. INDUSTRIAL TECHNOLOGY DEVELOPMENT IN MEXICO ................ 4 A. Background ..*.. ....................................... 4 B. Level and Distribution of ITD Activity in Mexico ....... 5 C. Economic Environment Constraint ..... ................ 7 D. ITD Policy Constraint ....................... ... .8 E. Infrastructure Support Constraint ...... 9 F. Financing Constraint ................................... 10 G. Scope for Improving ITD ..... .. ............... .......... 12 H. Government ITD Plans for 1984-88 ....................... 12 T. The Bank's ITD Lending Strategy in Mexico .............. 14 III. THE PROPOSED PROJECT AND BANK LOAN ......................... 15 A. Project Objectives and Composition ..................... 15 B. Project Cost and Financing ............................. 20 C. Loan Amount, Terms and Conditions ...................... 21 D. Procurement and Disbursement ........................... 23 E. Accounts and Audit . .............. ............ ........... 23 F. Supervision and Monitoring ..... ........................ 24 G. Project Benefits and Justification ..................... 24 H. Project Uncertainties and Risks ........................ 25 I. Environmental Impact ................................... 26 IV. AGREEMENTS AND RECOMMENDATIONS ....... .. . 26 List of Annexes 1. ITD Policy Responsibility .................................... 29 2. ITD Infrastructure ....................................... 30 3. Specialized ITD Financing .................................... 32 4. Current Bank Support for ITD . ............................... . 34 5. FONEI and Its Technology Development Program .............. ... 35 6. Chronogram of Preparation Infrastructure Components .. ........ 55 7. Loan Disbursement Schedule ......................................... 56 8. List of Selected Documents in Project File ... ................ 57 This report is based on a mission in August 1985 led by Bjorn Wellenius (Senior Economist) and including Cecile Ramsay (Financial Analyst), Julian Pavon, Steffan Peiser, Francisco Sercovich and Hangsup Shim (Consultants). Stephen Ettinger, Yutaka Suzuki, Antonio Tarnawiecki and Luis Marco participated in project preparation. This document hu a stricted distribution and may be used by ecipients only in the perfofmace Of their official duties Its contents may not otherwise be disclosed without World Bank authorization.  TKcUW~CY urnLOAN I. LOAN AND PROJECT SINKRY Borrower: Nacional Financiera, S.N.C. (NAFINSA) Giusrutor: United Mexican States RDn-ficlary: Secretaria de Comercio y Fomento Industrial (SECOFI) Fondo de Equipamiento Industrial (FONEI) Amount: US$48.0 million equivalent Terms: 15 years, including three years of grace, at the standard variable interest rate. Term: NAFINSA would pass on through the Government nearly 96% of loan funds to FONEI and the balance 4% to SECOFI. The Government would repay the principal of the Bank loan, pay interest and all other charges and assume the foreign exchange risk. FONEI would onlend funds through financial intermediaries for conventional and conditional technology subloans to industrial enterprises at interest rates to the intermediaries not less than 88% and 104% of the average cost of funds to the banking system (ACF), respectively. On conditional subloans, FONEI would charge an additional risk premium. FONEI would likewise onlend funds for industrial enterprises to invest in research and development (R&D) centers, at interest rates not less than 94% of ACF to the intermediary. The intermediaries would take a margin of 6% of ACF. FONEI would additionally onlend funds to financial intermediaries, at an interest rate of not less than ACF plus one percentage point, for them to take equity positions in industrial firms. Maturities would be up to 13 years, including a maximum grace period of 3 years for conventional and conditional technology subloans and 5 years for equity loans. R&D investment loans would have up to 10 years maturity including 5 years of grace. FONEI would offer, as an option, the Present Value Payment System (PVP) in order to ease the cash flow of borrowers. Project Description: The proposed project would be the Bank's first to support exclusively industrial technology development in Mexico. Its three main objectives would be to (a) review instruments  - 2 - and related measures designed to encourage industrial technology development; (b) strengthen technology infrastructure and metrology services; and (c) expand and improve FONEI's specialized financing program. These objectives would be achieved through five components: (i) ind-strial technology development analysis; (ii) sxrengthening of technology infrastructure through feasibility studies and private industry investments in restructured R&D centers; (iii) strengthening of metrology services by assessing the needs of the industrial sector and programs for initial improvement of metrology services; and (iv) specialized finance for technology development investments of industrial enterprises; and (v) institutional strengthening of FONEI. The project would help accelerate industrial technological innovation, thereby helping private firms compete in domestic and export markets. Increased availability of funds on terms suitable for industrial technology development projects, selective use of government subsidy, and improved assistance in identification and formulation of subprojects are expected to result in more, larger or earlier technological improvements in participating firms. Project benefits would continue to accrue after project completion. -isks: This operation would face some uncertainty in that delays in economic recovery could reduce demand for technology development finance. It would also face five project specific risks: delays in expanding FONEI's specialized staff, in implementing SECOFI's policy and metrology components, and in restructuring R&D centers; s'-ow demand for FONEI's conditional loans; and potential financial losses due to failure of subprojects. To deal with some of these risks, Government has already authorized expansion of FONEI staff and recruitment is underway; feasibility studies for the R&D centers have been completed and investment plans are under preparation with the assistance of consultants. Delays in restructuring the four centers would not jeopardize other project objectives, while a slack demand for conditional loans would only extend the commitment period for subloans by one year. Furthermore, adequate provisions have been made for potential losses under FONEI's conventional and conditional technology loans. The probability that these risks will materialize is low and the arrangements proposed to., deal with them are satisfactory.  -3 - Estimsted Cost: Foreign Local Total US$ Millions Policy Analysis 0.1 0.7 0.8 R&D centers Studies and promotion - 0.2 0.2 Investments 5.5 8.2 13.7 Metrology services Studies 0.1 0.2 0.3 Initial metrology improvement 1.3 1.3 2.6 Line of credit 19.4 55.6 75.0 Technical assistance to FONEI 0.5 0.1 0.6 BASE COST 26.9 66.3 93.2 Contingencies Physical 0.7 1.0 1.7 Price 0.8 1.1 1.9 Subtotal contingencies 1.5 2.1 3.6 TOTAL COST 28.4 68.4 96.8 _ _ World Bank 28.4 19.6 48.0 FONEI/Government/CONACYT - 33.8 33.8 Industrial Enterprises - 15.0 15.0 TOTAL 28.4 68.4 96.8 = - Estimated USS Millions Disbursiens Bank FY 87 88 89 90 91 92 Annual 7.4 9.1 10.8 9.9 6.9 3.9 Cumulative 7.4 16.5 27.3 37.2 44.1 48.0 Staff Xeport: No. 5925-ME, June 10, 1986.  II. INDUSTRIAL TECHNOLOGY DEVELOPMIENT IN MEXICO A. Background Industrial Sector 2.01 Over the past three decades, Mexico's manufacturing industry developed into one of the leading sectors of the economy: its share in GDP rose from 17Z in 1950 to 24% in early 1980s, currently generating roughly one out of eight jobs in the country. The engine of growth had been an import-substitution strategy which provided high protective barriers, together with tax breaks and subsidies. As a result, Mexican industry has remained largely uncompetitive, with a limited export base. 2.02 In the wake of the 1982 economic and financial crisis, the domestic market collapsed and industrial growth came to an abrupt halt. After a drop in industrial production during 1981-1983, the industrial sector began a recovery as output grew 4.8Z in 1984. But this upswing stemmed from a recovery of the domestic market and, to a minor extent, from rising exports that were encouraged by the drastic devaluation of the peso. Given the Government's commitment to a gradual opening of the economy that was initiated in 1985, prospects for further growth are good. But, it would have to be achieved through substantially increased exports and efficient import substitution; the recent fall in oil prices has made this even more urgent. This will require Mexican industry to adjust by becoming competitive both abroad and at home. Without significant technol- ogy improvement, Mexico's industry cannot face this challenge; hence the central importance of industrial technology for the country's economy over the years to come. The Nature of ITD 2.03 Industrial technology development (ITD) comprises a variety of activities ultimately aimed at the firms' utilization of specialized technical knowledge for improving or developing industrial pro"aucts snd processes. ITD largely takes place within the industrial firm. Buiilding up domestic ITD capability, and achieving a balance between foreign and own sources of technological change, are essential components in developing an industrial sector which is efficient, can adjust to changing markets and resources, and is able to export. In the less developed countries (LDCs), ITD is often confined to the selection, acquisition and operation of technology and minor improvements in the course of operation. Technology is largely acquired from abroad, mainly embodied in imported industrial plants, equipment and intermediate goods. At a more advanced stage, leading firms in newlv industrialized countries (NICs, e.g., Argentina, Mexico, Brazil, India, Korea) add considerable domestic value to imported technology, through local design, engineering and pursuit of quality. For this they utilize a mix of in-house resources and services provided by local engineering firms, research and development (R&D) organizations and  - 5 - sometimes higher education centers. Technology is imported ore selective- ly and unbundled mainly as product and process licenses, some plant and equipment designs, technical services to solve specific problems, and quality assurance methods, instrumentation and reference standards. Mastery allows the firms to improve the acquired technology as well as increase the firm's capability to handle subsequent technology problems. A stock of technology knowledge, expertise and nanagement skills is built up in the firms and specialized institutions and gradually disseminated through subcontractor development, personnel mobility, provision of techni- cal services and participation in higher education. Technology exports become significant, and technology trade imbalance and dependence is reduced. In mature industrial economies, technological capability is widely spread throughout industry, basic research plays a large role as a source of technological change, and product quality, production efficiency and pace of innovation are roughly comparable among countries. Justification and Forms of Government Intervention 2.04 Governments in all industrialized nations, most NICs and some LDCs have adopted measures, including various subsidies, to stimulate ITD. This is justified mainly on three grounds. First, social returns from ITD are higher than pr!yate returns, due to external benefits (diffusion of specific knowledge, development of specialized manpower and innovation management skills, and contribution to building up a competitive business environment). Second, investments in ITD are often considerably riskier than those for other industrial activities, due to technical as well a' market uncertainties. ITD may therefore be unacceptable to the individual firm, despite being desirable to society as a whole in the context of a large and more diversified investment portfolio. And third, even when entrepreneurs are willing to invest in ITD, gaps in the capital market inhibit financing these activities (Annex 3). 2.05 Government support for ITD in various countries comprises a mix of policy, investment and institution development measures. Industrial, trade, credit, foreign investment and taxation policies, although not specifically directed to ITD, strongly influence the firms' demand for lTD and the relative use of foreign and domestic resources to meet these needs. Explicit ITD policies include fiscal and financial incentives such as grants and subsidized credits for ITD investment, public sector procure- ment used to promote development of domestic suppliers, regulation of technology importation, and protection of industrial property rights. Governments also promote ITD by investing in R&D capability of public and parastatal industry, developing an Infrastructure of Industrial R&D and information services to support industry in general, and establishing and funding specialized ITD financing agencies. B. Level and Distribution of ITD Activity in Mexico 2.06 Governments since the 1950s, but especially from 1970, have actively sought to strengthen Mexican ITD capability, mainly by building up public sector R&D agencies. More recent measures include fiscal incen- tives, public sector purchase programs, regulation of technology imports, and specialized ITD financing.  - 6 - 2.07 While the proportion of Mexican GDP spent in industrial R&D (about 0.2%) is comparable to Brazil and Argentina, it is at the low end of the range for NICe and more advanced nations, despite a considerable expansion of total R&D (all sectors) from 0.17% of gross domestic product (GDP) in 1970 to 0.51% in 1982. Total R&D expenditure in 1984-88 is expected to remain at about 0.5% of GDP ($600 million per annum). Table 1 gives further details. 2.08 Furthermore, this expansion of R&D has largely failed to reach private firms. Of Mexico's total R&D expenditure (all sectors), about 87% is incurred by public sector agencies (compared with Brazil about 60Z, Korea 30% and USA 20%) and about 90% is financed by them (Brazil 67%, Korea 41%, USA 48%). Industrial R&D reflects this, albeit less acutely. The public sector accounts for about 70% of industrial R&D expenditure and financing. Despite Government attempts to support ITD industrywide, about 96% of public sector funds for industrial R&D are spent by public and parastatal agencies.2/ 2/ Private sector R&D has not been well quantified. The above figures are based on assuming that of total Mexican R&D expenditure, 10% is financed by the private sector, of which 90% is spent in industrial R&D; 80% is financed by the Federal Government budget, of which 19% was spent in industry (1980-83) including about 4% channeled to private industry; and 10% is financed by parastatal industrial firms. Under different assumptions, the public sector's participation of industrial R&D expenditure and financing vary in the ranges of 51%-76% and 56%-81% respectively, and the proportion of public sector industrial R&D funds spent within the public sector varies between 91%-96%, which does not materially change the above qualitative conclusions.  - 7 - Table 1: R&D EXPENDITURE, 1982 Industrial R&D Industrial R&D R&D expenditure as % of total expenditure as % of GDP R&D expenditure as Z of GDP Argentina 0.5 26 0.1 Brazil 0.6 28 0.2 Spain 0.6 56 0.3 Korea (Republic of) 0.9 42 0.4 Canada 1.2 43 0.5 United Kingdom 2.1 62 1.3 Japan 2.5 58 1.5 Hungary 2.6 61 1.6 USA 2.7 n.a. n.a. Mexico 0.5 35 0.2 Sources: Mexico: Movilizacion de Recursos de Ciencia y Tecnologia para el Desarrollo de Mexico,- CONACYT, February 1985 and mission estimates. Other: UNESCO Statistical Yearbook, 1984. -Industrial refers to manufac- turing (which on average accounts for 87% of total R&D shown), extractive industries and utilities. Some figures are for years other than 1982: Canada 1981, Argentina 1980, Spain and UK (column 1) 1978, Brazil (column 1) 1977, UK (column 2) 1975. For Mexico, column 1 is for public sector only (including private sector it is about 0.6) and the figure in column 2 is estimated (varies between 27% and 41% depending on assumptions). 2.09 Concentration of industrial R&D effort in the public sector reflects in in-house industrial technology capability being mostly confined to large parastatal enterprises, firms associated with multinational corporations, and a small number of mostly large private enterprises. Smaller firms often lack the management, technical knowledge, manpower and financial means to undertake technological innovation, and often have difficulty in formulating their ITD problems and needs in forms that lead to operational and bankable projects. Even a number of relatively large firms have imported technology extensively and done little to adapt and develop it, remaining essentially dependent on outside sources. The short- ages of in-house R&D capability are compounded by insufficient orientation of the public sector R&D infrastructure towards private industry's demands for technology support, and by the lack of an effective system of industri- al standards, metrology and quality assurance. C. Economic Environment Constraint 2.10 These problems partly stem from an economic environment which in the past did not generate a large demand for domestic industrial ITD. From the 1940s to 1970, protectionist policies directed towards import substitu- tion resulted in rapid industrial growth. However, industry remained  - 8 - highly fragmented and dependent on imported capital equipment, efficient production scale was achieved in only a few subsectors, and there was neither much competitive pressure on industrial enterprises in the domestic market nor a drive to export. Correspondingly, industrial enterprises generally developed little need or internal capability for technological innovation. When in 1970 Mexico experienced a short-lived attempt to open its economy, markets and investment expanded rapidly and the internal demand for industrial technology grew. However, industry's limited techno- logical capability could not meet this sudden rise in demand. In response, large parastatal enterprises set up or expanding associated technology development facilities. Mexican subsidiaries of multinational enterprises obtained the necessary new know how from their parent companies, some large private Mexican industrial conglomerates established enterprises specializ- ing in technology while others developed in-house R&D facilities, and Government stepped up efforts to promote R&D and developed an infrastruc- ture with some industrial support capacity. But with the reversal of economic policies toward a highly protected import-substitution model, most industries found it less risky and--with a gradually overvalued peso less costly to purchase foreign technology, which did not reflect Mexico's long-term comparative advantage. Such purchases were made all the more attractive by the country's promixity to the USA. D. ITD Policy Constraint 2.11 Limited ITD capability partly also reflects imperfections in the Government's policies to promote ITD (Annex 1). Fiscal incentives for ITD have been tried: a tax credit for up to 20% of company investment in ITD was available in 1981 and 1982, and some enterprises are now granted tax breaks for ITD as part of investment packages negotiated with Government in priority subsectors or regions. Industry's response has been limited, however, partly the result of the incentives' short time horizon, uncer- tainty about their permanence, cumbersome administration, and relative unimportance in the context of other large subsidies to industry and other factors affecting investment decisions. Regulation of technology imports (mainly patent licenses and technical services, worth about $300 million per annum) in the past focused on weeding out allegedly abbsive practices by suppliers. More recently it also seeks to guide firms in their choices of technology and sources, and to promote actions by the firms to enhance assimilation of imported technology. Government's comparative advantage to carry out these tasks, and the merits of the specific assimilation strategies being pursued, are uncertain. Use of public sector purchases to encourage ITD by Mexican suppliers has been limited by administrative restrictions, preference for straightforward importation of goods from established foreign sources, inadequate technical and business information to prospective contractors, and 7.ack of credit to finance their sales in terms comparable to those of foreign suppliers. 2.12 These explicit policies to promote ITD (and development of ITD infrastructure and financing, discussed below) have generally been designed and applied independently from one another, and from relevant implicit  - 9 - policies -e.g., taxation, which may influence the firms' propensity to undertake risky investments, and foreign industrial investment, which includes major technology transfers. Also, in revising specific policies (e.g., a new decree on fiscal incentives for industry in general), little attention has been given to the systematic assessment of Mexico's and other relevant countries' past experiences. E. Infrastructure Support Constraint 2.13 Mexico's considerable industrial R&D infrastructure (Annex 2), almost entirely in the public sector, is largely unresponsive to the needs of private industry. Firms which lack the size required to set up substan- tial in-house technology development facilities, are thus not well supported by this infrastructure. This reflects successive Governments' attempts to promote industrial innovation by strengthening research in universities and specialized public centers. Basic research, although important in achieving quality higher education thus indirectly benefiting ITD, is not a major source of technological change in Mexico's current stage of industrial development. Furthermore, Government's large emphasis on the supply of technology without commensurate attention to the factors that influence the firms' demand, has resulted in continuous difficulties in linking the centers and private industry. Industrial R&D centers established by CONACYT (the Government's science and technology council), for example, are generally run with little industry participation, often undertake projects for which industrial demand is unclear, on average require over 702 of their operating expenses to be met from Government funds, and reportedly are insufficiently equipped and staffed (partly the result of noncompetitive salaries). 2.14 Furthermore metrology, industrial standards, and quality assurance are inadequate to sustain effective industrial development, particularly of exports.3/ This is becoming more crucial as domestic producers face the increased competition resulting from trade liberaliza- tion and greater export orientation. Large multinational subsidiaries and firms with international connections have adopted the quality culture of their foreign partners, but industry largely lacks an appreciation of the role of quality assurance in industrial design, production and cost 3/ "Metrology- refers to making measurements at selected levels of accuracy. It requires measurement equipment, reference materials, etc., in the industrial firms and in specialized laboratories, whose quality and accuracy must be traceable to internationally accepted references. 'Standards- refers to characteristics of industrial goods which prQvide voluntary or mandatory benchmarks for judging the acceptability of products. -Quality assurance' refers to a focus on quality and meeting specifications within specified tolerance levels at all stages, from design to final production. Quality control- refers to the verification, generally through sampling, that products meet predetermined standards.  - 10 - control. The infrastructure of industrial metrology services is highly fragmented and incomplete, and lacks traceability to recognized interna- tional standards. SECOFI's (the Ministry of Trade and Industri-.l Development) Direccion General de Normas (DGN), whtch is responsible for establishing and monitoring standards in trade and industry, and for developing a unified metrology service, lacks the human and financial resources required. 2.15 Countrywide availability of specialized personnel does not appear to constrain ITD at present. Howevr-r, there are only about 6,000 scien- tists and engineers occupied in R&D or about 0.8 per 10,000 inhabitants which is low compared with other countries. Furthermore, Mexico's total pool of only about 13 scientists and engineers per 10,000 inhabitants is also small. This will in the longer term pose major problems, as the demand for engineers ar.d scientists increases. Table 2 gives further details. The proposed manpower training and development project (Education V-FY87) will focus on this problem. Table 2: R&D MANPOWER, 1982 Scientists and engineers per 10,000 inhabitants Total In R&D Brazil n.a 2.6 Korea (Republic of) 24 7.2 USA 139 30.3 Japan 595 41.5 Mexico 13 0.8 Sources: Mexico: Programa Nacional de Deserrollo Tecnologico y Cientifico 1984-88,- Pcder Ejecutivo Federal, 1984. Other countries: UNESCO Statistical Yearbook, 1984. Figures for Mexico are of 1983. F. Financing Constraint 2.16 Besides overall credit constraints in Mexico, normal industrial financing schemes are not well 3uited for ITD projects. Specialized financing for ITD projects is available from some of the trust funds established by Government to promote development by allocating credit to priority activities. The main source is FONEI (Fondo de Equipamiento Industrial), a trust fund established in 1971 and administrated by Banco de Mexico (the central bank) to provide long term financing for industrial projects by rediscounting commercial loans. In 1978 FONEI added a line of ITD loan rediscounting and guarantees. FOMIN (Fondo Nacional de Fomento Industrial, a trust fund established in 1972 and administrated by NAFINSA  - 11 - (the industrial development bank), makes direct equity investments provid- ing up to 49% of funds needed to start up or expand medium and small industrial firms, including some technologically innovative ventures. FONEP (Fondo Nacional de Estudio y Proyectos, another NAFINSA trust fund) finances engineering and other studies for industrial development, including some R&D projects. Besides the trust funds, CONACYT's "shared risk program" (established in 1980 and financed by the Government's budget) provides grants and conditional loans to industrial firms for ITD projects in line with Government's subsectoral and regional priorities, mainly utilizing the services of public sector R&D services and local engineering firms. A component of an Inter-American Development Bank's science and technology loan supported this program. 2.17 Despite these important efforts, ITD financing in Mexico is still i- its infancy. Total commitment of funds to industrial firms for ITD by specialized agencies in 1984 was only about $13 million (about 20% of total private industry R&D expenditures, paras 2.08-2.09), of which FONEI provided 78%. In general, existing schemes avoid risk and lack the neces- sary close integration of financial and technical assistance. The financial instruments do not match well industry's requirements, and are fragmented among various independent agencies. There are no formal private sources of venture capital (although commercial banks have voluntarily taken equity positions in many of their clients). Existing regulations do not encourage private financing of more risky ITD investments; recent measures to develop the capital market are expected to produce results only in the medium term. Private industry has been less responsive than expected to CONACYT's risk sharing scheme, reportedly due in part to slow processing, unresponsiveness to cost inflation, and issues of confidential- ity and industrial property rights; two-thirds of the program's financing in 1984 was for parastatal firms. FOMIN earmarked funds ($0.5 million) for technologically innovative ventures for the first time in 1985; it estimates that in the past only about 8% of total investments had signifi- cant ITD components. Tlkewise, about 5% of FONEP's funds supported ITD. Table 3 below summarizes estimated 1984 funding for ITD projects by these various agencies. Annex 3 gives further information.  - 12 - Table 3: ITD FINANCING, 1984 Approximate 1984 Commitments US$ million Z FONEI 9.8 78 FOMIN 1.2 10 FONEP 0.3 2 CONACYT 1.3 10 TOTAL 12.6 100 FONEI figures are new commitments (loans and grants). All others are disbursements. G. Scope for Improving ITD 2.18 As part of the IMF-supported stabilization program launched in late 1982, a more realistic exchange rate policy began to make Mexican products more competitive abroad, increase competition domestically, induce substitution of imported raw materials and raise the price of foreign technology. As a result, private investment in ITD has increased,4/ and specialized ITD financing has grown by about 20X per annum even though industrial enterprises have been faced with unusual financial difficulties in the same period (Annex 3). The 1985 trade liberalization measures, and export promotion efforts, are likely to further accelerate demand for ITD. This is conservatively forecast to result in about 40% per annum growth in demand for specialized financing for private industry technology invest- ments in 1986-88. H. Government ITD Plans for 1984-88 2.19 The Government's national programs for 1984-88 contain specific directives to support ITD. The national program for industrial development 4/ For example, CONACYT estimates that the metalmechanic, electronics and chemical industries increased in 1984 their investment in ITD on average to 3.6% of sales, which is comparable to mature industrial economies. Most of this growth was among private firms.  - 13 - and foreign trade,5/ for example, emphasizes the need to strengthen the relationships between technology development centers and industry. Govern- ment will direct public sector purchases to technologically innovative industrial firms, and establish domestic supplier development programs with participation of industry associations. Government financing will be made available to industrial firms through FONEI (complemented by FOMIN and FONEP) and CONACYT for ITD projects directed at exports, Import substitu- tion, and basic goods production. Accelerated depreciation and fiscal incentives to industrial firms will support ITD in priority areas and subsectors, technological modernization of productive plant, and investment in multifirm technology service centers and in trust funds that finance ITD projects. Government funding of R&D througn CONACYT will be revised to better address industrial needs. SECOFI will strengthen direct technical assistance to technology importers, and promote assimilation of foreign technology including that acquired through foreign investment in Mexican industry. The Government's science and technology national program6/ is overall consistent with the above. Additionally, it includes specific actions to strengthen technology information services (mainly through INFOTEC), improve and disseminate information on Mexican R&D facilities and manpower, strengthen graduate education, and develop the national metrology center. 2.20 These programs express the Government's ITD philosophy and broad investment priorities. They are expected to guide public sector agencies in the decisions regarding budgetary allocations, import licensing, channeling of funds, tax credits, grants, etc. The national programs are not, however, operational plans. Specific ITD support actions are decided, budgeted and implemented by the various agencies largely independently from one another. A considerable number of such initiatives are underway._/ ,-ore than half way into the present Government's term in office, however, some major ITD activities signaled by the national programs are not being implemented (e.g., national metrology center). Recent reductions in public sector outlays-which are expected to continue into 1986-have had an understandable impact in this respect, but should not be allowed to stifle efforts to improve support for technology development. 5/ 'Programa Nacional de Fomento Industrial y Comercio Exterior, 1984-1988-, August 1984. The main section on technology policy is in pp. 150-156. 6/ Programa Nacional de Desarrollo Tecnologico y Cientifico, 1984-1988." 7/ A few involve joint actions between two or more agencies for specific purposes, e.g., SECOFI's promotion of identification of industrial business opportunities and related technological innovation needs, with CONACYT financing.  - 14 - I. The Bank's ITD Lending Strategy in Mexico 2.21 Bank support for industry in Mexico rests on macroeconomic and sector work, which have made possible the processing of several lending operations designed to address issues of trade liberalization, export promotion and industrial restructuring. Several operations include some support for technology development (Annex 4). Successful performance by Mexican industry in these three areas will depend on technological development, which is a prerequisite to increasing competitiveness abroad, substituting increasingly costly imported raw materials and technology, and improving industrial processes and products. To achieve the required level of domestic technology development, the Government must make progress in ITD policy and support institutions, and it must assure that specialized financing is available on suitable terms. Therefore, a Bank technology development project is appropriate at this time. This operation will focus on the development of technological capabilities of private industry, to help reduce excessive concentration of ITD resources and responsibilities in the public sector, and supplement Government's long standing technology supply approach which by itself has failed to benefit industry at large. 2.22 The Bank's experience in helping establish and finance special- ized ITD agencies in Spain and Korea, and related sector work in several countries, are directly relevant to some of Mexico's prob'ems. These experiences give the Bank some insight on the policy and operational problems of specialized ITD financing agencies, including the need to attain a critical mass of expertise and effective autonomy from Government administration. They also highlight the need for an integrated approach to ITD, with adequate attention to the macroeconomic country conditions, specific Government policies and constraints which have a direct bearing on ITD, and R&D and quality control support services. These lessons were applied in the design of this project. 2.23 However, the task of strengthening ITD capability is complex. The relationships between technology and industrial development are not sufficiently well understood. In Mexico's relatively large economy, numerous public and private agencies have a legitimate role in this process. Responsibility for ITD policy formulation and implementation is spread over several Government agencies with somewhat overlapping func- tions. The Bank has deliberarely concentrated initially on a few key issues and agencies (selected in terms of agency receptivity, overall impact, synergism among components, and likelihood of rapid progress) in order to focus action which is at present highly diffused, and which defies effective coordination and leadership. Although setting up a new financing agency could be advantageous in pursuing long term institutional objec- tives, the Bank chose to work with existing agencies to avoid further proliferation and the risk of major start-up delays; experience during the project will help clarify whether a new agency may need to be established or spun off in the future.  - 15 - III. THE PROPOSED PROJECT AND BANK LOAN A. Project Objectives and Composition 3.01 The proposed first ITD project and loan to Mexico are designed to help improve the capability of industry (especially private firms) to undertake technological innovation needed to face increasing competition in the context of the Government's economic liberalization program. The project has three objectives: (a) improving ITD policy instruments through policy analysis, (b) selective strengthening of infrastructure, and (c) expansion and strengthening of specialized technology financing. 3.02 PolicSy Analysis. A major objective of the project is to help focus the Government's attention on policies and related instruments designed to encourage ITD industry-wide. This is expected to become an integral part of the ongoing industrial policy dialogue between the Govern- ment and the Bank, and to help improve explicit policy instruments. Towards this objective, SECOFI, through its General Directorate of Industrial Policy (DGPI), will carry out or supervise studies on the factors that influence technological innovation in industrial enterprises, including fiscal incentives, specialized financing and technology assimilation strategies. The studies will assess the impact of explicit technology policies on industry, examine interdependences among them and with broader policy areas (e.g., general industrial policy, taxation), compare relevant experience in other countries, examine the effects of alternative mid-term macroeconomic scenarios on ITD strategy and on the demand for specialized ITD financing, and draw lessons and make specific recomendations for improving Government measures supporting technology development at the enterprise level. The studies, expected to cost about $0.8 million, would be financed entirely by SECOFI. 3.03 Selective Strengthening of Infrastructure. The Project seeks to increase the responsiveness of public sector infrastructure to private industry's need for support services, through: (a) restructuring of R&D centers and (b) improvement of metrology services. 3.04 The National Science and Technology Council (CONACYT) has, with the Bank's concurrence, selected four from among eight public sector R&D centers in the pharmaceutical, agroindustry and biotechnology, metal mechanics, and chemical sectors. The four centers currently employ some 145 professionals and provide service to 210 industrial enterprises, including some large parastatal companies. CONACYT has comvissioned feasibility studies for the corporate reorganization and fiuancial restructuring of each center (or, if necessary, to establish new centers) with priv4te sector participation. Based on these studies, specific investment plans would be prepared to enable the centers to meet the needs of their potential clients, which include product development, equipment and pilot plant design, technical assistance, quality control, metrology, technology information, and liaison with specialized agencies. These services are expected to be especially valuable to medium-sized enterprises  - 16 - which do not bave in-house ROD capability and, indirectly, to large firms which depend on suppliers and subcontractors whose quality control and technology problem-solving capability would benefit from the proposed project. 3.05 The proposed project would finance loans to private industrial enterprises, for their equity participation in the selected centers, thus injecting funds required for the execution of specific investment plans. Such R&D lnvestment loans would be made by FONEI and finance up to 100l of an enterprise's holding in any center. The amount of equity would be determined on the basis of the investment plans, which would specify the restructuring of the center's ownership, the equipment, works and services needed to start up the centers' new activities, and the institutional arrangements ensuring major (possibly dominant) participation of the private investors as well as of Government, CONACYT, and other entities as appropriate. For the four centers, the cost is estimated at about $16.8 million (including contingencies) of which the Bank would finance $8.2 million, including up to $0.2 million of retroactive financing to September 1, 1985 for the cost of consultants used to prepare studies and promote the proposed restructuring operations. 3.06 SECOFI's General Directorate of Standards (DGN) would, with the assistance of a metrology institution and consultants, assess the adequacy of existing industrial metrology infrastructure, as well as the quality of available services. This study, to be partly financed with loan funds (up to $0.4 million), would recomned cost effective solutions to problems arising from inadequate service and incomplete infrastructure. Specific metrology programs and institutions which require strengthening would also be identified, and, subject to the findings of the study, the proposed loan would provide up to $1.6 million for the execution of such programs, expected to cost about $3.1 million. 3.07 Expansion and Strof Specialized Technology Financing A primary objective of the project is strengthening of FONEI's financing for ITT) projects of private industry and development of R&D capability in industry, research centers and engineering firms (Annex 5). A line of credit of $37.1 million would be provided to FONEI to help expand its ITD progran. With this support, and related improvements in FONEI's policies and procedures, it is estimated that FONEI ITD commitments will grow an average 46% per annum in dollar terms between 1986 and 1988. Strong demand is expected for loans for full-scale production using locally developed technology, which will have larger than average size for ITD loans. Retroactive financing to September 1, 1985 of $4.6 million would be provided to support FONEI's efforts to achieve major expansion following this project's appraisal by the Bank. 3.08 FONEI's ITD program would be further strengthened through a technical assistance program which will (a) provide local and overseas training for FONEI staff and commercial banks' -industrial assistants,- particularly for personnel to be hired in 1986 and 1987, and (b) support FONEI's promotion efforts and provide assistance in project evaluation by  - 17 - financing short-term consultants as needed. Some $0.7 million of the loan will be allocated for this component. Project Execution 3.09 Loan funds for the proposed project are planned to be fully committed by June 30, 1989 and disbursed by June 30, 1992. SECOFI would carry out the policy and metrology strategies, CONACYT and the Government would carry out the restructuring of R&D centers; FONEI would provide loans to finance investments in these centers, and for initial improvement of metrology services. FONEI would be responsible for the specialized technology financing component and its own institutional strengthening. 3.10 The technology policy studies would be carried out by SECOFI with its own staff and consultants, guided by an advisory committee to be appointed by DGPI with representation of industry, academia and other Government agencies. Draft terms of reference for these studies were prepared with the Bank during project appraisal. During negotiations, agreement was reached that SECOFI would submit final terms of reference for the Bank's review; complete the studies not later than September 30, 1987; and furnish them to the Bank, and exchange views with it on the studies' conclusions and recommendations. 3.11 To facilitate restructuring of the R&D centers, feasibility studies have been completed and investment plans are being prepared by CONACYT and the centers with consultants, under terms of reference and timetable agreed with the Bank (Project File and Annex 6 respectively). The Bank loan will finance through FONEI s R&D investment loans 1OOZ of eligible expenditures (mainly for equipment and training). As conditions of disbursement for this component the Bank would need to (a) approve guidelines agreed between CONACYT and FONEI for evaluating, awarding and supervising such loans to industrial firms, (b) approve each center's investment plan and (c) receive satisfactory evidence of enough advance commitments from iudustrial firms to ensure adequate funding of each restructuring operation. Public sector support will be provided by Government through CONACYT's own funds (preparation), loans to industry from CONACYT's shared risk program (specific R&D projects) and the centers' Government budget allocations (incremental start-up operating costs). 3.12 Definition of metrology investments to be financed under the proposed loan would depend on the results of studies referred to in paragraph 3.06. SECOFI will carry out these studies with own staff and local consultants. Final retention by SECOFI of a metrology institution to help carry out these studies with qualifications and under .erms of reference to be agreed with the Bank, would be a condition of disbursement for the metrology studies as well as for any subsequent investments. During negotiations, agreement was also reached that SECOFI would complete the metrology studies not later than September 30, 1987, furnish such studies to the Bank, and exchange views with it on the studies' conclusions and recommendations. Assistance from a metrology institution is being negotiated by SECOFI as bilateral technical assistance on a grant basis.  - 18 - The proposed loan would help ueet SECOFI's estimated incremental costs resulting from the studies. Subject to Bank prior approval of investment and financing plans and timetables, a condition of disbursement for metrology investments agreed at negotiations, loan funds will also support urgent initial improvements identified by the DGN study. 3.13 Regarding specialized technology financing, FONEI's management is committed to expansion and strengthening of its technology program and is willing to implement necessary changes in operational policies and procedures. During loan processing, the following aspects of FONEI's policies and procedures were identified as areas to be improved to allow the ITD program to grow and better meet the needs of its target clients: (i) expansion of financial instruments; (ii) improvement in project evaluation and supervision procedures; and (iii) articulation of a clear policy and strategy for the technology program. 3.14 Until recently, all ITD financing by FONEI was through a mix of conventional loans and grants. To better support firms undertaking higb risk technology projects, FONEI has added a conditional loan instrument. This will be used primarily for financing investments required for full scale production using locally-developed technology, which has higher market risk than similar projects financed under the traditional equipment lending program. With conditional loans, FONEI and the investors share the investment risk. Loan repayment schedules are based on the expected revenues to be generated by the project. If revenues are less than expected, FONEI may in consideration of the enterprises' inadequate overall financial position, reduce amortization of principal to a percentage of net revenues generated by the project and reschedule or remit any outstanding balance when the subloan matures. To compensate for higher risk, interest rate on conditional loans include a risk premium. The criteria for determining the risk premium were reviewed by the Bank and found satisfactory. It was agreed at negotiations that introduction in GIRA of a new interest rate category for conditional loans is a condition of loan effectiveness. Additionally, FONEI will initiate a pilot program to provide equity loans for ITD lending. These are loans to commercial banks for them to take equity positions in firms as a means to finance lTD. Operating guidelines for ITD equity loans will be similar to equity loans for other FONEI lending with the financial intermediary bearing the investment risk. For ITD equity loans as for other ITD lending, FONEI will discount 1007 of the commercial banks' participation. Project appraisal will be carried out in accordance with procedures in FONEI's ITD operations manual (para 3.15). The type of financing provided (conventional loan, conditional loan or equity) will be determined by project and firm characteristics identified during project appraisal. 3.15 FONEI has gradually refined its project evaluation and supervision procedures to reflect the special characteristics of technology lending. Some deficiencies were identified during project appraisal. For example, existing project evaluation procedures lacked detailed project risk and market analysis; understaffing of the Technology Development Unit (TDU) resulted in poor project documentation, particularly when several  - 19 - projects are processed under the same credit; and supervision is minimal and primarily administrative, lacking a focus on identifying potential problems. These deficiencies have been addressed in FONEI's revised operating manual, satisfactory to the Bank, which is now in use. 3.16 To provide focus and direction for the ITD program, it was felt FONEI needed to articulate clearly its policy and strategy, identifying the program's objective, FONEI's grant and interest rate policy, lernding and staffing targets, promotional strategy including target growth in industri- al assistants, and other features discussed during loan processing. The ITD policy and strategy statement would also reflect FONEI's intention to review interest rates over the project execution period, adjusting towards market rates as the program became more established and to offer potential clients of conventional ITD loans, by January 1, 1987, the option of a non-subsidized loan with a larger direct grant to offset the interest rate difference. FONEI has prepared a policy and strategy statement, satisfactory to the Bank, concerning the items indicated. 3.17 During preparation of the proposed loan, it was agreed with FONEI's management and Banco de Mexico, that major expansion of TDU and Supervision Department staff was essential to allow increased growth in ITD lending, and improved project evaluation and supervision. This entailed expansion from an equivalent of 5 positions in 1985 to 12 in 1986 (8 in the TDU and 4 in Supervision), and about 18 in 1987. By loan negotiations, Government had approved a total of 17 new staff positions for FONEI, 7 in the ITD and supervision units and 10 in support units. It was agreed that staff requirements for 1987 would be reviewed in late 1986, based on updated lending targets. 3.18 To provide borrowers with ITD resources on favorable terms, FONEI has cross-subsidized technology operations by allocating part of its earnings to grants to enterprises and by accepting a lower return on the ITD program due to the lower interest rate (currently ACF-5Z as opposed to equipment lending at ACF %). Subsidized lending is justified (para 2.04) and the Bank has supported other subsidized technology lending programs, e.g., in Korea and Spain. However, adequate provisions must be made to ensure the finwncial health of the institution. The Government has decided to further strengthen FONEI by repaying both principal and interest for the industrial recovery and the technology development loans. With these measures, FONEI would be able to adequately finance its lending program (including grants to enterprises under the ITD program) during the project period. During loan negotiations, it was agreed that in the event financing was found to be inadequate or provision of subsidies to support the expected level of ITD lending would materially affect FONEI, the Government would make arrangements satisfactory to the Bank to provide FONEI with additional resources. To ensure transparency, it was agreed that separate financial statements will be prepared for the ITD program which will reflect the extent of grant and interest rate subsidy.  - 20 - B. Project Cost and Financing 3.19 Estimated project costs are summarized in Table 4 below. Base costs are as of April 1986. No allowance is added for physical or price contingencies for FONEI's line of credit. For all other components, 10% of base cost is added for physical contingencies and 7.5% per annum for price changes. The financing plan is in Table 5, with contingencies allocated approximately proportional to base costs (except line of credit). Table 4: PROJECT COST SUMMARY Foreign Local Currency Currency Total -________- USS million Policy Analysis 0.1 0.7 0.8 R&D centers Studies and promotion - 0.2 0.2 Investments 5.5 8.2 13.7 Metrology services Studies 0.1 0.2 0.3 Initial metrology improvement 1.3 1.3 2.6 Line of credit 19.4 55.6 75.0 Technical assistance to FONEI 0.5 0.1 0.6 BASE COST (including contingencies) 26.9 66.3 93.2 - - Contingencies Pbysical 0.7 1.0 1.7 Price 0.8 1.1 1.9 Subtotal contingencies 1.5 2.1 3.6 TOTAL COST 28.4 68.4 96.8  - 21 - Table 5: PROJECT FINANCING Govern- IBRD ment FONEI Firms Total - -- US$ million Policy Analysis - 0.8 - - 0.8 R&D centers Studies and promotion 0.2 - - - 0.2 Investments 8.0 8.6 - - 16.6 Quality assurance DGN study 0.4 - - - 0.4 Initial metrology improve- ment 1.6 1.5 - - 3.1 Line of credit 37.1 6.0 16.9 15.0 75.0 Technical assistance 0.7 -- - 0.7 TOTAL (including contingencies) 48.0 16.9 16.9 15.0 96.8 C. Loan Amount. Terms and Conditions Relending Terms 3.20 The proposed loan of $48.0 million would be made to NAFINSA with the guarantee of the Government, for 15 years including 3 years' grace, at the Bank's standard variable interest rate. NAFINSA would channel the resources to: (a) SECOFI for the metrology studies; and (b) FONEI for the specialized technology financing program and techni^al amsistance, for eigible industrial enterprises for R&D investments in four restructured (or new) R&D centers, and for eligible entities for metrology investments. The Government would repay the full principal of the loan, pay interest and other charges, and bear the related foreign exchange risk. Execution of contractual arrangements between the Government and NAFINSA and FONEI, on terms satisfactory to the Bank, would be a condition of effectiveness. Terms and Conditions of FONEI's R&D Investment Loans 3.21 To attract firms to this new concept FONEI would initially lend up to 100Z of the funds needed by eligible industrial enterprises to invest in restructured R&D centers, at an interest rate of not less than the average cost of funds to the banking system (ACF). After about one year FONEI's maximsu participation would be reviewed with a view to bringing it in line with the terms of POKEl's specialized ITD financing. It was also agreed at negotiations that GIRA would be modified accordingly as a condition of loan effectiveness. Maturities of R&D investment loans would be up to ten years, including up to five years' grace.  - 22 - Terms and Conditions of FONEI's Specialized ITD Financing 3.22 Under its ITD program, FONEI lends primarily to private sector industrial firms, research centers and engineering firms to finance all elements necessary to support ITD projects, including purchase of basic information, process engineering, raw materials and supplies, operational and training expenses for staff involved in the project, R&D equipment and operating expenses, and full scale production using locally developed technology. Its project review and approval process benefits from the input of a technical committee with representation of industry, academia and other outside agencies. All ITD lending is through commercial banks who assist with promotion of FONEI loans through an Induistrial Assistance Program. 3.23 To provide investors with financing on terms appropriate for ITD, FONEI provides a mix of loan and grant funds. FONEI discounts eligible subloans made by commercial banks, and provides grants to the enterprises. FONEI finances up to 80% of total investment costs and the firm the remaining 20%. FONEI's grant component is up to 30% (average IOZ), depending on project characteristics, such as its innovative merit and the level of risk. The criteria FONEI applies to determine the grant amount have been reviewed by the Bank and found satisfactory. The maximum outstanding technology subloans to any one borrower from the proceeds of the Bank loan would not exceed $4 million equivalent. Conventional and conditional ITD loans would have maturities of up to 13 years including a maximum krace period of 3 years. Equity subloans would have maturities of up to 10 years including a maximum grace period of 5 years. 3.24 FONEI would tharge the commercial banks interest rates equivalent to 88% of the ACF on conventional technology loans, ACF plus one percentage point on equity loans, and, on conditional loans, 104% of the ACF, plus a risk premium which would vary among loans. The commercial banks would retain a spread of 6% of ACF which is sufficient to attract commercial banks to technology financing, as FONEI would, in addition, discount 100% of technology subloans and guarantee up to 90% of conventional and conditional ITD subloans. Under the proposed project, financial intermediaries would charge to ultimate beneficiaries variable interest rates equivalent to 94% of the ACF for conventional technology subloans, and 110% of ACF for conditional subloans plus a risk premium. Currently, GIRA sets only the interest rate on conventional subsidized loans-in accordance with previous arrangements-at a minimum level equivalent to the ACF less three percentage points. It was agreed during negotiations that GIRA would be amended to reflect the above new nominal interest rates for technology financing; this amendment is a condition of loan effectiveness. 3.25 To mitigate the impact of high nominal interest rates, FONEI offers, as an alternative to conventional repayment terms, the PVP payment scheme. This, unlike the conventional repayment schedule, has no grace period, but interest is payable only on the principal being repaid in a given year. Under the PVP scheme, debt service is more closely linked to subproject cash generation, thus alleviating the adverse cash flow effect of early service payments.  - 23 - 3.26 Conventional ITD subloans and equity loans in excess of $0.5 million and conditional loans in excess of $0.8 million will require Bank approval prior to disbursement, based on full project documentation in a standard form acceptable to the Bank. On this basis, the Bank would review an estimated 20% of total subprojects representing about 80Z of total subloan value. Review will be done with the assistance of Bank subsector specialists. Subloans below the established free limits will require only abbreviated documentation for Bank approval, and this may take place after disbursement. Full documentation for all loans will bto available at FONEI for Bank review during supervision and for audit. The first five technology and equity subloans will be submitted for Bank prior approval regardless of size. D. Procurement and Disbursement 3.27 Procurement procedures for goods and services financed with loan funds would comply with those custamary for industrial development finance operations. Under the project's technology infrastructure and metrology components, limited international bidding procedures would be applied to goods costing in excess of US$500,000 equivalent, while below that level, and for civil works, local or international shopping procedures with a minimum of three quotations would be required; both types of procedures would be satisfactory to the Bank. The Bank would have prior review of contracts for goods and services estimated to cost in excess of US$150,000 equivalent under the agreed investment plan of any research and development center or metrology program. All consultants to be financed with loan funds would have qualifications, experience and terms and conditions of employment satisfactory to the Bank. 3.28 In line with country policy, the loan will meet about 50% of total project cost. The Bank would disburse against 70% of FONEI technology subloans; 65% of FONEI's technology equity loans; 100% of expenditures (a) financed under FONEI's R&D investment loans and (b) for consultancy services; and 50% of expenditures for goods, civil works and services required for the metrology component. To facilitate disbursements, a special account (revolving fund) of up to $4.0 million will be set up and administered by NAFINSA. Disbursements from this fund will be made on the basis of statements of expenditures (SOEs). The loan is expected to be fully disbursed by June 30, 1992 (para 3.09). E. Accounts and Audit 3.29 The accounts of NAFINSA and FONEI (including those kept for the purposes of the project), the Special Account, and statements of expendi- tures, would be audited annually by independent auditors acceptable to the Bank. The audit reports, including an opinion in respect of the supporting documentation for disbursements based on SOEs, would be submitted to the Bank annually within six months after the end of NAFINSA's and FONEI's fiscal year. In addition, FONEI would prepare separate accounts for its technology development program in a manner satisfactory to the Bank. These will be submitted to the Bank and relevant Government agencies annually.  - 24 - Payments for SECOFI's and CONACYT's project components, would be made directly by NAFINSA, and the relevant accounts and SOEs would be audited by NAFINSA's independent auditors. F. Supervision and Monitoring 3.30 Since this is the first Bank ITD project in Mexico, close super- vision is planned with frequent small missions. In particular, supervision missions (with subsector specialists if needed) will review a large propor- tion of FONEI's subloans above the free limit and samples of smaller opera- tions, to assess implementation of FONEI's revised subproject evaluation and supervision procedures and the application of FONEIts lending and grant award criteria, and the quality of FONEI's technical analysis. Any further desirable adjustments of policy or procedures can then be identified during project execution. At negotiations, it was agreed that a system for retrospective review of ITD subproject impact, satisfactory to the Bank, will be established Dy FONEI by June 30, 1987. G. ProJect Benefits and Justification 3.31 The project will help to accelerate industrial technological change, thereby helping private firms compete in domestic and export markets. During the project, increased availability of funds on terms suited to lTD projects, selective use of Government subsidy, and improved assistance in identification and formulation of ITD projects, are expected to result in more, larger or earlier technological improvements in partici- pating firms. 3.32 Project benefits will continue to accrue after project comple- tion. Firms will benefit from major expansion of specialized IT.D financing and improvement in financing instruments which will assist with all stages of ITD. A strengthened FONEI ITD unit will provide Government with a core of specialized expertise and policy advice on ITD financing and promotion. Pilot restructuring of R&D centers, besides achieving economies of scale in R&D that participating firms cannot individually attain, will provide an experience without precedent in Mexico (nor much elsewhere) that would help guide future broader efforts to develop public sector R&D infrastructures responsive to private industry needs. Likewise, the project will help establish an analytic base on which Government can update and revitalize its policy and investment decisions regarding industrial metrology infra- structure, as needed to facilitate industrywide pursuit of quality. In this context, modest but significant initial steps will have been taken in at least one or two industrial subsectors to overcome critical obstacles to the achievement of quality traceable to internationally recognized refer- ences. Finally, analysis of explicit Government ITD policies and their relationships to broader policies which implicitly influence ITD, will provide guidance for their improvement. 3.33 These benefits cannot be readily quantified. Information available by the end of the project will allow a review of the specific  - 25 - practical results obtained and an assessment of the participating agencies' performance, on the basis of which the project's overall merits can be re-examined and lessons drawn for future operations. Also, a system for more detailed retrospective review of ITD subprojects will be established (para 3.30), which would allow a better assessment of the impact of future operations on industrial development. H. Project Uncertainties and Risks 3.34 There are significant uncertainties associated with the project. First, expansion of FONEI technology staff to provide a minimum core of specialized staff, essential for project success, has been approved by Government and screening of candidates is underway. However, recruitment, training and consolidation of staff remains to be achieved. Second, under a recent reorganization of SECOFI, DGPI has been assigned a substantial number of staff and set up a studies group, but their experience in policy analyses of the nature and level envisaged in this project is limited. This would be overcome by appointment of an advisory committee, by retaining other agencies (e.g., UNAM) to assist with selected tasks, and by drawing on Bank expertise especially during supervision. Third, whereas CONACYT's Director in consultation with SPP decided to go ahead with the restructuring of centers with major participation of private industry, this is controversial and opposed by some senior CONACYT staff. Also, despite good initial responses from industry, it is uncertain whether eventually a sufficiently large number of firms will commit themselves as needed to go ahead with the restructuring operations. Lastly, the impact of the 1985 earthquake and 1986 oil price decline (subsequent to appraisal) on relevant Government economic measures is unknown at this time and it is uncertain how quickly Mexico will return to sustained economic growth and what impact any delay in economic recovery will have on the demand for ITD finance. Close Bank supervision will permit any necessary adjustments in project design during project implementation. 3.35 Government has made a commitment to strengthen FONEI (para 3.18) through repayment of principal and interest on new Bank loans which should ensure that FONEI can adequately provide the subsidies required to support expansion of the ITD program (both interest rate and direct grants) from its net income, over the project period. Provisions for losses in FONEI's financial projections of 2.5% of new ITD disbursements which is considered adequate, protect FONEI's net income in the event it has to honor its guarantees to financial intermediaries. The return on the conditional loan portfolio is expected on average to be equivalent to that on conventional loans, with high returns on most projects compensating for lower returns on those less successful; an additional risk premium currently calculated to range from 2-10% will compensate for an expected 30% failure rate on these loans. Provisions for losses in FONEI's financial projections also take into account this expected level of loss on conditional loans which will represent less that 10% of FONEI's overall portfolio in the project period. Even if the actual failure rate of conditional loans is as high as 50%, overall FONEI net income would be reduced by less than 3.12 and FONEI's return on equity would still be positive in real terms (Annex 5, Table lA).  - 26 - 3.36 As the program expands and financial intermediaries gain more experience with technology lending it is hoped that their participation will increase and the level of FONEI guarantees will decrease. Currently, the financial exposure of the intermediaries is limited to 10% of the total technology portfolio (since FONEI rediscounts 100% and guarantees 90% of technology subloans) and can be considered negligible. The pilot equity component of $5 million for which intermediaries will bear the investment risk will represent a minute percentage of their overall portfolio. I. Environmental Impact 3.37 FONEI's review of subprojects will include an assessment of their environmental impact; it is hoped that some projects may have potential for reducing air and water pollution and toxic w.ste. IV. AGREEMENTS AND RECOMMENDATIONS 4.01 During loan negotiations, assurances were obtained on the following matters: (a) Goverument will assume the obligation to repay principal and interest on the ITD loan. In the event FONEI's funds are inadequate to support the ITD lending program or the provision of subsidies would materially affect FONEI, the Government would make arrangements satisfactory to the Bank to provide FONEI with additional resources (para 3.18); Cb) The maximum outstanding to any single FONEI borrower out of the proceeds of the Bank loan will be $4.0 million (para 3.23); (c) FONEI technology subloans in excess of $0.5 million and equity loans in excess Of $0.8 million will require full documentation and Bank approval prior to disbursement from the spec'ia account. Full documentation on all subloans will be maintained by FONEI for Bank review and external audit (pars 3.26); (d) Separate financial statements in a format agreed with the Bank will be prepared for the ITD program. These will be submitted to the Bank and relevant Government agencies on an annual basis (paras 3.18 and 3.29). (e) SECOFI's policy and metrology studies will be completed by September 30, 1987 and sent to the Bank, and SECOFI will exchange views with it on their conclusions and recommendations. The Bank will review and comment on the terms of reference for the policy studies; the metrology  - 27 - institution's qualifications and terms of reference will be agreed with the Bank (paras 3.10 and 3.12); (f) Audit reports for FONEI and NAFINSA, including audits of the special account and statements of expenditures will be presented to the Bank within six months of the end of each calendar year. For expenditures under SECOFI's and CONACYT's project components, SPP would carry out an independent review of all documents including SOEs, and approve them before submission to the Bank (para 3.29). (g) By June 30, 1987 FONEI will have established a system of retrospective subproject review acceptable to the Bank (para 3.30); 4.02 The following are conditions of loan effectiveness: (a) Execution of contractual arrangements between the Govern- ment, FONEI and NAFINSA on terms satisfactory to the Bank (para 3.20); (b) Introduction into GIRA of new interest rate categories for (i) R&D investment loans equivalent to ACF, (ii) subsidized conventional technology subloans of 94% of ACF, (Mi) conditional loans of 110% of ACF plus a variable risk premium and (iv) equity loans of ACF plus 1Z (paras 3.14, 3.21 and 3.24). 4.03 The following are conditions of loan disbursement for particular project components: (a) FONEI and CONACYT agreeing on operating guidelines satisfactory to the Bank for evaluating, awarding and supervising R&D investment loans to private industrial enterprises (para 3.11) (b) Bank approval of the plans for initial investments in metrology and for restructuring CONACYT centers, and of evidence of advance commitment of a sufficient number of industrial enterprises to the centers' restructuring of CONACYT centers (paras 3.11 and 3.12); (c) Final agreement with a qualified metrology institution under terms of reference acceptable to the Bank, and Bank approval of metrology investment plans (para 3.12); (d) Bank approval of the first five FONEI technology subloans and equity loans, irrespective of size (para 3.26).  - 28 - 4.04 Retroactive financing from September 1, 1986 is recommended (a) up to $4.6 million for FONEI subloan disbursements and (b) up to $0.2 million for CONACYT s costs of consultants (paras 3.07 and 3.10). 4.05 Subject to the above, the proposed project provides a suitable basis for a Bank loan of $48.0 million for a term of 15 years including three years' grace.  - 29 - ANNEX 1 MEXICO INDUSTRIAL TECHNOLOGY DEVELOPMENT PROJECT ITD Policy Responsibility 1. Responsibility for ITD in Mexico is spread among various partly interdependent Government agencies, as well as in parastatal and private industry. The main ones are outlined below. 2. Secretaria de Comercio y Fomento Industrial (SECOFI, the trade and industry ministry) has primary responsibility for promoting the development of private industry, including technology innovation. SECOFI's Subsecretaria de Fomento Industrial reviews Government policies and instruments that influence ITD generally. With Secretaria de Hacienda y Credito Publico (SHCP, the finance ministry), it is responsible for improving the system of fiscal and financial incentives for ITD. It also determines subsector priorities for Government support, and undertakes specific programs to stimulate technological innovation in industry and strengthen the links with Mexican sources of R&D and engineering. SECOFI's Subscretaria de Regulacion de la Inversion Extranjera y Transferencia de Tecnologia regulates the importation of industrial technology (associated with foreign investment as well as through licenses and technical assistance contracts). In addition to the control and recording function, this includes assistance to firms in identifying foreign sources of technology, help in negotiating terms of transfer, and promotion of action programs by the firms to enhance assimilation of imported technclogy. SECOFI's Subsecretaria de Planeacion Industrial integrates Government plans for industry into the national plans for industrial development and foreign trade. 3. Secretaria de Energia, Minas e Industria Paraestatal (SEMIP) is the ministry that overviews parastatal industry. It provides directives for ITD by subsectors, and guides the use of public sector purchases for the development of domestic industry and technology. 4. Consejo Nacional de Ciencia y Tecnologia (CONACYT) is the Government's agency for science and technology policy. It promotes basic and applied research mainly by formularing indicative research programs, channeling federal funds to universities and other agencies for specific science and technology projects and for graduate education, and setting up and overviewing specialized and regional R&D facilities. CONACYT is the obligated consultative organization for all public and parastatal agencies in matters related to science and technology, the main advisory agency to Government in this field, and the representative of Government in related international affairs. CONACYT has a staff of about 1,000. Industry Department March 12, 1986  30 ANNEX 2 Page 1 of 2 MEXICO INDUSTRIAL TECENOLOGY DEVELOPMENT PROJECT ITD Infrastructure 1. Most industrial R&D in Mexico takes place within industry. Large private conglomerates have set up specialized ITD firms (e.g., VITROTEC, TECNOFIRSA, INDETELEC). Some other large private industrial firms, and firms associated with multinational corporations, have in-house R&D facilities. Large parastatals have established associated R&D institutes te.g., Instituto Nacional del Petroleo, Instituto de Investigaciones Electricas) which also provide some support to private supplier firms. 2. There is also a considerable science and technology support infrastructure. About 140 centers, mostly in the public sector, provide specialized R&D services; about 20 of these are mainly involved in industrial technology. CONACYT helped set up (and currently overviews) eight such industrial R&D centers in provincial cities, with both a regional support function and a degree of subsector specialization. INFOTEC, established by CONACYT and currently a Government trust under Nacional Financiera (NAFINSA, the state industrial development baink), provides industrial technology information services to about 300 subscriber firms and to industry in general. Instituto Mexicano de Investigaciones Tecnologicas (IMIT, a trust fund under Banco de Mexico, the central bank) and Laboratorios Nacionales de Fomento Industrial (LANFI, a part of SECOFI) are among the earliest public sector industrial R&D facilities set up in the 1950s and continue to be active in food technology, mineral processing, analytic chemistry and other fields. University R&D relevant to industry takes place mainly at Instituto Tecnologico y de Estudios Superiores de Monterrey (largely funded by local private industry), Universidad Nacional Autonoma de Mexico (UNAM, the largest state university, including Instituto de Ingenieria, a prestige civil engineering R&D center established in the 1950s and largely funded by private industry contracts, and also a recently set up specialized unit that promotes and manages the sale of university R&D to industry) and Instituto Politecnico Nacional. About 1,400 engineering firms (mostly private, some of them large and active in international markets) provide industry with basic engineering, design, technical assistance and other functions that link industry with foreign and domestic sources of technology. 3. Four of the CONACYT centers have been preselected for possible restructuring with private industry participation and Bank financing: Centro de Investigacion y Asistencia en Tecnologia y Diseno del Estado de Jalisco (CIATEJ), Instituto Mexicano de Investigaciones en Manufacturas Metalnecanicas (IMEC), Centro de Investigacion en Quimica Aplicada (CIQA) and Centro Nexicano de Desarrollo e Investigacion Farmaceutica (CEMIFAR). CIATEJ, IMEC and CEMIFAR are -asociaciones civiles,' and their statutes allow private industry representation in their Boards of Directors. CIQA is a decentralized public sector agency.  b - 31- ANNEX 2 Page 2 of 2 4. CIATEJ, located in the city of Qiadalajara, was established in 1978. In 1984 it had 41 professional staff (of which 9 with MSc or PhD degrees) including core teams in fitochemistry and biotechnology. Its main fields of activity are agroindustry (especially food) and chemical and farmochemical industries. Total operating revenues in 1984 were about $0.7 million, of which 48% were fees for services rendered to about 130 client firms (mostly private). 5. IMEC, located in the city of San Luis Potosi, was established in 1976. In 1984, it had 23 professional staff, none with graduate studies. Its main field of activity is in prototype development for the metal mechanic industry. Restructuring would strengthen its capabilities in the fields of electronic industrial controls, computer aided design, new materials (carbon and glass fibers), and forge and heat processes. Total operating revenues in 1984 were about $0.4 million, of which 21% were fees for services rendered to 36 client firms. 6. CIQA, located in the city of Saltillo, was established in 1976. In 1984 it had a total professional staff of 73, of which 38 had HSc or PhD degrees. Main areas of current capability are process and equipment designs for the plastics and chemical industries. Restructuring would largely strengthen activities in plastics, and possibly also chemical processes in general and biotechnology applied to agroindustry. Total revenues in 1984 were about $1.9 million, the largest among all CONACYT centers. However, only 16% of revenues were for services rendered to client firms (mostly PEMEX, the parastatal oil monopoly, and 5 other firms). 7. CEMIFAR, located in Mexico, DF, was established in 1976. It is unique among the CONACYT industrial centers in that it has no laboratories of its own. Rather, it identifies needs and promotes business opportuni- ties, and places R&D contracts with other R&D centers to provide the pharmaceutical industrial firms with the ITD support needed. Strengthening of CEMIFAR would result in equipment and trained personnel contributed to such other centers, or in establishing a center of its own, and would improve technical assistance, product development and technological innova- tion support for a large number of pharmaceutical 'irms throughout the country. In 1984, CEMIFAR had a total professional staff of 8 (including 4 with MSc and PhD degrees) and total revenues of about $0.1 million of which liz were in fees paid by about 38 client firms. Industry Department March 12, 1986  32 - Annex 3 Page 1 of 2 MEXICO INDUSTRIAL TECHNOLOGY DEVELOPMENT PROJECT Specialized ITD Financing The Need for Specialized Financing 1. Availability of specialized financing for specific ITD projects undertaken by industrial firms internally or contracted out to R&D centers, engineering firms or other sources, is a key factor of ITD. ITD generally goes through four phases: start-up (idea generation, feasibility studies and technical R&D), precommercial (development of prototypes and pilot plants, preliminary production and test marketing), expansion and maturi- ty. In the start-up phase, an ongoing firm typically draws on internally generated funds and on Government R&D grants and long-term loans when available, whereas a new entrepreneur usually resorts to private funding (investment of personal and friends' savings and borrowing). DI the precomercial phase, the same sources are used, with less emphasis on concessionary Government financing. The expansion and maturity phases are normally financed by self-generated funds and by development and commercial bank loans, and benefit from Government incentives such as preferential interest rates and tax breaks when available. 2. Institutional gaps in many developing economies inhibit financing of lTD. Commercial and development banks primarily finance the expansion and maturity phases, when the technology is proven and the market is reasonably assured. The first two phases typically contain major risks which are not acceptable to such financial institutions, partly b5ecause they lack the financial instruments to compensate for the higher risk. In addition, banks often lack technical and market expertise to evaluate the risk properly, and they are not organized and managed so as to include risky loans in their portfolios. Also, the projects' softwr.re intensity and low resale value of specialized R&D equipment, result in lack of viable collateral. In some highly industrialized countries, private formal venture capital sources, seeking rapid appreciation of capital, invest in uev firms in the precommercial phase (usually once initial prototypes and pilot plants are available, but occasionally also earlier). Experience so far suggests that private venture capital firms are difficult to establish in less developed capital markets, and when they are, they often attach low priority to investments in innovation (since many other attractive and less risky equity opportunities are typically available in these environments). 3. To help fill these gaps, specialized ITD financing agencies have been set up in several countries, including CDTI in Spain and KTDC in Korea, both financed by the Bank. Generally, three kinds of financial instruments are used by such agencies: (a) conventional loans, with or without collateral requirements, with or without a subsidy element; (b) conditional loans, that allow profit and risk sharing between the firm and the agency; such loans, which are most suitable for new product develop- ment, can be repaid through royalty payments from sales revenues if the project is successful, up to a certain return on the loans; if the project  33- - Annex 3 Page 2 of 2 does not result in additional sales revenues, the lender recovers only a portion of the principal; and (c) equity investments, in companies set up to commercialize R&D results. Table 1 summarizes the growth of the two main sources of specialized ITD financing in Mexico from 1980. Table 1: SPECIALIZED ITD FINANCING IN MEXICO ($ million) 1980 1981 1982 1983 1984 1985 (est.) FONEI 0.2 8.1 7.7 12.5 9.8 16.0 CONACYT 0.6 1.4 0.4 0.5 1.3 1.9 TOTAL 0.8 9.5 8.1 13.0 11.1 17.9 Sources: FONEI: Financing statistics (loans and grants). Others: CONACYT, Departamento de Planes Estrategicos, August 1984. FONEI data are for new commitments (loans and grarts); 1983 includes $8.8 million in two large, one-time loans. CONACYT figures are for disbursements of the shared risk program. PVP Mechanism 4. The PVP scheme avoids the adverse cash flow impact on borrowers of conventional loans in highly inflationary environments by essentially capitalizing interest in the earlier years. These loans have no grace period, i.e., principal repayments are scheduled throughout the life of the loan. Interest payable each period is the interest accrued on the principal being repayed instead of interest on the total outstanding balance as for conventional loans. Table 2 compares annual payment of PVP and conventional loans. Table 2: COMPARISON OF PVP LOAN AND CONVENTIONAL LOAN OLI-t- Prin- Conventional Loan PVP Loan standing cipal Interest Interest Year Balance PaymelLt Payment Total Payment Total 1 100 10 50 60 5 15 2 90 10 45 55 13 23 3 80 10 40 50 24 34 4 70 10 35 45 41 51 5 60 10 30 40 66 76 6 50 10 25 35 104 114 7 40 10 20 30 161 171 8 30 10 15 25 246 256 9 20 10 10 20 374 384 10 10 10 5 15 567 577 Industry Department March 12, 1986  - 34 - ANNEX 4 MEXICO INDUSTRIAL TECHNOLOGY DEVELOPMENT PROJECT Current Bank Support for ITD Reports were prepared (LCIMX) on Mexico industrial strategy (1983), country economic developments (1984) and export promotion policy (1984). A comparative study of the acquisition of technological capability on Mexico, Brazil, Korea and India is near completion (DRDPR/INDSP). Ongoing studies on international competitiveness and productivity in selected industrial subsectors (INDSP) are due also in late 1985. The fourth industrial equipment loan (1712-ME of 1979) for $175.0 million includes up to $5 million for FONEI's technology development program. A capital goods industries development loan (2142-ME of 1982) for $152.5 million, includes $2 million for technology development and strengthening INFOTEC's information facilities. The third small and medium industry development loan (2375-ME of 1983) includes about $18 million for FOHIN's equity financing program, part of which might be used in ventures with a significant component of technological innovation. An export development loan (2375-ME of 1983) of $350 million includes up to $2 million for financing technology imports. An industrial recovery loan to FONEI includes an equity financing program that could later evolve to a form of venture capital financing. Industry Department October 12, 1985  - 35 - ANNEX 5 Page 1 of 7 MEXICO INDUSTRIAL TECHNOLOGY DEVELOPMENT PROJECT FONEI and Its Technology Development Program A. Background 1. FONEI, a Government trust fund administrated by Banco de Mexico, was established in 1971 to provide long term financing for industrial projects through commercial banks. As it become a more mature institution, other operational objectives were emphasized. It encouraged banks to lend on the basis of project viability rather than collateral, promoted greater bank participation in loan preparation and supervision, and helped banks improve project analysis. FONEI has become an important source of long- term industrial financing, highly regarded by industrialists and banks. Organization and Management 2. FONEI's highest decision making body is its technical committee composed of high level Government officials from the Ministry of Finance, the Banco de Mexico, the Ministry of Planning, NAFINSA, the Ministry of Commerce and Industrial Development, and industrial chambers. The techni- cal committee meets once a month; its responsibilities include the approval of credits, the appointment of FONEI's director, and the approval of its operating rules and regulations. For technology subprojects, the technical committee has delegated most of its authority to a specialized subcommit- tee, that include officials from a number of research institutes, private sector representatives and Government ministries. 3. FONEI is organized in four departments, each headed by a subdirector who reports to the director. The four departments correspond to the main functions of the institution, Promotion, Training, Operation and Administration and Projects. FONEI's Financial Performance 4. FONEI's financial structure is sound and capable of supporting the increased lending projected. FONEI's equity has increased from 7% of total assets in 1980 to 45% in 1984, following Government's decision to assume the obligation of repayment of principal on Bank loans as a means of capitalizing FONEI. This arrangement will continue under the proposed loan and under the Industrial Recovery loan being processed concurrently. Caritalization will be further accelerated by Government's decision to repay interest on disbursements for new World Bank loans. 5. FONEI's past financial performance has been satisfactory. Real return on equity averaged 63% in 1980-84 and only dropped to a low 8% in 1983 as a result of the period's high inflation and reduced FONEI lending. By 1984, real return on equity improved to 28%. Good financial results were partly due to most FONEI assets earning variable rates linked to CPP,  - 36 - ANNEX 5 Page 2 of 7 while its liabilities mainly comprised low fixed rate instruments. To allow continued favorable performance in the future as new variable rate rate liabilities begin to predominate, FONEI has increased its lending rate to banks for nonsubsidized credits. Financial planning of FONEI will be strengthened through the implementation of a comprehensive management information system under the technical assistance component of the Industry Recovery loan. B. ITD Lending and Performance 6. In 1978, FONEI added a technology program to its well established fixed asset financing, providing credit on favorable terms for the development of new or improved products and procesess and to promote new technology to exploit domestic raw materials. A specialized Technology Development Unit (TDU) was established in FONEI's Projects Department to handle this program. ITD financing (loans plus grants) averaged $9.5 million per annum between 1981 and 1984 (Annex 3, Table 1). By the end of 1984, FONEI had approved a total of 242 ITD projects (113 different credits). More than 50% of the projects were for product development, and the balance comprised production process improvement, process and equipment design, trial run production and test marketing, and establishment and operation of in-house R&D facilities. Operations were concentrated mainly in chemical and metal mechanic industries (36% and 31Z respectively of 1984 lending) although there has been growing subsector coverage, with lending to nine subsectors in 1984 as opposed to five in 1981. Thirteen banks participated in FONEI's ITD lending in 1983 and 1984, with a growing presence of large banks. 7. FONEI' portfolio reflects its initially very conservative approach to ITD lending, biased in favor of large firms posing little credit risk despite technological uncertainties of the projects. So far FONEI has not had to honor any of its commercial bank guarantees. Of 98 projects supervised in 1984, 30% were completed essentially meeting original objectives, 65% were being implemented and only 5% had to be suspended. 8. Facing rapid growth in the demand for ITD financing, and following Government's agreement to support FONEI under the proposed Bank loan, FONEI embarked in early 1985 on a major effort of promotion, strengthening of operating policies and procedures, and building up of staff and external financing for the ITD program. C. Promotion of ITD Lending 9. FONEI's enhanced promotion of its ITD operations entails expanding the commercial banks' related expertise, training and orientation of entrepreneurs, and initiatives to develop domestic subcontractors for large private and public firms.  - 37 - ANNEX 5 Page 3 of 7 10. FONEI trains and partially finances selected staff of commercial banks assigned to promote and identify lending opportunities for FONEI's growing ITD and working capital programs. At appraisal, FONEI had signed contracts with 8 such industrial assistants (IA) and planned to reach a total of 30 in 2 years, covering all major industrial regions. Overall responsibility for the IA program is with FONEI's Promotion Department, assisted by the TDU on technical matters. IA performance and continuation of FONEI financing will be examined periodically in terms of agreed project generation targets. Continued IA training will include semiannual countrywide workshops to exchange experience, participation in selected FONEI courses, and in-service training in FONEI. 11. In the past, courses offered by FONEI for commercial bank staff (but attended as well by entrepreneurs, consultants and staff of other agencies) have improved Bank project analysis and promoted FONEI activities. FONEI's Training Department offers orientation seminars for entrepreneurs and managers, to explain the nature and relevance of ITD and advise on available sources of information and support. At appraisal, FONEI had already given 3 such courses with an average 20 non-FONEI participants and 12 more courses were scheduled by end 1985 in different regions. While it is too early to gauge results, it is anticipated that potential ITD clients will be identified through follow up of interested participants in these seminars. Courses for university teachers and graduating students are also planned in response to requests from these institutions; the first course of this kind was to 25 professors of ITESM in Monterrey. The Training Department organized in 1984 an exhibition of firms and products developed with FONEI's ITD financing, which promoted this program and also served as an effective marketing tool for participation firms. 12. The purchasing requirements of large firms can stimulate ITD activity by prospective suppliers. To identify potential R&D projects for local suppliers, FONEI's management currently attends meetings of purchasing committees of large parastatal agencies. Seminars for purchasing agents will be developed to highlight their role in promoting LTD among their suppliers. Additionally, FONEI will try to induce the large firms to make available relevant information on products that could be developed by subcontractors with FONEI or other financing. D. Operational Policies and Procedures Eligible Borrowers and Type of Financing Provided. 13. FONEI lends through financial intermediaries primarily to private sector industrial firms (although there is some lending to parastatals), research centers and engineering firms to finance all elements necessary to support ITD projects, including purchase of basic information, process engineering, raw materials and supplies, and operational and training expenses for staff involved in the project. Also, for engineering firms or R&D firms FONEI can authorize lines of credit to finance investment in equipment and operating expenses.  - 38 - ANNEX 5 Page 4 of 7 14. FONEI finances up to 80% of the estimated cost for each project with a mix of loan and grant funds. Retroactive financing can be provided for eligible expenditures incurred up to six months prior to approval by FONEI's technical committee. For projects which have an implementation period of more than one year, financing is based on the estimated expendi- ture for the first year; financing for subsequent years is considered as new credits and determined by progress made during the first year. Terms and Conditions of Financing 15. For conventional loans the proposed interest rate to financial intermediaries and final borrowers in FONEI's revised operating regulations is 88% of CPP and 94X of CPP respectively, replacing CPP-5 and CPP-3. Maturity and other loan conditions are determined by project characteris- tics and the financial capacity of the firm with the maximum repayment and grace period 13 years, and 3 years respectively. Borrowers can elect to repay using the PVP scheme which (a) provides for immediate amortization of principal, i.e., no grace period but (b) limits actual interest payments to interest accrued on the amortized principal (see Annex 3, para 4). Grant financing provided can be up to 30% of total FONEI financing depending on project characteristics, with priority given to the innovative merit of the project andhthe level of risk. Other factors given weight include (i) whether thie project involves the participation of a research institution or engineering firm (with the objective of strengthening linkages between these institutions and the industrial sector), and (ii) the size of the project in comparison with the economic capacity of the firm. Incentives to Participating Firms and Intermediaries 16. To encourage commercial bank ITD lending, FONEI provides guaran- tees against loss of payment of interest and principal of up to 90% of the credit approved, rediscounts 100% of ITD loans (against 90% for regular equipment lending), and provides a revolving guaranteed line of credit for smaller loans to reduce documentation and loan processing time. 17. Since it takes on average three months from the date of approval of a technology loan by FONEI, to finalize contracts between firms and participating financial intermediaries, FONEI can provide bridging loans for up to 50% of the loan amount approved to reduce the impact of this on project implementation, provided documentation is submitted indicating that eligible expenditure incurred exceeds 25%. For all credits, a bridging loan of up to 25% of the loan amount approved can be provided, following FONEI's loan approval. Improvements Required 18. During loan processing, aspects of FONEI's policies and proce- dures were identified which need to be improved to allow the ITD program  - 39 - ANNEX 5 Page 5 of 7 to grow and better meet the needs of its target clients. These included (a) expansion of financial instruments, (b) improvement in project evalua- tion and supervision procedures and (c) articulation of a clear statement of policy and strategy for the technology program. 19. Financial Instruments. To support firms undertaking higher risk projects FONEI plans to add a conditional loan instrument to its existing financial package. This will be used primarily but not exclusively for financing, commercialization of locally developed technology, which have higher market risk than similar projects financed under the traditional equipment lending program. With conditional loans, FONEI and the investors share the investment risk. Loan repayment schedules are based on the expected revenues to be generated by the project. If revenues are less than expected, FONEI may in consideration of the enterprises inadequate overall financial position, reduce amortization of principal to a percent- age of net revenues generated by the project and reschedule or remit any outstanding balance when the subloan matures. To compensate for higher risk, interest rate on conditional loans will include a risk premium, determined according to methods and criteria satisfactory to the Bank. Additionally, it was agreed during negotiations, FONEI would initiate equity lending for ITD on a pilot basis. Terms and conditions would be similar to those for other FONEI equity lending. Introduction in GIRA of a new interest rate category for conditional and equity loans would be a condition of loan effectiveness. 20. Project Evaluation and Supervision. FONEI has gradually developed and refined their project evaluation procedures to reflect the special characteristics of technology lending (Annex 3) but there are still some deficiencies. During the appraisal mission, existing procedures were reviewed with the assistance of consultants with experience in technology lending in Spain and Korea. Technical deficiencies were noted such as a lack of detailed project risk and market anialysis. Further, understaffing of the technology unit resulted in poor pt;ject documentation, particularly when several projects are processed in the same credit. Supervision was minimal and primarily administrative, lacking a focus on identifying potential problems. These deficiencies are being addressed in FONEI's new operating manual. Preparation of an operations manual satisfactory to the Bank was a condition of Board presentation. 21. Statement of Policy and Strategy. To provide focus and direction for the ITD program, it was felt FONEI needed to articulate clearly its policy and strategy, identifying the program's objective, FONEI's grant and interest rate policy, lending and staffing targets, promotional strategy including target growth in industrial assistants, grant award criteria and other features discussed during loan processing. Conclusion of a policy statement satisfactory to the Bank was a condition of Board presentation. E. Staff Resources 22. Recognizing that ITD lending requires specialized expertise, FONEI established a separate unit for ITD, within the Projects Department.  - 40 - ANNEX 5 Page 6 of 7 The unit has remained small, primarily because FONEI's management first wished to establish the program and ensure that its operating policies met the needs of industry, before embarking ou major staff expansion. Further, Banco de Mexico's personnel policies, restricted salaries and age limitations on entry level staff, made it difficult to hire the more experienced persons required for technology lending. Prior to late 1984, all promotional efforts, project evaluation and supervision of ITD projects were carried out by the ITD Unit. More recently, however, other depart- ments such as Promotion, Training and Supervision have been actively engaged in ITD support activities. 23. During the preparation of the proposed loan, it was agreed with FONEI's management and Banco de Mexico, that major expansion of staff was necessary to allow increased growth in ITD lending, and improved project evaluation and supervision procedures. It was considered critical to strengthen the technology and supervision units, in particular. This entailed expansion from an equivalent of 5 positions in 1985 to 12 positions in 1986, with 8 new positions in the technology unit and 4 in supervision. Attaining targeted lending in 1987 requires an estimated six additional positions. It was agreed with FONEI and SCHP during appraisal to make all efforts to secure approval for the additional seven staff required in 1986 by loan negotiation in January 1986. FONEI would promptly initiate an official request for staff, including staff for support areas not quantified above. To expedite hiring, FONEI would advauce identifica- tion of suitable candidates preferably with relevant industrial experi- ence. Given the extensive training requirements, the agreed objective is to fill five new positions as soon as possible following Government approval and an additional two by loan effectiveness. Submission of a formal request to SPP for the 1986 positions was a condition of negotia- tions, with Government approval a condition of Board presentation. By loan negotiations, Government had approved a total of 17 new staff positions for FONEI, 7 in the ITD and supervision units and 10 in support units. It was agreed that staff requirements for 1987 would he reviewed in late 1986 and adjusted in terms of updated lending targets. F. Projected Financial Performance of FONEI and the ITD Program 24. The industrial recovery in progress in Mexico has led to increasing commitments under FONEI's lending programs as wll as to a strong pipeline of projects with FONEI and commercial banks. Additionally, working capital financing which will be provided under the industrial recovery loan and expansion of the ITD program is expected to result in additional demand for FONEI's resources. FONEI's total annual commitments are expected to grow from Mex$71 billion in 1986 to Mex$259 billion in 1989 (nominal terms) with the working capital, equity and ITD programs showing the highest expected growth rates, and increasing from 17%, 10 and 13Z respectively of total commitments in 1986 to 21%, 12% and 14% respectively in 1989. FONEK's financial projections assume major demand for PVP loans, with commitments increasing from 5OZ of total in 1985 to 85Z of total commitments in 1989. Rapid growth in conditional loans, to be used primarily to finance full scale operations of locally developed technology,  - 41 - ANNEX 5 Page 7 of 7 is also projected with an estimated total FONEI commitment for ITD between 1986 and 1988 of $79 million. The Government will capitalize FONEI by repaying both principal and interest for new FONEI loans. FONEI has agreed with Banco de Mexico that additional funds required to carry out its expansion program, in excess of those provided by the Bank and self generated funds will be onlent at .895% of CPP. With this support FONEI's income is expected to grow from Mex$11 billion in 1986 to Mex$181 billion in 1989, and total assets from Mex$119 billion in 1986, Mex$731 billion in 1989 in nominal terms. On these bases, it is expected that FONEI's return on assets will average about 36% over the period and return on equity will be positive in real terms throughout the period. G. Impact of ITD Program 25. Government has made a commitment to strengthen FONEI (para 3.18) through repayment of principal and interest on new Bank loans which should ensure that FONEI can adequately provide the subsidies required to support expansion of the ITD program (both interest rate and direct grants) from its net income, over the project period. Provisions for losses in FONEI's financial projections of 2.5% of new disbursements, which is considered adequate, further protect FONEI's net income in the event it has to honor its guarantees to financial intermediaries. The return on the conditional loan portfolio is expected on average to be equivalent to that on conventional loans, with high returns on most projects compensating for lower returns on those less successful; an additional risk premium currently calculated to range from 2-10% will compensate for an expected failure rate on these loans of 30%. Provisions for losses in FONEI's financial projections also take into account this expected level of loss. Table 1A below shows the impact on overall FONEI net income duie to both income and principal loss if conditional loan losses exceed this level assuming zero inflation and zero growth in conditional loan lending after 1990 (the worst case scenario for reserve adequacy). Losses in earlier years would be minimal. Under these assumptions, at failure rates of up to 50%, losses due to conditional loans would not exceed 3.1% of overall FONEI income. Table IA Failure Rate of Z Change in FONEI's Net Income Conditional Loans 1990 1991 1992 1993 1994 1995 40 percent -0.77 -1.64 -0.59 0.51 -0.42 -1.34 50 percent -1.54 -1.29 -1.18 3.11 -3.07 -2.88  - 42 - ANNEX 5 Table 1 TECHNOLOGY DEVELOPMENT PROJECT FONEI ITD LENDING Distribution by Industrial Subsector Subsector 1981 1982 1983 1984 Amount (Million Pesos) Metal products, machinery 40 141 540 496 Construction 0 0 18 27 Non-metalic minerals 0 180 215 360 Food, drink, tobacco 15 2 11 0 Petrochemicals 25 108 99 570 Clothing, leather 0 36 0 90 Services 24 21 772 0 Printing, paper products 0 0 15 30 Basic metals 82 0 0 5 Wood and wood products 0 0 0 6 other 0 0 12 19 TOTAL 186 488 1,683 1,603 Composition (%) Metal products, machinery 22 29 32 31 Construction 2 0 1 2 Non-metallic minerals 0 37 13 22 Food, drink, tobacco 8 1 1 0 Petrochemicals 13 22 6 36 Clothing, leather 0 7 0 6 Services 0 7 0 6 Printing paper products 13 4 46 0 Basic metals 44 0 0 0 Wood and wood products 0 0 0 0 Other 0 0 0 1 100 100 10TO0 iOO  - 43 - ANNEX 5 Table 2 TECHNOLOGY DEVELOPMENT PROJECT FONEI ITD LENDING Distribution by Intermediary Intermediary 1981 1982 1983 1984 Amount (Million Pesos) Bancomext 9 82 438 399 Serfin 0 25 62 399 Comermex 0 34 23 164 Banpais 0 2 0 151 Banamex 79 7 0 140 International 6 241 121 130 B.C.H. 0 40 772 95 Bancomer 15 0 29 38 Banco Regional 0 0 174 27 Somex 20 21 20 0 Banco de Credito 50 0 0 0 Other banks 7 36 44 60 TOTAL 186 488 1,683 1,603 Composition (%) Banconext 5 1? 26 25 Serfin 0 5 4 25 comermex 0 7 1 10 Banpais 0 0 0 9 Banamex 42 1 0 9 International 3 50 7 8 B.C.H. 0 8 46 6 Bancomer 8 0 2 2 Banco Regional 0 0 10 2 Somex 11 4 1 0 Banco de Credito 27 0 0 0 Other banks 4 8 3 4 TOTAL 100 100 100 1O0  - 44 - ANNEX 5 Table 3 TECHNOLOGY DEVELOPMENT PROJECT FONEI ITD LENDING Distribution by Geographical Area Intermediary 1981 1982 1983 1984 Amount (Million Pesos) Nuevo Leon 110 204 98 810 Tlaxcala 0 28 46 394 Distrito Federal 37 94 790 102 Mexico 6 106 520 98 Jalisco 0 0 194 23 Others 33 56 36 176 TOTAL 186 488 683 1,603 Composition (C) Nuevo Leon 59 42 6 51 Tlaxcala 0 6 3 25 Distrito Federal 20 19 47 6 Mexico 3 22 31 6 Jalisco 0 0 12 1 Other 18 11 1 11 TOTAL 100 100 I17 100  - 45 - ANNEX 5 Table 4 TECHNOLOGY DEVELOPMENT PROJECT FONEI ITD LENDING Distribution by Loan Size Size (Million Pesos) 1981 1982 1983 1984 Amount (Million Pesos) Less than 15 43 64 104 129 15 to 25 40 95 76 153 25 to 50 26 149 50 233 50 to 75 0 0 0 190 75 to 100 77 0 84 90 100 to 175 0 180 173 214 More than 175 0 0 1194 594 TOTAL 186 448 1,683 1.603 No. of Projects Less than 15 14 12 12 15 15 to 25 2 5 4 8 25 to 50 1 4 1 7 50 to 75 0 0 0 3 75 to 100 1 0 1 1 100 to 175 0 1 1 2 More than 175 0 0 2 2 TOTAL 18 2T 2138  - 46 - ANNEX 5 Table 5 IIBIC0 Technlogqy Dmv.Iopst Pro;jct INCO1l STATEIENT (Pugs illiaon) AC TU AL FORECAST REVENUES 190 1981 1992 193 194 195 196 1937 I9S9 199 190 Interest ncus 1044 211 4662 12155 16543 21111 47359 0596 139411 214254 335796 EXPENSES Interest Ehpue 64 934 2052 6710 693 95 14613 1iS7l 21323 29166 29105 Persaonnl Costs 28 42 74 114 lql 386 524 743 1013 1391 1953 Other Atin Costs 14 57 721 1117 123 164 447 693 970 1310 1769 Provisions f{r Losses 79 16S 494 1093 2049 3434 .'ET INCOE 356 115S 1835 4214 9593 10657 31609 72991 115021 191346 29  - 47 - ANNEX 5 Table 6 BALANCE SHEET (Pesos lillion) A C T U A L F O R E C A S T ASSETS 1960 1991 1982 1983 1904 1995 1996 1967 1988 19B9 1990 Sovurnmnet Bonds 976 38 5 1 197 3751 15036 10 10 10 7391 Loans 7143 10573 1717 21906 36434 4f726 104045 229446 437191 730350 1152077 Receivables 307 625 1230 !9 26 42 74 119 172 239 330 Other Assets 2 4 4 4 15 115 136 164 200 247 307 TOTAL ASSET5 8328 1;240 19056 26930 36672 51635 119291 229739 437590 730846 1160106 LIABILITIES Payables 164 209 579 1272 1260 4162 7122 11015 16647 25039 36391 Banco DB exica Loans 3790 3260 3280 2960 3764 955 121 0 33254 542 51090 zlurd Bank Loan - 2331-NE 13 932 9453 16302 15359 14254 13150 lorid B.nk Loan - Others 3695 4846 6589 9298 12353 13562t 27484 28959 27106 '5119 21355 Other 9.mk Loans 116 1175 5042 7701 2879 5407 6500 5909 4614 2909 773 Other U .ilities 5 10 IS ;3 30 95 174 196 224 2.60 306 uOTAL LIABILITIES 7760 9519 15504 21164 20349 25012 49854 62291 97203 121960 123065 Capital .25 125 :2S 125 125 2903 17177 43049 103422 192211 322260 Accus Profits 87 441 1592 34:6 7606 16199 2759 57993 !30224 244452 424749 E.c:hange Variation 3040 56;3 6915 7497 7974 9156 Net Income ;56 1155 1835 4214 6593 10657 31609 72991 115021 11134 299636 Less Subsidies 97 475 660 793 1052 1U7 TOTAL EUUITY 568 1721 3552 7765 16323 26623 69438 166458 340 37 7 60696 1037041 TOTAL LIABILITIES & EQUIrT 9328 1:240 19056 29929 366;2 51635 119291 228739' 437580 730946 1160106 Reserves for Losses 79 244 738 1621 370 7130 E-'ity to rotal AssetsWl 6.8z 15.3Z 19.61 26.9? 44.51 51.61 59.21 72.9Z 77.9! 93.3? 89.4? Return an Assets 4.3! 11.9! 12.1S 17.6? 26.2! 24.1? 37.0! 41.?? 34.5? 31.0? 31.7? Return an Equity 167.9I 204.1? 106.9! 119.7? 111.2Z 66.7? 83.6? 78.1? 51.0! 42.4? 40.61  - 48 - ANNE 5 Table 7 tchnology IhlopuIt Projet SOIKES I USES OF FUS (Pn s mini2 FORECAST SOWRCES 198$ 1986 1997 1,99 1999 1990 Surplus 15024 0 0 0 RePaYets Pr.-!9P Credits 14294 7421 63 5251 3571 1819 Repaymt Normal Loans 0 114 1143 3219 95U 21370 Reiaymnt of PIP Loans 0 5344 14374 30 59182 84613 Payelen 2902 2960 3893 532 939 11352 3arco DB Mexico 3199 0 0 3325 21025 0 I[RD Dish.(exist. loans) 4906 24937 134 1996 1399 236 I=RD Disb.(neu loans) 0 10780 22336 56794 95422 126049 Other iabilities 15 79 22 2a 3 46 Net Incone 10657 31609 72991 115021 181341 299636 Non Cash Expenses 79 165 494 1093 2049 3434 TOTAL T3042 93410 150737 252812 370973 541554 PPLICATION Disbursemnts 20645 41044 92903 148228 218559 302795 PYP Financing 3612 24624 55932 96893 128650 20234 Interest Receivable 1408 3695 9171 13m77 19314 27922 Receivables 16 32 45 53 66 92 Domstic Repayments 6098 734 1225 1104 1104 4293 Foreign Repayents 512 1500 l173 1977 ;182 2318 Subsidies (Tech Program) 97 475 660 793 1052 1447 Fixed nvestsment 100 21 28 36 47 60 Surplus 3554 11295 0 0 0 7381 TOTAL 36042 83410 150737 252812 370973 54854  - 49 - ANNEX 5 Table 8 MEXICO Technaolgy Developunt Project INCOME STATEMET - TD PR0GRAM (Pesos Million) FSRECAST REVENUES ;19BS 986 1997 1988 1999 1"O0 [nterest Incom 1152 4799 10453 16931 26694 44003 Norul Payemts 302 953 1142 1134 1251 1504 SPYP 950 3936 9310 15797 25443 42499 EXPOSES Interest Expense a20 3046 4285 4806 5715 7114 ahnco de Mexico 0.995 920 3046 4265 4809 5715 7114 Operating Expnses 66 155 330 496 673 905 Provisions for Losses 79 165 49 1083 2049 3434 Guarantees .61 53 136 166 225 290 Conditional Loans 18 *12 358 917 1824 3143 TOTAL 965 3367 5109 6397 8437 11453 MET ICOME 1e89 1422 5344 10544 16257 32550  - 50 - ANNEX 5 Table 9 BALANCE SHEET - ITD PROGRAN (Pesos Million) F 0 REC AST ASSETS 1985 1996 1987 199B 1999 1990 Loans 3444 10403 27403 54647 94077 152963 Less Reserves for Losses 79 244 739 1921 3970 7304 Receivables 241 729 1919 3925 6595 10707 TOTAL ASSETS 3606 10897 29583 56651 9672 15637 LIABILITIES Payables 148 696 1467 2332 3361 4642 Banco de Mexico Loans 3271 6453 10955 15904 20586 24836 TOTAL LIABILITIES 3419 7149 12422 19236 23947 29479 EQUITY Capital 0 2129 9207 20916 37092 5598I Accus Earnings 0 189 1610 6954 17498 35755 Subsidy Authorized 97 572 1232 2025 3078 4525 Subsidy Disbursed -97 -572 -1232 -2025 -3079 -4525 Net Incsbe 189 1422 5344 10544 19257 32550 TOTAL EQUITY 198 3738 16161 39414 72847 126894 TOTAL LIABILITIES & EQUITY 3606 10897 28953 5660 96794 15672 Reserve for Losses 79 244 738 1921 3870 7304 Return on Assets 5.2Z 13.1: 19.7Z 18.6U 18.92 20.91  - 51 - ANNEX 5 Table 10 MEXICO Technology Development Project SOURCES & USES OF FUNDS - ITD PROGRAN (Pesas tilli(in) FO RECA ST SOURCES 1995 1986 1997 1999 1989 1990 Net Income 199 1422 5344 10544 1927 32550 Mon-cash expenses 79 165 494 1003 2049 3434 Repaysent of other loans 0 0 102 259 402 1045 Repayment of PVP loans 197 599 1242 3053 5782 9946 Payables 148 549 771 865 1029 1291 Banco Be 01exica 3271 3182 4502 4949 4682 4250 B3RD Disbursement 0 2!29 7079 11709 16176 21497 Srants Alioaated - FIIEI 97 475 660 793 1052 1447 TOTAL SOURCES 3979 9519 20194 33287 49421 75450 APPLICATION Disbursements 991 4275 10522 13016 26402 39730 ?VP Financing 750 3282 7922 12571 19212 31149 .eceivables 241 487 1190 1?07 760 4122 Loan Repayments 2 3 Subsidies -Fire Grants 97 475 660 793 1052 1447 TOTAL APPLICATIONS 3979 8519 20194 33287 4943 75450  -52 - ,-NNEX 5 'fable 1I Page 1 of 2 Tmbfulqy hwlopmt Fujuct hu_tims for FGI's Finacial ProjectieM ISS 19s i 195 1Jim 199 199 Cuuutsts (P. Nil limI Equipft 16944 37060 790 966K 12h76 179627 Capacity Optilizatiu 1114 2162 906 35 S70 7393 Pollutim CutreL 163 2040 3m 3499 3 2476 ITO CouVuis l Loon 35 4749 M601 794 1 14472 1tD Cmnitimml L_me 976 4731 "99 19514 24Z 3'7V akitng Capital 1291 12056 2611 37131 33137 MM Pr.-lutuut seiou 315 13 1614 2231 11 *124 Equity 0 ON0 13001 2515 2910 39 TOTAL 2605 71493 12 193103 25961 347193 Diuburhumts Equiput 11251 25547 4783 173 111312 133 Capacity Optimiz tiu 1151 1153 2970 4161 5709 6 Pollution Custrel 930 913 296 23 4227 36 ITO Convntiaid Lose 2452 2137 5439 27 m93 11619 ITD Cauitimul Loim 439 213- 503 11399 17419 27111 aorking tlCitul 950 5425 11909 2441 75 30 Pru-lnvetmt 9b_ 142 621 960 1992 2486 32 E;uity 0 3105 5650 14123 21127 31319 TcTAL. 1ms 41044 92903 189221 21539 3027 Prograu hturut Nate Equipswt 1.09 36.00 70.00 55.00 40.00 35.00 35.00 C:pacity Optim im 1.04 S.24 72.80 57.20 41.60 36.40 36.40 Pollutio Ctrde . O.N 49.21 61.60 49.40 35.20 30.80 30.90 iT1 Covati_d Lam O.N 49.2o 61.60 4.40 35.20 30.00 30.10 ITO CU itim Loans 1.00 56.00 70.00 55.00 40.00 35.00 35.00 Morking Capital 1.04 59.24 72.10 57.20 41.60 36.40 i6.U Pre-lavatmt Stuiu 0.0 49n.23 61.60 4.4 3S.20 30.80 30.80 Equity '..5 31.80 73.50 57.75 42.00 36.75 3.75 cOPpl 56 70 55 40 33 33 Focbigk m 5 me0 725 we I PoLUUUl 3 7, *0 5a is Is  53 - ANNEX 5 Table ll Page 2 of 2 World Bank Disbursements Disbursements-for new World Bank loans considered capital when disbursed. Disbursements-for existing World Bank loans cousidera.d capital when repaid. World Bauk disbursements assumed to average 25% of total annual PONEI disbursements. Banco de Mexico Loans Interest rate .895Z of ACF. Assumed cost of funds for all non-World Bank disbursements for the ITD program .895% of ACF. FONEI Conventional ITD Loans Average maturity eight years with two years grace. Conditional Loas Average return ou conditional loan portfolio assur d, equivalent to return on conventional nonsubsidized PVP loans. Expected failure rate conditional loans 30%. Losses will materialize in four years. Principal recovery in event of loss 25Z. Provision for Losses - Conditional Loans 0 1st 2nd 3rd year following disburs_meat 4% 6% 6% 6.5% Provision for Losses - Conventional Loans 2.5% of new disbursements. Grant Equivalent to 10% of FONEI commitments for subsidized ITD loans. Otbers 1. Personnel costs assumed to increase 5X per aniwm is real terms. 2. Other administrative costs assumed to increase vith inflation.  FONEI Organization Char? Techrical Camr tee I Aw hp ra ii i S lso an $ so ls S yit o m P tr d e CPod it h l Om Otlo n O fficuq O t loe n | O ff hM aNAs 9 d lg o f ah * h Auayc ti i UkYd9ar*-3CO27 I)  - 55 - ANNEX 6 "MOD JIIXJSTRIAL ThXUIW Y M.V3DPMFr PmJEcr OCrogram of Preparadoi - Infrast:rcture Capxaents 0ONAW - R&D Centers 1985 1986 Sept Oct Nov Dec Jan Feb __r Ar Jun Jul kg Oct Nov Dec Meeeirngs %th industriaLists Appointntrt nf CNACff cxultats __ Initial feasibility anluysis of preselectel *vnters Final feasibility analyses _ Prearatio of draft irnvsents PLV Final plans preparation ard start of discussio with inteested i-dustrialists DXGN - Metrology Stdies 1985 1086 Dec Jan Feb Mr Apr My Jun hd Aug Sep (k:t Call anr reception of expression of interest fron national laboratories Iritial diswsions Define work program Final ize contract  - 56 - ANNEX 7 MEXICO INDUSTRIAL TECHNOLOGY DEVELOPMENT PROJECT Loan Disbursement Schedule IBRD US$ Fiscal Estimated Disbursements Profile, Z Year Semester Period Cumulative Project Standardr/ 1987 1st 4.82/ 4.8 10 0 2nd 2.6 7.4 15 6 1988 1st 3.9 11.3 24 15 2nd 5.2 16.5 34 27 1989 1st 5.6 22.1 46 40 2nd 5.2 27.3 57 52 1990 1st 5.1 32.4 68 64 2nd 4.8 37.2 78 75 1991 1st 3.9 41.1 86 84 2nd 3.0 44.1 92 91 1992 1st 2.2 46.3 97 96 2nd 1.7 48.0 100 100 1/ Standard profile for IDF Mexico operations without retroactive financing. 2/ Retroactive financing.  - 57 - ANNEX 8 MEXICO INDUSTRIAL TECHNOLOGY DEVELOPMENT PROJECT List of Selected Documents in Project File A. Selected Reports and Studies on the Sector A.1 -Programa Nacional de Desarrollo Cientifico y Tecnologico 84-88-. Poder Ejecutivo Federal, August 1984. A.2 -Catalogo de Centros e Institutos de Investigacion Cientifica Desarrollo Tecnologico en Mexico". CONACYT, 1984. A.3 -Los Centros de Investigacion y Desarrollo Tecnologico Coordinad' por CONACYT-. CONACYT, 1984. A.4 "Mecanismos de Apoyo Financiero al Desarrollo Tecnologico de Mexico". CONACYT, 1985. B. Selected Reports and Studies Relating to the Project B.1 Project Brief. Revised August 2, 1985. B.2 Issues Paper. Revised September 18, 1985. B.3 Decision Memorandum. October 4, 1985. C. Selected Working Papers and Tables C.1 *Informe de la primera fase del proyecto conjunto CONACYT-Banco Mundial sobre participacion industrial en los centros publicos de investigacion y desarrollo tecnologico coordinados por SPP-CONACYT". J. Pavon and F. Medina, August 1985. C.2 *Ejemplos de proyectos realizados por centros coordinados con la industria". CONACYT, August 1985. C.3 'Report on the technology project appraisal mission to Mexico - policy studies". F. Sercovich, August 1985. C.4 "Analisis de los incentivos fiscales para el fomento de las inversiones en investigacion y desarrollo tecnologico -- primer avance del proyecto". SECOFI/DGPI, May 1985. C.5 "Quality control and metrology in Mexico". H. S. Peiser, December 12, 1985. C.6 -Comments on FONEI system and activities". H-S. Shim, August 1985. C.7 "FONEI - Notes for Appraisal Report" (Spanish). J. Pavon, August 1985. C.8 "Reglas Generales de Operacion del Fondo de Equipamiento Industrial (FONEI)". June, 1985. C.9 FONEI: "Manual de Operacion del Programa de Apoyo Financiero al Desarrollo Tecnologco." C.10 FONEI: Lineamientos de Politica Respecto del Programa de Apoyo Financiero al Desarrollo Tecnologico de FONEI."  - ~~~~~~~~~~~~~~~~~~~ir lo -''N- ,.. L UNITED STATES OF AMERICA 0E.ncodo \\s yA A O tfi-NograIesJT p'*, ;,,._ SA4ggIl~RJ A . Jae 1 1 ' . ' ' 20'~~ ~~~~ : - '\,f _ A .~~~~~U *ectemos S. .* '1 A f P ''..a NdN- '^ .^|. P ~~~~~~~~Torreon'^ ~ iC --acone. c..II ^ .*. ,ur,goo' N a~~~ ~ ke aro ' I,.. e MonMozotl (ul n -Aguof entesso Tewc V. Iorezner . Col KILOMETERS O tO0 200 300 *00 Soo . ~ ~ ~~~ M.oro .. MItLES O too 200 300o 0CnboS L' Zacrcs - r