Mexico - Fourth Small and Medium Scale Industry Project

Document of The World Bank FOR OFFICIAL, USE ONLY v 2t4s& Report No. P-4595-ME MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.N.C. WITH THE GUARANTEE OF THE UNITED MEXICAN STATES IN AN AMOUNT EQUIVALENT TO US$185.0 MILLION FOR A FOURTH SMALL- AND MEDIUM-SCALE INDUSTRY PROJECT June 4, 1987 This docuet bas a restricted dLstributhon and may be use by recipients only in tile performance of their otliail duties. Its contents may not otbendse be disclosed writbout World Bankt autborizatlon. .,  CURRENCY EQUIVALENT - Peso (Mex$) On May 12, 1987, the exchange rate in the controlled market was at US$1 Mex$1,218.3; the free market exchange rate was at US$1 = Mex$1,214.0. FISCAL YEAR January 1 - December 31 UNITS AND MEASURES The metric system has been used throughout the report. GLOSSARY OF ACRONYMS AND ABBREVIATIONS ACF Average Cost of Funds FIDEIN Fideicomiso de Conjuntos, Parques y Ciudades Industriales FOGAIN Fondo de Garantia y Fomento a la Industria Mediana y Pequena FOMIN Fondo Nacional de Fomento Industrial FONEI Fondo de Equipamiento Industrial GIRA General Interest Rate Agreement NAFIN Nacional Financiera, S.N.C. PAI Programa de Apoyo Integral a la Industria Mediana y Pequena SECOFI Secretaria de Comercio y Fomento Industrial  FOR OMCIL UE ONLY MEXICO .OURTH SMALL AND MED'UM SCALE INDUSTRY PROJECT LOAN AND PROJECT SUMMARY Borrower: Nacional Financiera, S.N.C. Guarantor: United Hexican States Beneficiaries: Nacional Financiers (NAFIN) in its own right and as trustee for Fondo de Garantia y Fomento a la Industria Mediana y Pequena (FOGAiN), Fondo Nacional de Fomento Industrial (FOMIN), Fideicomiso de Conjuntos, Ciudades y Parques Industriales (FIDEIN), and Secretaria de Comercio y Fomento Industrial (SECOFI) Amount: US$185 million equivalent Terms: 15 years, including three years of grace, at the standard variable interest rate OnlendLng Terms: The Borrower on behalf of the Guarantor would relend US$100.0 million of the loan proceeds to FOGAIN st a rate linked to the ACF (Average Cost of Funds) for onlending to industrial enterprises through partici- pating financial intermediaries (PFls) for investment in fixed assets and working capital. Another US$45.0 million would be onlent to FOMIN for providing equity and quasi-equity to private sector companies and financing for the restructuring component. FOMIN would, as in the past, share the capital gains on an equal basis with NAFIN, and for subordinated credits pay NAFIN 202 of its interest earnings. FIDEIN would receive as equity US$10.0 million to implement the industrial buildings and park development program. NAPIN would retain US$10.0 million for the micro- enterprise credit program. PFIs would bear the credit risk; and the Government would bear the cross currency risk and be responsible for interest and principal repayments of the loan to the Bank. Since the Mexican capital market is highly open, the interest rates structure as measured by the ACP reflects investors' perception of the relative return to assets denominated in foreign and domestic curren- cies. Because the interest rates under the project are linked to the ACF, the foreLgn exchange risk will be implicitly borne by the final borrowers. Financing Plan: World Bank $185.0 million Executing Agencies/Government $ 60.5 million Intermediaries/Beneficiaries $104.5 million UNDP $ 0.3 million TOTAL $350.3 million Economic Rate of Return: Not applicable Staff Appraisal Report: Report No. 6539-ME MTi document has a festricted distribution sand may be used by recipients only in the Porfomco Iof theif offcial duties. Its contents may not otherwie be disclosed without World Bank authodsatbon.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO NACIONAL FINANCIERA, S.N.C. WITH THE GUARANTEE OF THE UNITED MEXICAN STATES FOR A FOURTH SMALL- AND MEDIUM-SCALE INDUSTRY PROJECT 1. The following report on a proposed loan to Nacional Financiera, S.N.C. (NAFIN) for US$185.0 million equivalent is submitted for approval. The proposed loan would be repaid over 15 years, including 3 years of grace, at the standard variable interest rate. 2. Background. Of the 85,000 registered industrial establishments in Mexico, 97.8% are classified as small and medium enterprises (SMIs). SMIs account for 51% of industrial employment (2.6 million) and 40% of industrial value added, and are concentrated in consumer goods (mainly non-durables' and the intermediate goods subsector. SMIs play a critical role in generating employment at low investment costs, promoting regional development, providing the seedbed for the development of entrepreneurial talent, upgrading labor skills, and providing industrial employment for women. macroeconomic adjustment to the crisis of 1982/83 and to the subsequent decline in the price of oil has resulted in a sharp contraction of industrial output in Mexico since 1982. However, SMIs have been less affected by domestic demand contraction than industry in general. SMIs frequently show greater flexibility in adapting rapidly to changing demand conditions and product requirements. Moreover, industrial sector adjustment to recent government initiatives to liberalize imports, promote exports and enhance international competitiveness can be supported by further development of SMIs. Subsectors in which SMIs predominate are more competitive than the average for the economy. In addition, in their capacity as indirect exporters SMIs have significant potential to contribute to the more rapid growth of manufactured exports. The strategic role of SMIs in the process of industrial recovery and restructuring was recognized by the Government in a specific SMI development program, issued in April 1985. Shortage of term resources, insufficient working capital and high indebtedness of firms are important constraints to continued development of the SMI sector. The Bank has to date financed three projects in the SMI sector (US$322.0 million), the first two were successfully completed, and the third is nearly fully committed. Experience with the execution of the three projects has been good, resources were efficiently allocated and most institutional development objectives were achieved. 3. Project Objectives. The proposed project is aimed at improving the quality and range of financial and technical assistance services to SMIs in order to assist them in responding to the increased competitive pressure resulting from the Government's trade liberalization measures and to increase their financial viability. The proposed project would: (a) enable private small and medium scale investors to make their existing units more competitive by investing in the balancing, modernization, and expansion of existing units, and help them to establish new enterprises; (b) revive production of existing SMIs which are operationally viable but are overleveraged, through establishing an institutional and financial framework  -2- to plan, implement and support restructuring strategies for selected firms; (c) help informal micro-enterprises through a pilot credit and training scheme; and (d) improve the policy framework for SMI development by broadening the understanding of the potential and constraints of SMIs through a series of priority studies. 4. Project Description. The proposed project would include: (a) The Credit Component (US$100 million) accounts for about 54% of the loan and would be implemented by FOGAIN (Fondo de Garantia y Fomento a la Industria Mediana y Pequena). Of the total loan funds, at least US$50 million will be for financing fixed asset investments, covering plant and machinery purchases, associated working capital needs and related civil works. The balance of the credit funds could be applied to financing free-standing permanent working capital requirements of eligible firms; (b) The Risk Capital Comionent (US$20 million) would support and broaden the scope of FOMIN's (Fondo Nacional de Fomento Industrial) ongoing equity and quasi-equity investment program, which finances planned expansions by existing firms and venture capital type investments by new entrepreneurs. As in the past, FOMIN financing would support investments in fixed assets and related permanent working capital; (c) The Pilot Financial Restructuring Component (US$25.0 million) would offer comprehensive financial packages including debt/equity swaps, lengthening of terms of accumulated commercial bank debt and provision of fresh working capital and fixed asset investment resources, all designed to meet the long-term needs of companies that are operationally healthy and have good prospects, but currently suffer from a weak financial structure; (d) The Factory Building and Industrial Park Development Program (US$10.0 million) implemented through FIDEIN (Fideicomiso de Conjuntos, Ciudades y Parques Industriales) would finance credit to industrial park owners or operators in the private sector for the construction of factory buildings within industrial parks in the high priority industrial zones. In addition, financing would be available on a selective basis for the expansion and/or modernization of existing industrial estates and construction of new industrial parks in high priority zones 1 and 2; (e) The Pilot Micro-Enterprise Component (US$10.0 million) implemented through NAFIN would provide financing for fixed asset investment and working capital needs of micro-enterprises which are unable to borrow through the normal banking channels for want of collateral; (f) The Technical Assistance Component (US$5.5 million) would provide consultant services and equipment, including micro-computers, audio-visual equipment, and software development for: (i) further improving the technical and institutional capabilities of FOGAIN and the commercial banks by designing and implementing simplified loan evaluation, portfolio control, and supervision systems; (ii) supplementing FOMIN's existing staff skills with outside experts in financing instruments and legal issues related to financial restructuring; (iii) strengthening the technical capabilities of FIDEIN; (iv) on-the-job training to NAPIN staff responsible for reviewing subprojects; (v) gradually expanding PAI's extension service and initiating new support programs for credit unions, indirect exporters, and subcontracting arrangements between SMIs and large-scale producers including multinationals; (vi) strengthening the operations of the promotional agencies responsible for implementing the micro-enterprise component; and (vii) enabling SECOFI (the Secretariat of Commerce and Industry) to undertake key subsector studies to identify development constraints and to formulate policies to promote SMI development.  -3- 5. The total cost of the project is estimated at US$350.3 million equivalent, with a foreign exchange component of US$157.3 million (45%). A breakdown of costs and the financing plan are shown in Schedule A. Amounts and methods of procurement and of disbursements, and the disbursement schedule are shown in Schedule B. A timetable of key project processing events and the status of Bank Group Operations in Mexico are given in Schedules C and D, respectively. The Staff Appraisal Report, No. 6539-ME, dated June 2, 1987, is being distributed separately. 6. Rationale for Bank Involvement. The proposed project is part of a broad program of Bank assistance for Mexican recovery and restructuring efforts in industry. It will complement the Government's trade liberal- ization measures which were supported by the Trade Policy Loan (Ln. 2745-ME) by enabling small and medium industrial enterprises to restructure their production units to become more competitive, and by providing long-term crerUt and badly needed equity funds to reduce the "pain of transition" in moving from a highly protected environment to one which is internationally competitive. At the same time, the proposed project would extend to the SMI sector the lending instrument introduced for larger firms under the recent ndustrial Recovery Loan (Ln. 2746-ME) and facilitate the Bank's dialogue with the Government on overall industrial sector development strategy. 7. Agreed Actions. During negotiations, the Government of Mexico agreed on: (a) a commitment to provide counterpart resources of US$25.0 million for the FOMIN financial restructuring component; (b) including, as a condition of retaining the restructuring component, a study on formulation of proposals to strengthen banking regulations and supervision with particular reference to portfolio quality as part of the financial sector studies currently being carried out by the Government of Mexico; (c) satisfactory appraisal procedures, onlending terms, spreads, maturities, grace periods and free limits; and (d) implementation arrangements for technical assistance activities. NAEIN would duly execute subsidiary loan agreements with POGAIN, FOMIN and FIDEIN outlining the terms and conditions for the transfer of loan proceeds as a condition of loan effectiveness. 8. Justification. The proposed project would broaden the scope of the ongoing SKI development program by: (i) facilitating the restructuring of viable but overleveraged firms which are underutilizing installed capacity; and (ii) supporting micro-enterprises in the informal sector which are operated by low income producers (primarily women entrepreneurs) and which are normally left outside the formal institutional framework. Economic benefits under the proposed project are expected from: (a) increases in the production, productivity, and international competitiveness of small and medium enterprises arising from an improvement in the quality and breadth of financial services provided to the SMI sector; an (b) more efficient utilization of existing assets and maintenance of employment in the SMI sector due to improvements in the financial structure of firms. The project will also strengthen the participating financial institutions, extension services, and the policy making directorate of SECOFI. 9. Risks. The demand for inve'stment credit is sensitive to the macro-economic environment, particularly to the high inflation levels and pace of economic recovery. To minimize the dampening effect of high nominal interest rates on credit demand the project offers, as an option, a subloan  -4- repayment mechanism that is suitable in a high inflation environment. In addition, the overall size of the credit component has been based on conservative demand projections. The implementation of the financial restructuring component could be delayed due to the reluctance of commercial banks to participate, particularly if they perceive their own financial sacrifice as disproportionate to that of the othor participants. To deal with this uncertainty, the restructuring scheme Is predicated on the principle of equal sacrifice and benefit for all participants, including commercial banks and the entrepreneurs who would be converting a family owned company to one with outside participation. 10. Recommendations. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loan. Barber B. Conable President Attachments Washington, D.C. June 4, 1987 l~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~'  SCHEDULE A Estimated Cost Local Foreip Total -~~ US$Mllions -- Credit Program 106.0 84.0 190.0 Equity/Quasi-Equity Component 22.5 16.0 38.5 Industrial Restructuring 45.0 25.0 70.0 Industrial Buildings/Parks 10.0 7.0 17.0 Micro-enterprises 7.0 5.0 12.0 Technical Assistance 2.5 5.8 8.3 Unallocated - 14.5 14.5 193.0 157.3 350.3 Financing Plan World Bank 28.0 157.0 185.0 FOGAIN 25.0 - 25.0 FONIN 30.0 - 30.0 FIDEIN 2.0 - 2.0 Intermediaries/Beneficiaries 104.5 - 104.5 NAFIN 3.0 - 3.0 SECOFI 0.5 - 0.5 UNDP 0.3 0.3 TOTAL 193.0 157.3 350.3  - 6.- SCHEDULE B Page i of 2 PROCUREMENT Project Item Procurement Method Total Cost (US$ mill.on)a/ - Fixed Assets and Working Capital 310.5 310.5 Financed by Loans and Equity Investments (155.0) (155.0) - Industrial Buildings 17.0 17.0 (10.0) (10.0) - Technical Assistance 8.3 8.3 (5.5) (5.5) Of which: Micro-computers, and (1.0l)b/ (1.0) other office equipment Consultant services (4.5)c/ (4.5) - Unallocated (14.5) (14.5) TOTAL 350.3 350.3 (185.0) (185.0) a/ Figures in parentheses are the corresponding amounts financed by the Bank. b/ Contracts shall be awarded on the basis of comparison of price quotations solicited from a list of at least three suppliers eligible under the "Guidelines for Procurement under LBRD Loans and IDA Credits" published by the Bank in May 1985, in accordance with procedures acceptable to the Bank. c/ Consultants shall be selected in accordarce with principles and procedures satisfactory to the Bank on the basis of the "Guidelines for the Use of Consultants by World Bank Borrowers and by the World Bank as Executing Agency" published by the Bank in August 1981. DISBURSEMENTS Category Percentage Credit/Equity/Buildings - 80% of subloan amounts by FOGAIN/FOMIN/FIDEIN Microenterprises - 90% of subloan amounts by NAFIN Financial Restructuring - 100% of working capital and fixed asse.1 subloans Technical Assistance - 100% of expenditures  SCHEDULE B Page 2 of 2 Estimated (Based on Average Profile for IDF Bank Loans in Region) Disbursements: ----US$ million-------- 88 89 90 91 92 93 94 Annual 5.0 37.0 46.0 37.0 27.0 20.0 13.0 Cumulative 5.0 42.0 88.0 125.0 152.0 172.0 185.0  -8- SCHEDULE C MEXICO FOURTH SMALL AND MEDIUM SCALE INDUSTRY PROJECT Timetable of Key Project Processing Eventst (a) Time taken to prepare: six months (b) Prepared by: NAFIN/PAI with Bank assistance (c) First Bank Mission: March 1986 Cd) Appraisal Mission Departure: September 1986 (a) Negotiations: May 1987 (f) Planned Date of Effectiveness: July 1987 (g) List of Relevant PCRs and PPARs: Draft PCR dated September 1986 for first two SMI loans (1552-ME and 1881-HE)  -9- SCHEDULE D Page 1 or 2 1TATUS OP SANK GROUP OPERATYONI SP NXiECO I2 A, Stat1ment Of Bont Loans (As of *arsh lip lot?) tUgs ill1ionJ *----------__-_v--.*_-__e._....... ....."a- -o se, W......... c..... ..................... ....................................................... __._-__...................,__ P100t Acount Logo Undi1- Loon Noe. Toor orrevor Purpose coneollrtlOnn buresd 07 Loons fully disbursed 4,055.75 17t0-6 We7 NAPIRSA re riatoin 6.o00 85.16 1716-5 16 se0 NAPINSA nduetry 1 7.00 tt.10 tO005-0 4505 NAPZRSA tprigstien 10.,00 101.59 Isal uot SANCOAIS Voter Suppty 160,00 44.45 late 161 SAROSRAS Railways c 10.00 0.13 5660 1401 IANCORNA Urban DOvelopment St 164.00 @3.76 30438 133 NAPZNSA Integroatd Rurrl O*v. 173,00 94.47 8141 lssg NAPINSA Capital Seeds Industry 158.50, sales 6154 les3 NAPZNOA Pollution Oentrel 65,00 18.60 aill les NAPINSA Sn Pernande Agrie 46.40 6o.7? 6164 os8s SAANOSAS Urban Sngineoring 0.00 0.4R los3 tSll NAPNSlA Agrislturel Workloting tisO.o 53.64 6661 less SANCOSAS Third Motor Soppty 500.60 66.0o 6ase 1688 WAPtNIA Third ./Wod tIndvotry 176,00 30.61 Ias1 1666 IANOONIXT Expert DevoLopoens 650.00o 80.Q R466 1664 SANBORAS Mighasys 600.00 111.64 2450 1004 6ANPI6CA Pertos .80 go.os 65ll 1636 NAPINSA Chiepes Rurst RNeads 6100 1.6la sell l5s6 NAPINSA Ohilpee Agrie Dew. 00.00 66.83 *545 1988 RAPINSA so/wed Sealr Wning 1 n lt03.00 54.55 656o 1000 NAPZRLA Veeotionol Iduestien 61.00 86.60 3575 16o5 IANOORAS Reitey.e V SOO.OO 340.48 610 ilea NAPINSA Agrioeultural credit 180.00 44.30 6616 1666 UANOIRAI Loe--neooo Housing I t50.OO 1689.4 66s6 load NAP:# Prodarith It tO0.00 500.76 s0, loss SAN0IRAS Ierthquebe Rhaob. 400.00. Q06.06 666b lose UANO6RAS Wunleipat streogthenlng 40.00 37.68 goes lSS $ANGOSAS SoLid Moato PFile* 65.OO QQ.6 Q745 167 ANCONSXT Trade Pelley Loen t 5b000.0 1.00 3748 1967 NAPIN Industriet Regevory i10.OO 160.7t 9747 1967 lAPIN tehnoloegy owatopeoent 46.00 43.66 6777 1567 63C0 laport DOwtlepeent 2J OO.OO QO0.000 TOTAL 3t106.65 Ot whRei hae been repaid to tbe lenk 6R1.10t8 Total now outotending *S.08.os Amount seld 6.594 Of which 0o bean rapeid 026.4 0.00 Total now hetd bV entk R/ 86,06.06 Totat undlebureud 8694.69 osun ussuss I/ The stsats of the projects L1ised in Port A ts in a esperated raport on ltt Benk/IDA t1innced projects in oxecutlon. which Is updated tuiec yearty end eIrculteod to eth Executive Diretoreo on Aprit 30 and October 91. 2/ Prior to exehange adjJuoeento. ONKOPEIRIt IA.J78i EBArewvataLCINX April a3. 1087  - 10 - SCHEDULE D Page 2 of 2 O. Statemnt of IFC tnvet_me As of Nroh 31, 1SI (SS ilttion) F15sct - Original Approvtl- Year otiger Type of Business Equity Loan Tatut 18om Industrial Perfect Circet, 8.A. at Itdustriet Equipment 0.0 o.e 0.5 080 8r1itot de 1txei 8.A. a/ A.C. Engin Ovwrhout 0.0 0.5 0.5 195" Acoro Sator, S.A. u/ Twist OMrILL 0.0 0.8 0.3 19S/6W/8 Pirdidcra Rbnttrrey, S.A. / Steetl 21.4 2.8 18.7 195 Tub_s do A"rc de Bxice Staintess Steet Pipes 0.1 0.9 1.0 1g1 Wales dot ky, S.A. al Sodius 8utphte D.0 s.o 0.7 18oW Jndustri dot Hlerre, S.A. Construwtin Equipmet 2.0 0.0 0.0 1970 mners dot bareo *J Irn Ore ining 0.0 1.5 1.5 1971 Celten 1uioun, S.A. of Textile 0.0 18.0 12.0 1972 Promotes de Papel Periodicas, 8.A. de C.V. e/ PULp nd P_pr b/ 0.0 of 1971/9 Cmetos Vreruz, S.A. Cment 0.0 15. 15.9 1974SlI Cmun Arietas Stt Tour"im 0.9 1.0 1,3 1977 Ibainonx 8.A. Stainles Steet 38 11.0 15.2 1i79WWU Palates Peudeross, S.A. PULp mm epsi 5.0 10.7 15.7 1978 t refteetno. ebxasnos, S.A. Petrohemiclts 0.0 19.0 19.0 1S79/Bt "nt Csino ealt xtopo, S.A. de C.V. Tourism 9.1 0.0 8.1 197*a Empreas Totlteos, S.A. Cement 7.0 IW.0 175.9 197 Coduotors Ibterreyt S.A. Electrialt vim A Clts 0.0 19.0 18,0 199 Indutries teistot, B.A. Particto bard 0.0 25.0 25.0 199D Vidrio Ptle do Mulel., S.A. Flot Gln 0.0 114.9 114.9 1080 Nines r at de Angsle, l.A. de C.V. 1ining 0.0 11S.0 110.0 1llt CaOtuteicos Cnturo, S.A. o/ Pulp aud Paper 0.0 59.e s8.5 1S"1 Corpoare1 Agreinduatriot -.A. do C.V. Ar1boi- _ee S.o 11.3 14.3 1989 Capitalt Ibud Faciitty a Cepitai bode Finaing 0.0 100.0 100.0 19S4 etaltal, S.A. Auto Chasis 1.4 8.0 4.4 98B4 Prteison, B.A. do C.V. Aari-Resine 0.9 2.0 2.0 tm Promeolns industrieL N1iosroe, 8.A. de C.V. Putrhohetoal 0.0 16.4 10.4 lSS CeluLoao y Pest de Ourago, 8.A. de C.Y. PULp sod Paper 1. 10.0 11.S 19e Agroux Phse I tAESA) Veg. & Fruit Preeseing 0.5 1.8 1.0 Total Gross Comeiuten 50.0 717.2 797.8 Lass Cenclatica, Trminationsn Repayment, and Swles 28.5 619.1 841.0 tota Commeitmente ow Hatd by IFC 17.1 S8.1 126.1 TotatL Udiabursed tincluding participants) 6.1 3.4 9.5 r.r- -- ' bnestmnts which hove been . y concotted, terminstod, written off, sold, redemed or repaid. b/ Ut_,OOO, eo Exctude UU.289 capitatied internst. WiP tA[.]1 EsetaosLCIW Aporil 29, 197  UNITED STATES OF AMERICA 0 AJA } > \ Nogles t411tORN/A /It\ A_ A .) ~ ~ S N #< a R A t R _/ Cd.Ac La Pete / L AJA <0 Santo EceJb CI a xgcoA H V /A I A CAllfORNfA % ' Patrol AC5bcon U R A N Gg A 0' .n~~~~o ' a.Cy .i;Loreto Aor;<,-o * .C 5~ ~ ~ ~ ~ ~~~~~~~4 .oao i ,. SCAN 1 #~~~~~~~~~~ ' ta*WEtE* , 0 20 3900 400 500 IAILE5 0 tt# 200 tOO 110*~~~~~~~~~~~~~~~~~~~~~~~~. .~~~~~~~~~~~~~~~~~~~~~~~~~~Cm~ _, op..  JANUARY 1" 30' d,oN~ M E X I C O Aft Nhiou,a capjtel .g~~~~~~~~~~~~~~~~~~~~I ,, State coplites 0 Primcip; cities or toefi - Divided hiwas Seected aino rds h * | Railroads , N (/\f < 0 < ~~~~~~~~~~~~~~+ Prtndpel eifportb 'f l