Costa Rica - Second Industrial Equipment Project

R E S T R I C T E D FILE Copy R e p o r t N o. P-262 This report was prepared for use within the Bank. It may not be published nor may it be quoted as representing the Bank's views. The Bank accepts no responsibility for the accuracy or completeness of the contents of the report. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE BANCO CENTRAL DE COSTA RICA August 29, 1961  INTERNATIONAL BANK FOR RECONSTRUCTION A ND DEVELOPMENT REPORT AND RECO114ENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE BANCO CENTRAL DE COSTA RICA 1. I submit the following report and recommendations on a proposed Loan to the Banco Central de Costa Rica (the Central Bank) in an amount in various currencies equivalent to $3.0 million to assist in the continuation of Costa Rica's program for importation of industrial capital goods. PART I - HISTORICAL 2. On September 1.8, 1956, the Bank made a loan of $3.0 million equivalent (l;-OR) and on February 11, 1959 of $3.5 million equivalent (219-OR) to assist in financing the foreign exchange cost of a program for the importation of capital goods for the development of agriculture and industry. A third loan of $2.0 million was made on May 4, 1960 (254-CR) to assist in financing the importation of capital goods for industrial use only. The first two loans were totally disbursed by their closing dates of September 1, 1958 and September 30, 1960, re- spectively. By the end of July 1961, $0.5 million equivalent of Loan 258-CR had been disbursed; the bulk of the remainder had been committed and the uncommitted balance was far exceeded by the amount of applications under consideration. 3. In April 1961 a Bank mission visited Costa Rica to appraise the results of the third loan and to discuss with the Central Bank its request for a fourth loan to continue the program. It was agreed that the proposed Bank loan would be used only for the industrial sector, as was the case in the previous loan. 4. Formal negotiations for a Loan began in Washington on August 14, 1961. The Borrower was represented by Mr. Alvaro Castro Jenkins, General Manager of the Central Bank and the Costa Rican Government by Mr. Juan Hernandez, Counselor of the Embassy of Costa Rica in Washington.  - 2 - 5. The Loan would increase the total of the Bank's lending to Costa Rica from $17.3 million to $20.3 million. Loans made to date are as follows: Amount Year Borrower Purpose (Equiv.in $million) 1956 Banco Central de Agricultural development Costa Rica and light industry 3.0 1959 Banco Central de Agricultural development Costa Rica and light industry 3.5 1960 Banco Central de Industrial equipment 2.0 Costa Rica 1961 Instituto Costa- Electric power riccense de development Electricidad 8,8 Total (net of cancrIllations and refundings) 17.3 1/ of which has beei-i repaid 21_ Total now outstanding 15 2 Amount sold 2.3 of which has been repaid 0.9 lc4 Net amount held by Bank on July 31, 1961 13.8 J 1/ Includes $9.5 million not yet disbursed. 6. Consideration of a project for highway rehabilitation and improvement, requiring iil10O million in foreign exchange, is well advanced and negotiations are likely to begin shortly. PART II - DESCRIPTION OF THE PROPOSED LOAN 7. The proposed Loan would have the following characteristics: Borrower: Banco Central de Costa Rica Guarantor: Republica de Costa Rica  - 3- Amount: The equivalent in various currencies of 03.0 million Purpose: To finance imports of industrial equipment by means of medium and long- term credits granted through commercial banks Closing Date: June 30, 1964 Amortization: 19 semi-annual instalments from October 1, 1964 to October 1, 1973 Interest Rate: 5 3/4% per annum, including commission Commitment Charge: 3/4 of 1% per annum Payment Dates: April 1 and October 1 PART III - LEGAL INSTRUNENTS AND AUTHORITY 8. Attached are drafts of the Loan Agreement (No. 1) and of the Guarantee Agreement (No. 2). Provisions of the Loan Agreement relating to the loan account, interest rate and commitment charge are substantially similar to those in the usual form of Loan Agree- ment. In other respects, such as in the requirement of Bank approval of credits to be granted under the Loan, the Loan Agreement conforms generally to the pattern followed in recent Bank loans to development banks. 9. An exchange of letters between the Bank and the Borrower would provide that: (a) notwithstanding the provisions of Section 3.02(b) of the Loan Agreement, the Bank's prior approval would not be required with respect to credits of less than $25,000(as in the previous two loans); and  (b) the interest rate to be charged by the commercial banks to the ultimate borrowers would not be lower than 8% per annum. 10. The Guarantee Agreement is substantially similar to previous Guarantee Agreements between the Republic of Costa Rica and the Bank. The guarantee would be given pursuant to Law No. 2271, of October 18, 1958 which also authorizes the Central Bank to contract the Loan. PART IV - APPRAISAL OF THE PROPOSED LOAN Justification of the Project 11i A detailed appraisal of the Project (T.O. 290a) is attached (No. 3). 12. To strengthen he-' economy and reduce her present heavy dependence on coffee and bananas, Costa Rica is striving to dilversify agriculture and develop industry. Prospects for industrial empansion are good, part-cularly in light consumers' goods. The popuution is literate and fully capable of developing the necessary sLili-S The growing domestic market has brought new opportunities for expanding existing industries and establishing new ones. Industrial ermploy- ment generally has increased by 24% since 1957 and industrial wages paid have risen by over 40%. 13, Long term credit is needed to finance a continuation of industrial expansion on a sound basis. The proposed Loan would help satisfy this need. 14. The program financed under the first three loans has w7orked wJell thus far. Industrial projects financed with the proceeds of these three loans are operating satisfactorily or are under construc- tion. Organization and Procedure 15. To improve the organization and procedure of the commercial banks for carrying out the Project: (a) the major portion of the new Loan would be channelled  - 5 - through the two commercial banks which have established specialized departments for industrial lending; (b) the Central Bank and the above-mentioned two commercial banks are improving their organization for ap-praising and follouing up loans. The 2% margin to commercial banks, provided by relending at a minimum of 8%, would adequately cover their necessary expense of project aopraisal and loan administration. The Central Bank would have a margin of 1/4% to help cover its expenses in the administration of the Loan. Economic Position 16. A report (WH-llla) appraising the economic position and prospects of Costa Rica is attached (No. 4). 17. After 10 years of rapid growth in exports and national income, the rate of growth of the economy has slowed since 1955, mainly as a result of declines in the prices of the principal exports, coffee and bananas. 11ith a relative stagnation in traditional exports, vigorous steps are being taken to expand new exports and to increase production for the domestic market. Nevertheless, the impact of the decline in export prices has been such that, with a growth of population exceeding 4% annually, average per capita real income during the past five years has slowly declined. 18. Recent efforts to expand production and exports have been accompanied by a rapid credit expansion, rising imports and a serious loss of foreign exchange reserves. To assist export producers and to damp down import demand, the Costa Rican authorities have proposed to the Congress a devaluation of the colon and simultaneously have taken steps to arrange standby credits with the I.M.F. and the U.S. Treasury to bolster exchange reserves. The authorities have agreed with the I.M.F. on the limits to be imposed on credit increases over the next twelve months. They also propose to introduce tax increases and new taxes in order to eliminate a fiscal deficit which has not thus far been serious but which could become so in view of the large investment plans of the public sector.  -6- 19. The devaluation should provide same stimulus to the expansion of exports, and to i,iport substitution. Export earnings are expected to grow by about 3.5% a year in the next five years, and favourable opportunities exist for expanding production forthe domestic market. ivth good land resources awaiting developmrti an industrious and literate population living under stable social and nolitical conditions and a group of enterprising business leaders, Costa Rica should be able to achieve in the next several years a rate of growth of output in excess of the very fast growth of population. This will, however, require an intensification of efforts to diver- sify the economy and an increase in foreign capital inflows in the years immediately ahead. 20. As of December 31, 1960 the external public debt of Costa Rica totalled $56.0 million. Since then loans repayable in foreign exchange totalling $13.3 million have been obtained. Service on the existing debt re.ches a peak of '10.2 million in 1962, about 9% of estimated foreign exchange earnings, and falls rapidly thereafter. Prospects for Fulfillment of Obligations 21. The Borrower's financial position is satisfactory. The two commercial banks with specialized departments for industrial lending, through which the major portion of the Loan proceeds wiould be relent, have a long record of profitable operations. WFith the experience in industrial lending gained under the three previous loans and with the improvements to be made in procedures, they should administer the Project efficizntly under the direction of the Central Bank. 22. In view of Costa Ricals present economic position and economic prospects, the country should be able to provide the foreign exchange required to meet the service of the proDosed Loan in addition to its other external obligations. PART V - COMPLIANCE a-TTH ARTICLES OF =AGR NT 23. The report of the Comaittee provided for in Article III, Section 4 (iii) of the Articles of Agreement of the Bank is attached (hlo. 5).  - 7 - 24. I am satisfied that the proposed Loan would comply with the Articles of Agreement of the Bank. PART VI - RECOICIENDATIONS 25. I recommend that the Bank make a Loan to the Banco Central de Costa Rica with the guarantee of the Republic of Costa Rica in an amount, in various currencies, equivalent to d3.O million with interest (including commission) at 5 3/4% per annum for a term of 12 years and on such other terms as are specified in the attached draft Loan and Guarantee Agreements and that the Executive Directors adopt a Resolution to that effect in the fom attached (No. 6). W. A. B. Iliff Vice President for Eugene R. Black President Washington, D. C. August 29, 1961