Mozambique - Industrial Enterprise Restructuring Project

Docwment of The World Bank FOR OFFICIL USE ONLY Repwot No. P-5087-M4OZ MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 40 MILLION TO THE PEOPLE'S REPUBLIC OF MOZAMBIQUE FOR AN INDUSTRIAL ENTERPRISE RESTRUCTURING PROJECT NOVEMBER 21, 1989 This document has a restricted distribution and may be used by recipients only in the performance of their offcial duties. Its contents may not otberwise be disclosed without World Bank athorization.  I CURCRSN"EHlVALqt US$1 - 813 Nbticais Off) - October 1989 US$1 - 682 MHticais (MT) - at time of Appraisal (March 1989) MT 1000 - US$1.47 AB WIUTIONS AND ACRONYSM BE Beneficiary Enterprise BM Banco de Mocambique (the Central Bank) ERC Enterprise Rehabilitation Component ERP Economic Rehabilitation Program ERTU Enterprise Restructuring Technical Unit GOM Government of Mozambique HF Ministry of Finance MIE Ministry of Industry and Energy PPF Project Preparation Facility UNIDO United Nations Industrial Development Organization FISCAL YEAR Government and Public Enterprises: Calendar Year  FOR OFFIMCAL USE ONLY MOZAHSIOUE INDUSTRIAL ENTERPRISE RESTRUCTURING PROJECT CREDIT AND PROJECT SUMMARY Borrower: People's Republic of Mozambique Beneficiaries: Ministry of Finance (MF); Bank of Mozambique (BM); Ministry of Industry and Energy (MIE); and selected major beneficiary enterprises (BEs). Amount: SDR 40 million (US$50.1 million equivalent) Terms: Standard IDA terms, with 40 years maturity Qending Terms: Government will pass on US$50.1 million equivalent of the IDA Credit to the BM to: (a) channel US$39.9 million equivalent to BEs under the Enterprise Restructuring Component (ERC); and (b) retain US$10.2 million equivalent for technical assistanea to strengthen the Enterprise Restructuring Technical Unit (ERTU) and other agencies involved in the Project, for consultancies to BEs for subproject preparation, and for training. The ERC would be channelled to BEs primarily as loans through BM. However, in appropriate cases, the Government could use this component to make direct equity investments in BEs in combination with loans according to their assessed needs for financial restructuring. The BM would onlend the credit proceeds under the ERG in local currency to eligible BEs at adjustable interest rates based on the structure of rates prevailing in Mozambique, The credit risk on onlending would be borne by the BM who would receive an appropriate spread as determined by the banking system. The foreign exchange risk would be borne by the Government and would be covered by the interest yield on funds onlent, net of the service charge on the IDA credit, and the onlending spread of the BM. The Government would bear the risk on any equity investments. Subloans under the ERC would have a maturity of up to 15 years, including up to a 5-year grace period. Financing Plan: Government and enterprises US$ 34.1 million Co-financing 1/ US$ 22.5 million IDA US$ 50.1 million Total US$106.7 million Completion Date: December 31, 1996, and Closing Date of December 31, 1997. of Return: Subprojects financed under the Project must earn financial and economic rates of return of not less than 12%. Staff Appraisal Report: Report No. 7826-MOZ. I/ Government of Italy has expressed interest to co-finance (US$22.5 million equivalent), but arrangements have not yet been finalized. Other donors may participate on an enterprise by enterprise basis. This document has a restricted dbtribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be discosed without World Bank authorization A  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE PEOPLE'S REPUBLIC OF MOZAMBIQUE ON AN INDUSTRIAL ENTERPRISE RESTRUCTURING PROJECT 1. The following memorandum and recommendation on a proposed development credit to the People's Republic of Mozambique for SDR 40 million (US$50.1 million equivalent) is submitted for approval. The proposed credit would be on standard IDA terms with 40 years maturity and help to finance an industrial enterprise restructuring project. The project is expected to be co-financed by Italy for US$22.5 million equivalent. 2. Background. After independence in 1975 Mozambique's industry encountered serious problems through: (a) the departure of many enterprise owners and almost all skilled manpower which obliged the new Government to take control of over 300 enterprises, many neglected and with debt arrears; (b) the adverse security situation after 1980, which led to a severe drop in export earnings and an acute scarcity of foreign exchange for imports oi industrial inputs; and (c) control of exchange rates, interest rates, product prices, production and distribution under the central plan These factors resulted in currency overvaluation and major domestic market distortions and the build up of the fiscal deficit and external debt. As a result, 1986 industrial output fell to abDut 45% of that of 1980, with widespread disinvestment and excess capacity. Enterprises were affected by: (a) obsolescence, mechanical breakdown, serious shortages of replacements and spare parts, and war-related damage to plant and equipment; and (b) mounting enterprise losses, liquidity and capitalization problems. 3. Government Objectives and Strategy. Since 1987 the Government has been addressing the economic distortions and structural constraints through a comprehensive Economic Rehabilitation Program (ERP). Government objectives for industry under the ERP are: (a) to rehabilitate directly a selected group of larger-scale enterprises; and (b) to create a supportive environment for development and rehabilitation of small and medium enterprises, requiring restoration of the banks' capacity to mobilize deposits and conduct appraisal- based lending. This Project focusses on objective (a) while a parallel project, the Small and Medium Enterprise Development Project, would address objective (b). Under the ERP, Government strategy for industry has included: (a) currency devaluation (which has reduced real wages), and opening up of foreign exchange allocation; (b) price and distribution decontrol; (c) investment promotion through foreign and domestic investment codes, an exchange retention scheme, and corporate tax and tariff reforms; and (d) increased private sector participation, management autonomy and accountability. Out of approximately 300 enterprises initially intervened by the Government during 1975-77, about 140 have been returned to private interests. A UNDP-financed, Bank-executed, Business Environment Study made a series of recommendations in terms of the design of fiscal and monetary incentives for industry, industrial subsector efficiency, and the development of industrial finance. The report endorsed the general direction of policy reform in the sector a: it is currently being implemented. 4. A series of sector constraints must be addressed if the industrial sector is to be able to respond fully to the opportunity presented by the more favorable policy environment. A review of 40 major enterprises (representative of the enterprise sector), undertaken as part of the preparation work for the Project highlighted: (a) the poor condition of infrastructure and industrial plant; (b) severe skilled personnel shortages; (c) weak financial positions of  * 2 - mnny enterprises due to accumulated 1ossen and debt; (d) an uncertain corporate legal framework; and (e) lack of an institutional framework and capacity within Government and enterprises to plan and implement rehabilitation programs. The Government with support from IDA has begun to address these issues by: (a) setting up an Enterprise Restructuring Technical Unit (ERTU) in 1988 at tho Ministry of Finance to provide the institutional framework to co-ordinate the overall rehabilitation program and be responsible for implementation of the proposed Project; (b) preparing rehabilitation and restructuring plans for major enterprises on a case-by-case basis: and (c) initiating a study of the legal ownership status of intervened enterprises. The Business Environment Study identified several subsectors for in-depth review, includinS the edible oils, textiles and garments, metal-working and packaging. 5. Rationa for IDA Involvement. The Project is an important vehicle for supporting the Government's strategy to resuscitate industrial production in the context of the ERP. IDA's involvement, through general policy dialogue, three rehabilitation credits and several project-based investment credits, has contributed significantly in shaping the Government's strategy and in priority setting under the ERP. IDA's further involvement through this Project will help broaden and deepen the recovery program and is viewed by the Government as necessary to sustain the momentum of reform and generate an adequate supply response. It will also encourage other donors (many of whom have already given strong support to the ERP) to support these efforts in a well-coordinated manner. Industrial sector support mainly through short-term commodity aid has already been provided by Sweden, UK, Italy, Norway and other bilateral agencies, and by the African Development Bank. 6. Qkb1etives. The Project's overall objective, which is in support of the Government's strategy, is to restore production and efficiency in a selected group of major industrial and agro-industrial enterprises. More specifically, the Project aims to: (a) introduce a framework and criteria for selecting enterprises for rehabilitation based on each enterprise's potential economic, financial and technical viability, and on its management capacity to operate efficiently and profitably; (b) finance the rehabilitation, financial restructuring and operational support to selected enterprises. The restructuring process would, where appropriate, include rationalization of capacity, privatization, technical partnership arrangements, or if necessary, closure of nonviable operations; (c) protect the environment and worker safety by requiring that each BE introduce measures to minimize the discharge of pollutants and provide a safe working environment for their workers; (d) strengthen Government's capacity to implement the rehabilitation program; and (e) support policy reforms and subsector reviews designed to strengthen enterprise operations in a market-oriented environment. 7. Proiect Descrigtion. The Project will have two components. The Enterprise Rehabilitation Comoonent (EfiCa would be channelled through the Bank of Mozambique, for the rehabilitation, financial restructuring, and operational support of about fifteen existing priority enterprises that are potentially viable. Rehabilitation would cover replacement or modernization of equipment and provision of spare parts, raw material inventories and operational support to strengthen enterprise management. Financial restructuring would involve restructuring for those enterprises that have been selected for rehabilitation and currently face financial difficulties. Restructuring would be accomplished through a combination of the following: recapitalization, conversion of debt into equity, injection of new equity, and, where appropriate, through divestiture or joint venture arrangements with foreign and local private investors. In all  - 3- cases, the prospects for privatization would be carefully reviewed. IDA resources would be channelled to BEs primarily as loans, however, in appropriate cases the Government could use the ERC to make direct equity investments in BEs, in combination with loans according to the financial restructuring needs of the enterprise. The needs of each individual enterprise and its potential viability would be identified through detailed studies, from which a rehalilitation plan, financial plan and implementation timetable would be developed. Prefeasibility studies (initially financed through a PPF advance) for all the fifteen potential beneficiary enterprises and some design studies were completed in mid-1989. All subprojects to be financed under the ERC would be subject to review by the ERTU and prior approval by IDA. The Technical Assistance Cc ponent would comprise: (a) financing experts and consultancy services to strengthen Government's capacity to implement the overall rehabilitation program. Advisory support would be provided to the ERTU (initially financed through a PPF advance) to strengthen its capacity to manage implementation of the Project; (b) financing the consultancy costs of feasibility studies, developing rehabilitation plans and operational technical assistance to potential BEs. The experts assigned to the ERTU would organize training for enterprise management, banks and relevant Government agencies in project appraisal, supervision and preparation of enterprise rehabilitation and restructuring plans; and (c) conducting subsector and policy studies. Technical assistance will also be provided to assist enterprises in developing training programs for re-deployed staff and in financing tools and equipment for such staff who may wish to start businesses of their own. 8. Total Project costs are estimated at US$106.7 million equivalent, including US$71.2 million in foreign currency (67%). A breakdown of costs and a 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 status of Bank Group operations in Mozambique are given in Schedules C and D, respectively. The Staff Appraisal Report, No. 7826-MOZ dated November 21, 1989, is also attached. 9. Actions Agreed. At negotiations, the following main agreements were reached with the Government: (a) the subsector studies would be completed by December 31, 1991, and an action program based on the recommendations of the studies, and agreed with IDA, would be carried out by March 31, 1993; (b) the economic, financial and technical eligibility criteria to be used for BEs and subprojects, and subloan and investment processing procedures; (c) the onlending terms, including agreement on interest rates (in accordance with Government's program to achieve positive rates by 1990); (d) Government assuming the foreign exchange risk; and (e) Government would, with IDA support, formulate an action plan by December 31, 1990 to determine the legal ownership status of intervened enterprises, and would promptly thereafter take all necessary legal and administrative measures to implement the plan. Conditions of credit effectiveness would be: (a) the signing of the subsidiary administration agrecment between the Government and BM; and (b) appointment of an accountant to the ERTU. Other conditions: (a) all subloans and equity investments would require prior IDA approval; (b) financing of training programs for laid-off staff would require prior IDA approval; and (c) a model Subloan Agreement to be approved by IDA and the appointment of a Procurement advisor would be conditions of disbursement for the ERC. 10. Benefits. Rehabilitation of selected major enterprises will yield high economic returns through restoration of employment and higher levels of production and incomes. Improvements in the institutional and policy framework,  .4. plus increased enterprLse autonemy and competition, with more private sector Involvement through joint ventures and divestiture, should enhance enterprise efficiency and profitability. The rehabilitation, financial restructuring, privatization and technical nanagement approaches developed for enterprlies under the Project will serve as demonatration cases for the design and implementation of similar prcgrams in other enterprises. Further, the Project will aim to increase the market orientation of enterprises through improvements In fit cial and management information sy&.;ems, with emphasis on accurate record keeping, cost controls and related training of enterprise personnel. 11. Rlks. The major risks assoolated with the Project stem from: (a) the economy's fragility and therefore the possibility that political and social opposition may weaken Government's commitment to the WEP reform program during Project implementation, particularly the more sensitive changes (e.g. price liberalization and state enterprise divestiture or liquidations) which represent a significant departure from past policies; (b) limited Government and enterprise experience in implementing rehabilitation plans; and (c) the security situation, which may adversely affect project implementation. To mitigate these risks: (a) the Project would provide assistance in training and financing tools and equipment for laid-off staff in order to alleviate the social costs and, therefore, reduce the risk of resistance on the part of the public; and (b) 3Es will be selected primarily on the basis: of their potential economic, technical and financial viability; that they possess a capable management team or plans are made to secure such a team; and that their operations are not seriously affected by the security situation. The ERTU is being strengthened through the services of an experienced consulting firm and enterprise management will also be strengthened and, where necessary, assisted in formulating and implementing their rehabilitation plans. Close supervision during Project implementation will be maintained to deal with problems as they arise to ensure that the environment is not adversely affected by the operations of BEs. Government commitment to, and progress so far in, implementing the reform program has been encouraging and no evidence exists of flagging Government resolve. 12. R.agadation I am satisfied that the proposed credit would comply with the Articles of Agreement of IDA and recomLend that the Executive Directors approve the proposed credit. Barber B. Conable President Attachments Washington, DC November 21, 1989  .5 Schedule A MOZAMBIQUE INWUSTRIAL ENTERPRISE RESTRUCTURING PR(_JECT PROJECT COSTS AND FINANCING PLAN A. ESTIMATED PROJECT COSTS A/ Local Foreign Total (US$ million)------ Enterprise Rehabilitation Component Fixed Investment 4.8 36.6 41.4 Spare Parts 1.2 2.8 4.0 Raw Materials 27.2 18.2 45.4 TA to Enterprises 0.3 3 8 5.1 Sub-total 33.5 62.4 95.9 Technical Assistance Component 2.0 10.8 TItalPrlect Cost 3 ZL. 1Fro B. FINANCING PLAN Local Foreign Total -- (US$ million)------ IDA 1.4 48.7 50.1 Government and BEs 34.1 0.0 34.1 Co-financing 0.0 22.5 22.5 Total 2. ; o. a/ Net of duties and of taxes. Costs also include price and physical contingencies.  .6- Schedule B Page 1 of 2 MOUWZQUX XNDUSTRIAL EXUTRMSI RSSTRUCTURIN PROJECT PROCUREENT ASR.NGDIENTS (US$ M1lion) ICB Other Proce- Proce- Project Item dures IS/LS LCB dures z'tal Enterprise Rehabilitation Component (ERC): Rehabilitation, Restructuring and TA to Enterprises a/ 28.3 10.0 1.6 56.0 d/ 95.9 (2R.3) (10.0) (1.6) (0.0) (39.9) Technical Assistance Component (TAC) .3 10.5 10.8 (0.3) (9.9) (10.2) Consultants' Services bl 7.6 7.6 Training of laid-off staff 1.4 1.4 Vehicles and Equipment cl 0.3 0.0 0.3 Refunding of PPF 1.5 1.5 Total 28.3 10.6 1.6 66.5 106.7 (28.3) (10.3) (1.6) (9.9) (50.1) Note: Figures in parentheses are the respective amounts financed by IDA. a/ Contracts would be awarded as follows: ti) in excess of US$500,000 equivalent through ICB; (ii) less than US$t')0,000 through LCB and local and international shopping (IS/LS); LS/LCB (wit public bid offering) would be suitable for civil works contracts. b/ Consultant contracts would be procured in accordance with Bank's Consultants' Guidelines. cl Procurement of vehicles and equipment would require at least three price quotations. d/ Items to be financed by Government, enterprises and co-financiers.  -7- Schedule B Page 2 of 2 NOtZMBIQl INDUSTRIAL ENTERPRISE RESTRUCTURING PROWECT DISSURSDESNTS A. ALLOCATION AND DISBURSIEENT OF IDA CREDIS Percentage of Amount Expenditures to Category (US$ million) be Financed Enterprise Rehabilitation Component 39.9 100Z of foreign (Rehabilitation and restructuring expenditures of each and technical assistance to enterprises subproject. Operating Costs of ERTU 0.2 1001 of total expenditures. Technical Assistance to ERTU: 2.9 100t of foreign (Consultant services, expenditures. training, vehicles & equipment) Consultants Services for Feasibility 3.2 1001 of foreign Studies & Subsector Studies expenditures. Feasibility Studies & Subsector Studies Training of laid-off staff 1.4 1001 of total expenditures. Refunding of PPF 1.5 1001 of amount advanced. Unallocated 1.0 TOTAL 50.1 B. PROJECTED IDA DISBURSEMENTS IDA Fiscal Year: FY90 FY91 FY92 FY93 FY94 FY95 FY96 --------------------US$ million--------------------- Annual 1.8 6.8 11.4 15.5 8.1 4.0 2.5 Cumulative 1.8 8.6 20.0 35.5 43.6 47.6 50.1  0 8 - Scheftlo C rv_us __ E z a YfKAIL PDfFR KY PRJE30C?1 C VE (a) Tim. taken to prepare: 17 months (b) Prepared by: Government with IDA assistance (c) First IDA mission: October 1987 (d) Appraisal Mission Departure: March 1989 (a) Nego;-ations: September 1989 (f) Planned Date of Effectiveness: June 1990 (g) List of relevant PCR and PPARS: None  9 - Schedule D Page 1 of 2 MOZAMB1QUE INDUSTRIAL ENTERPRISE RESTRUCTURING PROJECT STATUS OF BANK SWOU OPERATIONS IN MOZANBIGUE SPNRO2I - SUMAY STATEMENT OF LOW l 0AS A IDA CREDITS tLOA DATA AS OF 9i01 - IS DATA AS OF 11:18199) Aent