Colombia - Industrial Restructuring and Development Project

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'a't _ ,. _ . .-s e x , . . .  FOR omcIL USE ONLY COLOBI T a 1YMAM9 W N miam PROM Loan and Project PSUmmar sorrowr *nd szctn Ao6nowl Banco de la Republica (BR) Quarantors Republic of Colombia hagLrLniaiest(a) Enterprises in the manufacturing and mining sectors, and institutions providing services to help prepare and implement investments by such sector businesses; (b) industrial workers displaced by the restructuring process; and (c) Governrent agencies managing the environmental pollution control and Project monitoring programs. aanN" U8S 200 million equivalent. 11151: Repayment in 17 years, including 5 years of grace, at the standard variable interest rate. ga-nds _ s t For the Project's private sector credit program component, BR would relend US$ 192 million of the proceeds of the loan in local currency to participating financial intermediaries (PFIs) and charge at least the fully variable average deposit rate of the Colombian banking system (DTIF) plus a margin to cover administrative costs and foreign exchange risk if denominated in Pesos or, if denominated in US$ equivalent, a rate reflecting at least the Bank's interest rate plus a fee to cover the cross- currency risk and BR's administrative costs. Relending rates to enterprises would be determined by the PFI1 according to the maturity, credit risk, operational cost and competition of each investment loan up to a maximum of six percentage points above BR's rate to the PFI. The ceiling on the spread has been set to equal or exceed the current average free market spreads. For Peso loans, BR would bear explicitly the full foreign exchange risk, and would bear only the cross-currency risk for USS equivalent loans. For the public sector support component, US$ 8 million of the loan proceeds would be made available by BR to the Government on terms identical to BR's repayment obligations to the Bank. This document has a restricted distribution and may be used by recipients onl- in the .1rformance of their official duties. Its contents may not otherwise be disclosod without Wo,td Batik *thorization. J  - LL- FJXnuciwaioP1SEs znterpri.see S 148 PartLcipatLng Financlal Interm dleries 103 Prlvate Investment & EnterprLse Equlty Funds 49 World Bank 2 TOTAL $ 500 Sate of Returs Investment loan approval. would reqplre normally at least a 12 percent flnancial rate of return in real terms. staff aouraisal Denoit: 8633-CO SE: mDIBM 1837oR  MEMORAND AND UCCMMATION 0F TUE MIDEIT OF TIE NOAL I 01 =RCONSTRUCTION AND DEVELOPAET TO THE EXECUTIE DIRICTORS ON A PROPOOSD LOAN TO COLOMBIA M11 I STRAL RISTCTRING ANDEVElOPNT PROJECT 1 The following memorandum and recommendation on a proposed loan to Colombia for US$200 millton is submitted for approval. The proposed loan would be on standard terms, including 17 years maturity and 5 year. grace. 2. B&SkLrgSU4. The structure of Colombia's industrial production which is almost entirely in the private sector, has remained relatively static since the mid-1970s and of modest importance to the economy, contrasting sharply with the dramatic changes that have taken place in many newly industrialized countries (NICs). Production facilities have a preponderance of older equipment and industrial output has been concentrated increasingly in a limited number of plants. Output has been focused consistently on the domestic market and bas failed to generate a level of exports wbich would reduce Colombia's heavy dependence on commodity exports. The competitive position in international markets of a number of important ColombianAindustries (agroindustry, textile. and clothing, leather and shoes, steel, vehicle assembly and parts) is quite weak. Average product costs are in most cases above their NIC comparators, while factor productivity is generally low. Product designs suffer basically from inadequate communication with external markets and local institutional support. Product quality is hampered by defective raw materials and the aging technology frequently in use. Market response time is uniformly high, partly a a consequence of organizational problems of producers. 3. Basic comparative advantages of Colombia, such as low unit labor costs, abundant raw materials and good geographical position, are offset further by a pletiort of public policy and institutional factors. These have included high duties and surcharges on imported capital goods and technology, scarce long- term credit and high real Interest rates, regulatory constraints on the nobility )f- labor, administrative barriers to the acquisition of technology, duty dr*vbacks and directed credit, and a time-consuming and costly transportation network. 4. The recently elected Colombian Government is implementing vigorously an Economic Modernization Program (SUP) set in motion early in 1990 to liberalize the external trade reginm, accelerate the reform of public services and devolop an internationally competitive private sector. The program marks the recognitian by many policy makers and private entrepreneurs that Colombia's socio-economic objectives for the 1990s---to accelerate the country's rate of economic growth and employment creation, lower prices to consumers, and further diversify the nation9' export structure---cannot be met by continued high trade protection, import substitution, and capital-driven growth. 5. Rationle for Bank Involvement. Preparation of the Industrial Restructuring and Development Project (IRDP) has facilitated the definition of policy issues and the competitive strengths and weaknesses of local industry. It has mobilized interest in the restructuring process and helped to build a dialogue between private industrialists and the public sector on how to achieve international competitiveness. Bank support of the Project has also helped to bring about the public policy and institutional changes required by enterprises  2 to compete and to mobilize the resources and oervices needed by them to implement the restructuring process. 6. The Project is part of a package of Bank-supported policy and institutional adjustments to facilitate the realization of the ENW. A Bank loan of US$80 million equivalent was approved in 1989 for a Fifth Small and Medium Scale Enterprise (SHE) Project, and a loan of US$300 million has recently been approved to support broad-based public sector regulatory and enterprise reforms. Two additional projects are under preparation which aim inter alia to facilitate the reorganization of Colombia's industrial development bank for large scale enterprises, the Instituto de Fomento Industrial (IFI), and to accelerate export development. The experience gained in past lending through financil intermediaries to Colombian industry has demonstrated in particular the importance of addressing directly policy and institutional constraints to international competitiveness. Therefore, the proposed Project embodies substantial adjustments mainly in the trade, financial sector and labor regimae. 7. Pro1ect Objectives and Descrintion. The Government seeks the Bank's support through the proposed Project in order to facilitate a supply response to the trade reform. The Project would provide capital and other support to assist the private sector in renovating existing industrial production capacity so as to reduce product costs, increasing product quality and services, building new capacity for goods in which Colombia has a dynamic comparative advantage, or phasing out capacity which is unlikely to produce acceptable long run returns tn an internationally competitive business environment. The Project incorporates those public policy and regulatory adjustments in the areas of external trade, domestic competition, the financial sector, labor and technology needed to achieve IRDP objectives. Most of these adjustments have already been achieved during Project processing. The Project, with an estimated total cost of US$500 million equivalent, would also include: (a) a private sector credit program to finance investments and technical assistance to industrial enterprises and supporting services (US$492 million)I and (b) programs to facilitate labor adjustment, environmental pollution control, and Project implementation monitoring (US$8 million). 8. The credit program would support investments by enterprises qualifying as (a) manufacturing and mining sector businesses, Jand (b) services to help prepare and implement investments by such sector businesses, Including those oriented to the subsector level (eg., product design, technology and export promotion centers). Eligible expenditures to be financed by the loan would be broadly defined to include goods and services associated with the acquisition of traditional fixed assets, working capital, and a broad range of other incremental expenditures commonly required in restructuring exercises, such as product research and development, development of new marketing and distributing networks, and employee retraining and relocation. 9. Oversight of' Project implementation would be exercised by the Ministry of Econumic Development, (NED) while management of the Project's financial resources would be performed by BR as "second-tier" institution. All development and commercial banks in Colombia could, in principlg, become participating financial intermediaries (PPIs). Qualifications as a PFI would depend upon (a) certification that they observe the financial and operating requirements of the  3 Superintendency of Banks, which are satisfactory to the Bank for the proposed Project, and (b) the ezistence of a valid participation agreement. BR would review semi-annually a PI'e organization, stafflng, credit portfolio performance, loan appraisal and supervision procedures for lending and equity contributions under the Project, thereafter maintaining or adjusting accordingly free limits applicable to subloans. 10. BR would denominate the proceeds of the Bank's loan for the credit program in Pesos or US$ equivalent, according to the preferences of the enterprise. If denominated In Pesos, SR would rediscount 701 of a subloan or equity investment made available by a M11 to finance an enterprise investment and charge an interest rate, to the m equivalent to at least DTF plus a margin to cover administrative cost and foreign exchange risk. If the proceeds are denominated in US$ quivalent, BR would rediscount OO1 of the US$ senomated subloans up to a maximum of 50 of total subproject cost and charge a rate reflecting the Bank's interest rate plus a fee to cover the cross-currency risks and BR's administrative costs. BR would bear explicitly the full foreign exchange rate risk on Peso-denominated financing and only the cross-currency risk on a US$ denominated loan. Maturities of funds relent to PMs wuld match those set for beneficiaries. PuIs would set interest rates to clients according to the investment characteristics, maturity, credit risk, processing cost and competition for each enterprise loan up to a maximm rate of six percentage points above the rate from BR to the PFI. This ceiling on the spread has been set to equal or exceed the current average free market spreads. Loan maturities and grace periods would be set by the P1I according to the cash flow and other characteristics of the Investment. PMs would mobilize the remaining 301 from their own sources on tems identical to the rediscounted portion. Enterprise loan approvals would normally require at least a 122 financial rate of return in real terms supported by a sensitivity analysis. Given that the current trade reform program should substantially reduce the distortions in the econey, an economic rate of return would not be required. BR would undertake with Bank support a regular specific supervision program of the Project portfolio of each P11. 11. A breakdown of costs and the financing plan are shown in Schedule A. The loan allocation and the Misbursement schedule are shown In Schedule S. A timetable of key project processing events and the status of Bank Group operations in Colombia are given in Schedules C and D, respectively. A map has been included, and the Staff Appraisal leport No. 8633-CO, dated March 20, 1991 is attached. 129 Ayreed Actions The main actions agreed upon under the Project are as followas (a) Trade PoUcy: under the Government' trade reform program initiated in February 1990, quantitative restrictions on imports have been eliminated (excluding those associated with health and safety and national security). It has further announced publicly final targets for the reform: by end-1993 the maximum tariff level will not exceed 231# the average import- weighted tariff will not exceed 161 and the number of tariff categories will be reduced to no more that four (the current maximum is 501 for all products excluding vehicles and the weighted average tariff lIs .11). Ongoing commitment of the Bank's loan under the IRDP credit program would be conditiatupom-i4 = maintenance of these three final targetst and (ii) coverage of industrial  4 domestic production by quantitative restrictions not exceeding 51 of value (excluding health and safety and national security related permits). This second condition would not apply If, in the opinion of the Bank, any such incarese above the 5S lImit Is required exclusively as a temporary measw to prevent a fall In the Government's ainternational reserves causei by an extreme and unexpected disequilibrium in its balance of payments, and, further, that the Government prepares within 120 days of the QR imposition, an action plan satisfactory to the Bank for the substantial elimination of the QRo exempted from the limitation and puts it into effect within 180 days of the imposition. Amendments needed to simplify and accelerate proceosing of the duty drawback scheme have already been made. (b) Domestic Competitions prior agreement with the Bank co a price stabilization mechanism for domestic cotton production purchased for the textiles and clothing industries and on a deregulation program for the vehicle assembly industry would be conditions of first disbursement -to enterprisos in the respective subsectors. (c) Finanscal Sector: (i) interest rate subsidies on industrial directed credit from BR to PFIs have been eliminated by setting the minimum rates between these entities at the DTF and setting maximum rates to users to-equal or exceed the current average free market spreads (6 percentage points above the rate from BR to PPle; and (iU) industrial directed credit regulations have been harmonised with the Bank loan by raising free limits and shifting the focus of second-tier management to ex post monitoring of m performanc and auditing of the use of fundsj- (d) Lahor- Congress-has approved legislation modifying the Labor Co4e to inter al& permit incresaed mobility of labor as required by the restructuring process, specifically aimed to: (i) introduce competitiveness as grounds for transfer and dismissal of employees, the adoption of new technology, and reduction of plant capacity, (ii) increase flexibility in labor contracts, and (iii) reduce the time needed for public sector approval when required; (e) Technology: agreed measures bave been taken to effectively elimminate the selection criteria for technology contracts and convert contract review procedures into a registration and verification of contract data by the Superintendency of Industry; (f) Public Sector Support Progras: a Pollution Control Program in the National Planning Department (DIP), a Project Monitoring Program in HED, and a Labor Adjustment Assistance Program Agreement (LAAP) have bean established. The detailed design of the LAAP would be a condition of first loan disbursement for this component. 13. Benefits and Risks. The Project is expected to help Colombia to shift its industrial production capacity to areas of comparative advantage in the international marketpla