Colombia - Acerias Paz del Rio Steel Project

RESTRICTED Report No. P-328 A? FILE LOPY This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO ACERIAS PAZ DEL RIO S. A., COLOMBIA June 18, 1963  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOP-ENT7 REPORT AND RECOIlEMNDATIO1TS OF THE PLiES DENT TO THE EXECUTIVE DIRCTORS ON A PROPOSED LOAN TO ACERIAS PAZ DEL RIO S.A., COLOTBIA 1. I submit the following report and recommendations on a proposed loan, of an amount in various currencies equivalent to $30 million to Acerias Paz del Rio S.A. (Paz del Rio)) to finance the major part of the foreign exchange cost of the Companyls investment program. PART I - HISTORICAL 2. An integrated steel mill was among the projects for which the Colombian Government sought Bank financial assistance in 1949. The Bank did not consider the steel project suitable at the time and, in 1951, the Government proceeded on its own with the construction of a mill at Belencito, with the foreign exchange cost being financed largely by suppliers and most of the local expenditures by the Government. Soon after operations started in 1955, major difficulties were encountered and the Government asked the Bank for advice on how to improve the mill's operations and expand produc- tion capacity. A Bank mission visited Colombia in 1955 and recommended that Paz del Rio employ competent consultants to orovide management advice and to prepare studies for the additional investment that would be required for effective utilization of the Company's basic steel-making capacity. 3. In 1958 Paz del Rio engaged consultants to make a study of opera- tions and finances and to assist in prepparing an investment program. After studying the preliminaryr consultants report, the Bank, in 1959, informed the Company and the Government that it would consider lending for the proposed program provided (a) the Company entered into a satisfactory management contract with a view to strengthening management, (b) a program was worked out to accelerate the transfer of stock to private hands, and (c) further study demonstrated that a new investment would enable the Company to become a profit-making institution within a reasonable period of time. Paz del Rio accepted these conditions. The consultants report on a revised investment program was submitted to the Bank in early 1961, and Bank missions went to Colombia in July 1961, October 1962 and April 1963 to review the program. I. The negotiations took longer than usual. Soon after the start of negotiations in March 1962, the Company got a new Board of Directors, with majority representation from the private sector, which had to acquaint itself with the investment program and the terms of the proposed loan. During the negotiations the Company requested a number of changes be made in the project which required separate studies and review. The Company was represented by Dr. Julian Moreno Mejia, President, and Dr. Dario Vallejo Jaramillo, Vice President. The Government was represented by Dr. Carlos Sanz de Santa- maria, first in his capacityr as Ambassador to Washington, and later as Finance Minister.  5. The proposed loan, together with the loan of $30 million to the Colombian National Railroads to be considered by the Executive Directors on June 18, would increase the Bankts lending fron 4278.9 million to $338.9 million net of cancellations. The status of previous Bank loans is as follows: As of May 31, 1963 ($ million) Total loans net of cancellation 3/ 278.9 of which has been repaid 57.6 Total now outstanding 221.3 Amount sold 12.0 of which has been repaid 6.3 3.7 Net a-mount held by Bank 217.6 1/ Including $S4.8 million not yet disbursed and the $83.8 million loan to CVC-CHIDRAL signed on June 3 and not yet effective. 6. IDA has made one credit of $19.5 million to Colombia, of which Jsll million has been disbursed. 7. A loan of $5 million for the expansion of the Cospique therno- electric plant near Cartagena is likely to be presented to the 3xecutive Directors soon. We are also studying orojects for the expansion of the generating capacity of the CVC and Medellin Power systems and the national telec ommunications program. PART II - DESCRIPTION OF TH7 PROPOSED LOAN 8. The nain features of the proposed loan are as follows: BORROWER: Acerias Paz del Rio S.A., a private corporation of which about 80% of the capital is now held by private shareholders. GITARAHTOR: Republic of Colombia. AMIOTU1NIT: The eqwivalent irn various cur encies of $30 million. PURPOSE: To assist in financing Paz del Rio's investment program, including interest during construction. WTEREST RATE: 5 1/2% per annum. COFfAITMENT CHARGE: 3/It of 1% per annum. TMWI AND AMORTIZATION: 15 years, including 5 years of grace (21 semi-anntual installments from April 15, 1968 to April 15, 1978).  - 3 - PART III - LEGAL TNSTRUMENTS AND LEGAL AUTHORITY 9. A draft Loan Agreement between Paz del Rio and the Bank (No. 1) and a draft Guarantee Agreement between the Republic of Colombia and the Bank (No. 2) are attached. 10. The draft Guarantee Agreement is in the usual form. In a letter (No. 3) the Government agrees that it will allow the Company to charge such prices as would be consistent with its operation as a private enterprise and with its obligations to the Bank. 11. The draft Loan Agreement follows in substance the normal pattern of agreement for loans to steel companies. The following provisions are of special interest: (a) Section 5.08 provides that the Borrower shall execute a mortgage on its plant at Belencito. (b) Section 5.14 provides that the Borrower shall not undertake, without approval of the Bank, investments outside the scope of the project exceeding $2 million per year prior to the completion of the project and $3 million per year thereafter. (c) Section 5.15 stipulates that the Borrower shall not, without approval of the Bank, incur any indebtedness, other than advances made by banks up to Col. $100 million (about $11 million equivalent). (d) Section 6.02(a) prohibits the payment of cash dividends until December 31, 1967 and thereafter if, as a result of such payments, the ratio of total current assets (other than inventories) to total current liabilities would be less than 2:1. 12. Execution of the Loan Agreement has been authorized by the Companyls shareholders. Guarantee of the proposed loan is authorized by a law enacted in April 1962 which permits the Government to incur or guarantee new external debt up to I35O million. 13. The report of the Committee provided for under Article III, Section 4 (iii) of the Articles of Agreement of the Bank is attached (No. [). PART IV - APPRAISAL OF TrE PROPOSED LOAN 14. A detailed appraisal of the project is attached (No. 5). 15. Paz del Rio operates Colombials only integrated steel mill. Produc- tion of finished products reached 126,000 tons in 1962, including structural steel, rail, merchant products and wire. In early 1963 the Company started to roll sheets on a reconditioned sheet mill. 16. The new facilities to be financed by the proposed loan will enable Paz dcl Rio to increase, improve and broaden its production through better utilization of the capacity of the existing plant and of raw materials and scrap. Most of the increase in production capacity from 126,000 tons to 220,000 tons wfould be in sheet and skelp (67,000 tons). The project also  includes constructicn of additional housing and cornunity facilities at Belenciro in order to reduce t-he oresent, high rate of turnover airong saper- viscr'; and professional personnel and skilled workers. 1?. The slabbing and blooming mill and the steckel mill included in the project are designed as a first step of a further exnansion which would include a cold rolling plant and a tinning line. 18. The Colombian steel market is exoected to grow from about 250,000 tons to at least h.oo,ooo tons by abouat 1970 md Paz del Ri.o shoould be able to increase its market share to about 55% as a result of the proposed project. 19. The inerease and diversification of Paz del Ric's production will reduce Colombia's dependence on steel imports. Net forcign exchange savings resulting from the project in full operation will amount to about 410 million per year aftter Drovision for an annual debt service of $3.6 million on the proposed Bank loan after the 5-year grace period. The development of a reliable domestic source for steel should stimulate the growth of metal fabri- cating industries, now dependent orn imported raw mnaterials, thus resulting in further foreign exchange savings. 20. Paz del Riots costs and prices are such that the Company, in its presen: relatively early stage of *evelopnent, needs a certain degree Df Drotecziorn. T1iasuever, in its najor market area, the Bogota region, the Coanpany lhas a fre-ight advantage 'is a vis impcrts, so -that there, itE orices (wi-neh however, are far from reflecting true costs, including an appropriate reti-rn on the original investment) are onlyr about 10, above delivered prices (excluding customs duties) of imported products. Colombia provides its dome!s tic steel production with an infant industry protection of an average 25-3C'% customs duty on steel innorts, Government regulations also prohibit imports when local prodacers can satisfy derand. 21. The project will enable Paz del Rio to lo-wer production costs and thereby improve its comanetitive position. The Company's profit margin should improve from about 127 of sales in 1961 to about 20% in 1968, and the return on the book value of its total investment should rise from 3.2% to 8.2%j. Tt is more meaningful to point out that the increase in annual income made pos- sible by the project represents about 11%; of the proposed added invest.ment. In 1968 the Comoany's current asset position is expected to permit further canital and replacement exrenditures, prepayment of debt or dividend distri- bution. P orrower 22. Acerias Paz del Rio S.A. is a corporation with a share capital of w,fhich about 30% has been transferred to private shareholders. Arrangements are in effect under ?Thich the balance neld bny the Central Eark wi- l have been transferred to the private sectcr by 1 96. The Boarc of Directors con- sists of 5 members, 3 of which now represent the private shareholders and 2 the Central Dank. In connection with guaranteeing the proposed loan, the Govern.ment will exercise the right of appointing one additional member of the Board as long as its guarantee is outstanding. By next. snrilg, the private shareholders will have enough votes to elect 4 directors, leaving only 1 for the Central Bank, so that I consider the arrangements as a whole acceptable. 23. For its guarantee the Goverrment will charge the borrower a 1% commission per annurm on the outstanding amount of the loan. Furthermore, the Government will share in the mortgage given to the Bank.  - 5 Arrangement for Financing 24. The total cost of the project is estimated at the equivalent of $58.7 million, of which $30 million would be covered by the proposed loan and the balance by Paz del Rio's own resources. Although during the construction period the company is expected to have adequate cash to meet requirements for an in- crease in working capital, it has made arrangements, as a precaution against contingencies, for a 100 million peso line of credit from the Central Bank. Procurement 25 Procurement under the proposed loan would be on the basis of inter- national competition to the fullest practicable extent, taking into account requirements of standardization and process design. Economic Situation 26. A report, "Current Economic Position and Prospects of Colombia" (TWH-126a), was distributed on June 6 and the latest economic situation was reviewed in the Presidentls Report on the loan to the Ferrocarriles Nacionales de Colombia (R 63-52, dated June 6, 1963). Prospect of Fulfillment of Obligations 27. The company, with the assistance of its consultants, should be able to carry out the construction of the project and operate the new facilities. 28, The prospects for marketing the enlarged and improved steel produc- tior. end the Government's policy of leaving the company free to charge such nalcos as will be consistent with its operation as a private enterprise, togeshsr with the line of credit arranged locally, afford assurances that funds will be available to complete the project and to service the proposed loan. 29. The transfer into foreign exchange of the service payments on the proposed loan, together with Colombia's other foreign exchange obligations, should not impose an undue burden on the Colombian economy. PART V - COMPLIANCE WITH ARTICLES OF AGRBEEiENT 30. I am satisfied that the proposed loan would mmply with the Articles of Agreement of the Bank. PART VI - RECOFTh4ENDATIONS 31. I recommend that the Bank make a loan to Acerias Paz del Rio S.A., with the guarantee of the Republic of Colombia, in an amount in various currencies equivalent to $30 million, for a total term of 15 years with interest (including commission) at 5- % per annum and on such other terms as are speci- fied in the attached draft Loan and Guarantee Agreements, and the Executive Directors adopt a resolution to that effect in the form attached (No. 6). George D. Woods Washington, D. C. President June 18, 1963