China - Shanghai Industrial Development Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-5043-CIL MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO $150.0 MILLION TO THE PEOPLE'S REPUBLIC OF CHINA FOR A SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT JANUARY 9, 1991 Thbis document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorizadon.  CURRENCY EQUIVALENTS (As of December 1990) Currency Name = Renminbi (RMB) Currency Unit = Yuan (Y) = 100 Fen Y 1.00 = $0.19 $1.00 = Y 5.22 GLOSSARY OF ABBREVIATIONS AND ACRONYMS ERR - Economic Rate of Return FRR - Financial Rate of Return GDP - Gross Domestic Product ICB - International Competitive Bidding JGF - Japanese Grant Facility OEM - Original Equipment Manufacturer PFIs - Participating Financial Institutions PMU - Project Monitoring Unit SC - Steering Committee SIDP - Shanghai Industrial Development Project SOE - State-Owned Enterprise SMG - Shanghai Municipal Government TA - Technical Assistance FISCAL YEAR January 1 to December 31  FOR OMCLAL USE ONLY CHINA SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT Loan and Project Summary Borrower: People's Republic of China. Beneficiaries: Shanghai Municipal Government (SMG) and the five Participat- ing Financial Institutions (PFIs). Amount: $150.0 million equivalent. Terms: Twenty years. including five years' grace; standard variable interest rate. Onlending Terms: The proceeds of the loan would be made available by the Borrower to the SMG on terms and conditions satisfactory to the Bank. SMG would onlend the entire proceeds to the five PFIs for 20 years, including five years' grace, and at a variable interest rate equal to the Bank rate. The PFIs would in turn extend subloans to eligible enterprises for a maximum period of 12 years including a maximum grace period of three years at a variable interest rate equal to the Bank rate plus at least 1.25 percent; subborrowers would carry the foreign exchange risks associated with the Bank's loan. Financing Plan: Local Foreign Total ---------- ($ million) ----------- IBRD - 150.0 150.0 PFIs, other banks and enterprises 139.2 - 139.2 Shanghai Municipal Government /a 0.1 30.3 30.4 Total 139.3 180.3 319.6 /a Includes $35,000 equivalent from the Japanese Grant Facility to finance the estimated foreign costs for the project-related studies. Economic Rate of Return: At least 12 percent for subprojects. Staff Appraisal Report: Report no. 7702-CHA Thisdocument has a restricted distribution and may be used by recipients only in the performance oftheirofficial duties. Its contents may not otherwise be disclosed without World Bank authorization.  - 1 - MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE PEOPLE'S REPUBLIC OF CHINA FOR A SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT 1. I submit the following memorandum and recommendation on a proposed loan to the People's Republic of China for the equivalent of $150.0 million to finance a Shanghai Industrial Development Project (SIDP). The proposed loan would have a repayment term of 20 years, including five years of grace, at the standard variable interest rate and would be onlent to the Shanghai Municipal Government (SMG) on terms and conditions satisfactory to the Bank. SMG, in turn, would make available the loan to the participating financial institu- tions (PFIs). The PFIs would onlend those funds for eligible subprojects for a maximum period of 12 years including up to three years of grace at a vari- able interest rate equal to the Bank rate plus a minimum spread of 1.25 per- cent and subborrowers would carry the foreign exchange risk. 2. Background. Industry is China's largest productive sector account- ing for almost half of its GDP. Gross industrial output has grown at an aver- age annual rate of about 10 percent over the last ten years. Despite its rapid growth, the industrial sector is characterized by low efficiency and productivity and a limited variety of products which are often of poor qual- ity. This is mainly due to inappropriate economic policies, outdated equip- ment and technology, inadequate infrastructure and weak support institutions. The Bank is assisting the Government to address the above problems through its economic and sector work and lending operations. 3. With the gradual decentralization of responsibilities for production and investment decisions under China's ongoing economic reforms, it is becom- ing increasingly important that the above-mentioned issues in industry be addressed at the provincial level. The Bank, therefore, has initiated a series of provincial operations designed to assist the provincial authorities in identifying and resolving policy and enterprise reform issues in conjunc- tion with specific subsector and enterprise-level restructuring. The Tianjin Light Industry Project, approved in 1989, was the first project. The proposed project is the second. 4. Shanghai Municipality, which has provincial status, has the second largest industrial output value (after Jiang i) among the provinces in China. The Municipality has recently been designated as one of the key sites for experiments in the implementation of enterprise and financial market reforms, including the introduction of the joint stock system in certain key enter- prises and expansion of the market for trading financial instruments. The Municipality is also introducing several models of industrial restructuring. The lessons of such experiments will contribute to national policy reforms in these fields. SMG attaches priority to these measures in recognition that they are necessary to solve some of the problems experienced by the Municipal- ity's industrial sector during the past dozen years. During most of that period, despite its size and historical strength, -hanghai's industrial sector grew more slowly than the rest of China's industry for several reasons: gov- ernment regulation was greater in Shanghai's industrial sector; until 1989,  - 2 - the enterprise reform program was implemented more slowly in Shanghai than in other provinces; and furthermore, the Municipality has been taxed more heavily than other provinces by the central government, leaving fewer resources for investment. Shanghai also has a much higher portion of state-owned enter- prises (SOEs) than the rest of the country. These have grown more slowly than the township and village enterprises, which play a relatively larger role in other areas. Shanghai faces increasing competition from other provinces while also being squeezed by raw material and energy shortages, and saddled with outmoded manufacturing technology, deteriorating infrastructure, and a scar- city of land for expansion. Important elements of Shanghai's industrial strategy are to- reform the ownership and management systems of its SOEs; move into higher value-added activities that are more technology intensive, less polluting, and less intensive in energy and raw materials; and improve the policy and infrastructural environment for foreign investors and other nonstate enterprises. 5. Four priority subsectors--electronic components, precision and sci- entific instruments, printing machinery, and electrical apparatus--face prob- lems of industrial adjustment that are found in many other subsectors in Shanghai. Following government efforts in the mid-1980s to reduce the number of layers of bureaucratic control over SOEs, these subsectors had been orga- nized as loose groups of suboptimally sized factories, along with a corporate office without the authority to restructure factories for efficiency gains. The factories are characterized by overlapping products, duplicate manufactur- ing processes, poor product quality, and limited marketing and distribution channels. Using funds under the Japanese Grant Facility (JGF), two interna- tional management consulting firms helped develop specific restructuring strategies for the four subsectors. 6. Rationale for Bank Involvement. To revitalize its economy Shanghai needs to improve the structure and management of its industrial sector. The Bank is well-placed to assist the SMG because of its ability to support the formulation, implementation and financing of an integrated package of needed policy and enterprise reform measures based on the experience gained from industrial restructuring projects elsewhere in the world, and previous eco- nomic and sector work and lending operations in China. The project is consis- tent with the Bank's overall strategy for assistance to the industrial sector in China. 7. Proiect Objectives and Description. The project would support the implementation of the technological and organizational restructuring program for the four priority subsectors (para. 5). Technological restructuring would focus on rehabilitation, consolidation, modernization and expansion of produc- tion for the domestic and international markets, particularly those of South- east Asia and on an OEM basis. In addition, joint ventures would be sought during the project. The organizational restructuring would support the devel- opment of reconstituted subsector corporations, which are integrated corpora- tions able to carry out the product and manufacturing rationalization needed in each subsector. Not all factories in the subsectors today would come under the new integrated corporations. Only those factories that have a critical role to play in implementing the agreed subsector strategies are included. The enterprise reforms are reflected in legal charters approved by SMG that are acceptable to the Bank. They would be supported by further actions to reorganize internally and strengthen management systems. The project would  have three components: (a) about $134 million of the proceeds of the loan would be utilized toward meeting the foreign currency requirements for techno- logical restructuring in the four subsectors. Specifically, it would finance subprojects appraised by the PF!s that are consistent with the ag'reed subsec- tor strategies, are environmentally sound, and meet agreed financial and eco- nomic criteria; (b) about $16 million of technical assistance (TA) to the four subsectors, including management consulting services to support organizational restructuring and project implementation, computer equipment and software and overseas training and travel abroad to acquire foreign technology; and (c) an institutional development component financed under the JGF consisting of pol- icy studies of enterprise reform issues and the effect of recent and planned policy changes in the four subsectors that would be carried out as part of the project. Under this component the PFIs would receive training covering sub- project appraisal methodology, and Bank procedures on procurement, disburse- ment and reporting. 8. The five PFIs are the China Investment Bank, Industrial and Commer- cial Bank of China, People's Construction Bank of China (acting through their Shanghai branches), the Bank of Communications Shanghai Branch and the Shanghai-based Shanghai Investment and Trust Company. They would be responsi- ble for the appraisal and supervision of subprojects to be financed under the proposed Bank loan and would each lend to only one of the subsectors included under the project. Each PFI is considered to be capable of carrying out the project appraisal, implementation and supervision tasks required under the proposed project. Although the project is to assist the four preidentified subsectors, the PFIs will be allowed the flexibility to finance subprojects in other subsectors as agreed between the Bank and SMG, on the basis of develop- ment strategies to be prepared by the Municipality. 9. The total cost of the project is tentatively estimated at $319.6 million equivalent, with a foreign exchange component of $180.3 million (36 percent of total costs). Final cost estimates would depend upon the indi- vidual subproject cost estimates that will be prepared by the PFIs at the time of subproject appraisal. After all subprojects are appraised and final for- eign exchange estimates are known, any remaining foreign exchange financing gap would be financed by SMG. Retroactive financing up to a total of $5 mil- lion will be allowed for eligible expenditures incurred after March 15, 1989. A breakdown of tentative cost estimates and the financing plan is shown in Schedule A. No procurement table is given since this is a line of credit and procurement packages will generally be small and awarded after a comparison is made of quotations solicited from at least three qualified suppliers from dif- ferent countries. Contracts above $1 million will be awarded following ICB. The methods 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 China are given in Schedules C and D respectively. The Staff Appraisal Report, No. 7702-CHA, dated January 9, 1991, is being dis- tributed separately. 10. Agreed Actions. Agreements were reached with SMG during negotia- tions on the following major actions and conditions: (a) maintain throughout project implementation a project monitoring unit (PMW) with functions and responsibilities acceptable to the Bank and with competent staff to coordinat, and monitor overall implementation of the project; (b) maintain a steering committee (SC) that would guide the work of the PMU and annually exchange  - 4 - views with the Bank on implementa ion of the development programs and strat- gies of the four subsectors, including policy and enterprise reforms; (c) approve charters for the integrated corporations that are acceptable to the Bank; (d) ensure that financial consolidation of the new integrated corpo- rations is carried out within nine months of charter issuance; (e) ensure the availability of funds for implementation of the project; and (f) carry out studies in accordance with terms of reference and timing agreed with the Bank. Agreement was reached with the PFIs on the following major actions and condi- tions: (i) eligible subprojects would be consistent with the development strategies agreed between the Bank and SMG, meet their lending criteria including a minimum FRR of 12 percent for all subprojects (and a minimum ERR of 12 percent for subprojects above the free limit), and be sponsored by cor- porations with satisfactory legal charters and projected financial positions; (ii) subprojects to comply with the Shanghai Environmental Protection Bureau's environmental protection guidelines which are satisfactory for the project subsectors; (iii) existing operations of the factories sponsoring subprojects to be in compliance with those guidelines; and (iv) each PFI would seek Bank approval of the first two investment subprojects below the free limit. Each corporation would appoint the necessary consultants as a condition of effec- tiveness. Ul. Benefits. Organi;ational and technological restructuring and policy reforms will result in greater efficiency, and better domestic and interna- tional competitiveness in the four project subsectors. The subproject selec- tion criteria will ensure that investments under the project are consistent with SMG's strategy for each subsector, financially and economically viable, and environmentally sound. The proposed project would provide SMG with a model for other industrial subsectors in Shanghai that need restructuring. 12. Risks. There are two main project risks. The first is a possible failure to implement the subsector enterprise and policy reforms. However, SMG is strongly committed to the reforms. In addition, legal restructuring of the subsector corporations, a requirement before subloans could be made to them, has already taken place. The Bank and SMG have also agreed on a frame- work for periodic reviews of the reforms during project implementation. Second, there is the possibility of delays in project implementation. How- ever, specific arrangements have been made to reduce this risk, including staff training prior to the project, establishment of the PMU hind SC, proce- dures for implementation at the level of the subsector corporations and engag- ing consultants to provide management assistance during project implementa- tion. A strong base for full implementation of the agreed restructuring has been laid through initial organizational and managerial changes introduced during 1990. 13. Recommendation. 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. January 9, 1991  - 5 - Schedule A CHINA SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT Estimated Cost and Financing Plar. (S million) Local Foreign Total ESTIMATED COSTS is Financial Assistance Component Technological Restructuring Capital Costs: Instrumentation 8.0 27.9 35.9 Electronic components 16.9 64.6 81.5 Printing machinery 11.1 22.3 33.4 Electrical apparatus 14.2 40.4 54.6 Subtotal 50.2 155.2 205.4 Incremental working capital Lb 81.5 - 81.5 Subtotal for Technological Restructuring 131.7 155.2 286.9 Technical Assistance Component Training 2.6 11.7 14.3 Computer hardware and software 0.8 3.7 4.5 Consultant services 4.1 9.7 13.8 Subtotal for Technical Assistance Component 7.5 25.1 32.6 INSTITUTIONAL DEVELOPMENT COMPONENT 0.1 - 0.1 Tctal Financing Required 139.3 180.3 319.6 FINANCING PLAN IBRD - 150.0 150.0 PFIs, other banks and enterprises 139.2 - 139.2 Shanghai Municipal Government /c 0.1 30.3 ^0.4 Total 139.3 180.3 319.6 /a Final estimates to depend on individual subproject cost estimates that will be prepared by the PFIs at the time of subproject appraisal. Since these are preliminary estimates, no attempt has been made to separate contingencies. Project cost estimates include taxes on local costs and customs duties on imports. Local taxes are about 15 percent of local costs. Foreign costs financed by the Bank would be exempt from customs duties. /b Imports of raw materials and parts will be financed through foreign exchange earnings, for which the working capital is included in the local cost. /c Includes $35,000 equivalent from the Japanese Grant Facility to finance the estimated foreigr. costs for the project-related studies.  - 6- chedule B CHINA SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT Disbursements Disbursement amount Category ($ million) Percentage to be financed Financial assistance subloans 133.8 1002 of foreign expenditures and 1002 of local expenditures (ex- factory) Technical assistancs subloans: Goods 2.7 1002 of foreign expenditures, 1002 of local ex-factory cost and 75z of local expenditures for other items procured locally Consultant services 5.0 1002 Training (overseas) 8.5 1002 Sut ztal technical assis- tance subloans 16.2 Total 150.0 Estimated Disbursements IBRD Fiscal Year 1991 1992 1993 1994 1995 1996 Annual 5.0 17.5 40.0 42.0 29.5 16.0 Cumulative 5.0 22.5 62.5 104.5 134.0 150.0  - 7 - Schedule C CHINA SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT Timetable of Key Project Processing Events (a) Time taken to prepare I One year (b) Prepared by s Government with assistance of the Bank, and consultants financed under the Japanese Grant Facility (c) First Bank mission January 1988 (d) Appraisal mission departure : February 1989 (e) Negotiations : May 15-19, 1989 (f) Postappraisal mission : March 1990 (g) Planned date of effectiveness : April 1991 (h) List of relevant PCRe and PPARs: Not applicable  Schedule D Page 1 of 3 STATUS OF BANK GROUP OPERATIONS IN THE PEOPLE'S REPUBLIC OF CHINA A. STATEMENT QF BANK LOAAS AND IDA CREDITS (As of Septeber 30. 1990) LoanlD Amount (US millbon) Credlt Bor.. net of cancellat ons Number FY rower Purpose ank IDA Undlsb. (a) sx lQajcs and ten credits have been fully disbursed. 447.6 523.9 _ or ncn SECALs 296 11932 88 PRC Rural Sector Adj. 200.0 100.0 - 2231 83 PRC Petroleum I (Daqing) 162.4 . 0.5 2252 83 PRC Petroleum I (Zhon yuan-Wenliu) 100.8 - 15.0 1411 84 PRC Po ytechnic TV University - 85.0 17.6 1417 84 PRC Ru ber Development - 100.0 2.0 2382 84 PRC LubuLe Hydroelectric 145.4 - 25.5 2394 84 PRC Railway 220.0 - 1.0 1472 84 PRC Rural Health & Medical Educ. - 85.0 12.2 2426 84 PRC Petroleum III (Karamay) 92.5 - 5.7 243411491 84 PRC Industrial CreI it II tCIB II) 105.0 70.0 0.9 244411500 84 PRC Agr culturalEducation II 45.3 (23.S)Jb) 6.8 156 85 PRC A~iuuraj Research II - 250 6.1 1551 8 PRC Unirersity eve opment II 145.0 26.2 2493 85 PRC Power II 117.0 - 16.7 2501 85 PRC Char acun (Luan) Coal Mining 79.5 - 55.2 1577 85 PRC Seed - 40.0 1.1 1578 85 Pac Rura Water Supply - 80.0 4.1 253911594 85 PRC H4hway I 42.6 (30.0)(b) 13.0 25 0 85 PRC RaIlwai II 235.0 - 132.0 2541 85 PRC Fertili2er Rehab. & 97.0 - 0.8 Ener Savin 1605 ~~85 P C Petr eveloment -47.3 13.0 2571911606 85 PRC piShiHa ogChlao Are a D V. 17.0 75.0 11.1 25 0 85 PRC Wei yuan as Field Technical 25.0 - 8.1 1642 86 PRC Rural CreditII 90.0 1.1 2659 1663 86 PRC Industrial Credit II (CIt IIT) 75.0 25.0 9.7 16 4 86 PRC Technical Cooperat Ion Credt II - 20.0 20.3 1671 86 PRC Provincial UnIvers ties - 120.0 15.8 2678/1680 86 PRC Third Railway 160.0 70.0 134.8 2689 86 PRC Tian1in Port 130.0 - 85.8 1689 86 PRC Fres water Fisheries - 60.0 1.9 2706 86 PRC Beilungans Thermal Power 225.0 - 52.3 2707 86 PRC uantan Hyroeetic5. -19.0 272311713 86 PaC Rural Health & Preventive Med. 15.0 65.0 55.1 17 3 87 PRC Red Soils - 40.0 1.0 2775 87 PRC Shuikou Hydroelectlic 140.0 - 58.1 278311763 87 P lRC Idustria lCredt IV (CIB IV) 250.0 50.0 84.7 27 4 87 'RC Sanhai Machine Tools 100.0 - 66.5 17 4 87 'Rc J.n3 anQ Agriculturas Dev. - 70.0 32.6 2796t779 87 PRC ShangaI S werage 45.0 100.0 116.6 281111792 87 RC i in Tian -in-Tanpgu Expressway 20.0 125.0 79.2 2812 /793 87 P Gansu Provincial De . 20.0 150.5 113.8 1835 87 PC Planing Support & Spec al Studies - 20.7 17.5 87 Pc Fe ti1izer Rationalization 97.4 - 64.9 2g8! Wuilg h Powe r 190.0 - 142.0 187 so 1 Rucau Cred III - 170.0 27.6 287711845 88 C Fu nu Port 63.0 25.0 71.7 2907/1875 88 C Diih Port 71.0 25.0 76.7 18 5 88 PRc NorS ern Irrigation - 103.0 63.3 292411887 88 PRC Coa tal Lands Dev. 40.0 60.0 43.0 19 8 88 PRC Teacher Trainig - 50.0 31.2 2913 88 PC Pha maceuticals 12 7.0 - 81.3 2951 1917 88PR Scha Highway 75.0 50.0 116.6 29 88 PRC Shaanxi Hi hway 50.0 - 38.8 19 88 PRC Daxing An ing Forestry - 56.9 37.7 2955 88 pRC Be i1nang II 165.0 - 111.1 2958 88 PRC Phoispl teIDe. 62.7 - 61.1 2968 88PCSalwyI 200.0 - 135.5  Schetdle 0 Page of 3 h08l 8AmoutttUSl NumDer FY rower Purpose lsb. (ta) 1984 89 RC Jiangit Proiinc tal Wtghway 161.0 1. 3 1997 89 RC Shaa xl A rco tura DeV. -106.0 1l 7 2006 89 IC Text ook 6eye.opment -7Q 2009 89 RC Inte1rated e 1a lth 2-5 A9.8 006 89 Cg han hai Ports 76.4 - 3 io 00 9 AR ae o 6.04: 302 89 R an h ndustt 154.0 - 149.4 306012014 89 e Mon laaia 70.0 80.0 6 201 89 ICU ha n F1uture iev. - l90 :1 3066 89 aeC uCP7o.oat e 137.0 - 13 0 3073912025 89 PC hloP v iha 50.0 16. 3075 89 PRC iltfh Idust&a CredIt 38:8 91 209 90 PRC C na Ear quake Reconstr. - 30.0 4.1 2097 90 P Jin ArcDe.60.0 . 21019 9980 stc O Ct ht Edu (c5 8)8 211 90 PRC Nat ans A orestation - 30000 320.0 2159 90 PRC Hebi Agricultural Dev. - 150 0 161 6 2172 91 PRC Mld-Yan tze Agricu1tural Dev. (c) - 640 6 6 Total 5143.8 3991.3 4296.3 of which has been repaid 270.4 0.0 Total now held by Bank and IDA 4873.4 3991.3 Amount soldt Of which repaid - - - Total Undisbursed 2508.2 1788.1 4296.3 s(a As credits are denominated in SDRs (since IDA Re 1enishment VI)$ undisbursed SDR credlt alances are converted to do11are at the cutr;nt exc n e rate b ween the dollar *n the SDR. In s9me cases, theretoXe the undisbursed b .8cEi cites a dollar amount greater than the orig cal pricipal credit amount expressed tn dollars. (b) Credit fully disbursed. (c) Not yet effective.  Jchedule D aSo of 3 a. STATI"2T o, tIC INVES X S {As os opt e 30. 990) Invest- ngeLoan T on) Total ment No. FY Obligor licflnfs ...... 813 85 Guangzhou and Peugeot Automobile 15.0 3.2 18.2 974 87 China Investment Co. Investment 3.0 0.0 3.0 1020 87 Shen*hen China Bicyc2le 5.0 - 5.0 B cycles tr.. Ltd. Ma ufacture 1066 88 Crown Electronics Electronics 15.0 - 15.0 1119 89 Shegshen Chronar Solar Solar 2.0 1.0 3.0 anet8y cness8y Total Gross Commitments 40.0 4.3 Less cancellations, terminations 2.2 - 2.2 repayment and sales Total Coiidtments now Held by IPC 37.8 4.3 42.1 Total Vhdisbursed 2.0 2.0 1 0/11190 AS3CO