Tunisia - Tourism Infrastructure Project

RESTRICTED Report No. P-1086 FILE COPY This report Is for official use only by the Bank Group and specifically authorized organizations or persons. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN AND CREDIT TO THE REPUBLIC OF TUNISIA FOR A TOURISM INFRASTRUCTURE PROJECT May 31, 1972  Exchange Rates us $ 1 = 0.48 Tunisian Dinars (D) Dinar1 = US $ 2.05 US $ 1 * 3.22 Deutsche Mark (DM) DM 1 * US $ 0.31 Abbreviations COFITOUR - Compagnie Financiare et Touristique KfW - Kreditanstalt fUr ldederaubau ONTT - Office National du Tourisme et du Thermalisme SNI - Soci6t6 Nationale d'Investissement SONEDE - Societe Nationale d'Exploitation et de Distribution des Eaux STEG - Soci6te Tunisienne de 1Electricit6 et du Gaz  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN AND CREDIT TO THE REPUBLIC OF TUNISIA FOR A TOURISM INFRASTRUCTURE PROJECT 1. 1 submit the following report and recommendatlon on a proposed loan for the equivalent of $14 million and a proposed credit for the equiv- alent of $10 million, both to the Republic of Tunisia, to help finance a tourism infrastructure project. The loan would have a term of 25 years, including 5 years of grace, with interest at 7-1/4 percent per annum. The credit would be on standard IDA terms. Kreditanstalt fur Wiederaufbau is considering a loan of DM 40 million (equivalent to about US$12.4 million) from German aid funds for the same project. PART I - THE ECONOMY 2. A report entitled "Current Economic Position and Prospects of Tunisia" (EMA-38a) was distributed to the Executive Directors on August 18, 1971. An economic mission visited Tunisia in March 1972 and its report is expected to be issued in early summer. A country Data Sheet (Annex II) and a Map of Tunisia are attached. 3. Tunisia's development has been hampered by scarcity of natural resources. Agriculture, the largest sector in the economy, is highly de- pendent on weather; minerals, particularly phosphate, are of low quality and have suffered from deteriorating world market conditions. Industrial development has been handicapped by the small size of the domestic market and in most sectors a lack of skills and experience has been a constraint. However, petroleum was discovered in the mid-sixties and has since become a relatively significant source of revenue; tourism expanded rapidly, con- tributing to regional development, employment and foreign exchange earnings. Tunisia's traditional society is beginning to modernize owing largely to fast expanding education and social services. In the 1960s, development policies emphasized social objectives and assigned a major role to the public sector. Despite high investment, overall economic performance was disappointing. A new development strategy was introduced in 1970, whose main objectives are to increase production, exports and employment, and to achieve this mainly by en- couraging private initiative and reducing direct Government involvement in economic decisions and relaxing administrative regulations. 4. GDP in real terms increased by an estimated 9 percent in 1971, largely because of better agricultural crops, and a very good tourist sea- son. By now, the new Government policies have raised confidence in the private sector, whose reactivation In turn appears to have benefited most  -2- sectors of the economy. The balance of payments position improved consid- erably. Foreign exchange earnings were substantially higher than in 1970, due to higher export prices for petroleum and the expansion of tourism and workers' remittances. The current deficit declined from $95 million to about $50 million despite rising imports. Since capital inflows remained at a high level, foreign exchange reserves increased by about $100 million. 5. The improved economic and financial situation facilitated a con- tinued liberalization of economic policies. To stimulate competition the Government further reduced import restrictions for domestic manufacturers. Approval procedures for new investments were considerably eased and banks were given more responsibility in allocating investment funds. The Govern- ment has undertaken a thorough review of the tax system, including customs tariffs, and is now introducing a number of reforms designed to stimulate production, encourage exports and achieve greater equity and simplicity in administrative procedures. These developments have led to a sharp rise in private investment projects submitted for official approval during 1971. 6. There has been less progress in relaxing price regulations and in reorganizing state-owned enterprises. Several of these enterprises still experience difficulties. An inter-ministerial committee on state-owned enterprises recommended changes in the financial structure, operation and management of six of these enterprises but the measures so far taken were largely insufficient. 7. Agriculture is still the dominant sector in the economy. It pro- vides nearly half of the employment, 30 percent of merchandise exports and 17 percent of GDP; food processing industries account for another 5 percent of GDP and over a third of value added in manufacturing. Agricultural out- put stagnated during the second half of the 1960s, due to unfavorable weather, the effects of organizational changes including sweeping land reform measures, and the lack of modern skills and inputs. The new Government policies, since 1969, have renewed confidence of private farmers. Due to their revived ini- tiative and better weather, agricultural output increased substantially in 1971 and is expected to grow further in 1972. Past investments, particularly in irrigation works, will permit expansion of production, and domestic and foreign markets could absorb much more than is presently produced. The sectorts future development will depend on energetic efforts to improve methods and efficiency of production, and on increased training. 8. Tunisia's crude oil production (primarily from the El Borma fields in the South) was slightly above four million tons in 1971. It has tended to level off since 1969, but recently intensified prospecting has led to the discovery of new deposits near Sfax and in the Gulf of Gabes, which are ex- pected to raise production to about 6 million tons per year by 1974. On the other hand, prospects for increasing phosphate production beyond the present level of about 3 million tons per year are uncertain, primarily because of high production costs.  -3. 9. Manufacturing contributes about 15 percent to GDP. Up to 1969, sector development focussed primarily on import substitution by state enter- prises and processing of minerals for export. Because of the small domestic market and difficulty of increasing exports, output grew slowly. Tunisia's proximity to Europe, low cost and relatively abundant labor and the 1969 Association Agreement with the EEC, which allows duty free access to the Community for most Tunisian industrial exports, favor the development of export industries. Recent import liberalization has given larger scope to private initiative in industry and should help foster domestic competi- tion; furthermore, legislation providing substantial incentives for domestic and foreign investments in export-oriented industries has recently been passed by Parliament. There appear to be good prospects for private foreign invest- ments and sub-contracting which could make a significant contribution to future industrial development. The Government now places high importance on the development of industry in its broadest sense as the main source of future growth and employment. 10. The current economic recovery, if it continues through 1972 as seems likely, should finally raise average annual growth of GDP during the Third Plan period (1969-72) to a rate close to the Plan target of 6.5 percent. It also seems likely that the Plan's projected investment and sav- ings ratios of 23 percent and 15 percent of GDP will be attained. Total in- vestment over the Plan period is expected to be about D 670 million compared with the Plan target of D 617 million. Over the period 1969-71, net external financing was equivalent to 9 percent of GDP and about 40 percent of invest- ment. 11. The main sources of external aid have been the members of the Con- sultative Group for Tunisia. In the last decade, the country received (in terms of actual disbursements) external official aid in the amount of about US$789 million, about 90 percent of which was granted by bilateral donor countries and agencies (mainly USAID, France, Federal Republic of Germany, Canada, Italy, Sweden and the Kuwait Fund for Arab Economic Development) and 10 percent by multilateral sources (primarily the Bank Group and, to a lesser extent, the U.N. and the African Development Bank). However, there has been a considerable increase in the proportion of multilateral aid over the period from about 3 percent in 1961-65 to 15 percent in 1966-70. Of total aid received, 28 percent was in the form of grants, including agricultural commodities and technical assistance, 30 percent in the form of non-project loans and 42 percent in project loans. The largest share of project loans was for irrigation infrastructure (about US$100 million), followed by trans- port and communications (about US$87 million) and tourism (about US$80 mil- lion). Total external aid received in 1971 amounted to about US$125 million. 12. The capital budget relies heavily on external finance. This re- flects the fact that public savings are as yet inadequate to finance the public sector investment program. In many sectors and for important projects, particularly in agriculture, education and other parts of the public sector, there is therefore a need for local currency financing in excess of what can  - 4 - be raised domestically. Repayments on external debt are preempting a large amount of domestic and external resources. For example, in 1971 this repre- sented over 30 percent of gross external borrowing. Domestic-savings have increased from 7 percent in 1969 to 19 percent in 1971, but at least 40 per- cent of investment needs between 1962 - 1971 have been financed externally. Maintenance of a rate of investment required to assure reasonable growth will continue to depend on a large amount of external aid including funds to finance local expenditure. 13. The 1973-76 plan which the authorities are now preparing, assumes that a satisfactory rate of economic growth in the coming years will require high investments; and although domestic savings will rise further, Tunisia will continue to need substantial amounts of external assistance. 14. Tunisia's foreign debt burden is relatively high: in 1970, the last year for which complete information is available, the debt service ratio was about 22 percent. Restrained short and medium-term borrowing, substantial foreign aid on favorable conditions, and higher foreign exchange earnings reduced this ratio to below 20 percent in 1971; with prudent debt management it should remain at this lower level in the next few years. Tunisia's creditworthiness for borrowing on conventional terms will continue to depend however on her ability to attract a large proportion of external assistance on concessional terms. The Consultative Group for Tunisia, which met in October 1971, welcomed Tunisia's new economic policies, and agreed that for a number of years the country needs continued assistance on soft terms which the members of the Group expressed their willingness to provide. PART II - BANK GROUP OPERATIONS 15. Beginning with a credit of $5 million for an education project in 1962, Tunisia has to date received a total of fourteen Bank loans and eight IDA credits amounting to, respectively, $128.3 million and $48.7 million, net of cancellations and refundings. The proposed loan and credit would bring the total to $201.0 million. 16. The bulk of Bank/IDA lending has been for transport. Two lending operations for port construction, one for the railway company, one for road construction and one for a gas pipeline account for 36 percent of the Bank Group's present commitment in Tunisia. Public utilities come second (21 per- cent) including two operations for water supply and one for power generation and distribution, followed by industrial and hotel financing through Societe Nationale d'Investissement - SNI - (20 percent), agriculture and fisheries (11 percent) and education (10 percent). 17. IFC has invested in a fertilizer plant, in SNI, and in COFITOUR, a tourism development company. Its net commitments presently held in these enterprises total US$11.3 million.  - 5 - 18. Annex I contains a Summary statement of Bank loans, IDA credits and IFC investments as of April 30, 1972, and notes on the execution of on-going projects. While in the first years of cooperation with Tunisia the Bank Group's lending primarily aimed at long term investments in infrastructure and resource development, its focus is now on the development of human re- sources and to mote immediately productive investments in industry including tourism and in agriculture, with particular emphasis on increasing foreign exchange earnings. Industrial and agricultural credit is being channelled at an increasing rate into the economy to allow full use of earlier infra- structure investments. The shift in the focus of Bank Group lending aims at supporting the new policies and development strategy of the Government described in Part I of this report. 19. Tourism has been the fastest expanding sector of the economy. However, infrastructure investments in this sector have been lagging behind vigorously expanding hotel facilities. The present project aims at correct- ing this situation and providing basic infrastructure for a further expansion of the industry until 1981. It would be the first Bank Group operation which attempts to meet the comprehensively planned infrastructure needs of virtually the entire tourism sector of a country. 20. A fifth loan to SNI and a second power project are under prepara- tion for presentation to the Executive Directors for the next fiscal year. Projects in agriculture (livestock, agriculture credit and rural development in rainfed and irrigated areas) together with an urban sewerage project and a second tourism project for infrastructure and training are expected to be prepared during Fiscal Year 1973 for consideration by the Executive Directors in Fiscal Year 1974. At the request of the Government, Bank consultants are presently assisting the Ministry of Agriculture of Tunisia in reviewing the situation of small and medium size farmers and assessing their demand for credit. The outcome of this study, to be completed by the end of July, is likely to be discussed at the next meeting of the Consultative Group sched- uled for next November. The Consultative Group will also review the progress made towards promoting export-oriented industries since the discussions held on this subject at their last October 1971 meeting. The studies carried out by consulting firms to finalize the Water Master Plan for Northern Tunisia under the supervision of the Bank will also be reviewed at the forthcoming session of the Consultative Group. No IUC investments are at present in an advanced stage of preparation. PART III - THE SECTOR 21. International tourism in Tunisia started from a low level in the early 1960s and expanded vigorously since. Foreign exchange receipts climbed from $3 mlllion in 1961 to an estimated $110 million last year. This cor- responds to about 22 percent of total current foreign exchange earnings and has made tourism Tunisia's most important source of foreign exchange. With  - 6 - growing personal income in western European countries, tourism demand is expected to expand further in the years to come. Tunisia has a good chance of winning a substantial part of the increasing tourism traffic if sufficient hotel capacity can be provided. About 1.5 million foreign visitors are ex- pected by 1980, up from 600,000 in 1971. This is the official projection on which planning of infrastructure and hotel capacity is based. 22. Several factors account for Tunisia's booming tourism development. For tourists from Europe's more affluent population centers it is the closest African country, reached in one hour's flight from Rome, two from Paris and Frankfurt, and three from London. It has fine beaches, numerous Arab, Roman and Phoenician historical sites, and offers a pleasant climate throughout most of the year. 23. Tunisia's principal tourism market is Western Europe which in 1970 accounted for 80 percent of total arrivals; 94 percent of European visitors arrived by air. Car ferry connnections to Europe exist between Tunis, Marseille, Genova and Sicily. However, because of distance and high cost of boat travel, motorized tourism from Europe is not expected to increase substantially above its present marginal share. 24. Its location puts Tunisia at some disadvantage compared with its main European competitors (Spain, Italy and Yugoslavia). Yet, higher cost of air travel provides for some selection; generally, tourists visiting Tunisia come from somewhat higher income groups and travel on fairly comfortable budgets, spending about $17 per day on the average. Generally, the Tunisian hotel industry caters to the more demanding tourist; holiday villages and youth hostels represent a small fraction of accommodations offered; and camp- ing grounds are still unknown. 25. Domestic tourism has not kept pace with the steep increase in the number of international vacationers, but still has grown, in number of bed- nights, by 40 percent over the last five years. 26. Accommodation has expanded with growing demand, from 4,000 hotel beds in 1961 to 46,000 in 1971. During the summer months, occupancy climbs above 80 percent. As in other Mediterranean countries, demand during the winter months is still lacking, bringing annual average occupancy to 38 per- cent in 1971. By offering attractive package tours for extended winter vacations, particularly for retired people, Tunisia may find a further prom- ising market. 27. The industry's rapid development has not only aided Tunisia's for- eign exchange position; it has had measurable side-effects on employment: 13,000 persons (i.e. 1 percent of the total labor force) are employed in hotels, and a still higher share in ancillary activities such as travel serv- ices, transportation, construction, and the supply of goods and other services to the tourist. For the handicraft industry, international tourism opens an export outlet, which because of noncompetitive prices, it would not otherwise find. Finally, tourism provides economic activity for regions, such as Tunisia's South, which have few other resources to support their development.  -7- The Government's Role 28. The Government intervened directly in the sector in the early years of tourism development; a government-owned hotel company was among the first hotel ventures but because of its modest success the Government subsequently left a growing share to private interests, and now refrains entirely from direct investment in hotels. Instead it promotes private hotel development through an incentive program, which is designed to attract foreign and domestic hotel investors. The Government's agent for these op- erations is the National Tourism Office (ONTT), a dynamically led, semi- autonomous agency, which took over its functions from the former Tourism Ministry some eighteen months ago. PART IV - THE PROJECT 29. An appraisal report entitled "Appraisal of the Tourism Infrastruc- ture ProJect Tunisia" (No. PT-5a) dated May 30, 1972, is being circulated separately to the Executive Directors. A Loan/Credit and Project Summary is attached as Annex III. 30. To date, tourism facilities developed without a clear plan. Land was amply available, and any investment was welcome. The Government pro- vided infrastructure, like roads, electricity, telephone and water although not on the scale required. The limits of this laissez-faire approach are becoming evident. Land for further development is becoming scarce, and pollution a problem. Only planned development can lead to better use of the remaining beaches. Public sewerage services will have to be provided if pollution of beach areas caused by hotels and nearby urban areas is not to restrain tourism growth. The Government early realized these needs, partly by learning from experience made by other Mediterranean countries that un- planned development can lead to an early exhaustion of their tourism re- sources. In 1968, it embarked on a sector-wide planning exercise. Starting from an investigation of market prospects, the Italian consultant bureau ITALCONSULT studied Tunisia's physical development potential for tourism and worked out a comprehensive framework for an integrated sector plan which covers investment needs until 1985. 31. The present project is largely based on this study and aims at implementing the first phase of an infrastructure program proposed in this study. The Government has selected six coastal zones covering a total of 36,500 hectares for this program. From North to South these zones are (see map): Tunis-North (2,575 hectares), Tunis-South (4,750 hectares), Hammamet including Nabeul (8,000 hectares), Sousse (4,475 hectares), Djerba (9,600 hectares), and Zarzis (7,100 hectares). Already today, these zones contain more than half of Tunisiats hotel capacity. In the absence of master plans and zoning regulations, hotels in these zones to date were built in a haphazard fashion, mostly along the coastline. They are generally self- contained and offer their patrons all necessary services including night-  - 8 - clubs, bars and shopping-bazaars on the site. As a result of this ribbon- like development, beaches are "under-utilized" and hotel guests are isolated from towns and villages. 32. The proposed project was appraised in November and December 1971. Negotiations were held in Washington in April and May 1972. The Borrower was represented by Mr. Ridha Azzabi, Director General of the National Tourism Office (ONTT). A delegation of KfW, headed by Mr. Hopfen, Director of the Africa Department, attended part of the negotiations. Project Organization 33. The National Tourism Office -- ONTT -- (see para. 28 above) which has been responsible for project preparation, will be in charge of the project's overall planning, financing and supervision. Technical execution would rest with five public agencies and corporations traditionally in charge of the infrastructure works included in the project. This would be the Ministry of Agriculture for sewerage works, the Ministry of Public Works for road construction, the national water supply company, SONEDE, for water works, the public power company, STEG, for power distribution, and the Ministry of Post and Telecommunications for telecommunications installations. A central project unit ("Direction des Travaux") would be set up in ONTT. One of its first functions will be to formulate by using a "critical path method" (CPM), a coordinated plan and schedule for the execution of the var- ious studies and ensuing project works. A preliminary version, covering the immediate steps to be undertaken, will be prepared before effectiveness. Cooperation between ONTT and the five agencies and corporations will be assured through a standing committee, in which all agencies will be repre- sented and which will be chaired by ONTT's director-general. Procedures for ONTT's cooperation with these agencies and corporations have been agreed upon in five protocols. Two special units will be created in the Ministries of Agriculture and Public Works to oversee execution of sewerage works and road construction. All units will be staffed with the assistance of con- sultants. ONTT will budget all project expenditure, award and sign con- tracts upon advice from the technical agencies and corporations, and reim- burse them for work done on force account. 34. The five agencies and corporations would operate and maintain the project installations, with the exception of sewerage installations which SONEDE would take over from the Ministry of Agriculture upon their comple- tion in order to operate and maintain them. Major Project Components 35. The project includes three major components: (i) preparation of master plans; (ii) infrastructure works; (iii) project operations and studies.  -9- (i) Preparation of Master Plans 36. Detailed master plans will be prepared as part of the project, in order to assure the integrated planning of the six zones (hereinafter referred to as "project zones"). They will be comprehensive and are to include exist- ing communities. Hotels and tourism facilities will be grouped in clusters to make more economic use of the seafront and to preserve the landscape and architectural character of each region. ITALCONSULT and SCET-Cooperation have been retained to work out the master plans for the project zones within eighteen months after loan signature. These plans will be based on the plan- ning exercise completed by ITALCONSULT in 1971. The Government has prepared legislation which will enable enforcement of these plans. These planning services are estimated to cost about $1.9 million, including price contin- gencies. (ii) Infrastructure Works 37. The project provides for infrastructure which would allow for hotel construction in the project zones providing about 43,000 additional beds by 1981, but would also meet the needs of existing hotels for which in- frastructure, particularly sewerage, is insufficient or lacking. In order of importance the project includes sewerage works, roads, water supply, electricity and telecommunications. Together with land acquisition and contingencies, these components have an estimated total cost of about $46.6 million. This amount would cover all major infrastructure works such as sewerage treatment and disposal facilities, main collectors and pumping stations, main water supply lines and reservoirs, as well as trunk roads. Major works will provide enough capacity to meet demand through 1981, except for water supply works in Djerba and Zarzis where known groundwater resources will support hotel expansion only through 1979. To supply hotels constructed after that date it will be necessary to resort to desalination or to mining of water, and exploration of these possiblities will be financed under the project. The major works should be completed in four years, by the end of 1976. Up to that year the project would also cover "minor works", that is in particular all hotel connections for sewerage, roads, water supply, elec- tricity and telecommunications. (iii) Project Operations and Studies 38. The project will cover the personnel and equipment expenditure of the project unit in ONTT and of the two special units in the Ministries of Agriculture and of Public Works, as well as the cost of consultants' assis- tance to these units. It would include the cost of detailed engineering of civil works in sewerage, roads and water supply, as well as construction and operation of a pilot stabilization pond in the Sousse area. This pond would enable the Government to decide on the most appropriate choice of sewage treatment for that area. In addition, the project provides for a feasibility study on improved sewage treatment in the Greater Tunis Area, where inadequate sewerage represents a growing health hazard for the local  - 10 - population. This study would provide the basis for an urban sewerage proj- ect which the Bank may eventually finance. Also related to the project's sewerage component would be a training program for specialists who will operate the sewage treatment and disposal facilities included in the proj- ect. The costs of this program are also part of the project. 39. Existing hotel training schools are not sufficient to meet the personnel requirements of the growing tourism sector, and the project pro- vides funds to meet the cost of studying the need for expanded facilities. It further provides funds for investment promotion, aimed at attracting local and foreign investment into the Tunisian hotel sector. 40. For project operations and studies, as mentioned in paras. 38 and 39, the project includes an amount of about $6.5 million. 41. Following is a summary of project cost including contingencies (in US$ million): Local Foreign Total (i) Preparation of master plans 0.2 1.7 1.9 (ii) Infrastructure works Sewerage (6.1) (8.4) (14.5) Roads (6.6) (6.4) (13.0) Water supply (3.4) (4.2) (7.6) Electricity (3.9) (3.4) (7.3) Telecommunications (1.1) (2.1) (3.2) Land acquisition (1.0) _ (1.0) 22.1 24.5 46.6 (iii) Project operations and studies 1.9 4.6 6.5 24.2 30.8 55.0 These cost estimates include taxes and import duties. The foreign exchange component of the project would be about 56 percent. Particular Project Features 42. An important aspect of the project is its organization, as des- cribed in paragraph 33. Instead of adding a new organization to existing ones for project execution the project will rely on the present setup which will be reinforced by qualified Tunisian or expatriate experts. The notion of a task force including different and independent agencies formed to carry out a particular project is new to Tunisia, and represents a promising attempt at modernizing its rigid administrative structures. 43. An interesting solution has been suggested for the control of land transactions. The Government is well aware of the need to hold down land prices if, in the longer run, it wants to attract investors into the project  - 11 - zones. At the same time, it intends to prevent land speculation and wind- fall gains for reasons of social justice. All this would be achieved through legislative and organizational measures. The project zones would be declared tourism development areas. Under proposed legislation (whose enactment by Parliament will be a condition for loan and credit effectiveness) the Gov- ernment would have the power to control land transfer, and to expropriate land in these areas in the interest of assuring sound tourism development. For this purpose a public land corporation (Agence Fonciere) is being created (its creation is likewise a condition for loan and credit effective- ness) which in close cooperation with ONTT will buy up or expropriate land required for tourism installations, and sell it to investors. The investor would be required to use the land for the purposes set by ONTT. Any use for other purposes would lead to forfeiture of ownership. The corporation will have an initial capital of D 1 million (about $2.1 million). This fund would revolve and replenish itself as land is sold to investors. 44. The success of the project will depend largely on the pace at which investment in superstructure, that is mainly hotels, follows the implementa- tion of the infrastructure program. With the favorable market prospects for Tunisia's tourism industry, it should not be difficult to mobilize sufficient funds for hotel construction. An estimated $220 million would be required for the construction of 43,000 additional hotel beds in the project zones over an eight year period from 1973 through 1980. In the light of past Tunisian experience, about 60 percent of this amount or $132 million would be in the form of loans and the balance in equity. An amount of $16 million in loan funds would thus be necessary per year. This amount could be provided by Tunisia's two long-term lending institutions, SNI and COFITOUR. Equity would be provided by Tunisian and foreign investors, and COFITOUR and its shareholders, among them well-known international tourism interests and IFC, would play an important role in attracting such foreign investment. To in- duce more domestic and foreign capital to invest in hotels, the Government intends to launch a promotional campaign for which $310,000 will be available under the project (see para. 39 above). Furthermore, under a covenant of the loan agreement, the Government undertakes to make its best efforts to ensure that adequate funds are available to potential investors. 45. Furthermore, the Government intends to concentrate its future investment promotion in the six project zones, and give special encouragement to tourism promoters in these zones. At present, the Government provides throughout the country minor infrastructure works for new hotels, allows duty free import of required materials, exempts new hotels for five years from profits tax, and grants a three percent interest bonus on all domestic loans for hotel construction. The level of these incentives is probably not out of line when compared to that of other Mediterranean countries with which Tunisia competes for tourists from western Europe. However, the existing system has serious shortcomings: procedures are cumbersome, pay- ments are often made after long delays, and all investment is treated equally, irrespective of economic priority. Under a covenant of the proj- ect agreement, ONTT will review, within eighteeen months, this system and  - 12 - recommend more selective measures of promoting investment, which then would provide more favorable incentives to project zones. Tunisia will review the study carried out by ONTT and determine, in agreement with the Bank and the Association, any amendment to be made to the existing incentive system. Co-Financing Arrangements 46. The Bank loan of US$14 million and the IDA credit of US$10 million would cover about 43.6 percent of total cost. German bilateral aid for the project through a loan by Kreditanstalt fUr Wiederaufbau (KfW) of up to DM 40 million (about US$12.4 million equivalent) would provide 22.6 per- cent of total cost. This loan would probably be for 30 years, including 10 years of grace at 2 percent annual interest. Civil works and equipment in the two southern zones, Djerba and Zarzis, would be primarily financed from German funds, while Bank/IDA funds would be used for financing equip- ment and civil works in the four other zones. All other cost would be met jointly. Substantial German aid funds have previously been invested in Djerba and Zarzis in roads, water supply and in the Djerba International Airport, and the German funds provided under the present project would com- plement these previous investments. -47. Under the financing arrangements with KfW, uniform project ad- ministration would be assured. The Bank/IDA would primarily be in charge of procurement supervision. However, disbursements would be separate for civil works and equipment for the Djerba and Zarzia zones and the other four project zones. Parallel disbursements are foreseen for all ex- penditure on consultants' services, and administration. Both institutions would later, subject to consultation, allow the use of savings made in Djerba/Zarzis for other zones and vice versa. Since this arrangement would only effect disbursement procedures, it should not put an unreasonable ad- ministrative burden on ONTT or jeopardize the project's organization. Procurement 48. Civil works other than minor works and equipment contracts, includ- ing those to be financed by KfW, would be internationally tendered on the basis of the Bank and IDA guidelines. On equipment, local suppliers would \ enjoy a 15 percent preference on the c.i.f. price of competing imports, or of the level of import duty whichever is lower. Under its association agree- ment with the EEC, Tunisia has preferential tariff arrangements in favor of EEC countries. However, bids for equipment for the project will not be in- ! tited for some six months and their evaluation will then confonm to whatever ; policy the Bank has on this subject at that time. Local Cost Financing 49. The Bank, IDA and KfW would together finance some US$5.6 million local cost amounting to 23 percent of total local cost (US$3.7 million by Bank/IDA and US$1.9 million by KfW). This amount of local cost financing from external funds is justified for the reasons given in para. 12 above.  - 13 - Economic Analysis 50. The project would generate substantial new revenue for Tunisia's tourism industry. When comparing expected revenues to expected cost which, together with the cost of the project, would include the expenditure on later hotel construction, net benefits would represent an internal economic return of 16.3 percent. This would assume an average life time of 25 years for infrastructure investments under the project. This rate of return, when tested for its sensitivity, did not fall below 12.8 percent. 51. The project would have considerable impact on Tunisia's balance of payments. Incremental annual foreign exchange earnings are expected to amount to $14 million in 1975, and to rise gradually to $97 million per year by 1984. This compares with the estimated total foreign exchange out- lays on the project and the necessary superstructure of about $100 million. The project will also have a notable effect on employment and will almost double the number of those presently employed in the industry (about 13,000). One-half of new jobs will be for unskilled personnel. Furthermore, the proj- ect will indirectly generate employment in other sectors. Finally, the pro- posed project will have a regional impact. With the exception of the tourist zones of Tunis North and South, which account for only 15 percent of the in- vestments, the project is concentrated in semi-urban and rural areas where unemployment and underemployment are high. 52. The project will be self-liquidating to the extent that water, power and telecommunications charges will cover depreciation, operation and maintenance costs and would allow for a return on investment. Sewerage charges are expected to cover only operation, maintenance and depreciation. Charges and tax revenues from incremental tourism expenditures, such as those deriving particularly from sales and income taxes, and import duties on goods and services sold to foreign and domestic tourists, are expected to provide a return of at least 22 percent on the total investment cost. PART V - LEGAL INSTRUMENTS AND AUTHORITY 53. The draft (a) Loan Agreement and Development Credit Agreement between the Republic of Tunisia and the Bank and the Association, respec- tively; (b) Project Agreement between the Bank, the Association and Office National du Tourisme et du Thermalisme (ONTT); and (c) Project Agreement between the Bank, the Association and SocietE Nationale d'Exploitation et de Distribution des Eaux (SONEDE); the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement of the Bank and the Recommendation of the Committee provided for in Article V, Section 1(d) of the Articles of Agreement of the Association, and the text of the resolutions approving the proposed loan and credit are being dis- tributed to the Executive Directors separately.  - 14 - 54. The draft Loan Agreement, Development Credit Agreement and Proj- ect Agreements conform substantially to the pattern of agreement used for this type of project. 55. The effectiveness of the Loan, Development Credit and Project Agreement, and of the KfW Loan and Project Agreement are conditional on each other. Additional conditions of effectiveneas include inter alia: (a) the enactment of the legislation referred to in paragraph 43 of this Report and of the regulations defining the functions of SONEDE under the Project, and (b) the establishment of a standing committee referred to in paragraph 33 of this Report. 56. Additional events of default would give the Bank and the Associa- tion the right to suspend or premature the Loan and the Credit if certain events occurred, including the suspension, termination or acceleration of the KfW Loan or if the legislation defining the status of ONTT, SONEDE and STEC and the legislation and regulatory measures referred to in paragraph 43 of this Report, and the Protocols regulating the relations among ONTT and the several entities concerned with the Project were amended, suspended, abrogated or terminated without the prior approval of the Bank and the Association. 57. I am satisfied that the proposed loan and development credit would comply with the Articles of Agreement of the Bank and the Association. PART VI - RECOMMENDATION 58. I recommend that the Executive Directors approve the proposed loan and credit. Robert S. McNamara President Attachments Washington, D.C. May 31 , 1972  ANNEX I Page 1 of 2 THE STATUS OF BANK GROUP OPERATIONS IN TUNISIA A. STATEMENT OF BANK LOANS AND IDA CREDITS (as at April 30, 1972) Loan or Amount in US$ millionm Credit (less cancellations) Number Year Borrower Purpose Bank IDA Undis. 29 1962 Republic of Tunisia Education 4.9 - 380 196bi Republic of Tunisia Pbrt Development 7.0 - 449 1966 Scciete Nationale Development d'Investissement Finance Co. 4.7 94 1966 Republic of Tunisia Eoucation 11.9 2.1 484 1967 Republic of Tunisia Cooperative Farms 6.1 0.9 99 1967 Republic of Tunisia Cooperative Farms 3.1 0.5 512 1967 Societ6 Nationale Development d tInvestissement Finance Co. 10.0 0.7 573 1968 Office des Fbrts Port Development Nationaux Tunisiens 8.5 3.2 581 1969 SONEDE Water Supply 15.0 lo.8 606 1969 SNCFT Railways 8.5 8.3 150 1969 Republic of Tunisia Railways 8.5 3.4 S2 19069 Republic of Tunisia Highway Engineering 648 1969 Societe Nationale Development d'Investissement Finance Co. 10.0 3.9 209 1970 Republic of Tunisia Water Supply 10.5 10.5 724 1971 STEG Gas PiTeline 7.5 2.3 238 1971 Republic of Tunisia Population h4.8 4.'3 46 1971 Republic of Tunisia Highway 2h.0 23.0 779 1971 Banque Nationale de Agricultural Tunisie Credit 5.0 5.o 263 1971 Republic of Tunisia Agricultural Credit 3.0 2.9 270 1971 Republic of Tunisia Fisheries 2.0 2.0 798 1972 Societ6 Nationale Development d'Investissement Finance Co. 10.0 10.0 815 1972 STEG Power 12.0*_ 12.0 Dotal (less cancellations) 123.3 48. , of which has been repaid _ h7 122'.6 Total now outstanding Amount sole 2.2 of which has been repaid .9 1. _ Total now held by Dank and IDA 122.3 Total undisbursed 30.1 26.2 106.3 -*Not yet effective  ANNEX T Page 2 of 2 B. STATEMENT OF IFC INVESTMEThS IN TUNISIA (as at April 30, 1972) Amount in US milllion Year Obligor TYpe of Business Loan EquitY Total 1962 NPK Engrais Fertilizer 2.0 1.5 365 1966 Soci6t6 Nationale d'Investisse- Development ment (SNI) Finance Co. .6 . 1969 COFITOUR (Tourism) Development Finance Co. E.0 2.0 10.0 1970 Soci4t6 Nationale d'Investisse- Development ment (SNI) Finance Co. .6 .6 Total gross commitments 10.0 4.7 1!t7 Less cancellations, terminations, repyaments and sales 3,0 Total commitments now held by IFC 7