Philippines - Fourth Development Corporation Project

Report No. 514a-PH FILE COPY Appraisal of the Private Development Corporation of the Philippines October 14, 1974 EAP Projects Department Not for Public Use Document of the International Bank for Reconstruction and Development International Development Association This report was prepared for official use only by the Bank Group. It may not be published, quoted or cited without Bank Group authorization.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.  CURRENCY EQUIVALENTS US$1 = R 6.72 p 1 = US$0.149 P 1 million US$148,800 P 1 billion US$149 million ABBREVIATIONS ADB - Asian Development Bank BOI - Board of Investments CB - Central Bank CBCI - Central Bank Certificate of Indebtedness DAP - Development Academy of the Philippines DBP - Development Bank of the Philippines DFC - Development Finance Company DFI - Development Finance Institute (PDCP's Training Arm) IFC - International Finance Corporation NEDA - National Economic Development Authority PDB - Private Development Bank PDCP - Private Development Corporation of the Philippines PICA - Private Investment Corporation of Asia PNB - Philippine National Bank FISCAL YEAR January 1 - December 31  PHILIPPINES APPRA SAL OF THE PRIVATE DEVELOPMENT CORPORATION OF THE PHILIPPINES TABLE OF CONTENTS Page No. BASIC DATA SUMMARY AND RECOMMENDATIONS ..... ...................... i-iv I. INTRODUCTION .......................................... 1 II. THE ECONOMY AND INDUSTRIAL SECTOR ..................... 2 Recent Economic Developments .............. 2 Industrial Investment ............................ 2 Recent Financial Developments ..2 Interest Rates ................. 3 III. PDCP'S DEVELOPMENTAL ROLE ............................. 4 Overall Operations ............................... 4 Diversification of Clientele .............. 4 Regional Dispersal of Investment ............. 5 Economic Impact of PDCP-Financed Projects ........ 5 Small-Scale Lending .............................. 6 Industrial Estate Development .................... 7 Participation in Private Development Banks ....... 7 Other Developmental Activities .... ............... 7 Training ......................................... 8 IV. PDCP - INSTITUTIONAL ASPECTS .......................... 8 Ownership and Share Capital ................ 8 Board of Directors ...... ......................... 9 Organization, Management and Staff ............... 9 Operating Policies ............. .. ................ 10 Project Evaluation and Follow-up ................ . 10 Procurement and Disbursement Practices ......... .. 11 This report was prepared following a field appraisal of PDCP by Messrs. T.N. Dinh and P. Mlistry in May 1974.  -2- Page No. Lending Operations ........ . ....................... 12 Capital Market Operations ........... ............. 12 Guarantee Operations .. ........................... 13 Money Market Operations ...... ..................... 13 Financial Position .................... .......... . 13 Financial Performance ............... o ............ 14 Portfolio Quality and Arrears ... ................ 15 Share Prices and Returns ............ ............. 15 Audit ............................................ 15 Business Prospects and Projections .............. 15 Peso Resource Position and Requirements .......... 16 Foreign Currency Resource Position and Requirements ......................... 17 V. THE LOAN - OBJECTIVES AND PRINCIPAL FEATURES .... ...... 17 Purposes of the Loan .............. ............... 17 Objectives ....o .................................. 18 Justification ................. ................... 18 Form of Bank Lending .............. ............... 18 Utilization and Withdrawal of Proceeds ........... 19 Foreign Exchange Risk ............................ 19 Amortization Schedule ........................... 19 Free Limit .................................. 19 Ceilings on the Size of Sub-Loans ............... 19 Relending Rate .................................. 19 VI. RECOMMENDATIONS AND AGREEMENTS REACHED .20 ANNEXES 1. The Philippine Economy and Industrial Sector 2. Summary of PDCP's Operations 1963 - March 31, 1974 Table 1 Summary of Loan Operations Table 2 Summary of Underwriting and Equity Operations Table 3 Summary of Guarantee Operations 3. Table of Repeat Loans Made by PDCP as of March 31, 1974 4. Economic Impact of PDCP Financed Projects 5. PDCP's Small Business Loan Program - Loans Approved and in the Pipeline as of May 15, 1974 6. PDCP's Major Stockholders as of March 31, 1974  - 3 - 7. PDCP's Board of Directors (elected March 1974) 8. Statement of General Business Policies 9. Comparative Data on PDCP Operations Between 1963 - March 31, 1974 Table 1 Comparative Statement of Loans Approved Table 2 Comparative Statement of Loan Sizes, Guarantees and Equity Investments 10. List of Underwritings/Private Placements Handled by PDCP Between 1963 and March 31, 1974 11. PDCP - List of Syndication Arrangements 1963 - March 31, 1974 12. Financial Position and Performance Table 1 Balance Sheets for FY70-73 (audited) and for March 31, 1974 (unaudited) Table 2 Income Statements for FY70-73 (audited) and for March 31, 1974 (unaudited) Table 3 Indicators of Financial Position and Performance for 1970 - March 31, 1974 13. PDCP - Accounts in Arrears as of March 31, 1974 14. PDCP - Pipeline of Projects for 1974-76 15. PDCP - Projection of Operations and Financial Performance FY74-78 Table 1 Projection of Operations Table 2 Projected Statement of Income and Expenses Table 3 Projected Cash Flow Table 4.1 Projected Balance Sheets: Assets Table 4.2 Projected Balance Sheets: Liabilities Table 5 Projected Financial Ratios Table 6 Projected Foreign Exchange Requirements 16. PDCP - Resource Position as of April 30, 1974 17. Estimated Schedule of Disbursements for Proposed Loan Chart 8903. PDCP's Organization as of May 16, 1974 Map. IBRD 10217   PHILIPPINES PRIVATE DEVELOPMffiT CORPORATION OF THE PHILIPPINES BASIC DATA (As of March 31, 1974) Subscribed Capital Shareholders (In Thousand Pesos) Per Cent 1. Ownership as of March 31, 1974 Class "Al Shareholders (Filipino) Privatz Institutions 188 23,894 59.4 Individuals 792 J4,281 1o.6 Sub-total 980 28,17 70.0 Class IB" Sharsholders (any person or entity) Filipino 58 190 .5 Non-Filipino 514 18 29.5 Sub-total 112 12075 0.0 Grand Total 2 400250 0.0 2. Operations March 31 Operations Approved 1971 1972 1973 1974 Total Local currency loans (POOO) 79,393 15,695 24,533 14,131 133,752 Local currency equity investments (pooo) 18,717 872 3,625 830 24,044 Foreign currency loans/debt securities (P000 equivalent) 339,970 71.689 83145 914 255 588,959 Total (P000) 4080 8 20 109216 746,75 3. Status of Loans (Cumulative as of March 31, 1974) Domestic Currecy Foreign Currency Approved 133,752 107,360 Coimitted 121,697 88,675 Disbursed 98,010 78,883 Repaid 42,735 23,096 Outstanding 61,260 62,406 March 31, 4. Earnings Record (Percentage) 1969 1970 971 1972 1973 1974 Earnings before provisions and tax to average total assets 5.1 4.2 4.3 4.7 3.7 3.4 Net profit to average equity 15.7 17.2 17.9 17.9 17.7 18.4 Cash dividend rate 10.0 10.0 10.0 10.0 13.0 14.0 Stock dividend rate - 10.0 - 15.0 - - Dividend payout, % of net profit 42.0 38.0 37.0 34.0 41.1 39.9 5. Financial Position (as of MNrch 31. 1974) Current ratio 2.19t 1 Total debt/equity ratio 7.1 s 1 Conventional debt to equity plus subordinated debt (limited to 6.5: 1 under the existing Bank Loan Agreement) 5.372 1 Reserves and provisions as % of loan and investment portfolio 6.o Liquid Assets/Total Assets (limited to minimum 4% under IFC Loan Agreement) 19.3%  Page 2 BASIC DATA 6. Interest Rates and Charges (ae of August 31, 1973) Interest rate on peso loans 12% p.a. plus 1% p.a. service fee on outstanding balance of new peso loans IntereSt rate on foreign currency loans (a) IERD first to third credit lines 11% p.&. (b) AEB first line and old loans from second line 11% p.a. (c) AIT second line (new loans) 11-3/4% p.a. (d) IFC loan Dollar portion 11-3/4% p.a. Swiss franc portion 10-3/14% p.a. Comnitment chargea 1-3/4% p.a. on undisbursed amount Underwriting coneission 4% - 5% of face value Guarantee fee (a) 1% p.a. one-time commission on face value of guarantee (b) 1% p.a. on unutilized amount (c) 1-1/2% on outstanding amount Syndication foe 1%-3% of syndicated amount 7. Penalty Charges (for long-term projects) 1/2% per month or a fraction thereof on unpaid installments Status of Loans as of March 31, 1974 8. IBRD Loans In Thousand Dollars Loan No. Dat. Signed Rate of Interest Amount Authorized Disbursed Outstanding2/ 331-PH February 15, 1963 Variable 15,000 L4,842 14,842 3,356 467-PH September 23,1966 Variable 25,000 24,864 24,572 14,895 630-PH July 10, 1969 6- 1/2% 25,000 23,672 23,672 20,500 9. Operational Performaone I In Thousand PeSON~ (a) Loans 1963-71 1972 1973 1724 Total Approvald/ Domestic Currency 79,393 15,695 24,533 14,131 133,752 Foreign Currency 338,050 71689 83.46 94255 587o4 Total 417,443 87.384 107.579 108,386 720,792 Comitmenta- Domestic Currency 75,588 14,800 20,084 11,225 121,697 Foreign Currency 296,731 59.703 100,442 37,296 498,172 Total 372,319 74,503 120,526 48,521 619,869 Disbursements Domestic Currency 65,216 14,115 13,852 4,827 98,010 Foreign Currency 2603 86.203 65,382 19,068 431,042 Total 325,605 100,318 7234 23.895 529.052 1/ Including Marinduque Mining convertible debenture bonds of $1 nillion and accounts in arrears due PDCP; amount per books before adjustment to prevailing exchange rates of foreign currencies other than U.S. dollars. 2/ Exchange Rate Applied: US$1 - P3.92 until 1969; US$1 - P6.435 until 1971; US$1 - P6.781 for 1972; US$1 - P6.73 for 1973; US$1 - K6.72 for 1974. 3/ Net of withdrawals and excluding Marinduque Mining convertible debenture bonds of $1 million. Excluding projects with signed loan agreements but not yet credited by AM. RAP Projects Department July 16, 1974  PHILIPPINES APPRAISAL OF THE PRIVATE DEVELOPMENT CORPORATION OF THE PHILIPPINES SUMMARY AND RECOMMENDATIONS i. The Private Development Corporation of the Philippines (PDCP), established with Bank Group assistance in 1963, has made a request for a fourth loan from the Bank. Three previous loans from the Bank (amounting to $65 million) have been fully disbursed and a further loan of $15 million syndicated by IFC has been fully committed. PDCP's volume of foreign currency lending has increased dramatically over the past twelve months, because of both a much higher level of real industrial investment in the Philippines and increases of between 30-50% in the cost of imported capital goods. At current rates of approval, PDCP's present foreign currency resources are expected to be fully committed by December 1974. Consequently it is in urgent need of foreign currency funds to support its project pipeline. Under present conditions, PDCP has found it impossible to raise these funds commercially, either directly or through a syndicated arrangement with IFC at a rate which would allow it to relend with a positive spread. With these considerations in view, and on the basis of a field appraisal conducted in May 1974 a Bank loan of $30 million to PDCP is recommended. ii. The Philippine economy, which experienced a real growth rate of about 5% during the 1960's and early 70's, is expected to grow at a faster rate of 7-8% in 1974 and over the next few years, after an exceptionally good year in 1973 when the real growth rate was 10%. Since mid-1973 inflation has emerged as a major problem, with consumer prices rising at an annual rate of almost 40%, owing in part to food shortages in 1973. This has inevitably led to a dilemma in monetary management given the need to curb the excess liquidity fuelling inflation and the need to expand credit to allow for a sustained high rate of investment. Uncertainty about future economic prospects notwithstanding, industrial investment continues to increase, especially in export-oriented manufacturing. iii. As PDCP is an important institutional source of long-term industrial finance in the Philippines, the Government's investment drive has had a quantitative impact on its operations. Qualitatively PDCP's operations continue to reflect its development orientation as it maintains its efforts to assist projects which: balance the industrial structure (for instance its heavy investment in intermediate and capital goods industries); maximize the utilization of domestic raw materials; result in a greater diversification of its clientele; and contribute to the regional dispersal of investment. In terms of some common indices of economic impact, PDCP-financed projects have: generated sales of about P 3.4 billion annually with a value-added component of P 1.2 billion; resulted in an estimated net saving or earning of  - il - foreign exchange of about US$278 million annually; and contributed to the creation of over 30,500 jobs at an average cost of about US$12,750 per job. Based on estimates made at the time of appraisal, PDCP-approved sub-projects in 1973 and the first quarter of 1974 have economic rates of return ranging from 22% to over 100%. More recently, PDCP has also focused its attention on assistance to small-scale entrepreneurs. It now has a special financing program for such clients which is about to be further extended and liberalized; it is actively promoting the development of industrial estates for small-scale industries; and it is about to invest in small private development banks which are geared primarily to meeting the financial needs of local communi- ties. To reach small borrowers in the provinces, PDCP is establishing three promotional branches in Davao, Cagayan de Oro and Cebu. PDCP's Business Development Office apart from providing direct technical assistance to clients has played an extensive role in major national and regional undertakings, and its Development Finance Institute has established a well-deserved reputation as a training school for staff from other development finance companies and government agencies. iv. PDCP is a privately-owned corporation with an authorized capital stock of P 100 million, of which P 40.25 million has been paid in. Owner- ship is presently distributed among some 1,100 stockholders but, with its next planned issue of a further one million shares (par value P 10; market value P 20), PDCP hopes that this ownership base will be doubled. With an influential and active Board, PDCP continues to be one of the best managed and staffed DFCs with which the Bank Group is associated. Its operating policies and practices, established in consultation with the Bank, are sound, and its project evaluation and follow-up standards are high. v. Since its inception, EDCP has provided (in terms of approvals) financial assistance totalling P 946 million (US$140 million) to the in- dustrial, agro-industrial and transportation sectors in the Philippines, with direct lending accounting for 76.2% of this amount; underwriting and syndication operations for 13%; equity investments for 3.4%; and guarantees for the remaining 7.4%. Foreign currency loans account for over 80% of its total lending. As of March 31, 1974, PDCP had 211 loans totalling P 475.5 million outstanding in 125 companies. The average size of its loans in dollar terms was about US$520,000. As of that date PDCP had also underwrit- ten (or privately placed) twelve separate issues (stocks and bonds) for a total of P 58.7 million; syndicated a further P 72.3 million for seven clients; directly invested nearly P 29.7 million (gross) in the equity of 40 different firms; and issued 18 guarantees for a total amount of i 64.5 million. PDCP plays an active role in the well developed Philippine money market, earning a fairly high return on its undisbursed liquid funds. In 1973 the volume of PDCP's short-term transactions reached P 1.8 billion, with the profit on such transactions contributing substantially to its net income. vi. PDCP's financial position is sound and its financial performance satisfactory. Its total assets, as of March 31, 1974, stood at nearly  - iii - P 706 million (US$105 million), the rate of growth declining from 40% in 1973 to an annual rate of about 17% in the first quarter of 1974. Long- term assets account for about 63% of total assets. Total liabilities were P 628 million and PDCP's net worth was P 78 million, with retained earn- ings accounting for 44.5% of this amount. The capital structure remains sound with PDCP keeping well within contractual debt/equity limits (as agreed between PDCP and the Bank/IFC). Net income in the first quarter of 1974 was P 3.5 million, reflecting an annual increase of 11% over the P 12.7 million earned in 1973. Long-term lending operations contributed 77.7% to gross income; money market operations 19.4%; and guarantee fees and other sources 2.8%. Earnings per share in the first quarter of 1974 amounted to P 0.88 (P 3.52 on an annual basis) with book value per share rising to P 19.34. The quality of PDCP's portfolio remains high, with arrearages being kept under close control. vii. The project pipeline built up by PDCP for the next two years confirms expectations of a continued rise in the level of Philippine industrial investment. In that period PDCP expects to approve loans totalling over P 500 million (US$75 million) of which 85% (or US$63 mil- lion) will be in foreign currency. Its present resources are clearly inadequate to cope with that volume of lending and will need to be aug- mented substantially. On the domestic front PDCP has already taken steps to mobilize domestic resources through the issue of medium-term notes (P 3 million in 1974 and a further P 20 million in 1975). It also plans to augment paid-in capital with issues of shares in 1974 and 1976 which are expected to yield P 20.0 million and P 25.0 million respectively. These efforts should adequately cover peso resource requirements, esti- mated at P 62 million, for the 1975-76 period. On the foreign resources front PDCP faces a critical problem. Its commitment of available lines of credit (the IFC loan and the third ADB loan) has been much more rapid than expected and although it has recently been deliberately husbanding these re- sources it is likely to run out of foreign currency funds by December 1974. Between then and December 1976,its foreign currency approvals are estimated at about $70 million. The proposed loan would only cover about 42% of this amount. viii. Through the proposed loan the Bank will provide a small part of the foreign exchange resources needed to support export oriented manufac- turing investment, a key component of the Government's overall development strategy. It will also help maintain the mutually beneficial relationship established with PDCP which has enabled the Bank to play a useful role in shaping PDCP's lending policies and improving the quality of its operations. ix. As with the three previous loans to PDCP, the proposed loan would be coursed through the Philippine National Bank (PNB), and would finance only the direct foreign exchange costs of capital goods required for a broad range of sub-projects. A flexible amortization schedule, conforming essentially with the aggregate of the individual sub-loan amortization schedules, will be applied. Bank funds will be re-lent by PDCP at the  - iv - current statutory maximum rate of 12%. This, taking into account the 0.75% p.a. handling fee to be paid by PDCP to PNB, would give PDCP a spread of 3.25%. It has been agreed in negotiations between the Bank, the Government and PDCP that, in case PDCP is allowed to increase its relending rate above 12% p.a., PDCP's net spread woild be limited to 3.5%, with the excess spread accruing to the Government. The foreign exchange risk would be borne by sub-borrowers. The Government may offer PDCP's sub-borrowers insurance to cover, for a fee, the exchange risk between the currency of procurement and the currency of obligation. To ensure the dispersal of the proposed loan to a relatively large number of sub-projects, a ceiling of $2.5 million would be applied to each sub-loan financed under this loan. A free limit of $1.5 million is recommended. The debt/equity ratio would be maintained at the present limit of 6.5:1.  PHILIPPINES APPRAISAL OF THE PRIVATE DEVELOPMENT CORPORATION OF THE PHILIPPINES I. INTRODUCTION 1.01 The Private Development Corporation of the Philippines (PDCP) was established in 1963 with active Bank Group assistance. At that time, the International Finance Corporation (IFC) subscribed P 800,000 ($205,217 equivalent at the exchange rate then prevailing) to PDCP's initial capital stock which it subsequently sold in 1967 at a profit. Since its inception PDCP has received three Bank loans totalling US$65 million and an IFC loan of US$15 million. PDCP has also received three loans from the Asian Dev- elopment Bank (ADB) totalling US$45 million. 1.02 PDCP enters its second decade as an efficient development financing institution with a solid record of performance from both the financial and development points of view. It is now an important institution within the Philippine financial system, with innovative approaches to appraisal and evaluation work and in the conduct of lending operations. PDCP has now committed all three Bank loans, the IFC loan, and two of the loans from ADB. The third ADB loan, made in January 1974, is expected to be committed by December 1974. Over the past year PDCP's volume of operations has increased sharply, reflecting both a rise in industrial investment in the Philippines and a higher level of prices for capital goods imports. 1.03 PDCP is, at present, confronted with an imminent shortage of long- term foreign exchange resources for financing further industrial investment. Its foreign exchange resource requirements over the two-year period 1975 and 1976 are estimated to be about $70 million. It has applied to the Bank and IFC for a $40 million financial package and plans to approach the ADB and the Export-Import Bank of Japan for the remaining $30 million. Under prevailing circumstances, with commercial sources unwilling to provide long-term funds at fixed rates, it is impossible for PDCP to tap them either directly 1/ or through a syndicated arrangement with IFC. With these considerations in mind, and on the basis of the appraisal contained in this report, a Bank loan to PDCP of $30 million is recommended. 1/ PDCP is, however, preparing to float a bond issue of $10 million on foreign capital markets in 1977. If market conditions permit PDCP may bring this issue forward.  -2- II. THE ECONOMY AND INDUSTRIAL SECTOR 2.01 A summary analysis of the performance and prospects of the Philippine economy and industrial sector in 1973 was provided in a recent report distributed to the Executive Directors. 1/ Annex 1 provides an updated version. The report of the Bank's economic mission of April/May 1974 will be distributed to the Executive Directors shortly. 2.02 Recent Economic Developments. The Philippine economy recorded a remarkable 10% real growth rate in 1973, compared with an average rate of 5% during 1965-1972. This rate is expected to settle to a lower, but sustainable, level of 7-8% over the next few years. The main cause for concern on the economic front lies in the present inflation rate. Consumer prices in Manila rose by 35.8% between .Tune 1973 and June 1974, the highest price increases being posted for food (45%), utilities and fuels. Recent monetary measures taken by the Central Bank reflect a duai concern for containing inflation on the one hand and maintaining the levels of liquidity necessary for sustained growth on the other. 2.03 Industrial Investment. Despite increases of 30-50% in the cost of capital goods and some uncertainties about investment prospects following the increase in petroleum prices, there is no sign of a slowdown in industrial investment. Although no firm figures are available as yet, discussions with commercial banks and the industrial financing institu- tions suggest that some industrial investment is being accelerated. Several reasons have been advanced in support of this observation: (a) the Government's strong emphasis on increasing export earnings to offset increased import costs has spurred investment in export-oriented manufacturing; (b) indus- trialists in some instances are advancing investment plans to reduce the impact of continually escalating costs of capital equipment; and (c) an increasing amount of foreign investment, particularly Japanese, is shifting from Korea, Taiwan and Hong-Kong to the Philippines. Based on the present flow of applications and the increase in costs both PDCP and DBP have had to revise their projections for the next two years sharply upwards. 2.04 Recent Financial Developments. Two developments have taken place which have implications for the availability of short and long-term credit for industry. First, the Central Bank recently approved the use of its own Certificates of Indebtedness (CBCI's) and other government securities as acceptable assets to cover temporary reserve requirement deficiencies of commercial banks and allowed export bills of less than 31 days to serve as 1/ "Appraisal of a Loan to the Republic of the Philippines for Financing (A) Industrial Investment and (B) Smallholder Tree-Farmers through the Development Bank of the Philippines". Report No. 424a-PH dated May 5, 1974.  -3- reserves on marginal deposits for letters of credit. This means that CBCI's can now be used as open market instruments and render less effective any contractionary mDnetary measures by providing a liquidity cushion. The second development was an announcement by the Board of Investments (BOI) 1/ on May 16, 1974 suggesting guidelines for restricting the availability of domestic credit to foreign subsidiaries in an attempt to force a greater inflow of foreign capital. Under these guidelines firms registered under R.A. 5455 (the Foreign Investments Regulation Act) would be allowed access to domestic credit resources to cover their needs in amounts proportional to the percentage of local ownership in them. These would range from no domestic credit for firms with less than 10% Filipino ownership to 60% of total credit requirements for firms with between 60-70% Filipino ownership. 2/ The announcement raised an immediate reaction from both foreign firms and the financial community with the prospect being raised of substantial dislocations in project implementation schedules and an adverse impact on industrial investment. The strength of the reaction caused BOI to reconsider its decision. It has now decided to hold public hearings before taking a final decision on the matter. The final decision, whatever it is, will affect only marginally PDCP's operations, since the overwhelming bulk of PDCP's present and prospective clientele consists of companies with domestic ownership exceeding 70%. 2.05 Interest Rates. The Anti-Usury Law of 1916 limits lending rates to 12% and 14% per annum on secured and unsecured loans respectively. Effective lending rates on some commercial bank loans were however 4 to 6 points higher with add-on charges, compensatory balances and advance interest collection. In the past few years these rigid legal limits have resulted in distorting both the mobilization and allocation of capital resources and led to the growth of an unorganized "private" market. On the deposit side, with current rates of inflation of 35-40%, depositors have received a highly negative rate of interest (present deposit rates are 6-8%) and the flow of private savings to the banking system has been depressed. With these rates of inflation it is unlikely that financial institutions will be able to mobilize a significantly greater volume of domestic savings without increasing their deposit and (consequently) lend- ing rates from current levels. Up to now they have not been in a position to compete for funds with the money market (whose rates are not covered by the Law) or even with short-term Government instruments which yield between 12 and 14%. The Law has been amended recently to empower the Monetary Board of the Central Bank to raise lending rate ceilings in accord with prevailing economic conditions. The Monetary Board, however, has not yet done so. 1/ For a detailed account of the BOI's role please see Annex 1, paragraph 10. 2/ Firms with over 70% Filipino ownership would not be under any domestic credit restraints.  - 4 - III. PDCP'S DEVELOPMENTAL ROLE 3.01 Overall Operations. As of March 31, 1974 PDCP had approved loans aggregating P 720.8 million, issued guarantees for a further P 64.5 million, and invested a total of P 29.7 million in the equity of industrial concerns. PDCP's underwriting totalled P 40.8 million for equity issues and P 12.5 million for bond issues, while syndications, as of May 31, 1974, totalled US$22.9 million in foreign currency loans and P 12.3 million in local cur- rency. Tabulated details of its operations are provided in Annex 2. PDCP's portfolio is concentrated mainly in medium and relatively large-scale manu- facturing enterprises (which account for 66.3% of its loan approvals by amount and 63.1% by number) with some financing of utilities (9.2% by amount) and transportation companies (12.5% by amount). Including equity operations, manufacturing has received over 83% of PDCP's total financial assistance. Its inter-industry portfolio dispersion reflects PDCP's propensity to em- phasize investments in non-traditional industries and projects involving the introduction of new technology into the Philippines. In its operations, PDCP has adhered closely to the BOI's investment priorities. It has actively assisted the development of intermediate and capital goods industries (with 138 such investments in projects which absorbed 67.4% of PDCP's total assist- ance to the manufacturing sector) and of projects which maximize the utili- zation of domestic raw materials; (over 66% of PDCP's projects are dependent on local sources for 86% or more of their raw material requirements). 3.02 Diversification of Clientele. Sensitive to previous criticisms (which were not entirely justified) about the concentration of its portfolio in a few very large firms linked Lo members of its Board, PDCP has made a conscious effort to diversify its clientele. The evidence indicates that it has been reasonably successful in doing so. As of March 31, 1974 the largest 20 (or 11.7%) of its clients accounted for 40.8% of its loan approvals and 36.6% of loans outstanding. The above ratio of 40.8% of approvals accounted for by the largest 20 of its clients as of March 31, 1974, compared with 55.3% for March 1973 and 50.8% for June 1972, indicates that PDCP's recent financing has gone mainly to new clients. Twenty-seven (or 16%) of its clients were associated in some way with PDCP's present or previous Board members and these firms accounted for about 21% of loan approvals and 17% of loans outstanding. These distributions are not indicative of portfolio concentration nor of undue favoritism towards Board associated clients. In fact, given the overall concentration of Philippine manufacturing industry, these figures are lower than might reasonably be expected. Available data (Annex 3) on repeater loans indicate that 89 (or 52%) of PDCP's 171 clients have received at least one repeat loan. However, the total amount approved in repeat loans to existing clients is P 207.4 million or 28.8% of total approvals for new and expansion projects. These statistics suggest that PDCP's continued financial support for projects sponsored by established clients has not been at the expense of pursuing project opportunities with new clients. In expanding its loan portfolio PDCP has attempted to strike  a reasonable balance between the need for maintaining a strong financial position and meeting its obligations to its creditors and shareholders on the one hand, and for retaining the development orientation which is integral to its reputation and institutional character on the other. 3.03 Regional Dispersal of Investment. Roughly 17% of PDCP's total investments as of March 31, 1974 have been in the Metropolitan Manila area, with a further 47.3% in Central and Southern Luzon, 14.1% in the Visayas, 18.2% in Mindanao and 3.4% elsewhere. Data for year-to-year approvals do not show an aggregate shift towards investments in less dev- eloped regions although there has been a discernible shift in investment away from the Greater Manila area (1973 was an exception). In keeping with the Government's development priorities PDCP is encouraging its clients to consider locating in less developed areas whenever it can demonstrate that there would not be an adverse impact on the financial viability of their operations. It is also playing a more direct role in facilitating regional investment dispersal through: (a) the opening of promotional branches in Davao, Cagayan de Oro and Cebu; (b) the development of industrial estates for small- and medium-scale industry in Paete and Davao (paragraph 3.06); and (c) its planned participation in the equity of local private development banks (paragraph 3.07). 3.04 Economic Impact of PDCP Financed Projects. An assessment of the economic significance of PDCP's operations must, of necessity 1/, rely on partial economic indicators (Annex 4) which are illustrative of overall impact rather than investment efficiency. In aggregate terms PDCP has, as of March 31, 1974 provided financial assistance totalling P 946 million to some 282 projects whose total investment requirements were P 2.64 bil- lion. Annual incremental sales attributable to these projects have aver- aged P 3.4 billion with a value-added component of P 1.2 billion. This volume of output has resulted in the direct earning or saving of about US$390 million equivalent in foreign exchange. Taking into account aver- age annual import requirements of about US$102 million, the net positive balance of payments effect of these projects is estimated to be an average US$278 million annually. In terms of employment creation, these projects have generated about 30,500 jobs with an annual incremental payroll of about P 138 million (or roughly P 4,500 per worker). The cost of job creation has been about P 86,550 (roughly $12,750) per job, less than the average for BOI-registered projects. Over the last 10 years, PDCP's invest- ments have, on average, accounted for roughly 6% of annual domestic gross fixed capital formation in the manufacturing sector and for about 10% of the total jobs created each year in manufacturing industry. An ex ante calcula- tion of the economic rate of return (which PDCP now regularly incorporates in each of its appraisal reports) for a representative sample of projects 1/ No systematic ex-post evaluation has yet been carried out on the economic rates of return of PDCP-financed projects which are fully operational. Hence no single meaningful index can be provided. For those projects still in the gestation period, the partial indicators included in the aggregate figures above represent expectations rather than actual impact.  -6- approved in 1973 and 1974 (Annex 4) shows rates of return varying from 22% to over 100%. Financial rates of return for the same projects vary from 16% to over 60%. 3.05 Small-Scale Lending. Although primarily geared for lending to medium- and large-scale enterprises, 1/ PDCP in February 1972 launched a small business lending program aimed at financing the fixed capital require- ments of firms with paid-in capital of between P 50,000 and P 300,000. Cognizant of its manpower limitations and aware that the needs of small scale entrepreneurs are substantially different to those of its larger, more sophisticated clients and necessitate a more intensive relationship, P])CP has emphasized quality rather than quantity in its small-scale opera- tions. It has so far been fairly selective and has restricted its exposure to those projects to which it could provide major inputs, such as organizational or technical assistance, sub-contracting arrangements with larger clients etc., in addition to finance. As of April 30, 1974 PDCP had approved P 3.27 million in loans to 19 small businesses in several industries (Annex 5), and had a further 17 firm projects requiring P 3.0 million in its pipeline. On the basis of its experience and spurred by the Government's policy em- phasis on small- and medium-scale industries PDCP is contemplating major changes in the scope of its program 2/, a relaxation of debt/equity propor- tion limits (from the previous 50:50 to 70:30) and of collateral require- ments, and the financing of working capital. PDCP has also developed close working relationships with the principal technical assistance agencies in this field 3/ through which its "reach" has been extended considerably. l 3.06 Industrial Estate Development. In addition to direct financing, PDCP is also actively involved in two pilot industrial estate projects for accommodating small-scale firms and providing them with infrastructure, utilities, and technical assistance services in a centralized location. The first estate project, on which work is expected to begin within the next 4-6 months, is at Paete on Laguna Lake. Meant to cater to the craft woodcarving industry, it will involve the development of a 30-hectare site at a cost of about P 3 million. The second estate, at Davao, will cater to) small-scale entrepreneurs in the metal working industry; site negotia- tions are presently under way. PDCP's approach is to develop the master plan for these estates, supervise the civil works and construction, attract entrepreneurs to the estates, and provide administrative and technical as- sistance services. After the initial 2-3 years PDCP hopes to establish a co-operative of the estate occupants and gradually turn management over to the co-operative, withdrawing eventually to the role of consultant. If its experience with these two pilot estates proves successful PDCP plans to re- plicate the model in various other locations. 1/ Excluding small business loans, the average size of PDCP's loans is about US$520,000 in dollar terms. 2/ PDCP will adopt the Government's definition for eligibility under its program iae firms with total fixed assets between P 100,000 and P 1,000,000 (roughly US$15,000-$150,000). 3/ The Institute for Small-Scale Industries (ISSI) and the Development Academy of the Philippines (DAP).  -7- 3.07 Participation in Private Development Banks (PDBs). 1/ To improve its access to industrial opportunities in rural communities and undeveloped regions of the Philippines (particularly Mindanao) PDCP is about to make fairly sizeable equity investments in an existing PDB in Davao and in a new PDB to be established in Cagayan de Oro. Through assuming a significant share in the ownership of these institutions, PDCP hopes to exercise its organizational and managerial expertise in getting these banks to operate on sound commercial lines and to realize their full potential in playing a greater catalytic role in local community development. Eventually PDCP hopes to invest in about 10-15 PDBs strategically located throughout the Philippines 2/, thus strengthening its role in assisting small enterprises. 3.08 Other Developmental Activities. PDCP's impact as a development- oriented financial institution in the Philippines is reinforced through a host of other activities. Its Economic and Corporate Research Unit (ECOR), in addition to providing economic advisory and consulting services to PDCP's clients, publishes monthly and quarterly economic reviews which have wide circulation in the Philippine business community; it has also published 11 1/ Private Development Banks are generilly small local institutions which confine their banking functions to the immediate community. As of June 30, 1973 (the last date for which figures are available) there were 33 PDBs in the Philippines with total assets of P 216.82 million (roughly US$32.1 million). Their paid-in capital amounted to P 64 million (nearly P 2 million per PDB) and their deposits amounted to P 108.1 million. Total PDB loan investments amounted to about P 57 million dispersed among 7,000 borrowers (average loan size of P 8,100). Of this amount P 43 million was in medium- and long-term loans. Agri- cultural loans to about 4,000 borrowers accounted for just over 50% of total PDB operations, whilst small loans to rural industries accounted for 28%. Up to now PDBs have been strongly supported by the Development Bank of the Philippines (DBP) by way of equity participation (DBP holds about 36% of the total equity in PDB's), rediscounting facilities (to the tune of P 32 million outstanding as of June 30, 1973), and by maintaining savings and time deposits. Recent amendments to the "General Banking Act" (Republic Act 337) and the "Private Development Banks Act" (RA 4093) have encouraged ownership participation by larger commercial banks and non-bank financial institutions in PDBs to strengthen the managerial capability of these institutions -- an asset of which PDB's are, at present, woefully short. 2/ PDCP has also been asked by the Government to provide technical assist- ance in the establishment, organization and initial management of a national commercial bank to cater specifically to the Moslem community.  -8- comprehensive industry surveys 1/. PDCP's Business Development Office, in the course of promoting new business for PDCP, has participated in the development of major regional or national undertakings, some notable examples being the identification of project possibilities under the Mindanao Devel- opment Program; active participation in the Tourism Industry Development Program; the Maritime Industry Development Program; identification of agri- business projects in the Bicol River Basin and undertaking a feasibility study for the Mindanao Group Port Terminal. BDO is also planning to increase its feasibility study assistance to clients and to exercise its influence with its existing and new clients in guiding investment into priority indus- tries and underdeveloped regions. In the past, whenever circumstances were appropriate BDO has endeavored to bring about changes in project design, putting together or reconfiguring financial packages, and arranging sub- contracting ties between small and larger firms. 3.09 Training. In the training field, PDCP's Development Finance Institute (DFI) has established a solid record. Apart from providing PDCP's own incoming staff with an induction to the various aspects of development finance company operations, the DFI also trains staff from several government departments and agencies in project analysis and follow-up, as well as personnel from DFC's in other countries (recent trainees being from Afghanistan, Mauritius, Sierra Leone, and Indonesia). In September, 1973 the DFI in co-operation with the Asian Development Bank held a successful six-week Regional Workshop for Small and Medium Industry Project Development. Asso- ciated with its training activities are the close ties which PDCP has established with the academic community serving as a bridge between academia and the Philippine business world. PDCP is an active corporate member of the Asian Institute of Management and has close institutional links with the major business schools. It has also released one of its senior staff members on sabbatical leave to start up a broad range of programs in the Develop- ment Academy of the Philippines. Its close relationship with the Bank Group has proved PDCP to be a dedicated and capable volunteer in pioneering innovations which would improve DFC performance or efficiency (e.g, its active participation as leader of a group of Asian DFCs in developing a computer model for DFC projections and for use in project appraisal). IV. PDCP - INSTITUTIONAL ASPECTS 4.01 Ownership and Share Capital. PDCP is a privately owned company with a fairly wide dispersion of ownership. On March 31, 1974 there were 1,092 shareholders (comprising 980 Class "A" or Filipino shareholders with voting stock and 112 Class "B" non-voting stock holders). This represented a reduction of 10% (resulting from market transactions) in the total number of shareholders since March 31, 1973. Foreign (Class B) shareholdings however increased by 12% with seven new foreign shareholders. PDCP's authorized 1/ On-the: electric power; wood; ocean-shipping; ship-building; cement; flour-milling; tourism; synthetic res-ins; concrete aggregates; textiles; and iron ore mining industries.  - 9 - capital stock is now P 100 million (including an increase of P 40 million authorized in March 1974) of which P 40.25 million has been paid-in along with a P 3 million capital premium 1/. For the immediate future, PDCP plans to make a primary offering in September 1974 of a further one million shares (par value P 10) at close to the current market price (which fluctuates around P 20). With this issue PDCP hopes to broaden the ownership base by attracting over 1,000 new shareholders and allowing present small shareholders to increase their holdings. To achieve these objectives PDCP's management has submitted to its Board a memorandum suggesting alternatives for having present large stockholders (those with over 10,000 shares) waive a portion (65%) of their pre-emptive rights. A further offering of a million shares is slated for 1976. PDCP's major shareholders and their holdings are listed in Annex 6. 4.02 Board of Directors. PDCP has an active and representative Board, which takes a keen interest in its affairs. PDCP's articles provide for eleven Directors, three of whom represent foreign Class V"B shareholders. In the last year there has been one change in directors representing Class "A" shareholders 2/ along with a change in all three directors representing Class B interests. 3/ As before, the Board continues to include two in- fluential members of the Government, Messrs. J.P. Enrile, Secretary of De- fence (and Chairman of the Philippine National Bank) and G. Sicat, Director- General of the National Economic Development Authority (NEDA).. The Chairman, Mr. R.T. Villanueva, has been re-elected and continues to serve concurrently as President. The composition of the Board of Directors as of March 31, 1974 is shown in Annex 7. 4.03 Organization, Management and Staff. Although fairly significant changes have occurred in the structure of its top management team, PDCP continues to be among the best organized and most efficiently managed DFCs with which the Bank Group is associated. The almost concurrent departures in early 1974 of the Senior Vice-President, 4/ the Vice-President for 1/ PDCP's initial paid-in share capital of P 25 million was increased to 1 27.5 million in February 1970 by issue of a 10% stock dividend. A rights issue for cash was offered in March 1971 increasing PDCP's paid-in capital to P 35 million. The offering price of P 14 resulted in a capital premium to PDCP of P 3 million. A further stock dividend of 15% was declared in 1972 bringing total paid-in share capital to the current level of P 40.25 million. 2/ Mr. Benigno Toda was replaced by Mr. Henry Sy. 3/ Messrs. Cooper, Pudner and Noguchi replaced Messrs. Carroll, Sutherland and Parnell. 4/ He has left PDCP on a temporary (3-year) basis to take up a senior appointment at the Asian Development Bank.  - 10 - Finance and Economics 1/ and the Asst. Vice-President for Administration, 2/ have caused a regrouping of the functional units at PDCP (Chart No. 8903) and imposed, at least for a short period, a heavier supervisory burden on the Executive Vice-President and the newly appointed Senior Vice-President (previously Vice-President for Project Administration). At the same time these departures have precipitated the promotion of experienced and dynamic younger executives who have been well-groomed for their new responsibilities. It is to PDCP's credit (and a reflection of its emphasis on quality training and career development) that the loss of three key personnel, in what remains a fairly small and well-knit entity, has been absorbed without any interrup- tion of workflow or deterioration in work quality. In fact, in the first few months of this year PDCP has coped effectively with an unprecedentedly high volume of business. The generally high quality of PDCP's staff is evident through all levels of the organization. Unfortunately the necessarily limited scope for promotional opportunities within PDCP together with the demand in the Philippine financial community for PDCP-trained staff have resulted in a high (but stable) turnover of staff (9-10% per annum) at lower organizational levels. As of March 31, 1974, PDCP had a total of 157 staff of whom 101 were professionals. This represents an increase of 22 staff (or 16%) over the previous year, all in the professional category. PDCP's present staff, strengthened by prospective recruits, will be sufficient both to maintain the usual good quality of PDCP's operations and to process the expanded volume of business over the next two years mentioned in paragraph 4.16. 4.04 Operating Policies. The amended Statement of General Business Policies (Annex 8) 3/ has remained essentially unchanged since September 1972 and continues to provide sound guidelines for PDCP's operations. PDCP's normal exposure limit in any single project, restrained by its policy guide- lines 4/, is now nearly P 21.4 m-llion (or US$3.2 million equivalent). This limit can, under exceptional circumstances, be exceeded. The last amendment to the policy statement emphasized PDCP's firm intention to diversify its clientele and to provide a greater level of assistance to small- and medium- scale firms. The direction of PDCP's recent operations suggests that it is living up to this policy commitment. 4.05 Project Evaluation and Follow-up. The practices adopted by, and standards applying to, PDCP's project appraisals and supervision continue to be of a high quality. An analysis of a sample of recent appraisal and follow-up reports reveals them to be precise, informative and incisive. P:DCP's analysis of the technical, market and financial aspects of projects continues to be thorough. It has now adopted as routine the calculation 1/ He has left PDCP permanently to set up his own investment organization. 2/ Loaned for two years to the Development Academy of the Philippines. 3/ The Statement was adopted in March 1964 and amended in July 1966, January 1967, June 1970, and September 1972. 4/1 Limited by Section V (a) of its policy statement to 20% of paid-in unimpaired capital plus surpluses and reserves plus amount of USAID loan not due and payable.  - 11 - of the internal economic rate of return as prescribed by the recently issued Bank guidelines on the calculation of an economic rate of return for DFC sub-projects. It is also developing refinements to protection rate criteria and to domestic resource cost criteria as additional measures for evaluating the economic implications of the projects it finances. PDCP has also in- corporated in its follow-up an evaluation mechanism for determining whether the financial and economic benefits expected to result at the time of proj- ect appraisal were actually realized (and if not to analyze the causes of variation). In an effort to employ PDCP's data on its own project portfolio to make wider assessments of the impact of DFC-financed projects in general, PDCP (along with six other DFCs) is cooperating with the Bank Group in a pilot scheme to develop a computerized data bank. Hopefully this will be a first step towards enabling both the Bank Group and other DFCs to understand better the effects and consequences of DFC financing and to undertake more meaningful project analysis and follow-up. 4.06 Procurement and Disbursement Practices. PDCP does not, in general, require its clients to invite bids for their equipment on an international basis. It does however ensure during appraisal that the equipment it fi- nances is suitable for the client's purposes and is being procured at a competitive price. Disbursements are made only after PDCP has satisfied itself that expenditures have been, or are about to be incurred for the purposes approved through a detailed scrutiny of supporting documents sup- plemented by site inspections wherever appropriate. The appraisal mission was satisfied that PDCP's procurement and disbursement procedures are appro- priate and thorough without being unduly time-consuming. 4.07 Lending Operations. A comparative analysis of PDCP's lending operations up to March 31, 1974 is provided in Annex 9. Total financial assistance approved by PDCP for the industrial, agro-industrial and trans- port sectors amounted to P 946.1 million, with direct lending accounting for 76.2% of this amount, the rest being accounted for by underwriting and syndication 1/ operations (13%), equity investments (3.4%) and issuance of guarantees (7.4%). Cumulative loan approvals as of March 31, 1974 totalled P 720.8 million for about 260 projects executed by 171 companies. Foreign currency loans (207) amounting to nearly US$107.4 million accounted for 81.4% of total lending with peso loans (177) totalling P 133.8 million accounting for the rest. The rate of loan approvals in the first quarter of 1974 was unprecedentedly high with approvals in that period accounting for 15% of the cumulative total for the previous ten years. Foreign cur- rency loan approvals (16) of over US$14 million, 2/ exceeded approvals for 1/ Inclusive 'of private placements totalling P 5.2 million and syndica- tions totalling P 72.3 million. 2/ A further US$3.86 million was approved in April and May 1974. Unless it runs out of foreign resources, its pipeline suggests that PDCP could approve a total of US$35 million in foreign currency loans in 1974 - or 3 times the 1973 level.  - 12 - the entire previous year; on an annualized basis local currency loan approv- als (14) for the first quarter (P 14.1 million) were about 130% above 1973 levels. As of March 31, 1974 PDCP had 211 loans amounting to P 475.5 mil- lion outstanding in 125 companies, including 19 small-scale loans totalling P 3.3 million (paragraph 3.05). In dollar terms the average size of PDCP loans (excluding small-scale loans referred to in paragraph 3.05) is around US$520,000, reflecting a levelling off in the trend towards financing larger projects. Inflationary trends may push the average dollar size of PDCP loans to a higher figure, but it is expected that, over the next year or two, the size of PDCP loans will decline slightly in real terms. 4.08 Capital Market Operations. PDCP's underwriting commitments includ- ing private placements (Annex 10), amounted to P 58.7 million for twelve separate clients; three of the issues underwritten were for long-term debt (bonds), one for a promissory note and the remainder for common stock. As of March 31, 1974 syndications amounting to P 72.3 million for seven clients had been approved by PDCP (Annex 11) 1/. These syndications involved foreign exchange financing 2/ of US$14.6 million equivalent and local financing of P 2.3 million. Direct equity participation by PDCP since its inception amounted to P 29.7 million (in gross approvals) for some 40 firms. PDCP later withdrew from 6 investments requiring P 5.6 million, resulting in net approvals of P 24.1 million for 34 firms. As of March 31, 1974, PDCP's equity portfolio stood at P 18.8 million in 24 investments. Capital market operations for the first quarter of 1974 did not reflect the same advances over previous year levels as did lending operations. There was only one private placement, for P 1.2 million, two equity investments totalling P 0.83 million 3/, and one syndication for P 13.4 million. PDCP expects that, at the end of 1974, syndications and equity investments will far sur- pass 1973 levels, but in view of the growing number of new "investment houses" eagerly scrambling for underwriting business, its own operations in this area will increase only nominally. 4.09 Guarantee Operations. Total guarantees (18) approved by PDCP as of March 31, 1974 amounted to P 64.5 million, of which 76.5% was accounted for by foreign currency guarantees (US$11.9 million equivalent) and the remainder (P 15.2 million) by peso guarantees (Annex 2). After repayments of amounts disbursed against these guarantees, PDCP had outstanding contin- gent liabilities amounting to P 29.8 million (US$3.66 million equivalent in foreign currency and P 5.16 million in local currency). Following the Central Bank's measures in 1970/71 to regulate the terms of foreign credits, PDCP 's guarantee operations have remained depressed, the much improved 1/ Three more syndications amounting to P 46.34 million were approved in April and May 1974. 2/ The principal foreign participants have been IFC and PICA. 3/ Two more equity investments for P 4.5 million were made in May 1974.  - 13 - investment climate in 1973/74 notwithstanding. Contrary to PDCP's expect- ations only two guarantees for foreign currency credits (totalling US$0.9 million) have been issued since 1971. 1/ 4.10 Money Market Operations. The volume of PDCP's money market trans- actions during 1973 reached P 1.8 billion, up 28% from the previous year's level of P 1.4 billion. Transactions in government securities, in which competition was intense, accounted for 29% of the total volume compared with 50.7% in the previous year. The level of temporary placements in the first quarter of 1974 was up by 53% from first-quarter 1973 levels although the yield decreased from 15.74% to 13.37%. 2/ The money market climate has been somewhat unsettled in the first few months of 1974 owing to successive attempts by the CB to mop up excess liquidity fuelling the present inflation and at the same time expand credit for investment purposes (paragraph 2.02). This has led to fluctuations in call money rates on a week to week basis of between 17-33% per annum. As of March 31, 1974 PDCP's holdings of money market instruments and cash amounted to P 173.9 million or 70% of current assets and 24.6% of total assets. Short-term liabilities attributable to money-market operations totalled P 49.7 million or 43.6% of current liabili- ties (paragraph 4.11). 4.11 Financial Position. PDCP's financial position remains sound and is analyzed in detail in Annex 12, with summary balance sheets for FY 70-73 and the first quarter of 1974 being provided in Annex 12, Table 1. While total assets in 1973 grew by 40% over 1972 levels, the increase of 4.4% in the first quarter of 1974 (which brought total assets up to P 705.9 million) did not fully reflect the stepped up tempo of lending activity mainly because of the lag in disbursements. Long-term investments of P 443.8 million accounted for 62.9% of total assets, as current assets (P 250.1 million) declined slightly in prominence from 40% of total assets at the end of 1973 to 35.4% as of March 31, 1974. On the other side of the balance sheet total liabilities amounted to P 628 million with net worth rising to P 77.9 million. Retained earnings, which grew by nearly 30% in 1973, increased by a further 6.5% in the first quarter to a level of P 34.6 million as of March 31, 1974; they presently account for 44.5% of stockholders' equity. Long-term debt amounted to P 511.7 million reflecting a growth of 8.8% in the first quarter (compared to overall growth of 40% through 1973), while short-term liabilities amounted to P 114.2 million, a decline of 12.4% over the 1973 year-end level. Consequently, PDCP was slightly more liquid at the end of the first quarter (current ratio of 2.2) than at the end of 1973 (current ratio of 2.0). The long-term debt/equity 3/ ratio as of March 31, 1974 stood at 5.37 (vis-a-vis 1/ Both in 1973. 2/ For the 5 months ending May 31, 1974, however, the sudden jump in money market rates boosted the overall yield from temporary place- ments to 16.4%. 3/ As defined by IBRD. No change in the current debt/equity limit of 6.5 is deemed necessary at this time.  - 14 - the contractual limit of 6.5); the short-term debt/equity I/ ratio was 0.54 (as against a contractual limit of 2.0) and the percentage of net liquid assets to total assets 1/ was 19.26% (against a contractual minimum of 4%). 4.12 Financial Performance. As with its overall financial position, PDCP's financial performance in 1973 and the first quarter of 1974 was satisfactory; (details are provided in Annex 12). Net income after taxes increased by 10.2% in 1973 to P 12.7 million versus P 11.5 million in 1972. As of March 31, 1974 net income after taxes was P 3.5 million (6% above last year's comparable figure or an 11% increase on an annual basis). 2/ The principal constituents of gross income (P 18.2 million) retained roughly the same proportions as for 1973 with long-term lending operations accounting for 77.7% of income (or P 14.2 million), money market operations for 19.4% (P 3.5 million) capital market operations for 0.03%; guarantee fees for 0.6% (P 0.1 million); and other sources for the remaining 2.3% (P 0.4 million). On an annualized basis, income from long-term lending operations rose by 7.8% from 1973 levels and that from money-market operations by 13.1%. Interest charges and financial expenses (P 10.1 million on March 31, 1974) on the other hand rose only by 8.1% from previous year levels (on an annual basis). First quarter results however indicated that operating expenses (exclusive of taxes and licenses) were running at about 30% above 1973 levels, mainly because of upward salary adjustments and the increased cost of utilities and maintenance of the headquarters building; this trend has continued into the second and third quarters of 1974 and is estimated to drive up total administrative expenses for 1974 to about 1.5% of total assets. 4. 13 Portfolio Quality and Arrears. PDCP's portfolio remains a sound one. This is attributable more to the quality of its appraisal and follow- up work than to any underlying predisposition towards financing "no-risk" projects undertaken by well-established sponsors. Of the 125 clients with 211 loans outstanding on its books as of March 31, 1974, 23 clients (or 18.4%) had 33 loan accounts (or 15.6%) in arrears for three months or more (Annex 13). The total amount (principal and interest) in arrears was P 16.15 mil- lion, an increase of 33.8% over arrears on December 31, 1973. Principal in arrears totalled P 7.47 million, or 1.6% of the total principal outstand- ing. An amount substantially more than the increase was attributable to accounts between 3-6 months overdue (which rose from P 1.53 million to P 7.56 million), as 6 more companies fell behind on their payments. Because of collection action taken by PDCP on some long overdue accounts there were material reductions in amounts between 6-12 months overdue (which fell from P 4.36 million to P 3.59 million) and more than 12 months overdue (from P 5.90 million to P 5 million). The total amount "infected" (i.e. principal outstanding for loans in arrears over 3 months) amounted to P 74.9 million 1/ As defined by IFC. 2/ Net income as of May 31, 1974 was P 6.4 million; on an annualized basis this suggests a somewhat higher growth rate of 20.9%.  - 15 - or 15.7% of the outstanding loan portfolio, compared to 15.8% at the end of 1973. Of the twenty-three clients in arrears, two (with arrears amounting to P 4.3 million) were in serious difficulty with PDCP considering fore- closure; restructuring of loans was being considered for a further five. Satisfactory payment arrangements have been made with the remaining 16 clients and PDCP is keeping a close watch on these accounts. The arrears problem has, to some extent, been exacerbated by recent money market rates. Present returns have made it worthwhile for client firms to withold repay- ments and incur penalty charges whilst using their funds for short-term investments. Although realizable collateral and securities for the accounts in jeopardy are sufficient and actual losses are unlikely, PDCP has more than adequately allowed for such an eventuality. For the first quarter of 1974, P 0.6 million was set aside as provision (against income) for doubtful ac- counts. Total allowances (against assets) for doubtful accounts as of March 31, 1974 amounted to P 11.1 million, whilst reserves and retained earnings amounted to P 34.6 million or 7.2% of the outstanding portfolio (net of allowances) as of that date. So far, no loans have been written off. 4.14 Share Prices and Returns. PDCP's net worth as of March 31, 1974 was P 77.9 million, up 3% from end-1973. On an annual basis, the increase in net worth through 1974 will be 12% compared to a 10% increase through 1973. Book value per share (par value P 10) grew from P 16.96 in 1972 to P 18.82 in 1973 and was P 19.34 as of March 31, 1974. Trading in PDCP's shares was active in the first half of 1973 but dropped sharply in the second half and has remained light since then; only 51,718 shares were traded in the first quarter of 1974. The market value of PDCP's shares rose from P 14.5 in January 1973 to P 22.0 in June 1973 and has fluctuated between P 18-22 since then, generally staying at a level above P 20. The cash dividend per share was P 1.30 in 1973 with a dividend pay-out ratio of 41%. The cash dividend for the first quarter was P 0.35 (P 1.4 annualized). 4.15 Audit. PDCP continues to retain the internationally recognized firm of Sycip, Gorres, Velayo and Co. as its auditors. Auditing require- ments have always been satisfactorily met, with reporting being prompt and thorough. No auditors' report on PDCP has contained any qualification. 4.16 Business Prospects and Projections. All available indicators suggest that the level of productive industrial investment in the Philippines, which increased significantly in 1973, will continue to rise in the foresee- able future (Annex 1, paragraph 14). On the basis of recent approval rates in the past 6-8 months and the substantial project pipeline it has built up (Annex 14), PDCP expects to approve in the next two years (1975 and 1976) loans totalling about P 500 million (US$75 million), of which 85% (or US$63 million) will be in foreign currency. Including guarantees, equity invest- ments and other capital market operations PDCP expects to provide financial assistance totalling nearly P 680 million (over US$100 million) to industry. The proposed Bank loan will consequently cover barely 30% of PDCP's total financial requirements. This level of operations is markedly higher than the growth trend over the previous ten years would appear to justify. How- ever,in view of the increased levels of actual and planned investments  - 16 - coupled with increases of between 30-50% in the cost of imported capital equipment, the assumptions on which PDCP's projections are based are reason- able; in fact, they probably are on the conservative side. PDCP's business projections along with their impact on its financial position and performance are analyzed in detail in Annex 15. On the basis of its assumptions (those on operating expenses being somewhat optimistic) PDCP's profitability is expected to remain satisfactory, climbing from P 14.4 million in 1974 to P 25.9 million in 1978, or at a compounded growth rate of about 12%. Total assets are expected to grow from P 723.4 million in 1974 to P 1,343.2 million in 1978, a compound growth of over 13%; net worth is expected to increase at an annual compounded rate of 12%. The return on average equity will dip gradually from 16% in 1974 to 15% in 1978. Dividends are expected to be maintained at 14% with the pay-out ratio dropping from 42% in 1974 to 32% in 1978. 4.17 Peso Resource Position and Requirements. PDCP's resource position as of April 30, 1974 is provided in Annex 16. As of that date undisbursed long-term peso commitments (P 35.2 million) exceeded available long-term peso resources (P 33.1) by about P 2.1 million. Short-term investments outstanding also exceeded short-term holdings of notes and commercial paper by about P 21.7 million, the excess being financed by long-term undisbursed resources. This situation reflects PDCP's policy of employing available idle resources to the maximum extent possible, rather than an imprudence on its part in overcommitting peso funds. In the short-term its ability to raise fairly large amounts of peso resources almost immediately through its money market operations, ensures that PDCP will be capable of meeting its current local currency commitments (i.e. upto end 1974). Nevertheless, it is beginning to feel the pressure for raising further domestic resources, and is drawing up plans for floating or privately placing (mainly with institutional investors) medium-term debt instruments (3-5 year debentures/notes) for P 3 million in 1974 and P 20 million in 1975 (further issues are planned for 1977 and 1978). In addition, the planned share capital increases in 1974 and 1976 are expected to yield P 20 million and f 25 million respectively. For the two year period FY75-76, PDCP thus expects to raise about P 68 million in peso resources in addition to peso loan collections estimated at P 32.8 million; its peso commitments in the same period are expected to be about P 62 million. The planned share capital increase and debentures issue for 1974, totalling P 23 million, will go a long way in correcting the over-commitment of long-term peso resources noted above. 4.18 Foreign Currency Resource Position and Requirements. As indicated in Annex 16, PDCP had about US$13.5 million equivalent in foreign currency resources available for commitment, as of April 30, 1974. In the month of May PDCP approved a further US$0.4 million, bringing the five month (January-May) total of foreign currency approvals to US$17.8 million. Based on its present pipeline, PDCP expects to approve the remaining US$13.1 million by around December 1974. (The rate of approvals could have been much faster had PDCP not been husbanding its remaining foreign exchange funds.) Unless  - 17 - it can mobilize additional resources by then it will have to withold further approvals. Given prevailing circumstances, PDCP has found it impossible to mobilize resources from foreign capital markets, even through a syndicated arrangement with IFC, except at a floating rate. Medium- and long-term funds at a fixed rate of interest are simply unavailable. Even if they were, PDCP, with its own lending rate legally limited to 12% (for secured loans), could not afford to borrow them.1/ To ensure the continuity of its operations PDCP is relying heavily on the Bank Group to cover at least part of its foreign currency needs, with a request for a US$40 million IBRD/IFC financing package. In the present monetary situation, IFC has felt unable to syndicate a loan for PDCP; even if the prospects improve, indications are that IFC will not be able to provide more than US$10-15 million. PDCP has also approached the Export-Import Bank of Japan for a yen loan equivalent to US$10 million, the terms of which are not yet certain. The loan is expected to bear a rate of about 7.5 to 7.75%, with a maturity of 10-12 years. PDCP expects the balance (US$20 million) of its foreign exchange requirements of US$70 million over the 1975-76 period to be covered by a further loan from the ADB in 1976. PDCP feels that, on present indications, it will be unable to approach foreign capital markets directly until about 1977 when it plans to float a bond issue for US$10 million. V. THE LOAN - OBJECTIVES AND PRINCIPAL FEATURES 5.01 Purposes of the Loan. Broadly, the proposed loan to PDCP will support one major constituent of the government's stated development policy, i.e. the rapid development of widely based export oriented manufacturing industries, by financing the direct foreign currency fixed capital costs of a number of sub-projects in the industrial, agro-industrial, tourism and transport sectors. 2/ The projects financed under this loan would be those 1/ Current Asian and Euro-dollar minimum lending rates are above 11.5% for short-term funds. 2/ Recent changes in legislation (particularly R.A. 6142, "The Foreign Borrowing Act") have enabled PDCP to utilize the proceeds of the Bank loan to finance virtually any type of project (except those involving foreign ownership in excess of 30%) without restriction. Industrial projects to be financed from the Bank loan do not necessarily require registration with the BOI, as long as such projects are authorized by the charter of the public institution (in this instance PNB) incurring the loan for relending to a private company. PNB's Charter effectively authorizes the financing of all projects for the "establishment, reha- bilitation or expansion of agricultura, export, industrial and other profitable enterprises". Nevertheless, PDCP has, as a matter of policy, provided its support primarily to those projects clearly approved as being in line with the Government's development objectives and priorities.  - 18 - approved by the appropriate government authorities in consonance with the country's investment priorities and development objectives. While small industry projects would be eligible for financing under this loan,1/ it is expected that the bulk of the loan proceeds would finance medium-scale projects, most of which would be oriented towards the earning or saving of f-oreign exchange. As with other Bank loans to DFCs, eligible projects would be broadly defined to include manufacturing, agro-industries, ocean and coastal shipping, hotels, etc. 5.02 Objectives. A Bank loan to PDCP at this time would ensure the continuity of its industrial financing operations over the next year, and would, over the longer term, contribute to relieving the expected pressure on the Philippine balance of payments. This loan would also serve to continue the long and mutually beneficial relationship the Bank Group has established with PDCP. As a result of that relationship the Bank Group has been instru- mental in helping establish a sound and efficient institution, and has been able to exert its influence in encouraging PDCP to be more innovative in its lending approach; to commit itself towards greater regional dispersal of investment; to ensure the viability and value of industrial projects from the economic and social viewpoints, and to provide greater assistance to smaller enterprises. The initiatives taken by PDCP in these directions (paragraphs 3.01 to 3.09) along with its successful syndication efforts (in which IFC has played a prominent role) are evidence that Bank Group influence has been beneficial. Over the period of the proposed loan's disbursement, the Bank Group can expect PDCP's efforts along these lines to be intensified. 5.03 Justification. Since the loan will finance sub-projects which have not as yet been identified, an ex ante calculation of the economic rate of return for any of these is clearly not possible. However, as pre- viously noted (paragraph 3.04), the economic rates of return 2/ on a sample of PDCE'-financed projects approved in 1973 and early 1974, range between 22% and over 100%. Subprojects financed from this loan are expected to show similar results. 3/ 5.04 Form of Bank Lending. As with the previous three Bank loans to PDCTP, disbursement and repayment of the proposed loan would be coursed through the Philippine National Bank (PNB). This is necessitated by a legal require- ment: which restricts the issuance of a government guarantee only to obligations 1/ Under previous Bank loans, there was a minimum limit of US$50,000 for sub-projects to be financed from Bank funds. There will be no such minimum limit under this loan. 2/ Calculated at the time of appraisal. 3/ PDCP has plans to undertake an economic analysis of some of its pre- vious projects which are now fully operational, to evaluate ex-post whether original expectations of economic and financial benefits emanating from them have been justified.  - 19 - incurred by public institutions. For its services as a conduit, the PNB will charge PDCP a handling fee of 0.75% per annum on the outstanding loan amount. 5.05 Utilization and Withdrawal of Proceeds. The loan would finance only direct foreign currency costs of capital goods required for eligible sub-projects. The authorization and approval of withdrawals would be in accordance with normal Bank practice as it relates to DFC loans. The estimated disbursement schedule of the loan is shown in Annex 17. 5.06 Foreign Exchange Risk. The main foreign exchange risk, e.g. that on the foreign currencies of the countries where the goods are procured, will be assumed by sub-borrowers. The Government may offer to PDCP's sub- borrowers insurance against the risk of fluctuations of exchange rates between the currencies of procurement and the currencies of obligation, for a fee to be determined. If this insurance is not forthcoming or if it is not desired by a PDCP sub-borrower, the sub-borrower will also bear the risk on currencies of obligation. 5.07 Amortization Schedule. The proposed loan would have a flexible amortization schedule which would conform essentially to the aggregate of the amortization schedules of the sub-loans made by PDCP to its clients. Our previous experience suggests that the loan would be fully amortized within a period of sixteen years, with a grace period of about 2 years. 5.08 Free Limit. In view of the high quality of PDCP's appraisal work and the control exercised by its management and Board, a free limit of US$1.5 million is recommended for industrial sub-loans. The free limit set at the time of the last Bank loan in 1969 was US$500,000. There was no requirement for prior approval of sub-projects of any size under the terms of the IFC loan of US$15 million made in 1972. An analysis of the loans approved in the first quarter of 1974 suggests that with the proposed free limit about one quarter of the number of projects financed with the proceeds of this loan (accounting for over two-thirds of the loan amount) will require the prior approval of the Bank. 5.09 Ceiling on the Size of Sub-Loans. To ensure that the proposed loan will be used to finance a relatively large number of industrial projects, a ceiling of US$2.5 million on each sub-loan made by PDCP under the proposed Bank loan is recommended. The recent IFC loan of US$15 million was used to finance 31 sub-loans (average size of sub-loan being about US$500,000). It is expected that the proposed loan would finance about 40-45 sub-loans aver- aging about US$600,000. 5.10 Relending Rate. As with the recent loan to DBP, it is expected that PDCP would relend the proceeds of the loan at 12%, the maximum legal rate that can be applied to secured loans in the Philippines (paragraph 2.05). After payment of the 0.75% per annum handling fee to PNB, PDCP would be left with a spread of 3.25%. If the legal lending rate ceiling of 12% is lifted PDCP would, after consultation with the Bank, raise its re-lending rate to competitive levels. If the new relending rate results in a spread  - 20 - to PDCP of greater than 3.5% (which appears reasonable), the excess spread would accrue to the Government as a guarantee fee. VI. RECOMMENDATIONS AND AGREEMENTS REACHED 6.01 Rapid growth of the export-oriented manufacturing sector is an important element in the continued economic development of the Philippines, and deserves the continued support of the Bank Group. In view of the competence of its management and staff and the soundness of its organization and financial position, PDCP is a suitable borrower of Bank funds. A Bank loan of US$30 million is recommended. 6.02 During negotiations the following matters were discussed and agreed: (a) the limitation of PDCP's spread to 3.5% in the event PDCP is allowed to raise its relending rate above the present legal limit of 12% p.a. (paragraph 5.10); (b) a ceiling of US$2.5 million on each industrial sub-loan to be made by PDCP under the proposed loan (paragraph 5.09); (c) a free limit of US$1.5 million (paragraph 5.08); (d) a handling fee of 0.75% per annum for PNB (paragraph 5.04); and (e) the maintenance of the lung-term debt/equity ratio at not more than 6.5:1, and of the short-term debt/equity at not more than 2:1 (paragraph 4.11).  ANNEX 1 Page 1 THE PHILIPPINE ECONOMY AND THE INDUSTRIAL SECTOR The Econoyl/ 1. Background. Prior to 1973 the performance of the Philippine economy was relatively disappointing. Its growth rate belied the poten- tial of a country with considerable natural resource endowments. Towards the end of the 1960's increasing budgetary deficits, losses of foreign reserves and ther apid accumulation of short-term foreign debt to an unmanageable level compelled the Government to adopt a floating exchange rate (para 2.11) and embark on a program of stabilization in February 1970. The restrained monetary and fiscal policies introduced under the program sharply curbed both investment and growth. The adjusted exchange rate reduced export earnings, increased the import bill and resulted in a signi- ficant deterioration in the external terms of trade. The economy also experienced rapid inflation between 1969-72; prices increased by about 45% over that period, resulting in a drop in real incomes for the wage-earning group and an increase in umemployment. Economic recovery, which began slowly in 1971, was severely set back in 1972 with the worst floods in 20 years and a large drop in agricultural production. The resulting eco- nomic pressures provoked widespread civil unrest which culminated in the imposition of martial law in September 1972. With the subsequent restoration of stability, the passage of economic reforms and favorable changes in world commodity prices, the economy registered an impressive 10% real growth rate in 1973. Improved performance was recorded in every sector. The agricultural sector which had suffered from adverse weather conditions during the previous three years grew by 11%. Export earnings rose to a record high of $1.7 billion in 1973 (55% over 1972) reflecting increases in both traditional exports (mainly due to prices) and new exports, particularly manufactures (paragraph 2.05). Net foreign exchange reserves rose to US$835 million at the close of 1973 - the highest in Philippine history. On the domestic front, measures such as tax reforms, amnesties and improved collection resulted in a 38% increase in tax revenues in 1973. Investment activity and foreign capital inflows also rose to levels substantially above those of 1972. 2. Current Performance: Results for the first quarter appear to bear out expectations that the remarkably high growth rate would not be sustained in 1974 but would level off to the long-term growth rate of around 6-7%. International reserves, over $1 billion on March 31, 1974, remain strong but the trade balance has deteriorated from a level of $102 million in the first quarter of 1973 to $8 million this year. Export receipts were 49% higher (due mainly to price increases) but imports rose by 105%, reflecting substantial increases in raw material and producer goods prices. Invisibles made up for some of the deterioration with a surplus of $126 million reflecting a much higher level of private 1/ For a detailed discussion please refer to "Current Economic Position and Prospects of the Philippines" (Report No. 78-PH dated April 20, 1973).  AINEX 1 Page 2 equity and debt capital inflow, offset to some extent by a $60 million increase in short-term debt service payments. The most worrying factor is an inflation rate of around 38-40% which has hit lower-income groups the hardest. 3. Future Directions. As outlined in the 1974-77 Development Plan, the Government's economic strategy aims at increasing the long-term annual growth rate to over 7% in real terms and increasing the annual rate of employment creation to over 4%. The projected oil import bill remains a continuing source of uncertainty threatening the country's reserves position. Whereas 1973 exceeded expectations, the ensuing period may be one of con- solidation with the groundwork being laid for a sustained rate of better distributed growth. The Philippine economny is a relatively open one and adverse changes in the economies of its major trading partners (the USA, Japan and Europe) will inevitablg have repercussions on the domestic front.