Jordan - Industrial Development Bank Project

Document of FILE COVY The World B FOR OMCIAL USE ONLY Report No. P-1863-JO REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE HASHEMITE KINGDOM OF JORDAN FOR A FIRST DFC PROJECT June 3, 1976 Tbis document has a restriced distribution and may be used by recipients only In the performance of their oficial dutes. Its contents may not otberwise be disclosed without World Bank authorlaton.  CURRENCY EQUIVALENTS Currency Unit = Jordanian Dinar (JD) - 1,000 fils JD 1.00 = US$ 3.03 JD 0.33 = US$ 1.00 ACRONYMS AND ABBREVIATIONS IDB - Industrial Development Bank of Jordan KfW - Kreditanstalt fur Wiederaufbau FISCAL YEAR January 1 - December 31  FOR OMCLAL USE ONLY INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE HASHEMITE KINGDOM OF JORDAN FOR A FIRST DFC PROJECT 1. I submit the following report and recommendation on a proposed credit in an amount in various currencies equivalent to US$4.0 million to the Hashemite Kingdom of Jordan on standard IDA terms, to help finance the First DFC project. TY2 Government would relend US$3,675,000 of the proceeds of the credit to the Industrial Development Bank of Jordan (IDB) for 18 years with a grace period of 3 years, at 8.85 percent per annum. The balance of the credit would be used as a grant to help finance IDB's small scale industry and handicraft program and related study. PART I - THE ECONOMY I/ 2. An economic mission visited Jordan in February 1976, and its report entitled "Special Economic Report, Jordan, Review of the Five-Year Plan (1976- 80)" (Report No. 1144-JO dated May 24, 1976) was distributed to the Executive Directors on May 27, 1976. Country data sheets are attached as Annex I. 3. The last decade has been an exceptionally difficult period for Jordan. The 1967 war with Israel resulted in a severe dislocation of econo- mic activities with the occupation of the West Bank, which accounted for some 35-40 percent of domestic production, and in a large influx of displaced per- sons to the East Bank. The following years were marked by severe fighting with Israel in the Jordan Valley, the internal disturbances of 1970 and 1971, the closure of the Suez Canal for eight years, and of the Syrian and Iraqi borders for over a year, and four alternate years of drought. As a result, Jordan's (East Bank) per capita income in 1975, estimated at around US$590, is probably somewhat lower in real terms than it was in 1966, when more than a decade of sustained high levels of economic growth was disrupted by the war. Despite these serious constraints, the Government was able to prevent a sub- stantial decline in the standards of living of the population, now estimated at some 2 million in the East Bank, and to progressively restore the effec- tiveness of public economic policies, and of the use of foreign resources, especially since 1971. As a result, the economy gradually recovered its pre- vious vitality. 4. Before the 1967 war, Jordan's real income grew at about 8 percent per year. Price stability prevailed, and high levels of foreign assistance permitted a sustained surplus in the balance of payments. Economic policy was guided by the objective of phasing out budget support by the mid-1970's so that foreign aid could be channeled exclusively to development projects. On the eve of the war, firm budgetary control and resource mobilization ef- forts appeared to be yielding positive results. In the immediate post-war 1/ Identical to Part I of the President's Report on Jordan Tourism Project. Thsdcueths etice itrbto admybeue y eiint nyinteprfrac  -2 - period, large budget support payments under the Khartoum Agreement encouraged a rapid rise in military expenditures and somewhat lessened the pressures for strict budgetary discipline. The emphasis of economic policy shifted to the short-run aim of revitalizing the economy through high government expenditures; government policy also stressed the support and encouragement of the private sector and the maintenance of price stability by absorbing excess purchasing power through easy access to imports. These policies shifted the burden of economic stability on to the balance of payments and profoundly altered the pattern of resource availability and use towards a greatly increased reliance on imports. By the early 1970's, the critical task of short-run economic management had been a-complished and, following the suspension of budget sup- port from Libya and Kuwait in 1971, the Government began to focus once again on medium and long-term economic policies. Late in 1971, the Jordan Devel- opment Board was replaced by the National Planning Council, which was charged with reactivating economic planning and drawing up a Three-Year Plan for Eco- nomic Development (1973-75). Recent Economic Events 5. As a result of particularly poor agricultural conditions, as well as slow growth in commerce and services in the wake of the October 1973 war, economic growth during the Three-Year Plan period (1973-75) averaged around 3 percent per year. Over the same period, the rate of inflation is thought to have exceeded 14 percent per year on average, compared to an average of about 5 percent per year during 1967-72, and under 2 percent per year for over a decade prior to that. With sustained high levels of public investment, which first exceeded private investment in 1974, the rate of capital formation in- creased from around 16 percent of GDP in 1966 to around 28 percent in 1975 (both at current prices). Public consumption expenditure has also grown faster than domestic production during this period. This has implied a very high reliance on imports, both to maintain the pace of aggregate expenditure growth and to curb inflationary pressures. As a result, the share of net imports in total available resources increased from 20 percent in 1966 to 30 percent in 1975. 6. Fiscal performance has been characterized in recent years by rapidly growing domestic revenues combined with sharp increases in current expenditures and capital outlays. The buoyancy in domestic revenues, which rose from about 16 percent of GDP prior to the 1967 war to over 25 percent in 1975, reflects increases in both tax and non-tax revenues (particularly receipts from phos- phate export royalties). The relative share of direct taxes has increased in recent years (though still less than 16 percent of total tax receipts and only 10 percent of domestic revenues) primarily due to the expansion of the cor- porate tax base and greater collection efforts by the authorities. The rapid rise in current expenditures since 1971 has, to a significant extent, resulted from the pay increases granted to Government employees to compensate for the erosion in their real incomes due to the high inflation experienced in the last few years. The growth of non-defense current expenditures, which com- prised about 55 percent of current expenditures in 1975 compared to 36 percent in 1970-71, has in recent years been higher than that of defense expenditures. The current domestic deficit has remained fairly stable at about US$125 mil- lion in the last four years, while the overall deficit has grown substantial- ly. Increasing inflows of external grants (mostly from Arab countries) have mitigated the need for increased reliance on domestic borrowings.  - 3 - 7. Despite growing export receipts, expansionary fiscal policies aimed at reviving the postwar economy and liberal trade policies coupled with peri- odic supply shortfalls due to a poor harvest led to a gradual widening of the trade deficit from a stable average level of around US$125 million prior to the 1967 war and immediately thereafter to over US$570 million in 1975. Exports of goods and non-factor services almost tripled during 1973-1975. Commodities leading this growth are phosphate and fruits. Tourism became again a major foreign exchange earner, accounting for 28 percent of exports of goods and non-factor services in 1975. On the other hand, imports of goods and non-factor services grew more than three times during the same period. The increase in capital goods imports was in particular significant as a result of the Three Year Plan investments. However, due to the sharp increase in budget support from Saudi Arabia and other Arab governments in the wake of the Rabat Conference and rising levels of workers' remittances, which exceeded commodity export receipts in 1975, the balance of payments was in surplus in 1975 (over US$150 million) for the fourth successive year. 8. On December 31, 1975, Jordan's external public debt amounted to US$560 million, of which US$330 million was disbursed (for comparison, 1975 GNP was US$1,100 million). The bulk of the debt is on extremely conces- sionary terms, with debt contracted during 1970-75 at 2.4 percent annual in- terest, and 25 years maturity with 6 years grace, on average. The ratio of debt service payments to exports of goods and non-factor services was 5.0 percent in 1975 and is expected to rise gradually but not exceed 10 percent by 1980. External reserves at end 1975 amounted to US$530 million gross, or US$486 million net, in comparison to merchandise imports of US$590 million in 1975. Development Planning 9. The Three-Year Plan was the first Jordanian Plan to be executed without revision or interruption. The first eighteen months of the Plan, however, were spent on project formulation and preparation. Implementation, which did not get started until the middle of the Plan period, suffered from lack of adequate preparation, monitoring and follow-up, shortage of skilled and managerial manpower, as well as delays in equipment deliveries and ris- ing costs, which necessitated updating of feasibility studies and reappraisal of project proposals. Consequently, the physical rate of implementation of the Plan projects was low, even though financial disbursements on projects were high. Nevertheless, the last few years saw the strong re-emergence of longer-term considerations of economic development in public policies, and with the considerable experience gained during this period, the stage was set for the promulgation of the Five-Year Plan (1976-80). 10. The Five-Year Plan has been drawn around a comprehensive list of investment projects whiich have been the subject of discussion in Jordan for a decade or more. Significantly, for the first time in Jordan, executing ministries were formally involved in the preparation of the plan; and a high- level ministerial committee deliberated on the setting of priorities. The  - 4 - fundamental objectives and strategy of the Plan are much the same as those prior to 1967, and are appropriate for Jordan. The long-term general devel- opment objective is to phase out the reliance of the economy on budget sup- port, to concentrate investment on economically justifiable projects that can contribute to the growth of national income, and to allow increased taxation and exports. The Plan adopts annual average growth targets for GDP of 12 per- cent (agriculture, 7 percent; mining and manufacturing, 26.2 percent); mer- chandise exports, 24.2 percent; with imports curtailed to 7.3 percent (elas- ticity of 0.6 with respect to GNP). Total investments under the Plan are en- visaged at JD 765 milion (US$2.3 billion), equivalent to an estimated JD 650 million (US$2.0 billion) at constant 1975 prices, of which 65 percent is al- located to the public sector (including public investment in the mixed sector). On these assumptions and with the budget support payments envisaged at JD 60 million per year (US$180 million), the Plan estimates gross foreign borrow- ing requirements at JD 334 million (US$1.0 billion), of which JD 267 million (US$810 million) represents public borrowing, while most of the remaining JD 67 million (US$200 million) for the private sector is to be covered by loans and equity from foreign Arab investors. 11. The agricultural strategy proposed in the Five-Year Plan is based on a reassessment of the agricultural potential of the economy, and aims pri- marily at stabilizing agricultural production and raising productivity, by major investments in irrigation. It attaches primary emphasis to export- oriented production, particularly for the growing Middle Eastern markets, of high-value fruits and vegetables, where Jordan's comparative advantage lies. 12. The Plan's industrial strategy is to exploit the country's phos- phate resources, as rapidly as possible, while encouraging exploration for other minerals; develop with active Government participation, an export- oriented mineral-based industrial sector (particularly fertilizer and cement); expand oil refining; and provide strong incentives to the private sector to develop manufacturing towards import-substitution in the short-run, and ex- ports in the medium-term. To do this, the Government has committed a large part of the Five-Year Plan investment (around 30 percent) to the mining and manufacturing sector, and almost half the increase in domestic output proj- ected in the Plan is expected from this sector. In encouraging industrial growth, the Government is conscious of promoting efficiency in resource al- location, and industrial incentives are being reviewed to eliminate exces- sive protection. In view of the emigration of Jordanian labor, the pressure on domestic wages, and the absence of the clear comparative advantage in labor-intensive production, the Government is increasingly adopting a cau- tious strategy of higher capital-intensity in industrial production. Prospects for Economic Growth 13. With the Government's serious concern with development issues, and a purposeful effort to restore the momentum of economic growth prevailing in Jordan prior to the 1967 war, as evidenced in the preparation and adoption  of the Five-Year Plan and in efforts to strengthen planning institutions, there are good prospects for rapid economic growth in the medium-term, bar- ring adverse political developments. There is considerable Government con- cern about the provision of an appropriate policy framework for the success- ful implementation of Plan objectives and strategy. Even though the size of the investment program envisaged may tax the physical, human, administrative and financial resources of Jordan, the relative sectoral emphasis of the in- vestment program seems well-placed and the bulk of the projects appear to be at an advanced state of preparation and of high priority. 14. While the JD 765 million is a target level of investment, the Government is aware that actual investment may be lower, for a variety of reasons. With low labor force participation rates, in addition to the high emigration rate of Jordanian labor to neighboring Arab countries in response to large wage differentials, the availability of manpower at all levels is likely to be a major constraint. Rapidly rising government expenditures, due to the size of the investment program, would exacerbate the already sub- stantial inflationary pressures. To implement its investment program, Jordan would require substantial financial assistance. In this connection, a meeting of major donor countries has been called to present the objectives and require- ments of the next Development Plan and will take place in Amman at the end of May 1976. Assuming that the borrowing includes a substantial portion of concessional aid as well as conventional loans, the debt service would not represent an excessive burden on the balance of payments. PART II - BANK GROUP OPERATIONS 15. Jordan has received twelve IDA credits totalling US$59.8 million (net of cancellations). Four credits were made before 1967 - two for agri- cultural credit and two for water supply - and are fully disbursed. Subse- quently, war and local disturbances (see paragraph 3 above) adversely af- fected the pace of economic activity and Bank Group lending only resumed in mid-1971. IDA credits concentrated mainly on the financing of infrastruc- ture projects such as education, highways, water supply, power and irriga- tion. Performance under these projects is generally satisfactory. An en- gineering credit of US$1.0 million to prepare a potash project was also pro- vided in 1975. A US$6 million IDA credit for a tourism project to develop the archeological sites of Petra and Jerash has recently been presented to the Executive Directors. IFC has made two investments in Jordan consisting of a US$244,000 equity participation and a US$1.6 million loan to Jordan Ceramic Industries Limited (JCI) in 1974, and also a US$3.1 million equity participa- tion in the promotion of a phosphatic fertilizer project in 1975. Annex II contains a summary statement of IDA credits and IFC investments as of April 30, 1976, and notes on the execution of on-going projects.  - 6 - 16. At the Government's request the Bank Group assisted since 1974 in formulating and mobilizing multilateral financing for a package of develop- ment projects in the Jordan Valley which have since been included in the cur- rent Five Year Plan (1976-1980). A large phosphate mining and integrated transport project is under preparation for Bank Group financing and is ex- pected to be presented to the Executive Directors in the second half of 1976. Other large scale projects contemplated include projects in phosphate fertil- izer and potash, as well as further development of the water resources in the Jordan Valley. Further Bank projects together with the establishment of in- dustrial zones and sw-porting services for light manufacturing aim at reduc- ing the concentration of economic activity in the Amman-Zerka area which is already suffering from overtaxing of its industrial infrastructure and severe pollution. Preparatory studies are also underway for projects in rainfed areas which would expand cereal and livestock production and reduce the country's dependence on agricultural imports. 17. The Bank was Executing Agency for a two-year UNDP Planning Assist- ance Project based in the National Planning Council which was completed in December 1975. The Bank is Executing Agency for a UNDP-financed study of the manufacturing industry and industrial estates in Jordan. The first phase, consisting of a study of the industrial sector, was completed in December 1975. The second phase, consisting of studies of specific industries and proposals for the establishment of industrial estates during the next Plan period, is expected to be completed by the second half of 1976. 18. At the end of 1975, the Bank Group's share in Jordan's external public debt was estimated at 13 percent, and its share in debt service was 1.4 percent. By 1980 the Bank Group's shares in debt outstanding and in debt service are expected to be about 3 percent and 4 percent respectively. PART III - THE INDUSTRIAL SECTOR 19. Preliminary results from the 1975 industrial census indicate that there were 7,478 mining and manufacturing enterprises in the East Bank of Jordan in 1974, employing some 26,700 people. Value added by the sector grew from JD 20 million (about US$61 million and 11 percent of GDP), in 1972, to an estimated JD 45 million (US$136 million and 15.6 percent of GDP) in 1975. Except during the 196' war and the 1970-71 domestic disturbances, the industrial production index based on 15 major commodities has increased steadily in the last decade by an average of about 6 percent per year. The increase was 6.1 percent in 1974, and 7.2 percent in 1975. Currently, industrial activity is heavily concentrated in the Amman-Zerka area. Although the Three Year Plan had called for better geographical distribution of industry, progress towards attaining this goal has been slow as the availability of basic infrastructure has remained a constraint.  - 7 - 20. The 1974 employment survey indicated that the 36 largest enterprises (employing 50 or more workers) accounted for 57 percent of total industrial employment, and the 8 largest enterprises accounted for 38 percent. Medium scale enterprises mostly produce non-durable consumer products and are prima- rily oriented towards import substitution. In recent years, however, their export role has steadily increased. Their principal products are clothing, textile, footwear, metal products and food processing. Because of the com- paratively tight labor market primarily due to emigration of Jordanian labor to neighboring Arab countries, Jordanian industry is relatively sophisticated and capital intensive, enabling it to become technologically advanced in relation to competing industry in neighboring countries. The resulting higher quality Jordanian products has enhanced their acceptability in these markets. The small scale industrial sector defined as enterprises employing less than 5 workers comprises 90 percent of all industrial establishments and employs some 10,800 workers. Institutional support for this subsector has been lacking until recently. This subsector is a mixture of very small scale industries, handicrafts and household or "cottage" industries. Stone cutting and car- pentry are typical examples of small scale industry in Amman, tailoring and traditional embroidery are examples of Jordan's cottage industries while pottery and wood carving are among the most popular handicrafts. 21. The large scale enterprises in Jordan enjoy substantial Government support and in many cases Government participation in ownership and the small scale sector is beginning to attract attention from government agencies and IDB because of its substantial economic potential. Incentives for industry are provided under the Encouragement of Investment Law. Projects approved under this law are exempted from income and social services tax for six years (nine outside the Amman-Zerka area), from customs duties and other import charges on fixed assets during project implementation, and building and land taxes for 5 years (seven outside the Amman-Zerka area). Projects located outside the Amman-Zerka area may also be provided with free tracts of Government land. Foreign capital is given similar privileges plus the freedom to repatriate profits and interest earned on foreign investment, and salaries earned by expatriate staff. Industrial projects must have fixed assets of at least JD 5,000 (US$15,200) excluding land to qualify for these incentives while tourism projects must have fixed assets of at least JD 15,000 (US$45,500). Between 1972 and 1975, 105 projects with capital investment totalling JD 21 million (US$64.1 million) were approved under this incentive scheme. Other incentives include tariff protection, especially from competing imports from non-Arab countries. Tariffs typically range from 10-30 percent; however, for a few items particularly important in local manufacturing and based on local raw materials such as confectionery, shoes, furniture, and tomato sauce, tariffs exceed 50 percent. Imports from the Arab Common Market (Egypt, Syria, Iraq, and Jordan) and imports under trade agreements with countries of the Council of Arab Economic Unity compete with Jordan's industry without tariff barriers. 22. Under the Licensing and Control of Industries Instructions of 1973 new industrial or tourist establishments are set up, modernized or expanded only after a license has been obtained from the Ministry of Industry and Trade or the Ministry of Tourism and Antiquities. Until about two years ago, the  - 8 - Government attempted to avoid "wasteful" competition by restricting the number of establishments in each field to what it felt the domestic market could sustain. However, because of the limited domestic market, many enterprises successfully turned to foreign markets. Encouraged by this trend, the Govern- ment has adopted a more liberal approach in granting licenses. This liberal approach has not led to excess capacity. 23. The financial sector in Jordan consists of the Central Bank, 11 com- mercial banks, 6 specialized credit institutions including IDB, and some 25 insurance companies and agencies. The Post Office began a savings funds in September 1974. 24. Commercial bank loans to industry accounted for only 12 percent of total bank lending of JD 121.4 million (US$368 million) outstanding at the end of 1975. In addition, commercial banks in Jordan are quite liquid with Government bonds and deposits with the Central Bank constituting 11 percent and 15 percent of total assets respectively, at the end of 1975. Commercial bank loans to the industrial sector consist mainly of bill discounting, and short-term loans and advances. Although commercial banks are reluctant to commit substantial amounts for term lending to industry, they frequently roll over their short-term advances for established clients. Commercial banks rarely lend to the small scale industrial sector mainly because of lack of security. 25. The six specialized credit institutions for agriculture, housing, industry and village development are each incorporated under a special law and extend medium- and long-term credit for specific purposes in these sectors. The insurance companies invest in real estate, Government securities and to a limited extent in equities of large industrial enterprises. IDB is the only major institutional source of long-term financing for the medium and small scale industrial sectors. 26. By 1975, inflation had caused term interest rates to become negative and to fall out of line with trends in the international capital market. To reverse this trend and encourage the channeling of private savings into the banking system, the Central Bank, on January 1, 1976, raised the minimum interest payable by commercial banks on savings and time deposits from 2.5-3.5 percent to 5-5.5 percent per annum. The commercial banks' prime lending rates were also raised from 6.5 percent to at least 7.5 percent per annum. The re- cent increase in the long-term lending rate of IDB from 8 percent to 9 percent should be seen in the light of this general overhaul of the interest rate structure in Jordan. There are currently clear signs that the inflation rate is slowly moving downward and the Government believes that these increases represent the maximum that is appropriate. In addition to the increase in term interest rates, a 75 percent credit-deposit ratio was imposed on commer- cial banks and the growth of credit for short-term loans and advances in the first six months of 1976 was limited to 10 percent above the level extended in the previous six months. Furthermore, effective March 1, 1976, commercial banks were subjected to an additional 3 percent reserve requirement for all overdrafts except on loans to joint stock industrial establishments. In February 1976, the Government established a pension fund which is likely to become an additional source of term financing for the industrial sector.  - 9 - 27. The Five Year Plan (1976-80) calls for the industrial sector's contribution to GDP to grow from 15.6 percent in 1975 to 28.3 percent by 1980. Income from industry is expected to grow by 26.2 percent annually and total investments during the Plan period is expected to reach JD 229 million (US$694 million) or about 30 percent of total planned investments. Most of the planned industrial development would be concentrated in a few large-scale projects such as phosphate mining and phosphate fertilizer, potash extraction, expansion of the oil refinery and a new cement plant. The Government has already started implementing several of these projects. It is expected that the private sector would invest about JD 35 million (US$106 million) in medium and small scale industries. In order to foster greater dispersion of industry, the Plan calls for the establishment of several industrial estates around the country. PART IV - THE PROJECT 28. The Industrial Development Bank of Jordan (IDB) was established in 1965 in accordance with a special Law which provides IDB with certain pri- vileges and powers not available to other companies. The proposed credit would constitute the first Bank Group financial assistance to IDB. The Proj- ect was appraised in November 1975 and negotiations took place in Washington in April 1976. The Jordanian delegation was headed by Mr. Ziyad Annab, General Manager of IDB. An appraisal report on IDB (No. 1018a-JO) dated June 3, 1976, is being distributed separately. A Credit and Project Summary is attached as Annex III. IDB's Objectives and Role in the Economy 29. Since its inception in 1965 and under the leadership of its General Manager, IDB has developed into a well-managed institution. IDB's invest- ment decisions are generally based on sound financial, technical and economic criteria. The IDB Law provides it with a mandate to finance private indus- trial, tourism, and mining projects in Jordan, through loans, equity participa- tions, underwriting and guarantees. IDB is also to assist in developing a stock market and in encouraging the private ownership of shares and bonds, to provide technical assistance, to promote new projects, and to help small industries. 30. IDB has so far concentrated its efforts in making loans to indus- trial and tourism projects and providing these clients with assistance in the fields of financial management and project preparation in particular. However, in March 1975, IDB expanded its activities to assist very small entrepreneurs through its small scale industry and handicraft program. IDB expects to become active in promoting new projects during the Five Year Plan period. Its overall activities are guided by a statement of investment policy which, to- gether with provisions in IDB's Law, provide a satisfactory framework within which IDB can carry out its operations.  - 10 - Resoures of IDB 31. IDB's subscribed share capital amounts to JD 2.24 million (US$6.8 mil- lion), divided into JD 1.11 million (US$3.36 million) ordinary shares held by by the Jordanian private sector and foreign investors. The IDB Law provides that the preference shares carry a minimum 6 percent tax free dividend guar- anteed by the Government and that their nominal value is guaranteed by the Government in case of liquidation. Other than these provisions and the voting procedures for the Board of Directors, the two classes of shares are equal. 32. Until 1974, IDB's resources were dominated by equity. In recent years, however, IDB has drawn heavily on. the Central Bank's discount facility and on lines of credit from KfW and the Kuwait Fund. Its debt/equity ratio rose from 0.2:1 at the end of 1972 to 1.3:1 at the end of 1975. The first KfW loan of DM 3 million (US$1.2 million) was made in 1972. A second loan from KfW of DM 5 million (US$2.0 million) was provided in 1974 and a third loan totalling DM 10 million (US$4.0 million) is anticipated around the end of 1976. The first KfW loan is to be repaid in 20 years beginning in 1982 at 4.5 percent per annum. Two percent is paid to KfW; the remaining 2.5 percent (out of the 4.5 percent interest payment) is retained in a special fund to be used for mutually agreed purpose (See para. 36). The second KfW loan has similar terms. The Kuwait Fund made its first loan of KD 1.0 million (US$3.3 million) in 1974; a second loan of KD 2.5 million (US$8.5 million) was signed in May, 1976. The first Kuwait Fund loan is to be repaid in 12 years beginning in 1980 at 4 percent per annum. IDB is allowed an interest spread of 2.5 percent and the difference of 2.5 percent (at IDB's current lending rate of 9 percent) is also retained by IDB in a special fund to be used for purposes to be agreed upon by IDB and the Kuwait Fund. The terms of the second Kuwait Fund loan are not yet available. In spite of its foreign borrowing, IDB has had to use its local currency resources to cover part of the foreign exchange needs of its borrowers. It is the Government's and IDB's stated policy, however, that IDB should use its local currency resources only to finance local purchases, rely- ing on foreign borrowings to finance foreign purchases. IDB intends to follow this policy as closely as possible in the future; the proposed credit would allow it to do so at least through mid-1978 when the credit is expected to be fully committed. Operations 33. The year-to-year trend in IDB's loan approvals reflects the changing political situation. After a promising first full year of operation in 1966 (approvals totalled almost JD 1 million), business dropped drastically in 1967 to about half of the level the year before; and by 1969 had only recovered to about 80 percent of the 1966 level. The internal disturbances in 1970 and 1971 led to another slump in business. Since 1972, however, loan approvals have continually reached new yearly highs and totalled over JD 2.4 million (US$7.3 million) in 1975. This reflects the political stabiliity within Jordan and the resulting improved investment climate.  - 11 - 34. From its inception in 1965 to December 1975, IDB approved 285 loans for a total of JD 10.3 million (US$31 million) including 45 loans for tourism projects for a total of JD 1.57 million (US$4.8 million). Major categories of IDB's loans by amount were as follows: 22.5 percent for food, beverage, and tobacco; 18.6 percent for chemicals, rubber, and plastic products; 15.2 per- cent for tourism; 10.1 percent for leather; the remaining 33.6 percent was distributed among several other industrial categories. Over half of the loans-have been for amounts less than JD 20,000 (US$60,600). The average size of the 285 loans approved by the end of 1975 was about JD 36,200 (US$109,700) with the average size of the 41 loans approved during 1975 being JD 59,400 (US$180,000). In recent years most of IDB's loans have had a re- payment period of between five and seven years plus a grace period of about a year and a half. The enterprises assisted by IDB have been heavily con- centrated in the Amman-Zerka area, reflecting the general pattern in Jordan. 35. IDB's West Bank portfolio, frozen since the 1967 Arab-Israeli war, consists of 56 loans for JD 481,000 (US$1.5 million), or about 9 percent of outstanding portfolio on December 31, 1975. Forty-six loans for JD 225,000 (US$682,000) of the principal outstanding were made by IDB's predecessor, the Industrial Development Fund, and were transferred to IDB as part of the Government's equity contribution when IDB was first established. IDB is considering asking the Government to reassume responsibility for these loans. Most of the West Bank loans IDB made itself are for hotels in Jerusalem and IDB considers these loans sound and collectible once a political settlement is reached. Loans in arrears in the East Bank repre- sented 5 percent of IDB's portfolio on December 31, 1975. 36. IDB has recently expanded its activities to include assistance to very small-enterprises, defined.as employing up to five people and using manual production methods or simple machinery. Small service establishments and traditional handicrafts are also included. This experimental small scale industry and handicraft program is being funded by yearly grants of JD 100,000 (US$303,000) each from the Government and the Central Bank and by smaller amounts available from the special funds to be established with the Kuwait Fund second loan and KfW's first credit. For additional funds, if needed, IDB can borrow from the Central Bank at a preferential interest rate of 4 percent against the promissory notes of its small scale clients. The cost of operating this program is to be accounted for separately from IDB's normal activities, and those costs not covered by the 7 percent per annum interest rate charged to borrowers under the program will be met-from the grant funds mentioned above. The-7 percent interest rate is seen as a necessary encouragement for these entrepreneur-s to approach IDB for funds to improve their operations. Moreover these small scale clients presently do not benefit from substantial investment incentives (para. 21) available to larger investors and the lower interest rate may-be seen as a form of compensation for this exclusion. 37. Since the program's inception in March, 1975 to the end of 1975, 129 loan applications had been-received by IDB. Of these 52 were approved,  - 12 - totalling JD 72,200 (US$218,800). Nine loans were later cancelled, leaving a net total of 43 loans amounting to JD 57,700 (US$174,800) or an average of JD 1,340 (US$4,100) per loan. IDB estimates that these 43 projects will create 71 new jobs at an average cost of about US$2,800 equivalent per job. IDB has established some general criteria for this program, though at this early stage flexibility is being stressed. The maximum size of loans granted under the program is JD 2,000 (US$6,100); no minimum size has been set. Loans can be granted for up to ten years and can be used only to finance machinery and tools. In general, IDB will lend up to 80 percent of the cost of such equip- ment, but no more than 75 percent of the total cost of the project. As security, IDB will take a mortgage on real estate if any is available; other- wise it will mortgage the machinery and accept personal guarantees. 38. This is the first institutional effort in Jordan to reach small entrepreneurs. IDB hopes to build its experience over the first 1-1/2 to 2 years of implementation of the program. The proposed credit contains a US$300,000 component which the Government would pass on to IDB as a grant for this program to be committed between July 1976 and June 1978. The IDA funds would finance an estimated 20 percent of the program during this period. These grant arrangements are based on the fact that the risks of the program's portfolio are expected to be high because of simplified appraisal and supervi- sion. Once the program's risk can be fully assessed in the light of the loan repayment experience during the experimental phase, IDB could consider dif- ferent methods of funding the program. Moreover, financing part of the program with Bank Group funds would ensure that the Bank Group is intimately involved with the program and gains with IDB, the maximum possible knowledge of this subsector. The program will be closely monitored by the Bank Group through extensive reporting and frequent visits to Jordan. A sample (every tenth) of appraisal reports will be translated and sent to Washington for review. Quarterly summary reports covering such areas as applications received, approved and rejected, amounts disbursed, repayment experience, problems detected, assistance provided and operating costs will be prepared and sent to Washington. Disbursements will be made periodically and will cover 20 percent of IDB's total disbursement under the program in line with the proportion of funds to be provided by the Bank Group (Section 2.02 (a) (ii) of the Development Credit Agreement). The foreign exchange component of the loans under the program will certainly be well above the portion to be financed from the proposed credit. 39. The proposed credit also contains a US$25,000 component which would be used by the Government to fund a special study of the small scale indus- trial sector (Section 2.02(iii) of the Development Credit Agreement). The study is intended to review the present and prospective markets available to small scale entrepreneurs, their need for services such as water and power, their impact on urban development, in particular. This study and the experi- ence gained through IDB's small industries program are expected to lay the basis for future Bank Group involvement with the small scale industrial subsector. IDB and the Faculty of Economics and Commerce at the University of  - 13 - Jordan have prepared a proposal for this study which has been reviewed and agreed to by the Association. Management and Organization 40. IDB's Board of Directors has nine members. Three represent the Government, two represent shareholding commercial banks, one represents the Chamber of Industries with the remaining three representing preference share- holders other than commercial banks. The Board meets about 14 times a year. It determines general policy and approves all loans over JD 10,000 (US$30,300) and all equity in;estments. Approval of loans under JD 10,000 has been delegated to a Loan Committee consisting of the General Manager, his deputy and the four division heads. 41. IDB's staff has grown substantially in recent years (from about 18, including 8 professionals at the end of 1971 to 35, including 21 professionals at the end of 1975), reflecting the growing volume of business. It is well trained and highly motivated. Morale is excellent, reflecting the above-average working conditions and remuneration and especially the open and participatory style of management. The General Manager, Mr. Ziyad Annab, is experienced and capable and has provided strong and effective leadership. His deputy and the division heads are well qualified for their positions. 42. IDB's appraisal procedures are generally satisfactory. Recently, IDB has begun to calculate the internal financial rate of return on projects, and will soon begin also to calculate the internal economic rate of return. It was agreed during negotiations that IDB would calculate the internal economic rate of return on all projects above the free limit that it submits to the Association for review unless it can convincingly demonstrate that this calculation will not be materially different from the calculation of the in- ternal financial rate of return which it calculated for the project. While appraisal work has steadily improved in recent years, IDB's management is aware that further improvements can be made. It anticipates that an asso- ciation with the Bank Group will be helpful in this regard. 43. IDB's supervision work, assigned to a separate division only in 1971, is still undergoing development and refinement. It is clear that IDB recognizes the importance of this work and it is continually strengthening its capabilities in this area. Again, its management is aware that more needs to be done and hopes to utilize Bank Group assistance to improve its supervi- sion work. Interest Rates 44. IDB's effective lending rate has been increased to 9 percent per annum from the 8 percent per annum that has been in effect since its estab- lishment. All IDB's loans are denominated in Jordanian Dinars; the Govern- ment bears the foreign exchange risk.  - 14 - Financial Results 45. Net profits in 1975 represented a return of 5.3 percent on average shareholders' equity, a relatively low figure but an improvement over prior years since the average return was 4.8 percent between 1972 and 1975. This is the result of IDB's low leverage and the fact that IDB realizes no income from its West Bank portfolio, frozen since the 1967 war. With greater use of borrowed funds in the future, return on equity is forecast to improve. Fi- nancial expenses are increasing as IDB uses more borrowed funds to finance its operations. The ratio of financial expenses to average total assets increased from 0.6 percent in 1972 to 2.5 percent in 1975. Administrative expense as a proportion of average total assets increased slightly from 1.5 percent in 1972 to 1.7 percent in 1975. Because of IDB's limited use of borrowed funds its financial expenses are low, but its administrative expenses are in line with those of other comparable DFC's. 46. IDB's balance sheet indicates a healthy position. With a debt/equity ratio of only 1.3:1 at the end of 1975, IDB has the capacity to carry substan- tially larger amounts of debt. Its current ratio has been maintained at around 3:1 between 1971 and 1975. The overall picture reflects the rather conservative approach taken during IDB's initial years when a solid basis was being established for IDB's future growth. Economic Impact of IDB's Operations 47. During the last Three Year Plan (1973-1975), it is estimated that projects financed by IDB accounted for 75 percent of private investment in medium scale industry. Although only 15 percent of IDB's loans were made to tourism projects during the Plan period, it is estimated that IDB was asso- ciated with 90 percent of all investment in this sector during the Plan period. The 28 industrial projects and 9 tourism projects assisted in 1974 accounted for the creation of 691 and 194 new jobs respectively. The average cost per job created was JD 8,800 (US$26,700) for new projects and JD 7,300 (US$22,100) for expansion projects, which is not excessive given the relative sophistication of Jordanian industrial sector. The economic impact of IDB's existing small-scale industry and handicraft program is difficult to measure at this early stage. However, it is expected to raise the skills, productiv- ity and income level of small entrepreneurs. Projected Operations and Resource Requirements 48. IDB's business prospects for the five years covered by its forecasts are good. Applications under study at the end of October 1975 involved a po-. tential investment of some JD 8 million (US$24 million). This is substantial in relation to the Plan investment target for the entire Five Year Plan period of JD 35 million (US$106 million) in medium and small scale industry. IDB expects to commit a total of JD 18.7 million (US$57 million) over this period and to disburse a total of JD 17.1 million (US$52 million) or about one-third of the Plan target. This contribution would be proportional to that achieved by IDB during the Three Year Plan.  - 15 - 49. IDB expects to continue to rely on borrowing all of its local cur- rency requirements from the Central Bank; however, all of its foreign currency requirements would be borrowed from abroad. Its present uncommitted foreign lines of credit and the anticipated second Kuwait Fund loan will cover its foreign exchange needs through mid-1976. During the two-year period starting in July 1976, IDB expects to commit some-US$14.4 million in foreign exchange. The uncommitted portion of the anticipated second Kuwait Fund loan and the expected third KfW loan would cover almost US$11 million of this, leaving a gap of about US$3.7 million which the proposed credit would fill. 50. IDB's projected financial results indicate steady improvement in profitability and a continuing sound financial position. The debt-equity ratio is forecast to grow from 2.1:1 at the end of 1976 to 3.8:1 at the end of 1980; this is within the limit of 4:1 proposed in the credit documents (Sec- tion 3.05 of the draft: Project Agreement). Interest coverage is expected to be maintained at about 1.5 times. Total debt service coverage is forecast to be satisfactory with loan collections exceeding by a substantial margin repayments on borrowings. Terms of the Proposed Credit 51. The proposed US$4 million credit would be made available to the Gov- ernment on standard IDA terms. The US$3,675,000 portion of the credit ear- marked for IDB's normal lending to the medium scale industrial and tourism sectors would be relent to IDB by the Government for 18 years, including 3 years of grace, at 8.85 percent per annum, and would be utilized by IDB to meet the foreign exchange cost of directly imported goods and services; IDB would relend these proceeds at an interest rate of at least 9 percent per annum and for a period of no longer than 15 years. The free limit would be US$150,000 and the aggregate free limit, US$1.8 million (Section 2.02(c) of the Develop- ment Credit Agreement). The maximum amount of the credit to be used for a single investment project would be US$500,000. The Government would bear the foreign exchange risk and would be repaid by IDB in accordance with a fixed amortization schedule. The US$300,000 portion earmarked for IDB's small scale industries and handicraft program would be provided to IDB by the Government as a grant and would be disbursed to cover 20 percent of the loan IDB makes to these clients. The US$25,000 portion earmarked for the study of the small scale industry subsector would be used by the Government to cover the local and foreign costs of the study. PART V - LEGAL INSTRUMENTS AND'AUTHORITY 52. The draft Development Credit Agreement between the Hashemite Kingdom of Jordan and the Association, the draft Project Agreement between the Associa- tion and IDB, the Recommendation of the Committee provided for in Article V  - 16 - Section I (d) of the Articles of Agreement and the text of a draft resolution approving the proposed credit are being distributed to the Executive Directors separately. 53. Features of the draft Development Credit and Project Agreements of special interest are referred to in paragraphs 38, 39, 50 and 51 of this Report. Otherwise, the draft agreements conform to the normal pattern of Credits for development finance companies. 54. I am satisfied that the proposed development credit would comply with the Articles of Agreement of the Association. PART VI - RECOMMENDATION 55. I recommend that the Executive Directors approve the proposed devel- opment credit. Robert S. McNamara President by J. Burke Knapp Attachments June 3, 1976  t ''I-l.n-1 ela1 ', e % oo n.. me o non .q oo nonooO 0007 000 oo 00o 0 o 0 o 0o o * 0oo K~~~ * * * * * ~ 4 *** * * ** 55 o N -- .n0 N_ _ 0 , NW 0^ ,O s -4 004 45*~ .._ 00 40 _ 0 _o 40 _ *o _ww J * * 40 *0 _ o0 0 -- iWO e - _ ) 5.0 k. @4 - 4 _ _ _0 5 I~~~ 1 r11 SONh -9 fJe St S 1 , -z1-1 fl 1 T1 *1 - a i 4.5 " * i i a - - K . Ni Oi _i _ i Rj ~ ~ ~ ;: *. ON 0 0;. 00 S* 0@. * *SS ** ::: 00@ * *e 0 i 00 q * *. 00 t J < | ^ " 3 " e ^ > ~~~~~~~~~~~~~~ ~~~