Bolivia - Banco Industrial Mining and Industrial Credit Project

Document of The World Bank FILE COPy FOR OFFICIAL USE ONLY Report No. 1132a-BO STAFF PROJECT REPORT BOLIVIA BANCO INDUSTRIAL MINING AND INDUSTRIAL CREDIT PROJECT June 4, 1976 Regional Projects Department Latin America and Caribbean Regional Office This d)cument has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS All currency amounts are quoted in Pesos Bolivianos ($b) and US Dollars (US$) $b 1.00 US$o.o50 $b20.OO US$1.00 GLOSSARY OF ABBREVIATIONS ADELA ADELA Investment Company, S.A. BAB Banco Agricola de Bolivia BAMIN Banco Minero de Bolivia BISA Banco Industrial, S.A. BHN Banco Hipotecario Nacional CAMARA Bolivian National Chamber of Industries CBF Corporacion Boliviana de Fomento COMIBOL Corporacion Minera Boliviana CXT Common External Tariff DFC Development Finance Company ERR Economic Rate of Return FOMEX Fondo Nacional de Exportacion IDB Interamerican Development Bank INI Instituto Nacional de Inversiones L/Cs Letters of Credit AMM Association of Medium Miners UNION Union de Bancos Bolivianos USAID US Agency for International Development MMM Ministry of Mining and Metallurgy FISCAL YEAR January 1 to December 31  FOR OMCIAL USE ONLY BOLIVIA BANCO INDUSTRIAL MINING AND INDUSTRIAL CREDIT PROJECT STAFF PROJECT REPORT TABLE OF CONTENTS Page No. INTRODUCTION AND SUMMARY i-xii I. THE MINING SECTOR .. .... ............ 1 A. The Bank Group's Participation in the Sector ...... 1 B. Contribution to the Economy ..... .................. 1 C. Sectoral Structure ..... ................. 3 D. Financing of Mining ............................... 4 E. Development Constraints and Requirements .......... 5 II. THE INDUSTRIAL SECTOR .................................. 7 A. Contribution to the Economy ..... .................. 7 B. Industrial Finance . ............................... 10 C. Industrial Policies and Public Institutions ....... 10 1. Protection .................... ................. *.............. 10 2. Investment Incentives ..... .................... 12 3. Taxation . ..... .......... ..................... 13 4. Export Promotion ..... ......................... 13 D. Problems and Outlook for the Industrial Sector .... 14 III. THE FINANCIAL SECTOR . .............. .................... 15 A. Recent Developments .. ................... . ....... . 15 B. Financial Institutions ..... ....................... 15 C. Monetary Policy ................................... 19 D. Interest Rates ..... ................ ......... ..................... 20 E. Financial Constraints and Prospects *......*......... 22 F. Project Implications .............................. 23 This report has been prepared by Messrs. J.Z. Mirskl, T. Hutcheson and N. Santiago of LAC Projects Dept., DFC, with the assistance of Mr. J. Richter, of LAC Country Programs Dept. It is based on the findings of an appraisal mission, led by Mr. Mirski, which visited Bolivia in November-December 1975. The mission was assisted by Mr. R. Rodger of the Industrial Projects Dept., Mr. R. Kanchuger of LAC Programs Dept., and Mr. P. Knotter of LAC Projects Dept., DFC. This document has a restricted distribution and may be used by recipients only in the performance of their official duties.-Its contents may not otherwise be disclosed without World Bank authorization.  TABLE OF CONTENTS (Continued) Page No. IV. BANCO INDUSTRIAL, S.A. (BISA) .................. ........ 24 A. Organization, Policies and Procedures ... .......... 24 1. Establishment and Objectives ......... ......... 24 2. Ownership and Board of Directors . ............. 24 3. Management and Staff ........... .. ............. 26 4. Appraisal and Supervision ......... .. .......... 29 5. Procurement and Disbursement .................. 30 B. Policy Statement and Strategy Paper ............ ... 30 C. Operations ........................................ 30 1. Lending Operations ............ .. .............. 30 2. Small Industrial Enterprise Credit ........... . 31 3. Equity Investments and Other Operations ....... 32 D. Financial Structure and Results ................ ... 32 1. Financial Structure ........... .. .............. 32 2. Profitability and Dividend Yield .............. 33 3. Portfolio Quality and Reserves ...... .......... 34 4. External Audit .............. .. ......... 35 E. Resource Position and Requirements .......... 35 1. Resource Position and Domestic Resource Mobllization ......... .. ............ 35 2. Demand for the Proposed Loan .. ................ 36 3. Share Capital Requirements and Financing Plan.. 36 F. Projected Operations, Financial Structure and Results .................. ................... 37 1. Projected Operations ........... .. ............. 37 2. Financial Structure ........... .. .............. 37 3. Profitability and Dividend Yield ............. . 38 FINANCIAL TABLES 4-4 Analysis of Loans Approved ..... ................... 40 4-5 Small Industrial Enterprise Credit - Summary of Loans Approved .................. ......... . 41 4-6 Status of Equity Investments, December 31, 1975 ... 42 4-7 Audited Balance Sheets as of December 31 .... ...... 43 4-8 Audited Profit and Loss Statements for Periods Ending December 31 ...... ........................ 44 4-9 Status of Arrears as of December 31, 1975 .... ..... 45 4-10 Loans in Arrears Over Three Months as of December 31, 1975 .............. 0 ................ 46 4-11 Statement of Loans Rescheduling ................. . . 47 4-12 Resource Position as of December 31, 1975 . 48 4-13 Long-term Borrowings as of December 31, 1975 49 4-14 Projected Operations ............................ 50 4-15 Projected Balance Sheets as of December 31 ........ 51 4-16 Projected Sources and Applications of Funds for Periods Ending December 31 ...... o .............. 52 4-17 Projected Profit and Loss Statements for Periods Ending December 31 ............................. 53  TABLE OF CONTENTS (Continued) Page No. V. THE PROPOSED BANK LOAN AND IFC INVESTMENT .... .......... 54 A. Previous Operations ................. * ............. 54 B. The Proposed Bank Loan ............ .. .............. 55 1. General Description . . ......................... 55 2. Subloan Terms ......................... ........... 55 3. Approval Limits ...... ......................... 57 4. Procurement and Disbursement ............... ... 57 C. The Proposed IFC Investment ................... .... 57 VI. BENEFITS AND JllSTIFICATION ............................. 58 A. General ..................... ...................... 58 B. The Proposed Bank Loan ............................ 58 C. The Proposed IFC Investment ....................... 59 VII. AGREEMENTS REACHED AND RECOMMENDATIONS ........ ......... 60 A. Agreements Reached .............. .. ................ 60 B. Recommendations ...... ............................. 61 ANNEX 1. Declaration of Policy and Procedures ................... 62 2. Strategy for the Conduct of BISA's Activities .... ...... 69 3. Related Documents and Data Available in the Project File 75 4. Bolivian Laws Applying to Banco Industrial and to the Proposed Investment .................................. 76 MAP   STAFF PROJECT REPORT INTRODUCTION AND SUMMARY Reprint of the Sector and Project Sections of the President's Report PART I - SECTORAL BACKGROUND A. The Mining Sector 1. Mining has traditionally exerted a dominant influence on the Bolivian economy. Despite difficult terrain, which makes mining costly, it is an important sector in which Bolivia has a comparative economic advantage, and accounts for about two-thirds of merchandise exports. As a capital- intensive activity, mining employs only about 3% of the labor force, but several hundred thousand Bolivians depend on it for their livelihood. 2. Mining operations are carried out by public and private sector enterprises, the latter consisting of medium and small mining firms. The public sector includes all the largest mines, which belong to the Corporacion Minera Boliviana (COMIBOL) and which account for over 50% of mineral exports and 40% of employment. COMIBOL is beset by serious problems of over- centralization, inefficiency, and excessive welfare expenditures, the resolu- tion of which would require difficult political decisions. 3. Medium mining consists of 29 private firms, both local and foreign owned, which form an Association of Medium Miners. Its members must have share capital of at least US$100,000 and a certain minimum monthly production. The rest of the private sector is referred to as small mining. It includes some 2,000 operating mines, varying in size from family operations to com- panies approaching the size of medium mining enterprises. 4. As a group, medium miners are the most efficient segment of the sector; they account for 22% of the mining exports and 28% of mining taxes. Their mines are relatively modern and capital intensive. Thus, they employ relatively less labor than the public or small mining subsectors, but pro- vide their workers with better working and living conditions. While some larger firms are gradually becoming diversified corporations with holdings in agriculture, industry and banking, the number of medium mining companies has been and will be increasing as the larger and more efficient units of the small mining subsector continue to develop. This natural process would be greatly accelerated through a small mining development project, which is being considered separately by the Bank. 5. Recent developments in the mining sector have been disappointing. Even apart from temporary adverse effects of deteriorating market conditions for major minerals since 1975, the sector's contribution to GDP has been declining for some time, reflecting the existence of deep-seated structural  - ii - problems. These include inadequate exploration, undercapitalization and inadequate maintenance of the existing mines, especially small ones, and an excessive dependence on tin mining. Past political instability, antiquated mining policies and a virtual lack of long-term credit have discouraged mining investment and have been mainly responsible for the present situation. 6. The present Government is determined to resolve some of these pro- blems by initiating better planning and new policies aiming at more equitable mining taxes, establishing a central fund to finance exploration, and opening of public lands for joint exploitation by public and private interests. The gradual change from the production tax--which under- or over-charges the miners, depending on market conditions, and discourages efficient mining-- to a profit tax is expected to induce private investment to modernize and expand existing operations and to search for new mineral reserves. Opening of public lands to joint exploitation and the creation of an exploration fund should facilitate expansion of known mining areas and induce the formation of joint ventures between foreign and local investors, private or public, thereby bringing in foreign capital, technology and administrative know-how. 7. Bank Group assistance, based on the recommendations of the 1972 sector report, 1/ is focused on the provision of term credit for private mining, but it also contains a substantial technical assistance component. The first IDA Credit, No. 455-BO, provided term credit for medium miners through Banco Industrial (BISA) and financed technical assistance, including studies of mining taxation and the possibility of creating an exploration fund. It also partially covered costs of the initial phase of the survey of small mines, which is a prerequisite for a small mining development project which is presently under preparation. The proposed project is designed, among other things, to expand the scope of medium-size mining investment and to fur- ther strengthen BISA, thus consolidating the gains made with the first IDA credit. Also, a government proposal for Bank participation in an exploration fund is expected shortly, but any Bank commitment would depend upon prior consultations with the Executive Directors. 8. Mining subloans of BISA to be financed under the proposed Bank loan would be used primarily to increase the efficiency of the existing medium- size minlng operations with resulting high economic benefits. In addition, BISA as the largest private development finance institution, is expected to play an active role in Implementing the Government's new mining policies and particularly in promoting joint mining ventures. Also, it would be expected to give special attention to subprojects producing metals other than tin and to evaluate carefully the economic viability of tin subprojects (para. 30). 1/ The Mining and Metallurglcal Sector, Report No. P1-14, dated December 7, 1972.  - i~ii - B. The Industrial Sector General 9. Industry contributes about 10% to GDP, as compared to 11% by mining, but employs almost three times as many workers, about 8 % of the labor force in 1974. This is because industrial activities are largely carried out in small plants and workshops which are labor intensive. With the exception of petroleum and metal refining, most industrial firms are privately owned. It is expected that the present share of industry in GDP would increase, in response to investment expenditures which have risen substantially since 1972 and which are likely to remain strong in coming years. 10. The principal problem for industrialization is the small size of the internal market which is further reduced by the high cost and difficul- ties of internal transportation. This and the distances from world markets and the lack of a Bolivian-owned port provide natural protection to local industry and make it difficult to sell in the international market. 11. Processing of Locally produced agricultural and mineral raw mate- rials accounted for over three-fourths of industrial output and employment in 1973. Imports satisfy about half of the domestic demand for industrial goods. Imports of goods competitive with those produced by the processing sectors accounted for 28% of total imports in 1973, suggesting that there is still room for additional efficient import substitution in processing indus- tries. Given Bolivia's natural resource base, it appears that industry has been developing along the lines of comparative advantage. 12. Reflecting the low level of financial development in Bolivia, a severe shortage of term credit limits investment mostly to retained earnings and other savings of a small group of entrepreneurs. As a result, investment projects are often undertaken on too small a scale or not at all. Most credit extended by the banking system is to finance working capital at short term, but it is nevertheless inadequate for Bolivian industry, which, due to diffi- cult transport, has to carry exceptionally large inventories. Firms could grow faster if more term credit for investment and working capital were avail- able. The current rapid development of the financial sector should thus stimulate industrial development. Policy 13. Tariffs are low and provide fairly even amount of protection to all sectors, thereby allowing relative profitability to be determined by economic efficiency. In October 1975, in response to a decline in inter- national reserves, the Government increased the number of items subject to import quotas and prohibitions, but they still apply only to about 4% of the items in the tariff schedule. Thus, Bolivian industry is still largely free of the distortions created by widespread trade controls. The benefits to Bolivia of belonging to the Andean Common Market may be offset by the very highi Common External Tariff which might finally be negotiated.  - iv - 14. The Investment Law encourages private investment in both new and existing enterprises, principally in industry. While successful in promoting investment, the Law grants benefits, mainly exemption from import duties, that stimulate most those industries which use the highest proportion of im- ported raw materials and capital goods and which are capital rather than labor intensive. 15. Income taxes in Bolivia are low but numerous national departmental and municipal excise taxes are levied at each stage of processing. In effect, highly processed goods are taxed more than less processed goods. This is particularly damaging as Bolivia's comparative advantage lies principally in processing industries. 16. If Bolivia follows trade, investment, and taxation policies which allow its comparative advantage to be realized, the processing industries should continue to grow faster than industry as a whole. In addition to maintaining low and uniform protection, authorities should search for new means of promoting industrial investment which do not favor import-intensive and capital-intensive industries. Measures are also needed to eliminate excess taxation of highLy processed goods and to offset the burden of excise taxes and import duties on exports, for example by a comprehensive rebate in the form of a transferable credit note. These measures could contribute significantly to the promotion of non-traditional exports. Sound, rapid industrial growth will be facilitated by recent changes in interest rates that should encourage financial intermediaries to attract savings and make longer term loans for industrial investment (para. 19). The need for improve- ments in both industrial and financial policies was discussed with the Bolivian authorities during preparation of the project as part of the Bank's ongoing dialogue with the Government on economic policy. C. Financial System 17. The financial system in Bolivia, which consists of the Central Bank, commercial and specialized banks, and other financial institutions, is at an early stage of development. Nevertheless, rising incomes, greater political stability, and more consistent government policies have recently sparked accel- erated financial development, resulting in the formation of some new banks and financial companies. Financial development has been reinforced by the increase in the share of total credit going to t.he private sector. This increase has resulted from rising public revenues due to higher oil prices which have re- duced the need for deficit financing. However, although commercial banks' resources and their total volume of lending have increased, the average lend- ing term has been actually shortened to less than one year following the full commitment of concessionary funds derived from foreign assistance grants and loans. The result is that short-term working capital credit is now easier to get, but the scarcity of term financing for investment and permanent working capital remains severe. BISA, the major domestic source of medium- and long- term financing for industry and mining, has been unable to satisfy the fast-  v - growing demand of private industries, while its mining lending, made possible through IDA Credit No. 455-BO, has not reached more than a modest number of medium-size projects. 18. Real interest rates in Bolivia have generally been positive since the 1959 stabilization program. Inflation, fluctuating in a range of 3 to 39% per annum since 1960, made real rates negative for about 18 months during 1973 and 1974, following the 68% devaluation in 1972. Since mid-1974, how- ever, real rates have again turned positive as the November 1974- November 1975 rate of inflation dropped to 7.5%. 19. Interest rates on savings deposits in commercial banks were raised from 9% to 10% in 1974, and the Central Bank started to guarantee the dollar value of the savings deposits of individuals. In August 1975, the dollar guarantee was extended to time deposits, whose interest rates were raised to 10-1/4% for 90-day deposits and to 11-3/4% for 360-day deposits. Commercial banks pay up to 9% per annum on US dollar time deposits. Central Bank regula- tions permit commercial banks to charge nominal interest of up to 15% per annum on loans made from their own resources. Because of taxes, commissions, and the prepayment of the interest normally required by banks, the effective rate to the borrower may exceed 23% on short-term peso "productive" loans and 33% on personal and commercial loans. In comparison to commercial banks, the cost of term loans made by development institutions such as BISA is much lower. There are no taxes or employees benefit fee on development loans and they are usually denominated in US dollars. Funds from international organiza- tions may not be relent at more than 12% per annum in foreign currency and after lending fees and commissions their cost to the borrower is about 13% per annum. On January 8, 1976, the maximum lending rate on development banks own resources was raised from 13% to 15% per annum to conform to the maximum nominal rate of commercial banks. Including a closing fee, the effective cost of these loans may now reach 16% per annum. However, despite the equal- ity in nominal lending rates as between commercial and development loans, sizeable differences continue to exist in their comparative effective costs due, on the one hand, to the foreign exchange risk inherent in dollar denom- inated loans for development and, on the other hand, to the taxes, commissions and requirements for prepayment of interest attaching to peso denominated com- mercial loans. 20. The need for an increase in the development banks' lending rate was discussed with the Central Bank during project preparation and the January increase may be an important breakthrough in the mobilization of domestlc resources for investment purposes. For the first time in recent years, BISA and other development finance institutions should be in a position to offer an Interest rate on term funds in excess of the rate paid on commercial bank time deposits and still have an adequate interest spread on relending the borrowed funds. 21. Development Prospects and Constraints. Although notable advances have been made, the Bolivian financial system still suffers from a number of structural weaknesses. A foremost weakness is the lack of a reasonable term  - vi - structure of interest rates. The arbitrary ceiling of 15% per annum on lending rates, particularly in pesos, without regard to loan maturities, discourages term lending and offers commercial banks no incentive to pay higher interest rates to mobilize longer-term savings. A second weakness is that much of the recent advancement in the financial system has relied on US dollar guarantee of individuals' savings instruments. This would endanger the effectiveness of monetary policy in the event of devaluation. Instead an adequate interest rate differential between guaranteed and non-guaranteed instruments should be established. Measures to correct these weaknesses will be discussed as part of the Bank's ongoing dialogue with the Government on economic policies. 22. Despite these weaknesses, the financial system should be able to mobilize increasing amounts of resources and to make a modest beginning in lengthening the average term of both assets and liabllities. The re- establishment of positive real interest rates has set the stage for healthy development of the financial system and made feasible the initiation of a modest capital market which would aid in the efficient allocation of Invest- ment funds throughout the economy. 23. Project Implications. Thus far, BISA has played a minor role in the mobilization of domestic resources, largely because of the previous ceiling of 13% per annum on lending from its own funds. The recent interest rate adjustment, which allows development banks to charge 15% per annum on their own resources, should enable BISA to initiate the issue of one- to two-year dollar bonds at competitive interest rates. BISA's issue of bonds would be facilitated by the prospective establishment of an over-the-counter securities market. A successful issue of bonds by BISA would set a precedent for other financlal institutions, thereby stimulating the development of the capital market and facilitating investment in mining and industry. PART II - THE PROJECT Background and Objectives 24. The proposed project, consisting of a Bank loan and an IFC invest- ment, would represent the second Bank Group financing of BISA. The first financing was included in the Mining Credit Project of IDA in 1974. Unlike the IDA Credit, which was restricted to the mining sector, the proposed loan would provide scarce long-term funds to both private mining and industrial projects, including projects of small industrial enterprises. The proposed IFC investment, which was first discussed during the appraisal of the IDA Credit in 1973, would consist of a subscription to BISA's share capital. The project would contribute to the further development of BISA as the principal term-lending institution to the private mining and industrial sectors in Bolivia, and would incorporate some features designed to help develop the Bolivian capital market.  - vii - 25. BISA, established in 1963 as a private development bank, was set up primarily to provide term financing to the private industrial sector. Since its participation in the IDA Credit, it now also finances the private mining sector. BISA is presently implementing a plan for geographic and functional expansion that would transform it into a truly national development finance institution. Other private development banks in Bolivia are much smaller and relatively ineffective, while the record of Government-owned Institutions has thus far been poor. Therefore, the growth and development of BISA has important implications for the overall development of the private mining and industrial sectors in Bolivia. 26. Ownership and Board of Directors. BISA's shareholders include the most important groups in the Bolivian private sector. Shareholders are grouped into four categories: private Bolivian banks (21% of share capital), industrial firms and individuals (32%), foreign investors (32%), and medium mining enterprises (15%). The biggest shareholder is ADELA Investment Company, with about 23% of share capital. No other shareholder accounts for more than 7%. Each shareholder category has two directors, a system that gives BISA an eight-member Board with a good balance of skills. BISA's Board, which in- clude several prominent bankers and businessmen, is effective in setting policy and takes an active interest in BISA's operations. 27. Management and Staff. BISA has competent and experienced management. Its general manager is well qualified and has headed BISA since 1969. BISA has built up an able staff of 19 professionals. It recently opened a branch office in Santa Cruz to help develop the considerable agro-industrial poten- tial of the western region, and a representative office in Tarija to cover the southern provinces of Bolivia. 28. Policies and Procedures. The quality of BISA's appraisal work is generally satisfactory. Technical evaluation and financial analysis are acceptable. Economic analysis includes the economic rate of return (ERR) for all subloans requiring more than US$50,000 equivalent, which account for close to 90% of total approval amount. Supervision is acceptable. Procurement and disbursement procedures are satisfactory. 29. BISA recently drafted an integrated policy statement which serves as a guide to BISA's operations. During negotiations, BISA agreed to modify its policy statement so that it would (i) reduce the total amount of Its exposure, as a percentage of its equity, in any single client from 35% to 25% by 1978 in step with its growth in equity and (ii) institute more efficient operating policies which should result in satisfactory profitability, increased dividend yields and thereby facilitate the mobilization of the necessary equity resources to assure BISA's sound financial growth. 30. As a guide for subsequent project supervision by the Bank Group, BISA's future operational strategy was discussed and agreed upon, in principle, during negotiations. Points covered, inter alia, were BISA's geographic expan- sion plans, capital market development efforts and overall operational targets, including loans to small-scale enterprises. It is BISA's intention to give  - viii - special attention to subprojects producing metals other than tin in support of the Government's policy of diversification in the mining sector, and to examine carefully those subprojects producing tin or goods whose importation is prohibited. Bolivian industrial policies have important implications for BISA. Because of the recent increases in import restrictions, BISA should evaluate carefully the economic viability of subprojects producing goods whose importation is prohibited. These implications were discussed during negotia- tions and BISA has agreed to adopt reasonable parameters for the shadow pricing of labor and foreign exchange. 31. Past Operations and Results. While still a relatively small insti- tution with total assets of about US$11 million, BISA has already established itself as a major source of scarce term financing for the private industrial and mining sectors. Since 1963 BISA has approved a total of 862 loans for about US$35,000 average. The processing industries in which Bolivia appears to have comparative advantage, such as food products and textiles, account for more than half of the total amount approved. Though recently started, mining already represents 10% of total approvals. Firms in the La Paz area continue to absorb the bulk of BISA's funds. This does not indicate a reversal of BISA's efforts to diversify operations geographically, but rather results from the financing of mining projects sponsored by firms with headquarters in La Paz but with operations elsewhere. A considerable lengthening of average loan term, and a much greater percentage of loans now financing fixed assets rather than working capital, indicate the growing maturity of BISA as a term-lending institution. Also, while BISA has not been very promotional in terms of equity investments, it has been active in financing the creation of new enter- prises, which accounted for 23% of total approval amount since inception. 32. BISA also provides credit to small-scale enterprises having no more than lUS$50,000 in equity and employing not more than 50 people. In 1975, these loans, made in amounts not exceeding US$30,000 equivalent, accounted for about half of the total number of loans approved and for about 8% of total approval amount. Active participation of commercial banks as channels for part of these loans has resulted in wide geographical distribution of this type of credit. BISA expects that about 10% of its future lending, including a part of the proposed loan, would be made to small enterprises. During negotiations it was agreed that BISA would institute a system of management controls for loans to small-scale enterprises which would assure that appraisal standards would be more evenly applied and subproject imple- mentation more closely supervised. 33. Loan approvals increased five-fold from $b 40 million in 1973 to about $b 216 million in 1975, while the total portfolio grew by about 60% in 1974 and 1975, reaching an estimated $b 230 million. BISA's earnings have now recovered from the decline in the early 1970s, and it plans to resume a minimum 5% yearly cash dividend (based on share capital) out of 1975 earnings. As a result of a doubling of assets from $b 109 million in 1973 to about $b 211 million in 1975, the debt/equity ratio rose from 3.5:1 at year-end 1973 to 4.9:1 at year-end 1975, although BISA retained all earnings during this period. This is still within its contractual limit with IDA of 6:1. As an  - ix - incentive for BISA's capital market development efforts, the Bank and IDA would expand this ratio limitation under the proposed project to allow a separate 1:1 ratio limited to bond resources mobilized in the domestic market (Section 3.05 of the Project Agreement). This is justified by financial and institutional improvements in BISA since the appraisal of the IDA Credit. 34. BISA's loan portfolio is adequately secured with guarantees. Arrears over three months represent about 7% of outstanding loans and recovery prospects of these loans are relatively good. Total loss reserves are cur- rently 1.2% of BISA's total portfolio. BISA has agreed that the current reserve for portfolio losses is barely adequate and has agreed to increase the provision annually, so as to reach 3% by 1980. 35. Projected Operations. BISA should have no difficulty in attaining its target for approvals through 1980 at a conservatively projected growth rate of about 12% per year. Due to large increases in approvals in 1974 and 1975, BISA's assets would triple by 1978 from the year-end 1975 base of $b 211 million. Profitability should also increase significantly to reach a 15% return on average equity from 1978 onwards, which should make BISA's shares more attractive. 36. This projected growth rate would require additional foreign long- term loans of at least IJS$10 million up to 1978, which the proposed loan is to supply. BISA would also require additional resources for working-capital loans, which it could obtain by mobilizing domestic resources through the issuance of debt securities of at least one year term, in addition to Its short-term foreign commercial bank credit lines. BISA has agreed (Section 2.09 of the Project Agreement) to undertake a study to determine the feasib- ility of a program for the sale of such securities and to use its best efforts to carry out a program which would have the equivalent of US$2 million worth of securities outstanding by December 31, 1978. There has been little exper- ience in Bolivia in selling medium-term debt securities, which may result in some unforeseen difficulties in meeting the aforementioned target. 37. Availability of sufficient additional share capital at this time represents a major constraint on BISA's growth. In order to grow at the projected rate and remain within the proposed debt/equity limitation, BISA would need at least US$1.9 million in new paid-in capital by 1978. BISA has informed us that they are in an advanced stage of negotiations with the Deutsche Entwicklungsgesellschaft (DEG), a German Government development institution, as well as with existing major shareholders, for subscriptions of share capital on a pari passu basis of 2:1 with the proposed IFC invest- ment. BISA expects to meet the subscription target of US$1.9 million by 1978. The Proposed Bank Loan 38. General Description. The proposed loan for US$10 million would be utilized to finance the foreign exchange component of projects in the private mining and industrial sectors. Based on BISA's tentative pipeline of projects,  x - about 70% of the loan would be utilized for mining and the rest for industry. However, a continuation of the presently depressed conditions of the mineral market could slow down loan commitments for mining, although medium-term market prospects are reasonably good. Industrial subloans would include lend- Ing to small enterprLses, which are expected to utilize up to 10% of the pro- posed loan. An analysis of BISA's tentative project pipeline indicates that the Bank loan would help finance investment projects whose total cost would be about US$19 million. 39. As requested, the proposed loan would be made to the Government of Bolivia, at the current Bank interest rate and standard commitment fee on the undisbursed balance. It would be relent to BISA on the same terms and condi- tions, but denominated in US dollars. The Government would take the exchange risk between the dollar and the currencies disbursed by the Bank for a fee of 1/4% to be passed on to subborrowers (Section 2.10 of the Loan Agreement). The loan is expected to be committed by December 31, 1978 and fully disbursed by December 31, 1980. Following standard DFC practice, amortization of the loan would conform to the amortization schedules of individual subloans. 40. Subloan Terms and Conditions. Subloans would be for up to 15 years, including a reasonable grace period not to exceed three years. The maximum amount of individual subproject financing would be governed by BISA's exposure limit, which is defined in BISA's policy statement (paragraph 29). Subloans would be denominated in US dollars. BISA would relend Bank funds at the high- est legal interest rate on foreign official funds (now 12% per annum). It would also charge its borrowers a commitment fee on the undisbursed balance (now 1% per annum), a closing fee (2-3% one-time charge), and the Government's fee of 1/4% for the exchange risk between the dollar and the currencies dis- bursed by the Bank. Subloans to small enterprises channeled through the com- mercial banks would also include a 3% per annum guarantee fee charged by the banks. 41. Approval Limits. The limits for subloans not requiring prior Bank approval would be raised from US$250,000 under the IDA Credit to US$600,000 for mining subloans and would be IJS$300,000 for industrial subloans, in recog- nition of improvements in BISA's appraisal capability. In addition, the first two industrial subprojects requiring Bank financing of over US$30,000 (the limit for small enterprise subloans) would be subject to Bank approval (Sec- tion 2.02 (b) of the Loan Agreement). The foregoing limits would result in Bank review of a representative sample (at least 40% of the Bank loan amount), since mining subloans are expected to average US$500,000 and industrial sub- loans US$200,000. A sample of small enterprise subloans would also be reviewed on a post-approval basis. 42. Procurement and Disbursement. Procurement would be in accordance with standard DFC practice, which normally calls for quotations from several suppliers. In the case of small enterprise subloans this would not be re- quired, but BISA would assure itself that goods and services procured are reasonably priced. Disbursements would be made directly to BISA with notif- ication to the Central Bank. Disbursements would cover the full foreign  - xi - exchange cost of direct imports, 35% of construction costs, and 60% of im- ported machinery and equipment purchased locally, both representing their estimated foreign exchange component (see Section 2.02 (a) of the Loan Agreement). Foreign equipment suppliers are fairly well represented in Bolivia. The Proposed IFC Investment 43. The proposed IFC investment would be for up to $b 11 million (US$550,000 equivalent) for 100,000 of BISA's common shares of par value $b 100 each at the price of $b 110 per share. It would be paid in from 1976 to 1978 and would be matched pari passu by payments from other sources of at least double the amount (paragraph 37). This would be reflected in the share subscription agreement. The proposed investment would make IFC an important shareholder in BISA, with about 15% of share capital in 1978. IFC's first payment under the subscription agreement is a condition of effectiveness of the proposed Bank loan (Section 6.01 (c) of the Loan Agreement). Economic Benefits and Justification 44. Based on an analysis of BISA's list of projects under consideration, it is expected that the economic rate of return (ERR) of the mining subprojects to be financed under the proposed loan, like those being financed by the IDA Credit, would exceed 40%. The high ERR is not surprising since most of BISA's mining subloans are for the improvement and expansion of existing mines. ERRs of new operations would be much lower. Projections indicate that the mining subprojects are likely to make contributions to Bolivia's net foreign exchange earnings of about US$115 million (net of import requirements) and to govern- ment revenues of nearly US$50 million, cumulative from inception up to 1985. Production increases are expected to account for about 20% of the output of medium mines and for some 5% of the cumulative mining output of Bolivia over the same period. Due to the need for relatively capital-intensive production methods, direct employment created would be relatively minor, about 650 jobs. Some improvement could be expected in health and safety conditions as a consequence of expansion and modernization of the mines, and in the standard of living of mine workers as a result of associated investment in on-site housing and infrastructure facilities. 45. Due to the variety of industrial subprojects, it Is not possible ex ante to estimate the ERR for this part of the loan. BISA assures itself, however, of the economic viability of the subprojects it finances, and does not normally finance projects with an ERR of less than 12%. A review of the evaluations of 10 recently approved industrial subprojects showed an average economic rate of return of 22%, which is satisfactory. The industrial sector review undertaken in connection with the appraisal of this project also con- cluded that Bolivian industry on the whole is only moderately protected, and appears to have been developing along the lines of comparative advantage (para. 11). In addition, it shows that potential still exists for efficient import substitution projects, such as those BISA normally finances. The em- ployment potential of industrial subprojects is difficult to quantify, but is expected to exceed that of mining. This should be particularly true of  - xii - the small enterprise subprojects. A sample of 12 such firms (which pre- viously received BISA financing) showed a favorable ratio of US$3,500 assets/ job on the average, an indication of their considerable employment potential. The part of the loan for small enterprises and artisans should be regarded as a pilot operation which would help provide the Bank with information and experience to lay the basis for a posslble larger involvement at a later date, and in this way complement the Bank's efforts to help the urban population at a lower income level. 46. Scarcity of term credit has continued to be a major deterrent to the growth of the mining and processing industries, in which Bolivia has a compara- tive advantage. Several years of political stability and increased export earnings have improved prospects for private investments, and have further intensified credit needs. The proposed project, consisting of a Bank loan and an IFC investment, would contribute both directly and indirectly to help fill this major gap in financing. It would provide term financing for prlvate mining and industrial projects, including projects of small industrial enter- prises, while at the same time contributing to the further development of BISA as the principal lending institution of the Bolivian private sector. The project would also contribute to the development of the Bolivian capital market by supporting BISA's efforts to mobilize domestic resources through bond issues and additional share capital. Although the amount to be raised is relatively minor, initial success in this activity could break the ground for much larger issues in the future, which could help meet the considerable working capital needs of Bolivian industry. 47. IFC's potential impact on BISA and on the development of the Bolivian private sector would be particularly significant at this point in time. As stated in paragraph 37 above, availability of share capital repre- sents the principal bottleneck to BISA's growth. The proposed investment and the parallel investments it would induce would allow BISA to increase its assets by up to US$10 million to help meet the great demand for term funds by private industrial and mining enterprises. 48. The proposed investment could constitute the basis for a mutually beneficial long-term relationship. BISA could be utilized as an important investment "window" in Bolivia, which could provide the Corporation with more opportunities to participate directly in the development of the Bolivian private sector. The investment is estimated to have a discounted rate of return exceeding 10% in current dollars, which is acceptable. The Bolivian Government views the proposed IFC investment favorably. 49. There are no unusual risks involved in the project. Whlle not probable, It is however possible that delays in obtaining local subscriptions to BISA's share capital could result in some delays in the disbursement of both the loan and investment. Also, since it would be the flrst time that BISA would try to issue bonds in the domestic market, some unforeseen setbacks could occur. A continuation of the presently depressed conditions of the mineral market could also result in a slowdown of loan commitments. How- ever, medium-term market prospects are reasonably good.  I. THE MIINING SECTOR A. The Bank Group's Participation in the Sector 1.01 The Bank Group has been active in Bolivia's mining sector since the early 1970s. The Mining and Metallurgical Sector Report No. PI-14, of 1972, made specific recommendations regarding the Government's development policies and institutions for the sector and stated investment priorities. Subsequently, IDA Credit No. 455-BO has made possible the expansion and modernization of medium-sized mines and has contributed to strengthening Banco Industrial (BISA), a private development bank, as the intermediary for the mining credit (para. 5.02). The credit also provided financing for the Survey of Small Mines, for a study on the reform of Bolivian mining taxation, for a feasibility study of a mining exploration fund and for setting up a documentation center within the Ministry of Mines and Metallurgy. Together with the preceding sector report, the IDA Credit was instrumental in initia- ting reforms in crucial mining policy and administrative areas such as ex- ploration, foreign investment, taxation, and credit. 1.02 A follow-up mining sector mission visited Bolivia in early 1976. Its report is now under preparation and will focus especially on major sector policy issues, including taxation, investment, commercialization and the mining development proram included in the Government's forthcoming 1976-80 Development Plan. 1.03 The present project will, among other things, expand the scope of medium mining investment and will further assist BISA in becoming a financial- ly stronger and technically competent development bank, thus consolidating the gains made with the first IDA Credit. In preparation is a small mining development project aiming at the transformation of small mines with economic mineral reserves into viable operations, and also at strengthening BAMIN, the selected credit intermediary. For that purpose, the loan would contain tech- nical assistance to both BAMIN and the subborrowing miners. 1.04 Also, on the basis of a study by the US Geological Survey, financed under IDA Credit No. 455-BO, the Government is to submit a proposal for the Bank's participation in the financing of a mining exploration fund, which is to be set up in Bolivia. In view of the importance of exploration for the sector's development, the Bank's participation in a soundly conceived explora- tion fund would be very important. However, in view of policy implications, consultations with the Executive Directors would be necessa-y before any Bank commitment could be made. B. Contribution to the Economy 1.05 Mining in Bolivia, since colonial times, has been an important economic activity, second only to agriculture. Its share in GDP during  - 2 - 1968-75 averaged 13%. 1/ The sector's contribution to exports and fiscal revenues is even more important. Almost the entire mining output is ex- ported and mining has been the principal source of the country's foreign exchange, accounting for nearly two thirds of merchandise exports in 1968-75. Over the same period, the sector also provided 15% of central government revenues. Due to largely capital-intensive production methods, the number of persons employed in mining is rather low, about 60,000-75,000, equivalent to about 3% of the employed labor force. However, due to sharp swings in pro- duced volumes and attainable prices, the sectoral contribution to output, employment, exports, and fiscal revenues has fluctuated significantly in individual years. 1.06 Bolivia produces a wide range of minerals which vary greatly in importance. Tin is still the most important and Bolivia is the second largest producer of this mineral after Malaysia. Tin output has stagnated since the late 1960s, and its share in mining output fell to below 60% by 1974. Most other minerals performed better. The relative importance of Bolivian minerals is shown in the following table: Minerals Produced in Bolivia, 1965-1974 Share in Bolivian Production /1 Share in World Production /2 1965-74 1965-69 1970-74 1965-74 1965-69 1970-74 ----------(Percent)---- ---------(Percent)--------- Tin 62.1 68.0 58.6 12.9 13.4 12.6 Zinc 7.1 3.5 9.3 0.6 0.4 0.8 Antimony 7.0 5.0 8.2 21.4 19.8 23.3 Tungsten 5.9 5.2 6.4 * * * Copper 5.0 5.0 5.1 0.1 0.1 0.1 Lead 3.7 4.2 3.4 0.7 0.7 0.6 Silver 5.7 5.9 5.7 1.9 1.8 1.9 Bismuth 2.3 1.3 2.8 * * * Gold 0.3 0.7 - 0.04 /3 0.07 * Cadmium 0.2 - 0.2 0.2 0.01 0.4 Other 0.7 1.2 0.3 * * * /1 Value. /2 Volume. /3 1965-72. *Not available. Source: Government of Bolivia, Ministry of Mines and Metallurgy. "Metallstatistik 1964-74" Metallgesellschaft. 1/ Based on Current Economic Position of Bolivia, Report No. 786-BO, Tables 2.1 and 2.2.  -3- 1.07 The bulk of Bolivia's mining output is still exported in the form of concentrates with a metal content ranging from less than 25% to 60%. Except for on2 third of tin and antimony production, minerals are not refined in Bolivia, Thuis, refining fees and transport costs are incurred abroad, which reduce net earnings from mineral exports by about 20%. The import re- quirements of miniiig are also substantial. Virtually all machinery and equip- -rnent has to be imported, elevating the import content cf fixed mining invest- ment to about C0%. The import content of operational costs exceeds 30%. C. Sectoral Structure 1.08 Mining enterprises in Bolivia basically fall into three categories whose contribution to sectoral exports, employment and fiscal revenue is shown below; Subsector Shares in Mining Exports, Employment and Taxes, 1965-75 (Percent) Mining Mining Mining Exports Employment Taxes Large Mining (COMIBOL) 58 40 58 Medium Mining 22 10 28 Small Mining 20 50 15 1.09 The dominant entity is the State-owned Bolivian Mining Corporation (COMIBOL), which owns and manages 14 large nationalized mines and accounts for over one half of mining exports and taxes, and over one third of mining employment. COMIBOL is beset by particularly serious problems. Inflexibility in decision-making, resulting from over-centralization and extremely diffi- cult labor relaticns, has led to inefficient use of labor, with only about 40% of the labor force employed underground. Excessive social welfare expen- ditures have been undertaken on behalf of the Central Government, while essen- tial operations and main4enance expenditures have not been carried out. In general, COMIBOL lacks a'*ommercial approach to mining operations. Only very recently has there been some investment in beneficiation, resulting in in- creased recovery ratios and higher concentration of minerals, despite a de- clining metal cortent of ores. Nevertheless, COMIBOL's operational costs continue to exceed those of medium mines, especially for tin. The resolution of COMIBOL