Morocco - Phosphate Fertilizer Expansion Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-2339-MOR REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO MARCC PHOSPHORE WITH THE GUARANTEE OF THE KINGDOM OF MOROCCO FOR A PHOSPHATE FERTILIZER EXPANSION PROJECT October 4, 1978 This document has a restricted distribution and may be used by recipients only in the performance of their offcial duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS WEIGHTS AND MEASURES US $1.00 - DH 4.3 All weights and measures are in DH 1.00 - US $0.23 metric units Fiscal Year: Calendar Year 1 Ton (T) - 1,000 kilograms (Kg) 1 Ton (T) - 2,204 Pounds 1 Kilometer (Km) - 0.62 miles 1 Cubic Meter(m3) - 264 US Gallons ABBREVIATIONS AND ACRONYMS BNDE Banque Nationale de Developpement Economique CIF Cost, Insurance and Freight Comanav Compagnie Marocaine de Navigation FAS Free Alongside Ship Gazocean French Partner in the Shipping Company KfW Kreditanstalt fur Wiederaufbau MAP Mono-Ammonium Phosphate (11-55-0) containing 11% of N and 55% of P205 Marphocean The Shipping Company MC Maroc-Chimie Company OCP Office Cherifien des Phosphates P205 Phosphoric Pentoxide - Nutrient Element in Phosphatic Fertilizer TPD Metric Tons per Day  FOR OFFICIAL USE ONLY KINGDOM OF MOROCCO MAROC-PHOSPHORE PHOSPHATE FERTILIZER EXPANSION PROJECT LOAN AND PROJECT SUMMARY Borrower: Maroc-Phosphore Guarantor: Kingdom of Morocco Amount: US$50 million in various currencies Terms: 14 years, including 4 years of grace with interest at 7.35 percent per annum. 1/ In addition, a fee of 2.65 percent would be charged by the Guarantor. Project Description: The project consists of the expansion of the Borrower's production facilities at Safi, for which a Bank Loan of US$50 million was made in 1974 (Loan 1017-MOR), through: (a) the erection, on the site of the existing Maroc- Phosphore plant, of an additional unit to produce for export 165,000 tons per year of phosphoric acid, complete with ancillary facilities and related civil works; (b) the construction of sulfur melting units and sul- fur storage facilities; and the construction of new phosphoric acid concentration and storage facilities. Once in full production, the net export value of the entire plant output will be about US$200 million per year in 1978 terms; the expansion project with an estimated financial rate of return (after taxes) of 15 percent and an economic rate of return of 19 percent, and the entire project with an estimated financial rate of return (after taxes) of 14 percent and an economic rate of return of 19 percent. No special implementation and market risks are expected. 1/ These terms are appropriate on project grounds. This document ha a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosd without World Bank authorization.  Project Costs: (US$ Million) Foreign Local Total Turnkey Contracts Sulfur Handling and Preparation 12.0 5.8 17.8 Sulfuric Acid Unit 9.8 5.3 15.1 Phosphoric Acid Concen- tration & Storage 2.6 1.6 4.2 Phosphoric Acid Unit 20.4 9.0 29.4 Electrical Installations 14.3 6.3 20.6 Other Installations & Pre- Operational Expenses 9.0 4.0 13.0 Spare Parts 2.3 - 2.3 Base Cost Estimate 70.4 32.0 102.4 Physical Contingencies 1.7 1.0 2.7 Price Contingencies 2.7 3.2 5.9 Additional Working Capital 1.0 5.0 6.0 Total Project Cost 75.8 41.2 117.0 Interest during Construction 5.5 1.9 7.4 Total Financing Required 81.3 43.1 124.4 Financing Plan (US$ Million) Foreign Local Total % Debt IBRD 50.0 _ 50.0 40 Polish Loan 13.7 - 13.7 11 Total 63.7 - 63.7 51 Equity OCP* and Maroc-Phosphore Cash Generation 17.6 43.1 60.7 49 Total 81.3 43.1 124.4 100 Estimated Disbursements: (All in foreign exchange) (US$ Million) 1979 1980 1981 Annual 27.5 17.5 5.0 Cumulative 27.5 45.0 50.0 * Office Cherifien des Phosphates.  Economic Rate of Return: Expansion Project: 19 percent. Entire Project: 19 percent. Appraisal Report of the Original Project: Report No. 351-MOR, dated April 19, 1974 Industrial Projects Department (see Annex IV to this Report for a summary excerpt of the original project Report of May 17, 1974).   REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO MAROC PHOSPHORE WITH THE GUARANTEE OF THE KINGDOM OF MOROCCO FOR A PHOSPHATE FERTILIZER EXPANSION PROJECT 1. I submit the following report and recommendation on a proposed loan to Maroc-Phosphore, with the guarantee of the Kingdom of Morocco, for the equivalent of US$50 million to help finance a phosphate fertilizer expansion project. The loan would have a term of 14 years, including 4 years of grace, with interest at 7.35 percent per annum. The Government of Morocco would charge a guarantee fee of 2.65 percent per annum on the out- standing amount of the Bank loan, bringing the cost of the loan to Maroc- Phosphore to 10 percent per annum. It is expected that the Polish Government will contribute US$13.7 million equivalent towards the cost of the project with a term of 14 years including 4 years of grace with interest at 7.25 percent. PART I - THE ECONOMY 2. A report entitled "Country Economic Memorandum on Morocco" (1473-MOR) was distributed to the Executive Directors in June 1977. An economic mission visited Morocco in February/March 1978 in preparation of a basic economic mission scheduled for November 1978. The findings and conclusions of this mission are reflected in the following paragraphs. Country Data Sheets are attached as Annex I. Recent Developments 3. Over the past year, Morocco completed the return towards a parlia- mentary regime. Following the national consensus that had resulted from the Western Sahara issue, King Hassan II called municipal, provincial and national elections between November 1976 and April 1977. Opposition parties with platforms stressing social reform scored strongly in municipal elections in the larger cities, while at the provincial level, the rural constituencies supported Government candidates, who obtained a majority of 141 seats out of 264 in the National Assembly. The post-election Government formed in October 1977, brought back into political responsibility the Istiqlal party which had been in the opposition since 1963, and the Mouvement Populaire whose main support is in the Berber areas of the country. The new Cabinet was appointed with the explicit mandate to prepare and implement economic austerity measures, the first of which were included in the 1978 Budget Law, and to pursue the social development objectives introduced with the 1973-77 Development Plan. 4. Morocco's economic and financial situation has been less balanced in 1977 than in previous years. The rapid growth of investments and imports, carried over from 1974-75 when phosphate export receipts reached an all-time high, did not slow down despite Government restrictions, while the world  -2 - demand for Morocco's main exports, especially phosphate, recovered only moderately. At the same time, efforts to increase budgetary savings were insufficient to meet the continued increase in expenditures on investment and security. As a result, in 1977 Morocco registered a large resource gap (15 percent of GDP) and overall budget deficit (15 percent of GDP), not including special military import payments and offsetting external grants. To cover these deficits, Morocco sharply increased external borrowings to $1.7 billion (commitments), from $878 million in 1976 and $710 million in 1975; most were from commercial sources. Despite these borrowings, the country's net foreign assets stayed at a rather low level (1.2 months of 1977 imports by year's end). On the domestic side, external borrowings have fueled monetary expan- sion which remained rapid in 1977; consumer prices rose nearly 13 percent over 1976 compared to about 8 percent in the previous two years. 5. The Government intends to reverse these unfavorable trends. A first policy package was introduced with the 1978 Budget Law, which cut Government capital expenditure by DH 2 billion (4 percent of 1977 GDP), introduced tax measures which should yield an estimated DH 550 million (1 percent of 1977 GDP) and contained current expenditure in sectors other than education, health and defense. Private credit expansion was limited to 3 percent for the first six months of 1978 and a number of imports were subjected to quantitative restrictions or higher tariffs. Furthermore, following the deterioration in the balance of payments which occurred during the first six months of 1978, the Government introduced a second policy package in June 1978. It includes a number of exchange and trade measures which aim at further tightening of import controls, encouraging workers' remittances from abroad, and raising interest rates for several types of deposits. Moreover, the Government intends to further reduce its capital expenditure to DH 7 billion (DH 10 billion in 1977). These measures may cause total investment to decline by 25 percent in 1978 and result in a substantial reduction in demand for imported capital and intermediate goods. Simultaneously, favorable weather conditions during the past winter should result in record crops enabling Morocco to reduce imports, particularly of cereals, and to maintain GDP growth at around 6 percent. External demand for phosphate rock is also expected to pick up and phosphate exports may reach their 1974 peak level without a recovery of prices. As a result, Morocco's resource gap may narrow to about 9 percent of GDP in 1978, and external borrowing needs may be reduced to around $1 billion in commitment terms. 6. The Government also announced that instead of a five-year plan (1978- 82), a three-year interim plan (1978-80) will be introduced in Parliament before the end of 1978. This plan will call for a reorientation emphasizing socially-oriented and directly productive and export-oriented projects. Imple- mentation of many major public projects has been postponed including that of a steel plant at Nador. In the meantime, ministries and other Government agencies are operating under the 1978 budget law which includes projects carried over from the 1973-77 plan and a few new projects. 7. The policy measures described above should be effective in re- balancing the economy. They essentially mean retrenchment and will affect adversely GDP growth and employment creation. Furthermore, the Government  - 3 - is aware that continued prudence in financial management and project selection will probably be needed in the next two years, in order to achieve the objective of putting the economy back on a financially sound growth path for the medium term. The Government is, however, likely to adopt a policy mix which will put less emphasis on retrenchment, and give more weight to export promotion, addi- tional tax measures, and an increase in domestic savings. Economic Development Issues and Prospects 8. Bank projections summarized in Annex I testify to the Government's keen concern of avoiding a liquidity crisis in the next two to three years. They assume sharp policy adjustments in order to keep the economy on a finan- cially viable growth path over the long run, but also reflect the Government's desire to maintain adequate GDP and employment growth during the adjustment period, and to achieve further progress towards the country's social objectives. The projections show that investment and GDP growth will indeed have to be curtailed for the next three to four years, given the short-term constraints on savings and exports. In this period, Morocco will need substantial capital transfers from abroad to sustain the projected investment and GDP growth levels; these transfers should be on terms as favorable as possible in view of the debt service limits. Beyond 1982, Morocco's export prospects should enable it to resume rapid growth of investments, output and employment while progressively reducing the relative burden of debt and debt service. 9. In the original 1973-77 Plan, annual GDP growth was to average 7.5 percent, sustained by rapid export expansion (10 percent p.a.) and a doubling of investments between 1972 and 1977. Following the large windfalls in foreign exchange and domestic savings caused by high phosphate prices in 1974-75, the investment target was raised to meet cost increases and some real expansion of original investment programs, and especially to undertake large capital- intensive projects geared to import substitution (in particular sugar, chemi- cals, shipping and steel). 10. The GDP growth target for 1973-77 was nearly met. Investment rose to nearly 32 percent of GDP in 1977 from less than 14 percent in 1972. In the process, Morocco built up its capacity to prepare, implement and absorb projects, not only in traditional sectors such as irrigation, import- substitution industries and physical infrastructure, but also in new and more difficult sectors such as rainfed and small-scale agriculture, export industries, and socially-oriented programs. There is little doubt that Morocco can achieve the investment levels assumed in the Bank projections. 11. The major shortcoming in the past, and the main problem for the years ahead, concerns domestic savings, which returned in 1977 to about the same level (14 percent) as in 1972 after a brief increase to 16 percent dur- ing the phosphate windfall years. The reasons lie mainly with the low Govern- ment savings of only 4.5 percent of GDP in 1977. Successful efforts to raise current Government revenues to 23 percent of GDP in 1977 were offset by increases in current spending, partly for education and health, but particu- larly for price subsidies and military expenses. To increase public savings  - 4 - in future will require tax reform measures, which were called for in the 1973- 77 Plan but were not implemented, and unpopular price policy decisions, such as reducing subsidies to urban consumers, farmers and industrial investors. In particular, improving domestic resource mobilization would require adjust- ing interest rates to reflect changes in the rate of domestic price inflation. 12. During the 1973-77 Plan period, exports rose by less than 2 percent p.a. in real terms (the Plan target was 10 percent). This lackluster per- formance was largely due to weak external demand for Morocco's main export products since 1974, especially phosphate, other minerals and agricultural products. Moreover, with some exceptions, such as textiles, export production and marketing were not sufficiently improved, and new markets were not aggres- sively sought; the dependence on EEC (especially French) demand continued. Yet, Morocco has considerable export potential which can be realized if pro- duct and market diversification is pursued aggressively. Export programs are under preparation especially in phosphate, its derivatives, fresh and processed foodstuffs, and tourism. For example, with regard to phosphate, Morocco and the USSR signed agreements in March 1978, under which Morocco will be able to export phosphate rock and phosphoric acid for the next thirty years in amounts possibly rising to 10 million tons per year by 1985-86; in return, the USSR will lend Morocco up to $2 billion on favorable terms to develop its phosphate export capacity and will export various commodities and goods to Morocco, including crude oil. These agreements substantially improve Morocco's long-term prospects for phosphate exports. 13. While the Government's stress on completion of high-return projects will have to be continued, a qualitative shift in investment, away from the recent emphasis on highly capital intensive, import substitution investments, as well as from some of its ambitious programs for physical infrastructure, will also be needed. A major study on industrial investment strategy which consultants are currently completing for the Government, should facilitate a better investment selection. A changed investment pattern should help both to reduce the external resource gap, and to contribute to growth and employ- ment at lower investment and import costs than in recent years. Social Development Strategy 14. Comparatively slow economic growth and employment creation up to the early 1970's were accompanied by widening income disparities and per- ceptible declines in real consumption for the weaker sections of Morocco's population. The 1973-77 Plan set out, as a national objective, to reverse these unfavorable trends. The Government's strategy since 1973 has empha- sized: (i) acceleration of employment creation; (ii) general measures aimed at reducing income disparities, and (iii) specific investment programs tar- getted on the least favored population groups. 15. Progress has been made towards attaining these objectives, as wit- nessed for example by the increased expenditures for social sectors (from DH 1.3 billion in 1972 to DH 3.7 billion in 1977). The institutions, how- ever, often newly established to meet social sector objectives, are in many instances still fragile. Understaffing and weak policy analysis and program  formulation are still common. Public programs to improve productivity, col- lective amenities and social services are, as a result, reaching relatively small proportions of the large groups, especially in rural areas. To add to this, in the period of financial stringency ahead, Morocco will not be able to sustain the current level of expenditures on socially oriented sectors, and cuts have been made as part of the measures to re-balance the economy. 16. With the population growth rate now at about 3 percent, the pres- sure to provide adequate social services will increase and it will become increasingly incumbent on the Government, despite its short-term financial constraints, to intensify its effort to limit such growth. Consequently both health and family planning services will have to be quantitatively and qualitatively strengthened to meet the Government's social objectives. External Debt And Debt Service 17. Morocco has sharply increased external borrowings since 1973 (para. 4). Nearly all of the increase came from Arab and commercial sources. With a hardening of terms on new commitments, average maturity shortened from 19 to 10 years and average interest rose from 5 to 7.5 percent between 1974 and 1977. Morocco also drew on the IMF automatic credit facilities in early 1976, and obtained about US$70 million in IMF compensatory financing in August 1978. From the low levels registered in 1974-75, Morocco's external debt has risen rapidly to an estimated $3.8 billion (disbursed only) at the end of 1977, and in that year debt service amounted to nearly $250 million (13 percent of exports and 10 percent of exports and workers' remittances). As a result of recent and projected borrowings, debt and debt service may be expected to increase further, and the debt service ratio may reach a peak of about 25 percent of exports and workers' remittances by 1980-82, and decline progressively thereafter. The country's net foreign assets may be expected to remain at a relatively low level. Because of the expected upswing in debt service, external debt management has become more restrictive and selective in 1978. If debt service is to stay manageable, Morocco will have to con- tinue this policy over the next few years. Additional commercial borrowing should be limited, and increased efforts should be made to seek loans on softer terms. External borrowing requirements are nonetheless likely to be sizeable. Assuming debt service should not in any year exceed 25 percent of exports and workers' remittances, Bank projections foresee average annual borrowing needs of $1.3 billion in 1978-82 and $1.5 billion in 1983-87 in terms of commitments. Beyond 1980, however, the situation should progressively improve with the Government exercising firm control over domestic demand, and good long-term prospects for exports--in particular, of assured sales of phos- phate rock and phosphate derivatives. Morocco should therefore be considered creditworthy for further Bank lending. PART II - BANK GROUP OPERATIONS IN MOROCCO 18. Bank and IDA lending to Morocco has supported 37 projects, financ- ing a total of $918.9 million (net of cancellations), of which $705 million  - 6 - has been lent since the beginning of FY73. IDA credits, totalling $50 mil- lion, have been made available for five projects. A Third Window loan for $25 million for the third education project was approved in March 1976. IFC investments have amounted to $12.6 million ($10.5 million after cancellations, terminations, repayments and sales). Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of August 31, 1978, and notes on the execution of ongoing IBRD/IDA projects. In some cases, delays in project implementation have been caused by management or procurement difficulties, and in 1974 cost overruns increased due to the upsurge in investment activity in Morocco and the acceleration of inflation. Overall performance in project execution however, has considerably improved during the last three years. Total disbursements as of December 31, 1977, amounted to 81 percent of original appraisal forecasts and to 85 percent of revised forecasts. 19. Past Bank Group lending has been concentrated in the agricultural and industrial sectors, which have accounted for 32 and 31 percent, respec- tively, of total net commitments; the balance is represented by utilities (18 percent), tourism (8 percent), roads (5 percent), education (4 percent) and urban development (2 percent). Apart from the transfer of resources to Morocco (Bank Group gross disbursements amounted to 5.5 percent of total fixed investment in 1970-74), the main objectives of lending were to foster and strengthen development institutions, provide technical assistance especially for project preparation, and increase productive capacity, particularly in order to improve the balance of payments. 20. While these objectives remain, greater emphasis is being given to prepare projects that support the Government's policy of fostering social development and improving income distribution. An increasing share of Bank Group lending will be devoted to projects directly or indirectly developing the productive capacity of the lowest urban and rural income groups and meeting their basic needs, including, possibly, Bank participation in the Government's program for promoting integrated regional development, which is under discussion. 21. Past lending for agriculture has supported irrigation development, credit and, through a first operation in FY75, improvement in the produc- tivity of rainfed farming. Continued selective lending for irrigation is envisaged but emphasis will be increasingly given to support small farmers and the development of rainfed areas. The Fez-Karia-Tissa Agriculture Proj- ect, approved in June 1978 was the second, after the Meknes Project (Credit 555-MOR) to directly address these objectives with the added advantage of being located in the favorable cereal producing zone. An integrated rural development project, including livestock/forestry development, is under preparation in a rainfed zone in northern Morocco, as are projects aimed at extending agricultural credit to farmers and at developing production, mar- keting and processing of vegetables on small holdings. A Government program for promoting integrated regional development is also under discussion. 22. Projects in industry and tourism have had as key objectives increased foreign exchange earnings or savings and the improvement of sectoral policies,  which have taken on increased importance in view of the country's short-term resource constraints. The recently approved eighth loan to BNDE included a pilot small-scale industry component. A follow-up project to promote labor intensive investments is under preparation. The proposed loan would finance the addition of a fourth production line of phosphoric acid for the Maroc Phosphore Plant financed under Loan 1017-MOR. Continued lending for industry through the Banque Nationale pour le Developpement Economique (BNDE) is con- templated as well as further lending to Credit Immobilier et Hotelier (CIH) for tourism development. A port project is also under consideration to assist the Government's efforts to develop year-round importing facilities for Morocco's growing oil needs. 23. Previous lending for utilities has consisted of one loan for water supply, two loans for power and one engineering loan for the preparation of a sewerage project for Casablanca. A follow up project for water supply and distribution in urban centers, including distribution to low income urban consumers, is under preparation, as are a sewerage project in Agadir and a village electrification project. 24. Education continues to need attention in ensuring Morocco's develop- ment. Two credits and a loan have been made to develop secondary education and teacher training, to improve technical and vocational training, and to expand facilities in rural areas. A fourth project with emphasis on technical education has been recently negotiated. 25. The recently approved Rabat project was the first Bank-financed project in the urban sector. Follow up projects are under consideration to support the Government's program for slum upgrading and urban development through the provision of basic infrastructure, housing and social. services and the creation of employment opportunities. 26. Loan commitments from multilateral and bilateral official sources to Morocco rose from $221 million in 1975 to $294 million in 1976 and $634 million in 1977. The major sources of aid were France, Saudi Arabia, the UAE, the U.S., Germany and the Bank Group. At the end of 1977, the Bank Group's share in Morocco's outstanding and disbursed external public debt was 10 percent. The share of the Bank Group in debt service was 24 percent in 1976 and declined to 14 percent in 1977. By 1983 the Bank Group's shares in debt outstanding and in debt service are expected to be about 25 percent and 12 percent respectively. PART III - PHOSPHATE FERTILIZER AND PHOSPHORIC ACID MARKET 1/ 27. Background on the phosphate fertilizer and phosphoric acid market was provided in Part III of my Report dated May 17, 1974 (P-1449) to the 1/ Phosphoric acid, P205, an intermediate product in the manufacture of concentrate phosphatic fertilizers, is generally produced by reacting phosphate rock and sulfuric acid.  - 8 - Executive Directors, and is attached hereto under Annex IV. The predictions made with regard to an expected decline in phosphate prices have in fact occurred and prices (about $33 per ton FAS for high grade Moroccan rock) are presently about 50 percent below the peak prices that were obtained in 1974. These high prices which remained in force throughout most of 1975 had, however, a more adverse effect on consumption growth than had been predicted so that the world phosphate consumption in 1976/77 reached only about 26.3 million nutrient tons as compared to the 31.3 million tons fore- cast for that year in 1974. The consumption pattern of phosphatic fertilizer has remained as predicted and presently about two thirds of such consumption occurs in North America, Western and Eastern Eurcpe including the USSR. Worldwide supply capability of phosphate fertilizers in the same year (1976/ 77) had reached about 29.3 million nutrient tons, indicating a potential supply excess of 3.0 million tons, mostly in North America and Western Europe. After the dip in the 1974/75 period, world phosphate fertilizer consumption is again expected to continue to grow at a rate of 5 percent per year through the 1980's (i.e. slightly below the 5.5 percent rate that had occurred in the 1969-73 period), with most of the growth taking place in Eastern Europe and the USSR and in the developing countries. It is expected that the surplus supply situation will disappear by the early 1980's and bring about a stabili- zation in prices of phospate rock, intermediate products, such as phosphoric acid, and finished phosphate fertilizers at above their current levels. 28. The major structural change in the trading pattern of phosphates mentioned in my 1974 Report is in fact now taking place and will accelerate. Several rock-producing countries favorably located for export--Morocco being prominent among them--will continue or commence to vertically integrate pro- duction and exports of processed phosphates. For example, during the period 1971/72 to 1976/77, international trade of phosphoric acid (P205) increased by an average of 34 percent per year from 0.3 to 1.3 million tons. Therefore, demand for exportable phosphoric acid has not experienced the temporary decline in demand that phosphate rock exports did in the mid-1970's and acid prices are now at about the level predicted in 1974 ($230-250 per ton de- livered). The additions in phosphoric acid capacity over the next five years will be only marginal in North America (0.2 million tons) and Western Europe (0.1 million tons), but more substantial in Africa (1.7 million tons), Latin America and the Near East (about 1.3 million tons each), and Eastern Europe including the USSR (2.3 million tons). 29. Morocco has more than half of the world's known phosphate reserves, and in 1977 accounted for about a third of world trade in phosphate rock. It has decisively opted for the strategy of participating in the rapidly developing trade of phosphate intermediate products used in the manufacturing of high grade phosphate fertilizers. In so doing, it has sought to become a leader in bridging the gap between producing and consuming countries, while at the same time equipping itself with the necessary infrastructure such as terminals and a shipping company (see Annex IV, para. 9) to ensure ready access to markets for its intermediate products. The existing production units, located near Safi, presently have a total annual capacity of 858,000 tons of phosphoric acid, and are also equipped to produce small quantities  - 9 - of other phosphate intermediate or final products. The Office Cherifien des Phosphates (OCP), a state-owned company, which has the responsibility for the development of Morocco's phosphate industries, plans to expand annual produc- tion capacity at Safi to 1,518,000 tons of P205 by the mid-80's, first through this expansion project by adding a fourth line (with a capacity of 165,000 tons of P205 annually) to the existing Maroc-Phosphore plant, and then by building a second Maroc-Phosphore plant (with a capacity of 495,000 tons of P205 annually). In the long term, the OCP has plans to build additional units near the port of Jorf Lasfar to produce phosphoric acid, mono and di-ammonium phosphates and triple superphosphate. In view of Morocco's comparative advantage in this sector, the level of development it has achieved, and the positive market prospects, such a strategy is appropriate. The proposed project constitutes the next step in implementing this strategy while at the same time helping Morocco meet its foreign exchange needs. PART IV - THE PROJECT The Original Project 30. The proposed project would be an expansion of the original Maroc- Phosphore project approved by the Executive Directors on June 30, 1974. It consisted of the construction of a phosphatic fertilizer plant at Safi, to produce in three units annually 495,000 tons of phosphoric acid (P205), of which 371,250 tons were to be exported and the balance converted into 225,780 tons per year of monoammonium phosphate (MAP) for the domestic and export markets. Total project financing, including interest during construction and initial working capital was estimated at $155.5 million, of which about $100 million was in foreign exchange. The Bank provided a loan of $50 million to Maroc-Phosphore, an OCP subsidiary, to meet a portion of the foreign exchange cost, the balance of which was to be provided by loans from the Kreditanstalt fur Wiederaufbau (Germany) and the Banque Nationale de Developpement Econo- mique (Morocco), and by OCP's equity contribution. The entire local cost was to be covered by equity subscribed by OCP. The detailed description of the original project, as well as the organizational, financial and procurement arrangements, were summarized in Part IV of my 1974 Report (attached hereto under Annex IV). The loan was signed on June 27, 1974, and became effective February 27, 1975. 31. A particular aspect of the original project was that it was to be executed under a turnkey contract. After international competitive bidding, Maroc-Phosphore selected the lowest evaluated bid submitted by a consortium, headed by Friedrich Uhde GmbH (Germany), and which included Polimex-Cekop (Polimex, Poland); Lurgi Gesellschaft fur Chemie (Germany); Siemens A.G. (Germany); Nissan (Japan); and Fisons (U.K.). The contract was based on a lump sum price with an escalation clause for price increases of some of the  - 10 - components, such as civil works, with payments in Dirhams for local cost, in Dollars for the Polimex part as per a sub-contract between Uhde and Polimex, and in Deutsche Mark for the foreign exchange balance. Project Execution 32. Implementation of the original project has largely proceeded as planned. Originally, the first two sulfuric and phosphoric acid units were scheduled for mechanical completion by November 1975, with the third unit to be completed by August 1976. Partly because of delays in the start of the civil works and of the difficult equipment delivery situation expe- rienced internationally in the aftermath of the oil price increases in 1973 and 1974, and partly because it was subsequently considered more convenient to implement all three units simultaneously, the three units were completed practically at the same time. Physical completion of the whole plant was achieved in October 1976, i.e. two months behind schedule. Several mechanical problems occurred during the start-up and testing period, which forced the plant to be shut down, inspected, and repaired for extended periods of time. Therefore, the final acceptance of the three sulfuric/phosphoric acid units, based on the strict performance tests defined in the turnkey contract, took place only in December 1977 after all problems had been solved. Maroc- Phosphore has, however, been able to produce and sell phosphoric acid since 1976 (69,000 tons); in 1977, Maroc-Phosphore operated at about 53 percent of capacity and produced 251,000 tons. 33. The MAP unit was mechanically completed on time, but serious mechanical and process problems developed during the start-up and testing period; they are practically overcome now and in May of this year the MAP unit began production of a satisfactory product. The investment cost of the MAP unit represents about 10 percent of total plant investment cost; the lack of MAP production handicapped Maroc-Phosphore's production and export sales pro- gram, yet the phosphoric acid not used by the MAP unit easily found customers on the world market. 34. The cost of the original project, excluding working capital and interest during construction, has increased from $132.1 million to $143.7 million, i.e., by 8.7 percent. The increase in foreign exchange ($6.1 mil- lion) stems for the most part from currency realignments which have taken place, particularly the change of parity of the Deutsche Mark vis-a-vis the US Dollar since 1973 when the contract between Maroc-Phosphore and Uhde was signed. The increase in local currency ($5.4 million) is mostly attributable to higher than expected costs of civil works and labor. Total financing requirements increased by 9.3 percent from $155.5 million to $169.9 million, as interest during construction also went up with the project cost, and start-up of the first two lines was delayed by almost a year. 35. Soon after the start-up of the plant, at the end of 1976, it became apparent that the storage in the open of large quantities of powdered sulfur (after phosphate rock the second most important raw material in the production of phosphoric acid) was causing serious environmental problems. Because of  - 11 - the proximity of the sea, spindrift produces corroding sulfuric and chloridric acids, and high winds spread the sulfur far outside its storage area causing substantial waste of sulfur and safety hazard to personnel and installations. Maroc-Phosphore, already considering the construction of a fourth line, and at a later stage that of a second plant adjacent to the existing facilities, decided to overcome this pollution problem as part of the investment needed to add the fourth line. In future, the sulfur will be melted immediately upon arrival at the site in a battery of four melting units and the liquid sulfur stored in a tank with enough capacity to feed the existing as well as the future units. Also as part of the fourth line expansion, storage for the phosphoric acid will be reorganized and improved. The Proposed Expansion Project 36. Project appraisal took place in late March/early April 1978 and negotiations were held in Washington in mid-May. The Moroccan delegation was headed by Mr. Sellam M'Hamedi, Director, Maroc-Phosphore. The expansion project consists of: (i) a fourth production line of sulfuric acid, with a capacity of 1,500 tons per day (tpd), and of phosphoric acid, with a capacity of 500 tpd, and related ancillary facilities; the fourth Maroc-Phosphore line will be identical in capacity to any of the first three, thereby increasing overall production capacity from 1,500 tpd to 2,000 tpd of phosphoric acid; and (ii) the construction of a sulfur melting facility and storage tanks for liquid sulfur, and the rearrangement of phosphoric acid concentration and storage to handle the increased output. Immediate construction of the fourth line is of a high priority for Maroc-Phosphore given the positive market prospects in derivative products in the medium and long term, and the fact that the addition of the fourth line will constitute a necessary incremental step in satisfying Maroc-Phosphore's market until the planned second Maroc- Phosphore plant, and hence the entire Safi complex, is in full production. In addition, the reorganization of the concentration and storage of phosphoric acid, and the implementation of the sulfur melting facility, will facilitate the second Maroc-Phosphore plant. The fourth line will be located next to the existing three lines, while the sulfur melting and storage facilities will be installed at the southern end of the entire complex. A second jetty now under construction at the port of Safi will handle the shipment of the increased production of the plant. 37. The expansion project is to be implemented by the same capable and competent management team of Maroc-Phosphore which executed the original proj- ect and which will also coordinate all expansion activities with that of the existing units. The project is to be implemented in 30 months, and the fourth line is expected to start commercial operations by July 1981. Cost Estimates and Proposed Financing Plan 38. Total investment costs for the expansion project, including addi- tional working capital and exclusive of interest during construction (see Loan and Project Summary), are estimated to be $117.0 million. Total financing, including interest during construction, is $124.4 million, of which US$81.3 million, or 65 percent, is in foreign exchange. Cost estimates include the  - 12 - lump sum price of $89.1 million for the turnkey contracts, of which $44 mil- lion would be subjected to the same price escalation clause as in the original contract. The foreign exchange costs include about $16.1 million for goods and services being contracted in Poland. 39. The proposed Bank loan of $50 million would cover 40 percent of the project's estimated total financing requirement and 62 percent of foreign exchange expenditures. It would be for 14 years with 4 years of grace. Maroc-Phosphore would pay to the Government a guarantee fee at the rate of 2.35 percent, bringing the total cost of Bank funds to Maroc-Phosphore to 10 per- cent. The foreign exchange risk on the Bank loan would be carried by Maroc- Phosphore. It is anticipated that debt financing for the project will be completed by a $13.7 million loan from the Polish Government with interest at 7.25 percent for 14 years including 4 years of grace. The Polish loan will cover 85 percent of the cost of Polish goods and services and is expected to be finalized by early October. Should there be a cost overrun in the project, OCP would ensure the provision of additional funds towards the cost of the proj- ect, on terms and conditions acceptable to the Bank (Shareholders' Guarantee Agreement, Section 2.02). Effectiveness of the Polish loan or any alternative loan, would be a condition of effectiveness of the proposed Bank loan (Loan Agreement, Section 8.01). The execution and delivery of the Shareholders' Guarantee Agreement on behalf of Maroc-Phosphore and OCP would be special conditions of effectiveness of the Bank loan (Loan Agreement, Section 8.01). $60.7 million of equity financing would be provided by OCP and Maroc-Phosphore cash generation. The equity would finance the local costs and the foreign exchange portion not covered by the Polish loan or the Bank loan ($17.6 mil- lion). The project would thus be financed with 51 percent debt and 49 percent equity, and Maroc-Phosphore has agreed to maintain its overall debt to equity ratio at 55:45, as was stipulated under the original project (Loan Agreement, Section 5.08). Procurement and Disbursements 40. The entire Bank loan amount will be used for foreign expenditures. As was the case for the first loan, disbursement of the portion of the Bank loan ($41.0 million) financing the turnkey contracts will be made against lump sum invoices submitted by Maroc-Phosphore and in agreement with the contracts' payment schedules. To save time and standardize equipment and spare parts, as well as to make operating conditions in the expanded plant compatible with those of the existing facilities, Maroc-Phosphore is contracting directly with the same firms that built the existing facilities at the Safi complex. Maroc-Phosphore intends by early October to have entered into a turnkey contract with Polimex for the sulfur melting and storage facilities and for the sulfuric acid unit, and has already signed a lump sum contract with Siemens for the electrical installations. As for the phosphoric acid unit and the reorganization of the phosphoric acid storage facilities, contract negotiations with the original contractor Uhde did not result in an offer satisfactory to Maroc-Phosphore, due in part to the strengthening of the Deutsche Mark which served to weaken Uhde's competitive position. As a result, Maroc-Phosphore has recently concluded a favorable contract with  - 13 - Spie-Batignolles (France), which has extensive experience in the Safi complex, having built the adjacent phosphoric acid plant for Maroc Chimie, another OCP subsidiary, while also having been the second lowest bidder for the phosphoric acid unit in the original Maroc-Phosphore project. Because of its past expe- rience in the Safi complex, Spie-Batignolles will assure optimal standardiza- tion thereby reducing the investment and operating costs of the expansion project. All three contracts would essentially duplicate the original turnkey contract which the Bank approved in 1974 and the terms of which were quite favorable to Maroc-Phosphore. The Bank has reviewed the Siemens and Spie- Batignolles contracts which are satisfactory and the signing of the Polimex sulfuric acid unit contract would be a condition of effectiveness of the Bank loan (Loan Agreement, Section 8.01(c)). In order to ensure an expeditious and effective execution of the project, civil works under the lump-sum contracts with Siemens and Spie-Batignolles has begun. Both contracts contain fixed payment schedules, and would hence explain the need for retroactive Bank financing for expenditures made after June 1, 1978, amounting to about $5.0 million. This constitutes about 10 percent of the Bank's loan. As a result of the protracted nature of these contract negotiations however, presentation of this loan for your approval had been postponed from June 1978, pending Maroc-Phosphore's selection of a contractor for the phosphoric acid plant. The Bank will not finance goods and services procured in Poland. For the portion not covered by the turnkey contracts which includes other equipment and spare parts ($9.0 million) also to be financed by the Bank, procurement will be through international competitive bidding except for (i) items costing less than $100,000 each, up to an aggregate amount of $2 million, and (ii) items whose availability is limited by the need for standardization of the four production units, and for which limited bidding using international shopping procedures will be followed. It is estimated that these items will not total more than $2 million. Financial Covenants 41. All financial covenants will be identical to those under the origi- nal project. Maroc-Phosphore is to maintain a debt service coverage of at least 1.4 and not to incur any debt that would increase its debt to equity ratio beyond 55:45 throughout the project life of 12 years, as envisaged for the original project. OCP (Shareholders' Guarantee Agreement, Section 2.03) and the Government (Guarantee Agreement, Section 2.02) will continue to guarantee Maroc-Phosphore's sound liquidity and financial position through the same financial covenants as for the first loan (see key financial pro- jections below). Furthermore, Maroc-Phosphore will inform the Bank prior to undertaking any new major capital investment in manufacturing of intermediate and finished phosphate fertilizers (Loan Agreement, Section 5.06). Finally, Maroc-Phosphore will have its accounts audited by independent auditors accept- able to the Bank (Loan Agreement, Section 5.02). The project's key financial indicators are given below:  - 14 - Key Financial Projections: (For the Original and Expansion Project) 1978 1979 1980 1981 1982 1983 1984 Debt/Equity Ratio 50/50 50/50 48/52 42/58 33/67 25/75 18/82 Current Ratio 1.2 1.3 1.5 1.8 2.2 2.8 3.4 Debt Service Coverage 2.7 2.4 2.7 2.8 3.3 3.3 3.5 Sales Volume ('000 tons) Phosphoric Acid 330.0 412.5 412.0 453.8 519.8 561.0 562.5 MAP 120.0 150.0 150.0 150.0 150.0 150.0 150.0 Sales Prices (1978 $ton) Phosphoric Acid 250 250 275 275 300 300 300 MAP 150 150 150 150 150 150 150 ---------------------