Nicaragua - Agricultural and Industrial Rehabilitation Project

Document of n I The World Bank FILE CurI FOR OFFICIAL USE ONLY RETIJI TO L CoReport No. P-2661-NI 'INFOBMAInGi GEITER REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT AND THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN AND CREDIT TO THE REPUBLIC OF NICARAGUA FOR AN AGRICULTURAL AND INDUSTRIAL REHABILITATION PROJECT November 29, 1979 r This document has a restricted distribution nd may be usd by recipients only in the performance of their offeia dutife. Its contents may not otberwise be disclosed without World Dank authorization.  CURRENCY EQUIVALENTS Currency Unit = Cordoba (t) US$1 = 0 10 I = US$.10 WEIGHTS AND MEASURES Metric System LIST OF ABBREVIATIONS ADP - Agricultural Development Program AGROINRA - Agroindustrial Division of INRA BAMER - Bank of America BANIC - Bank of Nicaragua BDN - Development Bank of Nicaragua BNN - National Bank of Nicaragua CNA - National Committee for Crops and Livestock DIPSA - Directorate for Agricultural Sector Planning FED - Special Development Fund FIR - International Fund for Reconstruction FRN - Trust for National Reconstruction IAN - National Agrarian Institute IDB - Inter-American Development Bank IDP - Industrial Development Program IFAD - International Fund for Agricultural Development INCAFE - Nicaragua Coffee Enterprise INFONAC - National Development Institution INRA - Nicaraguan Agrarian Reform Institute INTA - Nicaraguan Institute of Agricultural Technology INVIERNO - Institute of National Rural Development MIDA - Ministry of Agriculture and Development SSDP - Small-Scale Enterprise Development UNDP - United Nations Development Program FISCAL YEAR January 1 - December 31  FOR OFFICIAL USE ONLY NICARAGUA AGRICULTURAL AND INDUSTRIAL REHABILITATION PROJECT LOAN, CREDIT AND PROJECT SUMMARY Borrower: Republic of Nicaragua Executing Agency: Fondo Especial de Desarrollo (FED) Amounts: Loan: US$20 million Credit: US$10 million Terms: Loan: 20 years, including 5 years grace with an interest rate of 7.95 percent per annum Credit: Standard The Agricultural Component Relending Terms: The Republic of Nicaragua would channel the proceeds of the Bank loan/credit to the Banco de Desarrollo de Nicaragua (BDN) acting for the Fondo Especial de Desarrollo (FED); the term, grace period and interest rate to the FED would be the same as on the Bank loan to the Government, except that the Government would bear the foreign exchange risk. US$14.5 million of the loan/credit would be redis- counted by FED through participating institutions at interest rates ranging from 7 percent to 11 percent per annum. The participating institutions in turn would onlend to project beneficiaries at interest rates ranging from 10 percent to 14 percent per annum. Subloans would be made for terms of up to one and one-half years for short-term and up to five years for medium-term loans; terms for long- term lending would be up to nine years, including not more than four years of grace. Project Description: The Agricultural Component would provide (i) re- sources through participating institutions to reactivate production of crops and livestock, and (ii) technical assistance to participating insti- tutions. There would be three principal sub- components: (a) Agricultural Rehabilitation Credit Line (US$7 million), to provide short- and medium-term credit for medium scale private farms and for the crop and livestock activities of State controlled farms. 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.  - ii. - (b) FED Development Credit Line (US$7.5 mil- lion), to provide long-term-financing for the resumption of the coffee renova- tion program. (c) Technical Assistance (US$0.5 million), to finance about 14 man/months of services, vehicles and equipment, and a livestock survey. The principal risk to successful implementa- tion of the agricultural component arises from proposed lending to restructured farm enter- prises. The Government recognizes the impor- tance of these enterprises to the economy and is taking steps to assure a smooth transition to state ownership. Except for replacement of the very top management, the staff and organi- zation of these enterprises remain unchanged. The fact that Government policies are still being formulated on important agricultural issues (such as agrarian reform) could affect the demand for long-term credit; however, these risks have been taken into account by including in the project long-term lending.only for an on-going coffee renovation program, dealing with a commodity of high Government priority and involving small- and medium-scale producers who will be completing investment plans already underway. Estimated Costs: (US$ million) Local Foreign Total On-farm Investments 11.70 6.40 18.10 Technical Assistance Consultants 0.10 - 0.10 Vehicles and Equipment 0.20 0.05 0.25 Livestock Survey 0.20 0.20 0.40 Total Project Cost 12.20 6.65 18.85  - tiit - Financing Plan: (US$ million) Participating Govern- Institutions IBRD/IDA ment and/or Sub-borrower Total On-farm Investments 14.50 - 3.60 18.10 Technical Assistance Consultants 0.10 - - 0.10 Vehicles and Equipment 0.20 - 0.05 0.25 Livestock Survey 0.20 0.20 - 0.40 Total Costs 15.00 0.20 3.65 18.85 Estimated Disbursements: (US$ million) Jan/June 1980 July/Dec 1980 Jan/June 1981 Semi-Annual: 7.0 5.0 3.0 Cumulative: 7.0 12.0 15.0 The Industrial Component Relending Terms: The Republic of Nicaragua would channel the pro- ceeds of the Bank loan/credit through the Banco de Desarrollo de Nicaragua (BDN) acting for the Fondo Especial de Desarrollo (FED); the term, grace period and interest rate to the FED would be the same as on the Bank loan to the Government, except that the Government would bear the exchange risk. The loan/credit funds would be rediscounted by FED through participating institutions at interest rates ranging from 9 percent to 12 percent. The participating institution in turn would onlend to project beneficiaries at an interest rate of 15 percent. Sub-loan terms would be up to 5 years for the financing of current production and up to 15 years, including up to 3 years of grace, for the financing of repair or replacement of fixed installations. Project Description: The project would assist the Government in its efforts to assist viable industrial enterprises to regain prewar levels of industrial output, exports and employment. This component would also be administered by the FED which would channel funds through participating intermediaries to industrial enterprises in order to finance the cost of goods and services for:  - iv - (a) current production (excluding the construc- tion industry and inputs related to the production of goods for which sales would be financed by the agricultural component); and (b) the repair or replacement of fixed installa- tions. There are special risks associated with lending to industry which has been affected by civil war and is now undergoing substantial restructuring. The risks are minimized by lending through an expe- rienced institution (FED) to enterprises considered capable of rapid resumption of normal production and which have demonstrated a history of successful operations. Estimated Costs: (US$ million) Local Foreign Total Current Production 4.5 -12'.1 16.6 Fixed Installations 0.5 1.7 2.2 5.0 13.8 18.8 Financing Plan: (US$ million) Participating Institutions and/or IBRD/IDA Sub-borrower Total Current production 13.3 3.3 16.6 Fixed Installations 1.7 0.5 2.2 15.0 3.8 18.8 Estimated Disbursements: (US$ million) Jan/June July/Dec Jan/June 1980 1980 1981 Semi-annual: 1.5 8.0 5.5 Cumulative: 1.5 9.5 15.0 Rate of Return: Not applicable Appraisal Report: None. This is a combined President's and Staff Appraisal Report.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN AND CREDIT TO THE REPUBLIC OF NICARAGUA FOR AN AGRICULTURAL AND INDUSTRIAL REHABILITATION PROJECT 1. I submit the following Report and Recommendation on a proposed loan for the equivalent of US$20.0 million and a proposed credit for the equivalent of US$10.0 million to the Republic of Nicaragua for an agricultural and indus- trial rehabilitation project. The loan would have a term of 20 years, includ- ing a grace period of five years with interest at 7.95 percent per annum. The development credit would be on standard IDA terms. The grant element to the Republic of Nicaragua in the loan and credit is 47.3 percent. The loan and credit would be channelled through the Banco de Desarrollo de Nicaragua (BDN) acting for the Fondo Especial de Desarrollo (FED). US$29.5 million of the proceeds of the loan and credit would be relent through financial inter- mediaries to agricultural enterprises for up to 8 years, including 4 years of grace, with interest at 10-14 percent per annum, and to industrial enterprises for up to 15 years, including 3 years of grace, with interest at 15 percent per annum. PART I - THE ECONOMY I/ 2. After years of sporadic guerrilla activity and almost a year of intermittent but violent insurrection, the Government of Nicaragua was replaced in July 1979 by revolutionary forces led by the Sandinista Liberation Front. A 5-person Junta of National Reconstruction was immediately established, an agreed program of policy goals announced, and order quickly restored. In res- ponse to requests for assistance a Bank mission visited Nicaragua in September to review the new situation and consider new lending of an emergency nature that would assist the recovery effort. The economic section of this report reflects the mission's analysis. 3. During the Revolution an estimated 35,000 persons lost their lives. The main battlefields were Nicaragua's towns, and many civilians were killed in the intense battles during September 1978 and May-July 1979. Damage to physical structures and equipment has been estimated at US$185 million. While an additional US$250 million in inventories were stolen, burned, or otherwise lost to the original owners, all but US$60 million was probably used or sold by the new owners, thus reducing the total physical loss to the economy to about US$245 million, lower in cost than the Managua earthquake of 1972 but over one tenth of 1978 GDP. 1/ This section is identical to the section on the economy in the President's Report on the Urban Reconstruction project (P-2662-NI) dated November 29, 1979.  - 2 - WAR DAMAGE (US$ Million) Physical Structures Equipment Stocks Industry 15.0 35.0 60.0 Commerce 18.0 22.0 160.0 Agriculture 3.6 1.8 28.0 Infrastructure 60.5 24.7 1.0 Other -- 4.0 1.0 Total 97.1 87.5 250.0 The towns of Esteli, Leon, Masaya, and Matagalpa were particularly hard-hit; Esteli lost an estimated one third of its downtown housing units. National Guard posts, often located in urban centers, were the focus of much of the fighting; this led to destruction of many nearby shops, restaurants, houses, and othier service establishments. Most of the inventory losses stemmed from looting. As all semblance of order ended mobs looted stores and industries of massive amounta of finished goods, raw materials, and equipment. The planting of some key crops was also deferred, and this has adversely affected rural incomes, production and exports. 4. The effect of this wartime destruction is reflected throughout the economy. The sacking of shops and stores reduced many commercial firms to insolvency; some damaged, looted, or burned industrial establishments were also financially affected. More important in financial terms, however, was the capital flight from Nicaragua. As noted above most of the looted goods remained within the economy. During 1978 and 1979, however, massive capital flight of up to US$500 million occurred, and many firms are illiquid because of it. These insolvencies in turn led to massive loan defaults and the insolvency of domestic commercial banks. Taxes and utility bills were not paid in June and July; neither was the Government's civilian work force. The Central Bank had only US$3.5 million in gross foreign exchange on July 19; net foreign reserves were negative by US$215 million; and most external debt service had been in arrears since January. 5. The immediate consequences of this physical and financial destruc- tion are quite severe. Nicaragua's real GDP dropped 8 percent in 1978; during 1979 it may drop more than 26 percent. Even if there is an expected recovery of 18 percent in 1980, the foregone income (compared to a conservative growth rate of 4 percent) is well over US$1 billion for the years 1978-80. While all sectors of the economy were affected, industry, transport and commerce dropped most as the physical damage was also accompanied by severe import constraints and domestic trade and communications bottlenecks. Agriculture suffered less, but the 1979 cotton crop was ruined and the rice crop adversely affected as most fighting occurred during key planting times. Livestock inventories, par- ticularly chickens and cattle, were depleted. It is estimated that Nicaragua's per capita GNP in 1979 will fall to US$570 (US$1978, Atlas basis). Voluntary guard duty and clean-up campaigns have absorbed some of the potential unemployed, but the actual unemployed are still probably at least one quarter of the urban work force.  6. Faced with this situation the new Government of National Reconstruc- tion has undertaken action on a variety of fronts. It issued a policy state- ment shortly before it took power that has served as its guide so far. The Government has decided on a mixed economy with government, private, and joint government-private sectors in as yet undefined areas. It gives high priority to immediate recovery efforts, dividing them into two phases, an emergency program and an immediate recovery plan. The emergency program consists of food and medical distribution, recovery of public services and clearing of bombed neighborhoods. The recovery plan stresses output and employment expan- sion; reorganization of the balance of payments, debt, and public finances; and complementary monetary policies. A longer-term plan for reconstruction and socio-economic development is being prepared. 7. The emergency program has been completed efficiently and rapidly. Immediately after the victory, most municipal residents began the cleanup process. Within a month streets and sidewalks were cleared of rubble and barricades, the wounded were hospitalized, power, water, and telephones were operating, and the normal processes of Government had been restored. Given the lack of.foreign exchange and fiscal resources, most labor was voluntary, with neighborhood commmittees organizing the participants. While these committees have been extremely effective in clearing streets and repairing some partially damaged houses, the reconstruction of more heavily damaged homes, industries, shops, and public buildings will take considerably more time and resources. The rebuilding of commercial inventories, re-equipping and reconstruction of industries will require substantial foreign exchange. 8. One of the first acts of the new Government was to confiscate the assets of the family of ex-President Somoza and his most immediate associates as well as to nationalize the insolvent banking system 1/. As a result, the State now owns about one third of the nation's crop land, which in the past produced large amounts of sugar, cattle, rice, and tobacco. Over 160 here- tofore private firms now belong to the public sector. Except for slaughter- houses and fish processing firms, the expropriated agroindustrial companies have been placed under the responsibility of the Ministry of Agrarian Reform. Most of the rest have been placed temporarily with a Trust for National Reconstruction (FRN). Added to these new State assets are all the nation's domestic commercial banks, finance companies, and savings banks and insurance companies. Expropriated restaurants, supermarkets, shops, and other service establishments as well as the nationalization of much agricultural trade have made the State responsible for about 10-15 percent of the value added in commerce and other services. In total, the public sector of Nicaragua now probably accounts for at least 40 percent of the nation's GDP. In acquiring these substantial assets, of course, the Government also assumed their lia- bilities, a debt that is still being calculated. 1/ The Government is purchasing the shares of the banking system with 5-year bonds; the Somoza holdings were confiscated outright; but some other corporations (Somoza minority holdings, abandoned firms) have been legally intervened, expropriated, or requisitioned.  -4- 9. The immediate constraints on economic recovery now stem from public finance, monetary, and balance of payments problems. The new Government has repeatedly stressed that it intends to follow prudent fiscal and monetary policies, but because of the disruption in government operations from June through August, the current fiscal and monetary situation remains unclear. A number of new agencies and ministries have been established and some old ones disbanded or revised. A new Ministry of Agrarian Reform not only has responsibility for the cooperatives being established on confiscated lands, but it will direct most new state-owned agroindustries. The old housing bank has been terminated and much of its staff moved to a new Ministry of Housing and Human Settlements. The Planning Office was elevated to a Ministry; and the International Fund for Reconstruction (FIR) has been established to coordinate all foreign borrowing, debt re-negotiation, and relations with multilateral agencies. The state-owned commercial and development banks were combined with the staff of the Special Development Fund (FED) of the Central Bank to form a new Development Bank of Nicaragua (BDN). The National Guard has been disbanded and a new popular army established from the revolutionary forces. Both the army and a complementary militia receive only subsistence wages. 10. Because there was no official payments schedule for the new Govern- ment structure, the Central Bank (CB) was authorized to make direct payments to each Ministry or Agency for all necessary expenditures until October, when the Ministry of Finance established its first, tentative quarterly budget. The goal is to match operational expenditures with anticipated receipts, but even in late September expenditure obligations of many new ministries and agencies remained unclear. The quarterly budget system may remain in effect through 1980. 11. The Government is expected to announce shortly new regulations to increase tax receipts in the short-run, including a moratorium period to pay taxes in arrears, a resumption of the export taxes on traditional exports and increased tariffs on luxury imports. The salaries of many senior officials were reduced drastically by imposing a US$1,000 monthly salary ceiling. The Government is now carefully considering its salary policy for all public sector workers. The effect of these measures is still not clear, but one of its major purposes clearly is to bring a disastrous fiscal situation under control. In the first half of 1979 Central Government savings were negative and its deficit was 80 percent higher than that of the first semester of 1978. The Government hopes to reduce the deficit for all of 1979 to about t1 billion, almost 15 percent below that of 1978 but still about 7 to 8 percent of GDP. Because of the new army's low wages, the two months loss of wages, and reduc- tion of the civilian work force, the deficit may be less, and financed mostly from noninflationary external aid. The reduction in the 1979 deficit is possible only because capital outlays will be below one quarter of the 1978 level. The Government intends to continue the austerity measures at the same level in 1980. 12. The future financial needs of both the traditional and new public enterprises remain uncertain. Most public utilities were unable to collect receipts during a two to three month period; even in September their  -5- collections were poor because of bankruptcies and deteriorated management. Since many of these utilities have considerable external debts, the Govern- ment's efforts at arranging debt relief will also have a considerable effect on their cash flow needs for 1980-81. The Government wants its productive enterprises to be guided by principles that stress economic efficiency. Nevertheless, for the immediate future other goals, such as employment reten- tion or generation and a more egalitarian wage structure, may take precedence. Until the financial position of these entities is clarified decisions as to tradeoffs between these goals have been deferred. 13. The nationalized commercial banks are now technically insolvent. In effect, they have lost most of their capital and reserves and at present are dependent on the Central Bank or foreign funds for liquidity. Government policy is to reverse the recent emphasis of credit allocation. Between April 1978 and April 1979, internal banking credit to the private sector increased by a modest 11 percent while net credit to the public sector quintupled. The banking system's resources came from abroad; foreign loans doubled and net foreign reserves fell. In sum, external loans to the banking system, mostly to the Central Bank, were used to finance credit expansion to the public sector. 14. The Government now hopes to channel the greater portion of future credit to productive sectors, public or private. This will be difficult. The looting, burning, and destruction that reduced many firms to insolvency have greatly reduced the values of the commercial banks' loan portfolios. In an effort to both reduce the money supply as well as penalize those who had taken currency out of the country, the Central Bank forced holders of bills worth US$50 or more to exchange them immediately for six-months savings certificates. This reduced the bills outstanding by almost US$39 million, thus permitting a noninflationary credit expansion of that amount. Despite the enormous difficulties confronting the banking sector, depositors appear to have maintained confidence in the system. The outflow of deposits has reversed itself and there are indications of slight increases in deposits through September 21, 1979. Demand for credit by mid-September was slow since the commercial banks were just opening again for business and it was well known that their lending capacity was limited. The Government is eager to channel concessionary aid into credit expansion since rediscounting by the Central Bank to provide sufficient credit to finance the reconstruction effort could be highly inflationary, unless it is supported by foreign borrowing which would permit an expansion of supply through imports. 15. The most severe problem stems from the balance of payments. In the first semester of 1979 there was a balance of payments current account surplus of US$180 million, a stagnation of official capital flows and a substantial outflow of private capital about equal to the current account surplus. About 15 percent of annual GDP flowed out to unknown, private recipients in 6 months. Between July and December of 1979 the picture is expected to shift dramatic- ally. A current account deficit of about US$40 million can be expected in the second semester. With substantial assistance from abroad--about US$70 million in grants and more than US$100 million in soft loan disbursements--the new Government is importing badly needed food, medicine and other basic items.  - 6 - For 1979 as a whole, we expect a current account surplus of about US$140 million and a modest increase in reserves, because of a sharp drop in imports and a deferral of most interest payments on the country's external debt. In real terms annual imports may be more than a quarter below the 1978 level, and almost half the 1977 level. Net international reserves will likely be minus US$500 million by the end of 1979, if arrears in short-term debt are added. 16. The new Government has received a relatively quick response to its requests for concessional, external assistance. Among the first to respond were the Inter-American Development Bank (IDB) and the Government of Venezuela. Within days the IDB, with the agreement of the Government of Venezuela, had deposited in the Central Bank of Nicaragua US$20 million from its Venezuelan Trust Fund for supplementing gross foreign exchange needs. By mid-August the IDB had adjusted its undisbursed loans, and by mid-September it had approved loans for agricultural and industrial rehabilitation of US$61.5 million includ- ing US$25 million from the Venezuelan Trust Fund; cofinancing by the Inter- national Fund for Agricultural Development (IFAD) added US$12 million. The U.S. Government had begun an emergency air lift of medical supplies and has continued to provide foodstuffs since. The UN relief agencies, Red Cross, and nearby countries--particularly Costa Rica and Cuba--also were quick to provide emergency assistance. The list of assisting agencies and countries has grown rapidly. The Central American Bank for Economic Integration (CABEI) has recently adjusted its outstanding loans, has made a US$12.5 million loan to reactivate the program for the control of coffee leaf rust and has begun dis- cussions of other future projects. The UNDP Program for the next few years has been supplemented by the United Nations General Assembly; the resources that can be applied to Nicaragua now exceed US$5 million. Grants have also been forthcoming from the European Economic Community and Organization of Petroleum Export Countries' Special Fund. Among the major bilateral donors have been Germany (with a commitment of approximately US$39 million in grants for a 2-year period), Peru, Sweden, Canada, Norway, the Netherlands, Spain, and Mexico. The Central American countries have both individually and collectively, through their regional monetary agency, extended general export credits to Nicaragua. These have been particularly helpful in ensuring that some trade continued in the Central American area. 17. Very little external debt service payments are expected to be made in 1979. The mission estimates cumulative payment arrears during 1978 and 1979 at about US$215 million for the public sector and US$115 million for the former Nicaraguan private sector. An additional US$315 million in short-term arrears would bring total arrears to over US$645 million. Debt service payments due in 1979 for public and publicly guaranteed debt, not counting obligations associated with the firms and banks newly in the public sector or short-term obligations, would equal about 35 percent of expected receipts from exports of goods and nonfactor services; about 85 percent of it is payable to commercial banks. 18. The short-term balance of payments problem is exacerbated by the poor prospects for 1980 exports. While coffee receipts should continue to grow despite the expected decline in price and exports to the Central American Common Market should recover well, cotton receipts may be down US$100 million compared to 1979 because the July/August plantings were disrupted severely by  - 7 - the war. Because of the severe foreign exchange constraint, imports must be limited. For 1980, it is estimated that while real GDP will remain 20 percent below the pre-war year of 1977, real imports must be limited to 27 percent below 1977 levels if a modest level of gross reserves is to be gradually rebuilt. 19. Balance of payments projections for 1980 and 1981 can only be illus- trative. Nevertheless, based on the Bank mission's estimates of GDP, import, and export growth, the projections show net external assistance requirements of about US$670 million for these two years. Of this amount, it is anticipated that extraordinary grants averaging US$25 million yearly and disbursements of US$190 million and US$110 million might be possible in 1980 and 1981, respec- tively, from new loans and accelerated disbursement schedules on ongoing loans agreed to during the second half of 1979. Depending on the level of foreign investment and private inflows of capital during the next few years, up to an additional US$320 million could be needed in net capital flows (i.e., excluding grants) in 1980-1981. Current Account Balance of Payments, 1977-1979 and Net External Assistance Required - 1980-1981 (US$ Million) Actual Est. Projected 1977 1978 1979 1980 1981 Merchandise Exports, FOB 636.8 646.0 580 540 730 Merchandise Imports, FOB -704.1 -546.8 -420 -675 -830 Balance -67.3 99.2 160 -135 -100 NFS Receipts 105.3 113.0 80 85 115 NFS Payments -146.7 -139.2 -155 -140 -175 Balance -41.4 -26.2 -75 -55 -60 Resource Balance -108.7 73.0 85 -190 -160 Interest Payments -49.5 -50.7 -11 -140 1/ -60 1/ Profit Remittances -28.5 -22.4 - - - Transfers 11.0 10.0 70 50 20 Current Account Balance -175.7 9.9 144 -280 -200 Change in Net Reserves 2/ (- = increase) -56.6 22.3 -30 -60 -80 Net Capital Flows Required -340 -280 1/ Excludes interest payments and arrears on private debt. For 1980 includes interest arrearages on public debt for 1978 and 1979 of approximately US$72 million. No penalty interest is calculated on arrearages of principal or interest. 2/ After 1979, increases in reserves required to bring gross reserves to equivalence of three months imports, CIF, by the end of 1981. Note: If interest payments due on debt considered private before July 19, 1979 with an original maturity of one year or more were included as paid obligations, it would raise financial requirements by US$20 million yearly assuming it were rolled over.  -8 - 20. Nicaragua's creditworthiness for normal Bank lending is extremely limited. Its outstanding debt of US$1.5 billion at the end of 1978 (medium and long-term external debt of US$1,113 million and US$400 million in short- term debt) was about 80 percent of GDP. The known arrears in short-term debt amount to US$315 million. When the arrears in medium- and long-term debt are added, the total projected arrears in debt service at the end of 1979 are estimated at US$645 million. Debt service payments falling due in 1980 and 1981 are projected at US$230 million and US$180 million, respectively. Even assuming no carry-over of arrears into 1980, the projected debt service ratio would be about 35 percent. Some form of restructuring of Nicaragua's debt will be required over the next few years. This rescheduling would be in addi- tion to the estimated external borrowing of over US$300 million per year. The authorities realize that an economic program is necessary as part of this debt exercise. It is anticipated that such a program will be formulated, presented and discussed with its creditors and aid donors in early 1980. In the mean- time, it is apparent that Nicaragua's extremely weak balance of payments situa- tion and reduced income mean that a major share of the substantial assistance needed from institutions such as the World Bank for emergency reconstruction and rehabilitation should be on concessional terms and thus result in average terms as soft as possible. The balance of payments situation combined with an extremely difficult fiscal situation (see paragraphs 9-12 above) also justify official assistance in excess of the foreign exchange component of individual projects. Longer-Term Prospects 21. While Nicaragua's immediate and medium-term prospects are dominated by the recovery problems, its longer term prospects will depend on the new Government's ability to implement its economic and social goals effectively. Nicaragua has good agricultural potential; it has the highest ratio of arable land to population in Central America, a relatively good infrastructure, and an urban population dispersed relatively consistently with the country's spatial advantages. The country's longer run growth prospects will depend heavily on the Government's approach to attaining its income distribution goals and its management of the greatly enlarged public sector. It is too soon to make judgments in these areas now; the following discussion' only outlines the key issues the Government must confront. 22. First, the domestic savings need of the economy will be large. Even after a possible debt rescheduling, the Government will not only encounter difficulties in borrowing new significant funds from non-official sources, it may wish independently to limit such borrowings to avoid exacerbating its debt service. The Government has already firmly stated it will not place a great reliance on foreign savings for financing development. Secondly, the greater size of the public sector and the enlarged Government control over the banking system means public policy will be crucially responsible for marshalling domestic savings. As much as one third of past corporate savings was probably generated by firms now in the public sector. The reduced investment oppor- tunities for the upper classes and the Government's income distribution goals mean that Government and public enterprises, rather than households, must directly generate greater savings. This will be difficult to achieve unless the efficiency of Government programs is high and State enterprises are run  -9- profitably. Finally, not only will the Government control about one half of industry and some key marketing areas, but also from one-third to one-half the nation's farmers may be using state land and producing in accordance with Government-determined priorities. This situation means the State must assume the major, direct responsibility for ensuring that investment and production are conducted efficiently. 23. Secondly, the Government is determined to improve the lot of Nicaragua's poor. It expects to do this by stressing agricultural development and the provision of social services (health, nutrition, education) to all rural residents. The speed, cost, and success of measures developed to implement these goals will be crucial indeed. It may be difficult to develop agricultural activities in new regions of the country until the present, greatly changed agricultural production system is adequately redesigned and operating well. Some other countries in the hemisphere have quickly encoun- tered fiscal constraints when they expanded urban-designed social programs to rural areas; some have tried to improve urban programs as they expanded rural ones and found themselves constrained equally rapidly. The Government is aware that it must successfully link its growth and equity goals to increasing productivity and efficiency or it may jeopardize both of them. PART II - BANK GROUP OPERATIONS 1/ 24. Nicaragua has received to date 24 Bank loans and two IDA credits for a total of US$185 million. The last operation, a loan of US$3 million for a rural sanitation project was signed on February 9, 1978. Annex II con- tains a summary statement of Bank loans, IDA credits and IFC investments as of October 31, 1979, as well as notes on the execution of ongoing projects. Because of major fiscal difficulties that emerged during 1978 and the disrup- tive effects of the civil war that began in the latter part of that year, the Bank has not lent to Nicaragua since early 1978. In mid-1979 it concluded that meaningful project activities and adequate supervision of ongoing proj- ects were no longer possible. The Board was informed on July 16 (R79-192) that no further disbursements on existing loans and credits would be made. The Government of Nicaragua was subsequently replaced by a Junta of National Reconstruction. The Junta requested emergency assistance from the inter- national community to facilitate recovery from the economic disaster caused by war time devastation and looting as well as by large outflows of capital. In response to this request a Bank mission visited Nicaragua in September to review the overall situation and priorities, to recommend changes in outstand- ing loans, and to develop with the new Government proposals for emergency lending to assist in the recovery effort. The operations recommended today are the result of the work of that mission. The mission also recommended to the Board revision of ongoing loans (R79-264) which were approved on October 29. Disbursements on existing loans and credits were resumed in November. As of October 31, 1979, a total of US$40.2 million remained to be disbursed. 1/ This section is identical to the section on Bank Group Operations in the President's Report on the Urban Reconstruction Project (P-2662-NI) dated November 29, 1979.  - 10 - 25. In the past the objectives of the Bank/IDA program in Nicaragua have been (a) to support the Government's export diversification efforts; (b) to help build viable institutions in key sectors such as water supply and electric power; (c) to help spread the benefits of growth to more people through lending such as for education, rural sanitation, agriculture, and water supply. The Bank Group also assisted in the reconstruction effort after the devastating earthquake of 1972. 26. Because of the Government's preoccupation with emergency reconstruc- tion requirements it has not been possible to develop with the new Government a long-term lending program for the Bank Group. A new public investment pro- gram is now being formulated, and the Government expects to invite the Bank to begin discussions of new projects in early 1980. In preliminary discus- sion, the Government has indicated interest in Bank participation in the rural and energy sectors as well as continued involvement with major sectoral institutions (power and water supply) with which the Bank has had a long- standing relationship. The Bank group's lending activities to Nicaragua are being closely coordinated with other donors such as IDB, CABEI, USAID and other bilateral agencies. 27. IFC's first operation in Nicaragua involved a FY68 loan and equity investment of US$1 million and US$1.07 million, respectively, in a textile plant, Textiles Fabricato de Nicaragua, S.A. IFC's equity participation was sold in FY74 to local shareholders. In FY76 IFC provided US$6.5 million in long-term debt to Nicaragua Sugar Estates Ltd., a sugar mill, to help expand their production capacity and develop new cane fields. Also in FY76 IFC made a loan and equity investment of US$700,000 and US$200,000, respectively, to help finance the construction of the Camino Real Hotel. An IFC mission has visited Nicaragua after the change of Government. The mission was able to determine that IFC's three investments in Nicaragua received minor damages but were not destroyed during the civil war. The necessity for rescheduling the existing loans is now being analyzed. A further mission is planned for discussions with the new Government regarding assistance to private industry. PART III - BANKING, AGRICULTURAL AND INDUSTRIAL SECTORS Banking 28. Prior to the war, Nicaragua had a mixture of public and private commercial banks and specialized financial institutions regulated by the Central Bank and monitored by a Superintendent of Banks and other institu- tions. Government institutions, accounting for 53 percent of the financial system's total assets in 1976, included the National Bank of Nicaragua (BNN), the country's largest commercial bank; the National Development Institute (INFONAC); the Banco de la Vivienda, a public housing bank; and two insti- tutions specializing in small-scale loans. Private institutions including seven commercial banks, 1/ six finance companies and six financial warehouses, 1/ Including three branches of foreign banks.  - 11 - which together accounted for 43 percent of total assets. 1/ Despite the diversity of institutions, two competing private groups controlled approxi- mately three-fourths of the total assets of private financial institutions; thus the Government and these two private groups were the dominant forces in the financial system. 29. The largest and most important financial institutions were multi- purpose intermediaries; however, a certain degree of specialization by sector was reflected in their loan portfolios. BNN concentrated on agriculture and livestock loans (42 percent of 1977 portfolio), private banks on commercial and industrial loans (65 percent), and INFONAC and the finance companies on industry (67 percent and 42 percent, respectively). INFONAC has been the major lender of medium- and long-term funds for industry and agriculture; however, in recent years the banking system has been able to draw on the FED, administered by the Central Bank, for such lending. 30. After a long period of monetary stability, the financial sector had come to share many of the characteristics of more developed financial systems, including (i) a high level of financial assets (almost equal to the country's GDP); (ii) a considerable degree of savings intermediation (more than 50 percent in 1975-76); (iii) a relatively high proportion of time and savings deposits in the total money supply (about 41 percent); (iv) a fairly flexible interest rate structure with interest rate levels that tended to reflect market conditions; (v) good access to foreign exchange markets; and (vi) a growing spectrum of financial institutions that competed heavily for funds in the domestic market. The banking system had expanded to include 227 branches and agencies located throughout the country. While some public financial intermediaries were poorly run, Nicaragua's private banks enjoyed the public's confidence and were generally considered to be sound, well-managed institutions. 31. The financial situation of the country's intermediaries began to deteriorate after 1977 and continued deteriorating at an accelerating pace through the end of the revolution. Presently available financial figures on commercial banks, though preliminary and subject to change, illustrate the problems facing the financial system even before the revolution accelerated in June. Total deposits between March 1977 and April 1979 fell by 23 percent; during the same period, total loans outstanding increased by one-third. Interest and principal arrears accumulated by one unofficial estimate to around 30 percent of total loan portfolios, and operating revenues dropped. The commercial banks financed this drain of resources through increased borrowings from foreign sources and the Central Bank. Foreign currency borrowings during the period rose by 150 percent while borrowings from the Central Bank increased 230 percent. 1/ In addition, the financial system included insurance companies, warrants companies, and savings and loans associations which did not come under the supervision of the Banking Superintendent and represented 4 percent of total financial system assets.  - 12 - Preliminary Consolidated Commercial Bank Balance Sheets (million Cordobas) March 1977 April 1978 April 1979 Liquid Assets 1,166 581 644 Loans 2,579 3,111 3,429 Other 1/ 1,043 1,158 1,474 Total 4,788 4,850 5,547 Deposits 2,765 2,435 2,131 Foreign Currency Loans 470 771 1,171 Central Bank Loans 193 255 641 Other 856 858 1,054 Capital and Reserves . 504 531 550 4,788 4,850 5,547 1/ The April 1979 figure reportedly includes estimated probable foreign exchange losses. 32. An April 1979 devaluation of the Cordoba by 43 percent adversely affected the banks' finances and the destruction and looting of June/July 1979 dealt a further and devastating blow to the banking system. The foreign exchange loss, was considerable, but the precise amount has yet to be deter- mined. Additional, and perhaps larger, losses will arise from uncollectable loans to borrowers who face bankruptcy because of destroyed or looted assets or who have departed the country. To prevent a total collapse of the finan- cial system, the new Government nationalized private, domestic financial insti- tutions, named new top managers to replace those who had left the country, and provided some liquidity support through the Central Bank to keep them in operation. Foreign banks were not nationalized but their operations were restricted; principally there is now a prohibition against accepting deposits. While none of the country's intermediaries have closed, they are operating at substantially reduced lending levels while providing other basic banking services. 33. The Nicaraguan financial system will undergo a fundamental restruc- turing. The Banking Superintendent has ordered detailed internal audits of all institutions, including an assessment of the quality of all outstanding loans, in order to determine their true position. This effort is complicated by the recent expansion of the public sector. Many new State-owned firms owe large sums to state-owned banks, which--in turn--owe large sums to foreign creditors. Outside consultants have been contracted and consideration is being given to the use of international auditing firms. The Central Bank has undertaken studies to determine how the system might be restructured and recapitalized. These recommendations will be presented to the Government in  - 13 - the near future and may include some consolidation of institutions and specialization of operations, perhaps by sector. In the meantime, the BNN, INFONAC and the FED 1/ have been combined into a single successor development organization--the National Development Bank (BDN)--which is acting to meet the most urgent financial needs, particularly in the agricultural sector. 34. Despite the many serious problems confronting Nicaragua's financial system, it also displays several strengths which should facilitate the task of rehabilitation. First, the public's confidence in the system appears to have been somewhat restored. The deposit outflow was reversed in mid-August 1979 and total deposits increased through mid-September 1979, the latest date for which preliminary deposit figures are available. Second, individual institutions have retained experienced and well-trained professional staff despite the changes in top management. Third, the Government has committed itself to strong support and a rational restructuring of the system. 35. The Government would like to make credit from foreign sources available to industry and agriculture through the nationalized banking system. Its objective would be to provide financing to those enterprises that can resume production most expeditiously and which meet the country's most urgent priorities of earning foreign exchange, providing employment and producing foodstuffs. Loans would be granted for working capital as well as for the repair or replacement of fixed installations. In this manner the Government hopes to encourage some repatriation of private capital, to work towards the reopening of normal channels of trade credit and to begin rebuilding the national banking system. Agriculture 36. Agriculture continues to be the most important sector in the Nicara- guan economy, generating about 23 percent of GDP and providing 46 percent of employment. During the period 1972-78, the real agricultural value added grew at an average of over 6.5 percent per annum, slightly above the total GDP growth rate. With the exception of cotton, where yields are exceptionally high, most of the growth in output has come from increases in area farmed, especially in the Pacific and Central zones. As cropping expanded in the Pacific region, cattle activities have been slowly transferred from the Pacific to the Central and Atlantic regions. The crop subsector growth has come mainly from the export crops, mostly cotton, coffee, sugarcane, bananas and tobacco, which accounted for 42 percent of the area planted and 80 percent of the total value of the production (1976/77-1978/79 crop years). Output of export crops grew at about 8 percent per annum during 1972-78, over twice the growth rate of crops produced for the internal market. The growth of the livestock subsector has come mainly from cattle, which accounts for 73 percent of the total value of livestock production. 1/ Consideration is being given to the transfer of the FED to the FIR (para. 9) to ensure greater autonomy in the allocation of scarce foreign resources.  - 14 - 37. About 75 percent of mechandise exports originate from the agricul- tural sector, and a relatively small number of products contribute to these exports. The most important items are cotton, coffee, sugar, and beef; less important are bananas and tobacco. Besides contributing to exports and export growth, the agricultural sector has been able to supply most of the food pro- ducts required by the domestic market. Imports of products of agricultural origin averaged only US$31 million per year during the period 1977 and 1978. This was equivalent to about 4 percent of total imports. 38. Because of the war, the supply of food as well as future export earnings have been reduced. The final phase of the war was associated with general unrest in the countryside, labor problems, takeover of farms and loot- ing of livestock, farm machinery and equipment. It also coincided with the main planting of the 1979-80 crop year. Therefore, planting was disrupted seriously and the impact was felt with great intensity in the commercial farming subsector. 39. The information available indicates that the overall area planted in 1979/80 dropped by 229,000 ha (one-third) as compared with the previous crop year; the real value of production may be reduced by 27 percent. Pro- duction for export will be the most affected. The value of cotton production, representing about a quarter of Nicaragua's merchandise exports, will probably suffer a reduction of 70 percent (US$96 million), as only 53,000 ha have been planted, compared with normal years when 196,000 ha were under cotton. A further drop in production is expected because of late plantings. Sugarcane, bananas, and tobacco production may fall by 5 percent, mainly through decreases in productivity. The sugar decrease, however, will be greater if the San Antonio sugar mill, heavily damaged by the war, representing about 30 percent of the country's total processing capacity, is not fully operational. As a result of exceptionally good weather and an increase of about 3,000 ha in area harvested, production of coffee, the main export of Nicaragua, is expected to increase slightly. However, during the war, the program to control coffee leaf rust was discontinued and, consequently, the area affected by the disease may have increased, which would affect future coffee production. 1/ On the other hand, as a result of the efforts to increase total production, almost 15,000 ha not planted in cotton were planted with sesame, so that production of this crop is expected to increase by about 160 percent, and partially compensate for the shortfall in production of cottonmeal and oil. 40. A decrease of almost one-third in area planted and of almost one-half of the value of production is expected in crops for the domestic market this year. The total area used for corn production will be about halved; a re- duction of about 17 percent in area planted and of 26 percent in production is expected for beans, sorghum and tobacco for the domestic market. The total area under rice has decreased by 15 percent and production will fall by about 22 percent. 1/ Nicaragua has recently received a US$12.5 million loan from CABEI to reactivate the control of coffee leaf rust.  - 15 - 41. Losses in the livestock subsector were caused mainly by an increase in the slaughter and stealing of mature and immature beef cattle and the drastic depletion of the commercial poultry and pig stock. The annual beef export quota to the US (70 million pounds) was met by June 1979, through accelerated slaughter of both mature and immature cattle. Similarly, large numbers of cattle were killed in the countryside to feed guerrilla fighters and townspeople. In addition, it has been reported that relatively large numbers of cattle have been smuggled outside the country. The losses to the dairy sector are equivalent to a reduction of 7 percent of annual output. (It is difficult to make an assessment of the effective losses of beef cattle or the impact on future production of beef; however, it is estimated that herd size has been reduced by about 15 percent; it could require six years to bring the herd back to the 1979 level.) Depletion of commercial poultry and pig stocks implies a decrease in total availability of poultry by a quarter and in pigs by two-fifths. 42. The public agricultural institutions have been revised drastically by the new Government. The changes to the public credit institutions were discussed in paragraph 33 above. In the past, the Ministry of Crops and Livestock, now the Ministry of Agriculture and Development (MIDA), was responsible for planning, programming, budgeting, coordinating, monitoring, and evaluating all of the agricultural activities in the country through eleven decentralized agencies and one supporting institution. The main policy decisions were made through the National Committee for Crops and Livestock (CNA), a council made up of the managers of the decentralized institutions. The new institutional system divides responsibility for the public sector between two main institutions, but the extent, scope, nature, and organization of their activities are still being defined. 43. One of the two main institutions of the agricultural sector is the Nicaraguan Agrarian Reform Institute (INRA) now headed by a Minister. INRA has been assigned responsibility for all activities and policy-making pertain- ing to the agricultural reform. This includes some 0.5 million ha of recently confiscated land, about 140,000 ha of land settlements, and 4.5 million ha of Government land. INRA combines partially or totally the functions of the following agencies: the Land Titling Agency, the Directorate of Agricultural Sector Planning (DIPSA) and the Research and Extension Service for small-scale farmers of the Institute of Agricultural Technology. 44. INRA's activities are currently centered on dealing with the agri- cultural emergency and organizing production on recently expropriated land. The information available indicates that about 500,000 ha (of which 80 percent may be arable land), made up of former holdings of the Somoza family and some Government and military officials, are being currently managed through INRA. The land confiscated by INRA may represent about half of the land normally under crops in Nicaragua. The process of confiscation of these land holdings as well as other farmlands is being carried out in a decentralized and dis- organized manner. It has, therefore, been difficult for INRA to make a quick assessment of the use and value of this new land. 45. Management and control of the new state-owned land have been sepa- rated into two sections:  - 16 - (a) Integrated farm operations, including production and some processing such as sugar and rice milling, coffee and tobacco processing, and specialized farming operations such as modern and intensive dairy farms are the responsibility of the agroindustrial division of INRA (AGROINRA). These enterprises are being run as state farms; management at regional and national levels has been assigned to qualified professionals, and the overall productive and management structure still remains practically as it was under the former owners. AGROINRA controls four sugar mills, repre- senting about three-fifths of industrial sugar production; nearly all of the irrigated rice land; all the farms produc- ing tobacco for export; about one-tenth of the total coffee area, including one-quarter of coffee processing capacity; and 15 percent of commercial dairy production and one plant with one-fifth of the country's milk processing capacity; and (b) the responsibility for management of the balance of the con- fiscated land has been assigned to INRA's regional offices. Except for policy decisions that (i) all the confiscated land belongs to the State; (ii) no individual tenure rights would be granted; and (iii) some type of collective farming operations would be established, the future management and organization of these lands has not been defined. Nearly all of INRA's resources are directed towards bringing this land into production. During the 1979/80 crop year, INRA has encouraged former farm laborers, and even other landless laborers and sharecroppers, to plant as much land as possible; INRA is providing whatever inputs are available and the net proceeds of the harvest will be retained by the labor force. 46. The other main institution, MIDA, formerly had overall responsi- bility and capabilities for agricultural policy and planning and for the coordination of the sectoral public institutions, but these functions have been practically eliminated with the transfer of DIPSA to INRA. Therefore, the current functions of MIDA appear to be those related to research and extension for commercial farming; conservation of natural resources; agri- cultural statistics; and agricultural controls and inspections. 47. The Ministry of Domestic and Foreign Commerce, which is being created from the previous Institute of Domestic and Foreign Commerce, will be responsible, through seven autonomous agencies, for marketing nearly all agricultural production. These agencies will handle cotton, coffee, sugar, beef, marine products, basic food crops, and imports and distribution of agricultural inputs. The first of these agencies, the Nicaragua Coffee Enter- prise (INCAFE), is already in operation. Information provided by INCAFE's management indicates that the agency will control coffee sales in the domestic and export markets; establish and implement support prices to the producer and marketing margins and prices at the wholesale and retail levels; and provide credit through established buyers. At present, INCAFE's activities in the internal market are being implemented through the existing marketing  - 17 - channels; however, the agency has taken full control of coffee exports and its future plans call for direct intervention in the internal market through the establishment of buying points throughout the country. 48. To summarize, the Government now has direct control of approximately half the crop land in Nicaragua. In addition, it may assume full control of the marketing of major crops and agricultural inputs. This is a substan- tial change from the pre-war situation; the future of the agricultural sector depends largely on INRA's success in regaining past levels of production on expropriated lands. Industry 49. Nicaragua's industrial sector has experienced very high growth since 1960, increasing by about 15 percent yearly in real terms during 1960-68 and over 10 percent yearly from 1969-77, well above the growth rate for total product. As a consequence, its share in GDP rose from 12.5 percent in 1960 to 19.4 percent in 1977. While the principal factor has been the overall growth in domestic incomes, reflecting in great part the expansion and diver- sification of export-oriented agriculture, manufacturing activity also bene- fited from the country's participation in CACM. Exports of non-food manu- factures to that area rose from negligible levels in 1960 to over US$100 million in 1976, representing about one-fifth of the gross value of non-food industrial output in the latter year. These exports have been highly concen- trated in a few products: insecticides, caustic soda, polyvinyl chloride, and steel wires, all produced by plants which sell most of their output in the regional market. The industrial sector has provided employment to about 15 percent of the labor force in recent years. 50. During the period there was a marked change in the structure of the sector. The traditional consumer goods industries (food, beverages, tobacco, textiles, clothing and shoes) which had accounted for more than four-fifths of industrial value added in 1960, contributed about three-fifths in 1977. The sharp growth in the share of intermediate goods, principally chemicals and metal products, reflected in great part the impact of the CACM exports. 51. The political disturbances in 1978 led to a decline in industrial output of about 10 percent from the peak level recorded in 1977. Exports of manufactured products to the CACM, however, actually expanded in 1978, partly because of the contraction in domestic demand. The events of 1979 brought with them a more severe contraction of industrial activity. For almost two months, June and July, industrial production virtually ceased. In spite of the rather substantial efforts made at restoring order since then, the physi- cal and financial losses sustained during the period of armed conflict have continued to weigh heavily on the industrial sector; by the end of September, manufacturing activity appears to have been no more than one-half the 1977 level, and this is likely to be the average for the entire year. 52. In the face of the fall in output, unemployment in industry has risen sharply. In early 1979, it was estimated that one-quarter of the  - 18 - economically active population in manufacturing was without work, although the decline in output was twice that. The Government has taken measures to encourage enterprises to maintain employment, and many of the workers were being used in repair or maintenance activities. A number of firms were work- ing short shifts or alternating days in order to provide some income to the labor force. 53. Shortly after the cessatior of fighting, several independent assess- ments were undertaken of the physical losses experienced by the industrial sector. Damage was most severe in the industrial area along the northern highway in Managua, where a number of plants were completely destroyed and many others suffered major damages. Factories located in the Managua area account for about 60 percent of the value of total manufacturing output. While the urban centers of Esteli, Matagalpa and Masaya all suffered heavy damage, the industrial plants in those areas experienced relatively minor damages with only few exceptions. 54. The current replacement cost of the damaged industrial facilities (buildings, machinery and equipment) has been estimated at about US$50 million. A considerable proportion of this represents office buildings, storage, ware- house and related facilities. The loss in productive facilities is therefore estimated at 5 to 10 percent of the book value of fixed assets for the entire sector. Perhaps the most serious losses were sustained as a result of the looting of inventories of raw materials and finished products. Many plants which suffered no damage to production installations experienced widespread stock losses. A study by the Central Bank of 160 enterprises representing about 60 percent of the total gross value of manufacturing output indicates that they experienced losses equivalent to some 28 percent of the value of their inventories as compared to damages equivalent to 9 percent of fixed assets. While 16 percent of the firms had damages in excess of 25 percent of the value of fixed assets, 44 percent experienced losses in excess of 25 percent of the value of their inventories. For the entire sector, the value of inventory losses has been estimated at US$60 million. 55. Finally, the sector has experienced some losses in managerial and technical personnel. During the period of intense fighting, a relatively large share of the population left the country. While many have returned, some plant owners and top managers have not. Although the country boasts a fairly sizable dynamic and educated pool of executives, the losses in these personnel will lead to some problems in restoring output. 56. The major constraint on medium-term output expansion may be the poor financial situation of many enterprises as well as of the entire banking system. Overall domestic demand has stagnated due to the losses of income suffered since early 1978; moreover, many looted products were being traded in informal markets. Thus, while there have been limited scarcities, factories which are able to undertake some production have still not restored their inventories of finished products. Once the existing supplies of these goods are exhausted in the informal markets, the financial constraints will increas- ingly restrict necessary production unless measures are taken to ease them.  - 19 - 57. Aside from the physical damages suffered, the most significant change has occurred in the ownership of individual enterprises. As mentioned earlier, shortly after assuming power, the new Government confiscated the holdings of ex-President Somoza, his family, and associates. In addition, the Government intervened in a number of enterprises where there were questions concerning the ownership of assets. At the same time, through the nationaliza- tion of the domestic commercial banks, the Government became the majority or only stockholder 1/ of several industrial facilities where those banks pre- viously had held such shares. As a consequence, en,terprises producing between 40 and 50 percent of the value added in the industrial sector are now in the public sector. 58. The bulk of the non-agricultural enterprises controlled by the pub- lic sector (160 as of mid-September 1979) are managed by the Trust for National Reconstruction (FRN). Among these are 54 industrial plants including 11 processing fish and seafood, 11 producing construction materials, 3 slaughter- houses, 2/ 3 textile and garment manufacturers and various others producing consumer goods (e.g., furniture, jewelry, matches, baked items) and inter- mediate goods (e.g., steel wire, plywood and agro-chemicals). 59. FRN is now reviewing the status of each of these enterprises, including their previous performance and financial position as well as the extent, if any, of damages resulting from the fighting. Among the industrial establishments, a large number were not operating for a variety of reasons. Only a few suffered physical damage but a large number had their inventories looted. Following the review of these enterprises, it is expected that measures will be taken to restructure financially those which appear to have prospects for maintaining or achieving financial viability. FRN has indicated that it will consider the possibility of closing down those which do not offer prospects for achieving viability and which have been sustained in the past largely through extraordinary measures. 60. The second group of plants in the public sector, about 20, con- trolled by the financial institutions, covers a wide variety of products. Most of these companies have had financial difficulties in the past, often caused by inadequate financial structures or inappropriate production designs, including excessive diversification of output or obsolete equipment. These enterprises must also be reviewed to determine the steps needed to restruc- ture, either financially or technically, those with prospects for achieving economic and financial viability. As in the case of plants controlled by FRN, some of these enterprises are not currently operating, although few have suffered physical damage. 1/ In certain cases, the prior State-owned development finance company, INFONAC, held the balance of shares not held by the private banks. 2/ Two other slaughterhouses are also controlled by the government; one of these, the largest in the country (IFOGAN), is jointly owned with a livestock producers cooperative. These five installations account for 80-85 percent of meat exports.  - 20 - 61. Officials of the private industrialists' association estimated that, at the beginning of September 1979, private enterprises were working at about 25 percent of capacity. However, they expected that increases would gradually take place as managerial and technical personnel returned and as some semblance of administrative order was restored in firms where offices had been looted and records destroyed. Some improvements appeared to emerge already in September. The severest physical losses in the private sector occurred to facilities producing paints, pharmaceuticals, agricultural imple- ments, construction materials, textiles and beverages--as well as assembling radio and television sets. Restoration of production by these enterprises will require major investments which is unlikely in the immediate future. 62. Several private plants which suffered minor damage are now being repaired, but they will require working capital loans to restore production as they suffered inventory losses as well as financial losses due to destruc- tion of retail or distribution facilities to which they had extended credit. However, several foreign-owned or operated enterprises which export a sub- stantial proportion of their output experienced very little physical damage or looting and have been able to restore production and exports. 63. In its immediate reconstruction efforts, the new Government has established three priorities for the industrial sector: to promote (a) pro- duction of foodstuffs; (b) employment generation; and (c) exports. As regards the last item, privately owned plants which sell a substantial proportion of their output to the CACM have been able to restore output and exports (e.g., pvc, powdered milk, caustic soda and pesticides) while the FRN-controlled plywood plant has also been able to resume almost normal production and export levels. While plants producing steel wire and textiles for export are suffer- ing from working capital shortages, it is expected that, as international assistance including the proposed Bank Group assistance is made available, funds will be channelled to these enterprises. It is likely, therefore, that in 1980 exports of manufactured products to the CACM may be at about the level achieved in 1978. On the other hand, manufactured exports to third areas are not likely to recover as rapidly. The most important of these is processed seafood which has been adversely affected by the loss of fishing boats. It appears likely, moreover, that there will be only limited recovery in the minor export items, such as wood products and textiles, partly due to the general recession in world markets for these goods. 64. Given the gradual restoration of transportation and communications, as well as of administrative and financial order, it is expected that indus- trial output in 1980 will regain about two-thirds of the 1977 peak level. The major constraints on the production side will continue to come from the losses in managerial and technical personnel, the financial difficulties and some physical damages to capacity. On the demand side, it is likely that, in the face of the huge personal income losses sustained over 1978 and 1979, con- sumer purchases of other than absolute necessities will be kept at a minimum. Thus, exports will play a major role in maintaining industrial activity and may well account for one-third of the gross value of output. However, as a result of the current practice of maintaining factory employment in the face of sharply reduced levels of output, it appears likely that there will be little increase in total employment in industry in 1980 from end-1979 levels.  - 21 - 65. Based on this recovery expectation, the rehabilitation requirements bf industry will comprise (a) repair to damaged facilities; and (b) normal raw material requirements for a given level of production, plus rebuilding of stocks. As noted above, physical damages to facilities have been estimated at US$50 million. A small number of plants have been virtually destroyed and, within the context of an emergency program, rebuilding these facilities would not be a priority goal. It is estimated that total requirements for repairing damaged machinery and equipment to permit early restoration of what can be considered an adequate output level in the initial phase of reconstruc- tion would be US$10 million. Rebuilding of inventories is a priority item, particularly as stocks had already been drawn down in the period prior to the fighting. It is recognized, however, that it will not be possible to accom- plish this fully in one year. The estimated financing need for partial rebuilding of inventories in 1980 is US$20 million. 66. To estimate raw material needs for 1980, it is convenient to dis- tinguish between food processing industries and others. Production of the main inputs of the former group, such as sugar, rice, coffee and cattle, will be supported through the agricultural component of the proposed Bank Group financing; moreover, there are generally close links between the processing facilities and the growers. These industries will, however, require some inputs such as spare parts, chemicals and packaging materials, most of which are imported. Based on data for 1976, 1/ it is estimated that such inputs will amount to US$30 million in 1980, for which financing of US$15 million would be required. 67. The bulk of the working capital needs will originate in the nonfood processing industries which import about 70 percent of their inputs. Raw materials needs for 1980 are estimated at US$200 million on the expectation that output will be restored to about two-thirds the 1977 level. Allowing for a turnover of raw material inventories of three 1/ (due to the high im- port content), working capital financing of US$60-70 million would be required. 68. To summarize, financing needs for this initial phase of industrial reconstruction through the end of 1980 are estimated as follows: (a) Immediate needs for repairs to equipment US$10 million (b) Partial rebuilding of inventories US$20 million (c) Raw material needs for current operations (i) non-food industries US$65 million (ii) food processing industries US$15 million TOTAL US$110 million 1/ The Central Bank undertook a detailed investigation of a sample of indus- trial establishments which accounted for about two-thirds of industrial output in 1976. Relevant ratios have been used to calculate the require- ments indicated in this and subsequent paragraphs.  - 22 - 69. As regards the longer-term development of the sector, the new Gov- ernment has already indicated that industry will not be given high priority in public investment and development programs. Emphasis will be given to agriculture to provide employment opportunities and increased incomes to the rural population whose current income level is relatively low. For the future, it will be necessary to define more precisely the role of the Government in the industrial sector, including the question of ownership of the enterprises now controlled by FRN and the state-owned financial institutions. While there have been a number of official statements indicating that FRN as an institu- tion is temporary, it is not clear where control of the companies now under its administration will eventually lie. In the face of these uncertainties, it appears likely that new private investment in industry will remain at low levels. In these circumstances, medium-term priorities for the industrial sector are the rationalization of existing production capacity (see paras. 59 and 60) and the expansion of agro-processing facilities in line with possible expansion in agricultural output. PART IV - THE PROJECT 70. The project was identified and appraised during a mission that visited Nicaragua from September 9 to 26, 1979. Negotiations were held in Washington from November 19 to 21. The principal Government representatives were the Minister/Director of FIR, and the Director of FED. Project Objective 71. The objective of the project would be to assist Government efforts to regain prewar levels of output, exports and employment in the agricultural and industrial sectors. The project was designed taking into account Govern- ment priorities for emergency rehabilitation and was developed in light of the assistance already planned by other external agencies for agriculture and industry. The IDB has provided US$31.5 million for an agriculture re- habilitation project, and IFAD is providing US$12 million of cofinancing for this project. Under the IDB/IFAD project, 80 percent of the financing will be provided to small-scale producers, defined as those with total assets of less than US$50,000. The balance would be provided to producers with assets between US$50,000 and US$75,000. AID has also provided approximately US$10.5 million for rehabilitation of small-scale producers. The focus of the agri- cultural component of the Bank Group project is thus mainly on medium-scale private operations and some of the larger new state enterprises. On the industrial side, IDB has provided US$25 million from Venezuelan Trust Fund resources, and US$5 million from the Fund for Special Operations for a program of credits for industrial rehabilitation. Given the substantial amount of financing required by industries of varying sizes and types (discussed in the previous section of this report), the Bank Group financing would be available 1/ The 1976 data suggest a ratio of 2.8.  - 23 - for purposes similar to those of the IDB. A complementary line of credit would be provided for small-scale enterprises under the proposed Urban Reconstruction Credit (being presented simultaneously with this loan/credit). Executing Agency 72. Implementing responsibility for both the agricultural and industrial components would rest primarily with FED,a second-tier lending institution attached to the BDN. FED will also be the principal implementing agency for the IDB industrial and agricultural rehabilitation loans. The FED was created in 1972 as a Government-owned development fund administered by the Central Bank (CB) as the Government's fiduciary agent. Since the end of the war, the BDN rather than the CB has administered the FED; however, the Government is con- sidering transfering the FED to the International Fund for Reconstruction (FIR) which in turn has overall responsibility for all foreign public borrowings. (Such change, if made, would be fully acceptable, as it is likely to strengthen FED's autonomy as a second-tier institution). 73. The major purpose of the FED is to channel long-term resources from multilateral and bilateral financial institutions to economically sound invest- ment projects. The Government provides FED with counterpart funds through equity contributions and loans. 74. Before suspending operations in the country (para 24), the Bank had appraised a proposed industrial credit project and recommended that Bank funds be channelled through the FED. According to the appraisal mission's findings, the FED met the Bank's standards from both an operational and institutional point of view. The FED's operating capabilities were not materially affected by the events of 1978-79 and the new Government proposes to continue using the FED, when appropriate, as a channel for funds from international and bilateral sources. Consequently, the proposed agricultural/industrial loan would be channelled through the FED which would act as the Government's executing agent. 75. Organizationally, the FED is set up as an autonomous unit headed by an executive director who is assisted by area directors in charge of three lending programs--agricultural development (ADP), industrial development (IDP), and small-scale enterprise development (SSDP). A new executive director has been appointed. Since the revolution he has been senior vice president of BDN but will now devote full time to the FED. Many of the professional staff have remained, although several have been transferred to other duties within the BDN since the processing of new development projects has been temporarily halted. In the interim, remaining FED staff are working on supervision of existing subloans. 76. Although responsibility for appraisal and supervision of subprojects rests with the financial intermediaries, FED staff have frequently provided assistance, particularly with regard to the economic evaluation of investment projects. Under the proposed project, the task of subborrower appraisal will be simplified since subprojects will consist only of rehabilitation of exist- ing enterprises rather than new investment. However, FED management believes  - 24 - that the normal full complement of staff will be required to deal with the many uncertainties of the reconstruction effort and, therefore, the Govern- ment and BDN have expressed the intention to substantially strengthen the staff of FED. 77. FED's operations have grown rapidly since its establishment in 1972, particularly during 1976-78. Its largest program is the ADP which at year-end 1978 accounted for 52% of total cumulative loan commitments. Nicaragua: FED Cumulative Loan Approvals, through December 31, 1978 (V million) Total FED Loans Project Amount Amount % of Program Cost Disbursed Committed Commitments Agriculture 376 145 273 52% Industry 477 142 201 38% Small Scale Enterprise 68 48 52 10% Total 921 335 526 100% The ADP operations included a credit program for small and medium-scale bene- ficiaries to finance crops and livestock which was financed with Bank funds (Loan 943-NI), borrowings from the CB and a Government grant. Beneficiaries and intermediary institutions provided 40 percent of total project costs. A coffee plantation renovation program is also part of the ADP and is financed by the CB and the Government. The IDP operations, which have accounted for 38 percent of total lending, have emphasized agro-industrial projects, and have also included lending to the construction, construction materials and tourism subsectors as well as the financing of pre-investment studies. IDP operations have been financed by the IDB, CB and the Government, with the beneficiaries and intermediaries together providing about 58 percent of the total project costs. The SSDP was established in 1976 with funds from the Government and USAID and has grown to represent about 10 percent of total lending. 78. During its first five years of operations, interest rate differen- tials charged by FED did not fully compensate its operating costs, and it accumulated losses totalling