Mexico - First and Second Industrial Equipment Fund (FONEI) Projects

Document of The World Bank FOR OFFICIAL USE ONLY V11Cr Report No. 2594 PROJECT PERFORMANCE AUDIT REPORT MEXICO - FIRST AND SECOND INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (LOANS 824-ME AND 1205-ME) June 29, 1979 Operations Evaluation Department 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.  PROJECT PERFORMANCE AUDIT REPORT FOR OFFICIAL USE ONLY MEXICO - FIRST AND SECOND INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (LOANS 824-ME AND 1205-ME) TABLE OF CONTENTS Page No. Preface i Basic Data Sheet (Loan 824-NE) ii Basic Data Sheet (Loan 1205-ME) iii Highlights iv - V PROJECT PERFORMANCE AUDIT MEMORANDUM I. Introduction 1- 3 II. Use of Bank Funds 3 7 III. The Sub-project Selection Process 8 - 9 IV. FONEI's Organization, Overall Operations and 10 - 11 Procedures V. Conclusions 11 - 13 Annex I: Sub-projects financed under Loan 824-NE Basic Data 14 Annex II: Sub-projects financed under Loan 824-NE Export/Import Substitution Performance 15 Annex III: Comments received from the Borrower 16 ATTACHNENT: PROJECT COMPLETION REPORT I. Introduction 17 - 18 II. Objectives of Bank Lending 18 - 19 III. Utilization of Loan Proceeds 19 - 25 Commitment and Disbursement 19 Investment Cost and Financing of Subprojects 20 - 21 Characteristics of Subprojects Financed 21 - 22 Type of Enterprises Supported 22 - 23 Participating Intermediaries 23 FONEI's Onlending Rates 23 - 25 This document has a restricted distribution and may be used by recipients only in the performance of their ofcial duties. Its contents may not otherwise be disclosed without World Bank authorization. -2- (Cont.) Page No. IV. Economic Impact 25 - 27 Profitability and Efficiency 25 - 26 Balance of Payment Impact 26 - 27 Employment 27 V. Institution Building 28 - 38 Bank Involvement 28 Operational Growth 28 Organization, Management and Staffing 28 - 29 Relations with Borrowers and the Bank 30 Resources 30 Policies and Procedures 30 - 32 Project Appraisal 32 - 35 Project Supervision 35 - 37 Financial Performance 37 - 38 Role of Consultants 38 VI. Conclusions and Recommendations 38 - 39 ANNEXES ANNEX 1 Estimated and Actual Disbursements 40 ANNEX 2 Financial Composition of FONEI Financed Projects 41 ANNEX 3 Characteristics of FONEI's Subprojects 42 - 43 ANNEX 4 Size Distribution of FONEI's Subprojects 44 ANNEX 5 Classification of FONEI's Operations by Financial Intermediaries 45 ANNEX 6 Interest Rates 46 ANNEX 7 Projected and Realized Exports in 1977 by a Sample of Enterprises Financed by FONEI 47 ANNEX 8 Projected and Realized Import Substitution in 1977 by a Sample of Enterprises Financed by FONEI 48 ANNEX 9 Regional Distribution of FONEI's Lending Operations 49 -3- (Cont.) Page No. ANNEX 10 Projected and Realized Employment by a Sample of Projects Financed by FONEI 50 ANNEX 11 FONEI's Flow of Applications for Project Financing 51 ANNEX 12 Summary of FONEI's Financial Assistance 52 ANNEX 13 Projected Organization Chart of FONEI 53 ANNEX 14 FONEI's Personnel and Loans Approved 54 ANNEX 15 FONEI's Project Processing Times 55 ANNEX 16 FONEI's Audited Balance Sheets as of December 31 56 ANNEX 17 FONEI's Audited Income Statements as of December 31 57 ANNEX 18 FONEI's Sources and Uses of Funds Statements, 1972-1978 58 ANNEX 19 Estimated Employment, Income and Foreign Ex- change Savings Impact of FONEI's Lending Operations 59  PROJECT PERFORMANCE AUDIT REPORT MEXICO - FIRST AND SECOND INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (LOANS 824-ME AND 1205-ME) PREFACE This report covers an audit of performance under loans 824-ME and 1205-ME to Nacional Financiera of Mexico for on-lending to the Fondo de Equipamiento Industrial (FONEI), a trust fund established by the Government with Banco de Mexico as its Trustee, to finance industrial enterprises with capacity to produce industrial goods and services for the domestic and export markets. The loans, in respective amounts of US$35 million and US$50 million, were approved in June 1972 and April 1976. Loan 824-ME was closed, fully disbursed, in September 1978. By April 1979, loan 1205-ME was disbursed at 79%. An OED mission visited Mexico in March 1979 and held discussions with officials of FONEI, Banco de Mexico, Nacional Financiera and the Government, as well as with representatives of the banking and business communities. Assistance rendered during the mission is gratefully acknowledged. The audit memorandum is based on the attached Project Completion Report (PCR) prepared by the Bank's Latin America and the Caribbean Regional Office, file review and discussions with Bank staff as well as various project and other officials in Mexico during the OED mission. The con- clusions reached in the audit memorandum differ notably from those of the PCR in relation to achievement under the directed lending objective of the two loans, More precisely, the audit memorandum focuses on a review of the level of achievement under the loans' expectation of directing Bank resources toward efficient productive entities lacking adequate investment financing and discusses the feasibility of meeting this expectation in the context of FONEI's two-tier intermediation process. Comments received from the borrower have been taken into account in preparing this report and are reproduced as Annex III to the Audit Memorandum.  - ii - PROJECT PERFORMANCE AUDIT REPORT MEXICO: FIRST INDUSTRIAL EQUIPMENT FUND (FONEI) (LOAN 824-ME) BASIC DATA SHEET Amounts (in US$ mln) As of 4/30/79 Original Disbursed Cancelled Repaid Outstanding Loan 824-ME 35.00 35.00 - 4.90 30.10 CUMULATIVE LOAN DISBURSEMENT FY73 FY74 FY75 FY76 FY77 FY78 (i) Planned 5.6 15.2 28.7 35.0 35.0 35.0 (ii) Actual - 5.4 16.9 28.7 32.4 35.0 (iii) (ii) as % of () 35 59 82 92 100 PROJECT DATA Actual Original Plan Est. Actual Board Approval 5/23/72 Loan Agreement 6/03/72 Effectiveness 8/31/72 10/12/72 Loan Closing 6/30/76 9/30/78 Total Project Cost (US$ m1n) n.a. 108.0 MISSION DATA Sent Month No. of No. of Date of Item By Year Weeks Persons Manweeks Report Programs/IDF Identification 7-8/70 2.5 3 7.5 8/70 Preparation ) 10-11/70 4.0 4 16.0 11/70 4/71 3-4 /71 1.0 1 1.0 8/71 1.0 2 2.0 8/71 Preappraisal ) 10/71 1.5 2 3.0 Appraisal 11-12/71 2.5 2 5.0 5/72 TOTAL 12.5 34.5 IDF Supervision .1 10/72 1.0 2 2.0 10/72 Supervision II 6/73 0.5 1 0.5 6/73 Supervision Ill 7/74 3.0 3 9.0 1/74 Supervision IV 10/75 3.0 2 6.0 1/76 Supervision V 8/76 1.0 2 2.0 8/76 Supervision VI 1-2/77 1.0 2 2.0 2/77 Coimpletion 10-11/78 1.5 5 7.5 3/79 TOTAL 11.0 29.0 COUNTRY EXCHANGE RATES Name of Currency (Abbreviation) Mexican Peso (Mex$) Year: Appraisal Year Average (1975) Exchange Rate: US$1 - Mex$12.5 Intervening Years Average (1976-78) US$1 = Mex$22.0 Completion Year Average (1970) US$1 = Mex$22.7  - iii - PROJECT PERFORMANCE AUDIT REPORT MEXICO - SECOND INDUSTRIAL EQUIPMENT FUND (FONEI) (LOAN 1205-ME) BASIC DATA SHEET Amounts (in US$ m1n) As of 4/30/79 Original Disbursed Cancelled Repaid Outstanding Loan 1205-ME 50.00 39.28 - - 39.28 CUMULATIVE LOAN DISBURSEMENT FY77 FY78 FY79 (i) Planned 12.0 34.0 50 0 (ii) Actual 5.6 23.2 39-: (iii) (ii) as % of (i) 46 68 78.6 PROJECT DATA Original Plan Actual or Est. Actual Board Approval 2/03/76 Loan Agreement - 4/30/76 Effectiveness 7/30/76 8/30/76 Loan Closing 12/31/79 12/31/79 Total Project Cost (US$ m1n) n.a. 235.6 MISSION DATA Sent Month No. of No. of Date of Item By Year Weeks Persons Manweeks Report IDF Identification N/A Preparation N/A Preappraisal 7-8/74 3.0 4.0 12.0 8/74 Appraisal 1/75 3.0 3.0 9.0 1/76 TOTAL 6.0 21.0 Supervision I 8/76 1.0 3 3.0 8/76 Supervision II 172/77 2.0 2 4.0 2/77 Supervision III 11/77 3.0 3 9.0 4/78 Completion 10-11/78 1.5 2 3.0 3/79 TOTAL 7.5 19.0 COUNTRY EXCHANGE RATES Name of Currency (Abbreviation) Mexican Peso (ex$) Year: Appraisal Year Average (1975) Exchange Rate: US$1 - Mex$12.5 Intervening Years Average (1976-78) US$1 - Mex$22.0 Completion Year Average (1979) US$1 Mex$22.7 1/ As of April 30, 1979.  - iv - PROJECT PERFORMANCE AUDIT REPORT MEXICO - FIRST AND SECOND INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (LOANS 824-ME AND 1205-ME) HIGHLIGHTS This report covers an audit of achievement under loans 824-ME and 1205-ME to the Fondo de Equipamiento Industrial (FONEI) of Mexico. The proceeds of these loans, in respective amounts of US$35 million and US$50 million, were meant to be channelled to industrial projects producing for export or for efficient import substitution through the intermediary of commercial banks which were to carry the credit risk. The Bank also expected its funds to be allocated to companies lacking access to adequate investment financing facilities for lack of sufficient collateral or proper connections with the financial network. Because the private financieras being used as channels to process FONEI funds have been carrying the credit risk involved in FONEI's operations, they have not been ready to relinquish their traditional collateral requirements on the basis of FONEI's project appraisal procedures. Moreover, as a result of credit shortages in the country and because of the attractive terms provided under FONEI funds, there arose a situation of non-price credit allocation, which encouraged the use of FONEI funds by prime borrowers. As a result, FONEI was unable to reach the class of entrepreneurs which the Bank was expecting it to aim at. Moreover, even in the context of a more elastic credit supply, the small differential offered to financial intermediaries would not seem to have been sufficient to induce them to channel FONEI funds to borrowers representing a higher degree of risk which the Bank was seeking to reach (paras. 2.05 and 5.04 of the PPAM, para. 50 of the PCR). Bank funds available under the loans were allocated to sound projects, whose aggregate foreign exchange saving performance has been substantial, though below forecast in volume as well as value terms, due to some degree to prevailing economic conditions (para, 2.06 of the PPAM). Moreover, because the FONEI funds were largely fungible with the financieras' own financial resources, it can be argued - v - that the net impact of the scheme on the country's balance of payments was substantially lower than the aggregate performance of sub-projects it contributed to finance (paras. 2.07 and 5.02 of the PPAM). FONEI has, since the second bank loan, endeavored to involve the financieras in project appraisal work so as to induce a change in their decision-making process. This has proved much more difficult than anticipated, and there is no evidence so far that the basis of the financieras' use of FONEI funds has been modified to any significant extent (paras. 3.02 and 3.03 of the PPAM, para. 53 of the PCR). In this context, FONEI's intensified promotional efforts should, in the future, prove necessary to reach a less-favored class of investors (para. 3.04 of the PPAM). Other points of interest are: - the impact of overall credit availability on the demand for FONEI funds (paras. 2.02 and 2.03 of the PPAM), - the relatively high capital intensity of sub-projects financed under the two loans which resulted partially from efficiency criteria imposed by FONEI (para. 2.04 of the PPAM), - the spread effect of FONEI's use of consultants to carry out project appraisal tasks (para. 4.03 of the PPAM, para. 51 of the PCR), - FONEI's relatively long processing time and its efforts at shortening it (paras. 47 and 48 of the PCR), - the need for FONEI to intensify its supervision procedures (para. 4.04 of the PPAM, para. 58 to 61 of the PCR, - the Bank's efforts at raising FONEI's lending rate (paras. 22 to 29 of the PCR). PROJECT PERFORMANCE AUDIT MEMORANDUM MEXICO - FIRST AND SECOND INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (LOANS 824-ME AND 1205-ME) I. Introduction 1.01 Loans 824-ME and 1205-ME were the first two loans made by the Bank to assist the lending operations of the Fondo de Equipamiento Industrial (FONEI), a Government trust fund administered by Banco de Mexico, the central bank. These two loans, in amounts of US$35 million and $50 million, were approved in June 1972 and April 1976, respectively. Loan 824-ME was closed, fully disbursed, in September 1978 after the closing date had been extended four times by a total of more than two years from its original schedule. Loan 1205-ME was fully committed by December 1978 and is expected to be fully disbursed slightly before the original closing date of December 1979. A third loan (Loan 1560-ME), in an amount of US$100 million, was approved to FONEI in February 1978; due to the rapid commitment of its proceeds, a fourth loan is now under consideration by the Bank. 1.02 The strategy adopted under these loans to channel funds to eligible sub-projects departed strikingly from the Bank's normal traditional DFC-type approach to industrial financing. This strategy was inspired by the scheme developed by the Mexican Government to assist priority 'activities of the private sector in the fields of agriculture, industry and tourism and based on a number of trust funds (fideicomisos) managed by Banco de Mexico or Nacional Financiera, the main development finance institution of the Government; these trust funds have been allocated mostly from the legal reserves of the banking system (in the form of bonds held by the central bank), occasionally supplemented by foreign financial assistance. Available financial resources are channelled to eligible productive entities through financial intermediaries which are the direct borrowers of these trust funds, the whole mechanism functioning as a two-tier intermediation system. 1.03 In consonance with this general practice, the Mexican Government established FONEI in October 1971 as a trust fund, with Banco de Mexico designated as trustee, to channel funds to industrial projects producing for export or for efficient import substitution. As such, the establish- ment of FONEI was one of a number of measures taken in 1971 by Mexico's -2- new administration to improve the net impact of the industrial sector on the balance of payments. In order to correct policies which had, in the past, through excessive protection, led to the creation of inefficient enterprises with high domestic prices and limited growth capacity, the new Government had introduced, earlier in 1971, important fiscal incentives and institutional changes to stimulate export of industrial goods. New measures included a system of excise tax rebates on manufactured exports (CEDIs), liberalized legislation for duty-free temporary imports by export-oriented assembly plants along the U.S. border and the introduction of a tax refund on exports made by trading companies. In this context, the creation of FONEI was seen as com- plementing fiscal measures by facilitating the access to long-term credit of export-oriented industries. This effort at providing industrial policies with a stronger export promotion orientation was progressively accentuated in subsequent years. 1.04 The period covered by the two loans under review (1972-1978) witnessed a sharp acceleration of inflationary trends, with fluctuations from year to year. The annual rate of inflation averaged about 20% between 1973 and 1976. Mounting inflationary pressures prompted a progressive tightening of monetary controls by the Government, leading to a sharp reduction in credit availability starting mid-1973. This was compounded by a fall in resource mobilization as a result of low interest rate policies as well as exchange rate uncertainties. The fixed parity of the peso with the US dollar, in force since 1954, was abandoned in 1976 and the peso allowed to float freely thereafter. Because of investors' preference for liquid assets and foreign debentures, nonmonetary liabilities of the banking system dropped from 32% of GDP in 1972 to 22% in 1976. The new administration that took office towards the end of 1976 has revised interest rate policies; the introduction of higher maximum interest rates on deposits have led to an improvement in the banking 'system's resource mobilization performance, while cautious demand management brought about a decline in the rate of inflation. Overall, however, excluding the first year following the approval of loan 824-ME (1972), the funds available under the two loans have been committed in the context of increasing scarcity of credit which trust funds supporting priority economic activities could only partially alleviate. 1.05 The Bank's understanding of FONEI's objective was that the newly-created fund would facilitate investments for the expansion of exportable output or for efficient import-substitution by providing long-term funds to medium-size firms. Such companies were alternativ7ly referred to by their size (total employment of less than 250 workersli) 1/ This was only one of several criteria suggested for defining medium-size enterprises in Mexico. - 3 - and by their credit rating among financial institutionsal/. FONEI's operating regulations are broadly worded and related to export promotion/import substitution and do not confine it to any size group; further, FONEI never committed itself to restrict its operations to medium-size enterprises, however defined, whereas the Bank was expecting the proceeds of its loans to be used mainly to assist such companies. More specifically, the enterprises, to which the Bank thought FONEI would address itself most effectively, were to be those characterized by their less-than-prime credit rating and by vulnerability to fluctuations in credit availability; it was expected that the long maturities and grace periods offered under FONEI funds would be crucial to such enterprises. 1.06 This middle group of enterprises had emerged as an off-shoot of Mexico's economic development process, alongside much larger industrial interests often characterized by t? ir close ties with private investment banking institutions (financieras)- whose establishment they had usually been associated with. Moreover, most of these large groups also benefit- ted from foreign participation in their capital which facilitated their access to foreign financial markets. In comparison, the access of unallied enterprises to project financing was much more restricted, mostly on account of the banking system's emphasis on guarantees from entrepreneurs and on the latter's relationship with the lending insti- tutions, indicating that the Bank's focus in its lending to FONEI on medium-size enterprises with lesser connections was warranted. II. Use of Bank Funds 2.01 At the time of appraisal of the first loan, the choice of an adequate interest rate spread to be passed on to financial inter- mediaries was seen, alongside the level of fixed investment and the competitiveness of FONEI terms with those of alternative sources of financing, to be a crucial element in determining the volume of demand for FONEI funds and thereby, the pace of utilization of funds under the Bank loan. This spread was set for the two loans under review at two percentage points, which was expected to provide financieras with sufficient incentive to promote the use of FONEI funds along with their own resources given the lower risk of these projects because of FONEI's appraisal, although it was recognized to provide for 1/ However, because of cross-holding among companies, these two criteria are not necessarily equivalent. 2/ Financieras are the term lending arms of banking conglomerates which have progressively been fused into multipurpose banks. a differential barely larger than that which the ftnancieras sequred on their lending operations with prime borrowers (2% vs. 1.85%1/). 2.02 In actual fact, the critical factor in determining the use of FONEI funds and the pace of commitment under the loans appears to have been the volume of alternative sources of financing in the banking system,as financial intermediaries proved anxious to commit their own resources in priority. Thus, because of the high liquidity prevailing in the banking system, no funds were committed during the first year following Bank approval of the first loan although FONEI's own managerial difficulties which led to lack of promotion (necessary for a new scheme, since FONEI was almost totally unknown among investors in its earlier phase) were also contributing factors in causing this initial slippage. Thereafter, the demand for FONEI funds has grown regularly, as the effect on credit availability of the monetary controls imposed by the Government to deal with inflation was increasingly felt and financial intermediaries became willing to use FONEI funds, causing the second (as well as the third) Bank loan to be committed ahead of schedule. 2.03 Although FONEI was little known among the business community when the first Bank loan was getting committed (1974-1975), demand for FONEI funds was considerably encouraged by its low relending rate (11%) in relation to the average cost of alternative resources (14-18%), thus creating a situation of non-price rationing (see para. 2.05 below). Under the second loan, a system of regular revisions of the interest rate charged by FONEI on its sub-loans was set up on,the basis of changes in the average cost of funds to financieras2-' (ACF), FONEI's lending rate being initially set at 13.5%, i.e., 1.5 percentage points above ACF (see paras. 24 and 25 of the PCR). Moreover, following the practice of commercial banks and financieras, FONEI adopted, in August 1977, a system of flexible interest rates, its interest rate to 1/ At the time of appraisal of the first Bank loan, financieras were reportedly lending to their best customers at 13% and obtaining funds at an average of 11.15% (see para. 4.26 of Appraisal Report No. DB-91a). The latter included interest, administrative expenditures and cost of idle money as a result of reserve and portfolio require- ments (Source: National Bankers Commission). 2/ As regularly compiled by Banco de Mexico. - 5 - final borrowers being set at two percentage points above the ACF index (see para. 25 of the PCR). At these levels of interest rate, demand for FONEI funds has been ample but the imposition of credit restrictions which have altered market conditions makes it difficult to assess the suitability of some elements of the credit design such as the spread allowed to financial intermediaries. It is, however, unlikely that, when the banking system reverts to a period of high liquidity, the demand for FONEI funds would drop seriously, as FONEI has endeavored for the last few years to publicize its activities around the country and has undertaken to promote the utilization of its resources directly with potential investors. This is supported by FONEI's experience during the first half of 1978 when its operations kept expanding despite capital inflows from abroad which led to a surge in money supply and some excess liquidity. 2.04 Proceeds of the two loans under review were used to finance 85 sub-projects widely distributed over the country (para. 31 of the PCR). Their characteristics and the details of their financing are reviewed in paras. 11 to 20 of the PCR (ex-ante aggregate data are given in Annex 3 to the PCR; actual data related to a sample of sub- projects in Annexes 7 to 10 to the PCR; and actual data on sub-projects financed under the first loan in Annexes 1 and 2 to this memorandum). Contrary to Bank expectations, Bank funds are found to have, for the most part, been channelled to fairly large companies. The average cost of sub-projects was approximately US$4.5 million equivalent, borrow- ing firms having on average US$9 million equivalent in total assets. The contribution of Bank loans to total project costs averaged 21% and was complemented in a three-to-two ratio by FONEI's own local resources from Banco de Mexico. Ex-post data on sub-projects financed under the first loan indicate that, 17 average, cost overruns in local currency equivalent amounted to 477- and fixed invesp ent cost per job created to approximately US$25,000-30,000 equivalent- . Clearly, the large size of investment cost and high capital intensity of sub-projects financed under the loans partially reflect the fact that only firms with suf- ficient size and technology could meet industrial efficiency criteria imposed by FONEI. However, most firms having received finance under the loans were found to belong to large, well-established industrial groups (some of which obtaining finance for several projects) which could have been able to secure funds from alternative sources on adequate term'. 1/ The parity of the Mex$ with the US$ remained fixed until September 1976 when the Mex$ was allowed to float; by that date, the very large majority of projects financed under the first loan had been completed (see Annex 1 to this memorandum). On the other hand, about one-third of cost overruns may have been due to domestic inflation. 2/ The Region considers the capital intensity of subprojects to be moderate in relation to national indicators of Mexico and countries at a similar stage of development. 3/ Approximately 50% of Bank-financed projects had foreign contributions in their capital. -6- 2.05 Two factors have led to the concentration of FONEI's resources on prime borrowers. During the commitment period of the first loan (mid-1973-1975), a situation of non-price credit rationing resulted from FONEI's on-lending rate being between one and three percentage points below the rate offered by financieras to their best clients, clearly encouraging intermediaries to allocate FONEI's funds to those borrowers offering the best guarantees. Under the second loan, FONEI's on-lending rate was first set at 1.5% above the financieras' average cost of funds and later on at 2% above it comparable with the financieras' own prime rates. It was the Bank's expectation that the element of security, brought about by having investment projects appraised by FONEI, would encourage financial intermediaries to lower their collateral requirements. There is no evidence, however, that this took place to any substantial extent as regards the use of funds under the two loans under review. The scarcity of credit provided the financieras with little motivation to diversify their lending criteria and, inasmuch as the spreads taken by intermediaries on lending operations reflect the risk elements they associate with particular projects, the 2% spread offered to the financieras under the loans could not be sufficient, under the prevailing circumstances, to direct FONEI's lending towards the class of entrepreneurs which the Bank was expecting it to aim at. 2.06 Sub-projects were selected on the basis of their impact on the country's balance of payments through export or import substitution. Ex-ante economic rates of return indicated that FONEI's resources were being allocated to projects of high economic merits. Actual d ta on the performance of sub-projects financed under the first loanl suggest that, in general, the contribution of sub-projects to export or import substitution was, in volume, substantially below forecasts2/. However, in value terms, the net foreign exchange impact of sub-projects was substantial, though much lower than expected (US$240 million equivalent during 1977, instead of US$440 million as forecast). An analysis of the past performance of sub-projects shows that there was a tendency in appraisals to overestimate the performance of the sub- projects and the benefit to be derived from them. The lack of con- sistent export performance on the part of sub-borrowers also resulted from the fact that, in most cases, exports represented temporary excess production over domestic demand, uncertainty about the foreign exchange risk during the commitment period of the two loans under review discouraging Mexican enterprises, with the exception of a number of firms subsidiary to foreign companies, from planning their development on the basis of a long-term export strategy. 1/ This is based on data provided by FONEI and reproduced in Annexes 1 and 2 to this memorandum and, therefore, differs from the sample data given in PCR Annexes 7 and 8. 2/ The performance of import substitution projects partially reflected the lower growth of the overall economy between 1974 and 1977. Moreover, the overvaluation of the Mex$ partially contributed to the projects' poor export performance until the September 1976 devaluation. - 7 - 2.07 Because the two loans under review were committed and disbursed in the context of severe shortages of industrial credit, they clearly added to available resources and had a net positive impact on fixed investment. In this sense, the creation of FONEI enabled (to a limited extent because of its size in comparison to total industrial credit) the long-term segment of industrial credit to continue in the face of strict monetary controls. However, FONEI's resources were not allocated to those additional projects whose financing, by adding to total credit availability, it permitted. Rather, FONEI's funds were used to finance projects which would have been financed anyway, indicating a high element of substitution with the financieras' own financial resources. As FONEI funds remained small in size compared with those of the financial intermediaries with which it has been associated, the use of industrial efficiency criteria to select sub-projects eligible for financing did not alter the composition of the overall flow of funds to industry, suggesting that FONEI's net impact on the efficiency of the industrial sector (and on the country's balance of payments) was, in the context of the two loans under review, substantially lower than what the per- formance of indiv dual sub-projects financed under the Bank loans tends to suggestl 2.08 It can be argued that, to have an economic impact, FONEI should have addressed itself to projects lacking sufficient guarantees to obtain adequate financing from commercial sources. This link between economic efficiency and resource allocation would have been in keeping with the Bank's objective to have the proceeds of its loans allocated primarily to firms without strong connections with the financial network. This could have been achieved either by attempting to modify the financieras' own decision-making process, or by short- cutting it thrqugh FONEI directly addressing itself to potential sub-borrowersj2. 1/ The Bank's Latin America and Caribbean Regional Office's view regarding this issue, on the other hand, is that the element of selectivity introduced by FONEI, based on efficiency considera- tions, in the situation of credit scarcity which has been prevailing in Mexico, should have resulted in an incremental positive balance of payments impact and that the element of term credit substitution is not likely to be very significant in a situation of credit scarcity. For the reasons stated in the main text, OED's view is that this incre- mental impact has been negligible. 2/ Until 1978 the Banking Law required firms to provide guarantees of 133% of the loan amount, thus limiting FONEI's freedom of choice in this respect. However, there is some evidence that the amount of collateral required by the financieras has been well above the minimum legal requirements. III. Sub-project Selection Process 3.01 The creation of FONEI was expected to introduce the notion of project appraisal among the Mexican private sector business com- munity; inasmuch as its funds included an element of subsidy, part of it could be considered as a trade-off for having large projects prepared in bankable form. In the original design of the project, responsibility for selecting sub-projects was to be shared between FONEI itself and participating financial intermediaries. While the intermediaries were expected to evaluate the financial plan and risk of the project and to ensure adequate collateral before submitting project proposals to FONEI, the latter was to carry out a full appraisal of projects, including evaluation of their economic merits. Because FONEI did not wish to develop in-house the necessary capability to carry out project appraisal (see para. 4.03 below), it relied almost entirely on outside consultants for its appraisal work, focussing its activity on supervising the work done by the consulting firms it had appointed for this purpose. It has been seen, however, that, because it had to rely on financieras for the generation of sub-projects, FONEI was unable to reach non-established entrepreneurs, as the relevant criteria in selecting projects for financing under the loans under review were those determined by the financial intermediaries which were assuming the credit risk. 3.02 At the time of the approval of the second Bank loan to FONEI (February 1976), the Bank and FONEI became aware of the difficulties arising out of this situation and have since then endeavored to correct it, though with little success so far. The strategy which was adopted under the second loan, to encourage intermediaries to lend on the basis of project appraisal rather than primarily in relation to collateral, was to involve them in project appraisal work. This was to be done in two steps. First, the responsibility for the coordination between final borrowers and consultants during project appraisal, which had so far been FONEI's,was to be transferred to the financial intermediaries, FONEI reimbursing the financieras for the cost of consultant services. Later on, FONEI was expected to induce intermediaries to set up in-house appraisal units for which it was ready to provide financing. In this context, FONEI was to concentrate its efforts on the six or so financial groups which, in the past, had accounted for the bulk of its operations, behaving towards them in a way similar to the Bank towards typical borrowing DFCs. Since then the Government has also demonstrated its awareness of the importance of promoting appraisal practices by changing its banking legislation; minimum guarantee requirements have been eliminated and financieras are now supposed to make their financing decisions on the basis of feasibility studies of investment projects. While the spirit of this - 9 - new law would obviously be very difficult to enforce, it 4oes demonstrate the Government's support to FONEI's policies-. 3.03 Increased involvement of financial intermediaries in project appraisal work has so far proved considerably more difficult to im- plement than was originally expected. Moreover, in the few instances where appraisal work was coordinated by a financiera, there was no evidence that this led to its relinquishing collateral requirements. As already mentioned, with credit shortages, there was little in- centive for financieras to alter their decision-making process. FONEI, however, expects that its continuous emphasis on the advantages of turning to appraisal-based financing will eventually bear fruit. Whereas the desirability of FONEI's objective is obvious, the feasi- bility of the strategy which has been adopted remains to be demonstrated, as there is today very little evidence that financial intermediaries, which are organized as profit-making corporations based on large delegation of financial responsibilities in their organizational structure, will eventually modify the basis of their investment decisions. FONEI is now concentrating on modifying its compensation system for financial intermediaries which undertake project appraisal to make it more attractive. 3.04 In the context of its inability so far to change rapidly the financieras' decision-making process, FONEI's promotional activities with business communities around the country, which were greatly expanded after its new dirtor took office at the end of 1976, come into particular prominence- . Although FONEI has, through promotion, been aiming mostly at a wider geographical dispersion of its operations, its efforts should induce an increasing number of enterprises to apply directly for FONEI financing, rather than through financial inter- mediaries as at present. Final borrowers will still need to contact a financial intermediary to assume the task of processing FONEI's funds and carrying the credit risk; if, in this process, it is found that the proportion of operations initiated by FONEI but rejected by the financieras on the basis of insufficient financial backing is high, the need for an increase in the spread offered by FONEI to participating intermediaries would become essential. 1/ The Bank's Regional Office comments that the Banking Law does not prevent banks from requesting guarantees. 2/ One of the three sub-directors of FONEI now deals exclusively with promotional matters. - 10 - IV. FONEI's Organization, Overall Operations and Procedures 4.01 Owing mostly to capable management and continuous support from Banco de Mexico following an initial period of operational dif- ficulties, FONEI has, since the time of approval of the first loan, become an effective and competent institution, increasingly known among the business and banking community. By September 1978, its total assets had reached Mex$2.6 billion (US$113 million equivalent), of which outstandings under the two loans under review were 52%. FONEI's staff, which increased from 21 to 40 between 1973 and 1978, has not progressed in line with its volume of business, as successive manage- ments have endeavoured to keep it from becoming an excessively bureaucratic institution with inflated personnel and poor financial position. Rather, the two-tier mechanism, which permitted the dele- gation of sub-loan processing duties to financial intermediaries, was complemented by use of outside consultants to carry out project appraisal tasks. 4.02 Because FONEI does not carry any risk on its portfolio (as the financial intermediaries are FONEI's actual borrowers), benefits from a captive market for its bond issues (which the central bank has authorized financial institutions to hold against their reserve requirements) and is not responsible for repaying Bank loans (these being repaid by the Government), FONEI's financial position is of no direct relevance. Mostly on account of lower than expected adminis- trative expenses, FONEI's net income was until 1975 higher than forecast in absolute terms and even more so as a percentage of average total assets. However, following the devaluation of the peso, FONEI incurred exchange losses in connection with its interest payments to the Bank, on which it c iries the exchange risk. This resulted in net losses in 1976 and 1977--; profitability, however, appears to have been re-established in 1978, albeit marginally. 4.03 The procedure adopted by FONEI to conduct project appraisal appears to have been judicious. By relying on outside capacities, FONEI has been able to have a wider educational impact than could have been possible by building up its own staff in line with the increased volume of its operations. Moreover, this last alternative would have necessitated professional diversification of its staff; this would have been rendered difficult, as FONEI is entirely dependent upon the overall organization of Banco de Mexico for its staffing policies and 1/ Exchange losses on the principal of Bank loans also led to a theoret- ically negative equity for FONEI; however, as the Bank loans are repaid by the Government and the peso equivalent of amounts repaid is transferred from FONEI's outstanding debt to its equity, exchange losses will be eliminated (see para. 63 and Annex 14 of the PCR). - 11 - does not offer career prospects to financial analysts. Hence, given the prevailing circumstances, the working relatio7ships which FONEI has developed with a number of consulting groupsl appears to have been the more satisfactory solution. However, this policy has led to some unevenness in the quality of appraisal and was largely responsible for lengthening FONEI's average credit processing time which contributed to the financieras' reluctance to wait for the completion of project appraisals before approving loans. Recently, FONEI has endeavoured to tighten its monitoring of appraisal standards and cut sub-project processing time with some measure of success. 4.04 Supervision has remained a very marginal function within FONEI, as reflected by the limited staff of its recently created supervision department which consists only of two officers out of a total professional staff of 22. FONEI's appraoch to project super- vision has been to delegate responsibilities to the financial intermediaries which, by law, are compelled to supervise term loans so as to ensure that loan proceeds are used for the purposes intended. Financieras have been lax in conducting such supervision which, in any case, falls short of development banking requirements (see para. 61 of the PCR). The development of active supervisory procedures, the need for which will not directly emerge as long as financieras are able to protect themselves against credit risks by securing sufficient collaterals, should be a major element in FONEI's efforts when it reaches a less favored clientele. Increased supervision which would have no impact on FONEI's income position, as the latter suffers no arrears position, would, however, be essential to enhance the long- term credibility of appraisal banking it is striving to promote. The first step could be to obtain from participating intermediaries the arrears situation on loans made out of FONEI's funds, which FONEI has never requested in the past, and to require financieras to introduce in credit agreements a reporting requirement covenant. In the initial period, supervision could then appropriately focus on a review of loans under arrears as well as on an attempt at identifying problem projects ahead of default. V. Conclusions 5.01 The major objective of the Bank in making the two loans under review was to support FONEI's activities in financing industrial projects producing for export or efficient import substitution. The Bank also expected FONEI to channel the loan proceeds in priority to those 1/ FONEI's most used consultant by far has been the Instituto Mexicano de Investigaciones Technologicas (IMIT), a research and consulting institution jointly sponsored by Banco de Mexico and Nacional Financiera. - 12 - enterprises lacking connections with the banking system and/or sufficient collaterals to obtain project financing on adequate terms from existing sources. Realizing the difficulties experienced by FONEI in reaching the "unallied" class of medium-size Mexican entrepreneurs, while relying for project preparation on the financial intermediaries which have to bear the credit risk involved in its operations, the Bank sought, at the time of the second loan, to develop, together with FONEI. a strategy for inducing a change in the investment banks' decision-making process. It was then assumed that involving financial intermediaries in the appraisal work, originally carried out (directly or indirectly) by FONEI, would be instrumental in overcoming their reluctance to take project qualities into consideration in evaluating credit applications and in bringing about lower guarantee requirements. Accordingly, such a transfer of appraisal responsibilities became an important objective of the second Bank loan to FONEI. 5.02 Bank funds available under the loans were allocated to sound projects, whose aggregate foreign exchange saving performance has been substantial. FONEI's final impact on the balance of payment, however, was not as substantial because, despite the use of economic efficiency criteria, its funds acted, during the period covered by the loans under review, as substitute for other investment financing resources. Indeed, the only binding criteria for obtaining project financing during this period were those determined by the financial intermediaries which presented FONEI with those projects which they thought would qualify under its requirements and provided finance to the others through other resources. To 'Limit the fungibility of Bank funds with other sources1 f financing and thereby to improve the effectiveness of FONEI's lending-, it appears essential that FONEI addresses itself to projects which are marginal under the financieras' traditional requirements. FONEI's strategy in dealing with this issue has been to try to involve investment banks in project appraisal work. Little has been done so far in this regard; the linkage between appraisals carried out by the financieras' contract consultants (with FONEI's finan2ing) and their decision-making process appears weak and ineffective2- . 5.03 Demand for FONEI's funds, because these are channelled through a two-tier intermediation process, is influenced by the interest rate charged to the final beneficiaries as well as by the spread left to the financial intermediaries. Under the first Bank loan, the final rate was set at 11% and the spread to the financieras at 2%. The 11% interest rate was acknowledged to be lower than the cost of funds from alternative sources (13-15%), but a degree of subsidy was deemed to 1/ In respect to its balance of payment objective. 2/ FONEI pointed out at the difficulty of rapidly involving commercial banks in project appraisal work, given the latter's traditional emphasis on collaterals (see FONEI's comments in Annex 3 to this memorandum). - 13 - be necessary to compensate for the requirements, in terms of export or import substitution performance, attached to the provision of credit. Under the two subsequent Bank loans, the interest rate on FONEI funds was raised a number of times but remained lower than comparable market rates, while the spread passed on to the financieras was maintained at 2%. In the meantime, an emerging shortage of credit provided FONEI's own funds with a rapidly expanding market which only seems to have been constrained in the last few years by FONEI's own processing time. 5.04 Because of little overall credit availability, most of the Bank funds were channelled to prime borrowers,as the availability of funds at low interest rates largely compensated for FONEI's appraisal requirements. However, even in the context of a more elastic credit supply, it is unlikely that FONEI would have been in a position to ensure the allocation of its funds to a less-established class of entrepreneurs. Indeed, the small differential offered to financial intermediaries, while attractive enough to induce them to draw upon FONEI's resources, would not have been sufficient to cover the borrowers1/ representing a higher degree of risk which the Bank was seeking to reach-. The only rationale for maintaining a policy of low interest rates in the con- text of FONEI was that credit conditions were expected to have an impact on the development strategy of investing companies. There is, however, very little evidence to support that this actually has taken place to any sig- nificant extent and fiscal advantages appear, in this respect, to have been much more directly effective. A different approach, based on decreasing the degree of substitutability of FONEI's funds with alter- native sources of financing, could, now that FONEI is getting well-known among the business community, help in channelling funds to those projects lacking suitable financing and thus, provide FONEI's funds with a more effective impact on the country's balance of payments. 1/ The Regional Office comments that increases in the margins provided to the intermediaries on all of FONEI's operations would not be likely to change the preferential orientation of the intermediaries towards the prime borrowers, especially in periods of credit scarcity; it further suggests that a more appropriate measure would be a selec- tive differentiation of the margins to the intermediaries based on a proxy for the borrowing enterprises' risk class, such as its size. OED agrees with thisproposition which supports its basic argument for an increased spread, although it should be noticed that, because of cross-holdings among companies, asset size may not necessarily represent adequately the creditworthiness of potential borrowers. Operations Evaluation Department June 29, 1979 PROJECT PERFORMANCE AUDIT REPORT MEXICO - FIRST AND SECOND INDUS1*IA. EjUIPMENT FUND (FONE) PROJECTS (WANS 824-bM AMD 1205-nE) FONEI Sub-Prolect Data Fixed Asets Start-up of - Net For i pCchange Eployment Profit (Before TaxL)Eqoit? Ratio Investment Operations FONEI Type of 7fi§7 Generated Equity Profit Retur; Company Estimated Actuel Estimated Actuel Credit production* Estimated Actuel Est. Actuel before % (Mex$) sOj:) zý)) $000 SD:)D $133 Tes cen-antos Ar.&n,ac del Gotfo, S.A. 403 900 632 900 a,e/75 oct/7z 37 500 Ex 654 376 522 829 52 375 352 330 23 132 3.0 e 's e C ua, S.A. 53 500 94 000 ene/75 dic/76 37 500 Ex 36 534 29 664 40 100 797 053 33 332 4.9 L"erillara inds-rial, S.A. 15 000 10 600 mar/74 dic/74 7 050 Ex 44 495 41 490 32 BD 13 553 7 506 40.4 F d M6qiLnas, S.A. I 19 900 23 500 dic/74 rm.3y5 14 397 SI y Ex 425 874 122 175 50 110 222 003 3 00 3.6 Comi.~3x, S.A. 92 200 212 200 dic/74 dic/75 37 500 SI y Ex 63 30o 3_0 400 - 300 523 033 23 067 5.3 S.ez,-ax, S.A. 6 900 8 500 dic/74 oct/75 5 000 Si 429 000 354 492 55 6 120424 45 990 33.2 Camaia, S.A. 55 300 114 300 ene/75 dic/75 28 000 SIy Ex 326 193 103 262 82 100 103 733 27 746 26.7 Motores y Raacciones, S.A. 35 600 42'800 dic/73 ene/74 2? 000 SI 815 263 261 237 240 200 336 220 135 652 40.3 Mtarias Primas y Min. de Lampazos, S,A. 45 200 61 000 ene/75 en*/75 28 789 SI 123 164 102 831 120 159 45 237 3317 7.3 Pronoc iones Ind,suriales Mexicanas, S.A. 40 000 44 000 jun/74 ene/75 28 600 SI y Ex 446 551 143 361 20 49 107 B29 24 674 22.9 Fábricas OriSn, S.A. 10 000 13 500 ago/74 nov/7c 7 000 Ex 104 587 84 353 175 175 149 034 7 125 4.9 La Florida, S .A. 32 900 53 000 ena/75 oct/75 37 429 SI 629 678 353 680 89 205 126 663 19 492 15.4 Fnoq.imia, S.A. 71 700 90 500 'u1/75 oct/75 37 500 Si 36C 673 142 110 170 330 155 674 (63 292) (40.6) Fu,ndidora de Aceras Tapayac, S.A. 51 200 60 700 jun/77 dic/7e 36 900 SI y Ex 356 149 2S6 666 33 14 133 725 31 123 23.3 T,os Fleatbles, S.A. 63 600 52 300 dic/75 dic/76 37 500 Si y Ex 93 635 24 757 50 40 78 747 12 331 15.6 Dakormex, S .A. 15 000 20000 jul/74 jul/75 10 000 SI y Ex 125 746 41 312 40 - 9 794 (10 742) (109.7) Ma.sLIrcgica Almena, S.A. 10 900 10400 dic/75 dic/76 10 600 SI 30 524 26 470 15 - 29 209 7 752 24.5 Q'-ica Me.amra, S.A. 32 400 29 100 dic/75 dic/75 18 000 Si y Ex 119 057 101 150 15 40 90306 26519 29.4 AzarDs da Chihuahua, S.A. il 720 12 720 aor/75 m.ay/75 7 200 Si 33 557 30978 66 55 269 995 (22 04) ( 9.2) ladsru-ial Papelera Mexicana, S.A. 81 500 95 100 mar/75 noV/75 37 500 Si 470 425 357 604 161 210 202 499 6819 3.4 Cra. Fundidora del Norte, S.A. 29 300 54 500 mar/75 sap/75 20 000 Ex 439 469 22 553 700 359 509 956 79 741 15.6 . >ýerramIentas Nacionalae, S.A. 13 300 16 400 dic/75 a2a/73 9 360 Ex 18 431 . 6 975 55 17 14 956 ( 2576) (17. 2)Z' Autoforjas, S .A. 79 000 97 700 jun/75 dic/75 33 843 SI 137 563 109 385 155 368 27 123 253 0.9 I r.ductos de Estirano, S.A. 22 700 24 600i .na/75 dic/74 il 080 Si 262 614 352 011 17 12 157 657 65 875 £2.0 Folynova. S.A. 218 400 221 200 e,e/75 mar/75 37 500 Ex 421 799 - 66 650 101 644 54 107 52.1 Eýuectic L'oestm.ent Castings de M&x., S.A. 10 000 5 100 ene/75 atr/76 2 777 Si 53 815 10 329 112 52 7 454 893 12.0 Cfa. QAmica Am-eyat, S.A. 16 700 19500 jun/75 jurn/76 6 939 SI 64 147 6352 24 111 5 637 ( 5301) ( 7.0) CMIcs Càmral Ca Mixico, S.A. 19 700 - 39900 no./75 fab/7- 9 847 SI y Ex 310 796 239 300 25 - 66 786 5951 8.9 indjstr a de '-Os Intercontinental, S.A. de C.V. 16600 25 100; ane/76 nov/ 7e 11 930 SI 239 270 242 000 35 25 267 7'9 24 949 9.3 Conductoras not.rray, S.A. 11 200 30 000 dic/74 afe5-5 a 000 SI 370 636 119 739 20 40 941 504 119 33 14.1 Cas& Arias, S.A. 12 300 7 400 dîc/74 feD/75 9 500 Ex 60 300 13 570 206 147 25 538 10439 41.1 Resinaes S,n:ticas, S.A. . 8 500 14 400. nov/74 ag/75 5 508 SI y Ex 151 740 27 199 14 40 27 050 ( 556) ( 2.1) Transaes, S.A. 70 700 103 600 mar/76 oct/75 36 375 SI 8040 64 437 61 136 45 443 5 645 12.4 /-snua.raas, S.A. 72 400 125 600 'ae/76 ene/7= 49 670 SI 433 632 26 554 353 397 167 257 ( 4 231) ( 2.5> 7aIoqsimia, S.A. 15 300 16 300 nov/75 oct/75 12 430 Ex 37 574 35 092 30 9 14 185 5 015 35.3 - :.s;rias Rasis-D, S.A. 114 400 407 500 sap/76 dic,,75 37 500 SIy Ex 272 869 221 116 76 76 1233 304 262 260 21.3 Ivm, S.A. 6400 6 900 ae/76 dic/75 4 600 SI 8 041 2 605 36 14 31 347 ( 3 731) (11.9) C'a. M!xica.a de Espaciaidaese Indus., S.A. 15 400 15 500 - ,/76 faz/77 9 300 Si 34 903 27 247 36 46 4 330 ( 1 621) (37.0) e S.A. I 57800 .5 300 ciz/76 5es 77 33 753 =x 22 245 13 Ç23 27 - 227 e91 £2 .t6E 27.t 1c4rias 7.-ér4y, S.A. 47 200 ý5 500 !aD/76 ,,- - 34 O'0 Si y Ex 41 752 4 026 15 22 5a7 2j9 147 227 25.2 A ea , S.A. 9 90D 6 200 ;7=/76 3o is 33 SI 22 256 il 36 40 23 12 330 1 115 Ç.1 ;'s ra Mescar.a de Maasrr csrial, S.A. 47 100 37 100 dic/76 d,c/75 29 17D SI 92 950 53 530 170 179 16647 ( 332) (20.1) T O T A L E S 2 067 400 3 0.35 600 900 8?2 9 S64 161 5 451 933 ,414 5, 320 * EX - Exporta SI - Import Substitution - 15 - ANNEX I1 PROJECT PERFORMANCE AUDIT REPORT NUXICM - FIRST AND SECOND INDUSTRIAL EQUIPMFNT FUND (FONEI) PROJECTS (WAN$ 824-E AND 1205-HE) Import/Substítution And/Or Export In Volume During 1977 By FONEI Sub-Projects Start-up of Operatíons Type of Import/Export Substitution Company Forecast Actual Productíon* Estiaated Actual Dfference ( Cementos Anánuac del Golfo, S. A. ene/75 oct/75 Ex 700 000 ton 754 000 ton 5.6 Cementos de Chihuahua, S. A. ene/75 mar/75 Ex 65 000 ton 69 000 ton 6.1 Ladrillera Industrial, S. A. mar/74 dic/74 Ex 16 800 pzas 19 489 pzas 16.0 Fabricaci6n de Máquinas, S. A. 1 dic/74 may/75 SI y Ex 1/ 1/ - Condumex, S. A. dic/74 dic/75 SI y Ex 5 410 ton 4 215 ton (22.1) Swecomex, S. A. 1 dic/74 oct/75 si 1/ 1/ - Camesa, S. A. ene/75 dic/75 SI y Ex 12 757 ton 5 329 ton (58.2) Motores y Refacciones, S. A. dic/73 ene/74 si 5 250 pzas 1 409 pzas (73.1) Materias Primas y Minerales de Lampazos, S. A. ene/75 ene/75 SI 167 300 ton 143 196 ton (14.4) Promociones Industriales Mexicanas, S. A. junV74 ene/75 SI y Ex 15 600 ton 13 141 ton (15.7) Fábricas Ori6n, S. A. ago/74 nov/74 Ex 225 000 pzas 204 000 pzas ( 5.3) La Florida, S. A. ene/75 oct/75 SI 30 096 ton 19 472 ton (-5.3) Fenoquimia, S. A. Jul/75 oct/75 si 9 665 ton 4 880 ton (49.5) Fundidora de Aceros Tepeyac, S. A. jurV77 dic/76 SI y Ex 19 996 ton 16 136 ton (19.3) Trbos Flexibles, S. A. dic/75 dic/76 SI y Ex 2 209 ton 582 ton (73.6) Dekormex, S. A. jul/74 jul/75 -SI y Ex 8.2 mill.m2 2.6 mill.m2 (68.3) MetalOra,tca Almenas S. A. dic/75 dic/76 SI 300 ton 260 ton (13.3) Qufmtca Mexama, S. A. dic/75 dic/75 SI y Ex 9 321 ton 6 533 ton (2M -) Aceros de Chihuahua, S. A. abr/75 may/75 SI 1.2 mill. pzas 0.4 mill. pzas (E4.6) Industrial Papelera Mexicana, S. A. mar/75 nov/75 si 37 800 ton 28 040 ton (25.e) Cfa. Fundidora del Norte, S. A. mar/75 sep/75 SI 23 090 ton 5 383 ton ( 7e.7) Herramientas Nacionales, S. A. dic/75 ago/76 Ex 436 000 pzas 165 000 pzas (62.2) Autoforjas, S. A. jurV75 dic/75 SI 10 000 ton 10 17e ton 1.8 Productos de Estireno, S. A. ene/75 dic/74 si 7 670 ton 11 174 ton. Potynova, S. A. ene/75 mar/75 Ex 3 360 ton - ('929) Eutectic Investment Castings de México, S. A. ene/75 abr/76 SI 170 ton 31 ton (81.7 Cfa. Qu(mica Ameyal, S. A. jurV75 Jun/76 si 2 517 ton 210 ton (91.6) Qufmica Central de México, S. A. nov/75 feb/76 SI y Ex 1 894 ton 1 410 ton (25.5) Industria de Baleros Intercontinental, S. A. de C. V. ene/76 nov/76 SI 10 038 pzaýs 7 400 pzas (26.3) Conductores Monterrey, S. A. dic/74 ene/75 si 7 600 ton 4 746 ton (37.5) Casa Aries, S. A. dic/74 feb/75 Ex 1/ 1/ Resinas Sintéticas, S. A. nov/74 ago/75 SI y Ex 4 607 ton 1 142 ton (75.2) Transejes, S. A. mar/76 oct/76 SI 95 000 jgos 54 437 jgos (32. Automanufacturas, S. A. ene/76 ene/76 Si 1/ 1/ Taloquimia, S. A. nov/75 oct/75 Ex 9 000 ton 7 958 ton (1 I.e) Industrias Resistol, S. A. sep/76 dic/76 SI y Ex 26 465 ton 17 040 ton (35.6) Hulva, S. A. ene/76 díc/75 SI 71.4 ton 23.2 ton (67.6) C(a. Mexicana de Especialidades Industriales, S. A. nov/76 feb/77 si 3.9 mill. Its 3.1 mIll. Its (21.2) Negromex, S A. I dic/76 feb/77 Ex 3 900 ton 2 441 ton (37.4) Industrias Monterrey, S. A. feb/76 jurV76 SI y Ex 8 417 ton 1 127 ton (86.6) Multitek, S. A. jun/76 jun/76 SI 23.2 ton 12.4 ton (46.9) Reconstructora Mexicana de Maquina ria Industrial, S. A. dic/76 dic/76 si 1/ 1/ 1/ Because of the type of production, It ls not possible to show production in volume, * SI - Import Substitution EX - Exports - 16 - ANNEX III Translation from Spanish FONDO DE EQUIPAMIENTO INDUSTRIAL Banco de Mexico S. A. June 10, 1979 International Bank for Reconstruction and Development 1818 H. Street, N. W., Washington, D. C. 20433 U. S. A. Attention: Mr. Shiv S. Kapur Director, Operations Evaluation Department Reference your letter dated May 4 of the present year, in general, we do not have any significant comment to make on the report discussing the execution of loans 824-ME and 1205-NE to FONEI. Possibly, at the end of paragraph 5.02 of the report which states: . . . FONEI's strategy in dealing with this issue has been to try to involve investment banks in project appraisal work. Little has been done so far in this regard; the linkage between appraisals carried out by financieras' contract consultants (with FONEI's financing) and their decision making process appears weak and ineffective." it would be useful to add that this objective (which FONEI is aiming at) is not easily achievable in the short or medium run, as it would not be in a good number of countries, given the practice so common among commercial banks to emphasize collaterals in approving credits. Best regards, FONEI - 17 - PROJECT COMPLETION REPORT MEXICO: INDUSTRIAL EQUIPMENT FUND (FONEI) Loans 824-ME and 1205-ME I. INTRODUCTION 1, In the late 1960s increasing Mexican preoccupation with the deterio- rating balance of payments and with high industrial production costs led the Government to revise its industrial policies, and to adopt a series of incentives to promote industrial exports. Long-term funds for industrial investment were scarce in Mexico and were available almost exclusively fromigovernment-owned banks. Even the financieras (medium- and long-term lending institutions), which could lend for terms of up to 15 years, had been,forced by the short-term nature of their deposits and other resources to concentrate on shorter-term lending. Of the total domestic industrial credit granted by the Mexican banking system as of December 31, 1970, only 18% cairied maturities of five years or more. Financing of industrial projects was further handicapped by the unnecessarily high collateral frequently required by the credit institutions. 2. The Industrial Equipment Fund (FONEI) was created in October 1971, as a result of a dialogue between the Bank and the Mexican Government since 1969, on suitable lending schemes that would have a positive effect on the balance of payments as well as the efficiency of the industrial sector. FONEI was established as a government trust fund administered by Banco de Mexico (BANXICO), Mexico's central bank, to facilitate the financing of investment projects, mostly by medium-size industrial enterprises producing for export or for efficient import substitution. 3. FONEI's target group of clients were medium-sized industries covering a.wide range of products. Many of these enterprises were young and poorly organized. Supported by a protected and growing market, many of them had a favorable environment for rapid growth but had been hampered by the lack of suitable credit and adequate experience. Industrialization in Mexico had been encouraged by moderate taxes, generous depreciation allowances and low wages, but protection against competitive imports had been the major factor. The protection, which generally took the form of a licensing system rather than tariffs, stimulated industrial development; however, it also supported a considerable number of inefficient firms which did not have the capacity for sustained growth. It may be noted, however, that compared to other countries in Latin America, protection in Mexico has been moderate; thus, there is little reason to believe that the Mexican industry is inefficient in comparison to other countries in the region. 2/ 1/ In contrast, most loans approved by FONEI during 1972-78 (which covers the commitment period of the three Bank Loans to date to FONEI) had maturities of five years or more, thus reflecting FONEI's effectiveness in encouraging medium and long-term lending to industry. 2/ Since the end of 1977, the government has been gradually reducing the number of products subject to prior licensing. By the beginning of 1979, more than two-thirds of the items in the customs nomenclature were no longer subject to prior licenses, although items subject to import controls still accounted for about 65% of the total imports in 1978. The government is currently studying the prevailing levels of effective protection and possible strategies resulting in further import liberalization at moderate tariff levels. - 18 - 4. The first Bank financial support of FONEI for US$35 million (Loan 824-ME) was given in June 1972. It had been intended to present the loan to the Bank Board only after FONEI had started operating, but finally, despite repeated assurances from BANXICO, FONEI had made no subloans by the time t! loan was submitted for Board approval. Moreover, besieged by management problems and, to a lesser extent, by lack of promotion and ample liquidity in the banking system, FONEI did not extend any subloans during the first twelve months of Loan 824-ME. However, partly as a result of increasingly competitive onlending interest rates, by the third quarter of 1974 the commit- ments of funds had accelerated and supervision missions projected that all funds were going to be committed by the second quarter of 1975. Under these expectations, an appraisal mission for a second loan visited Mexico in January/ February 1975. A long and difficult discussion on the issue of FONEI's onlending interest rates ensued, requiring an updating appraisal mission in October 1975. Negotiations were finally completed in January 1976 and the second FONEI loan (Loan 1205-ME) for US$50 million was signed on April 30, 1976. 1/ II. OBJECTIVES OF BANK LENDING 5. The general objectives of Loan 824-ME were to assist FONEI in addressing Mexico's balance of payments, industrial inefficiency and structure of industrial financing problems. In order to promote industrial investment that would have a positive influence on the balance of payments, FONEI was to finance export and efficient import-substitution projects in the industrial sector and feasibility studies for such projects. Tourism projects also were to be eligible for financing, provided specific project selection criteria satisfactory to the Bank (which did not exist at the time Loan 824-ME was signed) were established. The export projects were required to be able to earn foreign exchange exceeding foreign exchange expenditures for the project (including import inputs and depreciation of the imported equipment) required for the production of export goods. Efficient import-substitution projects were defined as those that would produce locally at prices that did not exceed the c.i.f. price of the corresponding imports by more than 25%. The financing of tourism was also considered within FONEI's scope of activities, but as a future option rather than an immediate intention. Since Loan 824-ME was to fill a gap in the availability of industrial long-term develop- ment credit for medium size firms, FONEI resources were not to be used for projects for which sufficient resources were available from alternative sources. 6. . By early 1975, FONEI achievement of the objectives established in Loan 824-ME was significantly behind expectations. Although it had financed economically sound projects with a substantial favorable impact on Mexico's balance of payments and industrial decentralization, it failed to meet its 1/ In anticipation of the commitment of Loan 1205-ME, a third Bank loan to FONE1 (loan 1560-ME) was appraised in November 1977. It was approved by the Executivo Directors in May 1978 and signed in September 1978. - 19 - arnticipated role of channeling resourcas mainly to industrial firms without adequate alternative sources of financin.g. Based on Bank supervision visits and other data, a majority of the projectz financed, particularly under the first FONEI loan, were those of prime borrowers vwho might have been able to find alternative financing on suitable.terms and conditions. This resulted mainly because as a second--tier instittition, YONEI initially had to rely entirely for the generation of projects on the participating intermediaries who assumed the credit risk and because lendirg rates became very attractive during the re- lending period of the first loan (peras. 22-23). Also, initially the FONEI system did not include any incentives for the intermediaries to alter their usual lending policy, which was based mainly on the availability of adequate physical guarantees (para. 52). 7. The mai.n ctLjctivss of Loan 1205-ME were similar to those of the firsi: FONEI loan. However, in addition to filling a gap in the -availability of industrial long-tam development credit-and supporting the government's program to promote exports and efficient import substitution, the second FONEI Loan Was explicitly aimed at encouraging intermediaries to lend on the basis of project appraisal rather than mainly on the basis of availability of physical collaterals and the general reputation of the client companies, thus enabliog the financing through the banking system of some projects that would noz otherwise be implemented. because of the lack of financing. IEI. UTILIZATION OF LOAN PROCEEDS 3. Loan 824-tLE (hereinafter called FONEI-I) was signed on June 30, 1972 and be:ame effective on October 12, 1972. Because of managerial problems, lack of promotion and high liquidity in the banking system, FONEI did not make any loany until the second half of 1973. As a result of this as well as some difiLic,ities in disbursements (related to the computation of the c.i.f. price of off-the-shelf purchases) during the initial stages of the loan, disburse- ments ran significantly behind the appraisal estimates. The Loan's original closing date of June 30 1976, was extended four times (finally to Septer..ber 30, 1978) and the Loan was fully disbursed two years behind the appraisal forecast (Annex 1) 9, Loan 1.205--KE (hereinafter called FONEI-II) was signed on April 30, 1976, and became effective on August 30, 1976. Under this loan expenditures made up, to 180 days prior to the date of receipt of a subloan request by the Bank were eligible for Bank financing (instead of the normal 90-day limit), in view of the longer processing times occurring in a two-tier mechanism involving both FONEI and the intermediaries. 10 , Disbursements of FONEI-TI started about 9 months behind schedule, partly because of delays caused by internal negotiations between FONEI and NAFINSA on commissions to b2 paid tC: NAi'INSA. Disbursements accelerated since mid-1977 and reached US$35.2 million, or 80% of the appraisal estimate, by the end of 1978. Except for about US$200,000 of loan funds that became available because of cost reductions and partial cancellations on some of the subloans, FONEi-~1 was ful. comitted by year-cud 1973 and is expected to be fully dbun ed be for the o riginal. c los ng dare of Dece:r:ber 31, 1979 (Annex 1). - 20 - Investment Costs and Financing of Subprojects 11. As of October 31, 1978, the two Bank loans had been used to finance 85 projects for a total of Mex$7,362.4 million. I/ Forty projects with a total investment of Mex$2,114.3 million were financed under FONEI-I and 45 projects with a total investment of Mex$5,248.1 million under FONEI-II. The shares of the various sources of finance are as follows (in %): FONEI-1 FONEI-Il Total IBRD 22.0 20.4 20.9 FONEI (local resources) 19.9 11.9 14.2 Financial Intermediary 9.8 9.7 9.7 Client enterprise 34.8 34.9 34.8 Other 13.5 23.1 20.4 100.0 100.0 100.0 12. In addition, FONEI financed 12 projects for a total investment of Mex$438.8 million without using IBRD resources. Eight of these were financed during commitment of FONEI-I and 4 during commitment of FONEI-II. The share of FONEI in financing these 12 projects was 60.3% (Annex 2). Of all the projects financed by FONEI, 14 were granted supplemental credits to cover higher costs in Lhe amount of Mex$225.7 million, that is, cost overruns affected about 14% of the subprojects in number but only 3% in value. These figures are relatively low considering the sharp devaluation of the peso in mid-1976 and the unusual inflationary trend experienced by Mexico in recent years. It is possible, however, that several other firms that suffered cost overruns did not approach FONEI, either because of lack of knowledge of FONEI possibilities or because they were able to secure the additional resources from other sources. 13. A particular attraction of FONEI's funds for industrial firms is that the terms of its loans are adapted to project needs, within the limits set by FONEI's opprating regulations. FONEI's loans can be granted for up to 13 years maturity and 3 years of grace. Nearly two-thirds of all the loans granted by FONEI during the commitment periods for the two Bank loans, had a maturity of 5-8 years, and only 6% had a maturity of more than 10 years. The average maturity of FONEI's loans was about 7.7 years under FONEI-I and 6.5 years under FONEI-II; the corresponding average grace periods were 1.8 years and 1.7 years respectively. 1/ An additional subproject with a total investment cost of Mex$196.7 million was approved in November 1978, thus virtually fully committing the FONE-11 Loan. - 21 - 14. Under FONEI-I, the "free limit" for Bank financing was set at US$500,000 (then Mex$6.25 million) for individual subprojects, subject to an aggregate limit of US$10.0 million. FONEI had to submit all subloan requests exceeding the above limits for prior Bank approval. In view of FONEI's increased experience, the free limit was raised to US$750,000 (then Mex$9.37 million) under FONEI-II. Using the above free limits, about 48% of the number of Bank financed subprojects and 72% of the amount of the financing provided under FONEI-1 was subject to prior Bank approval; the corresponding figures for FONEI-II were 44% and 78% respectively (see Annex 3). Characteristics of Subprojects Financed 15. Of the 97 projects financed by FONEI (including 48 financed during the commitment period of FONEI-I and 49 during the commitment period of FONEI-II), 23% (accounting for nearly 43% of the total investment cost of FONEI-financed subprojects) involved only import substitution, 31% (accounting for 23% of the investment costs) were oriented only towTards the production of exports-and the remaining 23% (45% in terms of investment costs) were export- cum-import substitution projects (Annex 3). The number of export oriented projects financed was the same (15) under both FONEI-I and FONEI-II. However, the number of purely import substitution projects rose from 19 under FONEI-1 to 26 under FONEI-II, while the number of export-import substitution projects fell from 14 to 8. 1/ In addition to the above investment projects FONEI provided financing totalling Mex$8.9 million for 17 feasibility studies during the commitment period of the two Bank loans. 16. The metal products subsector was the largest recipient of FONEI's financing, accounting for 42% of FONEI's projects and 32% of the total invest- ment costs involved. The second largest group of projects financed was in the chemicals and petrochemicals subsector, accounting.for 25% in number of nearly 42% in value. These two subsectors together covered 67% of the number of projects and 74% of the total investment costs. FONEI's financing covered 10 subsectors under FONEI-I, but only 7 subsectors under FONEI-II. Under the latter, no loans were made for food, beverages, or glass products; the number of projects financed in the paper and building materials subsectors was reduced, while those for electrical products, chemicals and metal products increased (Annex 3). I/ Under FONEI-I, the efficiency criterion used to select eligible projects was that the products could be sold domestically at a price not higher than 25% of the c.i.f. cost of comparable imported products. Because of the limitations of this test (especially in cases where the production processes involve imported inputs which may themselves be overpriced due to import tariffs), the Bank agreed upon FONEI's request to replace the above test by the calculation of the economic rate of return of the subprojects. - 22 - 17. The average investment cost of the projects financed by FONEI was Mex$80.4 million. 1/ About 50% of all projects financed using IBRD funds were smaller than Mex$50 million and accounted for 20% of the investment costs. 2/ If the projects with total investment costs in the range of Mex$50-100 million were added to this group, they would cover 71% of projects and 46% of the total investment costs (Annex 4). Type of Enterprises Supported 18. Of the 97 investment projects financed by FONEI during the commit- ment period of the two Loans, 85 received Bank financing.(40 udner FONEI-I and 45 under FONEI-II). Of the latter, as many as 29 projects (involving a total investment cost of Mex$4,438.2 million) were carried out by new firms, while 56 (with total investment cost of Mex$2,924.2 million) were expansions of existing firms. Moreover, the proportion of new firms supported by FONEI experienced a significant increase, from 25% (9 new enterprises established) under FONEI-I to 44% (20 new enterprises) under FONEI-Il. This probably reflects the resurgence of Mexico's industrial growth starting in mid-1977 after two years of slackening economic activity, and the revival of optimism among entrepreneurs regarding the future prospects of the Mexican economy. 19. Based on an analysis of 70 investment projects financed by FONEI for which all relevant data are available, it appears that FONEI had financed mainly large, well established firms. Forty-eight of the seventy enter- prises had total fixed assets exceeding Mex$35 million, with average fixed assets of about Mex$272 million, and the remaining 22 firms had average assets of Mex$14.7 million. A classification of the firms financed under the two FONEI Loans reveals that the. proportion of FONEI's credits going to the relatively smaller firms increased somewhat under FONEI-II compared with FONEI-1. 1/ The average investment cost of FONEI's projects grew from Mex$51.1 mil- lion under FONEI-I to Mex$109.1 million under FONEI-II. This is largely explained by the effects of the domestic and world inflation and the major devaluation of the Mexican peso toward the end of 1976. In order to take account of the effects of devaluation and inflation, FONEI's minimum and maximum loan limits were revised upwards through a modifica- tion of its operating regulations in September 1977 to Mex$4.5 million and Mex$100 million, respectively (from a minimum of Mex$3.5 million and a maximum of Mex$37.5 million prevailing at the time of the signing of Loans 824-ME and 1205-ME). Under the new regulations FONEI is also allowed to make loans in excess of Mex$100 million in exceptional cases of high priority projects, with prior authorization from the Ministry of Finance. 2/ Excluding an unusually large chemical project of Mex$1,974.9 million, financed under FONEI-II but with a small FONEI participation of 7%. - 23 - Number of Firms Total Total Fixed Assets Financed Under Financed Under No. of of the Firms FONEI-I FONEI-Il Firms % Up to Mex$ 35 million 9 13 22 31.4 More than Mex$ 35 million 29 17 48 68.6 Source: FONEI's subproject appraisal reports and other data. Participating Intermediaries 20. Although all of Mexico's more than 150 banks and financieras are eligible to participate as intermediaries in FONEI financing, most of the smaller institutions do not have clients with suitable projects. In line with its objective of encouraging an active role for the intermediaries in the project appraisal process, FONEI also had to focus its promotional efforts in a limited number of financial groups with good appraisal capacity. As a result there was a considerable concentration in the distribution of FONEI's financing among the intermediaries. Intermediaries belonging to the largest nine financial groups channeled nearly 85% of the total financing (Annex 5). About 53% of the number and 59% of the amount of FONEI's loans were made through four intermediaries, which averaged about 4 FONEI oper- ations per year, with the most important financial intermediary averaging about 7 operations per year.1i/In spite of this concentration, it appears that even the most important financial intermediaries found their volume of FONEI credits insufficient to justify the establishment of in-house appraisal units, or to make significant changes in their lending policies by linking lending decisions more closely to detailed project appraisals. These factors acted against the achievement of FONEI's institutional objective of encouraging appraisal based lending among Mexican banks (paras. 54-55). FONEI's Onlending Rates 21. Under Loan 824-ME it was agreed that the intermediaries would charge the final beneficiaries an interest rate of 11% per annum, plus a 1% annual commitment fee on FONEI-supplied funds. FONEI was to charge inter- mediaries 9% interest per year plus a 1% annual commitment fee. The interest rate to be charged by the intermediary on its own resources could differ from the 11% rate applicable for FONEI's funds. 22. From the inception of FONEI until mid-1973, credit was readily available in Mexico. FONEI's relending rate of 11% per annum was somewhat below the cost of alternative funds, but intermediaries having excess resources discouraged prospective borrowers from using FONEI funds. By mid-1973, however, credit began to tighten and interest rates started rising (Annex 6). By 1974/75 FONEI's relending rate was well below that of alternative funds costing 14-18%. The changing conditions in the financial market helped to accelerate the use of FONEI funds. Because of FONEI's increasingly attractive lending rates, the intermediaries tended to allocate FONEI's funds to their best customers, many of whom could probably have secured alternative financing on adequate terms. 1/ To avoid excessive concentration of Bank funds a maximum limit of US$5 million per project was introduced under the third Bank loan to FONE. - 24 - Based on findings along the above lines during a supervision mission of FONEI-1 in mid-1974, the Bank expressed its strong concern to the Mexican authorities and recommended an increase in FONE1's lending rates in order to avoid subsidizing its borrowers excessively and to screen out prime borrowers that could secure'appropriate financing elsewhere. 23. The Mexicans agreed in principle with the rationale of the Bank's recommendation but were reluctant to increase the interest rate on the ongoing Loan 824-ME. Apparently, they were concerned that a substantial increase in the interest rate would decrease the demand for FONEI funds, and that FONE. might find itself facing a situation similar to that before mid-1973. As a result of continued negotiations, FONEI raised the interest rates to its final beneficiaries by the third quarter of 1975, but only to 12%. Based on the above experience and the unusual persistently high inflation rates that Mexico had been experiencing since early 1973, the Bank persevered in its efforts to reach agreement with the Mexican authorities on a more appropriate interest rate policy that could improve the allocation of FONEI's resources and maintain its relending rate in line with future changes in the cost of alternative funds. The ensuing discussions between the Bank and the Mexican authorities on the interest rate, issue were prolonged and lasted from the third quarter of 1974 until January 1976, when negotiations for Loan 1205-ME were finally completed. 24. Under the Second Loan, it was agreed that FONEI would initially charge an interest rate of 13.5% per annum to final borrowers, that is, 1.5 points above the index of the average cost of funds to financieras (ACF). 1/ The interest rate was to be adjusted, whenever necessary, to reflect fully changes of at least 0.25 percentage points of the ACF, as calculated monthly by the Banco de Mexico. Final borrowers were given the option of choosing between two interest rate regimes: (a) a variable (floating) interest rate which would change semi-annually, if necessary, to reflect changes in the ACF, or (b) a flat interest rate throughout the life of the loan, to be fixed at the "prevailing" interest rate (determined as above as the basis of investments in the ACF index) at the time of FONEI's loan commitment. Under both systems, FONEI continued to give a 2% interest rate spread to the intermediaries. Using the above scheme, FONEI's "prevailing" lending rates to its final borrowers gradually increased from 13.5% in the third quarter of 1976 to 14.5% by mid-1977. 25. As long as both options described above were offered by FONEI, all client enterprises opted for the flat rate system, reflecting investors' expectations of high inflation rates and the resulting large uncertainties regarding future interest rates. However, early in 1977, Mexican banks 1/ The ACF index is an indicator of financial costs calculated monthly by Banco de Mexico in order to determine how much to pay financieras for required reserves kept with Banco de Mexico. It is a weighted average of interest rates (before tax) paid on financial bonds and certificates, promissory notes, and the newly created certificates of deposit, instru- ments whose maturity vary from sight to one year. - 25 - and financieras began to switch increasingly to lending systems using fully floating interest rates on medium- and long-term loans to reflect the increased uncertainty about their future borrowing costs. The ACF index mentioned above was the most common reference used by the banks and financieras for the floating rate systems. Reacting to these trends and to its increased interest payment burden arising from the peso devaluation, 1/ FONEI decided, in consul- tation with the Bank, to further modify its interest rate structure in August 1977, by which time about half the FONEI-II Loan was committed. 2/ Since then FONEI's interest rate to the final borrowers has been set at 2.0 percentage points above the ACF index (rounded to the closest 0.25 percentage points), and is adjustable quarterly and borrowers are no longer offered the option of fixed interest rate loans. Using the new system, FONEI's interest rate to its final borrowers stood at 15.75% at the end of the third quarter of 1977 and increased gradually to 17.50% by mid-1978 and 18.25% by the end of 1978. Although with some sharT fluctuations, the can which ha. nrevailed since 1.7A (Annex 6' between inflation and FONEI's relending rate has been virtually eliminated,and FONEI's interest rate to final beneficiaries was slightly positive at year-end 1978. 26. Under both the Bank Loans the intermediaries generally lent their portion of the subloans at an interest rate somewhat higher than that for FONEI's funds. This rate was independently negotiated between the intermediary and the borrower, on the basis of the prevailing market rates for medium-term loans. According to FONEI, the difference between the interest rate charged by the intermediary on its own portion of the resources and that on the FONEI- funded portion has been narrowing, and in a few cases has disappeared completely. IV. ECONOMIC IMPACT Profitability and Efficiency 27. Annex 3 includes a summary distribution of financial and economic rates of return of FONEI-financed investment projects as estimated at the time of their appraisal by FONEI. Of the 79 investment projects for which a priori estimates of the internal financial rate of return (FRR) were avail- able, 27 had a financial rate of return between 15% and 20%, 17 projects between 10% and 15%, and 14 projects between 20% and 25%, all expressed in real terms. The corresponding economic rates of return (ERR) were expected to ,be significantly higher: nearly half of the 75 projects for which estimates were available had ERRs of 35% or more, and the estimated ERR was less than 15% (14.5%) for only one project. These figures indicate that, at least on a priori basis, FONEI financed economically sound and efficient projects, thus achieving one of its main institutional objectives. Although reliable data on the corresponding FRR and ERR estimates were not available, the project sponsors and FONEI appear very satisfied with the performance achieved under most of the projects financed. I/ Under the FONEI operations, the foreign exchange risks on the Bank loans is shared between FONEI and the Government, with FONEI assuming the exchange risk on the payments of interest and fees and the Government assuming the risk on principal amortization. 2/ The corresponding amendment of sections 2.02(b) and (c) of the Project Agreement between the Bank and Banco de Mexico took effect on September 30, 1977. - 26 - 28. FONEI also calculated the return on equity (before taxes) for sample of 31 of its client enterprises on f-e basis of their 1977 financial statements. Twelve reported returns on equity of up to 20% and 11 reported returns exceeding 20%, while 8 of the 31 firms reported losses (see table below). This is a very satisfactory record considering that many of the FONEI-financed new projects as well as of the significant expansion projects are still in their start-up phase of operations. Profit Before Taxes R.R.E. - Equity Number of Firms Making losses 8 0 - 5% 2 5% - 10% 6 10% - 15% 2 15% - 20% 2 20% - 30% 6 30% - 40% 2 40% or more 3 31 29. With the exception of one firm, no serious difficulties are reported at present by the firms financed by FONEI. However, during the second half of 1976 and most of 1977, many firms experienced financial difficulties arising from the sharp devaluation of the peso and depressed local demand and the policy un- certainties associated with the transition in the government. Most of these firms had debts denominated in foreign currency and consequently suffered heavy losses from the peso devaluation. Also, the change in government reduced the demand temporarily for many of the companies, since the federal government and the public enterprises tend to slow their procurements considerably during the transitional periods awaiting policy and administrative changes. At present most of the enterprises financed by FONEI appear to be working at or close to full capacity, and many are preparing new projects to expand their capacity. Balance of Payments Impact 30. The basic objective of FONEI is to finance projects that would have a substantial balance of payments impact. One of the main obstacles for the achievement of this objective was removed by eliminating the overvaluation of the Mexican peso, and the results are confirming the expectations. The projected incremental foreign exchange savings or earnings for the first 5 years of the enterprises operations, as of October 31, was estimated at Mex$22,850 million. Based on data collected from samples of firms whose projects are in operation, the overall results actually achieved appear to have exceeded expectations. A sample of 25 enterprises 1/ that exported in 1977 showed that 1/ Mostly financed under FONEI-I. - 27 - the actual exports for these 25 fikms reached.US$59.9 million that year, which exceeds by a slight margin the corresponding projected exports. While 11 of the 25 firms did not meet fully their export targets, 3 that had not expected to start exporting in 1977 were already doing sc (Annex 7). A similar sample of 32 enterprises producing import substitution goods in 1977 showed that they were able to substitute about US$142.1 millicn of imports, 1/ compared to only US$84.6 million expected at the time of appraisal of their projects; 14 of the 32 firms failed to meet their projected targets (Annex 8). Most of the exporting firms visited during the Bank's supervision/completion mission were projecting 1978 exports significantly higher than those achieved in 1977. 31. Although FONEI has not pursued an aggressive decentralization policy in its lending operations, it has made very substantial contribution to it. Of the 97 projects financed, 25 were located in Mexico City, and 15 in Guadalajara and Monterey, accounting for 41% of -all projects, but only for about 21% of the investment cost (Annexes 3 and 9). This means that 59% of the total investments and as much as 79% of FONEIrs financing went to the other areas, represented by zones 2 and 3 in Annex 9. Employment 32. In additicn to their subszanti.l imact on halance of paVymets, industrial output and decentralization, FONEI's projects contribuLed signif- icantly to employment generation in Mexico. based on the data for 73 FONEI- financed projects for which estimates were available, 1.,199 jobs were projected to be created at an average investment cost per jol of about ex$62:,55C however, a noteworthy difference'between the average investrant cost per job created by the smaller or medium sized projects and that for the larger projects, varying from about US$11,140 equivalent per job for projects with total investment costs of up to Mex$50 million to about US$66,100 equivalent per job for larger projects (Annex 4). in the course of supervision FONEI gathered data on the actual number of jobs created by a sample of 19 of its projects. Results from this survey indicate that the actual number of jobs created exceeded FONEI's expectations at the time of evaluation by about 32%, with 2,123 jobs actually created compared to 1,612 projected (Annex 10). This suggests that the actual cost per job created may be significantly less than had been projected ex ante. I/ Computed as total output of the firms less the exports. 2/ In addition, many of FONEI's subprojects involve in part the replace- ment or upgrading of existing industrial plants, thereby contributing to the preservation of existing jobs. Since the bulk of production inputs (other than capital goods) are supplied domestically, these subprojects should also have a substantial indirect employment creation effect. A recent study in Colombia, where a lower proportion of production inputs are supplied domstically, indicated that medium- sized industrial projects can generate indirectly at least 50% of the amount of employment generated directly. Colombia: Special Study- Devejopmentof_ Financiera Assisted Proiects, January_12 19761 Report #1037-CO. - 28 - V. INSTITUTION BUILDING Bank Involvement 33. The Bank has been closely involved in the development of FONEI, starting before its creation (para. 2), when several Bank missions visited Mexico to discuss with the Government alternative ways of formulating a suitable financing scheme for industrial projects that would have a favorable impact on Mexico's balance of payments and industrial efficiency. Since the signing of Loan 824-ME, FONEI has grown many times over in terms of size (with total assets of about MexS2,566.9 million as of September 30, 1978 compared to Mex$128.6 million at the end of 1972), complexity and its economic and sectoral impact. The bank has been in close contact with FONEI through the various stages of its institutional development over these years. Operational Growth 34. Since its inception in 1972 until October 31, 1978, FONEI attended to 450 financing applications from client companies, of which 294 (65%) were approved for detailed appraisal by FCNEI./ Of the latter, only 178 projects (about 40% of total applications received) were finally approved for financing (Annex 11), reflecting, in part, the thoroughness of FOHET's review and a large proportion of new projects which tend to ha,?e a much larger with- drawai and r.-Jectio-n rateF than expansions of existing projects. Total loan approvols g:&w ropidly tr.m about Mc-:213 million in 1972 to Mn1,51 million in 1977 and M4e-$1,817 million during the first three quarters of 1978, although there was - temporary decline in approvals in 1975 due to a shortage of resources "uring the iritcrval bc ween the first tco Bank loans (Annex 12). O ani.zatice, Manageiient and Staffinv 35. The highest decision-making body of FONEI is its Technical Comatittee, which is composed mainly of high level government officials. Initially the Comi: ittee ha-d 6 membe rs, including 2 representing BA3HXICO, 2 from the Ministry of Finance (one of whom is the Chairman), 1 from the Ministry of Industry and Commerce, and I frorm the Confederation of Chambers of Industry. In April 1972, it was decided to add to the Technical Committee a representative cf Na.ional Financiera, S.A. (NAFINSA), the largest government owned development hank. The Bank expressed to the Government its reservations on the addition of a NAFINSA representative because of a possible conflict of interest, since NAFINSA was eligible to be a FONEI intermediary. To overcome the difficulty, the Bank was assured by FONEI that the NAFINSA representative would abstain from voting on projects with NAFINSA participation. 2/ In 1973 the membership of the Technical Committee was further increased to 9, and again in 1977 to 10. 3/ During-ncgotiations of the Second Loan, the Bank was given assurances 1/ The most frequeat reasons for rejecting at the prelininary screening stage have been that the loan amounts fall beyond the maximum or minimum limits of FONEI's financing, or that the project is not likely to meet the criteria of: export generation or officiency (in the case of import substitution projects). / NAFItSA acted as the intermediary for only 2.1% of the total financing approved by FONEI during 1973-78. Banco Internacional S.A., a wholly owned subsidiary of NAFINSA was the intermediary for an additional 3.2% of FONEI's financing during the period. 3/ To include an additional representative from the private sector and to take account of the formation of the Minisiry of National Patrimony and Industrial Development and the Ministry of Commerce as independent ministries. - 29 - that the President of Instituto Mexicano de Investigaci6n Tecn6logica (IMIT), one of BANXICO representatives on the Technical Committee, would abstain from voting on projects in the appraisal of which IMIT acted as FONEI's consultant (para. 67), in order to avoid any possible conflict of interest. 36. BANXICO, as FONEI's trustee, provides the required staffing, office facilities and administrative services for FONEI; FONEI's staff is subject to BANXICO regulations, salary scales and other benefits. 37. FONEI's chief executive is its director. Since its inception FONEI has had three directors. The first helped FONEI establish itself and start its operations. During the tenure of the second director, who demonstrated good leadership abiliti.s and had BANXICO support, FONEI became an effective and competent financing institution known among the industrial and banking communities. The present director, who took up the position in December 1976, impresses as a very capable manager. He is well motivated and is providing dynamic leadership to FONEI. He has bedn paying particular attention to expanding the scope and quality of FONEI's operations and promoting its activities throughout Mexico. 38. FONEI's organization was modified on several occasions to adapt it to its growing operacions and responsibilities. At present. it is divided into 3 departments, namely, the Technical, Operations and Promotion Depart- ments, ea-zh of which is headed by a sub-director. The Promotion Department was created only recently and is concentrating its attention on establishing FONEI promotion offices in the interior. The new organization (Annex 13) will requi e a Local staii o 1 Dy eatly 1900, 01 f 'ew ecician below sub-director level. This increase in personnel has already been authorized by FONEI's Technical Committee and is expected to be completed within about one year. FON1 currently has a total staff of 40, including 20 professionals. The authorized number of personnel is 44 at present, leaving 4 vacaacies still to be filled. .39. Following the changes in the administrations in Mexico in late 1976 and the consequcnt shifts in personnel among various government agencies, FONEI experienced a substantial turnover in its professional staff, especially in the Technical Department. As a result, 12 of its present 16 professional staff below the sub-director level joined FONE1 after January 1, 1977. However, FONEI now appears to have overcome the scaff turnover problem and a stabiliza- tion of its professional. staff has been achieved. The present professional staff are relatively young but generally well qualified and responsive to the needs of the institution. They are highly regarded by FONEI's final borrowers as well as the staff of the participating intermediaries. 40. FONEI's staff increased from 21 in 1973 to 40 as of October 31, 1978. Its productivity as rteasured by the number of lending operations finalized per staff member shows very little increase since 1974 other than variations due to demand factors and the availability of adequate funds (Annex 14). However, some productivity gains are evident if one takes into consideration the steadily increasing average sizes of FONEI's operations, the increasing responsibilities assumzed by FONEI in managing the project appraisal process and the sharply increased promotional activities since 1976. In fact, che added responsibilities of the technical staff appear to be limiting severely the amo unt of subpioject supervision work undertaken by FONEI (pras. 48 and 57). - 30 - Relations with Borrowers and the Bank 41. In its early years of operation FONEI had to overcome a consider- able amount of skepticism on the part of L._ final borrowers and intermediaries with regard to the utility of detailed project appraisals and the addi- tional project processing time caused by FONEI's emphasis on such appraisals. Although it continues to be difficult to have the intermediaries and the final borrowers carry out detailed project appraisals on their own initia- tive (nara. 53). over the years, FONEI has been able to convince them gradually of the validity of its fundamental objectives, and developed a good image among them. The final borrowers-have become increasingly appreciative of FONEI's cooperation and assistance in improving their project.designs and in overcoming the difficulties during implementation. These were difficult and commendable tasks to achieve. 42. Throughout the period of its continuing relationship with the Bank FONEI offered excellent cooperation to Bank staff and consulted closely on all impcrtant matters. FONEI's personnel, were particularly helpful during the Bank's appraisal mission as well as the periodic supervision missions, by assisting in arran,ing and carrying out the necessary field visits. FONEI also zub=ittce! regul2rly to the Bank good quality qkiarterly and semi-annual reports on its operations. Resources Th_ _2- 4.:n i fnit11lv fidrd FONET with a non-repavable contribution of Mex$125 million (then US$10 million equivalent). Also, the two Bank Loans to FONET tor US$35 million and US$50 million in June 1972 and April 1976 kyerc to be repaid by the Mexican Government out of budgetary resources in order to gradually increase FONEI's equity. Since these loans were available only to cover the foreign exchange costs of imported fixed assets, the Government undertook to make available to FONEI additional funds of at least MexS375 million (then US$30 million equivalent) under Loan 824-ME and at least Mex$500 million (then US$40 million equivalent) under Loan 1205-ME, to help cover local project costs, including domestically manufactured fixed assets. For this purpose the Banco de Mexico authorized FONEI to issue renewable obligations at 9% and 10% annual interest rates, which could be subEcribed by financial institutions for meeting their reserve requirements. The Government and Banco de Mexico have met all the targets agreed to, thus ensuring the availability of adequate local funds for FONEI's operations. Policies and Procedures 44. The policies and procedures which govern FONEI's lending operations are set forth in its operating regulations. These regulations had been changed, with the Bank's concurrence, on three occasions. The first revision was published on October 11, 1976, and was made to reflect the agreements reached under FCNEI-II. The second revision was published on September 14, 1977, with the purpose of replacing the efficiency criterion for import-substitution projects (which employed a comparison of the domestic selling price of the final products with c.i.f. prices of comparable products--see para. 15) with an econemic rate of return test, to increase the maximum and minimum loan sizes (para. 17) and to eliminata the optional flat interest rate on its - 31 - loans (para. 25). The third revision, published on July 21, 1978, introduces specific new incentives to encourage intermediaries to take over the appraisal of projects (para. 55). 45. FONEI's processing of loan applications typically involves the following stages. Enquiries or preliminary applications for credit are received by FONEI from a potential industrial borrower either directly or through one of the participating .intermediaries. In practice, most borrowers are made aware of the possibility of FONEI's financing by the intermediaries whom they approach for credit. FONEI reviews the preliminary information received, and requests any additional information or clarifications that may be needed to determine if the proposed project meets the basic eligibility criteria for FONEI's financing (export or import-substitution prospects, limits on loan sizes, etc.). If the basic conditions are met, FONEI requests from the borrower/intermediary a full feasibility study of the project, indicating the types of informdtion and analyses which should be included in the study. Once the feasibility study is received, FONEI commissions a full evaluation of the project either by directly employing a consultant for this purpose or by requesting the intermediary to do the same. 1/ 'Ihe evaluation report is reviewed by one of FONEI's project analysts and then by the Director. if a favorable decision is reachcd, it is submitted for the final approval by the Technical Committee in the case of 'the larger projects (see para. 48). 46. Annex 15 includes an analysis of the distribution of FONEI's project processing LiiUe. vUL.L11g LiLe koUmiLWC;, L and 1205-ME, FONEI's average total processing time, from the receipt of a preliminary application from the client enterprise until the signing of a loan contract, was about 13 months undei FONEI-I and 12 months under FONEI-II. The majority of the loan requests involved total processing times of between 9 and 18 months. 47. FONEI's relatively long average project processing time has been the source of many problems and has made it very difficult for FONEI to achieve one of its principal objectives--that of encouraging appraisal- based lending by the intermediaries. The long processing times tended to make the borrowing enterprises skeptical about the usefulness of the evaluation process and less than fully cooperative with the consultants. Long lags between project preparation and completion of evaluation also made it hard (it was usually too late in the project preparation cycle) to effect any significant changes in the project that may have been indicated as a result of the evaluation. Finally, intermediaries frequently became reluctant to wait until the completion of FONEI's evaluation and made their own credit decision prior to it. Bank supervision missions discussed at length with FONEI these problems and possible ways to improve the quality of the appraisals and to cut processing times, including: (i) involvemaent of FONEI at an earlier stage of project preparation and ensuring that the borrowing enterprise understands the object and 1/ In aome instances FONEI has been using its own staff to carry out the full evaluation (para. 57). - 32 - philosophy of FONEI's lending; (ii) assumption of a more active role by FONET staff in suitably directing the consultants' work and ensuring a flexible approach to evalution that takes full account of the varying characteristics of the particular project and the enterprise implementing it, rather than applying a uniformly rigid approach; I/ (iii) preparing instruction booklets outlining FONEI's requirements regarding items to be included in the appraisal reports and the desired depth of analysis under each; and (iv) standardizing the format of presentation of certain parts of the evaluation reports to cut review time. 48. Starting in late 1976, FONEI attempted to implement some of the improvements along the above lines. As an additional step to help cut project processing times, starting mid-1977 FONEI's Technical Committee delegated to its director the authority to approve all operations of up to Mex$15 million without presentation to the Technical Committee. A compari- son of the average times under the FONEI-I and FONEI-II (Annex 15) indicates that while these measures led to some rdductions in the average elapsed time between the initial loan request and the initiation of a full project evalua- tion as well as the time taken after FONEI's formal approval of the loans until loan signing, the improvement in the overall ploject processing times was only marginal. The average time taken for the detailed evaluation by the consultants and FONEI actually appears to have risen, probably refliecting the "breaking-in" time required for FONEI's relatively new staff (para.39 ) and the pressures associated with the explosive growth of FONEI's operations over the past 2 years, especially in the workload of FONEI's project analysts. The following paragraphs discuss in greater detail various other aspects of " .uje,_ Lppe dl and bupeuvision procesb in reiatlon to its overall. institutional objectives. Project Appraisal 49. Under Loan 824-ME FONEI was made responsible for the full appraisal and follow-up of the projects, although the intermediaries were expected to evaluate the financial plan and risk of the projects and to secure adequate collateral. FONEI was also to encourage the intermediaries to appraise other than financial aspects of the projects. However, practically all the projects were appraised by consultants selected and paid for by FONE. FONEI used outside consultants because it did not wish to use up a large portion of its staff capacity in carrying out detailed appraisals, or to incur the costs of acquiring the adequate professional diversification this would require. There were only two cases in which the intermediary participated to any significant extent in the detailed appraisal of the projects. .2 Like FONEI, the financial intermediaries did not have the technical staff to carry out project appraisals meeting FONEI's standards, and the number of FONEI projects channeled through a single intermediary was too small (para. 20) to make it worthwhile for any of them to create the additional technical capacity needed. 1/ For instance, expansion projects being implemented by firms that are already well established may require a less detailed analysis of the technical and market aspects than projects involving new firms or new Droducts. 2/ In both these projects the participating intermediary was Financiera del Norte. - 33 - 50. Since the intermediaries were assuming the credit risk and since their involvement in FONEI's project appraisal process was very limited, they continued to use essentially the same lending criteria as before, that is, focussing on the firm's overall reputation and capacity to offer adequate physical collaterals for the loans, rather than on the merits of the project being financed. As a result, a majority of the firms financed under Loan 824-ME were prime borrowers who probably had the potential to find alternative financing sources on suitable conditions. The intermediaries' preferential orientation towards the prime borrowers was further accentuated by the lower lending rates that were applicable on FONEI funds compared to the market rates (para. 22). Thus one of FONEI's institutional objectives under FONEL-I, namely, to orient the financing towards client enterprises with sound pri-jects but without adequate alternative sources of financing, was only achieved in part. 51. In the early years of FONEI's existence (1972-75), the quality and depth of the appraisals were uneven,, largely reflecting the consultants' different capabilities. The consultants were acting almost independently of FONEI except when they needed a clarification, and FONEI was unable to impress upon them sufficiently its own concept of appraisal and its priorities regarding the poi.nts of relative emphasis in the appraisals. Also, FONEI's re'views of th, consultpit''ppraisals tt!n(d 1.o be nariro-l y fociussed P d to over,-emphasize etails rather than overall methodology and concepts. The less than adequate-performance in the early years is, however, understandable since the staff lacked sufficient experience and guidance. 1;. 7, CZi ro i n P F T -T 1 q n- 1 n rtc, T- r b.F:! -1 h P rnir m r-- i,ri;4r1h i p V .- , Ph institutional objeczive orienting the financing towards sound proj.ects thaL did not have adequate alternative financing scurces, the Bank believed that under FONEI-II, more explicit mechanisms should be established to ensure its accomplishient. This was to be achieved by orienting the intermediaries more towards lending based on systematic project appraisals through a two-step procedure. First, the responsibility for coordination (during project appraisal) between final borrowers and consultants was to be transferred from FONEI to the intermediaries. In the second step, FONEI would induce interme- diaries to set up in-house appraisal units. In both steps FONEI was to contribute towards the cost of appraising projects by (a) reimbursing interme- diaries for the consultants costs or (b) paying intermediaries a reasonable fee for appraisals carried out by their in-house appraisal units, and thus help to fund such-units. To secure the transfer of appraisal responsibility from FONE1 to the intermediaries, FONEI undertook, in a side letter to Loan 1205-ME, 'that intermediaries would be required to assume the responsibility for the appraisal of all projects requiring more than Mex$30 million of FONEI's financing. This was to be followed by attempts to persuade the intermediaries to assume ap5raisal responsibility for smaller loans as well. / It was hoped that as intermediaries began to appraise projects, Cheir exacting collateral requirements might gradually be lowered. This, together with the modification of FONLI's interest rate under Loan 1205-ME (para. 24),.should enable FONEI to focus much more on financinsg sound orojects that would not other- wise be implemented because of lack of financing on adequate terms. 1/ FONEI recently introduced a scheme providing additional soreads Io induce intermediaries to take an increasing responsibility for project appraisal (see para. 55). - 34 - 53. In retrospect, the above expectations regarding the achievement of Appraisal based lending by the intermediaries appear overly optimistic, since major shifts in the banking tradition and lending philosophy were called for in - chort time. Thus, the results actually a-i' under Loan 1205-ME fell far short of the goals stated in the FONEI-TI appraisal report regarding appraisal based lending. Because of a variety of factors discussed below, FONEI was unable to overcome the reluctance of the intermediaries to assume the primary re:sponsibility for project appraisals. Only two of the project appraisals under Loan 1205-ME were carried out by the intermediaries, 1/ and for the other projects, only a minority of the detailed appraisal reports prepared by the consultants appear to have been used by the intermediaries as a significant input in making their lending decisions. While FONEI was unable to meet the objective of transferring to the intermediaries the project appraisal responsibility for loans exceeding 11ex$30 milliun, in a few instances upon FONEI's request and with its encouragement, reasonably good feasibility studies of the investment projects were prepared by the borrowing enterprises themselves, usually in cooperation with rconsultants hired by them, thereby obviating the need for FONEI or the intermediary to commission a separate consultant study. Also, FONEI achieved considerable success in gradually developing a good image among its borrowers and the intermediaries based on its professional competence and cooperative attitude (para. 41) ; this should provide a good foundation for FONE'!S future efforts towards its institutional objectives. Recently FONEI has concentrated on inducing intermediaries to choose the consultaiits and oversee their work, with some success. 54. One of the factors that bindered a more Rctive involvement of the intermediaries in the appraisal process appears to have been the lack of proper publicIty to FONEI's willingness to reimburse the intermediaries for the cost of appraisals carried out by either their in-house staff or consultants contracted directly by them. Also, there were no clear statements from FONEI specifying the form and amounts of reimbursement and the exact procedures to claim it. Furthermore, the number of FONEI operations carried out by any single intermediary continued to be too small to justify, in the absence of specific incentives, establishment of in-house appraisal units by the intermediaries. This was especially true since the intermediaries participated in the use of FONEI funds in an ad hoc way, rather than according to a well thought out program of the number and size of FONEI-funded operations which they expected to handle, say, over the next 2-3 years. Finally, the relatively long times involved in FONEI's project processing made the interme- diaries as well as the borrowing enterprises reluctant to wait. for the comple- tion of the project evaluation before making a decision on the implementation of project and their financing (para. 46-47). 55. The above problems and possible ways to correct them were discussed in detail with FONEI during Bank supervision missions and in connection with the appraisal of FONEI-II. Partly as a result of the discussions, FONEI has been attempting, through various improvements (para. 47), to cut average processing times, and more recently (July 1978), also has approved new incen- tives for internediaries to take over the full appraisal responsibility, 1/ One appraisal each by SOMEX and Banco Mexicano. In 1978, four additional projects, which fall under the Third FONEI Loan (Loan 1560-ME) were appraised by the participating intermediaries. - 3-) - replacing the previous cost reimbursement system. Specifically, FONEI is now authorized by its Technical Committee to raise its interest rate margins to the intermediary up to 0.5% for loans less than Mex$30 million, and 0.25% for larger loans. The initial reaction to these incentives from most interme- diaries has been favorable, and their more active participation in full project appraisals may be expected in the future. However, at least in the short run, the incermediaries are likely to ieet this responsibility mainly by contracting consultant services rather than doing the appraisals themselves. 56. The quality of the appraisals carried out by consultants improved substantially during the commitment period of FONEI-II, mainly as a result of the measures referred to in para. 47. FCNEI took an increasingly active role in guiding the consultants' appraisal activities and coordinating relations among the consultants, the intermediaries and the final borrowers. Recent appraisal reports of FONEI's projects included a thorough treatment of the organization, management and technical aspects of the ,enterprise.undertaking the project, as well as a comprehensive analysis of the incremental economic and financial impact. An important fact in this has been that, in line with Bank recommen- dations, the consultants have been showing greater flexibility than in earlier years in tailoring the appraisal procedures to the specific features of indi- vidual projectis. rather than applying identical procedures for all projects. 57. Over the past 3 years FONEI has been carrying out an increasing number of appraisals using its internal staff, presumably in order to cut prczcssing times and to supplement the existing project processing ncnnitv of the consultants, However, this trend has been putting an excessive burdeii oi FONEI's liwited technical staff and is not likely to help, in the long run, in improving the quality of FONEI's appraisals or in cutting the Ptoject processing times. It may in fact hamper other activities of FONEi, such as supervision and FONEI's institutional objective of closely involving the intermediaries in the project appraisal process. This risk was discussed with FONEI during the completion mission and the trend towards increasing the number of full appraisals made by FONEI's internal staff can be expected to be reversed. Proget Spervi sion 58. Under the First Loan, FONEI assumed the responsibility to supervise the execution of investment projects and the performance of the borrowing enterprise and to ensure that the proceeds of its financing are used for the purposes intended. FONEI's operating regulations required the inter- mediaries to supervise the proper use of the loan proceeds and to ensure the maintenance of pertinent collateral. 1/ A similar agreement on super- vision was reached under Loan 1205-ME, with the additional understanding that FONEI would set up a standard follow-up procedure and prepare systematic supervision plans. A staff member of the intermediary was required to participate jointly with FONEI's staff in the supervision visits. 1/ In addition, the Mexican law finally requires all financial inter- mediaries to supervise term loans to ensure that the loans are used for the purposes intended. - 36 - 59. Most of the intermediaries carry out regular supervision of the subloans, especially during the construction period, when visits once every two or three months are common. After the project is in operation, the visits become less frequent, but generally occur at least once a year. Only a few intermediaries undertook no supervision visits, preferring to rely on the ample collaterals received, rather than incur the additional supervision costs. In their supervision activities the intermediaries concentrate on the financial performance of the borrower and on checking the collaterals given on guarantee. Albeit the intermediaries were required by FONEI's loan agreements to submit to FONEI periodic progress reports based on findings from their supervision visits, very few complied. FONEI apparently did not try sufficiently to enforce this requirement, as it was concentrating on eliciting adequate participation of the intermediaries in the appraisal process and in promotion. Instead, since 1975, it has itself attempted direct supervision based on plant visits to projects to detect problems, follow-up on specific loan conditions, and compare performance with expected results. A staff member from the interested intermediary is invited to participate and the intermediary receives a copy of FONEI's report, including any recommenda- tions for corrective action. 60. FONEI's supervision cover all aspects of the project's implemen- tation, including the use of the loan proceeds, production, market and finan- cial aspects of the firm, fulfillment-of export and import-substitution targets and compliance with agreements on guarantees and debt requirements. Field visits are well prepared, and in general its reports are of good quality and depth. The number of supervisions made by FONEI, however, have covered cnly a fraction of the total number of FONEI's operations to date (12 each in 1975 and 1976, 3 in 1977 and 13 in 1978) 1/ 2/ and have been insufficient to provide adequate feedback to FONEI on the performance of the FONEI system in comparison with the expectations on economic and sectoral impact and the effectiveness of FONEI's operational procedures. 61. FONEI's lax supervision procedures appear to. have been mainly a result of the work pressures generated by its rapidly growing approvals and portfolio size and its recently stepped up promotional activities. FONEI is aware of the need to strengthen its supervision activities. However, recognizing that it would be unrealistic to attempt to supervise in detail all the projects in its growing portfolio, FONEI outlined in its Development Strategy Paper for 1978-80, prepared in connection with the FONEI-III Loan, a three-step procedure that would be adopted in the future. First, in order to 1/ The figures include only formal supervision visits which result in a full supervision report. FONEI makes additional visits to address minor operational problems and to prepare for the formal supervision visits. In addition some useful information is received by FONEI through periodic reports (financial statements, etc.) received from the borrowing enterprises; however, only a minority of the client enterprises submit such reports regularly. 2/ About 10 of the supervisions (in 1975 and 1976) were carried out by external consultants contracted by FONEI for that purpose. - 37 - increase the involvement of the intermediaries in supervision activities, FONEI modified its operating regulations to make the intermediaries formally responsible for supervision of the projects and for submitting periodic progress reports periodically to FONEI. Using this and any other information it may have, FONEI intends to select a limited number of firms for direct supervision. These firms would receive a questionnaire designed to detect significant deviations of actual from expected results. On the basis of the information received, FONEI would select firms meriting more complete super- vision, including plant visits in which the intermediary would be invited to participate. Since the new measures were adopted only recently, no experience is yet available. However, at least until FONEI's increasing direct involvement in carrying out project appraisals (para. 57) is reversed, it is not likely to be able to achieve the above program. The Bank should, therefore, continue to impress upon FONEI the importance of strengthening the supervision program, including by delegating supervision responsibility increasingly to the financial intermediaries. 1/ Financial Performance 62. As of September 30, 1978, the book value of FONEI's total equity was negative (by Mex$96.7 million), due to the massive Mexican peso devaluation of 1976. FONEI's obligations to the Bank were adjusted upward on FONEI's balance sheet to reflect the devaluation, and a corresponding exchange loss was recorded as a reduction in FONEI's equity. As the Bank loans are repaid by the Government, the peso equivalents of the amounts repaid are subtracted from FONEI's outstanding-debt, and.a corresponding addition is-made to FONEI's- equity (a part of which is used to reduce the exchange loss and the rest to increase government contributions). When Loans 824-ME and 1205-ME are fully repaid, FONEI's paid-in capital will have increased by an amount equal to the peso equivalent of the Bank loans at the time of their disbursemcnt (Annex 16). 63. Although FONEI does not bear the exchange risk on the principal of the Bank loans, it does bear the exchange risk on the interest and other charges of these loans. Consequently its profit and loss statements for 1976 and 1977 were affected accordingly, showing losses of Mex$6.4 million and Mex$15.6 million in each year. FONEI's profits were modest in the early years, however, and it is expected that, given the appreciable increase in its interest rate introduced in April 1977 and the large volume of its new oper- ations, FONEI's profits will be substantially higher than in the past (Annex 17). 64. The most striking differences between FONEI's projected and actual financial statements other than the changes arising from the peso devaluation, are seen in the profit and loss accounts. The actual figures for payments of appraisal fees and administrative expenses are well below the projections made in the Bank appraisal report for Loan 1205-ME (years 1975-77Y. These unexpectedly low levels of expenditures helped produce Mex$5.9 million in profits, as against the projected Mex$1.8 million, in 1975. 65. As a second tier institution, FONEI does not bear any credit risk in its financing operations as the intermediaries are responsible for paying FONEI on time whether or not they receive payment from their industrial clients. In practice, since FONEI is a trust fund of the central bank (BANXICO), payments to FONEI are made out of the accounts for reserve 1/ FONEI is currently considering giving intermediaries an additional margin of 0.25% to undertake supervision of projects involving annual or more frequent visits to client enterprises and the submission of comprehensive reports. This approach appears to have a good potential of achieving the desired results in this regard. - 38 - requirements that the intermediary banks are required to maintian with BANXICO. Consequently, FONEI does not make provision in its annual state- ments for possible losses on lending operations. Nevertheless, FONEI does require its intermediaries to report on wheLer any of their FGNEI supported clients are in arrears, and is prepared in exceptional cases to consider rescheduling the repayments of an intermEdiary bank in line with its loan rescheduling to an industrial client. To date this has been necessary for only one project. 1/ 66. FONEI's accounts have been audited by Alonso Ochoa Raviza, a Mexican auditing firm And by Banco de exico's internal auditors. All the audited reports on FONEI's accounts have been unqualified and satisfactory to the Bank. Role of Consultants 67. As mentioned above, FONEI hasrrelied on consultants for the appraisals of projects and to a lesser extent for supervision. After the learning process of the early years, the consultants employed by FONEI appear to have come to perform well in most cases. FONEI used the services of 22 different individual and groups of consultants since 1973 and paid about Mex$7.8 million for 112 contracts until October 31, 976. The instituuo Nexicano de Investigaciones Tecnologicas (IMIT) has been FONEI's most important consultant by far. It carried cut about 42% of the appraisals and received about 62% of FONEI's total consultants' fee paid. IMIT is a decentralized public agency which is highly regarded in Mexico for the professional quality of its work. VI. CONCLUSIONS AND RECOMMENDATIONS 68. FONEI financed economically sound projects which have had, and continue to have, a substantial positive impact on Mexico's balance of payments through increasing exports as well as efficient import substitution. They have also had a very significant favorable effect on employment generation and industrial decentralization (Annex 19). Over che period of the commit- ment of the first two Bank Loans, FONLI multiplied by many times its'size and economic impact, and matured into a well-regarded and competent financial institution. 69. FONET fell short of reaching its objective of encouraging the participating financial intermediaries to shift to appraisal based lending and thus focus more on supporting those economically sound projects that could not otherwise have been undertaken due to a lack of sufficient financing. However, in retrospect it appears that expectations regarding this 1/ Except in this case, the intermediaries did not report to FONET (nor did FONET encounter during its supervisiun visits) any arrears of final borrowers. institutional goal, while very desirable and worth pursuing in the Mexican context, might have been overly optimistic, as stated in the Bank's two appraisal reports (particularly in the FONEI-II appraisal report). As a second-tier financial institution FONEI had to rely for the generation of the projects mainly on the intermediaries which assume the credit risk. Achievement of a major shift in the lending philosophy of the intermediaries (in favor of appraisal based lending) would require major changes in the banking tradition and the development of a suitable incentive structure, which could not realistically be developed only over a short period of tihe. FONEI did succeed, however, over the commitment periods of the first two Bank loans, in gradually developing a good image among its borrowers and the financial intermediaries, who have come to appreciate FONEI's technical capability and cooperative attitude. This should provide a good foundation on which FONEI can base its continued efforts towards its objective of fostering appraisal-based lending in Mexico. Recently promulgated revisions in the Mexican banking law, which abolish the previous legal minimum collateral requirements and strengthen the concept of combining the investment banking and commercial banking functions in multi-banks, should also be helpful in this respect. 70. The Bank's relations with FONEI through Loans 824-ME and 1205-ME have been very fruitful. In addition to the direct ecui-onomic iintpacL of th subprojects financed and the institutional development achieved by FONEI through support from the Loans, the Bank was able to have constructive discus- sions with the Government on issues such as priorities in resource allocaticn and the appropriate interest rate structure in industrial sector financing. As the irst two creait line operaziou6 of Lie Dalk luk L L e4:i sector, they helped improve the Bank's understanding of the important sectoral issues. In addition to laying the basis for the continued Bank involvement in the operations of FONEI, which is likely to have a rapidly growing role in the future development of the Mexican industrial sector, both Bank loans were instrumental in the Bank's and IFC's identification and/or development of other industrial credit projects in Mexico. For one of these, a project for supporting the Mexican small and medium industry, a Bank loan (Loan 1552-ME) was approved and signed in 1978. 71. Over the next several years the volume of FONEI's operations is likely to continue to grow rapidly-within a dynamic economy spurred by the expected growth in petroleum exports. Future Bank oper;Lions with FONEI should focus on a consolidation of FONEI's institutional achievements upon which the future growth can be built, as well as on a broadening of its financing activities to stimulate technology development and project preparation activities and financing of industrial pollution control projects, reflecting the changing *needs of the sector. To cope with the expected high operational growth rates, and to achieve FONEI's institutional objective of fostering appraisal-based lending by the intermediaries, future FONEI operations will have to closely follow up on the implementation of measures, such as differential spreads to the intermediaries, cutting down project processing times, and ensuring an adequate implementation of the spirit of the provisions of the new banking law, which would help further delegation of project appraisal and supervision responsibilities to the participating intermediaries. - 40 - ANNEX 1 PROJECT COMPLETION REPORT MEXICO: INDUSTRIAL EQUIPMENT FUND (FONEI) Loans 824-ME and 1205-ME Estimated and Actual Disbursements (1972-1979) IBRD Loan 824-ME Loan 1205-ME Fiscal Appraisal Actual % Appraisal Actual % Year Quarter (US$ million) (US$ million) of estimated (US$ million) (US$ million) of estimated 1972 III 0.4 IV 2.0 1973 I 3.7 II 5.6 III 7.7 IV 10.0 1974 I 12.5 2.0 16.0 II 15.2 5.4 35.5 III 18.0 6.9 38.3 IV 21.0 9.3 44.3 1975 I 24.5 13.0 53.1 II 28.7 16.9 58.9 III 33.5 19.2 57.3 IV 35.0 22.8 65.1 1976 I 25.8 II 28.7 0.5 - III 30.0 2.0 - IV 32.1 4.0 - - 1977 I 32.4 8.0 0.7 8.8 II 32.4 12.0 5.6 46.7 III 32.5 17.0 10.4 61.2 IV 35.0 22.0 13.5 61.4 1978 I 35.0a' 28.0 18.2 65.0 II 34.0 23.2 68.2 III 39.0 28.3 72.6 IV 44.0 35.2 80.0 1979 1 48.0 II 50.0 a/ Final disbursement January 16, 1978 for US$24,473.33. Source: ILRD PROJET COMLETtmN REPORT MEXTCOS INJUSTRIAt EciPm.ET FD (mFU Lon~ 874-mE -nd 1705-ME Fnan,cial Composition of FCNE1 FI~nn.d P af (as of Cýto.e ?1, 1979) !uiber of Projecta Mllione of Ylxican Pe*oc Nuber of Project. Xllion of Mexcan Fiasi Neber et Irojects 7.IMon ol Folcatr.ece % % $ % # % $ % % % $ % 1 _'_"_?__CS10 2 453.210,0.3.. , 100.00 ,0 71801,92 1e00 C' MTE. J !.A ?.CtS COST 48 -- 2,378.6 97.0 49 -- 3.196.9 97.2 97 -- 7.57,5 97.1 : (Projects affectod) 7 14.6 74.6 3.0 7 14.3 151.1 2.8 14 14.4 225.7 2.9 pr,oeer lcewh T!?3 Reourcec 40 83,3 100.0 2j14.3 86.2 100.0 t5 91.8 100.0 32..1 9 100.0 85 . 100.0 7 3624 94,4 100, h-3 hre 40 100.0 465.1 22.0 45 100.0 1,072.0 20.4 85 100.0 1.537.1 20.9 F i*1 local reo **rces 36 90.0 421.4 19.9 33 77.8 626.0 11.9 71 83.5 1,C.7.4 19.2 Fi.ncal Interoediry 40 100.0 207.5 9.8 45 100.0 505.9 9.7 83 100.0 713.4 9.7 C'her 4 10.0 285.0 13.5 8 17.8 1,213.7 23.1 12 14.1 1.493.7 20.' 40 100.0 735.3 34.8 45 100.0 1.830.5 34.9 85 100.0 2,565.8 34.8 oe e witho.t 5RD Itefoucree 8 7 100,0 338.9 13.8 100,0 3 10, 99.9 19 100,0 12 12.4 100,0 435.8 * 6 Um0 FI1 local r.so.rce 8 100.0 200,2 59.1 4 100.0 64.5 64.6 12 100.0 264.7 60.3 Financalterediary 8 100.0 33.0 9.7 4 100.0 9.1 9.1 12 100.0 42.1 9.6 Cther 1 12.5 8.4 2.3 - -- -- -- 1 8.3 8.4 1.9 fl- 8 100.0 97.3 28.7 4 100.0 26.3 26.3 12 100.0 123.6 28.2 R/ Does oot ic.ud. faibilicy studie and suppl~etal credite. Sovre: 0Ii - 42 - PROJECT COMPLETION REPORT ANNEX 3 MEXICO: INDUSTRIAL EQUIPMENT FUND (FONEI) Page 1 of 2 Loans 824-ME and 1205-ME Characteristics of FONEI's Subprojects e/ (as of October 31, 1978) FONEI-I FONEI-IIA/ TOTAL No. To Cost Mex$ No. of Cost Mex$ No. of Projects Project Cost projects Millions Projects Millions % Mex millions % A. BY CHARACTERISTICS OF FIRM Average size of project (Mex$ million) 50 and less 26 555.2 22 596.4 48 49.5 1,151.3 14.8 51 to 100 9 599.5 12 938.6 21 21.7 1,538.1 19.7 101 " 200 2 224.5 7 901.6 9 9.3 1,126.1 14.4 201 " 300 2 433.4 2 423.3 4 4.1 856.7 11.0 301 " 400 1 301.7 - - 1 1.0 301.7 3.9 401 " 500 - - 1 413.6 1 1.0 413.6 5.3 More than 5%0 - - 1 1,974.9 1 1.0 1,974.9 25.3 Unclassified- 8 338.9 4 99.9 12 12.4 438.8 5.6 Total 48 2,453.2 49 5,348.0 97 100.0 7,801.2 100.0 Locationosz/ Mexico City 13 429.7 12 500.4 25 25.8 930.1 11.9 Guadalajara and Monterrey 8 241.4 7 503.6 15 15.4 745.0 9.6 Other major cities 22 1,537.6 19 1,441.6 41 42.3 2,979.2 38.2 Other areas 5 244.5 11 2 4 16 16.5 3,146.9 40.3 Total 48 2,453.2 49 5,348.0 97 100.0 7,801.2 100.0 Type of Firm New 9 1,097.2 20 3,341.0 29 34.1 4,438.2 60.3 Expansion 31 1,017.1 25 1,907.1 56 65.9 2,924.2 39.7 Total 40 2,114.3 45 5,248.1 85 100.0 7,362.4 100.0 B. BY CHARACTERISTICS OF LOAN c/ d/ Size of loans (Mex$ millions) 25 and less 27 483.5 17 357.1 44 45.4 840.6 10.8 26 - 50 16 1,382.1 14 653.7 30 30.9 2,035.8 26.1 51 - 75 4 358.2 12 3,132.9 16 16.5 3,491.1 44.7 More than 75 1 229.4 6 1,204.3 7 7.2 1,433.7 18.4 Total 48 2,453.2 49 5,348.0 97 100.0 7,801.2 100.0 Maturity (years) - 0 - 5 5 415.3 13 643.3 18 18.5 1,059.1 13.6 5.1 - 8 30 1,131.6 28 2,133.0 58 59.8 3,264.6 41.8 8.1 - 10 8 515.1 7 596.3 15 15.5 1,111.4 14.3 More than 10 5 391.2 1 1,974.9 6 6.2 2,366.1 30.3 Total 48 2,453.2 49 5,348.0 97 100.0 7,801.2 100.0 Bank financing . A subprojects 21 1,537.6 20 4,127.6 41 42.2 5,665.2 72.6 B subprojects 19 576.7 25 1,120.5 44 45.4 1,697.2 21.8 No use of Bank funds 8 338.9 4 99.9 12 12.4 438.8 5.6 Total 48 2,453.2 49 5,348.0 97 100.0 7,801.2 100.0 a/ As of October 31, 1978. 9/ Projects not financed with Bank funds. c/ Including projects not financed with Bank funds. j/ Financed by FONEI resources including Bank funds and the Financial Intermediary. el Does not include feasibility studies financed and supplemental credits, as separate subprojects. - 43 - PROJECT COMPLETION REPORT ANNEX 3 KZXICO: INDUSTRIAL EQUIPMENT FUND (FONEI) Page 2 of 2 Loans 824-ME and 1205-E Characteristics of FONEI's Subprojects (as of October 31, 1978) FONEI-I FONEI-II Number of Cost Mex$ Number of Cost Mex$ Number of Projects Project Cost BY CHARACTERISTIC OF SUBPROJECT Projects millions Projects millions # % Mex$ millions % Destination of Output Iaport substitution 19 1,219.9 26 1,461.2 45 46.4 2,681.1 34.4 Import substitution-export 14 456.8 8 2,877.3- 22 22.7 3,334.1 42.7 Export 15 776.5 15 1,009.5 30 30.9 1,786.0 22.9 Total 48 2,453.2 49 5,348.0 97 100.0 7,801.2 100.0 Subsector Food 5 153.4 - - 5 5.2 153.4 2.0 Beverage 1 17.6 - 1 1.0 17.6 0.2 Textiles 1 301.7 1 6.0 2 2.1 307.7 3.9 Leather 1 14.7 1 24.2 2 2.1 38.9 0.5 Paper 4 412.3 2 129.3 6 6.2 541.6 6.9 Building materials and cement 4 166.2 3 93.2 7 7.2 259.4 3.3 Class 1 44.3 - - 1 1.0 44.3 0.6 Chemicals and Petrochemicals 10 512.5 14 2,721.6 24 24.7 3,234.1 41.5 Metal products 20 787.1 21 1,723.2 41 42.3 2,510.3 32.2 Electrical products 1 43.4 7 650.5 8 8 693.9 8.9 Total 48 2,453.2 49 5,348.0 97 100.0 7,801.2 100.0 Financial Rate of Return a/ 10 - 14.9 6 669.1 11 1,244.5 17 17.5 1,913.6 24.5 15 - 19.9 11 463.7 16 3.127.8 27 27.8 3,591.5 46.0 20 - 24.9 7 539.6 7 423.4 14 14.4 963.0 12.4 25 - 29.9 3 98.0 5 247.4 8 8.3 345.4 4.4 30 - 34.9 5 73.9 2 149.6 7 7.2 223.5 2.9 35 or more 2 72.8 4 55.4 6 6.2 128.2 1.6 Not available 14 536.1 4 99.9 18 18,6 636.0 8.2 Total 48 2,453.2 49 5,348.0 97 100.0 7,801.2 100.0 Economic Rate of Return a/ 10 - 14.9 1 15.2 - - 1 1.0 15.2 0.2 15 19.9 5 676.0 6 2,808.5 11 11.4 3,484.5 44.7 20 - 24.9 3 333.9 7 523.4 10 10.3 857.3 11.0 25 - 29.9 4 137.0 9 649.5 13 13.4 786.5 10.1 30 - 34.9 3 111.1 1 94.2 4 4.1 205.3 2.6 35 or more 14 394.2 22 1,172.5 36 37.1 1,566.7 20.1 Not available 18 785.8 4 99.9 22 22.7 885.7 11.3 Total 48 2,453.2 49 5,348.0 97 100.0 7,801.2 100.0 aE Estimated returns in real terms. PROJECT COMPLETION REPORT MEXICO: INDUSTRIAL EQUIPIIENT FUND (FONEI) Loans 824-VLE and 1205-ME Size Distribution of FONEI's Subprojects (as of October 31, 1978) FONET -1 FONEI -IJ TOTAL Investment costs of the subproject No. of Cost Mex$ No. of No. of Cost Mex$ No. of No. of Projects Project Cost No. of Jobs Cost per job (Mex$ million) Projects millions jobs . Projects millions jobs # % Mex$ million 7.% Mex$ thousand 50 and less 24 521.9 2,787 21 582.4 1,579 45 57.7 1,104.3 15.8 4,366 39.0 252.932 51 to 100 8 507.3 481 9 710.9 1,760 17 21.8 1,218.2 17.4 2,241 20.0 543,597 101 " 200 2 224.5 288 7 901.6 1,743 9 11.5 1,126.1 16.1 2,031 18.1 554,656 201 " 300 2 433.4 302 2 423.3 783 4 5.1 856.7 12.3 1,085 9.7 789,585 I 301 400 1 301.7 450 - - - 1 1.3 301.7 4.3 450 4.0 670,4 401 " 500 - - - 1 413.6 750 1 1.3 413.6 5.9 750 6.7 551,467 more than 500 - - - 1 1 276 1 1.3 1 28.2 276 2.5 7.155,435 Subtotal 37 1,988.8 4,308 41 5,006.7 6,891 78 100.0 6,995.5 100.0 11,199 100.0 624 654 Unavailable 11 464.4 - 8 341.3 - 19 - 805.7 TOTAL 48 2.453.2 49 5 348.0 97 7,801.2 a/ Appraisal estimate. Source: FON'EI 州藝辭；l〕 ；馴‘計！-;- 江―卜l&! 〕：:，一，一，,.!，、〕 -！〕，！一！1!!！〕〕‘〔〕； ―二～！才弓！l柑 -’樣“，領，&’造乏，J〔‘!―〕―,―〔。 -&&&&&&&&&&&&}&}―、｝｝〔廷 -&‘藝。：&：丑；:::-!：〕―&l！〔―: -&&&&&&&&&&&-’柚―｝運 I:,.,，。l實弓11 -’絕’&,,“乙”。江”―〔‘!- ―〕註l邑“江三日江‘叢〕’:‘〕 ―〕付”&&&&&&&&;l‘【―- 1！〕江〕〕〕〕〕〕〕〕〕―〕〕｝：〕 沼．11汗者I -I多F,,,,，戶斤賽汗莽―B:!I ,g觔一 - 46 - ANNFX 6 PROJECT COMPLETION REPORT MEXICO: INDUSTRIAL EQUIPMENT FUND (FONEI) Loans 824-ME and 1205-ME Interest rates (Percentage per Year) a/ Inflation during quarter, Higtiest Rate to Year Ouarter Highest Deposit Rate ACF Annualized Rate FONEI Borrower 1971 1 11.48 10.53 4.9 - 2 11.11 10.41 3.9 - 3 11.11 10.30 4.3 - 4 11.11 10.19 4.2 - 1972 1 10.60 10.03 7.7 - 2 10.60 9.97 4.1 - 3 10.60 9.91 5.8 - 4 10.60 9.90 4.6 - 1973 1 10.60 9.87 13.6 - 2 10.88 9.87 14.6 - 3 12.71 10.41 29.9 11.0 4 12.71 10.65 28.5 11.0 1974 1 12.78 10.88 29.9 11.0 2 13.74 11.35 13.1 11.0 3 14.21, 11.57 15.7 11.0 4 14.21 11.88 24.5 1110 1975 1 14.21. 11.86 10.4 11.0 2 14.21 11.89 16.7 11.0 3 14.21 11.91 9.9 11.0 4 14.21 11.97 8.3 12.0 1976 1 13.91 11.78 21.0 12.0 2 13.91 11.76 7.4 12.0 3 14.63 11.74 22.8 13.5 4 15.17 11.99 64.0 13.5 1977 1 15.17 11.99 32.7 14.00 2 16.28 12.59 15.4 14.50 3 18.52 13.85 21.7 15.75 4 18.52 14.30 13.9 16.25 1978 1 18.52 14.88 20.6 17.00 2 18.52 15.47 14.8 17.50 3 18.52 15.67 18.2 17.75 4 18.25 16.25 17.7 18.25 a/ Average cost of debt funds to financieras. Source: Banco de M6xico and FONEI. PROJECT COMPLETION REPORT MEXICO: INDUSTRIAL EQUIPMENT FUND (FONEI) Loans 824-ME and 1205-ME Projected and Realized Exports in 1977 by a Sample of Enterprises Financed by FONEI (in thousands of US$) IBRD ENTERPRISE Projected Actual Variation Loan a/ Cementos Anahuas del Golfo, S.A. 7,775 23,855 16,080 I Cementos de Chihuahua, S.A. 1,074 1,953 879 I Ladrillera Industrial, S A. 423 1,110 687 I Fabricacion de Maquinas, S.A. 1,947 4,542 2,595 I Condumex, S.A. 4,230 3,183 (1,047) I Camera, S.A. 1,161 5,165 4,004 I Promociones Industriales Mexican..s, S.A. 1,427 292 (1,136) I Fabricas Orion, S.A. 3,090 974 (2,116) I Fundidora de Aceros Tepeyec, S.A. -- 647 647 I Tubos Flexibles, S.A. 1,455 152 (1,303) I DeKormex, S.A. -- 31 31 I Quimica Mexr.ma, S.A. 2,913 3,312 399 I Cia. Fundidora del Norte, S.A. 10,128 6,116 (4,012) I Herramientas Nacionales, S.A. 716 677 (39) I Autoforjas, S.A. -- 16 16 I Polynova, S.A. 10,005 -- (10 ,605) I Quimica Central de Mexico, S.A. 922 294 (628 1 Ind. de Baleros Intercontinental, S,A, 913 1,780 867 I Casa Aries, S.A. 1,562 470 (1,092) I Resinas Senteticas, S.A. 900 137 (763) Transejes, S.A. -- 752 752 I Automanufacturas, S.A. 2,145 2,366 221 Taloquimica, S.A. .734 983 249 Industrias Resistol, S.A. 4,783 404 (4,379) II Negromex, S.A. 625 736 111 II TOTAL 59,528 59,947 419 a/ I - Loan 824-ME II - Loan 1205-ME SOURCE: FONEI PROJECT COMPLETION REPORT MEXICO: INDUSTRIAL EQUIPMENT FUND (FONEI) Loans 824-ME and 1205-ME Projected and Realized Import Substitution in 1977 by a Sample of Enterprises Financed by FONEI (in thousands of US$) TBRD ENTERPRISES Proiected Actual Variation Loan Fabricacion de Maquinas, S.A. 2,129 3,620 1,491 I Condumex, S.A. 8,670 29,504 20,834 I Swecomex, S.A. 2,859 4,032 1,173 I Comesa, S.A. 700 5,422 4,722 I Materias Primas y Minerales Lampazos S.A. 1,620 2,215 595 I Promociones Industriales Mexicanas, S.A. 1,986 6,118 4,132 I La Florida, S.A. 8,865 7,108 (1,757) I Fenoqutimica, S.A. 5,896 14,905 9,009 I Fundidora de Cueros Tepeyac, S.A. 2,533 2,522 (11) I Tubos Flexibles, S.A. 1,819 1,450 (369) I DeKormex, S.A. 1,208 619 (589) I Metalurgica Almena, S.A. 499 1,086 587 I Quimica Mexama, S.A. 343 3,425 3,082 I Industrial PapelerifiMexicana S.A. 8,129 6,537 (1,592) - Herramientas Nacionales, S.A. 697 1,139 442 1 Autoforjas, S.A. 4,678 6,198 1,520 I Productos de Estireno, S.A. 2,948 9,682 6,734 I Eutectic Investment Casting de Mexico, S.A. 1,401 439 (962) I Cia Quimica Ameyal, S.A. 1,909 58 (1,851) I Quimica Central de Mexico, S.A. 848 2,972 2,124 I Ind. de Baleros Intercontinental, S.A. 3,946 3,970 24 I Conductores Monterrey, S.A. 2,976 878 (2,098) I Resinas Sinteticas, S.A. 2,514 649 (1,865) Fransejes, S.A. 2,079 1,614 (465) I Automanufacturas, S.A. 3,329 4,166 837 - Industrias Resistol, S.A. 1,496 14,339 12,843 II Hulva, S.A. 217 113 (104) II Cia. Mex. de Especialidades Ind. S.A. 1,096 1,347 251 Aceros de Chihuahua, S.A. 781 1,062 281 I Industrias Monterrey, S.A. 2,128 2,010 (118) II Multitex, S.A. 685 520 (165) II Reconstructora Mexicana de Maquinaria Industrial, S.A. 3,606 2,340 (1,266) TOTAL 84,590 142,059 57,469 a/ I = Loan 824-ME II = Loan 1205-ME o0 SOUrCE: FONEI PROJECT COMPLETION REPORT MEXICO: IN)UNKLAL EuirMtAT FUND (FONE1) Loans 824-ME and 1205-HE Regional Distribution of FONEI's Lending Operations 1/ (U973-978) 1973 1974 1975 197f 1977 * 1978 k1 TOTAL Million Million Million Million Million Million Million Region 5. Number Max $ Number Max $ Number Max $ Number me x Number max $ Number Max $ Number Mex $ # () Amt (M) # (%) Amt ( ) # (%) Am ( ) # (Z) Amt ( ) # (%) Am (%) # (%) Amt ( ) (7.) Amt (7) zone 1 5 (55.6) 106.9 (50.3) 10 (43.5) 187.2 (39.2) 6 (30.0) 80.7 (24.2) 18 (56.2) 277.5 (42.1) 15 (45.5) 455.5 (39.3) 13 (29.5) 418.0 (23.0) 67 (41.6) 1,525.8 Zone 2 - -- -- -- 4 (17.4) 121.8 (25.5) 3 (15.0) 58.6 (17.6) 3 (9.4) 22.7 (3.5) 7 (21.2) 311.4 (26.9) 4 (9.1) 68.3 (3.8) 21 (13.0) 582.8 Zone 3 !4 (44.4) 15.8 (49.7) 1 (.1) 169.0 (35.3) 11 (55.0) I (58.2) i (344) 358.3 (54.4) Ll (33.3) 2RA (.41 1Z (61.4)1327.1 (73.2) L (j14) 2,545.5 TOTAL 9 (100.0) 212.7(100.0) 23(100.0) 478.0(100.0) 20 (100.0) 332.7 (100.0) 32(100.0) 658.5(100.0) 33 (100.0)1158.8(100.0) 44 (100.0)1813.4(100.0) 161(100.0) 4,654.1 '0 I/ Excluding feasibility studies financed b/ As of October 31, 1978 c/ Zone includes the Federal District and the municipalities of Atecapan do ZEaragosa, Coacalco, Cuantitlan. Ecatepec. Nalcapan do Juares, Flalnepantla, Pultitlan and Texcaco from the Mexico Tate; the municipalities of Apodace, Ga&a Garcia, General Eacobedo, Guadalupe, Monterrey, San Nicole de los Gars and Santa Catarina, from the Nuevo Leon State. and the municipality of Guadalajara from the Galirco State. Zone 2 includes the municipalities of Flaquepaque and Zapopan from the Jilisco State. the municipalities of Lama and Toluca, from the Mazico State; the municipalities of Cuernavaca and Fiutepec from the Noreloa State; the municipalities of Cucautlancingo, Puebla and San Pedro Cholula from the Pueblo State and the municipality of Queretaro in Queretaro State. Zn 3 covers the rest of the country. Source: FONEI - 50 - ANNEX 10 PROJECT COMPLETION REPORT MEXICO: INDUSTRIAL EQUIPMENT FUND (FONEI) Loans 824-ME and 1205-ME Projected and Realized Employment by a Sample of Projects Financed by FONEI Enterprises Projected Actual Fabricaci6n de Maquinas, S.A. (I) 50 110 Swecomex, S.A. (I) 55 6 Camesa, S.A. 82 100 Fenoquimia, S.A. 170 330 Fundidora de Aceros Tepeyac, S.A. 33 14 Tubos Flexibles, S.A. 50 40 Metalu'rgica Almena, S.A. 15 - QuImica Mexama, S.A. 15 40 Herramientas Nacionales, S.A. 55 17 Autoforjas, S.A. 155 368 Productos de Estireno, S.A. 17 12 Cla Qulmica Ameyal, S.A. 24 111 Casa Aries, S.A. 206 147 Transejes, S.A. 61 186 Automanufacturas, S.A. 388 397 Fabricaci'n de Maquinas, S.A. (II) 75 88 Hulva, S.A. 36 14 Multitek, S.A. 40 23 Sistemas y Componentes, S.A. 85 120 Total 1,612 2,123 Sourcei FONEI PROJECT COMPLETION REPORT MEXICO: INDUSTRIAL EQUIPMENT FUND (FONEI) a/ FONEI's Flow of Applications for,Project Financing - T 0 TA L 1972 1973 1974 1975 1976 1977 1978b/ Number % % Number of applications received 27 56 100 39 44 101, 83 450 100.0 - Number approved for evaluation 2 22 35 23 38 92 82 294 65.3 100.0 Number approved for financing C/ - 10 25 23 36 34 50 178 39.6 60.5 tI a! Dates in which decision was taken by FONEI. b/ As of October 31, 1974 including loans under FONEI III. c/ Gross of cancelations, including feasibility studies and supplemental credits. Source: VnNFI z M PROJECT COMPLETION REPORT MEXICO: INDUSTRIAL EQUIPMENT FUND (FONEI) Loans 824-ME and 1205-ME Summary of FONEI's Financial Assistance (1973-1978) 1973 3974 1975 1976 1977 1978/ TOTAL Amount Amount Amount Amount Amount Amount Amount Number Mex S Number Mex $ Number Mex $ Number Mex $ Number Mex $ Number Mex S Number Mex S millions Millions Millions Millions Millions Millions Million. New Credits 9 212.6 22 472.9 18 312.6 21 551.2 27 1,073.6 37 1,490.9 134 4,113.8 Supplemental Credits c 1 5.1 2 20.1 11 107.2 6 85.2 7 322.5 27 540.1 Feasibility Studies 1 0.1 2 1.4 3 1.3 4 2.1 1 0.3 6 3.7 17 8.9 TOTAL 10 212.7 25 479.4 23 334.0 36 660.5 34 1,159.1 50 1,817.1 178 4,662.8 a/ As of Octobet 31, 19F$ b/ Gross of cancellations. c/ Supplemental credits to finance increased costs. SOURCE: FONEI lqUICOp ImpJbrRIAL E'U1PM1ElT FUlD (ICU.I) Prpichn Orzmitate ChaSA£Lr~ ,ArtststetosDirectev e ical Secretary d S re Scr*tei7 I ~~~Sb reem tn r :r tnisi I e o•un Divialon Secretary Çhief .Chief Vokf .Chief' li -c il-Wu Promoter Reresen- OpaslPoet SupervisorCnacerdi nn21n. Pot18 Aseist:nt Secretary Appraieal Supervision __ A'rstn credit iAsGIstantt Processing Pronoter A3 saistant Assistant Adinsrao "" 1 Asitn Assistantt $Gcratary Secretery Teloephone Secretary 'ertr Center Records weseenger 2 Note: Figure~ in boxes indicate the number of ataff under the respective unit. Uj PROJECT COMPLETION REPORT MEXICO: INDUSTRIAL EQUIP-1ENT FUND (FONEI) Loans 824-ME and 1205-ME FONEI's Personnel and Loans Approved a! 1973 1974 1975 1976 1977 1978 a/ 1. Number of Loans- 10 25 23 36 34 50 b / 2. Amount of Loans (Million Mex$)- 212.7 479.4 334.0 660.6 1,159.1 1,817.1 3. FONEI's Staff 21 23 24 24 33 40 4. Average number of loans 0.48 1.09 0.96 1.50 1.03 125 staff member C(1) + (3)] 5. Average lending per staff member 10.13 20.84 13.92 27.53 35.12 45.4 E(2) - (3)] a/ As of October 31, 1978 (includes some loans under FONEI-III). b/ Gross of cancellations, including feasibility studies and supplemental credits. SOURCE: FONEI (1973.19 78) AVERAGE PROCESSING TIMES UNDER FUNEI-I AV4RAGE PROCESSIN" TI,ES UNDR FONEI-I: For Evaluation & For Evaljation & initial Formal Approval Approval to initial Forman Approval Approval to Total time for No. of decision by FONEI Loan Signing T,tu., times No. of decision by FONE1 Ioan Signing Total time Project Processin% Projects (months) (months) (months) (Months) Projects (months) (months) (months) (months) .6 months or less 3 1.3 3.0 1.6 5.9 4 0.7 3.9 1.3 5.9 From 6 to 9 months 5 1.0 3.6 4.2 8.8 6 0.7 5-.0 2.9 8.6. From 9 to 12 months 15 1.3 5.1 3.9 10.3 14 0.8 5.8 3.5 10.1 From 12 to 18 months 9 1.5 6.5 7.0 15.0 1i 0.7 7.5 7.2 15.4 1 From 18 to 24 months 8 3.1 8.0 9.4 20.5 5 0.7 15.0 5.5 21.2 Nore than 24 months - - - - - 2 1.1 21.0 6.0 28.1 Subtotal 40 1.7 5.8 5.6 13.1 42 0.8 7.0 4.5 12.3 Unavailable 8 7 TOTAL 48 49 a/ As of October 1978 Source: FONEI PROJECT COMPLETION REPURI MEXICO: INDUSTRIAL EQUIPMENT FUND (FONEI) Loans 824-ME and 1205-ME Audited Balance Sheets as of December 31 (in Mex$ million) September 30 1972 1973 1974 1975 1976 1977 1978 ASSETS Cash at Banco de Mexico S.A. 124.2 87.4 51.3 4.4 29.2 63.2 136.5 Loans Outstanding -- 52.7 294.7 726.2 995.3 1,613.2 2,353.4 Interest & Comissions Payable 4.0 5.0 8.0 14.6 20.2 37.7 77.0 Fixed and Other Assets 0.4 0.4 0.4 0.3 -- 0.4 -- TOTAL ASSETS 128.6 145.5 354.4 745.5 1,044.7 1,714.5 2,566.9 LIABILITIES IBRD Loan 824-ME -- -- 116.0 260.0 606.5 729.1 700.0 IBRD Loan 1205-ME -- -- -- -- -- 307.1 643.3 Banco de Mexico (Series A)/-- -- 100.0 332.0 375.0 375.0 375.0 Banco de Mexico (Series B)b/ -- -- -- 100.0 399.9 920.0 Other Liabilities 1.5 15.6 6.0 8.6 20.8 33.0 25.3 TOTAL LIABILITIES 1.5 15.6 222.0 600.6 1,102.3 1,844.1 2,663.6 EQUITY Government Contributions 125.0 125.0 125.0 131.7 146.0 161.2 177.6 Accumulated Profits 2.1 4.9 7.4 13.2 6.8 (8.8) (6.0) Exchange Rate Loss -- -- -- -- (210.4)-/ (282.0) (268.3) TOTAL EQUITY 127.1 129.9 132.4 144.9 (57.6) (129.6) (96.7) TOTAL LIABILITIES AND EQUITY 128.6 145.5 354.4 745.5 1,044.7 1,714.5 2,566.9 a/ As the principals are paid, corresponding amounts are converted into FONEI's equity. b/ Bonds held by Banco de Mexico S.A. c/ Revaluation of foreign liabilities. SOURCE: FONEI PROJECT COMLETION REPORT MEXICO: INDUSTRIAL EQUIPMENT FUND (FONEI) Loans 824-ME and 1205-ME FONEI'S Audited Income Statements as of December 31 (in Mexg million) September 30 1972 1973 1974 1975 1976 1977 1978 REVENUES Interest Income 5.8 10.3 18.8 47.8 77.4 132.5 176.5 Other Revenues 0.2 0.8 1.3 2.5 2.7 TOTAL REVENUE 5.8 10.3 19.0 48.6 78.7 135.0 179.2 EXPENSES Interest Expense -- -- 6.4 32.6 68.6- 125.0 154.6 Comitment fees and other charges 1.4 3.3 3.0 2.0 6.7 11.0 7.6 Appraisal fees -- 0.5 1.3 1.4 1.4. 2.5 1.8 Administrative Expense 2.3 3.7 5.9 6.7 8.4 12.1 12.4 TOTAL EXPENSES 3.7 7.5 16.6 42.7 85.1 150.6 176.4 Operating Profit (Loss) 2.1 2,8 2,4 5,9 (6,41 (15,61 2,8 SOURCE: FONEI PROJECT COMPLETION REPORT MEXICO: INDUSTRIAL EQUIPMENT FUND (FONEI) Loans 824-ME and 1205-ME FONEI's Sources and Uses of Fuin Statements, 1972-1978 (in Mex$ million) September 30 1972 1973 1974 1975 1976 1977 1978 SOURCES TBRD Loan 824-ME -- -- 116., 150.7 373.3 155.0 10.7 IBRD Loan 1205-ME -- -- -- -- -- 307.1 336.6 Banco de Mexico S.A. (Serie A) -- -- 100.0 232.0 43.0 -- -- Banco de Mexico S.A. (Serie B) -- -- -- -- 100.0 299.9 520.1 Increase Other Liabilities 1.5 14.1 (9.5) 2,5 12.2 12.4 (7.7) Profits 2.1 2.8 2,4 5.9 (6.4) (15.6) 2.8 Equity -- -- -- 6.7 14.3 15.2 16.4 Loan Recoveries -- -- 1.5 12.0 58.5 106.9 115.2 TOTAL SOURCES 3.6 16.9. 210.4 410.8 594.9 880.9 994.1 USES 00 Loans Disbursements -- 52.7 243.5 444.5 327.6 724.9 855.5 Increase in Interest and Commissions Receivable 4.4 0.8 2.8 6.6 5.1 17.3 39.2 Increase in Other Receivables -- 0.2 0.2 (0.1) 0.2 0.5 (0.3) Amortization Loan 824-ME 2) -- -- -- 6.7 26.8 32.4 39.8 Exchange Rate Loss -- -- -- -- 222.9 89.0 -- Amortization of Exchange Rate Loss a/ -- -- -- -- (12.5) (17.2) (13.4) TOTAL USES 4.4 53.7 246.5 457.7 570.1 846.9 920.8 Beginning Working Capital 125.0 124.2 87.4 51.3 4.4 29.2 63.2 Increase Decrease) in Working Capital (0.8) (36.8) (36.1) (46.9) 24.8 34.0 73.3 Ending Working Capital 124.2 87.4 51.3 4.4 29.2 63.2 136.5 a/ Amortization of Loan 824-ME are applied to increase equity and to reduce the accumulated exchange rate loss. SOURCE: FONEI PROJECT COMPLETION REPORT MEXICO: INDUSTRIAL EQUIPMENT FUND (FONEI) Loans 824-ME and 1205-ME Estimated Employment, Income and Foreign Exchange Savings Impact of FONEI's Lending Operations (1973-1978) b/ TOTAL 1973 1974 1975 1976 1977 1978 1973-77 Number of jobs created 671 2,990 2,039 2,697 4,573 4,883 12,970 Value added in the first 5 years of operations (Million of Mex$) a! 2,146.2 3,289.2 2,764.4 4,819.2 5,728.0 n.a. 18,747.0 Estimated salaries and wages paid in the first 5 years of the enterprise's operation (Million of Mex$ 951.0 1,279.8 1,469.1 1,408.1 1,955.0 n.a. 7,063.0 Estimated total foreign exchange savings for the first 5 years of the enterprise's operation (Million of'Mex$) a/ 1,724.7 3,381.8 3,546.6 6,145.9 8,052.0 15,795.6 22,851.0 a/ Computed in equivalent present value terms (16% in 5 years) b/ Loans approved up to October 31, 1978. SOURCE: FONEI