Nicaragua - Industrial Rehabilitation Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 3364b-NI STAFF APPRAISAL REPORT NICARAGUA INDUSTRIAL REHABILITATION CREDIT PROJECT June 5, 1981 Projects Department Latin America and the Caribbean Regional Office 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. CURRENCY EQUIVALENTS (Since 1979) Currency Unit = Cordoba (0) US$1 = 0 10 US$0.10 = 0 1 FISCAL YEAR January 1 - December 31 FOR OFFICIAL USE ONLY GLOSSARY OF ACRONYMS ADP - FED' Agricultural Development Program AGROINRA - Agroindustrias de la Reforma Agraria BAMER - Banco de America BANANIC - Banco Nacional de Nicaragua BANIC - Banco de Nicaragua BAVINIC - Banco de la Vivienda de Nicaragua BCN - Banco Central de Nicaragua BCP/BP - Banco de Credito Popular/Banco Popular BIN - Banco Inmobiliario BND - Banco Nacional de Desarrollo CAAFIID - Central American Agreement on Fiscal Incentives for Industrial Development CABEI - Central American Bank for Economic Integration CACM - Central American Common Market CET - Common External Tariff COIP - Corporacion Industrial del Pueblo COMNOMET - Corporacion de Minerales no Metalicos CONDEMINA - Corporacion Nicaraguense de Desarrollo Minero CORFIN - Corporacion Financiera de Nicaragua CORFOP - Corporacion Forestal del Pueblo COSEP - Consejo Superior del Sector Privado EEC - European Economic Community ENABAS - Empresa Nicaraguense de Alimentos Basicos ENAL - Empresa Nicaraguense del Algodon ENAZUCAR - Empresa Nicaraguense del Azucar ENCAFE - Empresa Nicaraguense del Cafe ENCAR - Empresa Nicaraguense de la Came ENIMPORT - Empresa Nicaraguense de Importaciones ENIPREX - Empresa Nicaraguense de Promociones de Exportacion EXPORTEMOS - Nicaraguan Center for Export Promotion FED - Fondo Especial de Desarrollo FINAPRI - Financiera de Preinversion FIR - Fondo Internacional para la Reconstrucion de Nicaragua FSLN - Frente Sandinista de Liberacion Nacional IDB - Inter-American Development Bank IDL - Nicaragua' Industrial Development Law IDP - FEDs Industrial Development Program IFAD - International Fund for Agricultural Development IMF - International Monetary Fund INAP - Instituto Nicaraguense de Administracion Publica INFONAC - Instituto de Fomento Nacional INMINEH - Instituto Nicaraguense de Minas e Hydrocarburos INPESCA - Instituto Nicaraguense de Pesca INVIERNO - Instituto de Bienestar Campesino IRENA - Instituto Nicaraguense de Recursos Naturales y del Ambiente JGRN - Junta del Gobierno de Reconstruccion Nacional MIDA - Ministerio de Desarrollo Agropecuario MIND - Ministerio de Industria MIPLAN - Ministerio de Planeacion OPEC - Organization of Petroleum Exporting Countries PETRONIC - Empresa Nicaraguense del Petroleo SBOI - Superintendencia de Bancos y de Otras Instituciones SSED - FEDs Small-Scale Enterprise Development Program UNDP - United Nations Development Programme USAID - United States Agency for International Development CADIN - Camara de Industrias 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.  NICARAGUA INDUSTRIAL REHABILITATION CREDIT PROJECT STAFF APPRAISAL REPORT TABLE OF CONTENTS Page No. I. THE INDUSTRIAL SECTOR ........................... ....1...... A. Introduction ....1................................... 1 B. Industrial Development in the 1960's and 1970's ....... 3 The Structure of Industry ............................. 3 Tariff Protection...................................... 5 Mining and Industrial Exports ......................... 5 Employment and Wages................................... 6 C. The War and Its Effects ...................... ........ 7 Decline in Output and Employment ......7..............7 Physical Damage and Looting .......................... 7 D. Post-War Reconstruction of Industry ................... 8 Initial Objectives and Expectations.................... 8 The New State Sector................................... 9 Attitude of the Private Sector......................... 10 Industrial and Mining Sector Performance in 1980....... 11 II. THE FINANCIAL SYSTEM ............................... ....... 16 A. The Financial System Prior to the War ................. 16 The Structure of the Financial System ................. 16 Monetary Policy ...................................... 18 B. The Post-War Financial System ......................... 20 The Banking System................................... 20 Monetary Policy........................................ 21 This report is based on the findings of an appraisal mission comprised of Messrs. N.C. Hughes and G. Faillace of the Bank, which visited Nicaragua in September-October 1980, and a post-appraisal mission comprised of Messrs. N.C. Hughes and M. Voljc of the Bank, which visited Nicaragua in March 1981. Information based on a visit to Nicaragua by Mr. K.M. Cline (Consultant) was used in the,preparation of this report. TABLE OF CONTENTS (Continued) Page No. III. THE PROJECT .............................................. 22 A. The First Agricultural and Industrial Rehabilitation Project ........................ ....... 22 B. The Second Industrial Rehabilitation Credit Project ... 23 Objectives .......................................... 23 The Need for Additional Rehabilitation Assistance ..... 24 Eligible Enterprises....................... ........... 24 Technical Assistance .................................. 25 C. Institutional Structure ....................... ...... 26 Executing Agency ................................... 26 Background ....................................... 26 Organization and Staff................... .......... 26 Appraisal and Supervision ........................... 27 Operating Policies ................................. 28 Operations..................................... ...... 28 Financial Position .......................... ...... 28 Projected Operations ................................ 29 Participating Intermediaries........................... 29 D. Loan Features ........................................ 30 The Proposed Loan. .....................................30 Project Cost. ..........................................30 Relending Terms and Conditions........................ 31 Sectoral Limit on Bank Financing...................... 32 Accounting and Auditing. ...............................32 Procurement and Disbursement ............... ......... 33 Project Benefits and Risks .................. ........ 33 IV. RECOMMENDATIONS .......................................... 35 TABLE OF CONTENTS (Continued) List of Annexes Page No. 1. CORFIN Organization Chart................................... 36 2. FED Organization Chart..................................... 37 3. FED Statement of Operating Policies and Procedures.......... 38 4. FED Supporting Tables: T-1 Balance Sheets 1973-80 ................................ 44 T-2 Income Statements 1973-79 ............................. 45 T-3 List of Pending Subprojects ........................... 46 T-4 Participation of Financial Intermediaries through June 30, 1980 ....................................... 48 T-5 Estimated Schedule of Disbursement .................... 49 5. Major Industrial and Mining Subsectors .................... 50 6. Technical Assistance and Training ......................... 65 7. Selected Documents and Data Available in the Project File . 71 Map of Nicaragua............................................. s 2 I. THE INDUSTRIAL SECTOR A. Introduction 1.01 After several years of steadily increasing guerrilla activity and almost a year of outright civil war, the Government of Nicaragua was replaced on July 19, 1979 by revolutionary forces led by the Frente Sandinista de Liberacion Nacional (FSLN). A Junta del Gobierno de Reconstruccion Nacional (JGRN) took over leadership of the new Government. 1.02 During the revolution an estimated 35,000 persons lost their lives. The main battlefields were Nicaragua's towns, and many civilians were killed in the intense battles which took place during September 1978 and May-July 1979. As all semblance of order ended in mid-1979, mobs looted stores and industries of massive amounts of finished goods, raw materials and equipment. Damage to physical structures and equipment was estimated at US$185 million. While an additional US$250 million in inventories were stolen, burned, or otherwise lost to the original owners, all but US$60 million was probably used or sold by the new owners, thus reducing the total physical loss to the economy to about US$245 million, or about one tenth of 1978 GDP. 1.03 More important in financial terms, however, was the capital flight from Nicaragua of over US$500 million during 1978 and 1979. Many firms became illiquid because of it, leading in turn to massive loan defaults and the insolvency of domestic commercial banks. On July 19, 1979, the Central Bank had only US$3.5 million in gross foreign exchange, net foreign reserves were minus US$215 million and almost all external debt service was in arrears. 1.04 The immediate consequences of this physical and financial destruc- tion were quite severe. Nicaragua's real GDP dropped 9% in 1978 and 27% in 1979. While all sectors of the economy were affected, industry, transport, and commerce suffered most of the physical damage as well as severe import constraints and domestic trade and communications bottlenecks. In agriculture, the 1979 cotton crop was largely lost and the grain crop adversely affected as most fighting occurred during key planting times, and planting was deferred. Livestock inventories, particularly chickens and cattle, were drastically depleted. It is estimated that Nicaragua's per capita GNP fell in 1979 to US$570 and that real unemployment and underemployment affected at least 30% of the urban work force. 1.05 Faced with this situation, the new Government announced an economic recovery program based on a mixed economy concept which envisaged full parti- cipation of both public and private sectors. It gave high priority to imme- diate recovery efforts, dividing them into two phases: an emergency program consisting of food and medical distribution, recovery of public services and clearing of bombed neighborhoods; and a recovery plan stressing output and employment expansion, reorganization of the balance of payments, debt and public finances, and complementary monetary policies. Given the lack of resources, most emergency phase labor was voluntary, with neighborhood com- mittees organizing the participants. While these committees have been effec- tive in clearing and partially repairing neighborhoods, the reconstruction of more heavily damaged homes, industries, shops and public buildings is taking considerably more time and resources, particularly foreign exchange. - 2 - 1.06 One of the first acts of the new Government was to confiscate the assets of the family of former President Somoza and his immediate associates as well as to nationalize the insolvent banking system. As a result, the State now owns about one-tenth of the nation's crop and grazing land (account- ing for about one-fifth of agricultural output), which in the past produced large amounts of sugar, rice and cattle, and has an equity interest in about 120 industrial firms. State ownership in industry accounts for almost one- third of industrial output. The nationalization of service enterprises and of much of agricultural trade, has made the State responsible for about 10-15% of the value added in commerce and other services. In total, the public sector in Nicaragua now probably accounts for about 40% of the nation's GDP. In acquiring these substantial assets, the Government also assumed their liabili- ties, a debt that is still being calculated. 1.07 Although the Government was concerned that the productive enter- prises it controls be guided by principles that stressed economic efficiency, for the immediate post-war period, other goals, such as recovery of produc- tion, employment retention and a more egalitarian wage structure, took pre- cedence. 1.08 The new Government received a relatively quick response to its requests for concessional, external assistance. The U.S. Government made an emergency air lift of medical supplies and food. The UN relief agencies, Red Cross, and nearby countries - particularly Costa Rica, Cuba and Mexico - also were quick to provide emergency assistance. The Inter-American Develop- ment Bank (IDB), with the agreement of the Government of Venezuela, made a loan of US$20 million from its Venezuelan Trust Fund for supplementing gross foreign exchange needs. In addition, the IDB rescheduled its undisbursed loans, and in September 1979 approved loans for agricultural and industrial rehabilitation of US$61.5 million including US$25 million from the Venezuelan Trust Fund; cofinancing by the International Fund for Agricultural Development (IFAD) added US$12 million. USAID approved loans totalling US$88 million. The Central American Bank for Economic Integration (CABEI) rescheduled its outstanding loans, and made a new US$12.5 million loan to reactivate the program for the control of coffee leaf rust. The UNDP obtained supplementary resources, and its annual program now exceeds US$5 million. Grants were also forthcoming from the EEC and OPEC's Special Fund. A Bank mission visited Nicaragua in September 1979 to review the status of projects not yet fully implemented, and to develop with the new Government proposals for emergency lending to assist in the recovery effort. Disbursements on existing Bank loans and credits were resumed in October 1979 (as of October 31, 1979, a total of US$40.2 million remained to be disbursed). 1.09 After taking into account Government priorities for emergency rehabilitation and the assistance already planned by other external agencies, the Bank approved a loan and a credit totalling US$30 million for agricultural and industrial rehabilitation 1/ and a credit of US$22 million for urban reconstruction on December 19, 1979. The objective of the former project was to assist Government efforts to regain prewar levels of output, exports and 1/ Comprising an IBRD loan of US$10 million and an IDA Credit of US$20 million. - 3 - employment in the agricultural and industrial sectors. The focus of the agricultural component was mainly on medium-scale private operations and some of the larger new state farms. On the industrial side, financing was made available to assist in restoring the productive capacity of previously viable industrial enterprises that had sufferred damage to physical facilities and inventories during the period of conflict. The urban project focussed on reconstruction of municipal infrastructure and services, a credit program for small-scale commercial and productive enterprises, and rehabilitation of Managua's public transportation system. Implementing responsibility for the agricultural and industrial project and the small-scale enterprise component of the urban project rested primarily with the Fondo Especial de Desarrollo (FED), a second-tier lending institution attached to the Banco Nacional de Desarrollo (BND) and later transferred to the Corporacion Financiera de Nicaragua (CORFIN). FED was also the principal implementing agency for the IDB industrial and agricultural rehabilitation loans. 1.10 By year end 1980 the resources made available under the Agricultural and Industrial Rehabilitation Project had been fully committed to subprojects and to a large extent disbursed. This report appraises a proposed follow up loan for the rehabilitation of industry. In order to put the rehabilitation effort in perspective, the remainder of this chapter describes the development of Nicaraguan industry in the period prior to the war, outlines the effects of the war on the industrial sector and reviews the process of rehabilitation and recovery in the initial post-war period. B. Industrial Development in the 1960's and 1970's The Structure of Industry 1.11 Industry grew in real terms at 21% p.a. during the 1960's and its share in GDP rose from 15.6% in 1960 to 22.8% in 1970. 1/ The rapid growth of the industrial sector was fostered by two distinct developmental trends. The first was the rapidly expanding exports of processed agricultural products, of which sugar, cotton and livestock were by far the most important. The other was the creation of the Central American Common Market (CACM), which offered opportunities for substituting for imports within the region, parti- cularly in the production of intermediate goods such as chemicals and metal products. Of particular importance was the classification of the chemical industry as an "integration industry" assigned to Nicaragua. A chemical complex was established near Managua, including plants for producing caustic soda and chlorine, polyvinyl chloride and toxaphene, a basic ingredient for insecticides used in large quantities in Central America. Fabricated metal for construction, fencing, wire, nails, furniture and containers also developed as important industries based on the regional market. The growth of industry was less dynamic in the 1970's, averaging 7% p.a. between 1970-78. Although industrial growth had well exceeded overall GDP growth during the 1960's, during 1/ Banco Central de Nicaragua (BCN) - Indicadores Economicos 1979. the early and mid-1970's it exceeded it by a smaller margin, and by 1978 the industrial sector accounted for 25.2% of GDP. The chief reason for the slowing down in the rate of growth was the using up of import substitution opportunities within the regional market. 1.12 After 1960, significant changes occurred in the structure of manu- facturing value added (Table 1.1). The share of traditional light industries (mostly consumer goods such as food, beverages, tobacco, clothing and wood products) decreased from 89% in 1960 to 73% in 1970, whereas the share of intermediate industries increased from 11% of 27%. Between 1970 and 1978 the share of light industries in manufacturing value added decreased further to 71% and the intermediate's share grew to 29%. By the end of 1978, seven subsectors accounted for 83.4% of industrial value added (Table 1.1): food processing (37.1%), beverages (11.2%), chemical products (9.8%), textiles, clothing and shoes (9.1%), petroleum products (6.5%) , tobacco (5.1%) and non-metallic minerals (4.6%). Table 1.1: STRUCTURE OF MANUFACTURING VALUE ADDED (Percentages) 1960 1965 1970 1976 1978 1. Food Products 49.2 44.1 40.3 36.4 37.1 2. Beverages 8.! 8.8 7.7 9.1 11.2 3. Tobacco 8.7 5.4 4.8 5.0 5.1 4. Textiles 7.4 10.7 5.8 6.7 5.7 5. Clothing, Footwear 5.3 4.1 4.9 3.9 3.4 6. Leather 1.4 1.0 1.0 0.6 0.8 7. Wood Products S3 2.6 3.6 3.1 3.2 8. Furniture 1.0 1zi 1.3 0 C 0.8 9. Paper Products U. 0.9 1.1 1.6 1.3 10. Printing 2.4 2.5 2.6 2.6 1.6 11. Chemical Products 3.8 5.4 8.0 9.4 9.8 12. Petroleum Products - 1.2 3.1 3.7 6.5 13. Rubber 0.3 0.3 0.5 0.5 0.6 14. Non-metallic Minerals 3.3 3.5 5.0 5.6 4.6 15. Metal Products 2.2 5.9 5.3 6.7 3.7 16. Machinery and Electrical Applicances 0.2 0.2 1.5 1.7 1.7 17. Transportation Equipment 0.1 0.2 0.3 0.4 0.3 18. Other 1.0 2.1 3.2 2.1 2.6 Manufacturing 100.0 100.0 100.0 100.0 100.0 Source: BCN-Indicadores Economicos 1979. -5- Tariff Protection 1.13 The formation of the CACM was probably the most important factor shaping Nicaragua's industrial development in the sixties. The Common External Tariff (CET) schedule specifies low import tariffs on capital goods and raw materials and high tariffs (ranging from 49%-148%) on final consumer goods 1/. A "temporary" 30% surcharge on import duties was also established for 5 years in 1973 and again in 1978. Another major policy instrument was the Central American Agreement on Fiscal Incentives for Industrial Development (CAAFIID), which expanded on existing incentives of Nicaragua's 1958 Industrial Develop- ment Law (IDL). CAAFIID classified firms in three incentive categories according to type of product and raw materials used. This incentive struc- ture, together with the tariff barriers mentioned above, strongly favored the development of regional import-substituting intermediate goods industries and gave relatively little support to the development of exports (other than agroindustries) outside the CACM. 1.14 Some specific incentives for expansion of manufactured exports outside the CACM were created in the late 1970's but they were concentrated in enclave industries (firms exporting their total production and generally importing a large proportion of raw materials or semi-processed goods). Decree 332 of 1972 granted import tariff and tax exemptions to firms exporting their total production outside the Central American area, and a more recent step in the same direction was the decree of March 1976 regulating the estab- lishment of free zones. The first of these was developed near Managua's international airport. In 1977, a special Central Bank credit line was established, to finance non-traditional manufactured exports. 2/ The credit line operated through the commercial banks, financieras, and the Instituto de Fomento Industrial (INFONAC), providing short-term credit (up to 180 days) to finance 80% of the value of non-traditional exports. Export promotion activi- ties, particularly market research and technical assistance in exports, were begun by the Nicaraguan Center for Export Promotion (EXPORTEMOS), which was created in 1974. Mining and In4ustrial Exports 1.15 Mining exports have been important for many years, and largely involved gold, silver, copper and zinc. The growth of manufacturing exports has been more recent. Mining exports reached their peak in the 1940's and 1950's, when world prices for copper and zinc were favorable. Subsequently, base metal prices declined. However, in recent years the price of gold has risen sharply, and gold became Nicaragua's leading metal export. Annual exports of gold alone reached 65,000 ounces during the four years prior to the revolution. Largely as a result of (i) the creation of a protected regional market and (ii) increasing world demand for Nicaraguan agroindustrial 1/ For a fuller description of CACM policies for fostering intra-regional trade and industrial development, see IBRD Report No.23256-CA of September 29, 1980 entitled Central America: SpeFial Report on the Common Market. 2/ They included practically all manufactured products except beef and sugar. - 6 - products, exports of manufactured products increased from US$11.5 million in 1960 to US$274.1 million in 1978. Starting from a low base, annual export growth rates in excess of 25% were achieved in 8 of the 18 years covered by this period. The structure of manufactured exports also became more diversified during the same period, although intra-CACM trade provided decreasing scope for expansion into new products as the easiest import-substitution possibil- ities at the regional level were used up. In 1960 processed food represented 70% of the total, with wood products providing the remaining 30%. By 1978 processed food was still the largest export subsector (60%), but wood products accounted for only 5%. Other subsectors such as chemicals (16%), textiles (6%) and metal products (4%) were also important exporters. Within the processed food subsector, sugar and meat constituted nearly 60% of total exports and other important items were frozen shrimp, milk products, and cotton seed oil. The most important chemical exports were insecticides, caustic soda and PVC; exports of textiles involved mostly cotton cloth; most wood products exports were in the form of sawn wood and their manufacturing value added content was low. Export diversification occurred largely within the protected CACM and Nicaragua s manufactured exports to countries outside the CACM, which were 49% of total manufactured exports, showed a different composition than regional exports. In 1978, processed foods accounted for 91% of manufactured exports outside the CACM. The only other significant items were textiles, chemicals and wood products with 3% each of the total. Employment and Wages 1.16 By 1978 Nicaragua still had only a relatively small and unskilled industrial labor force of 79,000, and employment in mining was about 3,000. Manufacturing accounted for 10.6% of the economically active population, down from 11.6% in 1972 1/. A major short-term drop occurred as a result of the 1972 earthquake, when the economically active population in manufacturing fell from 67,717 to 58,726 persons. Employment quickly began to recover, but largely as a result of the overall slowdown in manufacturing growth, it only reached the 1972 level by the end of 1976. With an annual average population growth of about 3.5% during the last 10 years and a growing urban sector, Nicaragua faces the double challenge of providing enough jobs for its rapidly growing population and of fostering the types of skills required by these jobs. Compared with other CACM countries (except Honduras) the labor force in Nicaragua is probably less skilled, as a result of a low adult literacy rate and lack of vocational training facilities. Nevertheless, average daily labor costs (i.e. wages and other benefits) were slightly higher (1976 data) than those of other Central American countries, except for Costa Rica. 2/ 1/ BCN: Indicadores Economicos 1979. 2/ Costa Rica - US$3.37; Nicaragua - US$2.74; Guatemala - US$2.63; Honduras - US$2.45; El Salvador - US$2.17. - 7 - C. The War and Its Effects Decline in Output and Employment 1.17 In spite of political disturbances in 1978, industrial output and value-added actually managed a very small increase (less than 1%) in that year over the previous peak recorded in 1977. With the outbreak of full-scale conflict in June 1979, industrial production virtually ceased for almost two months and there was a strong contraction in domestic demand. Nevertheless, industrial output and value added (down for the year by 26% and 27%, respectively) did not show the sharper decline anticipated. The reason for the better than expected performance of the industrial sector was the performance of industrial exports. They actually increased 11% in 1978, and although they declined in 1979, they only declined by about one-half the rate that output declined. An analysis of changes in export volume for individual products, shows that in 1978, over one-half of major items exported had volume increases and that the rest suffered only relatively small reductions. Although in 1979 all goods except beef products had volume declines, processed farm products, which were mostly destined for the US and other non-CACM markets, declined very little overall, while most of the largest volume declines occurred in manufactured goods destined for the regional market. It seems clear that as the domestic situation deteriorated over 1977-79 industrialists increasingly began to seek to increase exports, especially outside the CACM, not only because the domestic economy had become unable to absorb its share of industrial output, but also because the proceeds of export sales could be held abroad as a hedge against economic collapse. 1.18 The physical and financial losses sustained during the period of armed conflict have continued to weigh heavily on the industrial sector. In the face of the fall in output, unemployment in industry rose sharply. Although many workers were being used in emergency repair or maintenance activities, by the end of 1979 it was estimated that one-quarter of the manufacturing labor force was without work. Many firms (particularly state enterprises) simply kept their workers on the payroll, while other firms were operating in short shifts or on alternating days. Physical Damage and Looting 1.19 Shortly after the cessation of fighting, several independent assessments were undertaken of the physical losses experienced by the industrial sector. Damage was most severe in the industrial area along the north highway in Managua where a number of plants were completely destroyed and many others suffered major damage. This zone contains the heaviest concentration of industry in Nicaragua. While the urban centers of Esteli, Matagalpa and Masaya all suffered heavy damage, the industrial plants in those and other areas experienced relatively less damage then those in Managua. 1.20 The current replacement cost of the damaged industrial facilities (buildings, machinery and equipment) was estimated at about US$50 million. A considerable proportion of this represented office buildings, storage, - 8 - warehouse and related facilities. The loss in productive facilities was therefore estimated at 5% to 10% of the book value of fixed assets for the entire sector. Many plants, which suffered no damage to production installations, experienced widespread stock losses, as a result of the looting of inventories of raw materials and finished products, and the value of inventory losses was estimated at US$60 million. A study by the Central Bank of 160 enterprises representing about 60% of the total gross value of manufac- turing output indicates that they experienced losses equivalent to some 28% of the value of their inventories as compared to damages equivalent to 9% of fixed assets. While 16% of the firms had damages in excess of 25% of the value of fixed assets, 44% experienced losses in excess of 25% of the value of their inventories. 1.21 A major constraint on firms seeking financing for rehabilitation of output was their weak financial situation as well as the lack of funds in the banking system. Financial and other records were destroyed, either as a result of physical destruction from the war or as a deliberate act by the former owners. Many factories which were able to undertake some produc- tion did not restore their inventories of finished products due to political uncertainty and because demand had stagnated due to loss of income. Industry also experienced serious losses of managerial and technical personnel. During the period of intense fighting, a relatively large share of trained profes- sionals and technicians left the country. While some have returned, many top managers of plants partly or wholly owned by former President Somoza or his associates have not. Although the country still has a fairly sizeable pool of executives, personnel losses have led to problems in restoring output in key subsectors. D. Post-War Reconstruction of Industry Initial Objectives and Expectations 1.22 One of the major objectives of the Government's 1980-81 Recovery Program was to restore the productive capacity of the economy. First priority was given to rehabilitating the agricultural sector in time for the Spring 1980 planting, by greatly expanding the area under cultivation. A second, but still urgent priority was to recover lost industrial output. In its immediate reconstruction efforts, the new Government established three main priorities for the agricultural and industrial sectors: (a) restore production, parti- cularly of foodstuffs; (b) generate employment; and (c) promote exports. Given the gradual restoration of transportation and communications, improved administration and the availability of international financial assistance, it was hoped that industrial output in 1980 would regain about 87% of the 1978 peak level. On the production side, this would require some progress to be made in rehabilitating damaged facilities and restoring lost inventories of spare parts and production inputs and in overcoming the problems caused by the losses of key managerial and technical personnel in many of the former Somoza- controlled enterprises. On the demand side, it was considered likely that, in the face of the large personal income losses sustained over 1978 and 1979, consumer purchases of other than absolute necessities would be kept at a - 9 - minimum. Exports, which were expected to play a major role in maintaining industrial activity and in generating urgently needed foreign exchange were expected to account for about one-third of the gross value of industrial output. The New State Sector 1.23 Based upon Decree No. 3 of July 19, 1979, which authorized the Procurador General de Justicia to proceed immediately to intervene in, requisition and confiscate "todos los bienes de la familia Somoza, militares y funcionarios que hubiesen abandonado el pais en Diciembre de 1977", the state acquired a large portion of the productive facilities of the nation. The state now owns the mining sector outright, and in industry, effectively controls (though majority ownership in major enterprises) the construction, wood processing, and metal-mechanics industries, and has important holdings in textiles, chemicals and agroindustry (particularly meat packing, cotton ginning, sugar refining and milling of basic grains). These sectors together represent about four-fifths of industrial value added, and, since the state now accounts for 31% of the gross value of industrial production, its role will be a major factor in the future development of Nicaraguan industry. It should be noted that these enterprises could hardly have been considered as purely private prior to the revolution. 1/ 1.24 Four state corporations have been established to control state industrial enterprises and three state corporations to control mining and fossil fuels. The largest industrial entity is the Corporacion Industrial del Pueblo (COIP) which is under the Ministry of Industry and has an equity share in enterprises in textiles, food processing, construction, chemicals, metal- mechanics, wood products and printing. A separate entity, Agroindustrias de Reforma Agraria (AGROINRA), was responsible for most state agroindustrial activity. This function is now being carried out by a new Directorate General of Production in the Ministry of Agricultural Development (MIDA). Managers of individual enterprises are now directly responsible to one of MIDA's 18 regional offices. In addition, the Corporacion Forestal del Pueblo (CORFOP), which is part of the Instituto Nicaraguense de Recursos Naturales y del Ambiente (IRENA) is responsible for the industrialization of wood products, and the Instituto Nicaraguense de Pesca (INPESCA) controls fish catching and processing. The Instituto de Minas e Hidrocarburos (INMINEH), controls mining of metals through Corporacion Nicaraguense de Desarrollo Minero (CONDEMINA), non-metallic minerals through Corporation de Minerales no Metalicos (COMNOMET) and petroleum refining through Empresa Nicaraguense del Petroleo (PETRONIC). 1.25 The marketing of certain agricultural products which represent an important part of agroindustrial processing is now the responsibility of the state. The purchase of producers' output, its sale to processors, and the 1/ Contrasting the new state industrial enterprises with their previous identity as private sector enterprises is misleading. Most of these enterprises were either owned outright by former President Somoza or by individuals or organizations that he controlled, at the same time that he was Nicaragua's head of state. - 10 - marketing of processors output is the responsibility of the Empresa Nicara- guense del Algodon (ENAL) for cotton, the Empresa Nicaraguense de la Carne (ENCAR) for meat, Empresa Nicaraguense del Azucar (ENAZUCAR) for sugar, Empresa Nicaraguense del CAFE (ENCAFE) for coffee, and the Empresa Nicara- guense de Alimentos Basicos (ENABAS) for basic grains. In addition, the Empresa Nicaraguense de Importaciones (ENIMPORT) is responsible for the imports required by the industrial sector and the Empresa Nicaraguense de Promociones de Exportacion (ENIPREX) for industrial exports. A decentralized agency, the Instituto Nicaraguense de Administracion Publica (INAP), has been established under MIPLAN with responsibility for systematizing the adminis- tration of public enterprises and for training public officials. 1.26 As of June 30, 1980 the state held a majority interest in 91 1/ industrial enterprises, of which 70 were managed by COIP. COIP's total shareholdings involved a total of 99 enterprises, including the 70 majority owned firms, a minority interest in 22 and intervention 2/ in 7 enterprises. In some cases where COIP has a minority interest, it is the largest share- holder, and therefore assumes a leading role in the firm's activities. COIP is headed by a director, who also has the title of Vice Minister of Industry. COIP is organized into five departments: management of enterprises, planning, finance, administration and industrial relations. Each of the enterprises in which COIP has shares have been grouped into subsectors (food processing, chemicals, textiles, construction materials, metal-mechanics, plastics, wood processing and paper and printing). Each of these subsectors has been estab- lished as an organizational unit (i.e. "complejo industrial") under the Department of Management of Enterprises, and has a coordinator, who is res- ponsible for integrating and directing the activities of the COIP enterprises in that particular subsector. In the cases in which COIP has a majority shareholding (and in some cases in which it is an exceptionally large minority shareholder), COIP appoints an administrator to manage the enterprise. One of COIP-s main problems has been finding administrators with sufficient experience at the enterprise level. COIP's subsectoral coordinators appear on the whole to be quite capable and knowledgeable about their areas of responsibility. Attitude of the Private Sector 1.27 The main organizations which act as spokesman for the private sector are the Consejo Superior del Sector Privado (COSEP) and the Camara de Industrias (CADIN). Both organizations have played leading roles in representing the interests of the private sector to the new Government. In 1/ COIP - 70; Ministry of Agriculture - 12, INPESCA - 8; CORFOP - 1 (does not include 6 sawmills, which CORFOP lists as forestry activity). 2/ The concept of "intervenir" does not appear to have a clear legal basis. What this has meant in practice is that in cases where the Government has not been able to clearly establish whether a case for transfer to state ownership (i.e. under Decree No. 3) exists, the Government aasumes control over an enterprise until such time as the situation is clarified. - 11 - the immediate post-war period, the attitude of the private sector was, on the whole, extremely cautious about proceeding with a full rehabilitation effort. Many Nicaraguan entrepreneurs were able to draw on their own resources to help finance the relatively low levels of output justified by the reduced purchasing power prevailing after the revolution. An additional factor was the private sector's reluctance to apply for loans from nationalized banks which were required to investigate the ownership of applicant firms - a requirement which was removed in April 1980. Also, lack of labor disci- pline, which affected both publicly and privately owned enterprises, resulted in plant takeovers and serious work stoppages. Under these circumstances, private industrialists were reluctant to reinvest the sums required to fully restore existing capacity. 1.28 During the past year, however, an improvement has been noted in the relationship between the public and private sectors. The Government seems to have laid to rest most fears regarding expropriation, and it has demonstrated its good faith in pursuing the concept of equal treatment for both public and private sector enterprises in the settlement of labor disputes and the allocation of credit, which are critical areas for restoring investor confidence. Nevertheless, private industrialists are still concerned about the end result of the revolutionary process, the sector's role in the longer term, and the Government's failure to define what is meant by its full support of the mixed-economy concept. As a result, while some industrialists are making substantial investments in rehabilitating their firms, many others have adopted a "wait and see" attitude until the Government takes a clearer position on the role of the private sector. The trend in the private sector so far has been that many very small businesses, which must produce to sur- vive, as well as some of the larger enterprises, which control major shares of their markets, have made concerted efforts to rehabilitate their enterprises, while many middle-sized companies have not done so. Industrial and Mining Sector Performance in 1980 1.29 A complete assessment of the industrial and mining sectors per- formance in 1980 is difficult to make at the present time, as data is not available on some performance criteria, and only mid-year statistics are available on others. Also the relative performance of the private and public sectors is difficult to determine, because little comparative data exists. Nevertheless, some judgements about overall performance can be made, based on subsectoral surveys carried out by the Bank, and partial data supplemented by discussions with the Ministry of Industry (MIND), MIDA, COIP, CORFIN, CONDEMINA, COSEP, CADIN and individual industrialists. 1.30 In spite of thp many difficulties which faced the industrial sector in its initial efforts of rehabilitation, it has managed to restore an important part of its lost output. MIPLAN has estimated that real industrial output for the year reached C$3.0 billion, or 78% of the 1978 level (87% was the target set by MIPLAN), which was equivalent to a 7.3% increase over 1979 output of C$2.8 billion. Major industries that were able to exceed 1978 output levels were beverages, tobacco, clothing, and rubber, petroleum and leather products. Subsectors that continued to show declines in real - 12 - output were food processing, textiles, wood products, chemicals, and metal mechanics. However, it should be noted that the subsectors showing a de- clining trend, are those with the greatest rehabilitation needs, as well as the greatest reliance on export markets, and that an increasing proportion of output was directed to the reviving domestic market because industrial exports fared badly overall in 1980. Unlike 1979, when the reduction in exports was relatively small (12%) in comparison with 1978, exports in 1980 showed a marked decline of 30% below 1978 levels (from US$274.1 million in 1978 to US$193.9 million in 1980). Rapidly increasing costs and the resulting over- valuation of the cordoba affected the competitiveness of Nicaraguan exports in the CACM market, where the worsening relationship with neighboring countries such as Guatemala and El Salvador resulted in a substantial decline in export sales. Nevertheless, some encouraging trends could be observed in 1980. Exports of sugar, meat and seafood, gold and silver performed well, and further export potential exists for these products once full rehabilitation is achieved. While regional exports were down 51% overall, some private exporters were successful in finding new markets for their products, both within and outside the CACM. 1.31 A clearer view of how the principal industrial subsectors performed in 1980 and of their problems and prospects for 1981 can be obtained from the Bank's survey of major subsectors. By far the most important of these is the agroindustrial sector, with meat processing (largely beef) the most important industry. Historically, about one-half of beef processing has been for the export market, but the large-scale slaughters and uncontrolled live cattle exports of recent years has severely reduced the overall herd size. Nicaragua's 7 export-oriented slaughterhouses (5 are government-owned) are presently operated at 40%-50% of installed capacity. Prospects for full rehabilitation of this industry and for increasing beef exports depend upon regeneration of the national herd. Since most cattle production is dual purpose (i.e., meat and milk), the herd reduction has affected milk production as well. Abou, 12% of total milk prodictior i1volVC. modern milk processing techniques, with 4 pasteurizing plants serving the Managua market and 1 powdered milk plant producing principally for export. Two of the Managua firms suffered equipment and working capital losses and their rehabilitation was financed under the first rehabilitation loan. One private sugar mill accounts for over one-half of the nation's refining capacity, while 5 state- owned plants make up the balance. The private mill was financed under the first rehabilitation loan and it is expected that the state-owned mills would be financed under the proposed project. This would boost overall annual output to almost 6 million quintals. Although the extremely rapid rise in the world price of sugar during 1980 cannot be sustained, and in fact has already begun to decline, prices are expected to remain favorable and would justify rehabilitating the other mills. 1.32 The rapid growth of the manufacturing sector has depended a great deal on the development of new intermediate industries such as the chemical industry, which includes firms producing pharmaceuticals, plastics, insecti- cides, adhesives, inorganic gases and liquids, soaps, matches and paints. Four-fifths of total output represents enterprises with state participation, and the rest are 100% private owned. With few exceptions, little physical - 13 - damage took place in the chemical subsector; however, substantial losses in working capital occurred. In 1978, exports of chemicals were second only to food and beverage exports, among manufactured exports, but by mid-1980, chemical exports had decreased by 35% over the same period in 1978. Full rehabilitation of the chemical subsector is an urgent necessity. However, several important firms in the sector have lost a significant portion of their regional market (principally in El Salvador and Guatemala) and, while some readjustments (increased exports to Costa Rica) have taken place, full reha- bilitation will entail developing new markets outside of the CACM. The textile industry includes 3 spinning and weaving mills, 2 weaving mills, 7 knitting plants and about 12 clothing manufacturers. The government has an equity participation in about two-thirds of these firms, of which one-third amounts to a majority ownership. The most important textile firms are two of the spinning and weaving mills which together have accounted for 100% of domestic spinning capacity and 80% of weaving capacity; however, one of these plants which was the main domestic supplier of thread and cloth to the rest of the industry, was severely damaged both prior to and during the revolution. As a result, knitting mills and clothing manufacturers have to import most of their inputs. Several other firms also incurred damage to installations and many firms were looted of moveable goods and liquid assets. The sector urgently requires rehabilitation, but serious questions remain as to how this ought to be carried out, particularly in spinning and weaving. The government is presently carrying out a sector study to resolve this issue (para. 3.24). Construction materials firms, many of which are almost wholly-owned by the state, suffered little physical damage but considerable working capital losses during the war. Only three firms (an aluminium extrusion plant and two plants producing PVC piping) produce for export, and all lost their main markets in El Salvador and Guatemala. Production of the 7 most important firms in the subsector during the first half of 1980 shows a decrease over the corresponding period in 1977 (latest comparative data), but this can be attributed to the slow recuperation of construction activity rather than to other factors. Metal-mechanics covers a wide range of product lines including structural steel shapes, reinforcing bars, nails, steel fencing, metal con- tainers and metal furniture. With few exceptions, metal-mechanics firms sufferred little physical damage during the war, but many incurred considerable working capital losses. Firms with state participation account for 75% of output and exports. During the first half of 1980 exports from metal-mechanic industries decreased by 61% over the same period in 1978, and there is need to search for new export markets outside the CACM. Studies financed by FINAPRI are currently underway to determine ways for rationalizing production in view of the changing market patterns. 1.33 The mining sector in Nicaragua includes both metallic and non- metallic mineral mining. The former has involved the mining of gold, silver, zinc, copper and lead; the latter, limestone, gypsum, kaolin and bentonite. Five gold and silver mines account for 90% of total output of metals. A partial rehabilitation of Nicaragua's largest producing mine (30% of gold and 25% of silver output) is being financed under the first rehabilitation loan. In the non-metallic minerals field, three enterprises produce about 7 million kg. of limestone annually for use in construction and manufacturing. Another firm mines about 30 million kg. of gypsum per year for use in the cement and wood products industries. A fifth firm produces about 1 million tons of - 14 - bentonite and kaolin, which are used in the manufacture of detergents and ceramics, respectively. Not only did production of precious metals drop prior to and during the revolution but substantial losses were incurred in working capital and equipment. Most mining of metals was carried out by foreigners, and after the revolution, the mining sector was nationalized and INMINEH and its 3 state corporations (CONDEMINA, COMNOMET and PETRONIC) were established to conserve, control and develop the nation's mineral and hydro- carbon resources. Metallic minerals have been particularly important for their export potential, and by 1976 the value of gold and zinc exports were about equal. The production of zinc dropped drastically thereafter, in line with a decline in the world price, but the rapid rise in world prices for gold and silver since 1978 have led to a sharp rise in exports of these metals, in spite of a drop in production in 1979 to about 60% of the 1978 level. Although a substantial recovery began in 1980 (production was 82% of the 1978 level), and overall, metal export revenues rose from 1.5% of total export revenues in 1975 to about 8.0% in 1980, this sector still requires extensive rehabilitation if it is to increase its contribution to Nicaragua's export performance. 1.34 About one-third of industrial output was produced by the state industrial sector in 1980, mostly by enterprises under the direction of COIP. During the first half of 1980, COIP had to devote a good deal of effort to the reorganization of the new state enterprises. Fourteen additional enterprises were placed under its administration and 12 firms were transferred to the jurisdiction of other state management companies (mostly sawmills to CORFOP and food processing plants to AGROINRA). In addition, operations were begun in 16 enterprises that had closed their plants (after which COIP still controlled 12 enterprises which were not operating). By mid-year, 58 enterprises were able to provide COIP with information on their operating results. Thirty of these enterprises showed a profit, while 28 did not; just 8 of 48 firms reporting surpassed 1977 mid-year production levels. However, many of these firms were not producing at mid-year at the levels which they expected to by the end of the year and thus their performance was understated on an annual basis. 1.35 A MIND survey of 163 firms provides the only comparable data for private and public enterprises, since it includes 84 firms which have majority or 100% state ownership, and 79 which are wholly or majority owned by the private sector. Of the total number, 41 are mixed enterprises with both private and public shareholders. Since the enterprises surveyed are said to account for 60% of manufacturing output and 45% of employment, they represent a significant sample of the industrial sector, particularly for making com- parisons between private and state-owned enterprises. Survey data indicates that in 1980, the 79 firms with majority private ownership, accounted for 68% of output, 53% of exports, but only 44% of employment, while the 84 majority- owned public enterprises achieved only 32% of total output, 47% of exports but fully 56% of employment. The 41 mixed enterprises accounted for 27% of output, 23% of exports and 25% of employment. The sharpest contrast occurs between firms that are 100% owned by the state or by private individuals, with the former contributing more to employment than to output, while the reverse was true of the latter. - 15 - 1.36 CORFIN data for the first semester of 1980 shows that C$1.1 million or 22% of total credit granted of C$5.1 million during the period was destined for the industrial sector. Just over one-half of this amount (C$604,000) was lent to the private sector, with the balance (C$521,000) going to state enterprises. About 85% of the loans were for working capital. Preliminary year-end data from MIND indicates that as credit resources became scarce in the second half of 1980 there was a sharp decline in new loans granted to industry, which amounted to only about one-half (C$500 million) the amount lent to industry in the first semester. Some 80% of these loans were also for working capital. The emphasis on working capital financing would appear to reflect the scarcity of long-term funds and the need to replenish depleted inventories and other inputs, rather than a lack of interest in replacing or repairing fixed assets. This is borne out by the Bank's experience under the first rehabilitation project. Nineteen subprojects with a total project cost of US$12 million, received Bank financing amounting to US$8 million. Contrary to the Bank's initial expectations, almost 60% of the total project cost was for the financing of fixed assets. 1.37 The performance of COIP as well as the MIND survey data point to significant differences between the state and private industry in the early post-war period. Most publicly owned firms had lost their trained staff, and were financially insolvent. Some had ceased to function altogether and many others were operating at very low levels of capacity. Therefore, the Government's concern at the operating level was to get them operating and keep their work-forces employed. At the same time, the Government had to simultaneously organize the administration and management of a large number of enterprises. This task included the establishment of sectoral and subsectoral objectives and priorities, coordination both between and within subsectors, and with management of individual enterprises, as well as establishing a structure to provide overall policy direction and management guidance to state enterprises. To achieve production and employment targets set by MIPLAN, many COIP enterprises focussed on immediate short-term goals of commencing or increasing operations. In addition, the Government had taken a policy decision to maintain the payrolls of firms, even though they were not operating, or operating at very low levels of capacity. Consequently, state enterprises were able to maintain a high level of employment, but their productivity was lower overall than most privately owned firms. 1.38 The above data indicate that the recovery of the industrial sector in 1980 took place largely in those sub-sectors that have the least rehabilitation needs. The main reasons why rehabilitation did not keep pace with the revival in domestic demand were: (i) the generally cautious response of the private sector because of political and economic uncertainties; (ii) the need for the state to restructure the management of the enterprises under its control, and to resolve the serious operating problems of these enterprises, many of which had ceased to function; (iii) difficulties for both private and public enterprises in preparing projects, particularly in light of shortage of inputs and replacement parts, loss of markets, lack of trained technicians and workers and decapitalization of enterprises (the latter two especially for state-owned enterprises); and (iv) market uncertainties faced by some firms, particularly those exporting to the regional market. - 16 - 1.39 Clearly, much of the task of industrial rehabilitation remains to be carried out. Industrial sector data do not include primary processing of forest products (timber extraction and sawmilling), which is important to the nation's export performance, but in which the rehabilitation process is only just beginning. In agroindustry, major rehabilitation investments still need to be made in state-owned sugar mills, in the beef, 1/ poultry, fishing and animal feeds industries, in milling of basic grains and in food processing. The chemical-pharmaceutical industry still remains largely unrehabilitated because of the decline in regional export possibilities, and sizeable rehab- ilitation investments remain to be made in the metal-mechanics, metal and wood products and textile industries. The Mining sector requires extensive reha- bilitation, particularly in the metallic minerals subsector, involving financial as well as technical assistance. Almost all of these sub-sectors have an important export potential. Overall, the investment required to accomplish these rehabilitation tasks could exceed US$100 million. II. THE FINANCIAL SYSTEM A. The Financial System Prior to the War The Structure of the Financial System 2.01 Prior to the war, Nicaragua's banking system included a mixture of public and private commercial banks and specialized financial institutions (Table 2.1) regulated by the Central Bank, Banco Central de Nicaragua (BCN), and monitored by the Superintendencia de Bancos y de Otras Instituciones (SBOI). Government institutions, which accounted for 50% of the financial systems' total assets in 1978, included Instituto de Fomento Nacional (INFONAC), a development bank; the Banco de la Vivienda de Nicaragua (BAVINIC), a housing bank; Banco Nacional de Nicaragua (BANANIC), a commercial bank; and two specialized credit institutions, Banco de Credito Popular (BCP) and Instituto de Bienestar Campesino (INVIERNO), which provided credit assistance to small- scale commercial and industrial enterprises and small farmers, respectively. Private institutions, including seven commercial banks, six finance companies and six financial warehouses, together accounted for 50% of total assets. The private commercial banks held 31% of the intermediaries' assets in 1978, the financieras 12% and the balance (7%) was held by financial warehouses and insurance companies. Despite the diversity of institutions, two competing private banks 2/ controlled approximately three-fourths of the total assets of private financial institutions; thus the Government and these two private groups were the dominant forces in the financial system. 1/ Rehabilitation of the beef processing industry is dependent upon restoring the depleted herd, and can only be achieved over the longer term. 2/ Banco de Nicaragua and Banco de America. - 17 - 1/ Table 2.1: TOTAL ASSETS OF FINANCIAL INTERMEDIARIES- (0$ million) 1975 1976 1977 1978 1979 Intermediaries C$ % C$ % C$ % C$ % C$ % Commercial Banks 3,916 54 4,323 52 5,050 52 5,450 54 7,974 80 BANANIC-2 1,895 26 1,852 22 2,139 22 2,340 23 3,937 40 Private Banks 2,021 28 2,471 30 2,911 30 3,110 31 4,037 40 INFONAC- 1,075 15 1,127 14 1,150 12 1,173 12 - - Private Financieras 722 10 958 12 1,314 14 1,257 12 1,157 12 3/ BAVINIC- 1,136 15 1,353 16 1,412 15 1,280 13 - - Financial Warehouses 75 1 110 1 141 1 150 1 157 2 Insurance Companies 288 4 361 4 446 4 585 6 574 5 Specialized Credit Institutions 53 1 115 1 158 2 166 2 87 1 Total 7,265 100 8,347 100 9,671 100 10,061 100 9,949 100 Source: Superintendencia de Bancos de Otras Instituciones. 1/ Private savings and loan associations are not included. 2/ BANANIC and INFONAC merged in 1979 to form Banco Nacional de Desarrollo (BND). 3/ No 1979 data available; absorbed in that year by the new Ministry of Housing. 4/ BCP and INVIERNO. - 18 - 2.02 The three major public institutions (BANANIC, INFONAC, and BAVINIC) controlled 48% of the assets of the financial system in 1978 (Table 2.1) and had accounted for an even larger share of these assets in previous years (56% in 1975). While INFONAC's share of financial institution assets was reduced from 15% to 12% during 1975-78, the private financieras increased their share from 12% to 14% between 1975-77. BAVINIC also had its portion reduced, from 16% to 13%, while the commercial banks share remained stable at 54%. The government-owned BANANIC was the largest commercial bank, holding 43% of total commercial bank assets in 1978. All other commercial banks were privately owned, including three branches of foreign institutions, which together represented about 10% of the commercial bank's consolidated assets; domestic commercial banks held the balance of 47%. 2.03 While the commercial banks, the financieras and INFONAC were multi- purpose intermediaries, the sector composition and term characteristics of their portfolios reveal different degrees of specialization (Table 2.2). BANANIC concentrated relatively more on agriculture and livestock loans (47% of its portfolio in March 1977) and private banks on commerce and industry (24% and 33% of portfolio, respectively). The lending of INFONAC and the financieras was even more largely oriented to the industrial sector (67% and 42% of their portfolios) and to medium and long-term operations. Table 2.2: COMPARATIVE LOAN PORTFOLIOS, MARCH 31, 1977 (Percentages) Sector BANANIC Private Banks INFONAC Financieras Commerce 8.5 24.4 - 19.2 Consumers 0.3 7.5 - 4.3 Agriculture 27.3 11.9 17.3 16.8 Livestock 19.5 13.3 8.2 9.7 Industry 24.3 33.4 66.8 41.9 Other 20.1 9.5 7.7 8.1 Total 100.0 100.0 100.0 100.0 Source: Superintendencia de Bancos y de Otras Instituciones. Monetary Policy 2.04 The government, through BCN, followed an active monetary policy in the 1960's and 1970's, in which BCN played a major role in raising and channeling resources for activities considered of priority by the govern- ment. BCN had traditionally extended seasonal rediscount financing for major cash crops, but after the mid-1960's it became increasingly involved in longer-term financing to assist in the expansion and diversification of agricultural production and the promotion of industry. In 1972, BCN took a step forward in establishing a firm institutional and financial structure for the channeling of its developmental resources by the establishing of a - 19 - BCN-managed fund, the Fondo Especial de Desarrollo (FED). Following the December 1972 earthquake, BCN established specialized rediscount facilities to assist in earthquake reconstruction and accelerate the recuperation of the economy. At the same time, some attempt was made to regulate overall credit expansion by raising reserve requirements for the first time in 9 years. These requirements were not strictly enforced and a strong expansion of credit occurred, particularly in 1974. BANANIC continued to suffer from portfolio and liquidity problems 1/ arising from losses on its large agricultural portfolio, and most of the incremental credit growth financed by foreign banks and BCN rediscounts went to INFONAC and BAVINIC. This was accompanied by a shift in the destination of credit, with agriculture's share (BANANIC was the principal agricultural lender) reduced from 44% to 34% during 1970-74, while housing and construction grew from 10% to 18%. Manufacturing remained con- stant at 26%. In the mid-1970's there was a continued strong expansion of credit to state enterprises, much of which was financed by foreign commercial bank loans, and foreign loans were also used to cover central government budgetary deficits. This trend continued right up to the revolution and was accompanied in the late 1970's by a massive capital flight and withdrawal of savings from the financial system, as the political situation deteriorated. Consequently, more and more financing had to be provided by BCN and foreign borrowings. 2.05 As the situation became increasingly unstable, many borrowers did not repay outstanding loans and the arrears of the financial system as a whole actually increased at the same rate as outstanding loan portfolio from mid-1977 to mid-1979. In October 1978, the government made the first major change in the structure of interest rates since 1970. All ceilings were removed, in an apparent attempt to keep or bring back some of the funds that were rapidly flowing out of the banking system. As debt maturities shortened, the financial burden on the government became increasingly severe, while revenues remained stagnant and the public sector deficit widened. Pressure on BCN to increase its financing role increased. By early 1979, the economy was on the edge of disaster. Financially, it was almost illiquid 2/ and in April 1979, the Cordoba was devalued from C$7 to C$10 to the US dollar. In May 1979, the IMF approved a stand-by arrangement of SDR 34 million to provide the government with balance of payments support. It was not possible to determine the effect of these measures, as the onslaught of large scale fighting in June led to a virtual stoppage of all economic and financial activity. 1! BANANIC's share of total commercial bank credit to the private sector was reduced from about 70% to about 50% in 1974. 2/ Nicaragua was in default on current payments of its external debt. - 20 - B. The Post-War Financial System The Banking System 2.06 The new government that took office in 1979 had to deal with a financial system that was bankrupt. Liquid assets had disappeared. Pro- gressive transfers of assets had left banks decapitalized. They could not repay their own debts because of losses from uncollectable loans to borrowers who faced bankruptcy because of destroyed or looted assets or who had departed the country. To prevent a total collapse of the financial system, the new Government nationalized private domestic financial institutions, named new managers to replace those who had left the country and provided some liquidity support through BCN to keep them in operation. The Banking Superintendent ordered detailed internal audits of all institutions, including an assessment of the quality of all outstanding loans. This effort was complicated by the recent expansion of the public sector, since many new state-owned firms owed large sums to state-owned banks which, in turn, owned large sums to foreign creditors. In late 1979, BCN undertook studies to determine how the banking system could be restructured and recapitalized. As a result of these studies, a number of changes took place. The first of these involved the merger of BANANIC and INFONAC to form a single successor development organization: the Banco Nacional de Desarrollo (BND). 2.07 Despite the many serious problems which confronted Nicaragua's financial system immediately after the war, it also displayed some strengths which facilitated the task of rehabilitation. The public's confidence in the -,,stem was partially restored within a short time, resulting in a reversal of reposit outflows beginning in mid-August 1979. This restoration of confidence was fostered by the strong government commitment to support the banking system and restore its financial soundness. Moreover, individual institutions retained sufficient experienced and well trained professional staff to enable them to continue to function reasonably well, despite changes in top manage- ment. 2.08 In June 17, 1980, a complete reorganization of the structure of the banking system was announced. The total number of financial institu- tions was reduced from 17 to 5 through a series of mergers: (i) Banco de America (BAMER) absorbed Banco del Exterior, Financiera de Occidente, S.A., Financiera del Norte, S.A., and Financiera Industrial Agropecuaria; (ii) Banco de Nicaragua (BANIC) absorbed Interfinanciera, Banco de Centro- america, Corporacion Franco-Americana de Finanzas, Inversiones Nicaraguense de Desarrollo, S.A. and Corporacion Nicaraguense de Inversiones: (iii) Banco Nacional de Desarrollo (BND), which had resulted from the merger of BANANIC and INFONAC in 1979, and had absorbed Banco Calley Dagnall in early 1980, remained as it is; (iv) Banco de Credito Popular (BCP) also remained un- changed 1/; (v) a new mortgage bank, Banco Inmobiliario (BIN) was created through the integration of three mortgage banks: Financiera Inmobiliario, Centroamericana de Ahorro y Prestamo, S.A., and Nicaraguense de khorro y 1/ Except for its name which was subsequently changed to Banco Popular (BP). - 21 - Prestamo, S.A. The Government's stated objective in creating the new structure was to minimize the cost of maintaining separate institutions serving the same clientele, pursue a policy of decentralization which would do away with the clustering of branches in major urban areas, enable better coordination at the national level of institutions with clearly separate objectives and, more importantly, increase public confidence in the banking system by limiting it to a few well-established institutions fully backed by the Government. The entire system was placed under the direction of the newly-created CORFIN, which acts as a holding company for the five banks, providing overall direc- tion in the implementation of the government's monetary policy and ensuring overall consistency of banking practices throughout the system. Although initially the FED was placed under BND, it was subsequently made directly responsible to CORFIN. The organizational structure of the new banking system is shown in Annex 1. 2.09 Following the restructuring of the financial system 1/, BND became the largest bank in the system holding 57% of total commercial bank assets and 50% of the total assets of the financial system. BAMER and BANIC accounted for 43% of the assets of the banking system and 38% of the financial systems' assets. The remaining two institutions of the financial system, BIN and BP specialize in mortgage and small scale enterprise lending, respectively, and account for just 12% of financial system assets. The portfolio composition and term composition of the new intermediaries reveals some specialization. BND maintains about 51% of its lending in agriculture and livestock and about 24% in the industrial sector, BANIC's and BAMER's portfolios are quite similar with each maintaining about 20% in both commerce and agriculture, 7% and 9% in livestock and 40% and 47% in industry. About 55% of BANIC's total lending and 78% of BAMER's is for short-term operations of less than 18 months. With the exception of BND, which provided 43% of its lending to the public sector, the portfolio of the remaining four intermediaries was almost all concentrated in the private sector. In line with the government's stated policy of increasing specialization among banks, the government has also required commercial banks to direct their financing of publicly-owned industrial enterprises to assigned subsectors as follows: BND-chemicals, plastics and metal-mechanics; BAMER-food processing, paper and wood products; BANIC-textiles and construc- tion. Monetary Policy 2.10 The new government has pursued a monetary policy based upon two elements: interest rates and credit controls. Shortly after the revolution, interest ceilings were reimposed, with slightly higher rates for productive lending, substantially higher rates for lending to commerce and slightly reduced rates for export financing. On January 30, 1980 a new rate structure was adopted, based on the priority ranking of the activity to be financed. Depending upon end-use, rates of 14-17% were applicable to short-term loans and 12-15% for long-term loans (over 18-months). Enterprises which had suffered losses during the revolution of more than 35% of fixed assets could receive loans of up to 10 years; enterprises that had not, were limited to a 6-year term. Outstanding credit increased by one-fourth during the first 1/ Data as of June 30, 1980. - 22 - 6 months of 1980. Short-term credit increased the most (31%), while long-term credit only increased 17%. Due to the necessity to finance the critical 1980-81 crop year, and to provide a capital structure for several new state- owned commercial enterprises (para 1.25), much of the incremental credit resources were directed to these purposes. Preliminary year-end data showed less of a concentration of resources, but two-thirds of incremental credit had been directed to the public sector. 2.11 The Government intends to keep interest rates in the near future in line with inflationary trends in the economy, and to gradually raise rates to a positive level. As a first step, a general increase in interest rates took place on April 1, 1981, and the priority ranking system was dropped in favor of rates tied to credit end-use. Rates for industry and mining were raised overall to 17% (loans over 18 months) and 18% (loans up to 18 months), and rates for special programs such as export promotion were raised to 15%. However, the rate for small-scale industrial enterprises (i.e. with fixed assets of US$40,000 equivalent or less) remained unchanged at 12%. Since the Government expects that the level of inflation can be reduced to 20% by 1982, 1/ and lower thereafter, such rates (except for small-scale) should prove positive over the average life of investment subprojects. 2.12 The major issue facing the banking system in 1981 is the lack of credit availability. The capacity of the banking system to mobilize additional domestic savings is limited and the Government, which recently negotiated a rescheduling of its entire foreign banking liabilities, has been unable to obtain new foreign banking credits. Unless adequate external support is provided by foreign institutional lenders, the Government has little choice other than severe credit rationing. Consequently, Bank financing will be critical, if the country is to meet the urgent financial needs of the in- dustrial sector in 1981. III. THE PROJECT A. The First Agricultural and Industrial Rehabilitation Project 3.01 The objectives of the first rehabilitation project were to assist Government efforts to regain pre-war levels of output, exports and employment in the agricultural and industrial sectors. The US$15 million industrial component of the project, together with US$30 million provided by IDB, was designed to assist the government in its initial reconstruction efforts in the industrial sector. The US$15 million agricultural component, which financed the reactivation of crop and livestock production, was complemented by IDB/IFAD financing of US$43.5 million and a USAID loan of US$10.5 million. The project was appraised in September 1979, approved by the Bank's Board on December 18, 1979, and became effective on January 25, 1980. 3.02 Primary responsibility for channelling the Bank and local counter- part resources for sound rehabilitation projects rested with the FED, which was responsible for reviewing all subproject appraisals submitted by financial intermediaries (BND, BANIC, BAMER). Subprojects requiring Bank financing in excess of US$500,000 had to be sent to the Bank for prior approval. The 1/ The inflation rate dropped from 70% in 1979 to 35% in 1980, and is Dresentlv at an annual rate of about 25%. - 23 - utilization of the industrial component was slower than anticipated and, due to the more immediate needs of the agricultural sector, US$7 million of the US$15 million industrial allocation was reallocated to the agricultural component. The remaining US$8 million has been fully committed by the Bank. Nineteen subprojects were financed, with an average subloan size of US$350,000, of which 4 were over the free limit of US$500,000. The industries assisted included sugar refining, cotton ginning, milk processing, gold mining, shoe making, beverage production, and manufacturing of construction materials and metal products. About 60% of FED financing was for public sector projects and about 40% for private enterprises. BND was responsible for channelling 45% of loan funds, while BAMER committed 36% of the loan and BANIC 19%. 3.03 The slower utilization of the industrial component was due to the fact that unlike crop financing, which must follow a relatively rigid timetable related to the planting of crops at specified times in relation to seasonal and climatic conditions, industrial projects require considerably more lead time in preparation, since a decision to restore prior productive capacity must deal with what facilities to repair, replace or simply not reactivate and these decisions depend on the availability of inputs, replace- ment parts and equipment, reestablishing of a market for the firm's products, the replacement of key technical and managerial personnel, and the renegotia- tion of existing debt. Many firms have by now managed to resolve some or all of these basic issues, and are in a position to proceed with a full rehabi- litation effort. A considerable pipeline of reconstruction projects has now built up as described in paragraph 3.18. B. The Second Industrial Rehabilitation Credit Project Objectives 3.04 The proposed project would continue to assist the Government in its efforts to regain pre-war levels of output, exports and employment in the industrial sector, and would involve the rehabilitation of industries which suffered damage directly attributable to the revolution or to the events which culminated in the war. The proceeds of the loan would be made available to productive industrial enterprises in the public and private sectors, to finance the inputs, repair parts, machinery replacements and/or modifications and related civil works and services, which would enable such enterprises to restore their productive capacity. At least one-half of the loan would be allocated to enterprises whose rehabilitation would result in increased exports. The FED would be the main implementing agency for the project, and would provide financing for rehabilitation subloans made to industrial firms by BAMER, BANIC, BND, BP and BIN. The project would include a technical assistance and training component to assist FED, the financial intermediaries and beneficiaries to upgrade their project preparation, appraisal and super- vision capability, as well as technical assistance to the state industrial, mining and export promotion corporations, and the state's public administration - 24 - institute, to strengthen the enterprises under their control, or to resolve specific technical, administrative and accounting problems. The Need for Additional Rehabilitation Assistance 3.05 Under the first project, an assessment was made of rehabilitation needs based on broad categories (i.e. equipment repair and replacement, rebuilding inventories, and raw material stocks), derived from immediate post-war estimates of damage and looting. For the proposed project, more precise criteria are utilized, involving an assessment of the financial needs of firms comprising the FED's "pipeline" of pending subprojects (Annex 4, T-3), supplemented by data received from state institutions con- trolling important segments of industrial production and from individual firms, both public and private. This analysis was concentrated on five industrial subsectors and the mining sector, which comprise about four-fifths of manufacturing and 100% of mining value added. Brief profiles of the subsectors reviewed for this estimate are presented in Annex 5. 3.06 Based on a commitment period of 18 months and a disbursement period of 30 months, the need for external financing is estimated at about US$50 million, out of an estimated total cost of about US$68 million. This estimate includes no new investment in capacity expansion and is limited to rehabilitation needs. Except for a possible loan of US$16.5 million from IDB for financing agricultural production and agroindustrial subprojects not included in the above estimate, no external resources are expected to be available for the rehabilitation of the industrial sector, other than the proposed Bank loan. In view of the severe shortage of foreign exchange resources available to the Government, the rehabilitation of many firms depends largely on the availability of Bank financing. The most critical rehabilitation need involves those enterprises which can produce export earnings, particularly in mining, sugar refining, metal products and chemical-pharmaceutical products. The proposed project would, therefore, focus on the financing of such enterprises and related technical assistance (para. 3.08). Eligible Enterprises 3.07 Under the first project, eligible industrial enterprises included those in the manufacturing, mining, agroindustrial, construction and construc- tion materials subsectors, of either public or private ownership, which previously were financially viable, are presently adequately capitalized and whose need for rehabilitation is a direct result of the armed conflict. However, two elements in this definition of eligibility have limited the number of firms which could be assisted under the first loan. One is the requirement that the restoration of previously existing productive capacity be limited to enterprises which have previously been financially viable. The past financial viability of many enterprises--especially in the case of state-owned firms-is often difficult to establish. Financial and other records have been destroyed, either as a result of physical destruction resulting from the war or as a deliberate act by the former owners. The other - 25 - requirement is that a specific plan for the recapitalization of an enterprise would need to be submitted in each case where total outstanding debt exceeded 90% of the real value of total assets. The establishing of the real value of assets is a difficult problem for many firms and sorting out the relationship between asset value, outstanding debt service and paid-in capital is extremely complex and made even more difficult since it is linked to the renegotiation of existing debt by the state banking system. Firms have been asked to submit proposals for debt restructuring by CORFIN, but this is a lengthy process which cannot be resolved in the short term. Under the circumstances, it is unrealistic to insist on financial covenants which many enterprises in need of rehabilitation cannot meet. Under the proposed loan, the critical factor in establishing eligibility of an enterprise would be the future viability of the enterprises; i.e. whether a particular enterprise has the potential for success, given the required resources and provided that its existing debt burden can be satisfactorily restructured. Because of the uncertainties involved, the assessment of such potential would need to be more rigorous than was the case under the first project and revised subproject appraisal standards have been agreed upon (para. 3.12). Technical Assistance 3.08 The proposed project contains a crucial technical assistance compo- nent which would (i) assist CONDEMINA to obtain the foreign assistance it needs to fully rehabilitate and operate Nicaragua's major mines, as well as to determine the future potential for development of the mining sector; (ii) provide assistance to COIP to resolve technical and cost accounting problems in the metal-mechanics, food processing and pharmaceuticals subsectors; (iii) strengthen the capacity of FED, financial intermediaries and beneficiaries to strengthen their capability to prepare, appraise and supervise subprojects; (iv) assist INAP in developing an accounting system for public enterprises; (v) help ENIPREX to provide assistance in export promotion to industrial enter- prises; and (vi) provide scholarships to train local staff in specific technical disciplines (i.e. mining geology and engineering, metallurgy, hydrology, food technology, public administration of state enterprises). This technical assistance package, which is described in detail in Annex 6, is considered to be an essential part of the assistance needed to achieve full rehabilitation of the industrial and mining sectors. FED would be the executing agency for this component, and would be assisted by Financiera de Preinversion (FINAPRI), which was established in September 1980 to finance, administer and obtain the technical assistance required to implement preinvestment studies necessary for the future rehabilitation and development of the Nicaraguan economy. FINAPRI would assist the beneficiaries of technical assistance in preparation of detailed work programs, terms of reference and prequalification and selection of consultants. Final versions of terms of reference and consultants' contracts would need to be approved by the Bank. FINAPRI would also be responsible for monitoring the progress of this assistance, as well as overall supervision of each technical assistance contract, and would work closely with FED and Bank supervision missions in this task. FINAPRI is the beneficiary of the Asso- ciation's Preinvestment Fund Project, which was approved by the Association's Board on December 18, 1980. - 26 - C. Institutional Structure Executing Agency 3.09 Background. Both the industrial and agricultural components of the Agricultural and Industrial Rehabilitation Project are being administered by the FED, which was established by Decree No. 323 of April 12, 1972 as a Government fund, administered on behalf of the Government by BCN. The FED's main objectives are to channel foreign and domestic resources to development projects through loans to financial intermediaries, primarily for agricultural, agroindustrial, industrial, tourism and pre-investment activities. The FED's lending operations commenced in 1973 with three programs: agriculture and livestock development (partially financed under Loan 954-NI); development of agroindustrial and construction materials industries (both largely financed by IDB). A small-scale enterprise program was established at the end of 1975. Prior to the outbreak of civil war, the Bank had appraised a Development Banking Project and a Second Agricultural Credit Project, and had recommended channelling part of both proposed loans through the FED. FED's operating capabilities were not materially affected by the events of 1978-79 and, under the new Government, control of the FED was shifted from BCN to the recently established BND. Following the reorga- nization of the financial system in June 1980, the newly established CORFIN became responsible for the administration of FED. 3.10 Organization and Staff. The FED is headed by an executive director who was orginally responsible to BCN's Board of Directors. When the FED was transferred to BND after the revolution, the latter's Board assumed that function. Under the present system, all FED subprojects must be reviewed by the Government's Ad-Hoc Committee on Investments, which is an inter-ministerial group comprised of the Ministers of Planning and Industry, the Director of the Fondo Internacional para la Reconstruccion de Nicaragua (FIR), the Vice Minister in charge of COIP, the Director of FINAPRI and the Executive Director of the FED. This committee provides an initial screening of investment projects, taking into account sectoral priorities, domestic and foreign financing constraints and processing capabilities of the institutions concerned. Projects which pass this screening are then reviewed in detail by the FED, and submitted to FED's Credit Committee for approval. The Committee is made up of FED's executive director and its department directors. FED's organization chart is contained in Annex 2. 3.11 In managing the FED's day-to-day operations, its executive director is assisted by three directors, in charge of agricultural development (ADP), industrial development (IDP) and small-scale enterprise development (SSED). Each of these areas has its own staff, and although FED was fortunate enough to retain many of its staff members following the civil war, it has also had to strengthen its staff in order to deal with the requirements of the - 27 - rehabilitation effort. While existing staff of 5 1/ professionals in the IDP has been adequate in both numbers and quality for the present level of oper- ations, the planned increases in the volume of operations will require hiring additional professional staff. The FED will receive technical assistance in upgrading the IDP's overall capability in appraisal and supervision of sub- projects. Agreement was reached during negotiations on a timetable for hiring a deputy director and one financial analyst for the IDP. 3.12 Appraisal and Supervision. Under the proposed loan, the FED would need to pay particular attention to strengthening further its capabilities in the preparation and review of subproject appraisals. Appraisals would need to evaluate fully the technical, managerial and financial feasibility of rehabilitating an enterprise. A thorough analysis would be undertaken of the future prospects of each individual firm, taking into account its prospects for marketing its expanded output, potential for exports and foreign exchange earnings/savings, and its ability to adequately service its debt. During negotiations, agreement was reached on guidelines for appraisal and supervision for both the FED and financial institutions participating under the project, to enable them to adequately carry out these functions. These guidelines have been approved by the FED's Executive Director. 3.13 Although financial intermediaries would need to work closely with potential beneficiaries in the preparation of appraisals and ongoing supervi- sion of subprojects, and would bear the credit risk, the FED would have ultimate responsibility for the quality of appraisals and the effectiveness of supervision. The subsidiary loan agreements between the FED and the intermediaries would specify the latter's appraisal and supervision respon- sibilities in detail, as well as their reporting requirements and would include the FED's right to request additional subproject information and to make field inspections. During negotiations, agreement was reached on the terms of a draft subsidiary loan agreement. 3.14 The training required to enable FED staff and staff of financial intermediaries to carry out a substantially expanded role in subproject appraisal and supervision would be provided under the project. It would involve a program to be undertaken during the 12-18 month period during which Bank funds are expected to be committed, and would include: (i) a short course of 2-3 weeks covering the principles of project appraisal with emphasis on their financial and economic analysis; and (ii) a project supervision course of 1-2 weeks, to be offered near the end of the commitment period, which would focus on principles of project supervision, and on actual results of initial supervision efforts under the loan. Project beneficiaries would also be invited to participate in these courses. This is considered as 1/ FED recently hired an industrial engineer to strengthen its technical capability in project appraisal and supervision. - 28 - particularly necessary in Nicaragua, not only because the Government's greatly expanded role in industry necessitates a rapid training effort, but also to assist private sector enterprises in preparing subprojects. During nego- tiations, agreement was reached with FED that the content and timing of the proposed training program would have to be satisfactory to the Bank. 3.15 Operating Policies. The policies and procedures which would govern FED's utilization of the proposed Bank loan are set forth in FED's revised Statement of Operating Policies and Procedures for Industrial Lending (Annex 3). It specifies, among other things: (i) FED's objectives in financing industrial investment projects; (ii) the types of projects that FED would finance; (iii) the terms and limits of financing; (iv) criteria for project approval; (v) the responsibilities of intermediaries receiving financing from FED; and (vi) that FED would only finance subprojects for which adequate alternative sources of financing are not available. The policy statement as presently drafted, would form a satisfactory basis for FED's channeling of Bank funds for productive sector lending under the proposed project. Agreement on the revised policy statement was reached during negotiations and it was subse- quently approved by the Government's Financial Cabinet. Any subsequent modification of the policy statement would require prior Bank approval. 3.16 Operations. FED's operations have grown rapidly since its estab- lishment in 1972, particularly during the 1976-78 period. Its largest program is the ADP which included a credit program for small- and medium-scale bene- ficiaries to finance crops and livestock production under Bank Loan 943-NI which, as of November 30, 1980, amounted to 54% of its total lending opera- tions. Industrial financing, which accounted for 29% of total lending, has been concentrated on agroindustry, construction and financing of preinvestment studies. The balance of its lending (17%) has been for small-scale enterprise development in industry, commerce and the service sector. 3.17 Financial Position. FED's 1981 accounts will be audited by Peat, Marwick & Co. In the past, FED has contracted local auditing firms to conduct annual audits, but has not been fully satisfied with their performance. Consolidated historical balance sheets (Annex 4, T-1) show a rapidly growing loan portfolio for the years 1973-80 1/, from US$657,000 in nominal terms in 1973 to about US$73 million in 1980. The FED's annual audits contain no analysis of the quality of portfolio. However, the repayment record of financial intermediaries relending FED funds has been satisfactory. This is due to FED's policy of requiring loan repayments by financial inter- mediaries regardless of whether payments by the ultimate beneficiaries have been received, through the intermediaries' clearing accounts with BCN. This minimizes the possibility of arrears in the FED's portfolio. Except for 1978, the FED's financial spreads did not fully compensate for its operating costs, and through 1979, it incurred losses of US$1.8 million, mainly in connection with the administration of its agricultural portfolio. These losses were more than compensated for by BCN contributions of US$2.1 million to cover admini- strative expenses. Most of FED's initial resources were granted on conces- sional terms, and BCN's policy was that the cost of administering these funds 1/ Unaudited 1980 data as of October 31, 1980. - 29 - should not be passed on to the ultimate beneficiary, and that BCN should support FED with contributions to income. The spreads of 2.4% and 4.4% (para. 3.22) to be received by FED under the proposed project are estimated to be more than sufficient to enable FED to fully recover its operating expenses connected with the project. Net income earned as a result of the project would be retained to augment FED's capital. 3.18 Projected Operations. The FED's industrial pipeline for 1981-82 contains about 70 rehabilitation subprojects for the industrial and mining sectors with total investment costs of US$68 million equivalent (Annex 4, T-3), of which the FED expects to finance US$50 million equivalent, or about 70% of the total cost. The participating financial intermediaries and final borrowers would provide the balance of about US$18 million equivalent. While some projects are likely to be dropped, the existing project pipeline can be expected to be strengthened significantly during the implementation period of the proposed loan, and FED is expected to require at least US$50 million in external financing during 1981-82. The proposed Bank loan, which would be directed primarily to financing subprojects with an important export potential, would help provide part of the resources required. Since public enterprises had to submit their investment plans as part of the Government's 1981 invest- ment plan, FED "pipeline" is presently weighted towards public sector sub- projects, which account for about 70% of the total number of subprojects and of the total FED financing requested. However, as most new subprojects entering the"pipeline" are expected to be from the private sector, this trend should be reversed in the coming months. Nevertheless, to ensure that suffi- cient financing would be made available for eligibile subprojects from both the private and public sectors, access to the proceeds of the loan will be on an equal basis for both public and private sector enterprises. Participating Intermediaries 3.19 In the past, financial intermediaries eligible to participate in the FED's lending programs were prequalified based on criteria emphasizing the administrative, technical and financial capacity of the institutions and their ability to appraise and supervise subprojects. Participating institu- tions have included local and foreign commercial banks, financieras, savings and loan associations and INFONAC. The three largest commercial banks and INFONAC together accounted for about 93% of total FED operations (Annex 4, T-4). Following the reorganization of the banking system, only five banking institutions (i.e. BND, BANIC, BAMER, BP and BIN), now participate in the FED's lending programs. These five banks would continue to have specialized units to handle FED operations. It is expected that BND, BAMER, BANIC, BP and BIN would all participate as financial intermediaries in the proposed project, and their signing of subsidiary loan agreements would be a condition of effective- ness of the proposed loan. With the assistance of FINAPRI, FED would administer technical assistance funds under the proposed project and would re-lend to beneficiaries on terms and conditions satisfactory to the Bank. FED would enter into technical assistance agreements with FINAPRI and each of the beneficiaries of technical assistance, and the signing of such agreements, would be a condi- tion of disbursement for each respective technical assistance sub-component. - 30 - D. Loan Features The Proposed Loan 3.20 The proposed loan of US$30 million would be made to the Government of Nicaragua. It would be repaid over a period of 20 years, including 5 years of grace. Repayment would be made on the basis of equal semi-annual repay- ments in accordance with a fixed amortization schedule. Access to the proceeds of the loan would be provided on an equal basis to private and public sector enterprises, and the Government would relend the proceeds of the loan through CORFIN to FED in accordance with the following allocation: (a) US$27.5 million for subprojects carried out by industrial and mining enterprises; the former to include primary processing of agriculture, livestock and forestry production and construction materials, and the latter to include both metals and non-metallic minerals; at least US$15 million would be for subprojects exporting one-third or more of total output after the proposed rehabilitation has been completed, and the balance would finance other important exporting enterprises, firms producing inputs to the export sector, and projects which remove key bottlenecks to industrial rehabilitation; (b) US$2.5 million for technical assistance of which about (i) US$50,000 for consulting services to enable FED, the financial intermediaries and beneficiaries to upgrade their capability to prepare, appraise and supervise subprojects; (ii) US$1,265,000 to assist CONDEMINA by providing consulting services to operate the major mines under its jurisdiction, to conduct a mineral inventory, and to provide scholar- ships in mining to selected university students; (iii) US$970,000 to COIP to upgrade the performance of firms in the metal-mechanics, food processing and pharmaceutical sectors, and to provide scholar- ships in food technology; (iv) US$115,000 to enable INAP to develop an accounting system for public enterprises, and scholarships to train public officials in public administration; and (v) US$100,000 to enable ENIPREX to provide assistance in export promotion to industrial enterprises. Project Cost 3.21 The total cost of the project is expected to amount to US$43 mil- lion. The Bank would provide US$30 million, which would finance the total foreign exchange costs of the project, estimated at US$26 million (i.e. about 60% of total project cost), as well as a portion of local costs (US$4 million equivalent). Financing a portion of local costs is justified in view of the extreme scarcity of credit resources available in Nicaragua in relation to the needs of the economy in general and the project in particular. Without Bank financing of part of the local costs of the project, there is a danger that some high priority rehabilitation projects would be unable to proceed. Project sponsors would be required to provide at least 10% of the total project cost, and financial intermediaries would provide the balance needed to complete the financial plan (on average about 20% of total project cost). Table 3.1 shows the expected financing plan for the project. - 31 - Table 3.1: PROJECT COST AND FINANCING PLAN US$ Million Equivalent Local Foreign Total Estimated Cost Working Capital 14.0 6.5 20.5 Fixed Capital 2.0 18.0 20.0 Technical Assistance 1.0 1.5 2.5 17.0 26.0 43.0 Financing Plan Bank 4.0 26.0 30.0 FED/Intermediaries 8.6 - 8.6 Project Sponsors 4.4 - 4.4 Total 17.0 26.0 43.0 Relending Terms and Conditions 3.22 Terms and conditions of subloans would be similar to the Agricultural and Industrial Rehabilitation Project. All subloans would have a minimum maturity of 18 months. Subloans for financing working capital would have final maturities of up to 5 years and, for repair, replacement and/or modifica- tion of fixed installations, of up to 15 years. A grace period of up to 3 years would be available for both working and fixed capital subloans. During nego- tiations, it was agreed that under the proposed project the interest rate to the final beneficiary would be 15% for subloans to manufacturing enterprises which would export at least one-third of total output, and 17% for subloans to other qualifying enterprises (para 3.20). According to expected inflationary trends, such interest rates are expected to be positive over the average life of subloans financed under the project. A review of the adequacy of this rate would be made on an annual basis, and the first such review would be carried out not later than March 31, 1982. The Bank would have the right to stop authorizing or approving further commitments until an agreement is reached. The Government would assume the standard commitment fee of 0.75% p.a., as well as the foreign exchange risk, and would onlend the proceeds of the proposed loan to FED at the IBRD interest rate of 9.6%. FED would on-lend to financial intermediaries at 12% for exporters meeting the one-third requirement, and 14% for other qualifying firms, and would receive spreads of 2.4% and 4.4%, respectively. Financial intermediaries would re-lend to final beneficiaries - 32 - at 15% and 17% (the spread would be 3% in either case). The above conditions would be reflected in subsidiary loan agreements between the Government and the FED and between the FED and the financial intermediaries. 3.23 The FED would review all subproject appraisals submitted by finan- cial intermediaries. Prior Bank approval would be required for all subloans involving more than US$500,000 of Bank financing, as well as for the first 3 subprojects from each of the mining, chemicals, pharmaceuticals and sugar industries (regardless of subloan amount). This procedure is expected to result in a review by the Bank of some 30-35 subprojects covering 75% of the project financing being provided under the proposed loan. The maximum amount of Bank funds that could be relent to a single enterprise would be US$3 million. As under the first loan, any amounts repaid to the FED in excess of amounts needed to service the FED's debt to the Government would be used for additional lending as established under FED's organic law. Sectoral Limit on Bank Financing 3.24 The appraisal mission's review of major subsectors focussed on establishing a clear indication of rehabilitation needs within the context of rational subsectoral development. In most subsectors, initial rehabilitation steps appeared to be based on a reasonable perception of how this process ought to proceed (i.e. what should be produced, by what enterprise, for which markets, and at what benefit to the economy). One exception, however, was the textile subsector. The Government, which has the leading role in textiles, is presently studying alternative means of rehabilitating the subsector. 1/ Agreement was reached during negotiations that prior to authorizing disburse- ments for subprojects in this sector, the Government would need to present to the Bank for review the results of the on-going study. The Bank would deter- mine whether or not Bank lending could be justified on the basis of the study's findings. Accounting and Auditing 3.25 FED would continue to maintain separate project accounts as estab- lished for the first project in accordance with accounting principles con- sistently applied. The project accounts and related financial statements would be audited annually in accordance with generally accepted auditing principles consistently applied, by independent auditors acceptable to the Bank. Audited annual consolidated financial statements would include a balance sheet, a statement of income and expenses, a statement of source and application of funds, and the transactions of the project account. Supplemen- tary data on operations, quality of portfolio, financial position and scope of work carried out by the auditors would also be provided. Annual audit reports and financial statements would be submitted to the Bank not later than four months after the end of each fiscal year. 1/ This study is being financed under the Bank's Preinvestment Fund Project. - 33 - Procurement and Disbursement 3.26 The loan funds would finance the foreign exchange costs of imported and locally procured equipment, materials, civil works and services as well as a portion of the local costs involved. Consulting services for training and technical assistance would be open to international recruitment. The estimated man-month cost of such assistance is US$9,792. Participating intermediaries would satisfy themselves that procurement items were suitable for the respective investment projects and reasonably priced and that the beneficiaries had canvassed the main sources of supply and were purchasing from the most advantageous source. The Bank would need to be informed of all responses received, price quotations and reasons for selection of suppliers. All subproject appraisals would need to include a full discussion of procure- ment procedures used, responses received, prices quoted and criteria used for selection of suppliers. 3.27 The final date for the submission of subprojects would be March 31, 1983 and the closing date for disbursements would be March 31, 1984. The Bank would disburse against an approved subproject and list of goods and services, subject to the total cost of such goods and services not exceeding 70% of the total cost of the rehabilitation subproject. For items on the approved list of goods and services, the Bank would disburse for 100% of foreign expenditures for direct imports and 100% of expenditures for locally procured goods and services. The Bank would also disburse for 100% of total expenditures for consulting services and scholarships. Disbursements would be made for expenditures incurred up to 180 days prior to the receipt by the Bank of subloan requests, in lieu of the normal 90 day limit, since the use of a two-tier system for channeling the proceeds of the loan and the need to upgrade the appraisal capability of financial institutions will require considerably more time for processing subprojects. Disbursements would be fully documented, and supporting documentation would be retained by the participating banks or FED for review by Bank supervision missions. Agreement on these procedures was reached during negotiations. To prevent a sharp decline in output at three major gold mines, FED provided bridge financing for certain items of mining equipment in February of this year. Retroactive financing not to exceed US$1.6 million would be permitted for financing these items of mining equipment procured before the date of the Loan Agreement, but after February 1, 1981. Project Benefits and Risks 3.28 The proposed project is expected to have a significant economic impact. A large portion of the task of industrial rehabilitation still remains to be achieved, and the proposed project would focus on those areas in which the effects of rehabilitation would have the most immediate impact on meeting priority needs of the economy. Most of the loan proceeds would be channeled to firms with significant export potential, whose rehabilitation would result in significant foreign exchange earnings, such as refined gold and silver, processed sugar, chemicals, pharmaceuticals, metal and wood products. For example, the rehabilitation of Nicaragua's major gold mines - 34 - could result in incremental annual exports of 20,000 ounces of gold per year; restoring the lost output of five state-owned sugar mills would result in increasing sugar exports by over 100,000 metric tons; consequently, the impact of the project on Nicaragua's balance-of-payments should be substantial. 3.29 The proposed loan would result in the recovery of a substantial number of jobs lost as a result of the decline in industrial production following the revolution. Overall, it is estimated that about 5,000 jobs would be restored by the project. In addition, a substantial indirect employ- ment effect is expected from the project due to backward linkages to the agricultural sector, since about 38% of the proposed loan would finance agroindustrial subprojects. 3.30 The proposed project would also devote considerable effort to strengthening the capability of the FED, financial intermediaries, state corporations and enterprises and private industrialists to base lending decisions on sound technical and financial criteria, through upgrading their capacity to prepare, appraise and supervise subprojects. Other technical assistance would (i) assist the mining sector to obtain the full range of foreign expertise it requires to rehabilitate and operate Nicaragua's most important mines, as well as to develop a clear picture of the future mining potential; (ii) help MIND and COIP to resolve technical and cost accounting problems in 3 major industrial subsectors; (iii) aid INAP in developing an accounting system for public enterprises; (iv) assist ENIPREX in the promotion of industrial exports; and (v) provide scholarships for Nicaraguan nationals in key technical disciplines. 3.31 Lending to a sector that is still in the process of recovering from a major economic decline resulting from civil war, in which a large number of new public enterprises have required a new organization and manage- ment structure and in which the degree of participation of a significant number of enterprises is uncertain, inevitably involves significant risks. The proposed project incorporates features designed to reduce these risks to an acceptable level. Bank funds would be made available only to enterprises capable of successfully restoring productive capacity and marketing their increased output. To encourage private sector participation, assurances have been obtained that access to the proceeds of the loan will be on an equal basis for both private and public sector enterprises. Strengthened project appraisal procedures and the availability of technical assistance in marketing and procurement should give additional assurances that the subprojects financed are technically and financially viable, and have favorable market prospects. Moreover, Bank review of a high proportion of subprojects should provide further assurances of subproject quality. The technical assistance and training component, which is designed to strengthen the FED system and major state mining and industrial corporations, should also contribute to reducing project risks. Finally, the focus of the project on financing high priority export projects should help alleviate the severe foreign exchange constraints facing the economy as a whole. - 35 - IV. RECOMMENDATIONS 4.01 During negotiations, agreement was reached and assurances were obtained from: - The Government and CORFIN/FED on: (i) the terms and conditions of the proposed loan to the Government and of the subsidiary loan from the Government to CORFIN/FED (paragraphs 3.22 to 3.23); (ii) approval by the Bank of the contents and timing of a training program for FED, financial intermediaries and beneficiaries (paragraph 3.14). (iii) access to the proceeds of the loan being given on an equal basis to private and public sector enterprises (paragraph 3.20). - CORFIN/FED on: (i) the hiring of additional staff required to carry out the proposed project (paragraph 3.11); (ii) a draft subsidiary loan agreement between the FED and financial intermediaries participating under the project (paragraph 3.13); (iii) selection of an auditing firm, the format and timing of annual auditing requirements (paragraph 3.25). 4.02 Special conditions of loan effectiveness are that: (i) the Borrower and CORFIN have signed a satisfactory subsidiary loan agreement (paragraph 3.20); (ii) BND, BANIC, BAMER, BP and BIN have signed satisfactory subsidiary loan agreements with FED (paragraph 3.19). 4.03 Special conditions of loan disbursement are that: (i) FED has signed a satisfactory technical assistance agreement with FINAPRI and the respective beneficiary under each technical assistance sub-component (paragraph 3.19); (ii) the Bank would need to assess the results of a textile sector study prior to authorizing disbursements for any subprojects from this sector (paragraph 3.24); 4.04 The proposed project would constitute a suitable basis for a Bank loan of US$30 million with a term of 20 years including 5 years of grace on conditions as outlined in Chapter III. NICARAGUA INDUSTRIAL REHABILITATION CREDIT PROJECT CORFIN Organization Chart CORFIN FED BMRBP BIN INFONAC Interfinanciera FIA CAPSA Beo. Caley Dagnall Bco. de Centroamerica FINSA NIAPSA FRANCOFIN FIDOSA Financ iera INMOBILIARIA INDESA Bco. Exterior CNI F-4 ANNEX 2 37 NICARAGUA IiDUSTRIAL REHABILITATION CREDIT PROJECT FED Organization Chart Government ad-hoc Committee on Investment FED Credit Committee Executive Director of FED Agricultural Industrial Small-Scale Accounting Area Area Enterprise Department Director Director Area Director Director - 38 - ANNEX 3 Page 1 NICARAGUA INDUSTRIAL REHABILITATION CREDIT PROJECT FED Statement of Operating Policies and Procedures for Industrial Lending I. PURPOSE OF THE PRESENT DOCUMENT AND DEFINITIONS The Industrial Rehabilitation Program will be implemented by the Fondo Especial de Desarrollo (FED). It is governed by the Loan Agreement between International Bank for Rehabilitation and Development (IBRD) and the Republic of Nicaragua, and by the Project Agreement between the IBRD and CORFIN, on behalf of FED, by the Operating Rules and Regulations of the FED, and by FED's Guidelines for Industrial Project Appraisal and Supervision. II. GUIDELINES GOVERNING RELATIONS BETWEEN FED, THE INTERMEDIARIES AND THE BENEFICIARIES 2.1 Purpose and Description of the,Program 2.1.1. Purpose, Priority and Eligible Branches The purpose of the Program is to finance the rehabilitation of existing public and private industrial enterprises, including those in the agro and forest industries, mining, and construction and constructions mate- rials subsectors, which do not have adequate alternative sources of financing. The funds will primarily be channeled to export oriented enterprises, to finance working capital requirements and the repair, replacement and modifi- cation of fixed machinery, equipment and related services and civil works, of private and public enterprises. The Program shall be implemented by the FED and channeled through participating banks (hereinafter called banks) to enterprises operating in these subsectors. Priority will be given to projects which export at least one-third of their output (at least one-half of the Bank funds available under the program will finance such enterprises). Other exporting firms, as well as firms which produce critical inputs to the export sector and firms whose rehabilitation would remove important bottlenecks to industrial rehabilitation, could also be financed under the balance of the loan. Projects should also attempt to promote income creation and distribution, and the training of labor. For purposes of the Program, companies, cooperatives and other forms of manufacturing associations shall be understood to mean those carrying out their activities in the branches listed in the International Standard Classification of the United Nations, for manufacturing and mining. - 39 - ANNEX 3 Page 2 2.1.2 Resources The program's credit resources shall comprise the proceeds of the IBRD industrial rehabilitation loan (hereinafter called "The Loan") and funds contributed by the FED and the banks. To ensure that the cost of any subproject is fully financed, these resources shall be supplemented by contributions from the beneficiary enterprises. 2.2 Use of Resources The proportion of IBRD loan funds in the financing of a project may not exceed 70% of the total project cost. The contribution of either the beneficiary or the banks/FED may not be less than 10% each, of the total cost of project. The FED shall ensure that sufficient resources are available to finance the total cost of each project being financed by the Program's credit resources. 2.3 Intermediaries The following shall be intermediaries: Banco Nacional de Desarrollo, Banco Nicaraguense, Banco de America, Banco Popular and Banco Inmobiliario. The functions and obligations of the banks in the use and channelling of Program funds shall be set forth in the Participating Bank Subsidiary Loan Agreements between said institutions and the FED. The credit risk shall be borne by the intermediaries. 2.4 Restrictions on the Use of Program Funds Program funds may not be used to grant credits, inter alia, for: (a) the refinancing of debts to third parties by the beneficiary enterprise; (b) the rental or purchase of land or commercial buildings; (c) used goods, except in the case of used machinery guaranteed (and generally rebuilt) by an entity of recognized solvency; (d) the purchase of shares, bonds or other securities; (e) payment of dividends or recovery of invested capital. 2.5 Eligibility Criteria 2.5.1. Eligible Enterprises Entities deemed eligible for credit shall be those natural or juridicial persons in the private or public sector and those cooperatives and other forms of association that, in the opinion of the FED have sufficient administrative, technical and financial capacity to implement and operate the - 40 - ANNEX 3 Page 3 respective project regardless of ownership. The priority nature, potential for foreign exchange earnings or savings and future viability of the project would need to be clearly demonstrated. 2.5.2 Project Analysis Methodology The appraisal and supervision of projects submitted for financing under the Program, shall be carried out in accordance with FED's Guidelines for Industrial Project Appraisal and Supervision, which shall be applied uniformly for all subprojects. 2.5.3 Loan Ceilings Except for the first 3 subprojects in each of the mining, chemicals, pharmaceuticals and sugar industries, loans that merit autonomous approval by the FED shall be those that are to be financed out of Program funds and whose amount does not exceed US$500,000 when added to any other amounts of financing that are outstanding or have been applied for under the Program. Financing requests in excess of this limit require IBRD approval. Credits may not be granted to any one enterprise out of the proceeds of the Agricultural and Industrial Rehabilitation Project and/or the Industrial Rehabilitation Credit Project in an amount higher than US$3,000,000. 2.6 Terms and Conditions of Credits Granted Out of Program Funds 2.6.1 Terms Medium- and large-scale enterprises. Subloans for working capital requirements shall have a term of not more than 5 years including a grace period of up to 3 years. Subloans for the repair, replacement or modification of machinery, equipment or fixed installations shall have a term of not more than 15 years, including a grace period of up to 3 years. 2.6.2. Interest The annual interest to be paid by Program beneficiaries shall not be less than 15% for enterprises exporting at least one-third of their output upon completion of the investment project, and 17% for enterprises which (a) carry on significant export activities, (b) provide inputs to exporting enterprises, or (c) whose rehabilitation is essential to the rehabilitation of other investment enterprises; on the outstanding balance, exclusive of all applicable commissions, taxes, charges or fees of any kind whatsoever. The adequacy of this rate will be reviewed at least once every twelve months, and revised, as necessary, with a view to ensuring positive real rates of interest over the life of the subprojects financed. 2.6.3. Guarantees Banks shall obtain sufficient guarantees from the beneficiaries to cover the credit risk involved, in accordance with the country's current banking laws and practices. - 41 - ANNEX 3 Page 4 2.6.4. Other Conditions All credits granted out of Program funds shall include the following requirements as part of the conditions imposed on intermediaries and benefi- ciaries: (a) the right of the FED, the banks and IBRD to inspect the goods, sites and civil works related to the corresponding project; (b) an undertaking from the beneficiary that the goods and services financed out of the credit will be used exclusively in execution of the respective project and for the purposes intended; (c) the obligation to provide financial statements and any other information that the FED and/or the bank may reasonably request with respect to the Project and the beneficiary's financial situation; (d) the right of the intermediary to suspend credit disbursements if the beneficiary does not meet its obligations; (e) an undertaking by the beneficiary that it will take all necessary measures to ensure that all construction and service contracts and all purchases of goods for the Program are concluded at a reasonable cost, which shall generally be the lowest market price, taking into account such factors as quality, efficiency, and any other relevant aspects; (f) for procurement contracts over US$50,000 at least 3 price quotations would be required by FED; for contracts over US$250,000, represen- tatives of foreign governments would need to be advised and adver- tisements placed in local newspapers at least 30 days prior to the date of selection of the supplier; and all appraisals would need to include a full description of procurement procedures used, responses received, prices quoted, and criteria for selection of suppliers; (g) an undertaking by the beneficiary to take out and maintain insurance on the goods securing the credit, against such risks and in such amounts as shall be consistent with sound business practice. - 42 - ANNEX 3 Page 5 III. SPECIAL GUIDELINES APPLICABLE EXCLUSIVELY TO RELATIONS BETWEEN IBRD, FED AND BANKS 3.1 Cost of the Program and Financing The cost of the Program will be equivalent to US$43,000,000 to be financed as follows: the equivalent of US$30,000,000 out of IBRD funds, US$4,400,000 as the minimum contribution from the beneficiaries, and US$8,600,000 as the expected contribution from the banks and/or FED. 3.2 Analysis and Monitoring of Projects, Reports and Publicity 3.2.1 Applications Credit applications from the beneficiaries shall be submitted to the FED by the banks and shall include all requisite supporting documentation. 3.2.2. Analysis The FED shall analyze the feasibility of all projects submitted by the intermediaries with respect to their institutional, technical, financial and economic aspects. For the purpose of said analysis it shall use the FED Guidelines for Industrial Project Appraisal and Supervision. 3.2.3. Monitoring The FED shall have the right to inspect the site, construction, goods and services financed for each project, as well as accounting records and such other documents of the beneficiaries as it shall deem relevant, and to obtain such information as it deems pertinent to the development of the project, both from the banks and from the beneficiaries. Said inspections and rights shall exist until the beneficiary makes the final reimbursement to the bank and the latter reimburses the FED. FED shall make an inspection of each project subsequent to each disbursement made to the beneficiary enterprise, and at least one additional inspection in the 90 days following the last disbursement. 3.2.4. Records For each project financed, the FED shall keep satisfactory records in accordance with the Agreement between FED and IBRD. Said records shall identify the use of the proceeds of the loan, including the services contracted and goods purchased, and report on the status of the project account. - 43 - ANNEX 3 Page 6 3.2.5 Reports (a) The FED shall submit to IBRD, to the latter's satisfaction, the reports listed below, within the periods specified in each case: (i) within 60 days following the end of each calendar quarter, or within such other periods as may be agreed between the parties, the reports on implementation of the Program, in accordance with guidelines sent by IBRD to the FED; (ii) the other reports that IBRD shall reasonably request with respect to investment of the loan funds; (iii) within 120 days following the close of each fiscal year of the FED, starting with the fiscal year ended December 31, 1981, and for as long as the obligations of the Republic under the respective loan agreement shall subsist, FED's annual audit report, including balance sheet, statement of income and expenditures, cash flow, and analysis of quality of portfolio. (b) The statements and information described in (a) (iii) above shall be submitted accompanied by an auditor's report and opinion. The audit shall be performed by a firm of independent auditors acceptable to IBRD, whose fees and expenses shall be borne by the FED. The FED shall authorize the auditing firm to furnish directly to IBRD such additional information as it may request in connection with the Program. 3.3 Expansion and Amendment of These Regulations This Policy Statement shall take effect on the date of signature of the Loan Agreement between the Republic of Nicaragua and IBRD, and the Project Agreement between IBRD and CORFIN. Provided it does not affect the provisions of the above-mentioned Agreements, the FED may suggest amendments to this Policy Statement, to take account of any new circumstances or conditions that may arise during implementation of the Program, as a means of ensuring the success of the latter and in achieving its objectives. Said amendments shall enter into effect once IBRD has announced that it has no objections to them. In such case, should there be any omissions or discrepancies between this Policy Statement and the Loan Agreements, the provisions of the latter shall prevail. NICARAGUA INDUSTRIAL REHABILITATION CREDIT PROJECT Table 1: FED Consolidated Balance Sheets 1973 - June 1980 (US$ equivalent in thousands) October Balance Sheet 1973 1974 1975 1976 1977 1978 1979111 1980c/ (Unaudited) ASSETS Cash 653 278 1,255 1,434 3,355 4,772 4,239 4,642 Loan portfolio - 4,130 8,952 16,307. 28,122 42-227 37,900 48,862 Interest receivable - 46 194 - 615 1,334 2,336 2,370 Fixed assets (net) 4 48 64 100 221 195 60 14d Other assets - 388 369 816 1,107 3,048 10665 17, 014 Total Assets 657 4,890 10,834 18,657 33,420 51 576 55,200 73.036 LIABILITIES International borrowings 650 2,806 8,466 12,219 23,393 29,269 31,402 30,938 CB credit lines - 928 368 2,410 2,719 12,031 14,o02 14,132 Other liabilities 10 396 422 671 762 1,221 2,307 17,592 Total Liabilities 660 4,130 9 256 15,300 26,874 42521 48,591 62662 EQUITY Government contribution - 1,000 a/ 1,843 3,513 5,085 6,498 5,000 8,471 Accumulated surplus (deficit) 2) (240)- (265) (156) 1461 2,557 1,609 1,903 Total Equity (2) 760 1,578 3,357 6,546 9,055 6,609 10,374 Total Liabilities and Equity 657 4,890 10_834 18,657 33,420 A1,216 55_200 73,036 a/ Includes previous year's accounting adjustment of US$21,000. b/ Adjusted for devaluation of the Cordoba. NOTE: All data audited for years 1973 to 1979. NICARAGUA INDUSTRIAL RERATLTTATION CREDIT PROJECT FED Fondo Especial de Desarrollo Table 2: Consolidated Statement of Income for Year Ending December 31 (US$' 000) Revenue 1973 1974 1975 1976 1977 1978 1979 Interest and commissions - 65 357 823 1,434 2,555 3,816 Expenses Development expenditure 81 - - - - - - Feasibility study on meat marketing (Loan 943-NI) - - 74 - - - - Interest and finance costs - 178 246 390 709 1,316 3,252 4 General and other administrative expenses - 238 403 714 928 1,091 799 Other expenses - - - 143 163 80 39 Total expenses 81 416 723 1,247 1,800 2,487 4,091 Operating profit (loss) (81) (351) (366) (424) (366) 68 (273) Funding from BCN 79 134 341 540 521 314 171 Surplus (deficit) for year after FED funding (2) (217) (25) 116 155 382 (104) Prior years accounting adjustment - (21) - - - - - Deficits brought forward - (2) (240) (265) (149) 6 388 Accumulated surplus (deficits) (2) (240) (265) (149) 6 388 284 = - = = = q 46 ANNEX 4 T-3 Page 3 NICARAGUA INDUSTRIAL REHABILITATION CREDIT PROJECT FED Table 3: List of Pending Subprojects (C$ million) Subproject Subproject FED Cost Loan Commitment A. Projects Approved by FED 1. Mina La Libertad 10.0 8.2 2. Mina Siuna 17.6 14.1 3. Mina Bonanza 16.0 12.8 4. Mina Rosita 15.9 12.7 5. Amolonca 12.8 10.2 SUB-TOTAL 72.3 58.0 B. Projects Under Review by FED 1. Ingenio Camilo Ortega 15.0 12.0 2. Ingenio Javier Guerra 23.3 18.6 3. Ingenio Julio Buitrago 23.4 18.7 4. Ingenio German Pomares 26.0 20.8 5. Ingenio B. Zeledon 11.8 9.4 6. Sovipe Industrial 12.5 10.0 7. Avicola La Estrella 21.1 16.9 8. Sovipe Ingenieros 15.9 12.7 SUB-TOTAL 149.0 119.1 C. Projects Declared Eligible by FED 1. Ifagan 13.5 10.8 2. Laboratorios Solka 5.0 4.0 3. Agrotelica 0.7 0.6 4. El Pozo 1.8 1.4 5. Yodeco 7.0 6.0 6. Alimentos Mejorados 7.5 4.3 7. Indust. Papeleras Merc. 10.0 4.0 8. Coniprolesa 2.7 1.6 9. Industrias El Triunfo 5.1 3.8 10. Albers 2.0 1.3 11. Quimicas Borden 17.3 14.3 12. Tanic 58.4 30.2 13. Polymer 11.5 6.9 SUB-TOTAL 142.5 89.2 (Continued) ANNEX 4 T-3 Page 4 NICARAGUA INDUSTRIAL REHABILITATION CREDIT PROJECT FED Table 3: List of Pending Subprojects (C$ million) Subproj ect Subproject FED Cost Loan Commitment D. Prospective Projects (with Financial Intermediaries) 1. Telasa 8.0 6.4 2. Textiles Nicarao 48.0 22.0 3. Imusa 0.8 0.6 4. Metasa 31.3 25.0 5. Maquinaria Varia 9.0 7.2 6. Esanicsa 2.0 1.6 7. Plasticos Robelo 2.0 1.6 8. Cilindros Copa 2.0 1.6 9. Hielera Polar 2.0 1.6 10. Inca 31.3 25.0 11. Intercasa 0.7 0.6 12. Emensa 1.1 0.9 13. Taller Central de Mantenia 6.0 4.8 14. Fundicion de Acero 28.0 22.4 15. Enuacasa 7.5 6.0 16. Anisa 2.0 1.6 17. Elpesa 14.0 11.2 18. Beneficios de Cafe 24.5 19.6 19. Nutribal 7.6 6.1 20. Procon 5.0 4.0 21. Proinco 5.0 4.0 22. Plastinic 1.9 1.5 23. Implagsa 3.0 2.4 24. Piedracal 3.6 2.9 25. Yesera 0.8 0.6 26. Cal Sapoa 1.2 1.0 27. Emp. Dario 1.0 0.8 28. Cal el Pueblo 2.1 1.7 29. Canteras 3.6 2.9 30. Areneras 0.8 0.6 31. Promsa 4.5 3.6 SUB-TOTAL 260.3 191.8 1/ E. Other Projects- 50.0 40.0 TOTAL 674.3 498.1 1/ Being prepared by beneficiary enterprises. NICARAGUA INDUSTRIAL REHABILITATION CREDIT PROJECT Table 4: Financial Intermediary Participation in Loans by FED's Industrial Development Program (to June, 1980) (C$ million) Agroindustry Rehabilitation Construction Tourism Preinvestment Totals Financial Intermediaries Total Cost FED Contri- Total Cost FED Contri- Total Cost FED Contri- Total Cost FED Contri- Total Cost FED Contri- rotal Cost FED Contri- bution bution bution bution bution bution BAMER 75.55 31.62 2.5 1.8 15.13 7.97 0.11 0.04 1.31 0.52 94.60 41.95 BANIC 108.90 53.11 - - 23.42 12.12 1.74 1.00 2.34 1.0 136.40 67.23 INDESA 11.00 4.39 - - 2.30 1.29 - - - - 13.30 5.68 BANIC 86,36 42.62 - - 17.33 8.26 1.57 0.88 2.34 1.0 107.60 52.70 BC0. DE C.A. 4.67 3.01 - - 3.79 2.57 0.17 0.12 - - 8.63 5.70 CNI 6.87 3.09 - - - - - - - - 6.87 3.09 BND 12.0 5 27.75 2.0 23.12 10.50 27.47 10.87 0.97 0.45 203.39 99.24 BND 51.60 27.11 27.75 2.0 23.12 10.50 16.87 5.31 0.97 0.45 120.31 63.37 INFONAC 72.48 30.31 - - - - 10.60 5.56 - - 83.08 35.87 Bo. Inmobiliario - - - - - - 65.41 10.63 - - 63.41 10.68 CAPSA - - - - - - 5.81 3.48 - - 5.81 3.48 NIAPSA - - - - - - 56.00 4.90 - - 56.00 4.90 La Financiers - - - - - 3.60 2.25 - - 3.60 2.25 4 La Inmobiliaria - - - - - - - - - - First National City Bank - - 9.31 3.51 - - - - 9.31 3.51 Total 308.53 142.15 30.25 21.80 70.98 34.10 94.79 22.54 4.62 1.97 509.11 222.56 - -y - 49 - ANNEX 4 T-5 Page 6 NICARAGUA INDUSTRIAL REHABILITATION CREDIT PROJECT Table 5: Estimated Schedule of Disbursement IBRD Fiscal Year/Quarter Disbursement (US$000) By Quarter Cumulative 1982 September 30 1,600 December 31 2,500 March 31 2,900 June 30 3,000 10,000 1983 September 30 3,550 December 31 3,900 March 31 4,250 June 30 3,300 25,000 1984 September 30 3,000 December 31 2,000 30,000 Source: Mission Estimates - 50 - ANNEX 5 Page 1 NICARAGUA INDUSTRIAL REHABILITATION CREDIT PROJECT MAJOR INDUSTRIAL AND MINING SUBSECTORS A. Agroindustry Meat Processing 1. It was only in the 1960's that the beef export industry became important in Nicaragua, following the establishing of 3 export-oriented slaughterhouses. Over the decade, processed beef output increased 2-1/2 times, but overall calving rates only rose from 42% to 48% and boneless meat per carcass just increased from 289 lbs to 321 lbs. The increase in output was achieved through increasing the herd size and the rate and age range of slaughtering, rather than through increased productivity. The sector as a whole was characterized by low productivity (1 animal per ha.) due to insufficient attention to animal health and nutrition, uncontrolled mating and lack of adequate pastures. Nicaragua's long dry season (4-6 months) also had an adverse effect on animal health and available pasture. Technical assistance, including pasture improvement, rotational grazing, parasite control, seasonal mating, and artificial insemination, were largely concen- trated on about 250 large-scale ranches, which had a considerably higher level of productivity (i.e. 2 animals per ha., calving rates of 70-80%). 2. During the 1970's, 4 more slaughterhouses were constructed and slaughter rates continued to increase more rapidly than herd size. The overall increase in beef slaughter in the 1970's resulted partly from more intensive fattening operations and better nutritional and health practices, but was mostly due to a widening of the age of animals slaughtered (i.e. both younger and older animals), which slowed the net herd increase. In 1978-79, large-scale slaughter of cattle was carried out due to the increased political uncertainty, which culminated in the events of June/July 1979, when former President Somoza operated his slaughterhouses around-the-clock to slaughter beef and ship it to Miami. 1/ In addition, the Government has acknowledged a reduction of 200,000 head in 1979 due to clandestine exports, but USDA esti- mates that at least 350,000 head were smuggled out of Nicaragua (most probably to Honduras). 3. Meat processing continues to be largely concentrated on beef, which accounts for about 80% of the value added of processed meat and 30% of industrial exports. Beef slaughtering, de-boning, trimming and packing is presently carried out by 7 export-oriented slaughterhouses, which together account for about one-half of the meat processing in the country. The balance is carried out under uncontrolled conditions by municipal slaughterhouses who basically act as a service industry offering butchering facilities to local 1/ The USDA believes that the large slaughter in 1979 may have reduced the herd to as little as 2.2 million in that year, but in the absence of any herd inventory, the USDA herd estimate has been maintained at 2.6 million. The lower figure is probably a more correct estimate. - 51 - ANNEX 5 Page 2 merchants. About two-thirds of beef processing is carried out by 5 state- owned packing plants, with two private firms providing the balance. Meat by-products (i.e. sausage, ham, bologna etc.), and chicken (3 plants) and pork meat (4 small plants) are produced solely for the domestic market, and have largely substituted for beef in local markets. 4. On the basis of the first semester performance MIDA estimated that the annual output for 1980 was about 60 million lbs. p.a., which is about 50% of installed capacity. This decline is reflected the number of animals sacrified in comparison with previous years and is illustrative of the decline of this industry since 1978: 1960 1970 1977 1978 1979 1980 1/ Cattle Slaughter 133,650 310,025 383,000 453,000 434,000 325,000 Year-end Herd N.A. N.A. 2,774,000 2,846,000 2,604,000 2,200,000 5. The decline in slaughter for the export sector is shown in the following table: No. of Head Processed Percentage Change Firms 1979 1980 (1980/1979) IFAGAN 74,928 33,644 44.9% CARNIC 56,794 34,641 61.0% AMERRISQUE 33,244 18,103 54.5% EMPANICSA 27,691 11,928 43.1% EPCA 16,738 11,162 66.7% Total Pub. Sector 209,395 109,478 52.3% San Martin 49,891 35,924 72.0% IGOSA 27,659 17,790 64.3% Total Priv. Sector 77,550 53,714 69.3% Total Production 286,945 163,192 56.9% 6. Regeneration of the herd, which is essential if lost output is to be rehabilitated, is limited by the following: (i) uncertainty regarding ownership of certain cattle lands; (ii) decline of pastures in the last year 1/ Estimated annual rate. - 52 - ANNEX 5 Page 3 due to lack of proper management; (iii) low productivity of existing herd; (iv) loss of breeding stock through slaughter, rustling, and smuggling; (v) a shortage of working capital; and (vi) uncertainty as to future policies of government. Milk Processing 7. Since the early 1960's 4 pasteurizing plants located in Managua, and known as the "pool lechero", have provided 11-12% of the milk and the milk by-products consumed in Nicaragua. In 1969 Cia. Centroamericana de Productos Lacteos (PROLACSA) was established in Matagalpa to produce powdered milk for the CACM market. Its output increased from 3% of total output in 1973 to 5% in 1977. About half-a-dozen ice cream producers make up the balance of the industrialized portion of the milk industry. The balance of about four-fifths of milk production is non-processed and marketed as fluid milk or white cheese. In 1978 (latest data available) 136,100,000 gallons were produced of which 15,600,000 gallons were processed by the 4 Managua firms 1/ and 6,500,000 by PROLACSA. 8. Pasteurized milk is the single most important product sold (about one-half of total output), but dried milk (one-fourth of the total) as well as butter, ice cream, cheese, and cream are also produced. La Perfecta and CONIPROLESA have facilities to produce powdered milk, which is stored and used in the dry season (when raw material inputs drops drastically) when it is mixed with fluid milk to produce the final product. The seasonality of milk supply has resulted in shortages, particularly of milk by-products, during the dry season. 9. Two of the Managua firms, CONIPROLESA and La Completa, sufferred equipment and capital losses during the revolution and important losses in capacity. They are being financed by the FED with Bank sub-loans of US$250,000 and US$180,000; respectively. CONIPROLESA was formed by some of the largest producers in the pacific and central zones. The company maintains reception centers in production areas (i.e. Boaco, Rivas, San Jose de los Remates) and transports its crude milk to Managua in refrigerated trucks. Milk from dairy farms near Managua is transported without refrigeration. La Completa, has been taken over by the state and is being managed by MIDA. Milk prices to both producer and processor are set by a state-owned marketing agency. Sugar Refining 10. Since the early 1970's 6 sugar mills have processed Nicaragua's sugar crop. The largest mill, Ingenio San Antonio (ISA), was assisted by an IFC loan of US$6.5 million to expand its facilities, and by 1974, it 1/ La Perfecta (7.9 mm/gals.), CONIPROLESA (4.5 mm/gals.), La Completa (2.9 mm/gals.), Eskimo (0.3 mm/gals.) - 53 - ANNEX 5 Page 4 accounted for about 60% of output. Three other mills, which were controlled by former President Somoza, processing about 25% of output, and two other mills accounted for the balance. By 1974, about 40% of total output produced was being exported. The repeal of the US Sugar Agreement in 1974 meant that Nicaragua lost its preferential U.S. quota, but at that time prices were reaching a new high in world markets, and the prospects for Nicaraguan sugar exports were quite favorable. 11. In spite of the existence of an International Sugar Agreement, sugar prices are the most volatile of any commodity, and the world market is subject to sharp cyclical movements. Increasing prices lead to an overexpansion of production and to low prices in subsequent years, thus creating the preconditions for a new cyclical upswing. Consequently, prices are closely related to world stocks. They are depressed as long as stocks exceed about five months of consumption requirements, but once stocks drop below this level they become increasingly volatile, with very high prices recorded when stocks start to approach the four months supply level. Prices peaked in 1974-75, but production had expanded rapidly, stocks had increased, and prices subsequently became depressed once again. Low world prices persisted until 1979, and ISA had to reduce the scope of its expansion and US$2.5 million of the IFC loan was cancelled. 12. All the sugar mills suffered physical damage and working capital losses during the revolution, and all except ISA were placed under state control when the new Government came into power. By 1980, ISA still accounted for 2,112,848 qq., or most (56%) of the nation's total output of 3,740,000 qq. The balance of 1,627,368 qq. was produced by 4 of the 5 state owned mills. The rehabilitation of ISA to almost full capacity operation of 3,000,000 qq. p.a. was.financed under the Bank's first rehabilitation project. As world prices had begun to rise rapidly in late 1979 and continued to do so in 1980, ISA's increased capacity utilization would meet not only domestic needs but could be readily exported as well. Cotton Ginning 13. Cotton must be processed soon after harvesting and most of Nicaragua's 26 cotton processing plants containing 32 gins were established during the 1950's and 1960's when cotton production was undergoing its period of greatest expansion. About 85% of the land under cultivation is in the Leon-Chinandega area, and 22 of the gins are located there. The balance of the crop is grown in the Carazo-Granada region, where 4 gins are located. Prior to the revolu- tion, about 250,000 ma. were under cotton cultivation, but during this upheaval the area under cultivation was reduced by about four-fifths. After the revolution, 9 gins were transferred to government ownership. Of these, only 1 operated during the 1980 harvest, and the others were not rehabilitated due to the small size of that year's cotton crop. The state gin accounted for about 7% of processing output (7,054 bales) and most of the crop was ginned by private firms. The rehabilitation of 7 of the other 8 state-owned gins was financed under the first rehabilitation project. One of the major goals of the new government was to restore cotton output, and in the 1979 fall planting, the area under cultivation was increased to about 150,000 ma. -54- ANNEX 5 Page 5 14. Partly because of the lack of migrant labor from neighboring countries, the government has had difficulties in organizing the 1981 spring harvest, which has to be picked by hand. As of mid-March 1981 ENAL estimated that 270,000 bales had been packed and that about 17% of the crop has not been picked. Some of the remaining crop had already fallen to the ground and has been affected by early rains with consequent loss of quality due to higher moisture content and impurities collected. As a result, although most of the crop will eventually be picked, the quality (and therefore the price) of a substantial portion of the cotton picked in March-April will be lower than expected. During the past 5 crop-years, cotton production has been the following (number of 500 lb. bales): 1976/77 1977/78 1978/79 1979/80 1980/81 (estimate) 525,000 540,000 499,000 98,000 325,000 The state-owned gins are expected to process about 30% of the 1981 cotton crop (i.e. about 95,000 bales), while private gins would continue to process most of the crop. The government's policy for the future is to increase cotton output over the 1981 level, but to maintain it below the high levels of the mid-1970's and to devote a greater proportion of arable land to production of basic grains. Consequently, cotton ginning will remain below installed capacity for the foreseeable future. 15. In the past, about 80-90% of the ginned cotton was exported, and ENAL expects to maintain this level of exports, as local production of textiles is still in the process of being rehabilitated. Nicaragua's major markets are in Europe which receives one-half of total cotton exports. For 1981, European exports of 150,000 bales are forecast, and Japan (60,000), China (50,000) and Taiwan (40,000) would receive the balance. B. Manufacturing Textiles 16. Little information is available on how this subsector functioned prior to the war, and only partial information on what its overall present status is. As a result, the review presented below had to be based on limited data - mainly plant visits to the two most important spinning and weaving firms in the sector - and does not represent a comprehensive analysis of the Nicaraguan textile industry. As the main rehabilitation needs appear to be in spinning and weaving rather than finishing, these areas are the focus of this review. - 55 - ANNEX 5 Page 6 17. The textile industry is presently structured as follows: (i) Spinning - 3 mills contain about 57,000 spindles, of which some 20,000 are in operating condition; (ii) Weaving - 5 mills (including the 3 spinning mills) with about 1,100 looms of which 300 are operational; (iii) Knitting - 7 mills with 90 circular knitting machines (60 for outerwear and 30 for underwear), of which 12 are in operation; (iv) Garment making - 12 major factories produce a wide range of clothing. There are therefore about 25 important enterprises in the textile and clothing industry, of which the state has investments in 16 (9 are majority state-owned). This industry relies on domestic cotton for its raw material inputs. Nicaragua cotton is short-fiber, and therefore it cannot be spun into a thread of more than 20 wt. The top quality grades are exported and the lower grades are sold to local textile firms. 18. The two largest firms, Textiles Fabricato de Nicaragua (FABRITEX) and El Porvenir, in the past accounted for all domestic spinning capacity and about 80% of weaving capacity. They are also the only integrated plants in the country, including dyeing in addition to spinning and weaving (FABRITEX also produces its own finished textiles). FABRITEX has produced thread only for its own use, while El Porvenir sold part of its output to the three other weaving mills. As El Porvenir has not been operating since the end of 1977, these firms have had to import all of their thread inputs since that time 1/. About a dozen medium-scale firms are involved only in the production of finished goods for the clothing industry, but very little information is available regarding their status. 19. Considerable confusion exists as to how rehabilitation of the textile and clothing subsector ought to be carried out, and the government is presently carrying out a study of how best to proceed. The study will be financed under the Bank's Preinvestment Fund Project, and a consulting firm has been selected (the same firm carried out a study for FABRITEX in 1975). Once the study has been completed, and its results made available to the Bank, a determinations can be made as to whether Bank lending to this subsector could be justified at that time. 1/ Annual imports of thread from Honduras and El Salvador presently are estimated at 2.4 million yards. - 56 - ANNEX 5 Page 7 Construction Materials Industry 20. The modern construction industry was begun by the Somoza family, when La Cementera, Nicaragua's only large cement plant was founded about 30 years ago. This led to expansion into other areas of construction materials production, and by 1970, virtually the whole industry was controlled by the Somoza family. Other investors only began to enter the field following the 1972 earthquake. Following the revolution, the Somoza enterprises were expropriated, and as a result, the Government's (COIP's) participation in the construction materials industry is about 70%. 21. With few exceptions, little physical damage took place in this industry. An important exception is PROINCO, which is a major provider of concrete aggregate and ready-mixed concrete and which suffered considerable losses as a result of physical damage to its fleet of concrete mixing trucks and field plants. PROINCO is presently producing at 25% of installed capacity. Considerable accounts receivable losses were incurred by several enterprises manufacturing cement blocks and pipes, asbestos-cement sheets and PVC piping. The most significant losses (in terms of total assets) were incurred by ALUMEX, an aluminum extrusion plant (also producing at at about 25% of capacity). 22. A total of fifteen enterprises comprise this subsector, with a total gross value of production of about C$230 million for 1980. Total employment for the subsector is about 1,300. The construction materials subsector has not been traditionally an important exporter in Nicaragua. Only three firms in the sector have exported in the past: ALUMEX, TUCSA and CICA (the latter two produce PVC piping). These three firms have lost their main markets which were El Salvador and Guatemala, and exports in 1980 only amounted to C$4.0 million. While the available information for the gross value of production of the seven most important firms in the subsector (La Cementera, NICALIT, MAYCO, PROCON, PROINCO, TUCSA AND CICA) during the first half of 1980 shows a decrease over the corresponding period in 1977, this can be attributed to the slow recuperation of construction activity rather than to other factors. In fact, during the first quarter in 1980, with the exception of La Cementera (which represents about 40% of output for the subsector), ALUMEX, PROINCO and all remaining enterprises in the subsector showed an operating profit. La Cementera's financial situation is expected to improve with a reactivation of the construction industry. With the exception of ALUMEX and PROINCO, which have a negative capital, other construction firms have a positive net worth. It can be anticipated that with increases in construction activity (particularly public works) this subsector will recuperate to its prewar level within a relatively short period. The main exporters in the subsector ALUMEX, TUCSA and CICA, will need to renew efforts to find markets. Metal-Mechanics Industry 23. In terms of gross value of production, the Government participates (either through majority or minority ownership) in about 75% of the metal- mechanics subsector. Enterprises with Government participation accounted for - 57 - ANNEX 5 Page 8 74% and 76%, respectively of total exports and employment in the sector, and two Government majority controlled firms, METASA and INCA, accounted for over 90% of COIP's exports for this subsector. 24. Ten Government majority owned enterprises cover a wide range of product lines including structural steel shapes, reinforcing bars, nails, steel fencing and metal containers. Two minority Government owned enterprises produce metal fencing and agricultural tools; but they have not been in operation since the war as a result of financial and physical looting. There are six privately held enterprises in this subsector, which manufacture primarily metal furniture, metal containers for the petroleum and paint industries and structural steel shapes. 25. With few exceptions, these industries suffered little physical damage during the war, but many suffered considerable working capital losses. Nevertheless, except for METASA, a large manufacturer of structural steel shapes for construction with majority Government ownership, and three smaller firms IMPLAGSA, ANISA and Ferro-Arte, production levels, while still substan- tially below prewar levels, are slowly increasing. (INCA, which manufactures steel reinforcing bars, nails and steel fencing, production activity is producing well above 1977 levels). One important contributing factor for the slow rise in'activity has been the difficulties in purchasing adequate levels of raw materials inventories because of lack of liquidity, slower than expected construction activity, and the loss of Central American markets. The latter has particularly affected METASA's production levels, though the new markets developed in Costa Rica and Panama have partially compensated for the loss of the Salvadorean, Guatemalan and Honduran markets. In general, most of the firms in this subsector are now profitable, with the notable exception of METASA which has continued to produce losses . All, but INCA, which suffered very large finished inventory losses, and REDELSA, have a positive capital base. 26. The most important firms in the subsector (INCA, METASA, Estructuras Rap and Intercasa, which account for over 50% of the production value in the sector) manufacture steel construction materials. The remaining firms in the sector, of which Van Lee (privately owned) is the largest, produce metal containers for petroleum byproducts or paints. Of less importance in terms of production value are the few metal furniture manufacturers (of which the largest is Standardsteel), and the agricultural and transportation equipment manufacturers (IMPLAGSA and EMEMSA, respectively). In general there is a need for better planning and rationalizing of production in the steel construction materials industries (particularly in METASA, which has a high level of obsolesence of equipment). Studies are presently being carried out by FINAPRI under COIP's direction to develop a strategy for this subsector which will assist in rationalizing production. Chemical-Pharmaceutical Industries 27. The gross value of production of the seven Government majority owned enterprises in the chemical-pharmaceutical subsector, represents about 39% of - 58 - ANNEX 5 Page 9 the total for the subsector. The Government has minority participation in five enterprises, who represent about another 39% of total production in the subsector. There are ten major 100% privately owned enterprises in this subsector which account for about 22% of the subsector's output. The chemical firms which are wholly or partially owned by the Government include industries involved in the production of insecticides, adhesives, inorganic gases and liquids, matches and paints. The private sector enterprises manufacture paints, soaps, adhesives, plastic bags, and insecticides. With few exceptions, such as the paint enterprise Kativo, which was completely demolished during the civil war, little physical damage took place in the chemical-pharmaceutical and plastics subsector. However, substantial losses in working capital (losses in accounts receivables abroad and looting of inventories) took place. During 1980, the subsector's output of C$450 million represented a decrease of 5% over 1979 and a 35% decrease over 1978. 28. The chemical industries are important to the country's exports. Of these, the most important firms, representing over 90% of total exports of the subsector, include Atchenco (a minority Government owned firm), which produces pine resin subproducts, sold primarily outside Central American, Elpesa (minority Government ownership), which produces caustic soda, liquid chloride and insecticides, primarily sold in the Central American market; Hercasa (minority Government ownership), which produces insecticides for cotton and Quimica Borden (100% private), which produces adhesives for wood products (mainly plywood) sold primarily in Central America. As a result of the political situation in El Salvador and Guatemala, both Hercasa and Quimica Borden have lost a significant portion of their market (particularly Hercasa, with exports primarily to El Salvador and Guatemala). Quimica-Borden has readjusted its market somewhat with the result that production previously directed to El Salvador and Guitemala is now being diverted to Costa Rica. Atchenco's production on the other hand, has decreased as a result of depletion of its forest reserves, at a time when export market conditions are quite favorable, and is planning to relocate some of its facilities. Considerable pollution and technical problems with Elpesa have kept production to levels well below maximum capacity. With the exception of Kativo (which is privately held and suffered total destruction during the war), the paint manufacturing industries (Micar-Quimica, with minority Government ownership, is the major producer with 60% of domestic sales) have recuperated to almost prewar levels. With the expected increase in construction activity these industries expect to surpass prewar levels of production. 29. COIP's majority participation in the plastics industries is very small, however, on a minority basis COIP participates in the most important firms in the sector. Policasa (financed under the first rehabilitation project), a minority owned Government firm which manufactures PVC subproducts, either as inputs for further processing or as final products, accounts for the majority of exports of the chemical group, and about 48% of COIP's total exports. Although its primary export markets in El Salvador and Guatemala were lost, Policasa has largely compensated for this by developing markets elsewhere (mainly in Costa Rica). - 59 - ANNEX 5 Page 10 30. The pharmaceutical industries in Nicaragua include two Government majority owned enterprises (Solka-Elfar and Prosan), one minority owned enterprise (Recipe) and four 100% privately owned enterprises (Rarpe, Ahler, Riego and E. Chamorro). Of these firms, Solka-Elfar is the country's most important pharmaceutical firm, producing about 30% of output, with Rarpe (100% privately held) a close second. The remainder of production is roughly equally divided between Government or mixed ownership firms and privately held firms. While production increased during and immediately following the civil war, a significant decrease took place during the first half of 1980. Lack of coordination between the Ministry of Health and the pharmaceutical industries and serious labor problems resulted in erratic inventory levels and serious transportation bottlenecks of some raw materials. The pharmaceutical sector in general did not suffer major financial or physical loss during the civil war. However, clearly there is a need to better coordinate, program and rationalize production of the pharmaceutical industry in the country. A UNDP project (RP/NIC/80/002) was approved in early 1980 to assist the Government in such an objective. 31. In general, with the exception of the chemical enterprises dependent on exports, the firms in this subsector seem to be making a satisfactory adjustment to the post-war environment. Better planning and rationalization of production is needed in the pharmaceutical group, but assistance is being provided by UNDP. With the exception of Prosan, the remaining enterprises in the chemical and pharmaceutical subsector show a positive capital base. Of the four majority Government owned enterprises in the plastics subsector two show a positive capital base (Esplasa and Promosa) and two (Esanica and Sisa) show a negative capital base. The remaining firms in the plastics subsector, have a positive capital base. C. Mining Mining History 32. Nicaragua has long been known for its mineral resources; specific- ally gold and associated silver, copper, zinc and lead. It has a long history of gold exploitation by foreign interests beginning with the period of coloni- zation in the mid-to-late 16th century. The Spanish, using indigenous labor, actively exploited the rich alluvial gold deposits (placers) of Eastern Nicaragua. In the 18th and 19th centuries the British and North Americans replaced the Spanish in the placer fields and gold continued to remain the key mineral resource to be exploitsd. In the mid-19th century substantial gold, silver and base metal (copper, zinc and lead) lode deposits were found; however, limited accessability and general political instability delayed the introduction of modern equipment for large scale mining of these deposits until the early 20th century. Mining of precious and base metals continued to expand until it levelled off in the 1940's, with gold and copper being the primary export products followed by zinc, silver and lead. The mines account- ing for 80-90% of the total production (between 3000 and 3400 tons per day of - 60 - ANNEX 5 Page 11 ore) were El Limon, Siuna, Rosita and Bonanza; all were majority owned and operated by North American firms (Noranda, Rosario, and Neptune Mining), relying on low cost local labor, and inhouse technology. 33. With the decrease in base metal prices after the Korean conflict, gold began replacing other metals (with the exception of copper between 1965-70 and zinc in 1974) as the primary source of revenue for the mining sector. In the 1960's and 1970's the overall production of metals in Nicaragua continued to decrease, apparently due to depletion of known high grade reserves and increased "down time" due to equipment failure and engineering problems at the mines. 34. Non-metallic mining (gypsum, calcium carbonate, limestone, kaolinite and bentonite) was a minor undertaking prior to the 1950's and early 1960's when it began to expand due to the increase in construction activity asso- ciated with the rapid urbanization of Managua and the growth of large-scale building associated with increased public works and the rise of industry. After the 1972 earthquake, the non-metallic subsector grew even more rapidly for a short time due to increased construction activity associated with the reconstruction of Managua. Most of these materials are mined for the domestic market; however, some (notably white gypsum, pure limestone and bentonite) have been exported to other Central American countries. 35. The mines of the non-metallic subsector are located in the Pacific Coastal region and were operated by local firms. Compared with the metallic mining subsector the non-metallic subsector is very small. Total annual production of calcium carbonate, limestone and gypsum was about 65,000 tons. 36. The revolution had a major effect on the mining industry. With the increased political instability in the late 1970s the foreign corporations ceased exploration activity and made no new investments in developing new deposits or replacing equipment. Operational repair and maintenance practically came to a standstill. A reduction in technical staff accompanied the slowdown in operations. As the political situation continued to deteriorate, the mines concentrated on exploiting easily accessible ore using only limited support staff. As a result, there was a substantial drop in gold production, proven reserves dwindled, equipment maintenance was seriously neglected, and inven- tories of critical supplies were substantially depleted. During the final days of severe fighting and for several months after the new government took control, mining activity virtually stopped altogether. The El Limon mine was completely abandoned, and all mines suffered vandalism, theft and neglect. Inventories, portable equipment, and vehicles were looted or destroyed. At El Limon, the theft of a large sum of gold bullion and a twin engine airplane occurred, and the main mine shaft was blocked, probably by the setting off of explosive charges. In the four years prior to the revolution, the production of gold averaged 65,000 ounces troy; however, during the revolution production dropped to one third of the four-year pre-revolution average. At present, the mines under state control are operating at approximately 62% of their installed capacity. Given their present status, this level of capacity is about the maximum that can be achieved. - 61 - ANNEX 5 Page 12 Structure of the Mining Sector 37. After the revolution the entire mining sector was nationalized. On September 20, 1980, the new government established a Vice Ministry, Instituto Nicaraguense de Minas e Hidrocarburos (INMINEH), to be responsible for all mineral and hydrocarbon resources of Nicaragua. Its objectives are to: (i) establish policies for the development and use of all mineral and hydrocarbon resources; (ii) regulate production of the state corporations; (iii) assess the national mineral resources of the country; and (iv) prepare, compile and analyze data necessary for rational planning and operations of the sector. The Vice Ministry also plans to develop a national technical group capable of conducting exploration and feasibility studies for development of mineral and petroleum reserves. Corporacion Nicaraguense de Desarrollo Minero (CONDEMINA),,one of the three state corporations under INMINEH, was established on November 2, 1979 to manage the development of the nation's metallic mineral resources. Corporacion de Minerales no Metalicos (COMNOMET), was established to manage the development of the nations non-metallic mineral resources. The third state corporation, Empresa Nicaraguense del Petroleo (PETRONIC), was established to manage the nation's petroleum resources. The rehabilitation needs of the sector are mostly in mining, particularly in the metallic mining subsector. Therefore, the discussion which follows emphasizes the needs of metallic mining. Less emphasis is placed on non-metallic minerals which are produced primarily for domestic use and not for export. Status of the Sector 38. After its creation, CONDEMINA was immediately faced with the task of rehabilitating the major gold and silver mines of Nicaragua (El Limon, Siuna, Bonanza, Rosita and La Libertad). the immediate problems that faced CONDEMINA were: (i) lack of qualified personnel to manage CONDEMINA, operate the mines and explore for new reserves; (ii) inadequate working conditions and reduced productivity of personnel; and (iii) destroyed, neglected and antiquated plant, transport and mining equipment generating high maintenance costs and frequent "down time". Due to a sharp rise in world prices of gold and silver in 1979, the government put a high priority on the rehabilitation of the mining sector, and in 1980 CONDEMINA was able to achieve 82% of 1978 production (59,000 vs 65,000 ounces troy). This is a remarkable achievement considering CONDEMINA was faced with major administrative and technical problems and received only limited private and bilateral assistance. For 1981, CONDEMINA hopes to achieve the 1978 production level. Production data for January 1981 shows that the 1980 level of production was maintained (40,000 tons of ore was processed and 5,701 ounces troy of gold was produced). However, given the existing problems of the subsector, it is questionable whether this level of production can be maintained, much less increased. - 62 - ANNEX 5 Page 13 CONDEMINA is aware of this situation, and its immediate goals are to replace stolen, war damaged, neglected and obsolete equipment and to secure foreign technical assistance to effectively operate the mines, train local personnel, reopen other existing mines, locate new ore bodies and improve working condi- tions for the miners. 39. Like CONDEMINA, COMNOMET faces similar problems of inadequately trained personnel, worn out or antiquated equipment and limited information on reserves. For 1980, COMNOMET had projected total production for calcium carbonate, limestone and gypsum at 81,765 tons; however, actual production only reached 79% of this goal. For 1981, COMNOMET hopes to increase total production by more than 47%. Given existing personnel and equipment problems, this increase is unlikely. Technical Assistance Needs 40. The mines are presently operating with very little technical expertise. Very few of CONDEMINA's 3,000 employees are qualified technical personnel. Therefore, CONDEMINA has.been in the process of recruiting entry- level foreign professionals who are well trained but with limited operating experience. These professionals will be supported by local technicians who were trained on-the-job by the previous owners. High level technical assis- tance for various aspects of mining is needed on a limited basis to assist in the direction of mining operations until the less experienced personnel can effectively operate the mines. CONDEMINA has received some bilateral aid in providing high level technical assistance for exploration and operation of the mines; however, this is not adequate to achieve full rehabilitation. Most recently, CONDEMINA has retained the technical services of an exploration firm, Leeman and Associates, to increase the known reserves of El Limon, La Libertad, Siuna, Rosita and Bonanza. The exploration program should increase the proven reserves significantly, and will provide the necessary technical assistance for short-term exploration, but the expertise necessary for develop- ing long-term exploration programs to locate new ore bodies is still needed. Annex 6 discusses a technical assistance program, to be funded by the proposed Bank loan, which would finance two foreign consulting firms to assist CONDEMINA in the operation of the mines, to improve working conditions at the mines, and to develop and initiate long-term exploration programs. 41. There are extremely few Nicaraguan's with formal training in the mining industry, and the contribution of the young foreign professionals and foreign consultants is limited to the length of their stay in Nicaragua. Therefore, local expertise must be developed through training by the consul- tants, as well as by formal university training. CONDEMINA plans to offer a scholarship program to attract Nicaraguan's interested in a career in mining. Annex 6 also discusses a program to assist CONDEMINA by providing scholarships for Nicaraguans to receive formal training in the mining profession. Working Conditions 42. To improve working conditions at the mines, CONDEMINA is actively upgrading living quarters in the camps for the mine laborers, as well as - 63 - ANNEX 5 Page 14 building schools and providing other infrastructure for the mining communities. To improve underground working conditions CONDEMINA is purchasing and installing pumps to dewater the mines, and new ventilation systems for better air circula- tion; however, CONDEMINA lacks the technical expertise to address more diffi- cult problems such as caving associated with weak rock structures and high underground temperatures resulting from the geothermal environment. Equipment Requirements 43. The present operational costs of extracting and processing one ton of ore at different gold and silver mines ranges from US$15 (open pit) to US 98 (underground) while production ranges from 50-575 tons per day. Except for one mill, all the others have excessive operating costs which are quite high compared to world-wide standards. For example, in most countries mines producing about 100 tons of underground ore per day have costs that generally range between $40 and $50 per ton. As output increases, costs should drop considerably below this level. The high cost of Nicaraguan mining is reflected in part in the inefficiency of ore extraction (open pit or underground), trans- portation, and plant (milling and benefication) operations, as well as the lack of qualified personnel directing operations, but it is largely related to the status of mining equipment. As stated above, equipment maintenance and repair was for the most part neglected over the past few year and in some cases, equipment was stolen and damaged during the revolution. Furthermore, much of the equipment in the mines of the Atlantic coastal region was intro- duced into Nicaragua 40 to 50 years ago, and shculd have been replaced long ago. As a result, repairs are commonplace, spare part inventories are low and breakdowns are frequent. Frequent "down time" leads to reduced production, and severely limits CONDEMINA's capability to increase capacity utilization over the present level of 62% of installed capacity. Consequently a major upgrading of equipment status is required, if CONDEMINA is to achieve rehabil- itation of the mining sector. CONDEMINA is aware of the equipment problem and has taken some steps to replace missing, damaged and neglected equipment, but requires substantial Bank assistance if this effort is to be completed. A list of equipment required is presented below: Milling and Construct- Extract. Explor. Maint. tion Misc. Trans. Total Equipment Equip. Equip. Costs Equip. Equip. Cost Bonanza 2,135,000 75,000 150,000 100,000 12,000 2,472,000 El Limon 1,328,000 400,000 2,000 12,000 1,742,000 Siuna 549,000 156,000 - - 57,000 762,000 Rosita 369,050 20,000 - - 62,000 451,050 La Libertad 150,000 200,000 - 12,000 362,000 Total: US$5,789,050 - 64 - ANNEX 5 Page 15 44. COMNOMET faces a similar problem, and has also prepared a list of equipment needs for the enterprises it controls. Its needs are indicated below: Equipment Other Fixed Total Milling Mining Transport Costs Costs Cal Sapoa 36,000 85,000 121,000 Cal El Pueblo 120,000 170,000 18,000 308,000 Empresa Dario 100,000 100,000 Yesera Centro 20,000 50,000 10,000 80,000 America Piedra Cal 360,000 360,000 US$969,000 Mining Future 45. The present status of the Nicaraguan mining industry gives some cause for optimism in spite of the lack of qualified personnel and equipment problems. Existing production capabilities and probable reserves, and renewed interest in old mines suggests that known reserves of at least five years duration exist, and that the potential for mineral exploitation has barely been tapped. However, immediate action must be taken if the future success of the sector is to be assured. Given existing rehabilitation needs, the mines are probably operating at their maximum production levels, even though these levels are substantially less than the installed capacity. With proper technical assistance and new or upgraded plant and extraction equipment, the mines can approach their capacities, at least in the case of the five major metallic mines. If a sound rehabilitation strategy is followed, gold produc- tion in the short-term can be increased by 20% in 1981 and another 20% during 1982. With the exploration, location and development of new ore boides, and with the opening of additional gold-silver mines, these production levels can be expanded substantially. - 65 - ANNEX 6 Page 1 NICARAGUA INDUSTRIAL REHABILITATION CREDIT PROJECT Technical Assistance and Training 1. Total technical assistance to be provided under the proposed project is expected to amount to about 216 man-months at an average cost of US$9,792 per man-month. Related training would involve 26.3 man-years of scholarhips, at an average cost of US$14,667 per man-year. The total cost for this compo- nent would be US$2,500,000 and would be directed primarily to assist FED, CONDEMINA, COIP, INAP and ENIPREX to upgrade their institutional capacity to carry out the proposed rehabilitation project and to meet their other respon- sibilities in the rehabilitation of productive industrial and mining enter- prises in Nicaragua. 2. The total cost of this component would be as follows: Consulting Services Scholarships (Man- (Scholastic Total Expertise months) US$ year) US$ US$ FED - subproject prepara- tion, appraisal, and supervision (4) 50,000 50,000 CONDEMINA - assistance to mines (60) 700,000 - mineral inventory (24) 280,000 Subtotal (84) 980,000 (20.0) 285,000 1,265,000 COIP - metal mechanics (30) 255,000 - food processing (48) 405,000 - pharmaceutical (26) 225,000 Subtotal (104) 885,000 ( 6.0) 85,000 970,000 INAP - accounting and public enterprise adminis- tration (12) 100,000 ( 0.3) 15,000 115,000 ENIPREX - export promotion (12) 100,000 100,000 Total (216) 2,115,000 (26.3) 385,000 2,500,000 - 66 - ANNEX 6 Page 2 The FED 3. Technical assistance would be provided in order to enable the FED, the financial intermediaries and subproject beneficiaries to upgrade their capability to prepare, appraise and supervise subprojects. The training required would be provided by consultants during the initial 12-18 months of project implementation. It would involve the following: (a) a 2-3 week course in project preparation and appraisal. The course would give equal emphasis to the study of principles of project preparation and appraisal, as well as to the analysis of actual projects, utilizing individual or group case studies, independent research, etc. The course work should cover a broad spectrum of industries, including all major industrial subsectors. (b) a 1-2 week course in project supervision. The course would emphasize the planning of supervision, monitoring techniques and reporting requirements. Special attention would be paid to a review of actual supervision work carried out under the project. 4. This program would involve 1.0 man-months of preparation and 3.0 man-months of course work, at an estimated cost per man-month of US$12,500. CONDEMINA 5. After the nationalization of the mines, an effort was begun to identify the technical assistance necessary to enable a fast and efficient recovery of the sector and assure its future growth. This task has largely been completed, and CONDEMINA has listed the technical disciplines of mining geology, hydrology, mining engineering, metallurgy, accounting and procurement as areas in which it requires technical assistance. CONDEMINA is in the process of recruiting young foreign professionals to fill the entry-level positions in these technical disciplines. In addition, CONDEMINA has iden- tified the need for technical assistance in establishing a national mineral inventory, oriented towards locating potential new reserves. As yet, only limited technical assistance has been provided through foreign private (US and Canada) and bilateral aid (mainly Mexico, Peru, and the Soviet Union). The most significant aid thus far is coming from a US exploration firm contracted to increase the known reserves at the existing mines. In order to provide the remaining intermediate and upper level assistance that CONDEMINA still needs, the following technical assistance would be provided: - 67 - ANNEX 6 Page 3 (a) a consulting firm specialized in mine management to provide intermediate level and upper level technical assistance to Nicaragua's 5 major mines 1/ in mining geology, metallurgy, hydrology, mining engineering, accounting and procurement. This assistance would involve about 60 man-months, and would include the following: - review and organize existing geological data related to major producing mines; - set up procedures for recording, disseminating and storing new data; - review inventory and procurement procedures, recommend action for improving quality of goods procured and reducing delivery time; - review accounting procedures for each mine, improve and standardize accounting systems; - direct work for calculating shape, size and grades of ore bodies (known reserves) and identify geologic problems that may affect access or extraction of the ore bodies; - assist in designing improved techniques for extraction of ore and recovery of metals; - assist in developing better recovery techniques for ore concentrates through improved milling and chemical precipitation procedures; - identify hydrological problems such as flooding and high water temperature and outline methods for reducing their impact; - design and implement programs for isolation of toxic chemical wastes; - produce a final report covering each of the five mines listing work completed, problems sited, improvements made, and recom- mendations. 1/ These mines are expected to be financed under the proposed project. - 68 - ANNEX 6 Page 4 (b) A consulting firm specialized in exploration geology to develop a mineral inventory for Nicaragua. This task is expected to require 24 man-months, and would focus on: - extensive review of existing data; - selective geochemical sampling; - limited geophysical surveys; - photo-geologic mapping with field checking; - outline a long-term exploration program to assess potential reserves; - prepare a final report on potential ore bodies. 6. The consulting firms can only provide technical assistance for a limited time, and professional staff working for CONDEMINA will be for the most part foreign and therefore temporary. CONDEMINA recognizes the potential future problem of being left with no experienced professionals, and it has conducted a survey at the national universities to assess the interest of engineering students to study for a degree in the mining profession. The survey showed that at present there are about 20 students who would be interested provided they receive financial assistance. As Nicaragua offers no formal training for the mining profession, scholarships are necessary and the proposed loan would finance 10 students for an average of 2 years of specialized training in mining engineering, mining geology or metallurgy. The cost for providing regional scholarships for 10 students would average US$1,200 per month. 7. The cost per man-month of mining consulting services is estimated at US$11,667 and the total cost of the mining technical assistance described above would amount to US$980,000. The 20 man-year of scholarships would cost US$285,000. COIP 8. Based on priority subsectors identified in the Government's 1980-81 economic program, the Ministry of Industry (MIND) has been identifying technical assistance needs in the state owned/controlled part of the industrial sector. Initially, MIND focussed on the textiles and metal-mechanics sub- sectors, and COIP and a number of state enterprises are presently receiving technical assistance (mainly sponsored by UNIDO and UNDP) in these areas. Under the proposed project, these on-going programs would be complemented by some additional technical assistance to the metal-mechanics subsector, and would be expanded to include food processing and pharmaceuticals. On this basis, the proposed project would finance the following: - 69 - ANNEX 6 Page 5 Metal-mechanics Subsector 9. COIP - the main objectives would be to introduce a system of cost accounting and cost standards for all COIP enterprises in this complex and to improve the capacity of METASA, a major firm, to deal with the design and construction of large structures. For this purpose, a cost accountant would work with COIP for one year to develop a cost accounting system at each plant. An industrial engineer (also for one year) would work with the cost accountant to analyse the production lay-out for each of these enterprises, make judgements about its efficiency, and make recommendations regarding its upgrading if required. In addition, METASA would require a civil engineer to assist in the calculation, design and construction of metallic structures for high-rise buildings. This assistance would be carried out over a six-month period. Total assistance to this subsector would amount to 30 man-months, for a total cost of US$255,000. Food Processing Subsector 10. The principal technical assistance needs identified in this subsector are linked to preparation of an inventory of technological resources in the subsector, identification of new technology, raw material alternatives, product development, and design of administrative, planning, and production controls. For these needs, two systems or industrial engineers would be needed at the COIP's food complex level for about 12 months each, to design and implement adequate planning and control systems at the enterprise level, conduct necessary studies for rationalization of production processes, and train the personnel to operate such systems. In addition to that, two electrical/mechanical engineers would be required for a period of 12 months each to help the food processing complex to design an appropriate maintenance program, and train technical personnel in its use. Funds would also be provided for regional scholarships for a masters course in food technology for a period of two years for three students. Average cost per student is estimated at about US$1,200 per month. Total assistance to this subsector would amount to 48 man-months of consulting services and 6 man-years of scholarships, at a total cost of US$490,000. Pharmaceutical Subsector 11. Technical assistance under the proposed project would be provided to help SOLKA-ELFAR, the country's most important pharmaceutical firm. An industrial planner/administrator would, during a 12-month period, establish an appropriate product mix by reducing, eliminating or adding new product lines, design control systems, (i.e. involving costs, inventory, financial reporting) and train the administrative staff in the enterprise. A chemical or industrial engineer would be required for about 4 months to design adequate technology for serum production and an industrial engineer (6 months) would advise the enterprise in the equipment maintenance program and train the technical personnel. A chemist/pharmacist (4 months) would assist the enterprise to establish a veterinary medicine division. Total assistance to this subsector would require about 26 man-months of consultants ' services costing about US$225.000. - 70 - ANNEX 6 Page 6 INAP 12. INAP requires assistance in designing an accounting system for individual public enterprises. A senior level accountant with international experience would develop a unified accounting system for COIP and other enterprises, which would form a base for establishing financial accountability and for improving financial planning and budgeting, and management information systems. In addition, INAP would select two senior government officials to attend a seminar at the Harvard Institute for International Development on public enterprise administration. Total assistance to INAP would amount to 12 man-months of technical assistance and 0.3 man-years of scholarships at a total cost of US$115,000. ENIPREX 13. Exporters of manufactured goods are faced with the need to expand existing export markets or develop new ones. In doing so, some of these firms will probably seek Bank financing. However, in many cases, these efforts will be hampered by lack of information and experience on how to achieve this goal. Consequently, technical assistance in export development would be provided through ENIPREX to assist industrial enterprises with export potential, as well as to train FED and financial intermediary staff to provide on-going assistance to their borrowers. It would include the following components: (a) production for export - assist firms to meet export production standards through upgrading of product design, packaging, quality and inventory control; (b) logistical support - help firms to resolve problems related to meeting of delivery dates (in particular those resulting from complex documentation requirements, difficulties in obtaining adequate transportation and import licenses); (c) export marketing - assistance in obtaining improved access to information on potential markets, identification of specific market opportunities, help in product promotion and in contacting local importers/distributors. 14. This assistance would involve approximately 12 man-months of con- sultancy services, to be provided during the commitment period of the loan. Additional assistance, as required, could be provided on an interim basis if the Bank agrees. The total cost of this assistance would be US$100,000. - 71 - ANNEX 7 NICARAGUA INDUSTRIAL REHABILITATION CREDIT PROJECT Selected Documents and Data Available in the Project File A. The Industrial Sector 1. Evaluacion de las Operaciones de sus Complejos Industriales y Empresas - Primer Semestre 1980: Corporacion Industrial del Pueblo. 2. Boletin Informativo Industrial 1980: Ministerio de Industria. 3. Technical Assistance Project Proposals for the Textile and Metal Products Industries: United Nations Development Programme 1980. 4. Nicaragua - Agricultural/Rural Sector Survey: Agroindustry and Agricultural Import Industries. IBRD/IDB/AID 1975 (unpublished report). 5. Informe de Actividades de AGROINRA, Enero-Junio 1980. Ministerio de Desarrollo Agropecuario. 6. Indicadores Economicos 1979. Banco Central de Nicaragua. B. The Mining Sector 1. A review of the Post and Present Status of Mining in Nicaragua. Consultant's report by Mr. K. Michael Cline, 1981. 2. Annual Report 1980. Instituto Nicaraguense de Minas e Hydrocarburos. 3. The Geology of Western Nicaragua: Tax Improvement and Natural Resource Inventory Project, Vol. IV. Parsons Corp. 1972. 4. Consejo de Recursos Minerales: Asistencia Tecnica Mexico - Nicaragua 1980. Gobierno de Mexico. C. The Financial System 1. Resumen de Actividades del Area Industrial 1978. Fondo Especial de Desarrollo. 2. Fondo Especial de Desarrollo: Informe Sobre Auditoria de Estados Financieros Combinados al 31 de Diciembre de 1979. Federico Cossio & Cia. 3. Informacion Trimestral del Sistema Bancario y de Otras Instituciones de Credito, Tercer Trimestre de 1980. Superintendencia de Bancos y de Otras Instituciones. - 72 - ANNEX 7 Page 2 D. General 1. Nicaragua: Comercio Externo 1979. Banco Central de Nicaragua. 2. Programa de Emergencia y Reactivacion en Beneficio del Pueblo 1980-81. Ministerio de Planification. 3. Programa Economico de Austeridad y Eficiencia 1981. Ministerio de Planificacion. 不