Tunisia - Small-scale Industry Development Project

Document of The World Bank Ff1 COy FOR OFFICIAL USE ONLY Report No.. 3266-TUN TUNISIA STAFF APPRAISAL REPORT FIRST SMALL SCALE INDUSTRY DEVELOPMENT PROJECT March 25, 1981 Regional Projects Department Industrial Development and Finance Division Europe, Middle East and North Africa Region 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 Currency Unit = Dinar (D) US$ 1 = D 0.40 D 1 - US$ 2.50 LIST OF ABBREVIATIONS AFI Agence Fonciere Industrielle (Industrial Estates Agency) API Agence de Promotion des Investissements (Industrial Investment Promotion Agency) BCT Banque Centrale de Tunisie BDET Banque de Developpement Economique de Tunisie BFT Banque Franco-Tunisienne BIAT Banque Internationale Arabe de Tunisie BNT Banque Nationale de Tunisie BS Banque du Sud CFCT Credit Foncier et Commercial de Tunisie CNEI Centre National des Etudes Industrielles (National Center for Industrial Studies) FOPRODI Fonds de Promotion et de Decentralisation Industrielle (Industrial Promotion and Decentralization Fund) SSI Small Scale Industries STB Societe Tunisienne de Banque UBCI Union Bancaire pour le Commerce et l'Industrie UIB Union Internationale de Banques UTICA Union Tunisienne de l'Industrie, du Commerce et de l'Artisanat  FOR OFFICIAL USE ONLY TUNISIA: FIRST SMALL SCALE INDUSTRY DEVELOPMENT PROJECT STAFF APPRAISAL REPORT TABLE OF CONTENTS Page No. I. INTRODUCTION .................1.. ..... l II. THE MANUFACTURING SECTOR ...........1 Performance and Issues ................ 1 Plan Realization and Prospects. 2 III. THE SMALL SCALE INDUSTRY SUBSECTOR ......... ...... 2 Structure and Performance ..................... 2 Basic Characteristics of SSIs. 3 Performance of SSIs. 3 SSI Development Constraints. 4 Program of Support for SSIs. 5 Incentive System for SSIs. 7 Administrative Support to SSIs. 7 IV. THE FINANCIAL SECTOR AND ITS ROLE ON SSI'S. 8 Central Bank's Role and Monetary Policy 8 Constraints of the Monetary Policy on the Banks 9 Cost of Capital .10 Financial Intermediaries and SSI Financing 10 SSI Financing .11 V. THE PROJECT .14 Project Objectives .14 Project Components .15 A. Financial Assistance .15 Target Group and Eligibility Criteria . 15 Role of Participating Banks ..... .............. 16 Project Appraisal Procedures .... ............... 17 Disbursement Procedures ..... .................. 19 Terms and Conditions of Subloans .... .......... 20 Remuneration of Participating Banks .... ....... 21 Central Bank Incentive ..... ................... 21 Risk-Sharing Scheme ...... ..................... 21 This report is based on the findings of pre-appraisal and appraisal missions, consisting of Mr. F. Batzella (Chief of Mission), Mr. J.F. Landeau and Ms. K. Nguyen, that visited Tunisia in December 1979 and April 1980. A post-appraisal mission with Mr. Landeau (Chief of Mission) and Ms. Nguyen followed in November 1980. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  TABLE OF CONTENTS (Continued) Page No. B. Technical Assistance ..... .................. 22 SSI Dialogue between the Government and the Bank ............................. 24 Proposed Loan Amount .......................24 VI. PROJECT BENEFITS AND RISKS ..... ................. 25 The Benefits ............................25 The Risks ........................ 26 VII. RECOMMENDATIONS ........................ 27 A. General Features of the Loan .... ........... 27 B. Agreements and Understandings to be Reached During Negotiations Concerning the Tech- nical Assistance Arrangements ............ 28 C. Agreements and Understandings to be Reached During Negotiations Concerning the Proposed Line ot Credit ...... ..................... 28 D. Agreement and Understanding to be Reached During Negotiations Concerning Policies and Measures for SSIs ..... ................... 29 Conditions of Effectiveness .... ............ 28 Annex 1 Selected Documents and Data Available in the Project File ........... 30  I. INTRODUCTION 1.01 This report appraises a project to provide financial and technical assistance to Small Scale Industries (SSIs) in Tunisia. The proposed proj- ect follows from the $5 million pilot SSI project (Loan 1505-TUN, approved December 23, 1977) associated with the seventh industrial credit line to BDET. 1.02 The project would include three main elements, namely: (i) a $29.35 million line of credit to the Government to be onlent to eligible SSIs through the intermediation of all Tunisian financial institutions willing to participate in the scheme; (ii) provision of technical assistance to new and existing SSI, chiefly through Agence de Promotion des Investissements (API), a government agen:y; and (iii) technical assistance to API to enable it to fulfill its function of reviewing subproject appraisal reports, for which the Bank loan includes a provision of $650,000. II. THE MANUFACTURING SECTOR Performance and Issues 2.01 During the last decade, the performance of Tunisia's manufacturing sector has been good. Real growth in the sector's value added increased from 6.4% p.a. during the 1960s to some 9.7% during 1970-1978. The manu- facturing share in total gross fixed capital formation increased from 11.7% in 1970 to about 20% in 1979. In response to the Government's objective of developing the private sector, private investments increased from 35% of total manufacturing investment during 1969-1972 to 58.5% during 1976-1979. The public sector retains control over a sizeable number of larger enter- prises (especially chemicals, construction materials and electrical mechani- cal projects) which still dominate the Tunisian industrial structure. In 1979, manufacturing was the leading sector in the Tunisian economy for its ability to generate employment (20,000 jobs or 45% of total new jobs). The subsectors most active in terms of employment creation are: Textiles, Electrical-Mechanical Products, Construction Materials and Wood/Paper/ Miscellaneous Products. In 1979, manufacturing exports amounted to some D 313 million, or 43% of all merchandise exports (crude oil exports excluded). These results have been fostered by the investment incentive framework and the establishment of institutions to promote and assist indus- try, such as Agence de Promotion des Investissements (API), and Agence Fonciere Industrielle (AFI). 1/ There remain, however, several sectoral issues 2/ of which the following are partially addressed by the proposed project: a complex system of administrative controls with regards to 1/ See Annex 24 of SAR for the seventh credit line to BDET for more details. 2/ See Tunisia-Industrial Sector Memorandum dated March 7, 1980 (Report No. 2751-TUN, Yellow Cover) for more details on the manufacturing sector as a whole.  - 2 - investment criteria, wage/price structure, tariff protection and import quotas; and weaknesses in the incentive scheme, particularly with regards to a more efficient creation of employment, the development of inter- and intra-industry linkages, and the decentralization ot manutacturing activities outside of Tunis and the coastal cities. Plan Realization and Prospects 2.02 In spite of good results in manufacturing, real growth in the manufacturing sector has been slower than targeted for the Fifth Plan (1977- 1981). Actual manufacturing investment for the first three years, at about 459.0 million Dinars, represented only 48% of the five-year projected total for the sector, essentially because of delays in a number of public proj- ects. About 59,000 new jobs were created by manufacturing industries, representing some 59% of the target set for the sector for the whole Plan period. Finally, exports of major manufactured commodities (olive oil, phosphates, textiles) were subject to considerable demand fluctuations in the world market. 2.03 Preparation of the Sixth Plan (1982-1986) is just starting and, therefore, no official projections are yet available. It is expected that the Government will pursue the same development objectives and policies as in the past two Plans. The outlook for the manufacturing sector over the 1982-1986 period is favorable. The Government is likely to put more stress on productivity, employment creation and exports. A larger share of the planned direct productive investments would be allocated to small- and medium-scale industries which can create employment at lower cost per job, contribute to industrial decentralization and help integrate the industrial sector. III. THE SMALL SCALE INDUSTRY SUBSECTOR A. Structure and performance 3.01 No comprehensive survey of the SSI sector has been conducted so far in Tunisia. The Industrial Censuses have only covered manufacturing enter- prises of 10 or more workers 1/, excluding from statistical data handi- crafts as well as the bulk of SSIs with less than 10 workers. It is felt, however, that, based on information collected from field visits to SSIs, the characteristics of larger SSIs (with more than 9 workers) generally apply to the smaller ones as well. The target group of this project includes all SSIs which employ less than 50 workers (para 5.03). 1/ Even so, the listing of enterprises covered by the Industrial Census is out of date, and does not include all enterprises of 10 or more workers that actually exist in Tunisia now.  -3- Basic Characteristics of SSIs 3.02 Tunisian SSIs, generally, have the same basic~ features ot small manufacturing firms as those in other countries at th- same level of devel- opment. The SSI firm owner is typically a crattsman-cntrepreneur who has started either as an apprentice, a merchant, or a migrant worker who has picked up new skills abroad. More recently, small industrialists estab- lished with FOPRODI assistance (para 4.15) tended to originate from the technical and administrative statf of larger enterprises or of Government agencies. Most small entrepreneurs are still unfamiliar with basic account- ing methods, inventory planning and other management techniques. As typical of a transition stage from traditional workshops to mire modern small pro- duction units, the production characteristics ot Tunisian SSIs vary greatly, even within the same subsector: technology is a mixture of very modern machinery and almost archaic equipment; workshops have poor layout but are housed in over-designed buildings. Because of their zmall size, SSIs, generally, have to rely on wholesalers or other middlemen for the supply ot their raw materials and for the marketing of their products, resulting in higher costs and, at times, long delays. 3.03 According to the 1978 Industrial Census, there were 850 SSIs in Tunisia (defined as firms with employment between 10-50 workers, excluding handicrafts). These represented some 65% of all manufacturing enterprises surveyed (excluding handicrafts and firms with less than 10 workers), and accounted for 19% of total manufacturing employment. They generated about 13% of total manufacturing value added. Their investment in 1978 represen- ted 11.5% of all manufacturing investments. The subsectoral distribution of SSI is dominated by four activities mainly oriented towards production ot consumer goods for local markets: food products, electrical/mechanical products, construction materials, and textile/leather procucts. In 1978, these activities accounted for about 70% of the number, employment, value- added, and 90% of the annual investment of all SSI establishments. In general, the geographical distribution of SSIs follows the same pattern for larger industries, with the majority concentrated in the greater Tunis area and the regions bordering the east coast. There is indication however that SSIs have responded favorably to the government's policies ot decentralizing industrial activities towards the less-developed regions of the country; 30% of FOPRODI projects and the resulting employment creation approved by API (para 3.09) are to be located in the Northwest, Center West and South in 1979, compared to 19% in 1976. Performance of SSIs 3.04 According to the Industrial Censuses, growth in real annual SSI investment (estimated at 1970 prices) has been quite good, at 8.6% p.a. between 1973 and 1978. SSI employment has been increasing at some 7% p.a. over the same period, keeping well in pace with the growth registered for larger firms. SSI real labor productivity (as measured by value added per worker in 1970 prices) has essentially remained stable at about D 1,000 per worker between 1973 and 1978, compared to the slight increase in value added  - 4 - per worker for the larger firms (D 1,385 in 1973 to D 1,542 in 1978). This quasi-stagnation observed for SSI labor productivity compared to the growth in 5SI investments may be explained by the fact that most SSI investments realized during this period may have been for renewal of outdated capital stock. No data on fixed assets are available to allow further investigation of the SSIs' efficiency in utilizing capital and labor in their production process. Partial data show that SSIs tend to be relatively more labor intensive than their larger counterparts. Statistics about FOPRODI-assisted projects indicate an average investment cost per job of D 4,434 in 1979 (about $11,000), which is 40X of the average cost per job of larger non-FOPRODI projects approved by API in 1979. Overall data suggest that, in general, SSI is a dynamic sector, particularly in its ability to create employment, and deserves further promotional efforts from the government. SSI Development Constraints 3.05 The problems affecting the development ot Tunisian SSIs are not different from those observed in other countries at similar stages of development. They can be grouped into two major categories: problems that exist within the small-scale firm, and institutional problems stemming from the Government's policies for SSI development. 3.06 The internal problems which affect adversely the productivity of SSIs and constrain their growth include: limited access to financing, defi- cient production planning and accounting-management, poor product design and plant layout, at times inappropriate selection of equipment, and lack of quality control. Because of their small size, SSIs also suffer from short- ages of raw materials (most of which are indirectly imported through whole- sale dealers), and limited marketing capabilities (channeling through several intermediaries, thus adding further to the production costs). To help resolve these constraints, mechanisms for financial and technical assistance to SSIs have been set up, and they will be further strengthened in the context of the proposed project (paras. 3.10-3.15). 3.07 The institutional problems faced by SSIs, which this project will also address, are mainly: a limited access to institutional financing (para 4.14); a system of investment incentives linked to criteria into which SSIs do not fit well, such as the absolute size of employment creation and value of exports; 1/ and a dispersed institutional responsibility toward SSIs (e.g., the administration of regulations affecting SSIs lies within several 1/ To be eligible for the investment incentives of Law 1974-74 a new firm must create at least 10 permanent jobs, which eliminates the bulk of smaller workshops. Furthermore, firms employing 10 to 15 workers receive less concessions than larger firms, and the choice of technology is left unaffected. Law 1972-38 providing incentives for export- oriented enterprises benefitted mostly foreign firms without however promoting local subcontracting with smaller Tunisian firms. For more details, see Tunisia "Review of the Electrical-Mechanical Subsector," Report No. 2666-TUN.  Ministries and GoVernment agencies: Ministry of National Economy, Ministry of Planning and Finance, API, etc.) (paras. 3.16-3.19). 3.08 The curr=nt Plan has given greater attention to the SSI sub-sector because of its potential contribution to further creation of employment and geographic decent.alization of industrial activities. As discussed in the paragraphs below, measures have been taken by the Government to help resolve the above constraints, and further efforts will be made in the context or thc -roposed project to achieve an accelerated and more effective SSI development in the future. Program of Supporc. for SSIs 3.09 Financial Assistance. The first change in the Government's pre- vious attitude of benign neglect toward SSIs' specific needs was the crea- tion, in 1974, of the FOPRODI, a budget-financea fund intended to encourage SSI promoters, especially those with limited assets, and those located out- side of Tunis. between 1976 (year in which it became operative) and 1979, the FOPRODI has helped finance some 375 projects, with total investments ot D 43.0 million. The teatures and impact of the FOPRODI scheme are discussed in paras. 4.13-4.15. Further actions are detailed in the financial component of the proposed project design (paras. 5.03-5.24). 3.10 Technical Assistance. In recognition of the technical difficulties encountered by SSIs during their transition from traditional small shops to small but more efficient, modern production units, and in the context of the Bank Pilot Line of credit to SSIs, the Government has established, in 1978, a program of technical assistance for all SSIs in Tunisia. The program was originally organized around the regional network ot API; it was recently joined by another public agency, CNEI. API and CNEI share the same facili- ties at their seven local oftices. Various degrees of informal advising of SSIs are also being provided by other public or private agencies such as AFI for industrial intrastructure and land; and UTICA, a federation ot Tunisian employers to promote private business interests. Generally commercial banks do not provide technical assistance to SSIs. BDET has set up an SSI unit 1/ in Tunis in the context of the Bank Pilot Line. In the whole of Tunisia, as of now, there are about 40 fulltime professionals devoted to extend techni- cal assistance to SSIs. 3.11 API's technical assistance program is aimed at helping SbIs with the problems encountered during project processing, and especially during project implementation (production/financial management, marketing). Its regional network comprises 14 extension agents (two for each local office). These have been trained abroad and their activities are coordinated and supplemented by a core of six experts (including two expatriates) operating from API's headquarters in Tunis. API's activities consist of custom- designed consultations with individual enterprises for specific problems and collective actions (such as workshops/seminars on elementary accounting 1/ There is at present one full time statt to deal with BDET's SSI projects.  -6- principles, general management guidelines; dissemination of information through questions-and-answers sessions and various technical publications ot Who-produces-What). Since its beginning in 1978, API's staff have provided personalized assistance (from project preparation/processing to implementa- tion) to an estimated 100 enterprises. Its collective/informative actions are estimated to have reached at least 500 SSIs. 3.12 Available statistics on API's services to SSIs during 1979 suggest a lopsided concentration of API's assistance on new SSIs versus existing, ongoing concerns; on accounting/production management matters versus techni- cal production and marketing questions; and on individual/custom designed consultations versus collective actions. This tendency is somewhat imposed upon API by its clients' attitudes toward technical assistance and to some extent, the newness of its own experience in the field. API is conscious of this imbalance and has started serious efforts to widen the impact of its services. 3.13 CNEI has, because of its long-standing tradition of doing sectoral studies, thus far concentrated its activities on helping SSIs during the project preparation stage in carrying out their project teasibility studies at a modest fee. CNEI has a total of 60 engineers and economists, upon whom it draws to provide SSI assistance. Of these staff, 2 are devoted tull-time to SSIs at the Tunis headquarters, and about 14 are regional agents, doing SSI work. As of end 1979, CNEI had prepared 250 feasibility studies for SSI projects. CNEI's effectiveness until now has been more limited than API's, mainly because of the recent and limited SSI experience of its staff. Although there is no clear delineation in their respective scope of activi- ties, both API and CNEI have developed their own type of clientele, while still maintaining close cooperation and coordination at the regional working level. As the needs of SSIs for technical assistance are still much larger than the availability of such services in the near future, it is not neces- sary to rigidly delineate the scope of actions of either API and CNEI. CNEI is currently seeking to expand its present activities, and diversify into technical and management assistance to its old as well as new SSI customers (see para. 5.28). 3.14 Undoubtedly, definite progress has been made, in the past three years, to help SSIs, old and new alike, resolve some of the problems of a more efficient, modern production unit. The scope of the existing technical assistance activities remains, however, fairly limited in terms of number of SSIs and types of services rendered, mainly due to the shortage of staff with practical experience, and the reluctance of many SSIs to recognize and disclose their problems, and/or to trust outside advice. 3.15 For the future, both API and CNEI will need to strengthen their staffing and widen the scope of their technical assistance services. Also, new features should be added to the system of technical assistance to SSIs, such as promotion of subcontracting between small and larger enterprises, assistance in standardization, quality monitoring of selected products, and marketing. In the long-run, reliance on private consulting firms for speci- fic technical assistance actions to complement API's or CNEI's services may  -7- also become an attractive proposition to be considered. Specific actions to be carried out during the next two years have been reviewed and discussed between the Bank and API and CNEI (paras. 5.27 and 5.28). This dialogue will be continued in the context of the proposed project (para. 5.31). Incentive System for SSIs 3.16 The Tunisian authorities recognize that SSIs do not fit well into the existing standard incentive scheme to industry. In the context of its industrial sector work 1/, the bank has initiated a fruitful dialogue with the Government on investment incentives for SSIs. In December 1979, the Government has made some modifications to Law 1974-74 to allow for slightly higher benefits for SSI projects 2/. The main tenor of the fiscal exemp- tions under Law 1974-74 continue, however, to favor in a disproportionate fashion the larger investment projects and the larger number of work places created, without consideration for the efficiency of such employment. 3.17 Modifications to both the Law 1974-74 and 1972-38 are now being proposed and examined within the Government, to take into account expe- rience, as well as to reflect the sectoral priorities and industrial decentralization policies of the Government. In particular, the existing incentives are expected to be further fine-tuned by breaking down the current employment, regional and sectoral incentive-eligible categories into new, more refined classifications. Special emphasis would also be given to promoting sub-contracting. Finally, a subsidy (in the amount ot 1% of total investment cost, with a maximum of D 5,000) is also being examined to help industrialists cover partially or fully the costs of project teasibility studies. These changes are expected to be established in the context of the Sixth Plan. They are in the right direction, but more remains to be done. This would be pursued further in the context of our future sector dialogue with the Government as well as in the context of this proposed project (para. 5.31). Administrative Support to SSIs 3.18 There is at present no single agency catering exclusively to SSIs' needs in Tunisia. The responsibility for implementing the various 1/ See the Tunisia; Review of the Electrical and Mechanical Industries (Report No. 2666 TUN, dated June 4, 1980) and the Draft Industrial Sector Memorandum dated March 10, 1980 (available in Project File) for more details. 2/ They are, namely: investments creating less than 20 jobs are now fully exempted from customs duties and turnover taxes on imported capital goods needed for production; expansion projects creating at least 10 additional jobs benefit now from the same advantages as new projects creating the same number of jobs.  -8- administrative policies and measures affecting SSI is scattered among several different Government agencies (Ministry of National Economy, Ministry of Planning and Finance, API, CNEI, AFI, etc.). Lack of communica- tion and unified criteria among these agencies have hampered the development of consistent policies and of integrated programs in support of SSIs. The bureaucratic maze through which SSI promoters must go through at various stages of their project cycle and the absence of a recognized spokesman within the Government are deterrents to the promotion of the small entre- preneurship in Tunisia. 3.19 A Committee for SSIs was created in 1978 under the aegis of the Minister of Industry to encourage coordination between the institutions participating in the FOPRODI scheme (API, Central Bank, Treasury, financial institution, etc.). The meetings called by this Committee have helped raise general consciousness about the role of SSIs and their specific needs. This Committee, however, did not have the mandate and staff to formulate strategy guidelines for an accelerated SSI development. The Government has thus recently created within the Ministry of National Economy a new Department for Small Scale Industries and Modern Handicrafts to coordinate all policy activities and foreign aid for assistance to SSIs. The head of this new Department has been appointed and preparations are being made to recruit the appropriate staff. This is a positive step. The Government has agreed to keep the Bank informed of the work progress of this new Department, and to continue the SSI policy dialogue already started with the Bank (para. 5.31). IV. THE FINANCIAL SECTOR AND ITS ROLE ON SSI'S 4.01 The financial system in Tunisia is characterized by a relatively high number of banks and financial institutions per inhabitant. The finan- cial community is composed of ten commercial banks, seventeen local and mutual credit banks (Caisses Locales de Credit Mutuel), two development finance companies (BDET and COFIT, the latter specializing in tourism financing), a small investment bank (Banque Generale d'Investissement, which is entirely controlled by Tunisian private interests), five portfolio management institutions affiliated with either one of the banks or one of the several insurance companies, two savings institutions (Caisse d'Epargne Nationale Tunisienne and Caisse Nationale d'Epargne-Logement), and four offshore banks (whose activity is limited to foreign currency financing). Central Bank's Role and Monetary Policy 4.02 The banking system is controlled by the Banque Centrale de Tunisie (BCT) which, in addition to its function as currency-issuing bank and custodian of foreign currency reserves, acts as banker to the Government and to the commercial banks. It controls the banks and the credit supply through a variety of monetary policy instruments: various ratios designed to monitor the financial structure of the banks (among them the liquidity,  - 9 - solvency, and development financing ratios), rediscount rate, regulation ot interest rates on deposits and loans. BCT, however, has relied primarily on prior approval of credits and on rediscount ceilings to implement the Government's credit policy which is designed to encourage private investment while keeping a tight rein on the money supply. While the large industrial development projects, generally sponsored by public sector enterprises, are financed by the Government or through direct toreign borrowings, the authorities rely on the banking system for financing small and medium scale industrial development projects. Constraints on the Banks of the Monetary Policy 4.03 The monetary policy imposes two major constraints on the commercial banks, namely the development ratio and the ceiling on interest rates. Commercial banks are encouraged to participate in development financing by the requirement that a percentage of their deposits be transformea into medium-term loans to the private sector. When this ratio was introduced in 1963, it was set at 5%; it was gradually increased to 18%, its level since 1976. If a bank does not satisfy this requirement, it is penalized by having the counterpart of its shortfall frozen in a non-interest-bearing deposit at the Central Bank. In spite of the high opportunity cost in- volved, only three banks were complying with the 18% ratio at the end of 1979; three other banks were within one point of the required level. Compared to the end of 1977 and 1978 when eight and six banks respectively were above the limit, it was more difficult in 1979 for commercial banks to find bankable medium-term credit projects at the same rate at which their deposits were growing. 4.04 During 1980, more banks have been able to satisfy the ratio though it remains a constant concern and operational constraint for most of them. The Central Bank is currently studying a revision of the ratio definition that could help the banks meet the transformation target more easily. Several alternatives are considered with the common objective of letting the banks know well in advance their transformation target. The banks, thus, could plan better their medium-term lending strategy; this, in turn, could facilitate the use of the proposed loan. Because the definition revision might be implemented when the proposed loan becomes effective, the Central Bank agreed to keep the Bank informed of any developments in this respect. If, however, the redefinition is postponed, it will not affect adversely the project because of additional incentives given to the banks (paras. 5.23- 5.25). 4.05 The ceilings on interest rates imposed by the Government have deprived the banks of the incentive to take term risks beyond the 18% requirement and may have caused a rationing of medium- and long-term credits. 1/ In proportion to total outstanding loans to the economy made by 1/ While the banks earn a spread on short-term financing of about 6%, the average spread on medium-term credits does not exceed 3.8% which is not attractive enough to induce the banks to exceed the development ratio.  - 10 - the commercial banks, medium-term loans are disappointingly low--19% at the end of March 1980--while long-term loans maturing beyond seven years accounted for an additional 11%. Consequently, at the same date, as much as 80% of the term deposits and savings accounts received by the banks and 17% of their special resources (i.e., government long-term loans and government guaranteed foreign exchange borrowings) were used for granting 54% of all short-term credits outstanding at the end of March 1980, which is a sub- optimal allocation of term resources. Cost of Capital 4.06 Interest rates for rediscountable medium-term credits and long-term credits for industrial projects (respectively 8.25% and 9% 1/) have been r positive in real terms in recent years and are expected to remain positive in the future. A balanced budget and strict price controls have maintained inflation rates at about 7% a year or below. The official retail price index rose by 5.4% per year on the average between 1970 and 1978. Inflation was estimated at 5.4% for 1978, 7.6% for 1979, and 9.2% tor 1980. Over the commitment life of the proposed bank loan, the on-lending rate, assumed to be 8.25%, will be positive when compared with inflation rates projected to average 7% for 1981 through 1983. 4.07 Industrial projects located in the less developed regions of Tunisia are eligible for a five-point (5% )rebate on the interest rate. Out of the D 363 million of investment agreed to by API in 1979, 20% in number and 33% in investment volume were eligible for such rebates. This subsidy has been an effective factor in inducing decentralization of industries and appears, therefore, justified. Financial Intermediaries and SSI Financing 4.08 At the end of 1979, the total assets of the ten commercial banks amounted to D 1,360 million, of which D 950 million were in loans to the economy; total sight and term deposits amounted to D 882 million. The degree of concentration is, however, great. Three banks, BNT, STB and BS, account for 60% of the deposits because they are also the only ones to have set up a country-wide branch network, although two others, UIB and BIAT, are in the process of doing the same. 4.09 A certain degree of specialization has developed among the commer- cial banks. Since its creation by the Government in 1958, just after Independence, STB has become the largest commercial bank in Tunisia, reach- ing all sectors of the economy. BNT was created in 1959 as the National Agricultural Bank; it has since diversified its activities into other sec- tors, but continues to channel World Bank loans and other special resources 1/ 9% is BDET's nominal on-lending interest rate; with all the commissions and fees included, it comes to about 9.65%.  - -11l- to agriculture. Banque du Sud was established in 1968 to stimulate the economic development of the Tunisian South. UIB and BIAT have been estab- lished with some foreign capital participation relatively recently and still have to find an identity of their own in the banking system. 4.10 While commercial banks in Tunisia have limited project appraisal capacity, they, especially the larger banks, have begun to build up exper- tise in this respect. The credit departments of the commercial banks prepare short but competent reports on the projects they finance with medium term credit. These reports, however, focus on guarantees offered, market prospects, and projected financial statements of the enterprise, without providing an adequate analysis of either the choice of technology and the investment cost estimates, or the economic justification of the project. For the choice of technology and of equipment, they rely on the feasibility reports submitted by the promoters and prepared at times by the equipment suppliers, at times by consultants (such as CNEI, for example). For the economic justification of projects, the banks rely on the judgement of API, whose approval of all industrial projects is a condition for their financing. 4.11 BDET. BDET plays a key role in financing the Tunisian economy, having granted some 40% of all long-term credits outstanding at the end of 1979 and taken close to 20% of all equity participations (excluding cross- participations in other banks). In 1979 it provided 30% (on a disbursement basis) of all investment financing to the private manufacturing industry, up from 15% in 1965. To support its action, it received seven Bank loans between 1966 and 1977. A completion report covering the third, fourth, and fifth loans made in 1969, 1972, and 1973 has been prepared. Its main con- clusions are that, over the life of these loans (1970-77), considerable progress in terms of institution building was achieved; a major reorganiza- tion was carried out in 1972; the credit department stafting was expanded; a project promotion department and a follow-up division were created; under Bank guidance, projects appraisal was notably improved. SSI Financing 4.12 The proportion of the commercial banks' total lending going to SSIs is difficult to measure because only a few banks keep statistics broken down by size of projects financed. Although some banks grant credits to SSIs they judge to be reasonable risks (generally by virtue of the collateral they can offer), SSIs usually have difficulty in securing adequate credit. Two initiatives have been taken in recent years to remedy this problem: the creation of FOPRODI in 1975 and the Bank's pilot project unaer two 1978 loans to BDET/Government (Loans 1504/1505-TUN).  - 12 - 4.13 The FOPRODI Scheme. FOPRODI became operational in December 1975. It is a fund financed with allocations from the State budget and admin- istered by banks who signed an agreement with the Ministry ot Finance. 1/ It is intended to encourage the sponsors of small industrial projects, especially those without much capital assets and located outside the Tunis region. The financial assistance provided to eligible promoters 2/ takes two forms, which may be combined for the smallest projects: (a) A personal loan to the promoter to help him put down the equity (a minimum of 30% of the investment cost). The terms are soft; repayment over 12 years, including 5 years of grace, and interest rate of 4%; the only guarantee is an insurance policy on the promoter's life. r (b) A medium- or long-term loan for up to 10 years (including 3 years of grace) at 5% interest rate to help finance the smallest SSIs, whose investment cost is below D 75,000 ($187,500 equivalent). 4.14 375 projects, which probably would not have been promoted and financed otherwise, were financed between 1976 and 1979. They represented D 43 million of investment and more than 10,000 jobs created. Initially, only four banks (STB, BNT, BS and UIB) participated in the scheme; BDET and BIAT joined later. Data for 1979 indicate that out of 145 projects financed, STB's share was 47%, BNT's 23%, BDET's 16%, BS's 10%, and UIB's 4%; BIAT has only been active since 1980. The commercial banks have focused on the smallest category (less than D 75,000) whereas BDET directed the majority of its financing to the middle category (between D 75,000 and D 250,000). 4.15 By providing equity financing to SSI promoters, FOPRODI has suc- ceeded in improving their access to bank credit. The scheme has, however, some deficiencies. First, the application procedures are somewhat complex for the eligible promoters. Second, eligibility for FOPRODI assistance does not automatically guarantee that the project will receive the necessary com- plementary financing from the participating banks, in particular for working capital needs. Third, FOPRODI encourages only new projects and its assis- tance in financing the credit part of investments is limited only to the smallest projects. Because of these shortcomings, FOPRODI-assisted projects represented a small proportion (10%) of the 1,433 projects under D 500,000 of investment approved by API in 1979. 1/ For more details, see Annex 24 of the Staff Appraisal Report for the 7th line of credit to BDET, Report No. 1734 b-TUN dated November 29, 1977. 2/ Tunisian citizens with technical qualifications willing to devote themselves full-time to the new enterprise and sponsoring a project costing less than D 500,000 (US$1,250,000 equivalent) including working capital.  - 13 - 4.16 The SSI Pilot Line. The Pilot Line extended by the Bank in con- junction with the seventh Loan to BDET was designed to help remedy for the above shortcomings, to encourage SSI investments and more participation trom the banks in their financing, and to draw lessons trom the experience acquired. Out of the $7 million earmarked for this purpose, $5 million have been lent to the Government (Loan 1505-TUN) for onlending to new SSI projects, through the banks participating in the FOPRODI scheme; and $2 mil- lion have been lent directly to BDET (Loan 1504-TUN) to finance the expn"-ion of existing SSIs which are not eligible for FOPRODI assistance. The Pilot Line's target group was projects below D 200,000 of investment cost, including permanent working capital needs at 1976 prices (D 275,000 as of January 1, 1980) and with a ceiling on the investment cost per job of less than D 4,600 (D 6,300 as of January 1, 1980). The Pilot Line became effective on October 13, 1978, and after a slow start, it was fully com- mitted on January 30, 1981. Twenty-six subprojects have been approved for a total commitment of $4.95 million under the $5 million component, and eight subprojects tor $1.4 million under the $2 million component reserved for BDET. 4.17 Contrary to what was expected during appraisal of the Pilot Line, commercial banks did not compete for its use. While BDET has submitted fifteen subprojects, BNT has submitted seven subprojects, STB three, BIAT one, and UIB, and BS none. Commercial banks have explained their lack of interest by a combination of reasons: obligation to satisfy the development ratio out of their ordinary resources, lack of adequate guarantees otfered by SSI promoters, unattractive remuneration system, and cumbersome admin- istrative procedures. The use of special resources, such as Bank funds, does not count towards the satisfaction of the ratio. Thus, as long as a high liquidity situation prevailed, as in 1979, the banks preferred using their own resources rather than the Pilot Line. BDET which is not constrained by the ratio has therefore an edge over the commercial banks. 4.18 The lack of adequate guarantees is not a problem specific to the Pilot Line, but affects SSI financing in general. Banks are accustomed to take multiple guarantees (mortgage on land and buildings, chattel mortgages on equipment, and good will) which often cover 150% of more of the credits extended. This practice is, however, more difficult with SSIs, whose sponsors own modest, if any, personal properties. The problem is compli- cated when land registration procedures have not been completed so that no valid mortgages can be offered on lands and buildings. As a result, many SSI projects have been approved by API, then rejected by the commercial banks on a risk basis (in 1976 the rejection rate was 1 in 3). In contrast, BDET, being a development bank, has traditionally given higher priority to project appraisal than to guarantee prerequisites. Although the risk of loss under the Pilot Line on both the loan financed with Bank funds and the loan financed with the sponsoring bank's own resources is evenly shared between the bank and the Government, the banks considered this provision inadequate. 4.19 Because Bank funds are administered by the participating banks on behalf of the Government, the banks are not remunerated with a spread, but  - 14 - receive various commissions from the Government patterned after those they receive for the administration of the FOPRODI loans. Since the loan collec- tion responsibility is with the banks, most of their remuneration is linked to actual collection of principal and interest to avoid the build up of arrears. Added together, these commissions are equivalent to a 1.5% spread assuming smooth collection of the loans. Such a remuneration thus falls substantially short of what the commercial banks expect to earn (page 9, footnote). Consequently, commercial banks gave low priority to the use of Bank funds for SSI financing. This has, however, been less of a problem for BDET which has a developmental role to play and is guaranteed by the Govern- ment a 3-percent spread on its borrowed resources. 4.20 The proposed project has addressed the above shortcomings with three measures developped in agreement with the Tunisian authorities. First, the Central Bank agreed to increase a bank's rediscount quota by one Dinar for every Dinar it commits on the Bank loan. This increase in the bank's access to cheaper resources will partly compensate it for the risk of incurring the penalty of not meeting the 18% development ratio (para. 5.24). Second, the levels of commissions have been increased substantially (para. 5.23). Third, the guarantee scheme has been improved and extended to projects not eligible under the Pilot Line (para. 5.25). V. THE PROJECT Project Objectives 5.01 By contributing to the further development of small scale industries in Tunisia, the proposed project aims at the following set of objectives: (i) employment creation at an investment cost per job signif- icantly lower than the national average in the industrial sector; this will be possible because of the labor intensity inherent in SSI projects; (ii) fostering the development of a new class of industrial entre- preneurs in Tunisia, as SSIs are the training ground for industrial managers and technicians. In addition, the project also supports the Government's objectives of; (iii) encouraging the establishment of industrial firms in the less developed regions of Tunisia, thus helping alleviate regional imbalances; (iv) improving the efticiency of existing SSIs through the delivery of technical assistance to make them more competitive both in the domestic and in the international markets with regards to product quality, prices and delivery time; and  (v) improving intersectoral linkages, as more etticient SSIs will be able to undertake some of the operations needed in the pro- duction processes of larger industrial enterprises, including manufacturing components currently being imported. These objectives are consistent with the current policies ot the Tunisian Government as the 1977-81 Plan had identified among the main goals of the country's economic development efforts low-cost employment, SSI growth, and regional development. Preliminary information show that the same objectives will be given priority in the forthcoming Plan (1982-86) in preparation. Project Components 5.02 The project aims at meeting these objectives through a three- pronged approach by; (a) providing $29.35 million (para 5.30) to finance SSI medium- and long-term credit needs through the intermediation of all Tunisian banks willing to participate in the scheme; (b) fostering the development of delivery systems of technical assistance to SSI promoters, and (c) improving API's subproject appraisal capability. The ultimate achievement of the project's objectives also requires a strengthening of the Government's administrative structures concerned with SSI development, and an improvement of SSI related policies and legislation. The latter are long-term goals, towards which the authorities are gradually moving. A. Financial Assistance Target Group and Eligibility Criteria 5.03 The proposed line of credit will be open to all SSI subprojects which meet a maximum investment cost criterion, a labor intensity criterion, and are assessed to be technically, financially, and economically viable by API (para. 5.10). The eligibility criterion of size will be aligned to the Tunisian definition of SSIs, that is projects with an investment cost up to D 500,000 ($1,250,000) with, however, two qualitications. First, to ensure that permanent working capital needs get adequately financed, they will be included in the investment cost. This practice was initiated in the Pilot Line in an effort to change the Tunisian practice which is to have them financed with short-term credits. Second, to avoid financing small expan- sions of large concerns, the ceiling in the case of expansions (or modern- ization) will be D 500,000 ($1,250,000) of net fixed assets atter project realization. This is a reasonable departure from the Pilot Line. The Pilot Line ceiling of D 100,000 ($250,000) net fixed assets before expansion has proven to be unrealistically low and BDET has had difficulties finding expansion projects meeting this criterion. 5.04 To avoid favoring larger SSI projects over smaller projects, at least half of the loan amount will be reserved for projects with investment cost of less than D 250,000. Also, to ensure that the poorer promoters who  - 16 - are eligible for FOPRODI are not neglected by the participating banks, at least $10 million of the line ot credit amount will be earmarked for FOPRODI-assisted projects. 5.05 To ensure that subprojects financed under the proposed line of credit meet the employment creation objective (para. 5.01(i)), the invest- ment cost per job criterion introduced with the Pilot Line will be main- tained. For the purpose of computing the investment cost per job, the cost of land, which can vary widely between subprojects and is difficult to monitor, will not be included, but permanent working capital needs will. In the case of new or expansion projects, the ratio will be computed as addi- tional investment divided by number of jobs to be created. To allow for cases--expected to be small in number--where an SSI promoter is only replac- ing obsolete equipment without creating significant employment, the cost per job ratio will be computed as net fixed assets after project realization divided by number of jobs to be created and/or maintained. The investment cost per job created or maintained by the project should be less than D 6,900 in terms of January 1, 1981 prices, a ceiling which is the same in real terms as under the Pilot Line. This ceiling will imply some promo- tional effort by the participating banks, but it should not be an obstacle to using the proposed line because in 1979 average investment cost per job was below D 6,500 in all sectors (except in the construction materials and glass industries and excluding some large capital-intensive projects); for FOPRODI-assisted projects the average was D 4,400. Furthermore, as under the Pilot Line, the investment cost per job ceiling will be indexed twice a year to reflect inflation and a provision referring to the wholesale price index for industrial products has been incorporated in the Loan Agreement. 5.06 The calculation of the internal financial rate of return will be required for all subprojects, which are expected to yield a minimum rate or 10% over the duration of the proposed subloans. Furthermore, a simplified economic rate of return will also be calculated by API for subprojects with investment costs between D 250,000 and D 500,000 when the rate of nominal protection applicable to the proposed products exceeds 30%. For this pur- pose, the CIF price of the imported product will be used instead of the domestic price, and the labor cost will be reduced by 25% to reflect the difference between the market wages and the economic wages. It has been agreed that a minimum rate of 10% would be expected. Role of Participating Banks 5.07 Like the Pilot Line, the proposed loan will be made to the Govern- ment. The proceeds of the loan will transit through a special account in the Central Bank, and be made available to eligible SSIs through the inter- mediation of BDET and of the commercial banks participating in the scheme as in the Pilot Line. The banks sponsoring subprojects will be responsible for their appraisal under conditions spelled out in para 5.09 as well as for the disbursement and collection of the subloans and will be remunerated by com- missions proportional to the amounts disbursed and collected on the Govern- ment's behalf. Although the subborrowers' formal repayment obligations will  - 17 - be directly to the Government, the banks will share with the Government the ultimate risk of losses on the subloans. 5.08 The loan proceeds are intended to cover all direct and indirect foreign exchange costs of eligible SSI subprojects. In the interest of administrative simplicity, it has been agreed that, as with the Pilot Line, subloans will amount to up to 50% of the subprojects' total investment cost (as defined in para. 5.02). Based on the experience with the Pilot Line, this percentage represents a fair estimate of the foreign exchange component of SSI investments in Tunisia. Thus, the proposed loan would not finance, on average, any local currency expenditures. To ensure their involvement, the participating banks will finance at least 20% of each subproject's investment cost with medium-term loans made out of their own resources. As a consequence, the typical financing plan of an SSI subproject woulo be: 30% equity, 20% medium- or long-term loans from the sponsoring bank; 50% from the proposed Bank loan. These proportions may vary in particular for subprojects eligible for FOPRODI assistance because part of the equity can be financed with personal loans to the promoters, and/or with FOPRODI medium/long-term loans to the projects. Project Appraisal Procedures 5.09 Because of the insufficient experience of commercial banks with project appraisals in general and with Bank procedures in particular, estab- lishing direct legal agreements between the Bank and eleven different finan- cial institutions would be too cumbersome for this line of credit to SSIs, and it would be impractical to require all participating banks to submit directly to the Bank applications (and the attending appraisal reports) for the financing of subprojects under the proposed loan, considering their unfamiliarity with Bank procedures and standards. 5.10 Under the 1978 Pilot Line, BDET agreed to serve as an intermediary between the other participating banks and the Bank. BDET reviewed, on behalf of the Bank, all subproject appraisal reports submitted by the commercial banks, verified the subprojects' compliance with the agreed eligibility criteria, and submitted approval requests to the Bank. This procedure hampered the effectiveness of the Pilot Line for two reasons. First, BDET's limited SSI staff (para. 3.09) did not permit quick processing of SSI loan applications. Second, commercial banks' reaction was unfavor- able because they viewed BDET as a competitor interfering in their own affairs. 5.11 API's Role. To overcome this problem, API will be responsible for reviewing all subproject appraisal reports to ensure that subprojects are technically, financially, and economically viable (i.e. with appropriate technologic process, minimum financial profitability, and adequate economic evaluation) and also meet the three quantitative eligibility criteria (paras. 5.03-5.06). For projects not assisted by FOPRODI, this review on behalf of the Bank will occur after a Tunisian bank has decided to finance a project and proposes to use the Bank line of credit for this purpose. For  - 18 - FOPRODI-assisted projects, no additional step will be involved since pro- moters must go first to a bank and then to API for approval which, by law, must be decided within a month. For non-FOPRODI projects, however, there will be an additional step; this will concern about 60 projects. 5.12 Two measures will ensure that no undue delay will burden the pro- cessing of projects. First, to help API undertake and expedite the neces- sary review, a technical assistance component to API will be earmarked out of the loan proceeds. It will finance the cost over two years of two experts; one engineer to verify the technical viability of subprojects, assess their needs for technical assistance and help train API's staff in these respects (para. 5.29); and one economist/market expert to check the economic viability of subprojects and also train API's staff in market analyses. The terms of reference of these experts were agreed upon during negotiations. Short analyses prepared by foreign consultants such as to check whether a subsector receiving numerous applications is saturated will also be eligible for financing under this component of the Bank loan. The experts, expected to be hired from abroad, will be engaged for two years each at an estimated cost of $10,000 per man-month. The estimate includes all foreign exchange cost (salaries, travel abroad, and vehicles), but excludes office space, supplies, and other local costs, estimated at about $100,000 equivalent which would be financed by the Government. The total foreign currency cost involved is estimated at $650,000. 5.13 Second, there will be a Free Limit for subprojects with investment cost of less than D 250,000. For such subprojects, API's approval and the sponsorship of one of the banks participating in the scheme would be suffi- cient for the Bank's automatic authorization to finance the subproject with the proceeds of the proposed loan. However, because some of the banks did not participate in the Pilot Line, the first two subprojects submitted by each participating bank will be sent by the Central Bank to the Bank for review and approval. For subprojects with investment cost of between D 250,000 and D 500,000, the appraisal reports would be forwarded to the bank for approval after API's review together with API's comments. 5.14 This proposed review arrangement would permit the Bank, through its supervision of the proposed loan, to exert a direct influence over API's project appraisal and follow-up procedures and, through API, over the practices of all participating banks. The commercial banks would readily accept this monitoring role of API because API is already responsible for reviewing the feasibility reports of all industrial projects and appraising their financial, technical, and economic viability for their eligibility to fiscal incentives. 5.15 Supervision of Subprojects. Sponsoring banks, API and the Central Bank will each carry out supervision of bank-financed subprojects as they do normally for other SSI projects, but from different points ot view. To harmonize their different monitoring view points (essentially of risk assessment for the banks, granting of fiscal incentives for API, and eligibility in general and quality of rediscountable paper in particular for  - 19 - BCT), API will prepare for BCT and the Bank an annual supervision report covering all SSI subprojects financed under the line of credit on the basis of data furnished by the participating banks. The format will contain an analysis of data to show subsector and regional trends as well as stages of development of and problems encountered by each subproject. Detailed monitoring arrangements have been agreed with the Tunisian authorities during negotiations. These procedures will be incorporated into the Agree- ment between the Government, the Central Bank, API, and the participating banks to be submitted for the Bank's review and approval prior to the Loan's effectiveness. 5.16 Procurement. The goods and services required under the proposed project would be for the most part purchased by borrowing SSIs through local commercial channels. Given the size and type of subloans, competitive bidding is not feasible. BDET and the commercial banks, however, will ensure that procurement is carried out in an economically etticient manner. API, when reviewing the technical viability of subprojects, will ensure that borrowers have normally obtained at least three price quotations from suppliers/contractors. For subprojects above the Free-Limit, each appraisal will include a description of the procurement procedure to be used. Disbursement Procedures 5.17 Loan Administration Responsibility. The responsibility to admin- ister the Loan, maintain records, correspond with the Bank, and act as its agent for the disbursement of the Loan's proceeds will be undertaken by the Central Bank. This will not introduce an additional step in the processing of SSI subprojects as the Central Bank already reviews all medium-term loan proposals of the commercial banks for purposes of determining their eligi- bility to rediscounting, and their suitability to be counted toward the development ratio. 5.18 The Central Bank will periodically submit to the Bank requests to allocate Loan funds to subprojects submitted to it by the commercial banks. It will transmit to the Bank, the commercial banks' appraisal reports for subprojects above the Free Limit together with API's report. All documenta- tion concerning subprojects below the Free Limit will be kept in Tunisia by the Central Bank at the disposition of Bank supervision missions. There will be no preestablished allocation of Loan funds for subprojects sponsored by the various participating banks, which will be accommodated on a first- come-first-servedbasis. However, the Central Bank will monitor the loan commitments to satisfy the proposed allocations by subproject size/type (paras. 5.03 and 5.04) and will keep the participating banks intormed accordingly. It will also ensure that, for each subproject, the financing plan will include the 20% - minimum participation of the sponsoring bank out of its ordinary resources (para. 5.08). The pooling of different banks to finance the same project will be acceptable, especially for BDET which has limited access to local currency resources and may encounter difficulties in securing the necessary complement to the foreign exchange financing providea under the Loan. For the technical assistance component to API, the Bank will reimburse 100% of fully documented foreign exchange expenditures.  - 20 - 5.19 The Central Bank will submit to the Bank disbursement applications, together with full supporting documentation, subsequent to the requests to allocate Loan funds to specific subprojects. Disbursement applications could also be submitted periodically and for several subprojects at a time which the Central bank would receive from the participating banks. Bank disbursements will be made to the Central Bank, which would transfer the local currency counterpart of such disbursements to the account of the participating banks. The Central Bank will also centralize the collection of subloans repayments, and make the necessary repayments to the Bank in accordance with the amortization schedule, debiting the Government account for any shortfall resulting from arrears or aetaults of the subborrowers in their repayments to the sponsoring bank. 5.20 The final amortization schedule or the Loan will be prepared by the Central Bank after the Loan is fully committed, on the basis of the composite amortization schedules of all subloans. The Central Bank's agree- ment to carry out these administrative functions, to monitor the utilization of the loan proceeds according to the agreed purposes, and to regularly report to the Bank on the status of the Loan Account is reflected in the legal documents. No independent audit of the Central bank is proposed because it is adequately monitored by the Ministry of Planning and Finance. Terms and Conditions of Subloans 5.21 In order to put all sizes of industries on the same tooting as regards the cost of money, the interest rate payable by SSI subborrowers to the Government (through the participating banks) on the subloans made out ot Bank funds will be at least equal to the rate applicable to commercial banks' rediscountable medium-term loans to industry made out ot the banks' ordinary resources (currently 8.25% p.a.), except for subloans maturing beyond 7 years which could carry higher rates. The Government will absorb the difference between the cost of borrowing from the Bank and administering the proposed Loan, and the onlending rate of 8.25%. It rightly argues that increasing the onlending rate for the proposed project would unduly discrim- inate against SSIs, and that commercial banks would be reluctant to make use of the Bank's facility if this required a penalization of their clients com- pared to the interest rates which are offered on other loans. The question of the adequacy of the level of interest rates in general in Tunisia is being discussed in the context of the Bank's economic work. The toreign exchange risk would be assumed, as under the Pilot Line, by the Government, which is in line with the prevailing practice for Bank loans to financial intermediaries in Tunisia. 5.22 The maturity of subloans would be determinea so as to retlect the length of the economic lite of the equipment to be purchasec and the sub- borrower's debt service capacity. It will range between 5 years and a maxi- mum of 13 years, with grace periods of up to 3 years. Based on the experi- ence of the Pilot Line and of the Bank's other loans to BDET, it is expected that the average maturity of all SSI subloans will be about 9 years, includ- ing 2 years of grace.  - 21 - Remuneration of Participating Banks 5.23 A bank's intermediation for the proposed line of credit will be remunerated with: (a) a one-time commission of 3% of subloan disbursements on subprojects committed under the Loan during the first year after its effectiveness (for subprojects committed subsequently, the commission on disbursements will be 2%); and (b) a one-time commission varying between 7A and 1% of all principal and interest collected by the bank on behalf of the Government in repayment of the subloans (with 7% being payable in the case of full recovery of all amounts due, and 1% being payable when the bank recovers 50% or less of the repayments due by its subborrowers in the course of a given year). Based on smooth collection, this system of commissions offers the banks a remuneration of about 2% per year on Bank funds (to which the new Central Bank incentive, described in para. 5.24, must be added). This is slightly lower than what they would earn on medium-term loans made out of their own resources, but most banks believe this difference is reasonably offset by the special Central Bank incentive (para 5.24). The proposed system retains, the principle adopted under the Pilot Line that the banks' remuneration should provide an incentive to follow-up on the sub- borrowers' repayment. However, the levels proposed in (a) and (b) are twice of those under the Pilot Line to ensure that the banks' remuneration for administering the proposed Loan will not be significantly less than that they would earn on medium-term loans rediscounted at the Central Bank. A mission visited all the banks and BDET in November 1980 and was satisfied that the participating banks found this new set of commissions to be a substantial improvement that would help use the proposed Loan. Central Bank Incentive 5.24 One factor which discouraged commercial banks from using the Pilot Line was that subloans made out of its proceeds did not count toward meeting the development ratio (para 4.17). To address this difficulty, the Central Bank agreed to allow subloans made out of the Loan proceeds to entail an increase of the sponsoring bank's ordinary rediscount quota 1/ by an amount equal to the subloan. Commercial banks have reacted favorably to this new measure that would translate also into an additional remuneration of between 0.75% and 1.75% per year due to the differential between the interest rate prevailing on the monetary market (usually between 6% and 7%) and the redis- count rate (5.25%). This agreement is reflected in the legal documents. Risk-sharing Scheme 5.25 To ensure that the banks will follow-up on the repayment of sub- loans they will be required to share part of the final risk in case of 1/ Each commercial bank is given a quota of commercial paper which it can take to the Central Bank for rediscounting.  - 22 - irrecoverable arrears. To encourage SSI lending, the Government has agreed to increase the share of risk it is prepared to bear from 50% (under the Pilot Line) to two-thirds for FOPRODI projects. For non-FOPRODI SSI proj- ects (which were not financed under the Pilot Line), the Government agreed to guarantee 50% of the final risk. This relatively lower percentage is justified on the grounds that non-FOPRODI promoters can provide the guarantees required by commercial banks more easily than FOPRODI promoters who, by definition, have limited financial means. As under the Pilot Line, the sharing of risk will apply to the Bank loan as well as to the loans made by the banks out of their resources. The guarantee will only be acti- vated after a loss is ascertained and normal legal procedures to collect the arrears have been exhausted. Until then the bank sponsoring a sub- borrower in default will be obligated to channel back to the Government only the amounts actually collected. No formal funding of the guarantee scheme is required as the Treasury will stand by to finance all eligible claims. B. Technical Assistance 5.26 An effective system to deliver technical assistance to SSIs, whether or not they are recipients of Bank financial assistance, is essen- tial to the success of the project. As discussed in Chapter III, there are two major agencies providing technical assistance to SSIs, namely API and CNEI. Although progress has been made to help small entrepreneurs improve their project design, select equipment, obtain needed permits, and gain access to financial assistance, the level and scope of available technical assistance services are still much below the needs of SSIs. Both API and CNEI are currently preparing to consolidate their past achievements, and strengthen their respective organization and staffing to cope with future increase in the SSI demand for their services. BDET also plans to strengthen its small SSI division with the hiring of one new staff. 5.27 API's SSI work program for the next two years has been reviewed by the Bank and found satisfactory. It includes the creation ot a new local office in Kairouan and the hiring of at leat four new SSI technical agents. More importantly, API foresees an increase in the productivity of its staff, as the rapid build-up of their experience so far should permit them to provide technical, administrative and management assistance to about 150-200 enterprises per year from 1981 onward. In parallel to these custom-designed consultations, API plans to continue the collective exten- sion activities it has already started and will intensify them whenever appropriate and desirable in order to reach a wider coverage of SSIs (para. 3.12). API also recognizes the need to improve its capability to help SSIs in the technical design, the production standards and the marketing of their products. It proposes to tackle this issue partly through closer  - 23 - cooperation with specialized institutions, 1/ and partly through increased recourse to the specialized services of foreign experts on an ad hoc basis to be financed with bilateral aid or UNDP funds (para. 5.28). The Govern- ment agreed to provide the necessary support to API's technical assistance program for 1981 and 1982. Agreements have also been reached on the principle of periodic joint reviews by the Government and the Bank of the functioning and progress of API's SSI technical assistance activities. These are reflected in the legal documents. 5.28 CNEI is aware that its effectiveness in providing technical assis- tance to SSIs will depend on an improvement of its staff's problem-solving skills at the enterprise level. To this end, CNEI is now preparing an action program to benefit from a new UNDP grant of $650,000. This grant is to finance the needed foreign expertise and train the Tunisian staft in the delivery of technical assistance services to SSIs. Ongoing discussions between CNEI, the Government and UNDP on the orientation and scope of the proposed project are expected to lead to a program which should spell out: (a) the orientation of CNEI as an agency providing technical assistance to SSIs; and (b) the priorities and approach of CNEI's SSI assistance activi- ties, and a number of specific actions to be undertaken with UNDP's assis- tance. The Bank has discussed at length the above aspects with UNDP and CNEI, both of whom agreed on the need