China - Industrial Credit (China Investment Bank) Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 4009-CHA STAFF APPRAISAL REPORT CHINA INDUSTRIAL CREDIT PROJECT (CHINA INVESTMENT BANS November 23, 1982 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 EQUIVALENT Official Rate 1 Yuan (Y) = US$0.50 2.00 Yuan (Y) = US$1.00 (as of November 1, 1982) Internal Settlement Rate 1 Yuan (Y) = US$0.36 2.8 Yuan (Y) = US$1.00 FISCAL YEAR January 1 to December 31 PRINCIPAL ABBREVIATIONS AND ACRONYMS USED ABC - Agricultural Bank of China BOC - Bank of China CCAFM - China Consultants of Accounting and Financial Management CIB - China Investment Bank CIECC - China International Engineering Consulting Corporation CITIC - China International Trust and Investment Corporation CNTIC - China National Technical Import Corporation DFC - Development Finance Company GAFX - General Administration for Foreign Exchange GDP - Gross Domestic Product GOC - Government of China ICB - International Competitive Bidding MFERT - Ministry of Foreign Economic Relations and Trade MOF - Ministry of Finance NMP - Net Material Product PBC - People's Bank of China PCBC - People's Construction Bank of China PICC - People's Insurance Company of China SDR - Special Drawing Right SEC - State Economic Commission SPC - State Planning Commission UNDP - Un:Lted Nations Development Program  FOR OFFICIAL USE ONLY CHINA INDUSTRIAL CREDIT PROJECT (CHINA INVESTMENT BANK) STAFF APPRAISAL REPORT Table of Contents Page No. I. THEINDUSTRIALSECTOR .1................ . . . Characteristics .1 Performance: Growth and Satructural hnge. 2 Organization. 3 ProductionPlanning. 4 Investment Project Planning.5 Pricing System. 6 Problems. 6 Recent Policy Changes.7 II. THE FINANCIAL SECTOR. 8 Objectives. 8 Institutional Framework.8 Industrial Finance .11 Financial Statistics .14 TII. OBJECTIVES OF THE CHINA INVESTMENT BANK AND PROJECT .15 General .15 Technology Transfer .15 Improved Project Appraisal Methodology .16 IV. THE CHINA INVESTMENT BANK (CIB).18 Establishment and Autonomy .18 Management, Organization, Staffing and Training .18 Operating Policies and Strategies .20 Procedures .21 Lending Policies .22 This report is based on the findings of an appraisal mission to China in April 1982. Mission members were Stephen Ettinger (Mission Leader), Edgar Su, Helen Chan, Gene Tidrick, Adrian Wood, Josephine Woo, Shinji Ichishima (World Bank), Geoffrey Hilton (IFC) and Robert Gober (Consultant). Thisdocument has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - Page No. Subproject Pipeline . . . . . . . . . . . . . . . . . . . . 23 Resources, Financial Structure and Projections. . . . . . . 23 Accounts, Audit, Management Information and Reporting Requirements . . . . . . . . . . . . . . . . . 24 V. THE PROPOSED LOAN/CREDIT . . . . . . . . . . . . . . . . . . 25 Amount and Maturity . . . . . . . . . . . . . . . . . . . . 25 Onlending Terms.. ............. 25 Preparation Subloans . . . . . . . . . . . . . . . . . . . 26 CIB Technical Assistance and Training Component . . . . . . 26 Maximum Subloan Size and Free Limit . . . . . . . . . . . . 27 Procurement and Disbursement . . . . . . . . . . . . . . . 27 Environmental Safeguards. . . . . . . . . . . . . . . . . . 28 Benefits and Risks . . . . . . . . . . . . . . . . . . . . 29 VI. AGREEMENTS REACHED AND RECOMMENDATIONS . . . . . . . . . . . 29 ANNEXES 1. Policy Statement of the China Investment Bank 2. Development Strategy Statement for 1982-84 of the China Investment Bank 3. CIB Five-Year Financial and Operational Projections 4. Estimated Cumulative Disbursements of the Proposed Loan/Credit 5. Selected Documents and Data Available in the Project File CHART Organization of China Investment Bank MAP IBRD 16488 - China Industrial Credit Project  C-li TA INDUSTRIAL CRED)IT PROJECT (CHLNA INVESTMENT BANK) I. THE INDUSTRIAL SECTOR /1 Characteristics 1.01 China employs more people in industry /2 than does any other country. In 1980, China's industrial employment was 56 million, or about 66 million including brigade industries, many of whose workers are part- time. (Industrial employment in the USA, Canada, and Western Europe combined was about 60 million in 1976.) China is also one of the world's ten leading countries in total industrial production. In 1979, China produced the largest volume of cotton yarn and fabric, ranked third in cement and coal, fifth in steel and seventh in electric power. But manufacturing output per capita is only about 25% of the average for all middle-income countries and about 4% of the average for industrialized market economies. 1.02 Within China, industry is especially important in production, employment, and revenue generation. Industry's share of Net Material Product (NMP) rose from 28% in 1957 to 47% in 1980, as industry accounted for two-thirds of the increase in real NMP. Manufacturing alone accounts for about 35% of GDP, compared to only 13% for all low-income countries, 25% for middle-income countries, and 27% for industrialized market economies. Manufacturing's share of China's GDP now exceeds that of agriculture. Manufacturing has a much smaller share (13%) of total employment, but it has absorbed more new entrants to the labor force since 1957 than agriculture. Finally, industrial profits and taxes contributed nearly two-thirds of state budget revenue/3 in recent years and were equivalent to about the same share of total investment. About half of this revenue was reinvested in industry. /1 For details see the IBRD Economic Report, "China: Socialist Economic Development" (No. 3391-CHA, dated June 1, 1981), especially "Annex D: Challenges and Achievements in Industry." /2 In Chinese statistics, "industry" includes manufacturing, electric power, mining, logging, and services provided to workers within industrial enterprises. Manufacturing comprises about 80% of net output and 90% of gross output in industry. /3 But the large revenue from industry gives little indication of the ultimate source of industrial taxes or profits (see para. 1.16).  -2- 1.03 Manufactured exports were only 3.4% of gross industrial output in 1981, but accounted for half of total merchandise exports (reflecting the small share of exports in China's total production). Textiles were 17% of total exports, other light industrial products 15%, and heavy industrial goods 18%. Industrial exports have grown by about 20% p.a. (in real terms) over the past four years, and prospects for continued growth appear good. Local retention of a share of foreign exchange earnings (para. 1.23) is a main export incentive. 1.04 Industry has traditionally been concentrated in the coastal areas. The relative importance of these areas has declined due to the great effort made to disperse -industry. However, Shanghai alone still produces 13% of China's industrial output with only 1.2% of the population, and the three municipalities and seven provinces along the east coast produce 59% of total output with 37% of the population. 1.05 One other well-known feature of Chinese industry is the large number of small-scale rural factories producing for local markets. These are most notable in cement, agricultural implements, nitrogenous fertilizer, iron and steel, and paper, in which plants of widely varying scale coexist and produce for different markets. These were established on the principle of "walking on two legs" (large-scale and small-scale industry) designed to save on transport costs and capital, and to reduce the urban-rural income gap. Some small-scale Eactories have recently been criticized as inefficient and competing for energy and raw materials with more efficient large-scale plants. Performance: Growth and Structural Change 1.06 China has had one of the highest and most sustained industrial growth rates in the world, though it has fallen gradually in recent years. Gross industrial output grew at 18% p.a. during 1952-57 and at 10% p.a. between 1957 and 1980. This growth has been fueled by very high rates of capital accumulation, including the mobilization of underutilized rural resources for industry, and the ability of the planning system to channel resources into high priority investment, and was supported by a highly diversified machine building sector. But there have been periodic setbacks, followed by recovery, due to the disruptions of the Great Leap Forward (1958-60), withdrawal of Soviet assistance (1960), and Cultural Revolution (1966-76). The effects of this last disruption on industrial management and technology are still being felt. The growth rate of industry fell to 4% in 1981, as many heavy industrial factories were retooled to produce goods more in demand, as part of the economic restructuring (para. 1.22). 1.07 Industrial growth has been achieved at considerable resource cost. During 1953-57 capital per uinit of output remained constant, while labor productivity increased at more than 15% p.a. But during 1957-79 capital intensity increased by 3% p.a. and labor productivity growth slowed to 3% p.a., so that total factor productivity remained approximately constant. China's industrial growth was therefore due entirely to increased inputs, while its efficiency of input use stagnated at a low level.  -3- 1.08 One reason for growing capital intensity has been the priority given to heavy industry, whose gross output increased by 10.8% p.a. from 1957-79, while light industry's increased by 8.3% p.a. As a result, China's industrial structure is more heavily weighted toward heavy industry than are those of other developing countries. But since 1979 there has been a dramatic reversal of emphasis between light and heavy industry (Table 1.1), as China sought to satisfy growing consumer demand. Table 1.1: INDUSTRIAL GROWTH: PERCENT CHANGE PER YEAR IN GROSS OUTPUT Heavy Light Total industry industry 1970-78 (average) 10.1 8.2 9.3 1979 7.7 9.6 8.5 1980 1.4 18.4 8.7 1981 -4.7 14.1 4.0 1982 (projected) 1 7 4 Source: State Statistical Bureau and Official Statements. Organization 1.09 Chinese industrial organization is characterized by socialized ownership, planned production, geographically decentralized control and poor horizontal communications. These interact to create a highly complex system. Industrial enterprises are owned either by the state or by urban or rural (commune-owned) collectives. State enterprises comprise fewer than 25% of China's 355,000 industrial enterprises, but account for over 80% of net output, compared to 11.7% from urban and 6.5% from rural collectives./l State enterprises are on average much more capital-intensive than collectives, having over 90% of fixed assets but less than 60% of total employment. /1 There are also an estimated 580,000 industrial enterprises in production brigades (below the commune level) which are excluded from the statis- tics cited in the text. Many of these are only part-time operations and their contribution to total production is very small.  1.10 All state and collective industrial enterprises come under one of eleven central government ministries primarily concerned with manufacturing (e.g., Ministries of Chemicals, of Metallurgy, of Textiles, of Light Industries, etc.). A few key state enterprises are under direct national control, but most are supervised by the ministries' provincial- /1 or county- level bureaus. In the past three years, many enterprises have been grouped into corporations, an intermediate layer below the bureau. Provincial bureaus look to their central ministry for their production plans, to the provincial government for their labor and utility requirements, and to both for their financial and raw material allocations and investment approval. 1.11 Above the ministries are commissions which coordinate inter- ministerial activities. The most important are the State Planning Commission (SPC), which draws up production plans and approves major investment pro- jects, and the State Economic Commission (SEC)/2, which oversees implemen- tation of the annual plan and of policy directives of the State Council. These commissions are also duplicated at the provincial level. Production Planning 1.12 Because of disruptions and policy reversals, there has been almost no medium- or long-term planning since the First Five Year Plan ended in 1957, although a Sixth Five Year Plan (1981-85) has now been prepared. The primary instrument of economic coordination is the annual plan, which covers production of key commodities. The planning process is iterative, with proposals flowing up and down between enterprises at the bottom and the SPC at the top. The SPC matches supply and demand for key commodities and prepares final aggregate production targets for elaboration at lower levels of administration. Less important goods are controlled by provincial plans or local purchase agreements. The annual plan is integrated with a consoli- dated budget and a credit plan so that taxes, profit remissions, budgetary allocations and bank lending are consistent with overall macroeconomic balance and with physical production flows. But the availability and dissemination of relevant statistics to lower levels are often insufficient for effective detailed planning. /1 Three municipalities (Beijing, Shanghai, and Tianjin) are administra- tively equivalent to provinces, as are five autonomous regions (Xinjiang, Tibet, Guangxi, Ningxia and Inner Mongolia). /2 The SEC was greatly expanded in early 1982 when the Agriculture, Machine Building, Capital Construction and Energy Commissions, and part of the Science and Technology Commission, were absorbed into it.  -5- 1.13 The plan which comes down to the enterprise typically contains targets for physical production (historically the most important targets), output value, profit, materials and energy use, employment, production cost and working capital. Frequently both the market outlets and input sources are specified. With mostly quantitative targets, fixed prices (para. 1.16), assured markets and relatively little contact with users, enterprises have lacked incentive to improve product quality. Investment Project Planning 1.14 The level of approval for an investment project depends on its size, its location (some provinces have more autonomy) and whether import of technology is involved. Provincial Planning Commissions can normally approve projects up to Y 10 million. Beijing, Tianjin, and Shanghai municipalities and Liaoning province can approve foreign exchange payments of up to $5 million, and several other coastal provinces of up to $3 mil- lion. Large-scale projects must be approved by the SPC, and those involving foreign licensing agreements by the Ministry of Foreign Economic Relations and Trade (MFERT). Most subprojects under the proposed loan/credit would be approved at the provincial level. In all cases, many different agencies must "sign off" on a proposal before it is included in the annual plan, and thus eligible for allocation of construction material and equipment. 1.15 Each project must have a feasibility study which is supposed to cover a wide range of issues: objectives, justification, scale, inputs, output, investment and production costs, market, profit, transport require- ments, site, environmental aspects, and construction schedule. In addition to technical feasibility, the main investment criterion is whether the project is consistent with the plan and national economic objectives. But investment proposals are frequently not evaluated in their sectoral or national context, due to the absence of medium-term plans and to fragmenta- tion of responsibility for many individual industries among ministries as well as regions, with inadequate sharing of information about the national market or investment plans in the industry. Although economic criteria are supposed to largely determine project selection, there is no formal cost/benefit analysis, and insufficient examination of relevant alternatives with respect to scale, technology, location or timing. And projects may be poorly prepared technically because of lack of knowledge by the enterprise concerned, due largely to the scarcity of contact with firms making similar investments in other provinces or with foreign users of the technology, and to reluctance to purchase foreign software of any kind. Government is aware of these problems. The proposed project would be an important pilot effort for dealing with them.  -6- Pricing System 1.16 Prices are set by central or provincial authorities, according to the level of planning for the particular commodity. As prices are determined on the basis of Government's social and economic objectives rather than by supply and demand (essential producer goods are allocated administratively, and many basic consumer goods are rationed), and as most have remained essentially unchanged since the 1950s, relative prices do not reflect production costs or market scarcity. There are thus great variations in profitability among different industries. The rate of return (profits and taxes) on investment in 1979 in light industry equalled 48% of fixed assets plus working capital, compared to only 19% in heavy industry, because manufactured consumer products on average are priced relatively high compared to basic industrial products. And the high overall profitability of industry reflects in part the generally low wages and low prices of agricultural goods used as inputs. 1.17 In the past, prices and profits were not supposed to affect significantly the production decisions of either planners or enterprises. Planners were supposed to base decisions on the physical requirements to achieve targeted output levels. Enterprises should have been little influenced by profit considerations because they were constrained by numerous physical targets and turned over all profits to the state. However, as many enterprises now retain a share of profits, they have a strong incentive to favor more profitable products. Thus, realignment of prices would improve the efficiency even of centralized planning, and is especially important if investment and production planning are further decentralized. Otherwise price distortions will increasingly be mirrored in investment distortions. Problems 1.18 Although respectable rates of industrial growth are expected to continue, growth may be constrained by shortages of key inputs, especially energy, agricultural raw materials, foreign exchange and qualified managers, engineers and scientists. These constraints may become increasingly significant as growth of oil production slows, thus limiting foreign exchange earnings and energy supplies, and as the older generation of managers and technical experts retires, with insufficient trained people to replace them. 1.19 Moreover, there are important structural weaknesses in the industrial sector. Recent criticism from within China has centered on (a) structural imbalance, (b) production inefficiency, and (c) technological backwardness. Structural imbalance has arisen from overemphasis on heavy industry, excessive investment, and "production for production's sake." Over 1966-78, heavy industry received more than ten times as much investment as light industry. In addition, there have been shortages of many consumer and producer goods, excess production and inventory accumulation of some  - 7 - other goods, delays in completing investments because of overextended construction capacity, and complaints about the quality of consumer goods. 1.20 Despite "learning-by-doing" and technological improvements, use of labor and capital has not become more efficient since the 1950s (para. 1.07), which suggests, inter alia, problems with industrial management and investment choices. China is also an inefficient user of energy: the ratio of energy consumption to GNP is three times the average in other developing countries or industrialized market economies. Inefficient enterprises, once established, are hard to close down. A further source of inefficiency has been the emphasis on self-sufficiency within individual enterprises or regions, which sacrifices the benefits of specialized production and economies of scale. 1.21 Chinese officials are acutely aware of their country's relative technological backwardness, which is due in large part to China's prolonged international isolation and sometimes excessive emphasis on self-sufficiency. The designs of many new machines are 20 to 30 years old; shortages of certain alloys and other specialized products reduce machine life and performance; and a high proportion of existing equipment is over 40 years old. However, some Chinese machines, old as well as new, are still well-suited to China's needs, and China should not replace them indiscriminately. China has also often failed to make the best use of imported equipment because it lacked the necessary technical and management expertise. Recent Policy Changes 1.22 In 1979, Government launched a new economic strategy to correct some of these fundamental weaknesses and lay a sounder basis for sustained growtlh. The new strategy has two elements: a period of readjustment, and experimentation with reform of the price and incentive system. The readjustment emphasizes: (a) agriculture and light (consumer) industry (including for export) rather than heavy industry; (b) consumption at the expense of investment; (c) modernization of existing enterprises, particularly through importation of foreign technology; and (d) energy conservation. The readjustment policies led to a dramatic shift in the relative growth rates of heavy and light industry (para. 1.08). In addition, total investment dropped from 36.5% of national income in 1978 to about 30% in 1981, and Government plans to reduce it further to about 25%; however, total investment has fallen less than originally planned because the greater financial autonomy given to some enterprises and local governments reduced central control over investment. 1.23 The main thrust of reform is to decentralize economic decision- making and to rely more on the market to provide incentives and guide decisions. Three aspects are particularly relevant to industry: (a) profit and foreign exchange retention; (b) a gradual shift from grant to loan finance, primarily for light industry; and (c) relative price changes.  - 8 - Most industrial enterprises may now retain 10-30% of incremental profits, for specified uses including minor investments. In Shanghai, corporations can retain 10.5% of their subsidiary enterprises' foreign exchange earnings; their supervisory bureaus retain another 4.5%, and the municipality 15%. Guangdong and Fujian provinces can retain even more of their export earnings. In most other provinces, about 8% of export earnings are retained locally. These measures help decentralize investment decisions and give incentives to increase profits and exports. 1.24 The shift from grant to loan finance is intended to increase enterprises' sense of responsibility for their investments. In the course of appraisal and supervision, the People's Construction Bank of China (PCBC), which handles all capital construction grants and loans (para. 2.11), can modify or even reject projects. Both PCBC and the borrowing enterprises reportedly make greater efforts now to assure the financial profitability of the investments, and to reduce waste of resources. In this transition stage, interest rates on local currency loans are still low (2.4-3.6% p.a. for capital construction; 5.8-6.5% p.a. for modernization). 1.25 The shifts toward decentralized investment decision-making using loan- and self-finance increase the importance of continuing the rational- ization of prices to bring financial returns more into line with economic returns. The use of shadow prices (para. 3.12), while now essential for proper investment appraisal, is only a partial solution. Government apparently intends to make relative prices more rational; however, while some prices (mainly for agricultural goods and coal) have already been altered, fundamental change will necessarily be complicated and slow because of the income distribution and budgetary implications of price changes, fear of inflation, and the inherent complexity of the adjustment process. II. THE FINANCIAL SECTOR Objectives 2.01 As in other socialist countries, China's financial system has served mainly to channel government budgetary funds for approved purposes, and to help control state-owned and collective enterprises. More recently, increasing attention has been paid to using the banks to mobilize savings from enterprises, other agencies and individuals, and to increase investment efficiency. Institutional Framework 2.02 The banking system has been very closely tied to the Ministry of Finance (MOF), and has consisted of relatively few institutions, most of  - 9 - which were only reestablished by the 1979 banking reforms. The financial system at present comprises the People's Bank of China (PBC), four specialized banks (the Agricultural Bank of China (ABC); the Bank of China (BOC), which handles foreign exchange transactions; PCBC; and the newly created China Investment Bank (CIB) (Chapter IV), which will implement this project) and three other institutions (the General Administration for Foreign Exchange (GAFX); the People's Insurance Company of China (PICC); and the China International Trust and Investment Corporation (CITIC)). As of the end of 1981, 23 foreign banks had representative offices in China, but their activities there were very limited. 2.03 The People's Bank of China (PBC) was established December 1, 1948. In the early 1950s, it played a major role in controlling the hyperinflation inherited by the People's Republic of China, and in furthering the socialization of industry, commerce and agriculture. In 1958, with the Great Leap Forward, PBC branches came under the control of local Party committees, and established banking principles gave way to raising and disbursing funds for "backyard" iron and steel furnaces, etc. During the subsequent readjustment period, PBC was strengthened and partly recentralized. In 1966, at the onset of the Cultural Revolution, normal banking activities were largely suspended and PBC itself was afterwards incorporated into MOF. In 1976, PBC regained its independent, ministry level status directly under the State Council. 2.04 PBC is the administrative organ for government financial management, the central bank, and a commercial bank. In the first role, it: (a) adminis- ters budget revenue and expenditure; (b) manages cash reserves of local government units and enterprises; and (c) transfers and settles accounts throughout the country - as most enterprise transactions are conducted by crediting and debiting accounts with PBC, this enables PBC to monitor consistency with both the credit and physical plans. As the Central Bank, PBC: (a) prints and issues currency; (b) devises national plans for currency and credit; (c) formulates foreign exchange rates and interest rates; and (d) supervises ABC, BOC, GAFX and PICC. And as a commercial bank, it: (a) mobilizes savings of organizations and individuals; and (b) extends working capital and equipment loans. To carry out these diverse functions, PBC has over 18,000 units and 335,000 employees. 2.05 In the 1950s and 1960s, agricultural funds were usually handled by PBC, until the Agricultural Bank of China (ABC) was re-established in February 1979. ABC is in charge of banking and financial administration in rural areas nationwide. It: (a) manages various state agricultural funds; (b) supervises rural credit cooperatives; (c) guides and trains rural communes in accounting; (d) handles all deposits and loans of state agencies in rural areas and supervises their cash management and noncash transactions; and (e) provides working capital and equipment loans to communes and their sub-units, state farms and state-owned rural enterprises. ABC has some 27,800 branches and subbranches, and 284,000 staff.  - 10 - 2.06 Rural Credit Cooperatives, collective financial institutions owned by the farmers, operate essentially as the basic level institutions of ABC. There are more than 59,000 rural credit cooperatives at the commune level and at state farms, and 350,000 subordinate credit stations at the production brigade level. Rural credit cooperatives manage deposits and loans of the communes and their sub-units and individuals. Their deposits generally exceed loans, but the gap is narrowing somewhat: loans were only 22% of deposits at the end of 1979, but 30% at the ends of 1980 and 1981. The excess is deposited with ABC. 2.07 The Bank of China (BOC) was established in 1912 as a joint government/private bank. Until 1949, BOC concentrated on international banking, with a world-wide network of branches and correspondents, but did domestic banking as well. In March 1950, it received a new Charter and Board of Directors and became PBC's subsidiary for international finance, and in March 1979 BOC was reestablished as a separate bank. BOC's paid-in capital was increased from Y 20 million in 1949 to Y 400 million in 1975 and to Y 1 billion in 1980. BOC: (a) raises foreign currency funds from abroad; (b) settles accounts for foreign transactions; (c) handles overseas Chinese and other international remittances; (d) engages in foreign exchange and international gold transactions; (e) participates in international consortium loans; (f) undertakes consulting, trust business and investment; (g) handles foreign currency deposits and loans, and local currency deposits and loans related to international trade; and (h) through its overseas branches participates in other banking activities abroad. BOC has some 150 branches and subbranches, with total staff of 12,000, and has representative relations with over 1,000 banks in 144 countries. 2.08 The General Administration for Foreign Exchange (GAFX) was established in March 1979; the president of BOC serves concurrently as GAFX's director. GAFX has branches in most provinces; elsewhere BOC or PBC handles its business. CAFX formulates laws and regulations on foreign exchange,/1 verifies and supervises foreign exchange receipts and disbursements, and prepares consolidated foreign exchange receipts and expenditure plans. 2.09 The People's Insurance Company of China (PICC), a PBC subsidiary, established in September 1949, is China's only state-owned insurance company. It expanded rapidly during the 1950s, but its domestic insurance business was discontinued from 1958-80, and its international insurance was /1 The basic one is the "Provisional Regulations for Exchange Control in the People's Republic of China" promulgated by the State Council on December 18, 1980 and effective March 1, 1981.  - 11 - also disrupted temporarily during the Cultural Revolution. As China has diversified its foreign dealings, PICC has expanded its scope to cover virtually all types of international insurance. In November 1979, the National Insurance Conference decided to reinstate domestic insurance business on an experimental basis. PICC's gross insurance income now exceeds Y 1 billion. PICC has over 700 branches and subbranches, and more than 8,000 staff. 2.10 The China International Trust and Investment Corporation (CITIC) was inaugurated as a state enterprise, directly under the State Council, in October 1979. It has a paid-in capital of Y 200 million, authorized capital of Y 600 million, and a 44 person Board of Directors. CITIC acts as a "marriage broker", arranging compensation trade, co-production, assembly and processing, joint venture and trade contracts between Chinese and foreign partners. It also borrows funds abroad (including by selling bonds) to lend to or invest in such ventures itself. CITIC has also spun off the China International Economic Consultants Inc. Nineteen provinces and municipalities have set up similar international trust and investment corporations to promote and channel foreign investment. 2.11 The People's Construction Bank of China (PCBC) was first estab- lished in 1954, re-absorbed into MOF in 1958, partially resurrected during the 1960s, and formally re-established as a bank in November 1979. It is supervised primarily by MOF and secondarily by PBC. It has the main financial responsibility for investment in fixed assets, in both industry and physical infrastructure, through both grants and loans. PCBC, in close association with other agencies, examines the cost and other aspects of the proposed investments. It then handles disbursements, making sure that funds are used only for approved purposes, and seeking ways to reduce cost and construction time. These investments are made primarily in accordance with the annual plan, and financed mainly from the national and local budgets. The gradual shift from grants to loans for fixed investment, since 1979, has expanded the scope of PCBC work, and led to a major expansion; its 2,700 branches now have over 43,000 staff. While most of the loans have been financed from the budget, PCBC has also started lending out enterprise depreciation and development funds deposited with it in anticipation of future investments. As a related task, PCBC manages the budget and finan- cial affairs of state construction enterprises, and lends them working capital. In all of its programs, PCBC lends local currency only; enter- prises needing foreign exchange must look elsewhere (paras. 2.16-2.19). Industrial Finance 2.12 Industrial investment is divided into (a) "capital construction" (generally on new plants and expansions) and (b) "modernization, renovation, and technical improvement". During the 1970s, industry accounted for about 60% of total state capital construction, though with the share falling from  - 12 - 65% in 1970 to 53% in 1980. Annual capital construction in industry remained about Y 28-30 billion over 1978-80, but fell to Y 20 billion in 1981. Over the same period, light industry's share of this rose from 10% to 20%, and energy's share climbed from 42% to 50%, while the portion of other heavy industry dropped from 48% to 30%. Of the investment in light industry, almost half was for textiles and about one-sixth for food, beverages and tobacco in 1979. 2.13 All capital construction funds pass through PCBC. The finance comes from the central, provincial and local budgets, enterprise/ corporation/bureau retained earnings, PCBC deposits, and a variety of other "extra budgetary" funds at the local level. "Extra-budgetary" sources financed only about 10% of capital construction before 1970, rising to almost 20% in 1975-79, and probably more in 1980-81, due to (a) introduction of profit retention (para. 1.25), (b) PCBC lending deposit funds for capital construction beginning in 1980 (Y 1.3 billion in 1980 and about Y 2 billion in 1981), and (c) efforts to reduce capital construction through tight budgetary restrictions. The central budget has traditionally been the primary source, but its share is now down to about half. By 1981, some 15% of capital construction was loan-financed, mostly in light industry, energy and mining. The large majority of heavy industrial investment is still financed by grants, but most light industries are now financed by loans /1 (at 3.6% p.a. interest, with an average five-year maturity). 2.14 Modernization and improvements have been financed by loan programs starting in 1964 for investments below Y 200,000 and in 1972 for up to Y 1,000,000 by PCBC, and since 1979, with no set ceiling, by PBC. PCBC and PBC each lent about Y 2 billion for industrial modernization and improve- ments in 1981. PBC began its program, using deposits, to conserve budget funds. The average loan amount has been about Y 400,000, and the maturity period 1-3 years. The two programs are similar, except that PBC's loans are generally limited to equipment, without civil works, and are financed by deposits; PCBC lends primarily special central and local budget allocations. PCBC has a number cf categories of modernization loans, with separate aggregate lending ceilings, of which light and textile industries and export-oriented projects are the most important. PBC's main categories are light and textile industries, and energy-saving projects. Modernization of commune industries is financed by ABC. Most working capital loans for communes come from ABC, for construction firms from PCBC, and for other enterprises from PBC. /1 Except for projects which are financially unprofitable, or for enter- prises which are not independent accounting units.  - 13 - 2.15 The interest rates on modernization and working capital loans were increased in 1982 from 5.04% p.a. to 7.20% p.a. for working capital, 5.76% p.a. for modernization loans of 1-3 years maturity, and 6.48% for 3-5 year loans. The average maturity period on modernization loans is only 2-3 years, and for capital construction for light industries about five years, because of the high financial profitability of most light industries due to low input prices and high output prices (para. 1.16). Aggregate lending from deposits for each purpose (capital construction, modernization, working capital) is incorporated in an annual credit plan prepared by PBC and approved by the SPC, based on both the expected availability of funds and the project proposals received. The plan is revised as necessary during the year. The increase in interest rates is expected to attract savings and induce enterprises to economize on fixed investment and working capital. However, the allocation of investment resources in China continues to be made primarily administratively, rather than by interest rates. 2.16 China's import of machinery and equipment, excluding vehicles, jumped from an average of $1.0 billion during 1975-78 to $2.5 billion in 1979 and $3.9 billion in 1980. Enterprises requiring foreign exchange for equipment and technology may obtain it in a variety of ways. Many high priority projects in the plan get permission to buy foreign exchange from BOC,/1 using grant or loan funds or retained earnings. Other projects, especially those which would earn foreign exchange and which might need assistance in management, technology or export marketing, might be proposed for joint ventures (of which 29 were approved in 1979-81), co-production (similar to joint ventures, but with no Chinese capital), compensation trade (where the equipment supplier agrees to accept Chinese exports, generally but not necessarily from the project itself, as repayment of the loan), or assembly and processing of imported materials/parts, for export. Reportedly, some $1.5 billion has been obtained for coproduction ventures (of which more than 400 have been approved) and $0.3 billion under compensation trade during 1979-81. CITIC and similar bodies at the provincial level often help arrange such investments. 2.17 Export-oriented projects needing to import only relatively small items of equipment can obtain direct BOC loans. Over 1973-81 BOC lent $1.13 billion /2 for equipment imports for some 4,000 projects, of which $0.37 billion remains outstanding. These loans have averaged three years maturity, with a seven-year maximum for very large projects. About 70-80% of the funds went to light industry. However, most of this was during 1977-79, and lending dropped almost to zero in 1980 and 1981 when the interest rate was raised from 7% p.a. to 14-17% p.a. and producers of export products were allowed to retain a portion of their foreign exchange earnings. /_ At the "internal settlement rate" of Y 2.8 = US$1. /2 Loan approvals totalled $1.8 billion, but about one-third was never used.  - i4 - 2.18 in addition, BOC handles bilateral buyers' credit arrangements with foreign countries, whereby subsidized funds (recently increased from 7-8% p.a. to about 10% p.a.) are provided by foreign banks for purchase of equipment, usually in the financing country. Suppliers' credits are also available from several countries, mainly for larger contracts (e.g. the US Export-Import Bank has a $5 million minimum). Although about $17 billion of credit lines have been negotiated since 1978, only a small fraction has been used so far, in keeping with: (a) China's general reluctance to incur foreign debt; and (b) the investment slowdown during the readjustment (para. 1.22) which began after most of these were negotiated. 2.19 Despite this variety of foreign exchange sources, it has remained quite difficult for many enterprises, especially small- and medium-scale ones and non-exporters, to obtain foreign exchange for investment, because of tight Government restrictions on its use and because many of these sources did not address the need for complete projects integrating imported equipment with local equipment and civil works. But two recent developments are changing this. First, starting in 1982, BOC has begun using the available buyers' credit lines more, and supplementing these, as necessary, with its own foreign exchange, also lent at or slightly above 10% p.a. Secondly, CIB has now been established, and w:ill begin operations using the proposed loan and credit, bringing to bear PCBC experience in investment finance, as well as new approaches to project appraisal and technology transfer. 2.20 Defaults under all of the PCBC, PBC and BOC credit programs have been virtually nil, due to: (a) the high profitability of most light indus- tries (para. 1.16); (b) the relatively low degree of uncertainty regarding their profits, given fixed prices and guaranteed markets; (c) financial controls on the enterprises which assure that loan repayment is given first priority; and (d) loan guarantees in all cases from supervisory bodies. Modest penalty rates (20% above the regular interest rate) are applied to overdue payments, and higher ones (50% above the regular interest rate) for diversion of loan funds. Financial Statistics 2.21 China makes very few general financial statistics public. The banking statistics published by PBC consolidate PBC, BOC and ABC data, and provide little detail. BOC also publishes separately its summary balance sheet. PCBC makes few loan data public; in fact, PCBC apparently does not even have comprehensive aggregate internal data on its loan disbursements, outstandings, etc. It is not clear how much of this is due to poor statistical systems within the banks, and how much is an effort to keep most banking data confidential.  - 15 - III. OBJECTIVES OF THE CHINA INVESTMENT BANK AND PROJECT General 3.01 The creation of CIB and the proposed loan/credit grew out of China's new industrial priorities and the desire to help further improve investment efficiency in China's industrial sector. A development finance company (DFC) which focusses initially on modernization/expansion of existing light industrial enterprises fits in well with Government's readjustment strategies of increasing production quantity and quality with the minimal investment necessary and correcting the imbalance between heavy and light industry. CIB is also expected to support the reform objective of improving project design and selection criteria. CIB was set up both to help fill a gap in foreign exchange industrial finance (para. 2.19) and to address some of the central issues in improving investment efficiency by (a) helping to organize transfer of foreign technology to investing enterprises, and (b) improving project appraisal methodology, within a broader economic and sector perspective. Technology Transfer 3.02 Industrial technology in China has generally lagged behind that in more developed countries (para. 1.21). Moreover, light industries have received a disproportionately small share of local research and development resources because of the primacy formerly accorded to heavy industry. Furthermore, many light industries in China (textiles being a notable exception) have been too small for the country to economically provide the critical mass of scientists and technicians needed to keep pace with international technology. As a result, China, during its long period of relative isolation, fell particularly far behind the level of technology in most light industries. With the recent shift in emphasis to light industry, Government is trying to compensate for this neglect, in large part by importing technology. 3.03 A major goal of light industrial development is export expansion (para. 1.03). That market requires much greater emphasis on quality and style than has been the case with the domestic market. Thus China's need is not only for production technology, but also for assistance in design, packaging and marketing. 3.04 Technology Import Process. After an enterprise learns (usually from publications or equipment salesmen) about foreign technology of direct use to it, it is necessary to determine whether that technology is suitable for China, based on the availability of Chinese technicians to apply and adapt it, production costs in China's labor-abundant economy, markets to be served, etc. This determination involves the responsible bureau/ministry, the local Planning and Economic Commissions, etc. CIB will help provide, as necessary,  -16- three key elements which have usually been missing: (a) short-tern foreign industrial experts (independent of suppliers of particular brands of equip- ment) to advise the enterprises involved and other concerned agencies about the state of the industry in the world and the technological choices avail- able; (b) overseas factory visits by enterprise and CIB staff to see the technologies in operation and learn their advantages and problems; and (c) through its project appraisal manual, a rigorous framework for evaluating the economics of alternative technologies. 3.05 The next stage is deciding how to import the technology; this involves selection of both equipment and the system for knowledge transfer (licensing agreemients, foreign consultancy, sending Chinese technicians overseas etc.). The software element is particularly important because in the past the import of machinery has not always been accompanied by an adequate knowledge of how to design plants, processes and products, and to operate, maintain, and adapt the machinery. CIB would provide an independent outside judgement on issues such as design choices and systems of knowledge transfer. CIB would initially need to rely heavily on domestic and foreign short-term consultants for this (para. 4.05), but would gradually develop in-house experience and expertise. 3.06 The enterprise would then have to adapt the technology to local conditions. CIB's monitoring/evaluation of its loans would help show how successful the new technology had been, what problems were associated with it, and how they had been dealt with. Design institutes would play the most critical role in deciding whether and how to spread the technology to other enterprises. 3.07 Summary of CIB's Role. In summary, CIB's contribution to technology transfer would be: (a) financing hardware and software imports; (b) appraising the economics of alternative technologies; (c) serving as a channel for locating and utilizing Chinese and, as necessary, international experts, and sending local engineers to visit factories abroad; and (d) monitoring the technology import process. CIB would be able to play such a role in part because it would be involved from an early stage in subproject preparation. However, the process would remain a difficult one, not only because of the inherent problems of importing and adapting technology, but also because of: (a) interagency coordination problems; (b) shortage of domestic technical experts with up-to-date knowledge of technological developments abroad in light industry; aLnd (c) inexperience in utilizing foreign consultants. CIB's role will be a challenging one, going well beyond that of most DFCs, in a difficult environment. Improved Project Appraisal Methodology 3.08 In China, capital construction projects and to a lesser extent modernization projects are subject to feasibility studies covering technical, financial and certain economic aspects. However, these often do not form an  - 17 - adequate basis for proper project design and selection (para. 1.15). Govern- ment has therefore selected CIB to be a pilot institution for improving appraisal methodology. CIB staff and other Chinese officials and researchers have drafted a project appraisal manual for CIB, while Bank staff have participated extensively in discussions of the draft manual and have also written a background paper on economic evaluation of projects under Chinese conditions and a case study. 3.09 One important objective of the manual is to make appraisal more comprehensive and systematic. In particular, greater attention generally needs to be paid to: (a) the relationship of the project to overall medium- or long-term plans for the industry; (b) output and experiences of other producers of the same product; (c) the availability of key inputs for construction and operation; (d) enterprise management and technical skills; (e) market prospects; (f) environmental effects; and (g) linkages with other industries. CIB will have to work closely with other agencies to obtain adequate supporting data for project appraisal, some of which are either not collected systematically or not freely shared with other agencies. 3.10 The second, and more innovative objective is to supplement present Chinese methods of economic evaluation (essentially by reference to plan targets) with cost/benefit analysis based on shadow prices (as is now done in many other developing countries and some East European countries). The use of shadow prices is important because actual Chinese prices, which will continue to be used for financial aspects of project analysis, do not provide good measures of economic costs and benefits. The need for improved methods of economic evaluation of projects is becoming more widely accepted in China, as is the potential usefulness of cost/benefit analysis and shadow prices in this regard. CIB, by developing and using its appraisal manual, will provide experience in adapting new methods of appraisal to Chinese circumstances. 3.11 An immediate practical issue is the derivation of appropriate shadow prices. Some such prices (for project outputs and raw materials) must neces- sarily be estimated on a project-by-project basis, by CIB analysts. Others, such as the shadow prices of electricity, construction, transport, labor and other inputs common to a wide range of projects, and the shadow interest rate (or opportunity cost of capital) to be applied in evaluating all projects, would, for consistency and economy of effort, be provided by CIB's head office in collaboration with other agencies, and then adjusted as necessary for individual regions. Work done by Bank staff will form a basis for CIB's initial estimates of most of the important shadow prices. A continuing program of work by CIB and other agencies will be important to refine and improve shadow prices on the basis of further research and a wider set of data, and to regularly update them to reflect changing economic circumstances in China and abroad. 3.12 CIB has already begun to use the draft manual for appraisal of its initial subprojects. The revised draft manual and the main shadow prices for  - 18 - general use are now being reviewed by Bank staff. Formal issuance to CIB's branches, of an appraisal manual and instructions for its experimental use, satisfactory to the Bank/Association, would be a condition of loan/credit effectiveness. An assurance was also obtained at negotiations that, after revision based on branch experience and comments and as agreed with the Bank/Association, the use of the manual would become mandatory six months after the initial issuance. Irrespective of the extent to which the manual is applied, the Bank/Association will evaluate CIB subproject appraisals and authorize withdrawals for all subprojects above the free limit (para. 5.06) only after it is satisfied with the quality of the appraisal and the economic, financial and technical viability of the subprojects. To help CIB meet those standards, substantial training of CIB staff in project appraisal is underway, and more is planned (para. 4.07). IV. THE CHINA INVESTMENT BANK (CIB) Establishment and Autonomy 4.01 PCBC, under MOF's guidance, played the major role in setting up CIB, with advice from Bank missions to China in July, September and November 1981. In a relatively short period, PCBC/CIB have made considerable progress in preparing CIB's basic documents, designing the organizational structure, establishing branc'nes, recruiting and training staff, drafting a project appraisal manual and identifying a pipeline of subprojects. In December 1981, CIB's Charter was approved by the State Council, the composition of its Board of Directors was approved by MOF and submitted to the State Council for record, and the Board held its first meeting. In the first quarter of 1982, Government paid in Y400 million representing 10% of CIB's authorized share capital, and branchnes were established at Shanghai, Tianjin and Nanjing (for Jiangsu Province). Although autonomous, CIB is administratively under the leadership primarily of MOF and secondarily of PCBC, with whom it maintains a close relationship, with 12 PCBC executives on CIB's 29-person Board. CIB will continue to need PCBC's help in obtaining staff, facilities and entree to PCBC clients. In its project appraisal, CIB will work closely with other agencies, including the provincial Planning and Economic Commissions, and the supervising corporations and bureaus. However, CIB will be able to reject projects that do not meet its standards. Management, Organization, Staffing and Training 4.02 Board of Directors and Managing Committee. CIB's Board of Directors consists of the Minister of Finance as Honorary Chairman, a Vice Minister of Finance and PCBC President as Chairman, three PCBC Vice Presidents as Deputy Chairmen, seven Managing Directors (four other PCBC executives along with Deputy Chairmen of the SPC and SEC), and seventeen Directors (including four PCBC branch managers and the Deputy Mayors of Shanghai and Tianjin). The  - 19 - Board will meet at least once a year. The Board reviews and decides upon CIB's annual plan, major policies, financial and operational performance, proposed CIB borrowings of $50 million or more, and any proposed Charter amendments. A Managing Committee consisting of the Board Chairman, Deputy Chairmen and Managing Directors will meet from time to time to deal with all other important matters including loan approvals of Y 10 million or more, borrowings below $50 million, and appointment of senior officials below Vice President. 4.03 Management and Organization. The President and chief executive officer of CIB, Mr. Zhou Hanrong, is a Deputy Chairman of CIB's Board, as well as the First Vice President of PCBC. Mr. Geng Gengshan, also a PCBC Vice President and a CIB Managing Director, has been nominated by CIB's Board and has been acting as CIB's First Vice President. Formal appointment by Government of a Vice President would be a condition of loan/credit effectiveness. CIB also intends to have a second Vice President, who is currently being sought, nominated and on the job by March 31, 1983. An understanding to this effect was reached with CIB at negotiations. The head office has five departments: Project Lending; Finance and Accounting; Survey and Research; Coordination and Planning; and General Affairs and Administra- tion (Chart 23988). An internal audit unit is directly responsible to the Managing Committee. 4.04 Staffing. About 20 key officers have been appointed in the head office in Beijing, and about 10 in each of the three existing branches, mainly drawn from PCBC. As the work expands, additional staff will be transferred from PCBC and other agencies. The main recruitment difficulties are expected to be technical personnel, especially mechanical and chemical engineers, who are generally in short supply, and economists familiar with cost/benefit analysis. At negotiations, CIB's overall staffing plan was reviewed, and an understanding reached that CIB would soon have a suitable engineer in each branch. More financial and economic staff would also be sought. In addi- tion, as a condition of effectivness, CIB would hire a full-time qualified and experienced senior economic advisor, to direct and review the economic work done at the head office and the branches. 4.05 Technical Consultancy. To satisfy its own needs and those of its borrowers for technical advice on specific projects (paras. 3.04-3.05), CIB would help to locate and arrange for the necessary domestic and foreign technical expertise. The consultants might work directly with the enterprises on the investment feasibility study, in addition to helping CIB assemble the data for its economic and financial appraisals. As a condition of effectiveness, CIB is to conclude a contract, satisfactory to the Bank/Association, for provision of domestic engineering consultancy. CIB intends to contract with the China International Engineering Consulting Corporation (CIECC), an umbrella organization of the 17 newly-established industry-specific engineering consulting firms created from the design institutes in various ministries. An understanding was reached that CIB would submit all subprojects under the loan/credit to CIECC or other experts for technical review. Dr. Lu Huanzhang, CIECC Deputy General Manager, would be CIB's part-time senior engineering advisor and would help CIB estimate the need for, arrange for and oversee the work of short-term consultants from  - 20 - CIECC constituent firms. In addition, where suitable domestic consultants were not available, as when the project involved specialized technology not well-known in China, CIB would select individual short-term foreign consultants to advise it on its appraisal work. 4.06 Branches. During 1983, CIB will concentrate its lending in Shanghai, Tianjin and Jiangsu province (see Map No. 16488), which together account for 8% of China's population and 25% of its gross industrial output. As its experience, staff trained in project appraisal and DFC operations, and financial resources increase, CIB will open about one additional branch per year, with initial priority given to the northern and central coastal provinces where export prospects are best. The branches will identify and appraise all projects, subject to head office approval. PCBC may act as CIB's agent where CIB has no branch, and, for a fee, appraise projects using the same standards and methodology; relatively few such cases are expected under the proposed loan/credit. 4.07 Training. While most CIB staff have had many years of experience in PCBC, they need special training in all aspects of development banking, as well as international exposure. As arranged through the Bank and financed under the UNDP Multi-Sector "Umbrella" Project for Preparation of Investment Projects, four CIB staff each made two-month study tours to DFCs in Pakistan and the Philippines, and five senior CIB executives visited the Bank and two development institutions in Ireland. Further tours in 1983 and 1984 are planned. The Economic Development Institute (EDI) gave a five-week develop- ment banking course in Shanghai in April/May 1982 to 40 participants mainly from CIB and PCBC, and plans a similar course in 1983. CIB will also send its staff to banking and management seminars overseas, and is planning in-house seminars especially on project appraisal, so that all CIB head office and branch staff involved with project appraisal will be thoroughly familiar with the new appraisal methodology. During negotiations, the Bank/Association and CIB reviewed together and agreed upon CIB's overall training program for 1983. Operating Policies and Strategies 4.08 CIB has become China's fifth bank and will be a major source of foreign exchange for small- and medium-size fixed investments in state enterprises./l Emphasis will be given to export-oriented projects and those involving technical modernization. Although CIB will mainly make loans, equity participation (in joint ventures), guarantees and loan syndications may also be undertaken, as may other banking operations. CIB intends to develop consultancy services to its borrowers in project preparation and finance. CIB will obtain foreign exchange from international institutions (and eventually, perhaps, from international capital markets) and local currency from Government as share capital. It will lend local currency only /1 It may lend also to urban collectives and joint ventures.  - 21 - in conjunction with foreign exchange./I Loans will be for capital expend- itures only; PBC, which already has working capital accounts for virtually all enterprises, will provide the complementary working capital, as it normally does for all approved investments. 4.09 CIB is permitted to lend to all sectors, except agriculture and commune industries financed by ABC. At present, emphasis is on light industries, in keeping with China's priorities and due to the larger size and lower creditworthiness (given current pricing policies) of most heavy industrial projects (para. 1.16). To the extent feasible, CIB will con- centrate initially on a limited number of industries, to build up better sectoral knowledge, and to upgrade subproject appraisal and supervision and the provision of technological assistance. CIB will also generally not lend to projects which are particularly suitable for other sources of foreign exchange (e.g. international-class hotels, which are usually financed as joint ventures or by private sources overseas). 4.10 CIB's major operational and financial policies, within the frame- work of its Charter and the national economic plans, are outlined in its Policy Statement (Annex 1), and specific areas of emphasis for the next two years are in its Development Strategy Statement (Annex 2). These documents were reviewed by Bank staff and subsequently approved by CIB's Board. An assurance was obtained at negotiations that CIB would exchange views with the Bank/Association on any proposed changes in its Charter, Supplethental Regu- lations, Policy Statement, Development Strategy Stateeent or Lending Regula- tions. Procedures 4.11 Preparation and Processing. Loan applicants, after obtaining clearance from their corporations and bureaus, will send project proposal reports to the local CIB branch, which will discuss them with the provin- cial Planning and Economic Commissions, responsible bureau, other relevant local agencies, and the CIB head office. After a project is preliminarily accepted into CIB's lending program, the enterprise will prepare a feasi- bility study, with assistance as necessary from CIB and the relevant minis- try and its design institutes, or local or expatriate consultants. It probably will also contact equipment suppliers at an early stage. In accordance with CIB's appraisal manual, the branch will appraise the project and submit its report, together with the feasibility study, to CIB's head office. If the head office approves the loan, the branch can sign a loan agreement with the enterprise. At all stages, CIB may turn down any project that does not meet its technical, financial and economic standards. /1 Projects needing only local currency will be referred to PCBC.  - 22 - 4.12 Integration of CIB Lending into the National Plan. CIB will prepare an annual disbursement program around October for the following year, covering both loans already approved and estimates for projects still under prepara- tion. The program will include both projected quarterly disbursements and the construction materials and other inputs needed during the coming year./l This annual program will be submitted to the SPC for incorporation into China s annual plan. During the year, CIB will submit revisions as necessary. 4.13 Procurement and Disbursement. The procurement and disbursement procedures for subloans are described in paras. 5.07-5.08. Local procurement would be done through normal Government channels, generally with fixed prices and assigned suppliers. CIB would disburse upon delivery of local equip- ment, or in accordance with contracts for civil works or imported equipment. The procedures summarized in paras. 4.11-4.13 above will be spelled out in CIB's Lending Regulations, the issuance of which, satisfactory to the Bank/ Association, would be a condition of loan/credit effectiveness. 4.14 Project Supervision, Monitoring and Assistance. From their tenure in PCBC, most CIB staff are experienced in supervising the use of investment funds by enterprises. CIB, however, will go further. It will monitor the performance of its projects by reviewing their periodic reports and making plant visits until the loans are fully repaid, and be prepared to provide or organize technical assistance to its borrowers. After full repayment, CIB will prepare project completion reports summarizing the experience and lessons of its subloans. At negotiations, an assurance was obtained that CIB would issue detailed project supervision instructions to its staff by June 30, 1983. Lending Policies 4.15 Interest Rates. PCBC will initially lend local currency at 3.6% p.a., the national rate for capital construction projects in light industry. Government recognizes that this rate is low; however, it is already a vast improvement over the total dependence on grants until 1979 (para. 1.24). Since CIB gets all its local currency resources from Government as paid-in capital, CIB will enjoy the full 3.6% p.a. spread on its local currency lending. 4.16 CIB will be able to charge a higher rate for foreign exchange lending, due to its scarcity in China and the current high international interest rates. However, it faces competition from BOC, which is now lending significant amounts at or slightly above 10% p.a. for projects often similar to CIB's (para. 2.19). As CIB will be making more extensive subproject appraisals than BOC presently does, requiring more data and time (including for Bank/Association review), the enterprises will be reluctant to submit to these procedures unless there is some incentive for doing so. Furthermore, they may be reluctant to accept project design alternatives that give higher /1 Most materials would be supplied by central or provincial Material Supply  - 23 - economic, but lower financial returns. For CIB to have much choice of and influence over its potential clients, its interest rate has to be competitive. CIB's management has strongly indicated that it would have difficulty now charging more than 8% p.a. In addition, given the divergence between economic and financial prices in China (para. 1.16), it is economically more efficient for cost/benefit analysis (para. 3.10), rathet than interest rates, to be the main determinant of loan allocations by CIB. At negotia- tions, assurances were obtained that (a) CIB would onlend the blended loan/ credit at not less than 8% p.a. (para. 5.02); (b) CIB would inform the Bank/Association, in time for an exchange of views, in advance of any change in its interest rates; and (c) at the request of either party, CIB would review its lending rates with the Bank/Association in the light of CIB's cost of funds and profitability, and of movements in interest and inflation rates in China. As inflation over the past three years has averaged about 3.5% p.a., and no major increase is anticipated over the next three years, 8% p.a. is expected to be a positive real rate. 4.17 Loan Repayments. According to CIB's draft Lending Regulations, the maturity of CIB's loans will normally not exceed seven years, and the longest period will not exceed twelve years including a grace period of two to three years. A short average loan period is possible because of the high financial profitability of most light industries. The grace and repayment period will be based on the incremental profits and depreciation allowances, which will be used to service the loans. At negotiations, an assurance was obtained from Government that enterprises would be allowed to obtain as much foreign exchange as needed for interest and principal payments on their foreign exchange loans from CIB. If any enterprise does not have sufficient retained foreign exchange to make such payments, the supervisory agencies and local government should provide the balance, or the enterprise will have to purchase the foreign exchange from BOC (at the internal settlement rate). Subproject Pipeline 4.18 After informing other agencies in Shanghai, Tianjin and Jiangsu of the proposed project, CIB has received over 100 subproject proposals, at varying stages of preparation. CIB selected the more promising and more advanced ones to concentrate on. Bank missions have visited sixteen poten- tial subprojects, covering a wide range of the light industrial sector, with most being export-oriented and with some concentration on textile. These could account for about a third of the loan/credit funds. Most looked promising, but all needed considerable additional preparation. Appraisal reports for about the first ten subprojects are expected to be sent to the Bank/Association by January 1983 for field review in anticipation of loan/credit effectiveness. Resources, Financial Structure and Projections 4.19 Government is CIB's sole shareholder. CIB's authorized capital is Y 4 billion ($1.43 billion) /1 of which Y 400 million was paid in early 1982 to ensure that CIB had the local currency needed for its initial loans. For /1 At the internal settlement rate of Y 2.80 = US$1.00.  - 24 - the foreseeable future, all local currency for investment will come from the budget as share capital, and all foreign exchange from overseas loans, except for an initial $1() million revolving fund to be made available by Government to bridge the time gap before reimbursements from the loan/credit. The proposed loan/credit is expected to meet CIB s foreign exchange commitments up to the latter half of calendar year 1984, while the paid-in capital should be sufficient to finance CIB's local currency operations through 1986. At negotiations, an assurance was obtained that CIB would not exceed a 5:1 long-term debt/equity ratio. This would be a prudent and reasonable ratio and is unlikely to become a constraint on CIB because all local currency lending will be from equity. 4.20 As CIB is a new institution and the first DFC in China, it is difficult to project the volume of its lending operations. Nonetheless, on the basis of CIB's present project pipeline, the suppressed demand in China for foreign equipment and technology, and CIB's projected branch network expansion, CIB loan approvals are projected to grow by about an average of 40% p.a. over 1983-87, to total $680 million over five years in foreign exchange, and Y 680 million (US$240 million) in local currency. CIB hopes to get most of the foreign currency from the Bank Group, but expects to raise some funds from other foreign sources as well. Additional capital of about Y 0.3 billion woul]d need to be paid in by Government for these projected operations. CIB i's projected to be profitable from the start, initially due to interest earned on its paid-in capital. Net earnings would reach about 1.7% of equity by 1987. This would be reasonable for a new DFC making loans yielding relatively low spreads. Administrative expenses would be very low compared to other DFCs (only some 0.2% of average total assets by 1986-87) primarily due to Chinese salary scales, free use of Government offices, the relatively large average loan size, and the ease of collecting repayments. CIB's 3.6% p.a. spread on local currency (para. 4.15) and 0.6% p.a. on foreign exchange (para. 5.02) would give it an overall 1.4% p.a. spread. This would be sufficient given its low overhead costs and low default risks (para. 2.20), and the fact that Government does not wish any dividends from CIB. CIB's 5-year operational and financial projections are in Annex 3. Accounts, Audit, Management Information and Reporting Requirements 4.21 CIB wilL maintain accounting records adequate to reflect its operations and financial position in accordance with generally accepted accounting principles and standards. CIB's draft accounting manual has been reviewed by the Bank/Association and will be finalized in December 1982 by CIB. At negotiations, an assurance was obtained that CIB's accounts would be audited annually by independent auditors acceptable to the Bank/Association, and that the audil report would be submitted to the Bank/Association within six months after the end of each financial year. Independent audit is a relatively new concept in China. Government and CIB have proposed that the newly-established China Consultants of Accounting and Financial Management (CCAFM) audit CIB. The first CIB accounts to be audited would be those for  - 25 - calendar year 1983. After CCAFM carries out some other audits, the Bank/ Association would evaluate its performance before approving it to audit CIB's accounts. CCA;'M might also advise CIB, as necessary, on its management information and accounting systems. The Bank/Association and CII have also discussed arid agreed upon reporting requirements. V. THE PROPOSFD LOAN/CREDIT Amount and Maturity 5.01 The proposed Bank loan of S40.6 million (including a capitalized front-end fee of $0.6 million) and IDA credit of $30 million equivalent (SDR 28 million) would provide CIB with its first significant foreign exchange resources for lending. The funds are expected to be committed to some 30-40 subprojects over about 18 months, although this is difficult to predict accurately as CIB is a new institution. Subprojects could be submitted to the Bank/Association for approval until March 31, 1985. The credit would also provide foreign exchange for preparation subloans and for CIB's technical assistance and training needs (paras. 5.03-5.04). The loan and credit would be made to the People's Republic of China; to the extent practicable, the credit would be drawn down first. Back-to-back repayment of the subloans and Bank loan would not be appropriate because the subloans would have unusually short maturities averaging about 5-6 years (para. 4.17). Therefore, the Bank loan would be of fixed maturity, on the standard country terms for China, which are 20 years, including five years grace on principal. Onlending Terms 5.02 Government would onlend both the loan and credit to CIB under a Subsidiary Loan Agreement, satisfactory to the Bank/Association, the signing of which would be a condition of loan/credit effectiveness. Both IDA and Bank funds would be onlent for 20 years including five years grace, with CIB allowed to roll-over the funds. Government would charge CIB a fixed interest rate of 6.9% p.a. (a weighted average of the present Bank interest rate and the IDA service charge), plus the Bank and IDA commitment fees. Government would thus bear the risk from the variable Bank interest rate. Including the front end and commitment fees, the total cost of these funds to CIB would be ahout 7.4% p.a., compared to its onlending rate of 8% p.a. Government would also bear the foreign exchange risk between the USS and (a) the currency pool index (for the Bank loan portion) and (b) the SDR (for the IDA credit portion). Government would bear this risk by onlending to CIB denominated in USS valued at the date of withdrawal. These arrangements have been made because it would be too complicated and burdensome for CIB to pass these interest rate and foreign exchange risks on to its subborrowers, most of whom have no experience with foreign borrowings. As subloans would also be  - 26 - denominated in US$, valued at the date of withdrawal, subborrowers would be taking any foreign exchange risk between the US$ and Chinese Yuan./l Preparation Subloans 5.03 In preparing their feasibility studies (para. 4.11), some potential subborrowers would need foreign exchange for the costs of (a) expatriate technical consultants and (b) overseas factory visits (para. 3.04). Under the project, $1.0 million of the IDA credit would be earmarked for preparation subloans by CIB; this should cover 10-15 subprojects being prepared for financing under this loan/credit or its successor. The enterprises would repay CIB in foreign exchange, even if the subproject was later rejected by CIB. CIB Training and Technical Assistance Component 5.04 Some $0.3 million of the credit would be used to finance, over two years, the foreign exchange costs of: (a) study tours by CIB staff to other DFCs (para. 4.07) - 3 tours of 4 persons each for 50 days (at $30-35,000/tour), - $100,000; (b) short-term visits by technical experts to assist CIB in its appraisals (para. 4.05) - about 7 man-months - $100,000; (c) overseas factory and other technical visits by CIB staff (in conjunction with enterprise/corporation staff) (para. 3.04) - about 10 visits (at $5,000 apiece) - $50,000; and (c) contingencies - $50,000. The average man-month cost of foreign technical assistance including fees, overhead, international travel and subsistence, would be about $13,000. CIB would repay this portion of the credit from its interest margin on foreign exchange subloans. At negotiations, an assurance was obtained that the overseas study tours and technical visits would be carried out as agreed between CIB and the Bank/Association. /1 Most subborrowers, who would earn sufficient foreign exchange, would not face this risk, as they would repay directly in US$; however, those few who earned primarily local currency would have to convert it into US$ at the internal settlement rate, which Government might change from time to time.  - z7 - Maximum Subloan Size and Free Limit 5.05 Maximum Subloan Size. Under the proposed loan/credit, agreement was reached that CIB would be allowed to onlend for individual subprojects up to $8 million in foreign exchange. This high limit reflee,s the fact that: (a) CIB would be taking virtually no financial risk; and (b) in general it is for the larger projects that CIB's appraisal is most valuable, because these projects are more likely to involve major technology import, serve nationwide or international markets which must be studied, and have many linkages to other industries. 5.06 Free Limit. CIB is a new institution, and careful review of both the technical and economic aspects of its subproject appraisals will be essential at this early stage, especially as cost/benefit appraisal metho- dology is new to China. Agreement was therefore reached that the free limit would be set at $1.0 million, and the aggregate free limit at $20 million; in addition, the first three subprojects from each branch, regardless of size, would be subject to Bank/ Association approval. One million dollars is one of the highest free limits the Bank/Association has approved for a first loan to any DFC. Nevertheless, because CIB's loans would on average be rather large by DFC standards, an estimated 60% of the subprojects by number and 80% by amount would be above the free limit. The free limit will be kept under review, and might be increased somewhat during implementation if the quality of CIB appraisals justified this. Procurement and Disbursement 5.07 Procurement. Individual contracts of at least $3 million equiva- lent would be awarded after international competitive bidding (ICB), includ- ing prior Bank/Association review of bid documents, unless CIB and the Bank/Association agree otherwise. A preference equal to 15% of the c.i.f. cost or the customs duty, whichever is lower, would be extended to local manufacturers in the evaluation of bids. All contracts below $3 million would be awarded after evaluation and comparison of quotations elicited from at least three qualified suppliers. Government has authorized the China National Technical Import Corporation (CNTIC) /1 to handle all imports under this project. The existence of adequate competition to help ensure reasonr- able prices would be examined as part of the review of all subprojects above the free limit. All contracts of $1-3 million would be subject to post- review by the Bank/Association. Expatriate consultants for CIB or under preparation subloans would be selected in accordance with the Bank's Guide- lines on the Use of Consultants, and would have qualifications, experience and terms and conditions of employment satisfactory to the Bank/Association; an assurance to this effect was obtained at negotiations. /1 CNTIC, a state enterprise under MFERT, handles imports for turn-key and high technology projects, and has been acquiring experience with ICB and other forms of international procurement.  - 22 - 5.ng Dishursement. nisbursements would he made against full documenta- tion for (a) 1007 of the foreign expenditures of directly imported equipment, (b) 1007 of the foreign exchanRe cost of technology, technical assistance and overseas training, and (c) Qn% of the ex-factory price of locally-manufactured equipment procured under TCB. nisbursements are expected to be completed by December 31, 1Q27. The disbursment projections (Annex 4) are based on the disbursement Drofile of DFC lending in the East Asia and Pacific Region, taking into account that CIB already has a substantial subproject pipeline under preparation (para. 4.18). Environmental Safeguards 5.09 In recent years, China has been paying increasing attention to environmental questions, and has established standards and controls for waste disposal. Already, project feasibility studies cover environmental aspects (para. 1.15); CIB would give careful attention to this in its appraisal reports, as would the Bank/Association in reviewing those appraisals. Benefits and Risks 5.10 This project would involve considerable innovation in the Chinese context; as such, it offers potentially great benefits, but also faces significant risks. The main benefits would be much needed improvements in industrial efficiency through technology transfer and better project design and selection (Chapter III), and development of a new bank that would institutionalize these approaches and help fill a gap in Chinese industrial finance. While starting relatively small with this project, CIB is expected to become a major national bank. The success of CIB and the project would give further impetus to China's economic reform movement (paras. 1.23-1.25). The approaches to project appraisal and financing to be pioneered by CIB are expected to be replicable in other financial institutions in China; interest in CIB's project appraisal manual is already being shown by BOC and ABC. 5.11 One major project risk also stems for close association with China's economic reforms. Should economic reform be reversed in China (e.g. increased emphasis on technological self-sufficiency or less reliance on opportunity costs in making investment decisions), CIB's role could be undercut. But most indications are that economic reform will proceed, although at a cautious pace. 5.12 The other major risk is that CIB will not prove able to meet adequately the major challenges facing it. While CIB is obtaining quite experienced staff from PCBC, most have had virtually no exposure to foreign technology, economic cost/benefit analysis or international finance. Furthermore, CIB is still only partially staffed. The training and technical assistance arrangements under the project (paras. 4.05, 4.07 and 5.04), and the employment of two VTice Presidents plus a qualified economic advisor and branch engineers (paras. 4.04-4.05), would reduce this risk to an acceptable level.  17I. ACREEMENTS REACHED AND RF.COMMENDATIONS 6.01 The following would be conditions of loan/credit effectiveness: (a) issuance to CIB's branches of a project appraisal manual and instructions for its experimental use, satisfactory to the Bank/ Association (para. 3.12); (b) appointment of a CIB Vice President (para. 4.03); (c) appointment of a senior economic advisor (para. 4.04); (d) conclusion of a contract, satisfactory to the Bank/Association, for provision of domestic engineering consultancy to CIB (para. 4.04); (e) issuance of CIB's Lending Regulations, satisfactory to the Bank/ Association (para. 4.13); and (f) signing of a Subsidiary Loan Agreement, satisfactory to the Bank/Association (para. 5.02). 6.02 At negotiations, assurances were obtained that: (a) CIB's revised project appraisal manual, satisfactory to the Bank/ Association would be put into mandatory use by all branches not later than six months after its initial issuance (para. 3.12); (b) CIB would exchange views with the Bank/Association on any pro- posed change in its Charter, Supplemental Regulations, Policy Statement, Development Strategy Statement, or Lending Regulations (para. 4.10); (c) CIB would issue detailed project supervision instructions to its staff by June 30, 1983 (para. 4.14); (d) (i) CIB would onlend the blended loan/credit at not less than 8% p.a., (ii) CIB would inform the Bank/Association, in time for an exchange of views, in advance of any plans to change its interest rates, and (iii) at the request of either party, CIB would review its lending rates with the Bank/Association (para. 4.16); (e) enterprises would be allowed to obtain as much foreign exchange as needed for interest and principal payments on their foreign exchange loans from CIB (para. 4.17); (f) CIB would not exceed a 5:1 long-term debt/equity ratio (para. 4.19): and  - 30 - (g) CIB's accounts would be audited annually by independent auditors acceptable to the Bank/Association; the audit report would be submitted to the Bank/Association within six months after the end of each financial year (para. 4.21); (h) CIB would carry out its overseas study tours and technical visits as agreed with the Bank/Association (para. 5.04); (i) the maximum subloan size under the project would be $8 million (para. 5.05); (j) the free limit under the project would be A1 million, and the aggregate free limit 820 million; and (k) short-term expatriate consultants for CIB or under preparation subloans would have experience, qualifications and terms and conditions of employment satisfactory to the Bank/Association (para. 5.07); 6.03 In addition, at negotiations understandings were reached that CIB would: (a) nominate a second Vice President and have him working on the job by March 31, 1983 (para. 4.03); (b) soon have a suitable engineer in each branch (para. 4.04); and (c) submit all subprojects under the loan/credit to CIECC or other experts for technical review (para. 4.05). 6.04 With the above assurances and conditions, the project would be suitable for a Bank loan of $40.6 million (including the front-end fee of $0.6 million) for 20 years, and an IDA credit equivalent to $30 million (SDR 28 million). The Borrower would be the People's Republic of China.  - 31 - ANNEX 1 Page 1 CHINA INDUSTRIAL CREDIT PROJECT Policy Statement of the China Investment Bank /1 1. The China Investment Bank (hereinafter called CIB) is designated by the Chinese Government as a specialized bank to raise resources from abroad in order to make investment loans. It shares the workload and cooperates with other financial institutions of the country, in order to accelerate the socialist modernization program. 2. CIB's main activities are as follows: (a) Raising long- and medium-term foreign exchange funds from abroad: At present, CIB acts mainly as an intermediary, borrowing from international institutions (the World Bank, etc.). Hence- forth, CIB will also borrow long- and medium-term foreign exchange funds on favorable terms with low interest rates from other foreign banks, in accordance with the development of its operations. With the approval of the Government, CIB may also raise funds by issuing securities abroad; (b) Providing investment loans to domestic enterprises: The loans are mainly to finance medium and small projects, especially the modernization and technical improvement projects of existing enterprises; (c) Gradually developing consultancy services to borrowing units; and (d) Undertaking other barnking operations. 3. Under the direction of the overall national construction policy and national economic plans, and in conformity with the unified financial policy of the nation and CIB's own operational regulations, CIB shall select projects (including equity investment projects), make loans and handle other related operations. The projects selected by CIB must be incorporated in the nation's fixed asset investment plan. The borrowing units shall apply to the material supplying units for required materials in accordance with government regulations, or purchase them themselves. 4. CIB shall select projects on the basis of the following basic criteria: the products are suitable for sale and urgently needed for developing the national economy; the projects are technically, financially /1 This is an unofficial translation of the policy statement as agreed at negotiations, and may not exactly match the final version approved by CIB's Board.  - 32 - ANNEX 1 Page 2 and economically viable, are under adequate business management, involve modest investment costs, yield results quickly, and have the ability to repay both foreign and local currency loans. 5. CIB will require the borrowing units to make detailed feasibility studies before project approval. A loan will be approved only after CIB has made a thorough review and appraisal of the feasibility study and is assured that all the criteria have been met. Besides examining whether the projects meet the requirements stipulated in article 4 of this document, CIB shall pay attention to whether: (a) the raw material, energy and technical inputs necessary for production are reliably available, and the necessary ancillary equipment is fully taken into account; (b) the site to be selected is suitable, and communication and transportation facilities and the program of disposing wastes and emissions are adequate; (c) the supply of construction materials and labor is ensured, etc. 6. CIB shall make foreign currency investment loans and local currency investment loans. Foreign currency investment loans will be used mainly for import of technology and equipment, while local currency loans will cover local costs of ancillary domestic equipment and construction. CIB may make a foreign currency investment loan and a local currency investment loan simultaneously to the same project for its successful implementation. For projects whichi need foreign currency loans exceeding US$8 million, CIB should generally make a loan jointly with other institutions or mobilize the funds of the enterprise itself. 7. The ratio of long-term debt of CIB to its equity (including paid-in capital, legal reserves and retained earnings) shall not exceed 5:1. The total exposure of CIB in an enterprise shall generally not exceed 20% of CIB's equity. 8. The interest rate on foreign currency investment loans shall be the borrowing rate plus a fixed margin. The interest rates on local currency investment loans shall be in line with the rates on similar loans, as specified by the Government. 9. The period of CIB's loans (from the time of loan agreement to the date when the principal and interest are fully repaid) shall normally not exceed seven years, with the longest not exceeding twelve years. The period of each loan shall be determined on a case by case basis and shall be specified in the loan agreement. The loan period includes the construction period (which will be the grace period) and the repayment period. The construction period shall be based on the construction plan as spelled out in the project feasibility study, while the repayment period shall be based on the projected annual cash flow available for loan repayment after the project is completed and production started.  ANNEX 1 Page 3 10. The borrowing units shall first repay foreign currency investment loans and >;,cn repay local currency investment loans. When a borrowing unit is delinquent in repayment of principal and interest during the repayment period, the penalty rate on the overdue portion shall be 20% above the original rate. When any loan is diverted to other uses, it shall be dealt with in accordance with CIB's "Lending Regulations for Trial Use". 11. According to the agreement between the Chinese Government and CIB, the foreign exchange risk on foreign currency investment loans extended by CIB shall be borne by the Chinese Government and the borrowing units respectively. CIB shall draw up concrete provisions in its relevant regula- tions for implementation of the above-mentioned principle. 12. CI shall ensure that the borrowing units choose the most suitable and most economical technology and equipment for importation. International competitive bidding should be used for procurement contracts amounting individually to over US$3 million. Comparison of quotations may be used for contracts amounting individually to below US83 million. When the latter method is used, the quotations of at least three acceptable equipment suppliers should be obtained. 13. During the loan period (including the construction period and the repayment period), CIB shall conduct systematic inspection and supervision of the projects to ensure the proper utilization of the loan proceeds, accelerate construction, improve management, maximize the economic benefit of the investments and ensure loan repayment on schedule. 14. CIB shall adopt various measures to vigorously recruit and train operational staff and raise operational standards, and shall gradually establish branches and sub-branches based on operational needs and the conditions of staff recruitment and training.  - 34 - ANNEX 2 Page 1 CHINA INDUSTRIAL CREDIT PROJECT Development Strategy Statement for 1982-1984 of the China Investment Bank /1 To facilitate the expansion of its operations in the initial stage of its establishment and to accomplish its assigned tasks, the China Investment Bank (hereinafter called CIB) will follow a development strategy in the period 1982--1984, as spelled out below: 1. CIB will follow the national policy of "carrying out technological transformation in key areas step by step and maximizing the role of existing enterprises." In the coming few years, CIB's lending will be aimed mainly at assisting existing enterprises to implement their technology transformation projects. 2. In the coming few years, CIB will focus mainly on projects of enterprises which require modest amounts of investment, obtain results quickly and have high ability to repay. Thus, CIB will select projects primarily from the textile and other light industrial sectors. 3. CIB-s assistance will be provided mainly for the implementation of small- and medium-scale projects. Total foreign currency lending to any one project shall not exceed US$8 million (but it can finance larger projects with the sponsoring enterprises' own funds or through cofinancing with other institutions); in general, total local currency lending to any one project shall not exceed 25 million yuan. 4. Projects financed by CIB in the coming few years should mainly be those whose products can be exported to generate foreign exchange, and can compete in international markets. Thus, CIB will initially select projects in the coastal provinces and municipalities (Shanghai, Tianjin, Jiangsu, etc.) where it is convenient to develop and expand export trade. 5. CIB and its branches will actively assist the borrowing enterprises to prepare feasibility studies, and will then appraise projects satisfactorily on the basis of such studies, so that only projects which are technically, financially and economically viable will be selected. In processing loan applications, CIB's branches and sub-branches will do the preliminary screening and appraisal, subject to final review and approval by the liead Office. 6. Borrowing enterprises which need to employ foreign consultants or to have their own staff make investigations abroad for project implementation, /1 This is an unofficial translation of the Development Strategy Statement as agreed at negotiations, and may not exactly match the final version approved by CIB's Board.  - 35 ANNEX 2 Page 2 may obtain preparation subloans or may use their foreign exchange investment loans to pay such expenditures, after CIB approval. 7. CIB shall vigorously recruit and train specialized staff who are familiar with international finance, foreign trade, industrial economics, engineering, foreign languages, etc., in order to raise its operational standards. TWhen necessary, CIB will hire short-term consultants to assist its technical staff to appraise and supervise projects satisfactorily.  - 36 - ANNEX 3 Table 1 CHINA CHINA INVESTMENT BANK CIB Five-Year Financial and Operational Projections Projected Operations, 1983-87 (Yuan million) 1986 1987 Rollover Rollover 1983 1984 1985 Total funds Total funds Loan Approvals /a Local currency 50.00 90.00 130.00 180.00 - 230.00 - Foreign currency lb 140.00 252.00 364.00 504.00 28.00 644.00 56.00 (in US$ million) (50.00) (90.00) (130.00) (180.00) (10.00) (230.00) (20.00) Total Approvals 190.00 342.00 494.00 684.00 28.00 874.00 56.00 Loan Commitments /c Local currency 40.00 82.00 122.00 170.00 - 220.00 - Foreign currency 112.00 229.60 341.60 476.00 22.40 616.00 50.40 (in US$ million) (40.00) (82.00) (122.00) (170.00) (8.00) (220.00) (18.00) Total Commitments 152.00 311.6D 463.60 646.00 22.40 836.00 50.40 Loan Disbursements Local currency /d 20.00 61.00 102.00 146.00 - 195.00 - Foreign currency /e 33.60 136.08 251.44 370.72 6.72 504.56 28.56 (in US$ million) (12.00) (48.60) (89.80) (132.40) (2.40) (108.20) (10.20) Total Disbursements 53.60 197.08 353.44 516.72 6.72 699.56 28.56 Loan Repayments Local currency - - - 10.00 Foreign currency - - - 28.00 56.00 (in US$ million) - - - (10.00) (20.00) Total Repayments - - _ 28.00 66.00 Loans Outstanding Local currency 20.00 81.00 183.00 329.00 514.00 Foreign currency /b 33.60 169.68 421.12 763.84 1,212.40 (in US$ million) (12.00) (60.60) (150.40) (272.80) (433.00) Total Outstanding 53.60 250.68 604.12 1,092.84 1,726.40 Assumptions: /a Local currency loans are approved together with foreign currency loans at the ratio of Y 1 to US$1. /b Converted at US$1 = Y 2.8. /c Commitments of both local currency and foreign currency loans are 80% of current year approvals and 20% of previous year approvals. /d Disbursements of local currency loans are 50% of current year commitments and 50% of previous year commitments. /e Disbursements of foreign currency loans are 30% of current year commitments, 60% of previous year commitments and 10% of commitments of tw, years ago. AEPID November 1982  ANNEX 3 - 37 - Table 2 CHINA CHINA INVESTMENT BANK Projected Balance Sheets, 1982-87 (Yuan million) As of December 31 1982 1983 1984 1985 1986 1987 ASSETS Current assets Cash and bank deposits: Local currency 400.00 354.30 295.11 204.39 140.46 31.23 Foreign currency - 28.00 28.00 28.00 28.00 28.00 Accrued interest receivable - 1.62 1.43 1.10 0.52 0.30 Current maturities of long-term loans Local currency - - - - 10.00 20.00 Foreign currency - - - 28.00 56.00 84.00 Total Current Assets 400.00 383.92 324.54 261.49 234.98 163.53 Long-term assets Investment and preparation loans Local currency - 20.00 81.00 183.00 329.00 514.00 Foreign currency - 33.60 169.68 421.12 763.84 1,212.40 Subtotal _ 53.60 250.68 604.12 1,092.84 1,726.40 Less: Provision for bad debts - (0.01) (0.06) (0.18) (0.40) (0.75) Current maturities - - (28.00) (66.00) (104.00) Loans (net) - 53.59 250.62 575.94 1,026.44 1,621.65 Deferred expenses on front-end fee - 1.68 6.72 6.72 14.28 14.28 Less: Amortization of front end fee - (0.08) (0.41) (0.74) (1.45) (2.16) Deferred expenses (net) - 1.60 6.31 5.98 12.83 12.12 Total Long-Term Assets - 55.19 256.93 581.92 1,039.27 1,633.77 TOTAL ASSETS 400.00 439.11 581.47 843.41 1,274.25 1,797.30 LIABTLITIES AND NET WORTH Liabilities Current liabilities Tax payable - 0.10 0.20 0.41 0.73 1.19 Accrued financial expenses payable - 1.20 5.85 12.86 25.64 39.07 Current maturities of long-term debts - - - - - 13.07 Total Current Liabilities - 1.30 6.05 13.27 26.37 53.33 Long-term debts Foreign currency loans/credit - 33.6 169.68 421.12 757.12 1,177.12 Less: Current maturities - - - - - (13.07) Total Long-Term Debts - 33.6 169.68 421.12 757.12 1,164.05 Total Liabilities _ 34.90 175.73 434.39 783.49 1,217.38 Net Worth Paid-in capital 400.00 400.00 400.00 400.00 480.00 560.00 Retained earnings - 4.21 5.74 9.02 10.76 19.92 Total Net Worth 400.00 404.21 405.74 409.02 490.76 579.92 TOTAI, LIABILITIES AND NET WORTH 400.00 439.11 581.47 843.41 1,274.25 1,797.30 Current ratio 295:1 54:1 20:1 9:1 3:1 Total debt/equity ratio 0.09:1 0.43:1 1.06:1 1.60:1 2.10:1 Long-term debt/equity ratio 0.08:1 0.42:1 1.06:1 1.54:1 2.01:1 AEPID November 1982  - 38 - ANNEX 3 Table 3 CHINA CHINA INVESTMENT BANK Projected Profit and Loss Statements, 1983-87 (Yuan million) 1983 1984 1985 1986 1987 Income Interest income from loans: Local currency 0.36 1.82 4.75 9.22 15.17 Foreign currency 1.34 8.13 23.63 47.40 79.05 Interest income from deposits Local currency 6.49 5.71 4.38 2.08 1.19 Total Income 8.19 15.66 32.76 58.70 95.41 Expenses Financial expenses 2.39 11.70 25.71 51.27 78.14 Administrative expenses 0.75 1.18 1.59 2.11 2.57 Overseas training and foreign consultancy 0.42 0.42 0.42 0.42 0.42 Provision for bad debts 0.01 0.05 0.12 0.22 0.35 Total Expenses 3.57 13.35 27.84 54.02 81.48 Income/(Loss) Before Tax 4.62 2.31 4.92 4.68 13.93 Less: Tax (0.41) (0.78) (1.64) (2.94) (4.77) Net Income/(Loss) 4.21 1.53 3.28 1.74 Q_16 Ratios As % of average total assets Total income 1.95 3.07 4.60 5.54 6.21 Financial expenses 0.57 2.29 3.61 4.84 5.09 Administrative expenses 0.18 0.23 0.22 0.20 0.17 Total expenses 0.85 2.62 3.91 5.10 5.31 Income before tax 1.10 0.45 0.69 0.44 0.91 Net income as % of average Equity 1.05 0.38 0.81 0.39 1.71 Paid-in capital 1.05 0.38 0.82 0.40 1.76 AEPID November 1982  - 39 - ANNEX 3 Table 4 CHINA CHINA INVESTMENT BANK Projected Cash Flow Statements, 1982-87 (Yuan million) 1982 1983 1984 1985 1986 1987 Sources Net income before tax - 4.62 2.31 4.92 4.68 13.93 Add: Non-cash items: Provisions for bad debts - 0.01 0.05 0.12 0.22 0.35 Amortization of front- end fee - 0.08 0.33 0.33 0.71 0.71 Accrued financial expenses payable - 1.20 4.65 7.01 12.78 13.43 Accrued tax payable - 0.10 0.10 0.21 0.32 0.46 Deduct: Accrued interest receivable - 1.62 (0.19) (0.33) (0.58) (0.22) Net Cash Income - 4.39 7.63 12.92 19.29 29.10 Paid-in capital 400.00 - - - 80.00 80.00 International borrowings - 33.60 136.08 251.44 336.00 420.00 Subtotal 400.00 33.60 136.08 251.44 416.00 500.00 Loan collections: Local currency - - - - - 10.00 Foreign currency - - - - 28.00 56.00 Subtotal - - - - 28.00 66.00 Total Sources 400.00 37.99 143.71 264.36 463.29 595.10 Uses Disbursements Local currency loans - 20.00 61.00 102.00 146.00 195.00 Foreign currency loans - 33.60 136.08 251.44 370.72 504.56 Subtotal - 53.60 197.08 353.44 516.72 699.56 Front-end fee - 1.68 5.04 - 7.56 - Tax paid - 0.41 0.78 1.64 2.94 4.77 Total Uses - 55.69 202.90 355.08 527.22 704.33 Surplus/deficit 400.00 (17.70) (59.19) (90.72) (63.93) (109.23) Ending balance of bank deposits: Local currency 400.00 354.30 295.11 204.39 140.46 31.23 Foreign currency - 28.00 28.00 28.00 28.00 28.00 AEPID November 1982  - 40 - ANNEX 3 Table 5 CHINA CHINA INVESTMENT BANK Projected Resource Position, 1982-87 As of December 31 1982 1983 1984 1985 1986 1987 Local Currency Funds (Yuan million) Resources available for approvals at beginning of the year - 400.00 326.21 237.74 110.99 12.91 Paid-in capital 400.00 - - - 80.00 80.00 Net income (loss) - 4.21 1.53 3.25 1.92 9.16 Loan collections - - - - - 10.00 Total 400.00 404.21 327.74 240.99 192.91 112.07 Approvals of investment loans during the year - 50.00 90.00 130.00 180.00 230.00 Funds transferred to revolving fund/a - 28.00 - - - - Resources available for approvals 400.00 326.21 237.74 110.99 12.91 (117.93) Foreign Currency Funds (US$ million) Resources available for approvals at beginning of the year - - 30.00 140.00 90.00 230.00 International borrowings - 70.00 200.00 80.00 310.00 110.00 Revolving fund /a - 10.00 - - - - Loan collections - - - - 10.00 20.00 Total - 80.00 230.00 220.00 410.00 360.00 Approvals of subloans during the year - 50.00 90.00 130.00 180.00 230.00 Resources available for approvals - 30.00 140.00 90.00 230.00 130.00 /a Refers to foreign currency bought with paid-in capital AEPID November 1982  - 41 - ANNEX 4 CHINA INDUSTRIAL CREDIT PROJECT Estimated Cumulative Disbursements of Proposed Loan/Credit /a (US$ million) CIB technical Bank/Association Front-end Investment Preparation assistance Total fiscal year and semester fee subloans subloans and training FY83 Second 0.6 0.8 0.2 - 1.6 FY84 First 9.5 0.4 0.1 10.6 Second 19.2 0.6 0.2 20.6 FY85 First 34.1 0.8 0.3 35.8 Second 48.7 1.0 " 50.6 FY86 First 58.7 " I 60.6 Second 63.7 " 65.6 FY87 First 66.7 68.6 Second 68.7 70.6 /a These projections allow for some slippage from the CIB projections in Annex 3, in accordance with Bank/Association experience in other projects as shown in the disbursement profiles. AEPID November 1982  - 42 - ANNEX 5 CHINA CHINA INVESTMENT BANK Selected Documents and Data Available in the Project File A. Sector Reports A.1 The Chinese Pa,ckaging Industry A.2 Chinese Banking Statistics B. Basic CIB Documents B.1 Charter and Supplemental Regulations (in both Chinese and English) B.2 Lending Procedures (draft) (in both Chinese and English) B.3 Accounting Manual (draft) (in both Chinese and English) B.4 Appraisal Manual (draft) (in both Chinese and English) B.5 Agreement on Entrusting Procurement Between CIB and CNTIC (draft) B.6 Agreement on Technical Evaluation of Industrial Projects Entrusted by CIB to CIECC (draft) B.7 Introduction to the China Investment Bank, February 1982 B.8 Introduction to the People's Construction Bank of China, October 1981 C. Working Papers C.1 Economic Evaluation of Investment Projects, Possibilities and Problems of Applying Western Methods in China (draft), by Adrian Wood, January 28, 1982 C.2 Project Planning, Pricing and Productivity in a Socialist Economy, A Study With Special Reference to the People's Republic of China (draft), by F.L.C.H. Helmers, EDI, February 1982 C.3 Economic Analysis of Aluminium Milling in Shanghai (draft), by Shinji Ichishima and Adrian Wood, March 26, 1982 C.4 The Shanghai Aluminium Plant: A General Introduction, by the Shanghai Aluminium Factory, July 10, 1981 C.5 The Shanghai Aluminium Plant, by David Humpage (Consultant), January 1982 and amended February 1982 C.6 Outline for a Proposed Strategic Plan for the Rationalization and Modernization of the Chinese Photographic Sensitized Goods Manufacturing Industry, by Norman Brick (Consultant), March 19, 1982 C.7 Proposed Project to Produce Polyester Base for Photographic Film, China Programs Division, May 28, 1982 C.8 China: Techn:ical Impressions of Possible China Investment Bank Projects, by Geoffrey Hilton, May 17, 1982 C.9 Notes on CIB subprojects (for World Bank files) by Gene Tidrick, May 28, 1982 C.10 Notes to CIB Five Year Financial and Operational Projections, November 12, [982  - 43 - CHINA CHINA INVESTMENT BANK ORGANIZATION CHART (AS OF OCTOBER 31, 1982I -OATOO,,o - I-- - Rb GCW LA IIGAAE1IACG GEE CEDANAGER DIRECTOR 4,05 AIR RET To DEPITA~~~~~~~~~~~~~OAP OF IRETOR -1- Hrn A. F2r1.1 TOTAL N ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~MNGN AIETP OPBOD IETER S LTIA TOTOL NA AD ORATE IN OBAB CERICE TDoO,A 01. 4.4 0, Coo,, 5ENIGR ~ ~ ~ ~ ~ ~ A ENIERN EiREONM-T-TRLN oeNlTAiE COSIAIG N L:KGPDE EDIGFNNEAI CDNTN UV DRSAC AD SDR ... h-gFIEDFRMETOPRMg eC ETDPRM9 Lu liuanzhgng FF CEMANAGER RECTOR Ms ChnJossong D *ECR E OFtbn S : Hakoel DIRECDR TonOToneEC TDTAL NO DF TDR lEDs *V 'AcA_B sN_'NS (Irx ud ng Honumrv Chal/man Cbe r ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~A- TnTn, Deul Ch IT'll fan X cYsE/tIUM RM G TDTAL ND DF STAFF IN HEAD DFF1CE = ZO~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~T,-l -I llnc udqns Se Monagementl _ 14 u Axnamum _ _~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~IIII   IBRD16488 11O C N 120