Malawi - Wood Industries Restructuring Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 5063-MAI STAFF APPRAISAL REPORT MALAWI WOOD INDUSTRIES RESTRUCTURING PROJECT December 12, 1984 Industry Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS US$1.00 = MK 1.33 (Malawi Kwacha) = DM 2.60 MK 1.00 = US$0.75 DM 1.00 = US$0.38 WEIGHTS AND MEASURES 1 board foot (BF) = 0.083 cu ft 1 meter (m) = 1.094 yards = 39.4 inches 1 kilometer (km) = 1,000 meters = 0.621 miles 1 cubic foot (cu ft) = 12 board feet = 0.0283 m3 1 cubic meter (m3) = 35.3 cu ft = 264 US gallons = 423.6 BF 1 square meter (m2) = 10.76 square feet 1 hectare (ha) = 10,000 m2 = 2.47 acres ABBREVIATIONS AND ACRONYMS USED ADMARC - Agricultural Development and Marketing Corporation DEG - Economic Aid Agency of the Federal Republic of Germany EIB - European Investment Bank FIAG - Forest Industries Advisory Group for Africa FID - Forest Industries Division in the Ministry of Forestry and Natural Resources FRG - Federal Republic of Germany Government - Government of Malawi GTZ - Agency for Technical Cooperation of the FRG INDEBANK - Investment and Development Bank of Malawi KfW - Kreditanstalt fur Wiederaufbau MDC - Malawi Development Corporation ODA - Overseas Development Agency of the United Kingdom RAI - Rai Plywoods (Kenya) Ltd. SAL - Structural Adjustment Loan TA - Technical Assistance TPL - Timber Products (Malawi) Ltd. UK - United Kingdom VIPCOR - Viphya Pulp and Paper Corp. Ltd. WICO - Wood Industries Corporation Ltd. (formerly FID) FISCAL YEAR April 1 - March 31  FOR OFFICIAL USE ONLY MALAWI APPRAISAL OF THE WOOD INDUSTRIES PROJECT TABLE OF CONTENTS Page No. Loan & Project Summary i-ii I. INTRODUCTION ............................................... I II. WOOD PROCESSING INDUSTRY IN MALAWI ......................... 2 A. Introduction ......... ........... ............ . . 2 B. Manufacturing ...................... 3 C. Forestry and Wood Processing Sector ..................... 5 1. The Forest Resource . . ......................., 5 2. Primary Wood Processing Industries ................. 6 3. Production Prospects from Existing Plants .......... 8 4. Secondary Wood Processing Industries ....... . .. 8 D. Government Policy . .................................... . 8 E. Bank Role ...................................... 9 III. THE MARKET AND MARKETING ................................... 10 A. Sawnwood ........................ ....................... 10 B. Panel board (Plywood and Blockboard) .................... 11 C. Prices ......... 12 D. Wood Supplies ....... .............. ..................... 13 IV. THE COMPANY ................................................ 13 A. Introduction ....... ............... ..................... 13 B. Capital Structure ...... ............. ................... 14 C. Management and Organization ............................ 14 D. Accounts and Auditing ............... .. ................. 15 E. Facilities and Operations ............. .. ............... 16 V. THE PROJECT ............... ................................. 17 A. Introduction ....... ............... ..................... 17 B. The WICO Restructuring and Technical Assistance Program 18 C. Technical Assistance to the Government ................ . 19 D. Start-up Activities .................. .................. 20 E. Project Implementation, Staffing and Training ........ .. 20 F. Environmental Considerations ........................... 23 G. Employment ....................... ...................... 23 This Report was prepared by Messrs. D. Brown and R. Venkateswaran (Industry Department) and A. Tarnawiecki (consultant). This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - TABLE OF CONTENTS (Continued) Page No. VI. CAPITAL COSTS, FINANCING PLAN, PROCUREMENT AND DISBIURSEMENT 23 A. Capital Costs ................. 23 B. Financing Plan ......................................... 26 C. Procurement and Disbursement ........................... 27 VII. FINANCIAL ANALYSIS ......................................... 30 A. Recent Performance ..................................... 30 B. Projected Financial Performance .... .................... 32 C. Financial Rates of Return and Sensitivity Analyses ..... 35 D. Financial Covenants .......................... 36 E. Auditing and Reporting Requirements ................. ... 36 VIII. ECONOMIC ANALYSIS AND RISKS ................................ 37 A. Adjusted Costs and Benefits for Economic Analysis ...... 37 B. Economic Rate of Return ................................ 37 C. Other Benefits ......................................... 38 D. Analysis of Risk ....................................... 38 E. Sector and Policy Consideration ........................ 38 IX. AGREEMENTS .................... ...... ................... 39 ANNEXES 2-1 Sawnwood Production in Malawi 2-2 Production and Imports of Panelboard 3-1 Consumption of Mechanical Wood Products 3-2 Projected Production of the Mechanical Wood Industries in Malawi 3-3 Prices of Imported Wood Products 3-4 Projected Wood Requirements for Mechanical Processing 4-1 WICO Organization Chart 4-2 Terms of Reference - Establishment of Accounting and Control Systems 5-1 Terms of Reference for Technical Assistance to WICO 5-2 Project Implementation Schedule 6-1 Cost Estimates & Financing Plan 6-2 Estimated Disbursement Schedule of Bank Loan 7-1 Assumptions Used in Financial Projections 7-2 Forecast Production and Sales Volumes/Working Capital Schedule 7-3 Forecast Income Statements 7-4 Forecast Statement of Source and Applcation of Funds 7-5 Forecast Proforma Balance Sheets 7-6 Cost and Benefit Streams for Financial Rates of Return 8-1 Cost and Benefit Streams for Economic Rate of Return  - iii - TABLE OF CONTENTS (Continued) DOCUMENTS AVAILABLE IN THE PROJECT FILE Reference 1. INDUFOR - Markets for Sawnwood and Wood-based Panels for the Viphya Wood Industries Project in Malawi, by M. Simula, Helsinki, June 30, 1982 (revised August 23, 1982) (File Code E-1323) 2. The Demand for Sawnwood and Related Products in Malawi until 2005 and Recommendations on the Establishment and Management of Softwood Timber Plantations to Satisfy the Requirement for Construction Timbers, A Study, by M.J. Birchmore, August 22, 1974 (File Code E-1902) 3. The Companies Acts 1908 and 1913 as Applied to Malawi by the Companies Act (CAP. 46:03) Company Limited by Shares. A Memorandum and Articles of Association of Viphya Pulp and Paper Corporation Ltd., December 31, 1983 by Wilson Morgan and Co. (File Code E-1842) 4. Utilization of the Viphya Forest Resources A. Second Intermediate Report (2 vols) B. Main Report (3 vols) dated June 30, 1981 C. Contract between Viphya Pulp and Paper Corp. and Jaako Poyry dated July 23, 1980 D. Utilization Study Report by ODA mission, September 1980 E. Forest Resources and Proposed Operations - Annex I F. Draft Final Report: Viphya Wood Industries Project, prepared by VIPCOR and GOPA/Jaako Poyry Team, Blantyre, October 1983 (revised November 11, 1983). Main Report and Annexes VI, VIII, IX, X, XI, XII; Main Report and Amendments to Annexes (File Code E-1319) MAP IBRD 18115 - Malawi   MALAWI WOOD INDUSTRIES RESTRUCTURING PROJECT LOAN AND PROJECT-SUMMARY Borrower: Republic of Malawi. Beneficiary: Wood Industries Corporation (Malawi) Limited (WICO). Amount: US$6.4 million equivalent, including front-end fee. Terms: Payable in 20 years, including 5 years of grace, with standard variable interest rate. Relending US$5.1 million equivalent onlent to WICO, payable in Terms: 10 years, including 4 years of grace, with interest rate at 12 percent, WICO to bear the foreign exchange risk. Project The project would assist Malawi in meeting its demand Description: for wood products, managing and optimizing forest resources, increasing industrial productivity, encouraging privatization, and developing institutions in the sector. Specifically it would provide: (a) technical assistance to WICO to assist it to organize and operate as a private company, restructure its Mazamba and Dedza sawmills and rehabilitate its Zomba mill, purchase critical spares and equipment, establish training programs and carry out feasibility studies for new processing facilities, product development and quality control; and (b) technical assistance to the Government for developing alternative uses for forest resources, mainly in Viphya. Benefits and The project will substantially increase output from Risks: WICO's mills, improve product quality, and lead to more efficient use of forestry resources, which in turn would generate significant long-term returns to the economy. It would also identify additional economically viable investments for Malawi's extensive wood resources. The project faces no special risks, although realization of the expected benefits will depend mainly on the pace of managerial improvements. The incrmental economic and before-tax financial rates of return for the project as a whole (including the technical assistance costs) are 25 percent and 23 percent, respectively. The after-tax financial rate of return is 15 percent.  - ii - US$ Million Local Foreign Total Estimated Cost: (a) Restructuring and Technical 1.8 4.1 5.9 assistance to WICO (b) Technical assistance to 0.1 1.0 1.1 Government Total Base Cost (Feb. 1984 prices) 1.9 5.1 7.0 Physical Contingencies 0.1 0.5 0.6 Price Escalation 0.2 0.8 1.0 Total Project Cost 2.2 6.4 8.6 IBRD Front-End Fee ($15,960) - 0.0 0.0 Total Financing Required 2.2 6.4 8.6 Financing Plan: IJS$ Million Local Foreign Total WICO 2.1 - 2.1 Government 0.1 - 0.1 IBRD Loan - 6.4 6.4 Total 2.2 6.4 8.6 Estimated Disbursements: US$ Million Bank FY: 1985 1986 1987 1988 1989 1990 Annual 0.3 1.4 2.4 1.6 0.5 0.2 Cumulative 0.3 1.7 4.1 5.7 6.2 6.4 Economic Rate 25 percent. of Return: Appraisal Report: No. 5063-MAI ( , 1984). Map: IBRD 18115.  MALAWI - WOOD INDUSTRIES RESTRUCTURING PROJECT I. INTRODUCTION 1.01 The Government of Malawi has requested a Bank loan of US$6.4 million to help finance development of the mechanical wood processing industry in Malawi (Map IBRD No. 18115). In parallel, on August 2, 1984, IFC's Board approved an investment in a wood processing plant at Chikangawa in the Viphya forest in Northern Malawi that was originally part of the Bank project. The Bank loan would be used to provide technical assistance to rehabilitate existing Government-owned production facilities and to further develop industrial forest utilization in Malawi. 1.02 The IFC-financed project at Chikangawa has a capacity of 6,500 cubic meters per year (m3/yr) of sawnwood and 15,000 m3/yr of panelboard. It will be owned and operated by a joint venture between Viphya Pulp and Paper Corporation (VIPCOR) and RAI Plywood (Kenya) Ltd., a private technical/equity partner (RAI). VIPCOR is a wholly owned Government corporation originally set up in 1973 to promote commercial development of the Viphya forest.l/ RAI is a privately owned, profitable and efficiently run plywood manufacturer with many years of commercial and operating experience. Financing required for the Chikangawa project is estimated to be US$23.5 million equivalent and will be provided by Kreditanstalt fur Wiederaufbau (KfW) (DM 35 million, US$13.5 million equivalent), VIPCOR and the Partner (US$7 million).2/ The balance of US$3 million will be provided by IFC and the Investment and Development Bank of Malawi (INDEBANK). The KfW funds would be a grant to the Government that will be passed on to the project as a combination of loan and income notes. The European Investment Bank (EIB) will provide US$3.3 million equivalent of equity funds for VIPCOR through a loan to the Government on concessional terms. 1.03 The Bank project will increase output of sawnwood from the existing government-owned mills operated by the Forestry Industries Division (FID) of the Ministry of Forestry and Natural Resources and, coupled with the Chikangawa project, will enable the country to satisfy its needs for mechanical wood products through the end of this decade. The proposed Chikangawa mill will utilize about 12% of Viphya forests and under the Bank's technical assistance program the forecast industrial use of the Viphya forest could increase to a maximum of 25% of the mean annual 1/ IDA supported an engineering project that attempted to develop an export pulp mill in Viphya. The project was not implemented due primarily to unexpectedly high infrastructure and transport costs, low pulp prices and the inability to attract the essential foreign partner. 2/ US$1 million of KfW funds will be made available to VIPCOR as part of the latter's equity contribution so that both partners will share equally in the US$8 million capital of the new company -- Viphya Plywoods and Allied Industries Ltd (VIPLY) to be formed.  -2 increment (MAI). In addition, more effective use of commercial forests in the Dedza and Zomba areas will be sought. Co-financing for the Bank project is not included at present, although discussions are continuing with GTZ (FRG) to provide minor amounts of funding. 1.04 The Bank project comprises: (i) technical assistance, training and facilities to convert FID into a corporation, the Wood Industries Corp. (WICO), and to improve the operation of its sawmills, and (ii) technical assistance to the Government for the development of additional industrial uses for the Viphya forest. 1.05 The project, developed over the past three years in cooperation with the Government and KfW, is the result of the Governmentts efforts directed towards development of northern Malawi 3/ and more efficient industrial utilization of the Viphya and other forest resources. Forest industries represent one of the few opportunities for industrial development in Malawi. The country has ample commercial plantations but their geographical distribution does not fit consumption patterns: There is an overall shortage of wood in the South, both for processing and for use as fuel and there are overmature forests in the north. The Viphya plateau plantation has been developed by the Government with the assistance of FAO and the UK's Overseas Development Agency (ODA). The Bank Group has been actively assisting the Government, initially through technical assistance to develop an export pulp mill (which did not materialize) and, at present, through the IFC Chikangawa project. Other Bank Group activities proceeding in parallel with the Bank project are a Forestry Sector Review, assistance to a project aimed at reducing fuelwood consumption in the tobacco industry, and IFC assistance to the Government in promoting a small pulp and paper project. A second IDF operation with INDEBANK is also under preparation. 1.06 The Bank appraisal was carried out in November 1983 by a mission comprised of Messrs. D. Brown of the Industry Department and S. Saukkonen and A. Tarnawiecki, consultants. Appraisal was completed in May 1984 by Messrs. D. Brown and R. Venkateswaran, following the government decision to create the Wood Industries Corp. (WICO) a year earlier than had originally been envisaged. II. THE WOOD PROCESSING INDUSTRY IN MALAWI A. Introduction 2.01 Malawi is a densely populated (about 6.6 million inhabitants in 1983), small (118,500 km2 land area) landlocked country in Southeastern Africa, and its per capita income in 1982 was US$210. Malawi has moderately fertile land in a diversified ecological environment, good water resources and climate favorable to many types of crops. uInlike its neighbors, no substantial mineral deposits have been found in Malawi. 3/ The Bank Group is currently implementing the Fifth Highway Project (Report No. P-3656-MAI) which will pave a portion of the main North-South highway that passes adjacent to the Chikangawa mill.  Relative to other countries in the region, Malawi has a better cadre of trained professional people, although their number is insufficient for sustained, long-term economic growth. 2.02 In spite of the lack of oil and other resources, the country's economic development since independence in 1964 has been encouraging as compared to other countries in the region. Between 1964 and 1979, GDP grew at an average annual rate of 6% and manufacturing output and volume of exports, on the average, by 10% and 4.5% respectively.4/ Gross domestic investment has increased steadily in the same period from 9% to 33% of GDP. This has been made possible by significant inflows of official and private external capital but also by a jump in domestic savings from virtually nil in 1964 to 14% of GDP in 1979. 2.03 Malawi's economy is heavily dependent on three primary commodity exports (tea, sugar and tobacco) and is vulnerable to international price fluctuations; steady escalation in import prices and disruptions of overland transportation to and from ocean ports and delays in freight-handling through congested port facilities, together with the above-mentioned cyclical swings in export prices,5/ have had a depressing effect on the country's economy. Agricultural production suffered from recurring droughts in 1980 and 1981 and GDP dropped slightly in those two years. 2.04 Malawi has been able to steer a realistic and purposeful policy under difficult conditions by providing satisfactory infrastructural and service facilities and creating a supportive framework to promote private initiative and investment. It has recently taken steps to ensure that, with few exceptions, manufactured products are not subject to price controls. The Government is also addressing budgetary and trade disruptions through a realistic approach to foreign exchange rates and by limiting government borrowing. This economic program has been supported by the IMF through a standby agreement (August 1982) and an Extended Fund Facility (September 1983) and by the Bank through two SAL operations (June 1981 and April 1982). 2.05 As a consequence of the programs described above and improved weather conditions (1982 agricultural output was 6.2% higher than in 1981), GDP increased by an estimated 2.6% in 1982 and 4.3% in 1983 and it is forecast to continue to grow moderately (between 3.5-4.0% annually) in 1984-88.6/ B. Manufacturing 2.06 From independence through the late 1970s, manufacturing activity in Malawi was buoyant and starting from a very low level, it grew vigorously in the period 1970-78 at an average rate of over 10% per year, 4/ Report No. 3082-MAI (Malawi-Growth and Structural Change - A Basic Economic Report), page 104. 5/ Weighted average export prices declined by 16% between 1977 and 1980 while import prices rose by 39%. 6/ Estimates from CEM mission in February 1984.  or twice the rate of GDP growth. Initially, food, beverages, and the processing of tea and tobacco crops accounted for the bulk of manufacturing operations, but over the years the range of goods produced expanded to include textiles, clothing, footwear, pharmaceuticals, soap, packaging materials, and wood and metal products. Production of consumer goods recorded the most rapid advance, followed by export industries, particularly after sugar had become a major foreign exchange earner. 2.07 The favorable trend was not sustained from 1978 to 1982. Production initially stagnated and, after a recovery in 1981, fell by 6% in 1982. Over the period 1978-82, growth of manufacturing output averaged just over 1% per year. However, in 1983, manufacturing value added grew by more than 15%, the lead coming from agricultural processing and food and beverages. 2.08 In spite of the 1978-82 slowdown, the Malawian industrial sector is relatively important, having accounted for 16.9% of the country's GDP in 1982. In terms of sales, the leading manufacturing industries in Malawi are food (mainly sugar) and beverages (26% of manufacturing), tobacco processing (15%), building materials (12%) and textiles, footwear and clothing (15%). Tea processing and other export industries account for another 18% of total manufacturing sales. The manufacturing sector is dominated by a small number of enterprises and three major holding companies: the Malawi Development Corp. (MDC), the Agricultural Development and Marketing Corp. (ADMARC) and Press (Holdings) Ltd. and a development bank (INDEBANK). Foreign firms are major partners in beer, textiles and vegetable oil production. Small enterprises may play an important but under-reported role in some branches of industry such as baking, garments and furniture. 2.09 The potential industrial use of coal deposits in the North and relatively large bauxite ore bodies in the Mulanje area merit further investigation but prospects are not very promising because these products are generally exploited in large operations given their low value per unit volume. Forests and some agricultural products are apparently the only practical resources available for industrial development in the near future. Small projects in vegetable oil production by solvent extraction, coffee vacuum drying, fishing, and mnanufacture of insecticides and polypropylene bags have been proposed but have not been started. An IFC-assisted project for the manufacture of ethanol from sugar cane molasses is in operation. A relatively large project to manufacture fertilizer (120-140 tons daily of ammonium nitrate) has also been discussed but the Bank does not consider it to be economically justifiable at present. 2.10 Malawi's policy has been complemented by a system in which the private sector has been given the role of being the primary engine for growth. Although tariffs and quantitative import restrictions exist they have been applied judiciously, thus discouraging inefficient import-substitution. The Government's wage-control policy has helped to keep exports competitive and to expand employment. In particular, this policy has encouraged a relatively labor-intensive manufacturing, the 40,000 Malawians employed in the sector representing about 12-13% of the  - 5 - wage-earning labor force. Industrial management in Malawi is generally good, and considerable attention is paid to maintenance. Spares and semi-skilled labor are generally available to industries, and capacity utilization has been relatively high. C. Forestry and Wood Processing Sector 1. The Forest Resource 2.11 Large tracts of Malawi were originally covered with natural woodlands (where valuable hardwood species existed) but much of the forest has been cleared for food and industrial crops or cut for fuelwood. At present, 39% of the land area (i.e., about 3.7 million ha) 7/ is forested. The natural woodlands contain at present few trees of valuable species, except in areas not easily accessible. Therefore, indigenous forests (apart from their importance as protective cover) are mainly utilized for the supply of traditional building poles and firewood, generally free of charge if used for domestic purposes. Consumption for these uses (approximately 8 million m3/yr) exceeds considerably the annual sustainable yields of the national forests.8/ The country-wide figures, however, do not show the full size of the problem. As most of the population lives in the South, where the forest reserves are smallest, the deficit in wood availability is a particularly serious issue in this region. However, because there are still accessible, unprotected forests, and hence untrammelled scavenging, fuelwood and charcoal prices remain low and there have been insufficient economic incentives for landholders to replant trees on a systematic basis. Woodfuel price differentials between the northern region and the heavily populated southern river valleys, however, are now growing in response to increasing scarcity. The Forestry Subsector Report for Malawi (green cover report dated March 15, 1984) describes the forest resource and its uses in more detail. 2.12 Since the 1950s, the Government, assisted by ODA and other agencies, has pursued a forestry development policy which has led to the establishment of plantations in the following three main groups: (i) Government and private plantations for sawnwood, plywood and poles for transmission and telephone lines; (ii) the Viphya Plateau plantations originally planned for pulpwood; and (iii) Government and small farmer fuelwood plantings. 2.13 Partly in response to the emerging fuelwood crisis and as a result of policy initiatives supported by the Bank, the Government is tackling the fuelwood problem with a three-pronged strategy aimed at building up long-term supply through small farmer wood plantings, intensive forest development in areas of shortages and improvement of the management of customary land by District Councils. The first two aspects of this 7/ Mechanical Wood Industries in Malawi by M.J. Lyons, Forest Industries Advisory Group for Africa (FIAG 80/24), October 1980. This area does not include brush areas or land with isolated clumps of trees. 8/ IBRD, Malawi: Issues and Options in Energy Sector (Report No. 3903-MAI), August 1982, and Forestry Subsector Review mission data.  - 6 - strategy are being carried out with the help of an IDA-financed project aimed at establishing 12,900 ha of fuelwood plantations and 88 nurseries to provide seedlings for farmers' woodlots. While the main thrust of the Government's strategy has been to tackle the supply side of fuelwood, some headway has been made on the demand side as well, particularly with regard to more efficient use of fuelwood by the tobacco industry. Under the IDA-financed Technical Assistance II Project, the Bank is supporting the first phase of a program to be carried out by the Tobacco Research Association. The other plantations which the Government has developed for industrial use total about 73,000 ha, of which 54,000 ha are in the Viphya region in the North. Details of all new plantations are summarized below: Malawi - Government Forest Plantations (1982) (000 Ha) Other Sub-total Pines Coniferous Softwoods Hardwoods Totals Northern Region 51.1 - 51.1 2.6 53.7 Central Region 8.9 0.2 9.1 3.0 12.1 Southern Region 5.3 0.2 5.5 3.8 9.3 Totals 65.3 0.4 65.7 9.4 75.1 More than one half of the planted areas in the Northern and Southern regions are 15 years or older, while the Central region plantations are much younger (Annex 2-2). Estimates made by the Forestry Department and Bank missions show that the overall availability of wood suitable for mechanical processing in Malawi is ample for the current country needs (para 3.07) but, as in the case of fuelwood, the geographical distribution of supplies does not match regional demands.9/ 2. Primary Wood Processing Industries 2.14 The most important industrial activity utilizing forest resources in Malawi is sawmilling. (Traditional use of untreated poles for housing is not considered part of the industrial sector.) Eight sawmills are now in operation, five of which account for 90% of the total production of about 38,000 m3. Four of them (Mazamba, Dedza, Zomba and Blantyre) are in the public sector and the fifth (the largest of the five) belongs to Timber Products (Malawi) Ltd. (TPL), a subsidiary of the UK Imperial Group Ltd., which also operates a plant in Blantyre making plywood and flush doors. The plants' output is shown in Annex 2-1, summarized in the following table. 9/ Availability of Pine Peeler Logs from the Viphya Plantations in Malawi, Interforest Report to the World Bank, June 1982.  Malawi - Sawnwood Production (000 m3) FY Region 1969 1974 1979 1980 1981 1982 1983 Northern Mazamba 1.0 0.9 - - - 0.1 2.4 Central Dedza 2.6 5.0 5.6 8.4 5.8 6.1 4.3 Southern Zomba 3.6 6.7 8.3 8.5 6.5 8.4 7.4 Blantyre 1.9 5.3 7.6 7.2 6.9 4.8 4.2 TPL 9.6 14.9 16.6 17.4 15.5 15.9 16.5 Subtotal South 15.1 26.9 32.5 33.1 28.9 29.1 28.2 Other a/ 3.6 4.6 5.1 5.1 3.5 3.0 3.5 Totals 22.3 37.4 43.2 46.6 38.2 38.3 38.3 a/ Estimates for portable circular saws and pit sawing. 2.15 The Blantyre and Zomba sawmills are obsolete and their location is inadequate. The Mazamba sawmill was designed mainly to process thinnings for future construction work in the area and has inadequate facilities for handling and processing lumber of the size and quality for which there is a market deficit. The Dedza sawmill, though relatively new, is handicapped by insufficient drying capacity and by the small size of the logs and thinnings fed to it. The TPL mill operates efficiently but it has difficulties in obtaining log supplies due to the depletion of indigenous forests and the limited yield of the company's own eucalyptus plantations in the Blantyre area. The conversion factors (i.e. the volume of sawnwood obtained from a given volume of logs) for the mills depend to a large degree on the average size of logs used. The average conversion factor for the public sector mills has been 46% in the last three years but the averages for Dedza and Mazamba are less than 40%. The optimum would be 50-55%, indicating that these mills are not utilizing the timber resources efficiently. 2.16 The main users of timber are dissatisfied with the present quality of sawn softwood because of poor grading, insufficient or non-uniform drying, inadequate pesticide treatment, lack of joinery/furniture grade timber and scarcity of larger cross sections and longer lengths needed for construction. Eucalyptus sawnwood is used mainly for boxes and tea chests and indigenous species for furniture where no grading is applied. A Technical Committee for Timber Products--with the participation of producers and the main users--has been proposed by WICO and its establishment is expected in the near future.  - 8 - 2.17 The only commercial producer of panelboard in Malawi is the TPL plywood and blockboard mill in Blantyre whose output has averaged about 4,360 m3/yr in the last three years (Annex 2-2). 3. Production Prospects from Existing Plants 2.18 Significant overall increases in production by existing mills are possible through some plant modifications and improved management and operating procedures as well as by the timely supply of suitable logs to the mills. The Mazamba mill has a theoretical capacity of 15,000 m3/yr but it is not expected to produce more than 5,000 m3/yr in the near future because of design and log supply deficiencies. With substantial improvements in design, log supply and technical management (para 5.03), this mill is expected to reach an output of at least 10,000 m3 by the mid-1990s, further increases being dependent on market conditions. The Dedza mill's capacity could be increased to 20,000 m3/yr; after substantial upgrading and a better log supply, its output is expected to reach 16,000 m after 1990. The Zomba mill is obsolete and is assumed to stop operating in the mid-1990s. The WICO's Blantyre mill is also obsolete and should stop operating before 1990 although the associated furniture, pallet and pole making activities will continue and expand. For the TPL mill, it is assumed that purchase of logs from the Forestry Department will allow the mill to maintain output (possibly increasing it to 20,000 m3 annually by 1990), but the product mix will gradually shift from hardwoods to a higher share of softwood. Output from TPL's plywood and blockboard mill is estimated to be maintained at about 5,000 m3 annually. The increased output of the existing mills, combined with projected output from the Chikangawa project (para 1.02), should give the country a relatively balanced supply/demand situation for mechanical wood products through 1990. 4. Secondary Wood Processing Industries 2.19 Most sawmills are integrated to some degree with further conversion operations. The Dedza sawmill makes some furniture and also moulding, woodwool/cement boards and sawdust pellets. The FID Blantyre mill has a separate unit to manufacture furniture and it also produces pallets, boxes, crates, etc. These conversion activities are not, however, strongly promoted. TPL, on the other hand, not only makes tea chests, tobacco cases and other boxes, but also produces 2,000 flush doors annually using its own plywood and sawnwood. In addition, there are ten firms specialized in joinery and furniture production (of which three employ more than 50 people) and many artisans or cottage operations, whose output is under-reported. D. Government Policy 2.20 Given the relative scarcity of other natural resources, forestry and associated industries are important to the Government's economic development plans. The large-scale utilization of Viphya's extensive plantations for pulp (mainly for export) has been studied extensively but it has not been demonstrated to be economically feasible. Other projects for the exploitation of .e Viphya resources and the expanded utilization of other plantations have been proposed (para 4.06).  -9- 2.21 To encourage the private sector to participate in the development of forest industries, the Government has agreed to decontrol wood product prices and to set reasonable stumpage fees to promote economically viable projects. To improve the efficiency of forest industries already established in the country it has also converted FID (at present a Ministry division) into a private corporation (WICO) fully subject to commercial law (para 4.04). Some or all of the WICO mills could eventually become joint ventures with private investors. Also the IFC Chikangawa project as well as a proposed small paper project will be developed in cooperation with private technical/equity partners (paras 1.02 and 1.05). E. Bank Role 2.22 The Bank Group's strategy in the industrial sector is to assist existing enterprises to attain substantial improvement in their performance and to encourage continued expansion of manufacturing based on the utilization of forestry, agricultural and livestock resources through economically justifiable projects. Projects with significant export potential have been identified with the assistance of the Bank and other organizations. The Bank's lending for industry in the medium term will focus on: (i) INDEBANK because of its position as the main local source of long-term financing for industrial enterprises; (ii) through the Bank and IFC for commercially oriented industrial projects larger than INDEBANK can undertake; and (iii) continue to promote co-financing and privatization. Other improvements in the sector are being sought by the Bank through the structural adjustment process, including the reform of income, price and incentive policies and the promotion and diversification of exports. 2.23 The Bank's involvement in the proposed project for improvements in the industrial utilization of Malawi's forestry resources is discussed in Chapter IV. In March 1980, IDA extended a credit of US$13.8 million (National Rural Program II) to assist the Government of Malawi with the fuelwood problem (para 2.11). IDA had previously made (in June 1974) an Engineering Credit of US$2.0 million for studies related to the proposed export-oriented Viphya pulp project which did not materialize (para 2.18). In addition, a draft report of the Forestry Subsector Study carried out by the Bank in November 1983 is currently being reviewed by the Malawian Government. Among other conclusions, this study recommends that: fuelwood revenue collection be studied to improve revenues and reduce gradually access to free wood; legal and management procedures be designed to make it compulsory for agricultural estates to grow trees for fuelwood; availability of land for forestry be identified; and investments in forestry research, plantations and extension work (particularly in training) be increased. The proposed Wood Industries Restructuring Project has a component to further develop industrial uses of wood. The Bank also provided a US$3 million line of credit to INDEBANK in 1979 and a second project is being prepared. 2.24 IFC has participated in Malawi in the financing of a textile plant (US$10.8 million), a sugar mill (US$9.9 million), in the manufacture of ethanol from molasses (US$2.4 million) and in a hotel (US$0.4 million). It has also provided US$0.6 million in the equity of INDEBANK, a financial intermediary. IFC is also currently re-examining the prospects of a small paper mill.  - 10 - 2.25 The Bank Group's assistance to Malawi during the next five years will continue to be directed to help restructure the country's economy, especially through improved agricultural and forestry productivity and more efficient operation of public and private enterprises.10/ It is within this framework that the Bank Group agreed to explore the possibility of financing the mechanical wood processing complex in Viphya and the technical assistance required to restructure existing forest industries and the potential development of new uses for timber. III. THE MARKET AND MARKETING _/ A. Sawnwood 3.01 Consumption of sawnwood grew at an average rate of 6.7% annually from 1968 to 1975 when it reached 49,400 m3. In the three following years, consumption dropped but, in 1979, it again peaked at more than 51,000 m3. It has since declined sharply, to less than 39,000 m3 in 1982 (Annex 3-1), due to balance of payments deficits and the Government's measures to combat inflation. More than half of the 1979-81 demand was for softwood, the share of which has been gradually increasing, and this trend is expected to continue. The main end-users of sawn softwood have been construction (61%) and packaging (27%). On the other hand, 55% of the sawn hardwood is used in packaging and 32% in construction. Regional sawnwood demand is concentrated in the South: Malawi - Regional Distribution of Sawnwood Demand (1979-81) (000 m3/yr) North Central South Total % of Total Construction 4.3 11.7 8.7 24.7 55.0 Packaging 0.9 2.8 11.2 14.9 33.1 Furniture, etc. 0.5 1.6 3.3 5.4 11.9 Total 5.7 16.1 23.2 45.0 100.0 Regional % 12.8 35.8 51.4 100.0 3.02 Adopting a three-year moving average to eliminate year-to-year fluctuations, sawnwood consumption grew, on the average, at 3.4% p.a. from 1969 to 1979, approximately matching the growth of GDP. During 1979-1981 average consumption fell by 4.3% annually, reflecting the recessionary conditions prevailing in the country. Demand is projected to increase by 4.0% annually between 1982 and 1995. The growth rate of demand in the South (including Blantyre) is expected to be lower than for the other regions but the South will remain the major consuming area. It will be supplied from TPL and expanded output from Dedza as Zomba and Blantyre mills are phased out. The projected demand is summarized below: 10/ IBRD, Report No. P-3656-MAI. 11/ The chapter is an updated summary of the Bank consultant report "The Market for Mechanical Wood Products in Malawi", M. Simula, August 1982.  - 11 - Malawi - Projected Sawnwood Demand (000 m3) Total 1982 Actual (3-year average) 40.9 1987 Projected 49.7 1990 Projected 56.0 1995 Projected 68.0 3.03 The existing Mazamba and Dedza sawmills can increase their present output through mechanical and organizational improvements (para 2.18) but the existing and obsolete Zomba and Blantyre mills can at best be kept operating for a few more years (Annex 3-2). The loss of their output would consequently leave a growing deficit in domestic supplies. Only the Viphya and Zomba areas (in the northern and the southern regions, respectively) have sufficient volumes of sawlogs adequate for economically sized sawmills. The Dedza planted area is extensive (6,800 ha) but the bulk of the planting has taken place after 1971 and the growth rate for trees in the region is slower than in Viphya and Zomba. Therefore, productive capacity increments in the near future should be first located at Viphya and Zomba. The proposed IFC-financed Chikangawa project (para 1.02), together with the increased output from existing mills under the Bank project, will help to ease the gap between supply and demand until the end of the decade. Malawi - Projected Demand and Supply of Sawnwood (000 mj) 1987 1990 1995 Supplies from Existing Mills: WICO 24.4 - 35.0 TPL & Other Private 22.0 23.0 26.5 Subtotal 46.4 55.1 61.5 Supplies from the Chikangawa Project 3.2 6.5 6.5 Total Supplies 49.6 55.5 68.0 Demand 49.7 56.0 68.0 Surplus (Deficit) (0.1) (0.5) 0 B. Panelboard (Plywood and Blockboard) 3.04 The supply and demand projections for panelboard are summarized in the table below. These projections show the need for the proposed plant in the Viphya area and for continued upgrading of output from the existing mill. Exports to neighboring countries would absorb the moderate surpluses produced in some years.  - 12 - Malawi - Projected Demand and Supply of Panelboard a/ (000 m3) 1990 1995 Demand 19,600 23,600 Supplies from TPL Mill 5,000 5,000 Deficit 14,600 18,600 a/ Excluding fiberboard, hardboard and wood-wool slabs. C. Prices 3.05 Sawnwood and panelboard prices in Malawi have been government-controlled as were those of most other commodities. This policy has not encouraged the private sector to participate more dynamically in the mechanical wood industries and has not been conducive to quality improvement since no price differential was allowed for higher quality products. For example, the MK 10/m3 differential allowed for kiln-dried over air-dried wood was insufficient to cover the extra cost of kiln-drying. As part of the second SAL operation (para 2.04), the Government has recently agreed to letting market forces set prices, except for a small number of products. Wood products have been included among those that will be decontrolled. During negotiations agreement will be sought that sawnwood and panelboard will continue to be maintained on the decontrolled list. Current prices for the main imported wood products are shown in Annex 3-3 and summarized in the table below: Malawi - Current and Projected Wood Product Prices (MK/mJ3) Projected Prices Current Prices (1985) Domestic Imported a/ Domestic Sawnwood Pine Construction Sawnwood 193 438 200b/ Furniture & Joinery 265 635 - Panelboard Plywood, 4 mm (construction) 650 820 780 Plywood, 9 mm (packaging quality) 354 - 400 Blockboard 19 mm (internal quality) 530 760 630 a/ CIF Blantyre, excluding all duties and taxes. b/ It is assumed that the price of sawnwood will increase at 5% p.a. in real terms up to MK 250/m3. The typical product mix at the WICO sawmills comprises 45% construction grade I, 45% grade II and 10% box wood. Under the project, the air dried quality would be upgraded to the kiln-dried variety commanding the higher price shown.  - 13 - The prices for domestic sawnwood in Malawi are less than one half of current border prices. Because of high customs duty,12/ the domestic prices of imported panel products, of qualities similar to those which would be produced by the Chikangawa mill, are significantly higher than current import parity whereas domestically produced panel products, largely of poorer quality for tea chests only, are considerably lower than import parity. Domestic prices are assumed to increase but to continue to be depressed in relation to border prices for imported products because of the well established marketing practices for domestic products and the likelihood of consumer resistance to higher prices. By 1987, there would be three major companies producing sawnwood and two companies making panelboard. In addition there will be traders who would be expected to be able to import products freely. Thus, there would be sufficient competition to prevent a monopoly price situation from developing. D. Wood Supplies 3.06 Timber volumes required by the existing and proposed wood processing industries are shown in Annex 3-4. The northern region has a surplus of sawlogs and peelers available even after installation of the proposed Chikangawa mill (and also a large volume of surplus pulpwood). On the other hand, the mills located in Blantyre will run into increasing unavailability of timber grown in nearby areas and will have to purchase at least part of its wood inputs from plantations in the Zomba area or even further away, thereby lowering the profitability of their operations, or will require new plantations. The Forestry Department has indicated that it is willing to sell timber from its commercial plantations, including Zomba, to any purchaser including the private sector. For the southern plantations, the selling price would correspond to the market value and/or replacement cost, whichever is higher, and would correspond to a stumpage fee of about US$18-26/m3 (MK 25-35/m3). A stumpage fee of US$3.75/m3 (MK 5/m3) to be maintained for five years has been agreed by the Government with regard to the Chikangawa project. This would be close to the economic opportunity cost for timber in the Northern region. The Government has confirmed that the same stumpage fee would be maintained for log purchases by the Mazamba mill. IV. THE COMPANY A. Introduction 4.01 The Forestry Department in the Ministry of Forestry and Natural Resources has overall responsibility for forestry development, protection and conservation and for forest utilization. Most of the plantations are owned by the state through the Department of Forestry. The Department is headed by the Chief Conservator of Forests who oversees the work of four divisions: (a) Management of Plantations and Protected Forest Reserves; (b) Management Service, responsible for education, research and technical services; (c) Viphya Pulpwood Plantation; and (d) the recently established Wood Energy Division, responsible for present and future fuelwood 12/ Customs duties and taxes on all imported goods average 15-25% plus a 25% surcharge.  - 14 - productions. A fifth division, Forest Industries (FID), is being converted into an autonomous corporation. 4.02 The decision to convert the Forest Industries Division (FID) of the Ministry of Forestry and Natural Resources was officially approved by Presidential Directive on April 16, 1984. The Government is now taking the needed steps to complete registration of the newly formed Wood Industries Corp. (Malawi) Ltd. (WICO) under the Malawian Companies Act as a private corporation with limited liability. A preliminary valuation of FID plant and other fixed assets, inventories and other current assets, has been carried out by the Lands, Valuation and Water Department. Registration formalities were concluded on July 1, 1984, when WICO began its official legal existence. B. Capital Structure 4.03 WICO's opening balance sheet would have a totally debt-free capital structure so that at project completion a debt/equity ratio of around 50:50 could be reached (and would not be greater than 60:40), and so that the debt service coverage in the early years of the project would be not less than 1.5. It was agreed, at negotiations, that WICO's audited opening balance sheet would be submitted for Bank review and comment prior to any disbursement of the proposed loan allocated to the WICO Restructuring component. 4.04 The Government's intended final ownership structure for WICO is a 51/49 public/private split with the further possibility to sell all of the individual mills totally to the private sector and/or establish new projects as joint ventures with private partners. All of WICO's equity capital would be initially held by the Government. It is likely that an organization, such as ADMARC, INDEBANK or MDC, would be invited to acquire a stake in the new corporation. This would facilitate the later sale of WICO's capital stock to private parties. The Government's intention with regard to the future ownership structure of WICO and with regard to privatization was discussed at and recorded in the minutes of negotiations. The draft memorandum and articles of association do not preclude such divestiture. Agreement was also obtained that neither the Government nor WICO would materially change or modify the Memorandum and Articles of Association of WICO. C. Management and Organization 4.05 WICO's Board of Directors comprises five members, of whom the Principal Secretary of the Ministry of Forestry and National Resources is the ex-officio Chairman. Other Government nominated members would be the Deputy Secretary of the Treasury, the Chief Economist of the Office of the President and Cabinet, and the Chief Forestry Officer. In addition, there  - 15 - is a private individual as a non-government member. It is likely, that should an organization such as ADMARC, INDEBANK or MDC acquire an ownership interest, the composition of the Board would change and probably expand in size to accommodate perhaps two more nominees of the entity concerned. The General Manager of WICO would be the Chief Executive officer and would attend Board meetings as the company secretary. 4.06 WICO's proposed organization chart is shown as Annex 4-1. The heads of the main functional areas -- Operations, Marketing and Finance, as well as the maintenance chief -- would initially be expatriates, recruited under the project (para 5.03(a)). The position of Mazamba Mill Manager would also be filled by an experienced expatriate to be recruited under the project (para 5.03(g)). Recruitment of these key managerial staff is under way and the Government and the Bank have agreed to permit use of the balance in the Technical Assistance Loan (2027-MAI) to ensure that these staff could be in place as soon as possible. Promising Malawian professionals have been recruited and training is already under way and will continue under the Project to fill gradually the key managerial positions. 4.07 WICO's first General Manager had been head of the Forest Industries Division for several years. His untimely death led to the appointment of the present General Manager, an experienced forestry professional who has had several years' experience in VIPCOR and has been trained abroad. Major functional areas such as marketing and cost accounting have been neglected as FID functioned as a Government department and the mills sold their output to those customers who either chose to, or were forced by lack of alternatives, to come to the mill yards or to the timber depots (at Mzuzu, Mzimba, Lilongwe, Blantyre, Zomba, Karonga and Dedza) to purchase their requirements. The Government recognizes that this must change if WICO is to become a commercially viable enterprise. During project execution, WICO would also consider appointing selling agents as a complement to its own direct marketing efforts and also seek to develop a modest export market for quality sawnwood in neighboring countrIes. D. Accounts and Auditing 4.08 FID's accounting systems are based on accrual accounting methods. However, frequent changes in accounting staff, and lack of cost accounting systems and procedures, have resulted in inadequate financial information and records for cost control and financial planning. Financial reporting from year to year has been inconsistent and in some years not readily comparable. In earlier years, FID headquarter's overhead was not fully allocated to mill operations resulting in overstatement of profitability. FID's financial statements do, nevertheless, provide some measure of the financial worth of the various operations, although they do not properly reflect the financial position and the true earnings capacity  - 16 - of the capital being employed. The valuation exercise now underway is expected to set right this aspect of the FID's balance sheet prior to its conversion to a private limited liability corporation, so that future total or partial divestiture or formation of joint ventures could be made on the basis of the fair market value of performing assets. 4.09 WICO's immediate need is for the establishment of reliable enterprise-oriented accounting and financial information and control systems to be set up not later than the end of the current financial year, i.e., March 31, 1985. This requirement would be met as WICO has hired an accounting firm with terms of reference to design and set up the systems and train WICO staff (Annex 4-2). The system to be established would take into consideration a gradual computerization of the accounting and financial information functions, as well as related aspects such as inventory control, financial planning, cash flow forecasting, client records and budgeting. Under the project, assistance (both hardware and software) for the introduction of simple management information systems would be provided (para 5.03(g)). Funding for this initial effort has been provided under the TAI loan as well as through WICO's own resources. 4.10 Coopers and Lybrand (Malawi) have been appointed as WICO's auditors. WICO's financial year would run from April 1 to March 31. At negotiations, agreement was obtained that audited financial statements would be submitted for Bank review not later than 90 days after close of the financial year. E. Facilities and Operations 4.11 WICO's operating facilities at the date of transfer consist of the sawmills at Blantyre, Zomba, Dedza and Mazamba and depots at Mzimba, Mzuzu, Lilongwe, Blantyre, Dedza, Zomba and Karonga. The Blantyre mill has a separate furniture and box making unit as well as a treatment plant for poles. These activities have expanded substantially in recent years and now account for over 40% of the Blantyre mill's revenues. The Dedza mill has a furniture plant and a unit that makes a wood wool/cement boards, and sawdust pellets. The Zomba mill has a briquetting plant as well as a small furniture unit. The Mazamba mill also treats poles. 4.12 Conversion efficiencies at the mills have fallen steadily in recent years due to aging facilities and equipment, deficient log supply, inadequate or non-existent log sorting and debarking facilities to improve the quality of the feed to the sawmilling operations. Conversion averaged 50% in 1979/80 but had fallen to 44% in 1983/84. The Dedza mill has fallen to below 40%, while the Zomba and Blantyre mills, which had experienced efficiencies of up to 60% in the mid- to late-1970s, are now running at about 46%. The Mazamba mill has been struggling to reach the 45% level and is currently running below that rate. The investments under the proposed project, would improve conversion fators at all mills, so that on the average rates of above 50% could be achieved for all the mills (para 7.07).  - 17 - V. THE PROJECT A. Introduction 5.01 The Government and the Bank have agreed that the efficient utilization of forest resources is a high priority endeavor in the country's development. Therefore, in addition to the major investment for a new wood processing complex at Chikangawa in the Viphya area being financed by IFC, the proposed Bank project would concentrate on restructuring and rehabilitation of existing government-owned sawmills through the newly created WICO (para 4.02).13/ The project would provide funds for technical assistance and training as well as for improvements in the existing mills to bring them to full operating capacity, prolong their useful lives and substantially upgrade marketing activities and management capability. The project would also include assistance to WICO in carrying out feasibility studies for new processing facilities, product development and quality improvements and for implementation of such studies, if proven of sufficient economic, technical and financial merit. The other focus of the proposed project would be technical assistance to the Government for the development of technically and economically viable alternative uses for the surplus forest resources with emphasis in the Northern region of the country. 5.02 Training for management and intermediate level staff will be an important part of the TA program to be implemented by WICO. There is a shortage of qualified and experienced managers and technical staff (para 4.06). Therefore, it will be necessary to make expertise available to WICO to enable this new company to organize itself along commercial lines and to develop its staff skills. The required expertise will be supplied through management and consulting services provided for in the TA component of the project and it will also be necessary to develop in-house expertise through training programs. The TA program will include specific assistance to undertake the required training effort to be carried out by WICO including training outside the country. The details of the training program will be developed by WICO's technical assistance personnel in the first months and a schedule prepared not later than September 30, 1985 (para 5.10). 13/ Direct financial assistance to the major existing private sector mill is not contemplated, since this company did not indicate a need for investment funds, and INDEBANK would be the normal source if needed. However, the private mill, TPL, would benefit indirectly in assured access to timber supplies on an equal basis with WICO mills; and from the general pricing covenants under the project. Also, the TA program is sufficiently flexible to provide support to INDEBANK in assessing any investment proposals in the sector.  - 18 - B. The WICO Restructuring and Technical Assistance Program 5.03 The WICO restructuring and TA program comprises the following elements: (a) restructuring of the Mazamba sawmill through addition of a debarking and sorting line, improvements to the band-saw mill, purchase of log transport equipment and rehabilitation of existing vehicles; once the initial phase of restructuring has been completed and the mill's production has reached at least 5,000 m3/year, kiln drying capacity would also be installed if justified by a detailed feasibility study carried out by the technical assistance consultants to WICO to confirm that Mazamba can successfully reach an output of 10,000 m3/year in one shift operation; (b) restructuring of the Dedza sawmill through purchase of saw doctoring equipment, conical and/or semi-conical saws, extension of the sorting line and log decks, purchase of a fork lift truck to improve mill transfer operations, improvements to the briquetting plant and purchase of log transport equipment. In addition, the Dedza sawmill's drying facilities would be modified and their capacity increased following completion of a feasibility study by WICO's consultants that would assess Dedza's long-term potential including wood supply. This study would be carried out possibly in conjunction with the study of glue laminating facilities mentioned below under (f); (c) minor improvements and rehabilitation at the Zomba mill, including saw doctoring, overhaul of critical equipment and purchase of spares to maintain the mill's productive capacity and prolong its life through 1992, by which time decisions regarding future use of the Zomba forest resources would have been reached; (d) purchase of critical operating spares and consumables for all mills, including Blantyre, to ensure proper maintenance of existing equipment throughout their remaining useful lives; (e) purchase of equipment to establish a modern furniture and joinery plant at Blantyre, following a feasibility study to be carried out by WICO's consultants and TA staff; (f) purchase of equipment to install glue-laminating operations at the one or more mills to make better use of small sawnwood pieces and produce large size timber; (g) technical assistance program comprising up to 30 m/m for an experienced mill manager at Mazamba, 30 m/m for an Operations Manager to take charge of the total production operations at the WICO facilities and coordinate the overall implementation of the restructuring program, up to 18 m/m for a Marketing Manager, 24 m/m for a Finance Manager, 12 m/m for a maintenance expert, 12 m/m for engineering and procurement services, and 8 m/m for setting up of accounting control and data processing systems for a total of 134 m/m;  - 19 - (h) training programs for (i) mill maintenance personnel in saw doctoring techniques and other maintenance practices; (ii) management traineeships for up to six key WICO local managerial staff, consisting of both academic training in relevant technical fields and job training in suitable mills abroad before return to Malawi to complete on-the-job training under the respective technical assistance personnel; (iii) short-term training programs for other personnel, including plant visits to sawmills in other African countries, with a view to improving technical knowledge and gaining relevant additional experience in new techniques; and (i) consultant services for feasibility studies of (i) glue-laminating facilities, (ii) furniture and joinery plant, (iii) establishment of a future major wood processing complex using the Zomba resources, and (iv) the installation of an existing but unused 5,000 m3/year sawmill at Mulanje, including a comparative study of the transportation system to be used. A total of 18 m/m has been budgeted for this activity. C. Technical Assistance to the Government 5.04 There is a significant imbalance in the supply and demand of forest resources in Malawi with a large surplus of timber in the North and a large deficit in the South (para 2.08). The Government and the Bank have discussed the possible extent of the assistance required to find alternative uses for the country's forest resources, mainly in the Viphya area. The basis for this work will be the study on this subject that has just been completed by the Agency for Technical Cooperation (GTZ) of the F.R. of Germany. This part of the TA program should enable the Government to: (a) install industrial-sized demonstration ovens for the production of charcoal (and/or pelletized wood), and evaluate the technical and economic aspects of utilizing the wood fuel under actual commercial operating conditions (in particular, in the existing cement plant); (b) carry out small but commercially oriented tests on the viability of extraction and distillation of pine resins and turpentine; (c) carry out substitution trials using producer gas from wood as fuel in vehicles powered by gasoline engines; (d) study the viability of using producer gas from wood as a substitute for stationary (diesel) power generating plants; and (e) evaluate other possible uses of surplus wood. A total of 85 m/m of management and technical consultant services have been provided for this component under the project. In addition, about US$225,000 has been provided for demonstration equipment and hardware.  - 20 - D. Start-up Activities 5.05 WICO began operations as a private company on July 1, 1984. As stated earlier (paras 4.06 and 4.09), WICO is in need of technical assistance to fill major functional positions and set up appropriate financial control and management information systems. At the same time, WICO needs to procure critical spares for all the mills to ensure that prior to start of the restructuring and rehabilitation efforts under the project, essential equipment maintenance is carried out and the sawmills continue to perform at least at current levels. WICO's liquidity situation, although not precarious, would not permit it to make such needed purchases in a timely manner and it has no access to foreign exchange resources. The Government has agreed with the Bank's assessment that an early start to some essential project activities would be highly desirable. Consequently it was agreed that up to US$95,000 remaining in the TAl Credit would be used to finance: (a) engineering consultant services to establish priority spare parts lists and assist WICO in their procurement, particularly as many portions of WICO's plant are very old and in some cases original manufacturers may have ceased operations. Consequently an extensive search for alternative suppliers of such parts may be needed; (b) up to 3 m/m salary and other related expenses for technical assistance personnel who would then continue to head the main functional posts under the project, including, in particular, that of Mazamba Mill Manager; and (c) about 8 m/m of accounting technical services to set up accounting, financial information and cost and budget control systems. 5.06 Terms of Reference for the technical assistance and consultant services have been agreed with WICO and are attached as Annex 5-1. In order to start the initial engineering services work and assist WICO in recruiting suitable candidates for the technical assistance positions, the engineering service firm of Heilborn GmbH (FRG) has been retained by WICO for this purpose. As far as purchase of spares is concerned it was agreed that retroactive financing of up to US$100,000 would be permitted so that orders placed and contracts let after November 12, 1984 would be eligible. As there is a long lead time for acquisition of spares, this would permit prompt action now. E. Project Implementation, Staffing and Training 5.07 WICO Restructuring Program. WICO would implement the restructuring program with the aid of the TA team to be recruited under the project. WICO would employ the services of an engineering consultant to assist in all phases of procurement particularly as regards search for suitable manufacturers or other sources of spares and compatible equipment. Much of this work is now under way. The consultant would also  - 21 - assist in recruitment of individual TA personnel. Implementation of the restructuring investments would proceed in a staged manner. First, WICO and its TA team would conduct a thorough review of the physical condition of the plant at each mill. Next, priorities for rehabilitation, restructuring, and main overhaul would be assessed and set. Prior to undertaking larger capital investments each individually exceeding US$300,000 equivalent, WICO would carry out a feasibility study with the aid of consultants and would review the results with the Bank. This was confirmed during negotiations. Terms of reference for the proposed feasibility studies would be agreed with the Bank, and consultants selected in accordance with Bank guidelines, on terms and conditions satisfactory to the Bank. In view of their importance to the success of the WICO Restructuring Program, a Project Operations Manager, whose qualifications and experience have been deemed satisfactory by the Bank, has been selected and a firm appointment date and other employment conditions agreed. 5.08 TA to the Government. The program for study of alternative uses of the country's forest resources would be carried out by experienced consultants on terms of reference and conditions of employment acceptable to the Bank. The Government has appointed the Forestry Department in the Ministry of Forestry and Natural Resources as the agency to implement and coordinate the above activities under terms of reference acceptable to the Bank. Prior to any disbursement of the proposed loan allocated for the TA component, the Government and the selected agency would recruit and appoint a project manager whose qualifications and experience are deemed acceptable to the Bank, and on terms of reference and conditions of employment judged satisfactory to the Bank. 5.09 Training. WICO would select suitably qualified and experienced personnel for management training under the project. The scope and content of the individual study-cum-training programs would be developed by the TA personnel and WICO for each of the main functional areas. The management trainees would be initially sent overseas, but would, upon return to Malawi, work as counterparts to the individual TA team members, with a view to taking over the functional responsibilities within 6-12 months. WICO may employ a short-term expert to review other company-wide training needs and develop appropriate programs. 5.10 The estimated schedule of project implementation is summarized below and detailed in Annex 5-2. The project is expected to take about 5 years to complete, mainly with regard to new capital investments and staff training. The critical events are the recruitment of key TA personnel, and the completion of feasibility studies for the major investments. Transportation of imported equipment represents a potential problem in project implementation. To minimize delays, some items of expenditures such as spare parts and small subassemblies would be air-freighted to Malawi. A generous cost allowance for transport and freight insurance to  - 22 - Malawi has been provided in view of current international transit difficulties facing the country. To monitor project progress and keep the overall schedule in control, WICO would prepare, with the aid of the TA staff, a detailed master schedule of project implementation not later than September 30, 1985, and maintain such a schedule throughout project implementation. Agreement on this was obtained at negotiations. Malawi - WICO Restructuring, TA and Training Schematic Implementation Schedule 19841 Event Jul-Dec 1985 1986 1987 1988 1989 Project Organization Start-up Activities Recruitment of TA Personnel Loan Effectiveness x Master Schedule Prepared x Project Implementation Core Improvement, Restruc- turing, Overhaul, Repair at WICO Mills Feasibility Studies Implementation of Major Investments_ Staff Training - 5.11 Implementation of the government TA activities would take place over a 2-3 year period. The Government has appointed a Steering Committee, including representatives from the Ministry of Finance, the Ministry of Forestry and Natural Resources, WICO, INDEBANK, MDC and VIPCOR, whose function would be to oversee the program implementation by the appointed agency (para 5.08). The key event in these activities would be the recruitment of consultants, in particular, the TA Project Manager, who would report to the Forestry Department and who would in turn organize the study phase and coordinate the demonstration activities. Transport of large demonstration equipment would also be on the critical path of project implementation. It was agreed at negotiations that, not later than September 30, 1985, i.e., approximately six months after expected loan effectiveness, the government executing agency would prepare a Master Schedule of project activities and maintain such a schedule throughout project implementation. Agreement was obtained that the Government would employ a project manager and consultants under terms of reference and on terms and conditions deemed satisfactory by the Bank. 5.12 The WICO component is expected to be completed by June 30, 1989. The TA component to the Government is expected to be completed by September 30, 1990 (para 6.07).  - 23 - F. Environmental Considerations 5.13 The project does not pose any environmental hazards. The sawmill operations are similar to those undertaken in Africa and elsewhere, and are relatively pollution free. Solid wastes are burned for product drying, converted to briquette (fuel wood) or sold directly as fuel wood. WICO does not carry out logging operations. Logging is controlled and supervised by the Forestry Department and adequate environmental safeguards exist. G. Employment 5.14 WICO currently employs 1,167 workers and 72 clerical, administrative and managerial staff. This number is not expected to rise significantly in the course of project execution. Some redeployment of workers would occur as older facilities are shut down. The implementation of the furniture and joinery plant at Blantyre could add 25-50 workers to the industrial payroll. In the two/three years beyond project completion, the possible addition of a second shift operation at the Dedza and Mazamba mills could add significant numbers (150-250) to the payroll. On an incremental basis, the capital cost for each additional job created works out to approximately US$21,000 (in constant 1984 terms), which compares with the US$35,000/job under the Chikangawa Project. WICO is not expected to experience any difficulties recruiting and training skilled and semi-skilled personnel from the available labor pool in the country. VI. CAPITAL COSTS, FINANCING PLAN, PROCUREMENT AND DISBURSEMENT A. Capital Costs 6.01 The total project cost of both the WICO and the Government components, exclusive of taxes and duties to be paid by WICO on equipment imports, is estimated at MK 10.4 million (US$7.8 million equivalent), summarized in the table below and detailed in Annex 6-1. Of the total project cost, 82% or MK 8.6 million (US$6.4 million) represents the WICO component.14/ The direct and indirect foreign exchange component of the total project cost is estimated at 82% (US$6.4 million). The total financing requirement of MK 11.5 million (US$8.66 million equivalent) includes the estimated front-end fee on the proposed Bank loan of US$15,960 and the estimated taxes and duties. The proposed Bank loan of US$6.4 million equivalent would finance 82% of the total financing requirement net of taxes and duties, i.e., the estimated foreign exchange component of the project. 14/ Taxes and duties on the WICO component (MK 1.1 million or US$0.8 million equivalent) are estimated at an average rate of 21.6% of the c.i.f. value of imported equipment and spares.  - 24 - Malawi - Project Capital Cost Estima8e -------- ---- ------------- x of Total Local Foreign Total Local Foreign Total Base , ---Mh' million