Sri Lanka - Second Industrial Development Project

Document of The World Bank FOR OFFICIAL USE ONLY 1h 6o- Ct Repot No. 6009-CE SRI LANKA SECOND INDUSTRIAL DEVELOPMENT PROJECT STAFF APPRAISAL REPORT April 21, 1986 Industrial Development and Finance Division South Asia Projects Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its eontents may not otherwise be disclosed without World Bank authoriation.  CURRENCY EQUIVALEN18 Currency Unit - Sri Lanka Rupee Sri Lanka has a floating exchange rate. Since 1980 the annual average rate has been: 1980 - US$1 = Rs. 16.5; 1981 - US$1 = Rs. 19.3; 1982 - US$1 = Rs. 20.8; 1983 - US$1 = Rs. 23.5; and 1984 - US$1 = Rs. 25.4. As of December 31, 1984, US$1 = Rs. 26.3. As of December 31, 1985, US$1 = Rs. 27.4. The following rate is used in this report: US$1 = Rs. 27.4 Rs. 1 = US$0.036 Rs. 1 Million = US$36,000  FOR OFFWLAL USE ONLY PRINCIPAL ACRONYMS BOC - Bank of Ceylon BTT - Business Turnover Tax CBC - Central Bank of Ceylon CBOC - Commercial Ban,,- of Ceylon CDIC - Capital Development and Investment Corporation DFCC - Development Finance Corporation of Ceylon DFI - Development Finance Institutions EDB - Export Development Board EPC - Effective Protection Coefficients EPR - Effective Protection Rates COBU - Government Owned Business Undertaking GOSL Government of Sri Lanka IDP - Industrial Development Project IPC - Industrial Policy Committee ITC - Interim Tariff Commission MISA - Ministry of Industries and Scientific Affairs MOFP - Ministry of Finance and Planning MTIP - Medium Term Investment Program NDB - National Development Bank of Sri Lanka 14SB - National Savings Bank PR - Public Enterprises PED - Public Enterprise Division - MOFP PTC - Permanent Tariff Commission SMI - Small and Medium Industries SIC - State Industrial Corporation UNDP - United Nations Development Program FISCAL YEARS Government of Sri Lanka - January 1 to December 31 Commercial Banks - January 1 to December 31 NDB - January 1 to December 31 DFCC - April 1 to March 31 This document ha a stricted distribution and may be used by recipients only in the perormae of their offici duties. ItB contents may not otherwise be discioed without World Bank authoriation.  TABLE OF CONTENTS Page No. PROJECT AND CREDIT SUMMARY ....... .................... i-i I. INDUSTRIAL SECTOR .............. ...... A. Economic Setting . ......... ...... 1 B. Industrial Structure and Performance .............. 2 C. Trade and Industrial Policy Issues ................ 3 D. Investment Demand ................................. 5 II. FINANCIAL SECTOR ....... ..... ....... 7 A. The Financial System .........................., 7 B* Capital Market a.......................... C. Interest Rates ............... . 9 III. THE BANK'S INDUSTRIAL LENDING STRATEGY ............... 10 A. Lending and Industrial Strategy ................... 10 B. Impact of Past Operations ..... ................... 10 IV. INSTITUTIONAL ARRANGEMENTS ...................... ..... 14 A. Participating Financial Institutions .............. 14 B. Development Finance Corporation of Ceylon - DFCC .. 15 C. National Development Bank of Sri Lanka - NDB ...... 20 V. THE PROJECT .......................................... 24 A. Project Description and Objectives ...... .......... 24 B. Project Components .......................... ... 25 C. Participating Intermediaries ...................... 26 D. Policy and Institutional Reform ................... 27 E. Costs and Financing Plan .......................... 30 F. Terms and Conditions *............................. 30 C. Administration ................ ........... 32 H. Benefits and Risks ............................... 34 VI. RECOMMENDATIONS ..* .................................. 35 This report was prepared by Mr. D. K. Groves and Ms. D. Berthelot following an appraisal mission to Sri Lanka in June/July 1985. Messrs. P. V. Thuyet and D. Keesing provided detaiLed input on trade and industrial policy. The mission coordinated closely with an ADB mission preparing a parallel line of credit. The report was updated and finalised by Mr. Groves following a post-appraisal mission in November/December 1985.  -ii- LIST OF ANNEXES 1. Performance of Major State Industrial Corporations 1977 - 1984 2. Public Enterprise Efficiency Improvement - FY86 Action Program 3. Interest Rate Structure 4. DPCC Basic Data S. NDB Basic Data 6. Estimate of Technical AssistAnce 7. Estimated Disbursement Schedule 8. Supporting Documents and Data Available in Project File  SRI LANKA SECOND INDUSTRiAL DEVELOPMENT PROJECT Credit and Project Summary Borrower : Government- of Sri Lanka (GOSL). Beneficiaries : Development Finance Corporation of Ceylon (DFCC) and the National Development Bank of Sri Lanka (NDB) - the Development Finance Institutions (DFIs). Amount : SDRs. 17.4 million (US$20.0 million equivalent). Terms : Standard. Co-Financing : The Asian Develcoment Bank (ADB) has provide.i US$20 million through a parallel line of credit on terms and conditions similar to those of the proposed Project. Relending Terms : The Government would relend the project proceeds to DFCC and N1DB for 18 years including a five year grace period at an initial rate of 9% and 10 p.a. respectively, with the relending rate subject to annual review and adjustment. The DFIs would relend the proceeds at an initial rate of 14Z p.a. with a maximum repayment period of 15 years, including a three-year grace period. The foreign exchange risk would be borne by GOSL. Project The proposed project would finance the foreign exchange Descrirtion: cost of new and balancing, modernizing, rehabilitation and expansion investments (BMRE) by private sector firms. Funds also would be provided for the BMR of public enterprise units needing to restructure their facilities to improve efficiency. The project is designed to assist the Borrower to implement reforms in the areas of trade policy, industrial incentives, export promotion, public enterprise efficiency and indus-rial finance and financial policy. The project would also provide technical assistance to (a) the DFIs to assist them in improv- ing their operating efficiency and diversifying the range of their activities and funding sources; (b) Government to develop a comprehensive performance signalling system covering all major state industrial corporations (SICs) and rehabilitate individual public sector enterprises; and (c) consolidate existing studies and to develop a comprehensive industrial strategy. The benefits arising from the project would be more efficient investment in the industrial sector; improved perfor- mance of public enterprises; and increased employment opportunities. Although a risk exists that an adequate number of eligible subprojects will not materialize, the project  -ii- pipeline and projections indicate a credit demand well in excess of the amount to be provided by the proposed credit. There is also a risk that collection rates could deteriorate, but the project provides for strengthening the appraisal and supervision capabilities of the DFIs and for portfolio restruc- turing to help minimize this risk. The other risk is that the Government may not proceed with policy reform as rapidly as expected; however Government has already taken a number of important steps to improve industrial policy and the Association would continue to monitor developmencs closely in its economic and sector work and project supervision. Estimated Costs: Local Foreign Total -----------