Jordan - Second Arab Potash Project

Docume oir The World Bnk FOR OMCIL USE ONLY Report No. P-4460-Jo REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION A1lD DEVELOPMENT TO THE EKECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US;12.O KILLION TO THE ARAB POTASH COMPANY WITH THE GUARANTEE OF TfE HASHEMITE KINGDOM OF JORDAN FOR A SECOND ARAB POTASH PROJECT February 10, 1987 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.  KASHEMITE KINGDOM OF JORDAN CURRENCY EQUIVALENTS Calendar 1985 October 1986 Currency Unit = Jordan Dinar (JD) US$1.00 = JD .393 JD .342 JD 1.00 = US$2.54 US$2.92 FISCAL YEAR January 1 to December 31 ABBREVIATIONS AND ACRONYMS AMC - Arab Mining Company APC - Arab Potash Company GOJ - Government of Jordan ISDB - Islamic Development Bank KC1 - Potassium Chloride (Muriate of Potash) mtpy - million tons per year tpy - ton per year USAID - U.S. Agency for International Development  FOR oFIaL4 usS ONLY EASHEMITE KINGDOM OF JORDAN POTASH II PROJECT Loan and Project Summary Borrower: Arab Potash Company (APC). Guarantor: The Rashemite Kingdom of Jordan. Amount: US$12 million equivalent. Terms: 17 years, including four years of grace, at the standard variable interest rate. Project Description: The main objective of the project is to support an increase in the output of the existing potash production facilities and to initiate a research and development program for assessing the ultimate potential of these facilities. The project includes an investment and a technical assistance component. The investment component would help improve the efficiency of the decomposition and hot leach sections of the refinery and expand overall standby capacity. The technical assistance component would help determine future prospects for technology improvement, cost reduction and growth. The project is expected to generate critically-needed foreign exchange earnings for Jordan since all of the APC's production is for exports. There are no major risks associated with the project except the normal commercial risks of a business venture, such as sustainability of market demand, prices and effects of increased competition. rbis document has a distribution and may be uscd by mrpient only in the perfomaoe of their official dutie Its contents may not otbewis be disciosed without World Bank authoriztion.  Local Foreign Total - * US$ Million Estimated Cost*: Refinery Modifications - 11.96 11.96 Complementary Expansion 1.38 5.02 6.40 Studies 0.29 2.61 2.90 Training. 0.08 0.33 0.41 Base Cost 1.7 L21 Physical Contingencies 0.18 0.79 0.97 Price Contingencies 0.15 0.66 0.81 Total Installed Cost ZLZ Interest During Construction 3.23 3.23 Total Cost Financing Plan: APC (Internal Funds) 2.08 3.10 5.18 IBRD (Loan) - 12.00 12.00 ISDB (Loan) 8.00 8.00 USAID (Grant) 1.50 1.50 Total 2.08 24.60 26.6 Estimated Disbursements: Bank FY 1987 1988 1989 1990 1991 1992 -USS Million Aimual 0.8 2.2 3.3 2.8 2.0 0.9 Cumulative 0.8 3.0 6.3 9.1 11.1 12.0 Rate of Return: 98 percent. Appraisal Report: Number 6365-JO, dated December 24, 1986. Map: IBRD 19875R *1 Cost estimates do not include import duties and taxes from which the project is exempt.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMEDATION OF THE PRES mIENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE ARA POTAS COMPANY FOR A SECOND ARAB POTASH PROJECT 1. I submit the following report and recommendation on a proposed Bank loan to the Arab Potash Company with the guarantee of the Hashemite Kingdom of Jordan for the equivalent of US$12 million to help finance a Second Arab Potash Project. The loan would be for 17 years, including four years of grace, at the standard variable interest rate. The Government would charge a guarantee fee of 0.8 percent per annum on the outstanding amount of the Bank loan. The Islamic Development Bank and the US Agency for International Development are expected to co-finance the project. PART I - THE ECONOMY 1/ 2. A report entitled "Jordan, Review of the Five-Year Plan" (No. 4129-JO, dated May 1983) was distributed to the Executive Directors in June 1983. An economic mission visited the country in November 1985; its findings have been included in the present text. 2/ Country data sheets are attached as Annex 1. Recent Economic Developments 3. Conscious of the country's limited natural resources, its relatively narrow productive base and the sensitiveness of the economy to changes in its oil-rich regional environment, the Government has pursued liberal, outward-looking policies in trade, labor migration and foreign exchange. This enabled Jordan to alleviate the effects of a very high natural population growth rate (3.4 percent) through massive emigration stimulated by high salaries in the neighboring countries and, until 1982, through rapid expansion of domestic production fueled by an exceptionally high investment rate and rapidly growing export demand. At present, a large part of Jordan's total work force is employed abroad. In addition to sizable workers' remittance inflows, Jordan has benefited from large inflows of grant aid from neighboring countries as well as from a rapid increase in regional demand for its exports. During the period 1976-82, the yearly inflow of workers' remittances and grants reached on average close to two-thirds of Jordan's GDP. The abundant supply of these resources and a favorable entrepreneurial climate enabled Jordan to maintain both very high consumption and investment rates. 4. As a result, the Jordanian economy expanded rapidly with an annual average GDP growth rate of over 10 percent in real terms during the 1976-82 period; almost full employment was reached. The overall balance of payments remained strong despite a large chronic deficit in merchandise trade. 1/ This section is substantially the same as Part I of the President's Report for the Jordan Sixth Power Project (P-4318-JO), which was distributed to the Executive Directors on May 6, 1986. 2/ References in the text which follows are to the East Bank of Jordan.  Although esports of goods and non-factor services (primarily agricultural products, manufactured goods, tourism and exports of the new commodities. fertilizers and potash) grew at a rapid rate of about 16 percent in real terms during 1976482, its small base in relation to imports led to a continuous deterioration of the resource gap. These trade deficits, however, were almost fully covered by factor income and transfers from abroad. Government- guaranteed external borrowing remained therefore within reasonable limits and borrowing on comercial terms was reduced to a modest level. 5. Beginning in 1982, however, the economic slowdown in the neighboring countries has affected the Jordanian economy in many ways, leading to a slowdown of domestic economic activity and a reduction in the inflow of external transfers. The overall economic growth rate slowed to about 5.2 percent (in real terms) in 1983 and further declined to about 3 percent since then. Foreign grant aid in 1982-85 was about 40 percent lower compared to 1980-82, and workers' remittances stagnated while exports of manufactured goods and services to neighboring countries declined. Imports also declined, in line with the sizable reduction in public and private investments, thereby avoiding severe balance of payments problems. 6. The current account deficit for 1983 showed a slight increase to $390 million. In 1984, the decline in merchandise imports, combined with an increase in exports of manufactured goods, contributed to reducing the balance of trade from nearly $2.5 billion in 1983 to about $2.0 billion. Taking into account a slight reduction in official transfers, the current account deficit fell to $282 million. Although imports declined (in current terms) and exports increased in 1985 and 1986, the reduced worker's remittances and grants more than offset the trade gains, leading to a rise in the current account deficit to about 8.2 percent of GDP in 1986, compared to 7.1 percent in 1984 and 8.6 percent in 1985. 7. With the decline in government revenues from grants, public investment has been reduced, and the Government has further intensified its domestic resource mobilization efforts through cuts in subsidies and improved collection of direct and indirect taxes. The main concerns of monetary policy have been mobilizing savings and controlling domestic liquidity. Private savings have improved, but public savings have continued to be negative because of the high level of defense expenditures. To 3romote domestic savings, greater discretion has been given to the Central Bank in adjusting interest rates and banking comissions. As a result of increases in deposit rates in 1983, savings deposits rose faster than the money supply. A parallel situation materialized in 1984 and 1985 though both savings deposits and the money supply grew at slower rates in those years. Together with a marked decline in inflation to an average of 3.5 percent in 1984-1985, these increases have resulted in interest rates becoming substantially positive again in real terms. Medium-Term Prospects 8. Given the changed situation and outlook in the neighboring oil producing countries, GDP growth in the 4-5 percent range projected by the 1986-90 Plan appears feasible in the medium term. This projection assumes a reduction in the exceptionally high level of investments achieved during the early 1980s, which reflected the implementation of a number of large new projects such as potash, fertilizer and a refinery. While the new, natural resource-based industries have provided some new employment opportunities, the  -3- economic slowdown and a rapidly increasing domaestic work force (para. 12) are likely to change the manpower situation in Jordan from one of selective shortages to one of general excess supply. 9. The industrial sector (including mining, manufacturing and coaztruction) is expected to continue to lead the growth of GDP and exports. The new industries contributed one-third towards incremental GDP during 1984-85. With the coming on-stream of addItional phosphate mining and cement production, total industrial output could grow at an annual rate of about 6.2 percent for 1986-88 but slow down to an average rate of 4.9 percent per annum for the period 1988-90. Most of the growth beyond 1988 should originate in small-and medium-scale manufacturing. Since the rapid expansion of infrastructure and private housing during the boom years of the 1970s and early 1980s has slowed down substantially, the construction industry is likely to grow at a substantially lower rate (3.5 percent per annum) during 1986-90. Thus, industrial growth during the next plan period will have to rely increasingly on the development of small and medium-scale higher technology manufacturing, largely for exports. The projected 5.7 percent per annum for industrial growth (1986-90) assumes that adjustment of the industrial sector in this direction will be achieved, inter alia through changes in protection policies and improvements in export incentives. 10. Increased demand for services by returning Jordanians, coupled with their accumulation of savings and experience, is expected to raise the rate of private investment and growth of special services by an average annual rate of 4.5 percent per annum in the next few years. However it is expected that the transportation sector and the hotel industry, which at present have a large surplus capacity, will undergo a period of consolidation. In the trade sector, efficiency gains from modernization would likely be offset by increased pressure from higher unemployment to expand the less efficient informal trade sector. In contrast to the expected slow growth of traditional private services, the prospects are favorable for special services which can use Jordan's skilled labor in areas such as consulting, contracting, and maintenance. Agriculture is projected to continue to grow by about 5 percent per annum. 11. The projections for the external accounts assume that exports of goods and non-factor services would grow by an average rate of about 5.9 percent per annum in real terms for 1986-90. Exports from the output of previous and new industrial, natural resource-based projects to the world market would make the largest contribution to this growth performance. The export projections for the late 1980a assume that adequate measures are taken to develop Jordan's manufacturing exports. The import growth projections assume that imports would slow down in line with the overall economic growth rate. The fall in oil prices is expected to benefit Jordan by reducing its 1986 import bill by about $110 million, or 4 percent of its total merchandise imports, assuming purchases are made at market prices. Even though merchandise exports are projected to approach a rate of increase of 6 percent per annum thile imports would grow at a lower rate, the trade deficit could renain large and approach the $2.5 billion mark in 1990. However, thanks to large worker's remittances and external inmnts, the current account deficit would be about $300 million. In relation to GDP, the resource gap is expected to decline from about 44 percent in 1985 to about 20 percent in 1990. Nevertheless, Jordan would have to rely more on external borrowing (para. 15). To maintain its prudent debt management, Jordan will need to combine external borrowing with increased efforts to mobilize domestic resources, particularly in the public sector.  -4- Social Issues 12. Due to the substantial migration of Jordanian workers to neighboring countries and the rapid economic growth, the labor market situation has been characterized until recently by selective manpower shortages. However, according to recent manpower projections, supply of labor in Jordan in the medium term is likely to show selective surpluses, particularly throughout certain categories of skilled professionals. In 1985, it is estimated that 300,000 Jordanians were working abroad compared to a total domestic employment of about 645,000. Domestic employment includes a relatively large number of foreign workers currently estimated at about 143,000, half of whom are unskilled. A comprehensive manpower and training plan as well as improvements in vocational training are needed to help ensure that the education and training system is geared to meet both domestic and external demands for manpower. 13. The Government continues to emphasize social issues in the 1986-90 Five-Year Plan. Although the social indicators are relatively favorable in most sectors, social services are unevenly distributed across income groups and between urban and rural areas. Housing remains a problem despite the boom in 1978-80, mainly because housing costs have far exceeded the means of the lower income groups. External Assistance 14. With the large, chronic trade deficit offset by inflows of remittances and foreign transfers, the current account of the balance of payments was on average in equilibrium through 1975-81. Net workers' remittances increased from about $160 million in 1975 to about $980 million in 1984. In 1985, however, they decreased to $788 million reflecting the economic recession in the Arab Gulf countries. Following the Baghdad Arab Sui,-it Conference in November 1978, which pledged assistance of about $1.2 billion per year over a 10-year period, net foreign grant aid rose from $400-500 million in 1977-78 to about $1.3 billion in 1980 and 1981; it declined to some $0.8 billion in 1983 and to $0.7 billion in 1985. In 1986 it is expected to stabilize at $0.6 billion. This decline was the main reason for the current account deficits of $390 million in 1983, and $350 million in 1985, both of which were financed largely by external borrowing and partly by drawing on reserves. Jordan's reserves have remained, however, equal to three months of imports. The external public debt outstanding and disbursed reached $2.6 billion at the end of 1985 (about 54 percent of GNP including all workers' remittances). External debt service payments amounted to $419 million in 1985 or 13.5 percent of total exports of goods and services. 15. Jordan's impressive growth, pragmatic economic and social policies and efficient economic management have helped to attract large amounts of foreign assistance. The grant component of this foreign assistance is projected to decline gradually in real terms over the next few years. The projections on that basis indicate a need for average gross external borrowing of about $725 million over the 1986-1990 period, mostly in later years. While bilateral and multilateral sources can be expected to provide the bulk of extarnal resources, Jordan is likely to resort increasingly to the financial markets, and this would result in a hardening of loan terms. On these assumptions, the debt service ratio as a percentage of exports of goods and services is projected to reach 15 percent by 1990. Given this outlook and the country's record of prudent management, Jordan remains creditworthy for Bank lending.  -5- PART II - BANK GROUP OPERATIONS 1/ 16. Jordau has received 22 Bank loans totalling $551.9 million and 15 IDA credits totalling $86.1 million (net of cancellations) of which all the credits and three loans have been fully disbursed. Project implementation and disbursement performance have been generally satisfactory. In recent years, disbursements have amounted to about 55-65 percent of appraisal estimates, and this disbursement percentage has generally been higher than the average for the EMENA Region. The IDA credits have financed projects in key sectors, such as education, highways, water supply and sewerage, power, irrigation and tourism. By mid-1978, Jordan had attained a stage of economic development where it could be considered creditworthy for Bank lending and had reached a GNP per capita level that exceeded IDA limits. IDA lending was thus discontinued after March 1978. IFC has made loans and equity in Jordan with total comitments of $94.8 million. Annex II contains a swinary statement of Bank loans and IDA credits, and IFC investments as of March 31, 1986. 17. Under its last two development plans, Jordan has aimed at restructuring its economy to achieve a wider manufacturing base, to reduce its dependence on external grants, and to spread the benefits of development among different regions. The Bank's strategy has been tailored to support those objectives and in particular is designed to help the Government: (a) to diversify the country's economic base and promote exports; (b) to alleviate manpower and infrastructure constraints in the productive sectors; and (c) to encourage more balanced growth and distribution of social services among regions and income groups, with particular emphasis on low-income groups. 18. Within this broad framework, past lending has emphasized support for capital infrastructure and manpower development. Since 1962, Bank Group lending has focussed on water supply and sewerage, power and energy development, education and urban and municipal development. The Bank Group has also lent for irrigation, agricultural and industrial credit, transportation, tourism, and recently became involved in the health sector with a loan for a Primary Health Care Project. In addition, the Bank Group has financed technical assistance for developing and implementing a plan for expanding phosphate rock mining. An engineering credit was made in FY75 to help prepare a large project for potash production from the Dead Sea via solar evaporation, for which a first loan was approved in September 1978. These projects have been designed with an emphasis on institution building to assist the agencies involved to develop their capabilities to plan, prepare, and implement projects on their own. In addition to the proposed Second Arab Potash project, future lending would include projects for manpower development, transportation, water supply and sewerage, urban development, power generation expansion, and mining. IFC has provided loans and equity contributions for a major fertilizer project and for projects in the construction materials subsector. It has also assisted the capital market and leasing ventures. 1/ Substantially unchanged from Part II of the President's Report for the Jordan Sixth Power Project (No. P-4318-JO), which was distributed to the Executive Directors on May 6, 1986.  -6- 19. The Bank has recently helped the Government to review the energy, water supply, health, urban and education/training sectors, and the Bank's economic and sector work will continue to focus on strengthening the macroeconomic and sector base for our lending program. The Bank's economic work program aims to deepen and broaden the well-established policy dialogue with the Government in priority areas: (i) development planning, with a focus on resource mobilization and allocation; (ii) industrial and trade policies, including technology transfer and export strategy/promotion and industrial subsector studies; (iii) regional development and equity and efficiency of government revenues and social expenditures; and (iv) manpower development. These subjects are crucial because the substantially tighter balance of payments situation expected for the rest of the decade calls for increased efforts to step up domestic resource mobilization, to stimulate manufactured exports and to optimize resource allocation, while making particular efforts to reduce rural and urban poverty. 20. At the end of 1985, the actual Bank Group share in Jordan's total external public debt was estimated at 8.4 percent, and its share in debt service was 7.4 percent. In 1987, the Bank Group's sbares in debt outstanding and in debt service are expected to be about 6.5 and 9.4 percent, respectively. PART III - THE INDUSTRIAL SECTOR Background 21. Industry grew rapidly, although from a low base, during the seventies and early eighties and industrial output now accounts for about one-third of GDP and 40 percent of merchandise exports. The large industrial projects such as cement, fertilizer and potash which are now in the production stage accounted for over half of the increase in mining and manufacturing output, and for almost two-thirds of the increase in industrial exports. The overall industrial structure is dominated by these few large enterprises, although with the support of an able Industrial Development Bank numerous small and medium size private sector firma were also established. These are engaged in food processing and the production of textiles, detergents, furniture, and building materials. The small and medium scale industry has promising growth potential, given existing workers skills, preferential access to neighboring Arab markets, and the support from development finance institutions and industrial estates. There is, however, a widely diverging productivity performance in the various subsectors, and on the whole, industrial productivity is low, reflecting diseconomies of scale and the scarcity of managerial/technical know-how. 22. Rapid expansion and diversification of industrial production and growing regional demand for products have enabled Jordan to sustain a strong export performance in manufacturing. The mining and manufacturing industries accounted for about three quarters of domestic exports during the period 1980-B4. Although starting from a low level, manufacturing exports recorded a six-fold increase in value between 1975 and 1980, witb chemicals (mainly detergents and soap) accounting for the bulk of exports (11 percent), followed by wood products and cigarettes. Reflecting the economic slowdown in the Middle East, during the past three years, the rate of export growth slowed considerably.  -7- Industrial Strategy 23. The 1981-85 Plan outlined the following objectives in the industrial sector: (i) forward integration of the mining sector, with special emphasis on phosphate and potash derivatives; (ii) encouragement of the development of competitive export industries; (iii) intensified exploration of the country's energy and mineral resources; and (iv) creation of new geographical growth centers with a view to relieving industrial congestion in the Amman area, and fostering regional development. The Plan also highlighted the need for a broader introduction of up-to-date technologies and management methods, particularly through the large, key projects. These objectives are maintained in the new (1986-90) Plan, with further emphasis in developing private medium- and small-scale industry. 24. The industrial output now receives important corttributions from the large projects notably potash, phosphate fertilizers and cement. These large new industries, however, were they to expand no further, will not be able to contribute to restoring a healthy rate of growth beyond 1987. Therefore, identifying sources for industrial growth is a major concern. Jordan may no longer be favored by availability of low-cost capital (grants and concessionary lending). Instead, it must seek to develop a comprehensive advantage in skills, technology and productivity. With this in mind the new development plan assigns a leading role to the industrial sector, expecting the new industries to contribute more than one-third of the incremental GDP during 1986-90. It includes investments in few large scale industries, one of which is the potash works. 25. In the long run, because of the small size of Jordan's domestic market, industrial growth would depend heavily upon the development of exports. Aside from balance of payments criteria, only export markets can provide the necessary support for adequate economies of scale, employment generation, and meaningful industrial integration. There is a considerable potential for manufacturing exports to neighboring countries. However, excessive reliance upon these few markets could, and has, become a constraint to sustaining industrial growth and maintaining a good export performance. Exports of manufactured products to industrialized market economies are so far negligible. Only in targeting segments of the world markets particularly responsive to its resource endowment and industrial potential (including potash and derivatives), can Jordan partly overcome dependence on limited nearby markets. In this context, the expansion of the Dead Sea Potash production would be helpful, particularly if accompanied, as is the objective under the proposed Bank loan, by an optimization of production process, overall reduction in production costs and hence, enhanced competitiveness. Bank Role and Sector Lending Strategy 26. Jordan's last two development plans aimed at restructuring the economy to achieve a wider manufacturing base, reduce dependence on external grants, and spread development among different regions. The Bank's assistance to Jordan has been designed to support these objectives, and in particular help the Government: (i) diversify the country's economic base and promote exports; (ii) alleviate manpower and infrastructure constraints in the productive sectors; and (iii) encourage more balanced growth among regions. The macroeconomic framework to assess the long-term potential for Jordan's export-oriented industrial growth has been provided under the Bank's review of the 1981-85 Five Year Plan (Report No. 4179-JO of May 1983), and further  - 8 - recoimendations in this regard were formulated in the study on Export Strategy and Promotion in Manufacturing Industries (Report No. 4170-JO of June 1983). A manpower development study discussing strategies for employment and growth in the context of a weakening regional demand for Jordanian labor was also carried out by the Bank (Report No. 5117-JO cf June 1984). The Bank has recently conducted a review of the small and medium-scale manufacturing industry and it plans to carry out a review of public enterprises. 27. Bank assistance in the industrial sector has thus been directed at fostering Jordan's comparative advantages based on domestic resource endowment and manpower skills, and contributing towards the establishment of a broader export-oriented industrial base. In the 1970s direct Bank involvement in the sector consisted of a credit to the Industrial Development Bank of Jordan (1974) including financial and technical assistance to the small and medium scale industries, and an engineering credit (1975) to help prepare the first Arab Potash Project. 28. A $35 million loan for the first potash project was approved in 1978, and assisted the construction of a $460 million potash production facility on the Southern shore of the Dead Sea to exploit one of the few large physical resources available to Jordan-the Dead Sea brines--which are rich in minerals and salts. The project thus built and operated by the Arab Potash Company is amongst the largest industrial undertakings in Jordan. Designed to produce 1.2 million tons per year (mtpy) of potash in the form of potassium chloride (KCI), the project started operation in 1983. Its total production is exported. The facility has been going through a production build-up period, and reached an output level of 910,000 tons in 1985, or about 75 percent of design capacity. As this is below the projected levels, APC has studied the means of increasing production to the design capacity and surpassing it by a safety margin of about 15 percent. The resulting corrective measures, implemented through 1985 in the solar pond network, have already yielded satisfactory results, bringing in the solar pond potential capacity over its nominal design. The remaining bottleneck, yet to be corrected, is attributed to deficiencies in the refinery where the operating factor is still unsatisfactory and a low conversion efficiency rate results in excessive recycling to the ponds. The Borrower has submitted a draft report on the implementation of this project and a Bank completion report is under preparation. The draft report concluded that the high chemical and physical quality of the potash produced by APC led to an early acceptance of the product in all markets. The report also noted that satisfactory progress has been achieved in staffing and training but these efforts should continue in future years. The proposed project addresses staffing and training needs, and takes into account the existing marketing arrangements and patterns. Rationale for Bank Involvement 29. Jordan's resource based industries play a crucial role in reducing the foreign exchange constraints arising from falling remittances and grants. Gross foreign exchange earnings from potash exports exceeded $82 million (about 10 percent of all merchandise exports) in 1985 and the improvements under the proposed project would raise revenues by about one-third by 1990. Thus, the proposed project meets the Bank's strategic objective of assisting export industries.  -9- 30. Bark support for the pjroject would intotl-veessential technical advice to APC on a relatively sophisticated technology, particularly the evaluation of a new, energy efficient "cold crystallization" process for potash refining. An action plan for reinforcing the middle managerial level of the company, training, and appropriate deployment of technical assistance was prepared within the framework of the project and its implementation is underway. On a different front, the financial difficulties of the "mixed" enterprises have extinguished private interest in, and demand for, participation in such ventures and derailed government plans for increasing private ownership in mixed companies. If APC is able, as expected, to return to a profitable position in 1988, this would open the way towards boosting private participation, no doubt with positive impact on other industries as well. PART IV - THE PROJECT Project History 31. The project was identified in May 1985, prepared during 1985 and appraised in March 1986. Negotiations were held in Washington, D.C. during December 15-19, 1986. The Jordanian delegation was headed by Mr. Ziad Fariz, Secretary General, Ministry of Planning and included the Managing Director and other representatives of the Arab Potash Company. A Staff Appraisal Report (No. 6365-JO), dated December 24, 1986, is being distributed separately. The main features of the proposed loan and project are outlined in the Loan and Project Summary and in Annex III. Project Obiectives and Description 32. The main objective of the project is to support an increase in the output of the existing potash production facilities, and to initiate a research and development program for assessing the ultimate potential of these facilities and introducing progressive technologies. In addition, a financial rehabilitation plan, currently under implementation, aims at compensating the effects of past losses, strenghtening the capital structure of APC and improving the Company's liquidity position. 33. The project comprises an investment and a technical assistance component. The investment component would be carried out under two separate, yet parallel, programs: Ci) The first program would entail a turn-key contract in an amount of $12 million aiming mainly at removing bottlenecks in the decomposition section of the refinery, by conversion from a one-stage to a double-stage process. Indeed, following the corrective measures implemented in 1985 in the solar evaporation ponds (diversion dike in the salt pan and conversion of pre-carnallite into carnallite area), it has been established that the ultimate capacity of ponds will exceed the design capacity of 1.2 million tpy level. The remaining constraints are inherent to the refinery and would be alleviated by the proposed set of modifications. (ii) The second program aims at rationalizing the hot leach section of the refinery and providing increased operational flexibility. It would mainly consist of the acquisition and installation of proprietary equipmer- to expand stand-by capacity. The capacity of  - 10 - the refinery could thus be increased by about 15 percent, over the initial design, to 1.4 million, for a marginal capital cost amounting to about one percent of the cost of existing facilities. Such an investment would be well justified given its attractive return, and can now be committed as APC has gained experience and knowledge of the pond system's operation and capacity. The technical assistance component is essentially a part of APC's Research and Development Program to assess, given both market position and resource endowment, the long-term prospects of APC operations with a view to continued technology improvement, cost reduction and business growth. For this purpose the feasibility of further expansion would be studied. The first stage of the study would include, inter alia, the analysis of the poteatial to further expand the solar pond network capacity, laboratory tests and a pilot unit (cold crystallization) for an expanded, lower-cost productior scheme, and a market analysis to derive and justify the optimal level of expansion. Should the first stage studies yield positive conclusions, a second stage would provide the preparation of the basic engineering design, including technical specifications and bidding documents on the basis of which contractors can be selected and detailed engineering designs prepared. The project also includes provision for the training of APC's personnel(para.38). Project Implementation 34. The project would be implemented by the Arab Potash Company (ABC), founded in 1956 to commercially exploit minerals from the Dead Sea brines. APC has prepared the project with the assistance of Jacobs Engineering Group (USA). Incorporated under Jordanian law, APC shares are held by the Government (51 percent), Arab Mining Company (25 percent), Islamic Development Bank (6.3 percent), Iraq (5.7 percent), Libya (5 percent), Kuwait (5 percent), Saudi Arabia (0.4 percent), Jordan Post Office Savings Fund (0.6 percent), and other private Shareholders (1 percent). 35. The Company'E board has fifteen members, representing the various shareholders. The chairman and seven members are appointed by the majority shareholder, the Government, while the deputy chairman represents the second largest shareholder, the Arab Mining Company (AMC). The board has been closely involved in the decisions aiming at plant optimization and financial restructuring. The Board includes members having a broad spectrum of expertise from government institutions, and from the business and banking communities. 36. Management and Organization of APC. APC has an able top management and a sound management information system. Reliable information and monitoring systems have been developed in the marketing and personnel areas, as well as for stores and inventories. In finance and accounting, a good computerized system integrates both financial accounts and production control. The plant maintenance activities have so far had to cope with a long series of technical modifications and adjustments due to the unique chemical characteristics of the Dead Sea brines. This has somehow delayed the development of a well established mnintenance planning activity, although a good preventive maintenance scheme is now being devised. On the marketing side, ARC's marketing department has been reorganized and strengthened. Marketing arrangements include current agreements with specialized marketing and fertilizer companies.  - 11 - 37. APC staff now number about 1,320 employees, including 1,177 Jordanian nationals. The balance consists of a core of foreign experts and over 125 foreign daily laborers. In developing its management systems and organization APC has received considerable tecbnical assistance since 1980 from an Operations Management Team (OMT) from Jacobs Engineering Group providing for up to 2.5 experts including technical and financial specialists. The OT also provided on-the-job training to Jordanian counterparts. After the ONT contract expired in May 1986, APC retained a core of 4 experts out of the original team (including the technical, works and logistics managers) and assigned them to key in-line positions at least until full design capacity of the plant is reached. To increase operational efficiency and to strengthen its organizational set-up, APC has prepared a new organizational chart and a three-year training program. The Bank has reviewed the chart and the program and is satisfied that they are appropriate for APC's needs. 38. APC has an in-house training unit including a manager, four engineers, and video technicians. The unit's objective is to upgrade skills, with focus on operators, craftsmen, especially maintenance tecbnicians, and new recruits. The unit arranges for staff training in Jordanian Universities, specialized training institutions and abroad. In addition to theoretical education, there is a need to focus training more directly on operational issues. The proposed project would support a three-year training program, through fellowships, and on-the-job training by outside consultants/specialists with emphasis on craftsman level. Financial Position of APC 39. The financial position of APC has been adversely affected by the delay in capacity build-up in the initial years of operation. Given the sizeable fixed costs of production, the resulting shortfall in annual output from projected levels, combined with depressed potash prices, has considerably reduced APC's operating income and partly depleted its equity. Net losses amounted to JD 13.8 million in 1983, JD 6.5 million in 1985 and JD 6.3 million in 1986. 40. When the grace periods on loan repayments ended in 1984, APC's cash flow from operations did not cover cash needs. To fill the financial gap, APC contracted additional medium and long-term borrowings. At the end of 1984, the debt equity ratio of APC had deteriorated to 80/20. The ratio improved to 70130 in 1985. 41. To improve the financial position of the Company, APC's shareholders decided in 1985 to raise the share capital by 15 percent (or JD 9.5 million) to JD 72.4 million. The two largest shareholders, Government and the Arab Mining Company, subscribed to the increase and paid-in about JD 2.4 million. The balance has been called by APC's board with a deadline of March 31, 1987. The Government intends to ensure that APC's capital is increased to 3D 72.4 million, and it has confirmed that it would subscribe and pay in, at the latest by end-March 1988, any shares outstanding beyond the deadline. In addition, the Government has consolidated APC's debt to the Government and subordinated this debt to the rights of other lenders as quasi equity to strengthen the financial structure of the Company. 42. Implementation of the proposed investment with the associated financial measures is expected to result in a net profit of JD 0.9 million in 1988, increasing to JD 12.2 million in 1990, with a gradual improvement of  - 12 - APC's debt service coverage, debt/equity ratio and current ratio. To ensure a sound financial position, APC bas agreed to (i) avoid incurring any debt if as a result its debt/equity ratio would exceed 60/40; (ii) maintain a current ratio of no less than 1.0 through its fiscal year 1990 and 1.4 thereafter; (iii) avoid incurring any debt if its debt service coverage ratio would be less than 1.0 through its fiscal year 1991 and 1.3 thereafter; and (iv) consult with the Bank prior to undertaking capital investments exceeding $8 million per fiscal year. Project Costs and Financing Plan 43. The installed cost of the proposed project, including physical and price contingencies, is estimated at $23.5 million equivalent of which $21.4 million is in foreign exchange. With the addition of interest during construction ($3.2 million through 1989), the total cost would be about $26.7 million of which $24.6 million would be in foreign exchange. Cost estimates do not include import duties and taxes from which the project is exempt. Except for the refinery modifications turn-key contract (already awarded), the project cost includes physical contingencies of 10 percent of the total base cost which is calculated on 1986 prices. The price contingencies for civil works, material and equipment have been estimated at 7 percent p.a. through the project implementation period, both for local cost and foreign currency expenditures. This reflects the estimated average increase of the cost of equipment, erection and services related to this project. 44. The proposed Bank loan of $12 million would cover about 45 percent of the total financing requirements of the project. The balance would be financed by APC (19 percent), the Islamic Development Bank (30 percent), and USAID (6 percent). The Bank loan would be made to the Arab Potash Company for 17 years, including a 4 year grace period, and would be guaranteed by the Government. The APC would bear the foreign exchange and interest rate risks and pay the Government a guarantee fee of 0.8 percent per annum. Effectiveness of the Islamic Development Bank (ISDB) loan and the USAID grant would be a condition of effectiveness for the Bank loan. Procurement and Disbursement 45. The refinery modification (decomposition section) contract amounting to $12 million has been awarded after international competitive bidding (ICB) in accordance with Bank procurement guidelines. Bank financed procurement under the above contract and for the r-naining equipment, erection and services consists of (i) ICB for an estimated amount of $4.5 million and (ii) limited international bidding (LIB) for an estimated amount of $3.3 million. However, equipment proprietary to the process design (estimated to cost $0.8 million) would be procured through direct p.-chase, and small packages estimated to cost less than $200,000 each up to an aggregate amount of $1.5 million would be procured through international shopping with offers from at least three qualified suppliers. Under ICB procurement, local qualified suppliers are accorded a preference margin of 15 percent, or the duty applicable whichever is lower. Documents and awards for contracts exceeding $500,000 would be subject to prior review and others to ex-post review by the Bank. Consultants would be selected in accordance with the-Bank guidelines. Procurement arrangements are snmiarized below:  - 13 - Procurement Method a/ ICB LIB LCB Other bh Total -- --- ---US$ Mill ioa-- - Equipment and Materials 8.50 3.45 - 2.85 14.80 (0.50) (2.55) (-) (2.30) (5.35) License, Engineering and Consultancy Services 1.00 0.85 - 1.65 3.50 (1.00) (0.75) C-) (0.50) (2.25) Civil Works/Erection 3.00 - 1.65 - 4.65 (3.00) C-) C-) C-) (3.00) Training - - - 0.50 0.50 (-) C-) C-) (0.40) (0.40) Total Installed Cost 12.50 4.30 1.65 5.00 23.45 (4.50) (3.30) (-) (3.20) (11.00) a/ Figures in parentheses are the respective amounts financed by the Bank Loan. b/ Includes direct purchase, international shopping and recruitment of consultants. 46. The proposed loan would be disbursed over six years as follows: equipment and materials, 100 percent of foreign expenditures and 100 percent of local expenditures ex-factory; consultant services and training, 100 percent of total expenditures. The loan would cover about half of the interest during construction on the Bank loan, estimated at about $2 million. The six-year disbursement schedule in the Loan and Project Summary takes into account the standard disbursement profile for Jordan which is six and a half years on average for all types of loans. The loan closing date would be June 30, 1992. In order to expedite disbursements, a Special Account (revolving fund) of $0.75 million, equivalent to an average of about four months disbursements, would be opened by APC and replenished on the basis of standard documentation for eligible reimbursable expenditures. Disbursements for contracts below $50,000 equivalent would be claimed under statements of expenditure, documentation of which would be retained for review by Bank missions. Provision is made for retroactive financing of up to US$1.2 million to cover some consultancy services and other initial project expenditures incurred after June 30, 1986. Accounts, Audit and Monitoring 47. APC would be required to submit quarterly progress reports during project implementation, and annual progress reports thereafter during the life of the proposed loan. In addition, APC'e accounts, the Special Account and statements of expenditure would be audited annually by independent auditors acceptable to the Bank and sent to the Bank within six months of the end of APC's fiscal year. Project Benefits and Risks 48. Once full operating capacity is reached, the proposed project would provide critically needed foreign exchange estimated at $27 million per year (incremental gross foreign exchange earnings in 1986 terms). This would have  - 14 - a beneficial impact on Jordan in reducing the foreign exchange constraints arising from falling remittances and grants. Over a ten-year operating lifetime, the project investment, on an incremental basis, would yield an ERR approximating 100 percent due to APC's low marginal production costs. Using sensitivity tests under different production and sales scenarios, the ERR wculd vary from 10 percent under the worst possible scenario (market collapse and higher than expected output from the present facilities) to about 65 percent where market constraints alone would prevail. Given the assumptions on financial and economic prices, and limited distortions in the economy, the financial rate of return would be the same as the ERR. 49. The proposed investment would also help APC revert to profitability and would allow dividends, long overdue, to be paid inter-alia on Government equity. The Project will also have beneficial institution building effects, in adding to the expertise of APC engineering and operating staff, as the investment component will induce more efficient operating practices, while the TA component will allow transfer to APC of up-to-date technology. Finally, the proposed project will permit efficient use, at relatively low cost, of indigenous feedstock resources. 50. Impact of Proposed Capacity Increase on APC Market Position. The proposed project will bring gradually, by 1990, APC's annual output to the level of 1.4 million tons of KC1, an addition of 350,000 tons over the 1986 level, yet only 200,000 tons over the design capacity for which APC had initially set up its marketing and representation network, entered into specific marketing agreements, and designed its shipping and sales policies. The marketing record of APC, although short, has nonetheless been impressive, as APC has, with little difficulty, been able to capture a market share close to 1 million tons in a span of 3 years. The risk that APC will be unable to market, through 1990, annual average increments of 70,000 tons, is thus moderate. APC's projections through 1990, as regards this expanded output have been prepared on a country-by-country basis, taking into account the experience of the recent past, specific relations with the country involved, the potential for conclusion of long-term contracts, the position of APC agents in the respective areas and, where relevant, APC's competitive edge. The 1984 and 1985 actual sales, and sales estimates on a country-by-country basis, through 1990, are provided in Table-V and Annex 4-1 of the Staff Appraisal Report. 51. Regarding the commercial risk associated with the investment, the sensitivity analysis shows that potash prices, for the incremental output, could decline sharply from their present depressed levels before the justification for the investment is lost. The considerable price flexibility APC could afford in the event of tightening competition, markedly enhances the viability (while alleviating the risk) of the investment. The main market risk for APC would be associated with a mnrket collapse-for instance resulting from the imposition of quotas-where APC would be unable to market its full production. The technological risks associated with the investment and the ability of APC staff to operate effectively the optimized facility, are moderate, as the company has already acquired a satisfactory knowledge and experience on the technological and operational aspects of potash production. Moreover, the very purpose of the optimization measures foreseen under the project is to increase safety margins and add operating reliability to the plant. Measures have been adopted to improve mid-level managerial capabilities and staff skills, especially in operational areas.  - 15 - PART V - 3ESCGUATION 52. I - satisfied that the proposed loan would comply with the Articles of Agreement of the Dank and recomeand that the Executive Directors approve the proposed loan. 3. Coable President Attachments FebruarylO, 1987 Washington D.C.  -16- ANNEX Page 1 of 3 JM - ECUIIIC IEICAID apulatim 2 ai illi Us LMI. - E per capIta. 11 ,S51 0 (I)