Mexico - Third and Fourth Industrial Equipment Fund (FONEI) Projects

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 7859 PROJECT PERFORMANCE AUDIT REPORT MEXICO THIRD AND FOURTH INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (LOANS 1560-ME AND 1712-ME) JUNE 13, 1989 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in f of COUNTRY EXCHANGE RATES Currency Unit - Mexican Pesos (Nez$) YEAR-ND AVZRAGR 1977 US$ - 13$ 22.7 22.6 1978 IS$ - MEX$ 22.7 22.8 1979 US$ - HE$ 22.8 22.8 1980 US$ - NIX$ 23.3 23.0 1981 US$ - MHX$ 26.2 24.5 1982 US$ - MEX$ p6.5 56.4 1983 US$ - HZX$ 143.9 120.1 1984 US$ - HEX$ 192.6 167.8 1985 US$ - HEX$ 371.7 256.9 1986 US$ - MEX$ 923.5 611.8 ACRONYMS ACF - Average Cost of Funds BdM - Banco de Mexico CEDI - Certificate of Tax Reimbursement DFC - Development Finance Company FICORCA - Fideicomiso para la Cobertura de Riesgos de Cambios FIDEC - Fondo de Desarrollo Comercial FOGAIN - Fondo de Garantia y Fomento a la Industria Pequena y Mediana FONEI - Fondo de Equipamiento Ine.utrial GIRA - General Agreeien oin Interest Rates Applicable to Credit Operations of Fondos de Pomento Financed by the International Bank for Reconstruction and Development NAFINSA - Nacional Financiera, S.N.C. PVP - Sistema de Pagos Variables al Valor Presente SAP - Special Action Program SAR - Staff Appraisal Report FOR OFFICIAL USE ONLY THE WORLD BANK Washington. DC 20433 USA Oice of DvectWKC~e Opeatms IvaikatNm June 20, 1989 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Project Performance Audit Report on Mexico Third and Fourth Industrial Equipment Fund (FONEI) Projects (Loans 1560-ME and 1712-ME) Attached, for information, is a copy of a report entitled "Project Performance Audit Report on Mexico Third and Fourth Industrial Equipment Fund (FON9I) Projects (Loans 1560-ME and 1712-ME)', prepared by the Operations Evaluation Department. Yves Rovani by Ram K. "hopra Attachment 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. FOR OFFICIAL USE ONLY PROJECT PERFORMANCE AUDIT REPORT MEXICO THIRD AND FOURTH INDUSTRIAL EQUPMNT FUND (FONEI) PROJECTS (LOANS 1560-ME AND 1712-ME) TABLE OF CONTENTS Page No. Preface ......................i..................... Basic Data Sheet .................. ........ ........ .iii Evaluation Summary .... ........ ......... .. .. vi PROJECT PERFORMANCE AUDIT MEMORANDUM I. BACKGROUND -.............................................. 1 The Industrial Sector ...................... o ............. 2 Trade Policy .............................. ........ 2 The Financial Sector ..................................... . 3 Fiscal Incentives to Industry ................... .... 4 II. BANK AND LOAN OBJECTIVES AND THE FONEI PROJECTS ............. 6 III. PROJECT IMPLEMENTATION ...................................... 8 A. Characteristics of FONEI Operations ........... ...... . 8 The Distribution of Subloans ............................. 8 Utilization of Bank Funds ................ ............... 10 Operations ............................. ..... .. ......... 10 Institutional Development ................................ 11 B. Bank Supervision .. ...................... ............ 13 C. The Response to the Crisis ................. .. ...... 15 IV. MAIN ISSUES ........................................... 18 A. Consistency Between Project Objectives and the Macroeconomic Framework ............... .... 18 B. Availability of Term Credit and the Financial Sector...... 21 C. FONEI's Sustainabilitv . ................ 24 D. Government Policy on Trust Funds ................... 29 E. Lessons of Experience .................................... 31 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Table of Contents (Cont'd) Page No. ATTACHMENTS 1 - F01 Subloan Approvals 1978-1987 ........................... 36 2 - Participation of Bank-Funded Subloans in PON31 Operations.... 37 3 - Firms with FONBI Financing (Belonging to Mexico's 500 Largest Firms) ................... .. ............. .. 38 4 - Firms with FON31 Financing (Belonging to Mexico's Main Industrial Groups) ........... ............. . ........... 39 5 - FONEI Firms with More than One Subloan (by type of Financing. 40 6 - Authorized Subloans by Region ...................... 41 7 - Export Share in Total Manufacturing Production, 1980 Prices.. 42 8 - Share of Exports in Total Production, Main Products . 43 9 - Financial Ratios in Manufacturing .......................... 44 10 - Authorized Equipment Credits by Market ...................... 52 11 - Authorized Subloans by Economic and Financial Rates of Return 53 12 - Summary of the Sistema de Pagos al Valor Presente (PVP)...... 54 13 - Balance of Bank Loans as of November 30, 1983 ......... .. 56 14 - Comments Received from the Bank of Mexico ................... 57 15 - Comments Received fran FONEI ................................ 59 16 - Comments Received from Nacional Financiera .................. 62 PROJECT COMPLETION REPORT I. INTRODUCTION . ....................... ........ ..... 65 II. PREPARATION AND APPRAISAL OBJECTIVES ... ................. 67 Loan Preparation ................................... 67 Appraisal Objectives ......... .... ................ 67 III. UTILIZATION OF LOAN PROCEEDS ......................... 69 Resource Transfer .... 0 .......... ................ 69 Characteristics of Lending .................................. 69 Special Componencs ................................ ............ 72 Impact of Subprojects ........................ 73 IV. INSTITUTIONAL DEVELOPMENT .............. * ......... .... 74 The Institutions FONEI .......... ......... ....... 74 Management, Sta*fing and Organization .............. 75 Project Monitoring and the Role of Financial Intermediaries.. 75 Training .... . .................. ............... 78 Promotion ........... ........... ... ...... 78 Management Information Systems ..................... 79 Operations ........................... ......... 79 Financial Performance and Results ....... ..... ... 81 V. CONCLUSIONS .......................... * .... ..... ...... 82 Table of Contents (Cont'd) Pae No. ANNEXES 1 - Manufacturing Performance Indicators ...................... 84 2 - Estimated and Actual Cualative Disbursements ............. 85 3 - Characteristics of FONI-financed Subprojects ........... 86 4 - Financial Composition of FONEI-financed Subprojects ....... 87 5 - Selected FOUI-financed Subproject Data ................... 88 6 - Projected and Actual Rates of Return of a Sample of FONEI-financed Subprojects (Z) .......................... 89 7 - Projected and Actual Export Performance of a Sample of FONEI-financed Enterprises .................... ........... 90 8 - Project and Actual Import Substitution in 1984 by a Sample of FONEI-financed Enterprises ............. 91 9 - FONEIs Organization Chart ............................. 92 10 - FONEI's Disbursements by Financial Intermediary: 1979-1986 93 11 - Arrears Position under FONEI-financed Subloans by Participating Intermediary as of July 31, 1986 .......... 94 12 - Suimary of Sxpervision Activities: 1979-1986 .. ....... 95 13 - Subproject Processing Time ................................ 96 14 - Summary of Training Activitiess 1979-1986 ................ 99 15 - FONEI's Projected and Actual Operations: 1979-1986 ....... 100 16 - Summary of FONEI's Lending Operations by Program: 1978-1986 101 17 - FONEI's On-lending Interest Rates ....................... 102 18 - FONEI's Audited Balance Sheets: 1979-1986 ................ 103 19 - FONEI's Audited Income Statements: 1979-1986 ............. 104 PROJECT PERFORMANCE AUDIT REPORT MEXICO THIRD AND FOURTH INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (LOANS 1560-ME AND 1712-MZ) PREFACE Loans 1560-HE for US$100 million and 1712-ME for US$175 million were made in May 1978 and May 1979, respectively, to the Nacional Financiera, S.N.C. (NAFINSA), as agent for the Mexican Government, with the Fondo de Equipamiento Industrial (FONEI) as implementing agency. The above loans, representing the third and fourth FONEI projects, were intended to assist FONEI's on-lending operations, through commercial banks, to finance efficient industrial projects, and to support FONEI's institution-building efforts. The PPAR on the first and second FONEI loans (824-ME and 1205-ME) concluded that FONEI had financed economically sound projects and matured into a competent and well-regarded financial institution. However, the PPAR also found that FONEI's funds had acted as substitutes for other investment financing resources. Therefore, it recommended that future lending should be addressed to those projects which are marginal under the traditional requirements of the financial intermediaries and represent a higher degree of risk. This goal was not achieved under the third and fourth loans. Loan 1560-ME was fully disbursed and closed in November 1982, witain five months of the original Closing Date. Mainly because of Mexico's financial and economic crisis in 1982, commitments and disbursements under Loan 1712-ME took much longer than anticipated, with nearly 931 disbursed by December 1986, two-and-a-half years after the original Closing Date, and seven years after loan approval. The undisbursed balance of US$11.1 million was cancelled in March 1987. This PPAR consists of the Project Performance Audit Memorandum (PPAM) prepared by the Operations Evaluation Department (OED) and the Project Completion Report (PCR), prepared by the Latin America and the Caribbean Regional Office of the Bank (LAC), on the basis of a review of relevant project documents, subproject files and data obtained during a Bank mission to Mexico in February 1987. The PPAM is based on the PCR, Staff Appraisal and President's Reports for the two loans and for the Industrial Recovery Loan (2746-ME), the loan documents, economic and sector reports, IMF reports, study of the project files and discussions with Bank staff. An OED mission visited Mexico in May 1988 and discussed the effec- tiveness of Bank assistance with FONEI and NAFINSA, present and former officials, senior staff of the Bank of Mexico and the Finance Secretariat, with officials of the Comptroller General of the Republic, with private bankers and industrialists in Mexico City and other major industrial centers. Their kind assistance and valuable cooperation in the preparation of this report is gratefully acknowledged. - ii - The PCR presents a very good discussion of project experience in the implementation, operations, fin" cial performance and utilization of the Bank's funds. It also focuses on the recent institutional development program under the Industrial Recovery Loan. The PPAM examines in some depth the macroeceoioic environment surrounding the design and execution of the two loans, the Bank's sectoral knowledge, and the rationale for these projects within the Bank's country assistance strategy to the country. The PPAM then explores problems of sustainability of FONEI as a development finance institution within the framework of the country's macroeconomic and sector policies at the time when the loans were made and executed, and draws conclusions and lessons from the experience. It is important to point out that, after the completion of the two loans, the Mexican Government started to carry out new economic policies that are more closely in line with earlier Bank recommendations. These policies 4re not analyzed in the present report, but they seem to go a long way towards correcting the identified problems. In particular, the new authorities have invited the Bank to carry out a financial sector study, a necessary step for the design of effective new lending operations in the sector. Following standard OED procedures, copies of the draft PPAR vere sent to the Government, the Borrower, the Bank of Mexico and Nacional Financiera S.A. The comments received from the Bank of Mexico, from FONEI, and from Nacional Financiera are reproduced as Attachments 14, 15, and 16 to the PPAM. PROJECT PRFORMANCE AUDIT REPORT uEXICO THImD AND FOURTH IDUSWIAL EquIPM0T PtaS (PONEI) PROJECTS (LOANS 150-M and 17124-E) BASIC DATA SHEET Loan 150-tlE Loan 1712-M Projected Actual Projected Acetal Loan Amount (US$ millions) 100.0 100.0 175.0 162.5 Amount Disbursed 100.0 100.0 175.0 162.5 Amount Cancel led - - - 12.5 Amount Repaid to 12/81/8 - 80.8 - 47.1 Amount Outstanding to 12/81/6 - 69.2 - 118.4 Negotiations - 04/78 - 06/79 Board Approval - 06/02/78 - 06/31/79 Loan Agreement - 09/27/76 - 07/30/79 Effectiveness - 01/12/79 - 10/06/79 Terminal Date for Subproject Submlislon 06/80/60 06/80/80 06/80/81 06/30/85 Closing Date 06/80/62 11/16/62 06/80/84 06/30/86 Borrower NAFIN NAFIN Executing Agency FONEI FONEI Fiscal Year of Borrower 1/1-12/81 1/1-12/81 Follow on Project Nam FONEI IV Industrial Recovery Loan Number 1712-E 2746- Amount (USS millions) 176.0 150.0 Loan Agreement 07/80/79 08/08/68 CUMULATIVE DISBURSEMENTS (US$ Millions) Loan 1560-HE FY79 FY80 FY81 FY82 FY83 Planned 7.6 45.2 84.0 100.0 - Actual 10.7 52.6 80.0 97.8 100.0 Loan 1712-ME FY80 FY81 FY82 FY83 FY84 FY85 FY86 FY87 Planned 5.0 60.0 146.4 172.2 175.0 - - - Actual 7.2 42.2 92.0 110.5 131.2 147.7 163.4 162.5 - Iv - MISSION DATA Loan 1560-HE Honth/ No. of No. of Staff Date of Year Weeks Persons Weeks Report Preappraisal 07177 1.0 2 2.0 08/31177 Appraisal 11/77 3.0 2 6.0 04/11/78 Sub-total 8.0 Supervision 10/78 1.0 4 4.0 11/27/78 05/80 * 1.0 2 2.0 06/06/80 03/81 * 0.5 2 1.0 04/20181 02/82 * 0.5 2 1.0 03/18/82 Sub-total 8.0 Completion 02/87 ** 1.0 1 1.0 06/30/87 Total 17.0 Loan 1712-HE Maoth/ No. of No. of Staff Date of Year Weeks Persons Weeks Report Preappraisal 10/78 * 11/27/78 Appraisal 01-02/79 3.0 5 15.0 05/10/79 Sub-total 15.0 Supervision 05/80 * 1.0 2 2.0 06/06/80 03/81 * 0.5 2 1.0 04/20/81 02/82 * 0.5 2 1.0 03/18/82 05/83 0.5 1 0.5 06/13/83 05/84 1.5 2 3.0 03/31/84 08/85 *** 0.5 1 0.5 10/21/85 Sub-total 8.0 Completion 02/87 ** 1.5 1 1.5 06/30/87 Total 24.5 * Carried out in conjunction with supervision of Loans 1560-ME/1712-HE. ** Combined supervision/completion mission. *** Carried out in conjunction with supervision of Loans 1820-ME, 2142-E, 2154-ME, 2325-HE, and 2331-ME. - V - STAFF DmT7 (Mn.eks) Ln. 10-1 FY76 Y77 FY7* -FE9 f f f f Ftfl f FiE FXE f IR7-AFM Prappiwala - - .8 - - - - - - - - - - 0.8 Appealeet - - 81.4 - - - - - - - - - 81.4 Nagot1tIrn - - 8.7 - - - - - - - - - - 3.7 SupervisIon - - 6.8 16.9 9.7 .6 1.3 .2 - .2 .8 7.6 1.8 48.9 h - 1.4 - - .0 _- _. Sub-Total 44.1 16.9 .7 .6 1.8 .2 .2 .8 7.6 1.3 81.2 Ln. 1712-k1 FY78 FY? FY7 FY79 FY0 FYS1 FY*2 FYU FY4 FYM FYM FY* FYW TOTAL PreapprolseI .1 .7 - 2.6 - - - - - - - - - 3.8 Apprala"I - - - 41.6 - - - - - - - - - 41.6 Ngotlation - - - 10.7 - - - - - - - - - 10.7 Supervision -. - - - 12.2 16.6 10.6 4.6 11.6 11.9 4.2 9.2 .6 81.8 Othr - - - --z- 2 .- - , _= _ _ - 0. Sub-Total .1 .7 - 5.2 12.2 16.8 10.6 4.6 11.6 11.9 4.2 9.2 0.5 137.5 TOTAL .1 .7 44.1 71.1 21.9 17.6 11.8 4.8 11.6 23.8 12.1 9.2 1.8 218.7 - vi - PROJECT PERFORMANCE AUDIT REPORT MEXICO THIRD AND FOURTH INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (LOANS 1560-ME AND 1712-ME) EVALUATION SUMWARY General Economic Background 1. The Mexican economy had an impressive performance in the post World War II period, averaging a real annual growth rate of GDP of 6.4Z until 1980. Relatively low inflation allowed Mexico to maintain a fixed exchange rate with the US dollar from 1954 to 1976. After inflationary pressures, which started in 1974, forced the 1976 devaluation, a stabiliza- tion program was put into effect accompanied by an attempt to introduce structural reforms including a tax reform, trade liberalization and the promotion of non-oil exports. ii. Structural reform efforts were abandoned following new large oil discoveries in 1977. These new resources became the basis for the adoption of a demand-driven growth strategy. Public expenditure was doubled, cou- pled with a sharp increase in both public and private debt. Within a set- ting of strong real appreciation of the peso, eroding confidence and a very high fiscal deficit, capital flight became massive. By 1982 the economy entered a severe crisis with a sharp decline in output and reduced domestic demand and real wages. A new stabilization program allowed the exchange rate to depreciate rapidly; imports were tightened and non-oil export raised (PPAM, paras. 1-5). III. Mexican industry has followed a similar growth pattern. It grew very rapidly until the mid-seventies, lapsed with the 1976 crisis and recuperated during the oil boom. In the 1982-83 crisis, the industrial sector had a negative average growth rate of 5.1%, although manufactured exports surged up. Industry has developed under an import-substitution strategy and within an incentive system characterized by high effective protection, as well as fiscal rules that promoted a prolnged flow of resources into the sector and away from other activities. iv. Industrial protection increased steadily since 1956 through high tariffs and the introduction of quantitative restrictions, which by 1976 encompassed almost two-thirds of total imports. After the 1976 devalu- ation, Mexico tried to put into effect a tariff reform that would lower tariffs and reduce the scope of quantitative restricticns. However, with the onset of the oil boom, the trade liberalization effort was abandoned and quantitative restrictions reinstated to include all imports (PPAM, paras. 6-8). The trend towards increased protection was reversed in 1985 - Vii - when Mexico started a far-reaching reform of its trade regime. The process of trade deregulation has continued through the present. v. Mexico's financial sector is characterized by a high degree of segmentation and directed credit, subsidies, low efficiency and small resource mobilization. Since 1978 fiscal imbalances have placed large demands on financial resources, absorbing a growing proportion of the system's total lending. This process of gradual crowding-out forced the private sector to increasingly borrow from foreign sources. Legal reserves have served as a source of credit for a large number of trust fitnds (fideicomisos) created by the government to support different activities. By 1978 there were over 200 trust funds, of which the most important operate under the Banco de Mexico and Nacional Financiera (NAFINSA). There is considerable duplication and competition among funds (PPAM, paras. 8-10). vi. Policies that modify the incent.ve system have played a major role in Mexice's industrial development. Tax exemptions have been used to favor activities and industrial branches or geographical zones. In addition, fiscal incentives were used to achieve other objectives such as fostering of employment and exports, technology development and pollution control. However, the aggregation of incentives through time resulted in an incoher- ent system with a high degree of reliance on administrative discretion. Tax policy measures included tax holidays for 5 to 10 years to priority industries and regions. A drawback scheme (Certificate of tax reimburse- ment, CEDI) was used to reimburse exports of manufactures for duties paid on their imports. Also, the government instituted ad hoc tariff exemptions at the firm level to promote certain branches of industry, e.g., automo- biles. vii. As inflation and nominal interest increased, tax rules produced a strong bias in favor of debt-financed investment and against equity financ- ing, since the tax system permitted the full deduction of nominal interest payments in calculating the firm's tax liability whereas dividends were fully taxed (PPAM, paras. 13-14). These distortions were corrected with the tax reform of 1987 (PPAM, para. 49). viii. On balance, the incentive system had a strong bias against manu- factured exports, labor-intensive industrialization and equity investment in industry, which were important objectives for FONEI. Bank and Loan Objectives and the FONEI Projects ix. Bank objectives in Mexico at the time of project approval were broad and possibly inconsistent. These included the support of many policies and programs leading to a wider distribution of the benefits of economic growth, and helping to finance projects that were to make signifi- cant contributions to output, exports and employment. The two projects in hand appear thus to respond to this wide list of objectives; however, the main stated purpose of the loans was the provision of financial support to efficient import-substitution and export projects in the industrial sector. j -viii- This financial support was in turn deemed necessary by a number of per- ceived weaknesses of Mexico's financial sector, such as a lack of depth, a shortage of term financing and the excessively conservative behavior of commercial banks. However, the Bank did not have adequate knowledge of the financial sector at the time when these loans were prepared, and therefore these perceived weaknesses could not be verified. Indeed, some of these perceptions were not correct. Another set of objectives in both operations related to the need to continue supporting PONEI's institutional develop- ment, including its technical and training capabilities (PPAM, paras. 15-20). Characteristics of FONEI Operations x. Since 1978 FONEI has gradually diversified from its original activity of equipment financing. The main new financial programs were designed to support technology development, productive capacity optimiza- tion and productivity enhancement and financial restructuring. But the bulk of projects under Bank financing have obtained resources under the equipment and the capacity optimization program. Contrary to the recommen- dations of the earlier PPAM and to the Bank's expectations, FONEI has con- tinued to concentrate heavily on the financing of well established medium and large firms, including many of Mexico's 500 largest firms. Average subloan amount under both projects has been US$1.1 million and over 60% of firms with Bank financing employ over 250 workers. Sectoral concentration is heavy, with two-thirds of the subloans granted in the metal products and chemical subsectors. The borrower has indicated that the preceding assessment--which is based on a sample of subloans provided by FONEI--may not be representative of the total number of firms financed by FONEI throughout its entire existence. Furthermore, FONEI has specialized in financing medium and large firms through its traditional lending programs for equipment and working capital, given the existence in Mexico of alternative instruments for financing smaller scale firms (Attachment 15). FONEI has distributed its operations throughout the country; over 50% of total financing took place outside the main three Mexican industrial areas (Mexico, Nuevo Leon and Jalisco). But this compares unfavorably with the objective of 60-70% contained in the FONEI IV Staff Appraisal Report (PPAM, paras. 22-25). xi. Although in current prices FONEI appears to have been profitable, with net earnings increasing from 3.6Z of equity in 1979 to 302 in 1984 and declining slightly to 28? in 1986, inflation in this period averaged 57.5Z per annum, so in real terms the return on equity was highly negative. Government capital transfers helped to compensate for the resulting erosion in its capital. However, if all the capital transfers and retained earn- ings in the period 1980-1986 are valued at constant 1980 prices, FONEI's equity by the end of 1986 had suffered a real capital erosion of almost two-thirds. A similar calculation carried out in US dollars results in a capital loss of over four-fifths over the same period. This real capital erosion was not due to portfolio losses because FONEI, as a second-tier institution, did not share with the participating banks the risk of default - ix - in the sub-loans. Rather, it was the result of charging interest rates that were negative in real terms, and of absorbing the foreign-exchange risk on foreign loans (PPAM, paras. 63-67). xii. The actual economic and financial performance of the sub-projects financed under the two loans was significantly worse than had been pro- jected. Cost overruns were common, actual sales were just over -ne-half of the projected volumes, and actual rates of return were significantly lower than originally projected, with over two-fifths showing losses (PCR para. 3.16). This disappointing performance is explained largely by the finan- cial and economic crisis of 1982-1983. However, the large devaluation and severe contraction in domestic demand associated with the crisis benefitted export-oriented firms, and manufactured exports soared in 1983-1984. Simi- larly, efficient import-substituting industries were able to take advantage of the drastic cutback in imports following the crisis, and thus improved their market share (PPAM para. 28). Institutional Development xiii. FONEI has matured during the implementation of the two loans into a model second-tier institution for long-term financing of the industrial sector. It has developed a good technical capability with important spill- over effects within the country's financial sector, mainly through a broad training program covering a variety of topics with emphasis on project preparation appraisal and supervision. However, the extent of FONEI's spill-over effects is somewhat overrated. Most appraisal units within commercial banks were set up after the banking system nationalization of 1982 and there is substantial duplication in appraisal tasks between FONEI and the banks. The borrower, however, has indicated that, given the grow- ing utilization by banks of the project appraisal methodology developed by FONEI, this apparent duplication in reality represents a complementarity of analysis which is useful for decision-making (Attachment 15). Further, financial intermediaries still ascribe far greater importance to personal risk evaluations and to obtaining relatively high collateral. Neverthe- less, collateral requirements have been gradually lowered, following the nationalization of the commercial banks. In 1977-81 average collateral was 8:1, while at present it is 2:1 (PPAM, paras. 29-31). xiv. Subloan supervision tasks have been increasingly performed by financial intermediaries under the supervision of FONEI staff and according to monitoring guidelines set forth by FONEI. Since 1983 the spread charged by intermediaries on FONEI subloans includes the payment for both evalua- tion and monitoring (PPAM para. 33). The Response to the Crisis xv. The severe 1982-1983 crisis brought about a widespread general deterioration on the financial situation of firms, particularly those with high levels of foreign exchange denominated debt, and firms selling mainly in the domestic market. Profits in manufacturing dropped sharply, although - x - manufactured exports rose and certain efficient import-substitution activi- ties also gained. Most firms developed cash-flow problems and became high- ly leveraged. Faced with this situation, FONEI's operations slowed down markedly and the number of subloan cancellations increased dramatically. Over 50Z of all subloan cancellations since 1974 occurred in the 1982-83 period. In contrast to the impressive disbursement of the third loan, which was disbursed in eighteen months, the fourth loan took more than seven years, and an undisbursed balance of US$11 million was cancelled. This disbursement pattern reflected both the sharp contraction in domestic demand and a decision not to go ahead with many of the projects which did not correspond to the new economic realities that surfaced during the crisis, in part because they did not have the characteristics intended by the operations (PPAM para. 26). The borrower has indicated that, in spite of this less satisfactory performance, FONEI's subprojects performed better than the average for their respective subsectors (Attachment 15). xvi. FONEI reacted to the new situation with imagination and flexibili- ty. In cooperation with the Bank and under the Special Action Program, it increased disbursement percentages for eligible payments and started to finance working capital requirements. In order to ease the cash-flow prob- lem that firms were confronting, FONEI introduced a new repayment mechanism (PVP), which essentially capitalizes interest, to allow subloan repayments to better coincide with the project's real cash flow. Finally, JONEI introduced a program for capacity optimization to help firms adjust to the new market situation. The adoption of all these actions proved that FONEI could adjust to the new environment, resume lerding and protect the commer- cial bank's portfolio for which FONEI was a source of funds (PPAM paras. 45-48). Government Policy on Trust Funds xvii. The Government is now tackling the problems stemming from the inordinately large number of different trust funds which have contributed to the excessive segmentation of the financial market. At a time when the reduction of the public sector deficit carries a very high priority, their proliferation makes it difficult to assess with adequate transparency the extent of their fiscal burden. In addition, within the industrial sector there are various funds catering to the same industrial clients, thus gen- erating many conflicts, particularly between FONEI and other funds under NAFINSA. Further, there are conflicts within NAFINSA itself insofar as it acts as both a second-tier DFC as well as a commercial bank and also runs and owns a number of industrial firms. xviii. In the industrial sector, one possible solution to the conflicts described above is the merger of all NAFINSA industrial trust funds into a single second-tier DFC, which could then be subjected to a process of sub- stantial reorganization in order to improve its efficiency, while FONEI would be left to operate as an independent fund. Another perhaps more desirable alternative would be to bring all industrial funds under FONEI's administration- providing there is an adequate level of autonomy with -xi- respect to MAFINSA (PPAM, paras. 74-81). The authorities have indicated that appraisal of the alternatives and final selection will depend on the outcome of the new government's policies and on the plans drawn up for the necessary detailed restructuring. Main Findings and Lessons xix. The FONEI III and IV operations succeeded in consolidating FONEI as a mature apex finsacial institution with a record of efficient perfor- mance, which encouraged the participating commercial banks to develop a project appraisal and supervision capacity, relying less on personal links and on collateral requirements. FONEI has also helped to introduce in Mexico innovative financial techniques, beginning with flexible interest rates and including new loan amortization mechanisms. Although a relative- ly small actor within the Mexican financial sector, FONEI can be considered a model of a well managed, competent and lean second-tier institution. The World Bank'e support for thit model institution had a positive demoastration effect on the rest of the Mexican development finance sector, and eventually helped to bring about the desired structural changes in the country (Attachment 16). These accomplishments, however, are clouded by other aspects of the operations. First, the bulk of the lending under the two loans did not reach firms that were marginal under the commercial bank's traditional requirements regarding personal connections and/or high collateral, as was originally intended by the Bank and had been recommended by the PPAH of the first two FONEI operations. Instead, much of the funds benefitted firms that could have found easily other sources of financing because of their connections with industrial and banking groups (PPAM, para. 23). Second, the financial and economic performance of the sub- projects was much worse than had been projected, and the fourth loan was plagued by losses and loan cancellations. The economic and financial crisis of 1982-83 explains part ef this poor performance. But industrial exports, which the projects were originally meant to promote, boomed following the crisis, originally shifting production from local to export markets using existing capacity, and gradually by new investments. Third, in spite of its frugal management, FONEI was unable to conserve the real value of the cumulative resources that it received from the Government and its own re-invested profits: its equity at the end 1986 had lost between two-thirds and four-fifths of the real value of those cumulative resources. Such capital losses are a threat to its sustainability as a financial institution (PPAM para. 82). x. The mixed results serve to illustrate a number of weaknesses during the design and execution of the two loans, some of which have come up repeatedly in earlier OED reports. First, the Bank objectives in lend- ing to Mexico were vague, internally inconsistent and not well based on thorough and up-to-date economic analysis. Second, the Bank had insuffi- cient knowledge of the financial sector, and seemed to ignore the findings and recommendations of its own recent industrial sector report. Third, as a consequence of the first two, and of the absence of a productive policy dialogue, the loans were designed on tne basis of incomplete knowledge regarding the demand for and availability of investment credit, and were expected to succeed in spite of a hostile macroeconomic environment. Fourth, the Bank supervision focused more on ways to accelerate disburse- ments than on the weaknesses of the unfolding operations, and the recommendations of supervision missions did not receive adequate follow-up in headquarters (PPAM, para. 83). xxi. Bank Objectives and Country Economic Knowledge. Bank objectives seemed to call for primarily labor intensive investments, but the Govern- ment's announced development plans at the time signaled large, capital intensive projects, to be financed largely by the public sector. The fiscal and macroeconomic policies being pursued by the authorities were in conflict with other Bank objectives. The Bank seemed to ignore these con- flicts, in part because the regular formal economic reporting had been neglected. When the two loans were presented to the Board in 1978 and 1979, there had not been a full economic report on Mexico for several years, and the latest updating report was dated March 23, 1976. During this period internal reports on the Mexican economy continued to be pre- pared, but they were not openly discussed, even within the Bank. The next economic report was only distributed to the Board in May 1979. This neglect of formal economic reporting during a period when fundamental changes were taking place in the country, such as the major oil windfall and associated expansive fiscal policies, was bound to be reflected in problems of inappropriate country assistance strategy, poor design of projects, unproductive policy dialogue and weak conditionality. Further- more, the Board had to act on the loans without fully sharing the informa- tion available to the staff. Stricter enforcement of guidelines calling for frequent economic monitoring and reporting, particularly for large borrowers and for countries undergoing significant economic changes, could help the Bank to target its country objectives better and to design projects and conditionality with greater realism (PPAM para. 84). xxii. Sector Knowledge and Consistency with Project Design. The Bank went on for years making loans to Mexico that were to be channeled through the financial sector -- US$2.4 billion, or about two-thirds of total lend- ing to Mexico in the period of execution of the FONEI III & IV loans -- without carrying out a single financial sector study. Major problems in the sector, such as excessive segmentation, proliferation of directed credit and special funds, wasteful competition among different official credit windows, integrated industrial-banking cartels, high cost of interest rate subsidies, crowding out of the private sector, massive arrears and negative interest rates, were either ignored or overlooked. even though these problems were plaguing the Bank's own operations. Even the FONEI operations, although well conceived in themselves, contributed to aggravate some of these problems. Deeper knowledge of the sector should undoubtedly have helped to better design the operations and to formulate a stronger conditionality. The lack of financial sector work was due to the Government's reluctance to allow the Bank to carry out such studies. Thus the Bank agreed to lend massively without the expectation of effectively influencing financial sector policies (PPAM para. 85). Commenting on this - xiiL - point, the LAC Region has indicated that, while the attitude of the Mexican authorities of preventing the Bank from carrying out a financial sector report was very regrettable, it was felt that the Bank should not raise this as an important enough issue to stop lending through intermediaries, which constituted the bulk of Bank lending operations to Mexico. xxiii. As regards the industrial sector, equally critical to the success of the FONEI operations, the Bank had recently carried out a major Industrial Sector Report that raised grave concerns regarding excessive industrial protection, over-valuation of the currency, crowding out of private investment by the public sector, undesirable bias towards capital- intensive investment in both the public and the private sectors, and general discrimination of incentives against the growth of manufactured exports. These concerns, however, were virtually ignored in the appraisal of the two loans. As a result, these operations had little hope of influencing the government' industrial policies or of re-orienting private investment towards manufactured exports. The Projects Division has explained that it did not have any input into that Industrial Sector Report and it did not share many of the conclusions and recommendations of the Report. The lesson that emerges from this experience is that the existence of adequate sector work is a necessary but not a sufficient condition for the appropriate design of a lending strategy and sector conditionality. There is a need as well for management intervention, preferably at a level removed from the normal operational pressures to lend, to ensure that the findings and recommendations of sector work are fully reflected in the loan design and conditionality (PPAM para. 86). xxiv. Policy Dialogue. Throughout the period of preparation and imple- mentation of the two loans, the Government's general economic policies were not only not conducive to the success of these operations but, more impor- tant, started to lead Mexico towards the grave crisis of 1982. In addition to the financial and industrial sector policies discussed in the preceding paragraphs, the tax system encouraged corporations to maximize their borrowing rather than re-invest their own earnings, and fiscal policy was becoming dangerously expansionary. Easy access to massive foreign borrow- ing by both the Government and the private sector -- encouraged in turn by official policies and by the crowding out of domestic credit -- aggravated the over-heating of the economy, contributed to the over-valuation of the peso, discouraged exports and eventually resulted in private capital flight and an untenable balance of payments and foreign debt situation. The Bank was aware of these danger signals, in spite of the long delay in economic reporting. Indeed, the 1979 Economic Report, which was in preparation since 1977 and had been discussed with the Government long before its pub- lication, gave ample warning. The Government, however, seems to have ignored the Bank's advice and continued the expansionary policies as long as it was able to obtain foreign financing. In spite of the lack of a productive pelicy dialogue, the Bank continued to lend, and its President's Reports voiced an unjustified optimism about future policies, the decline of inflation, and growth in private sector investment demand. The need for the FONEI loans was explained on the basis of a supposed scarcity of term -xiv- credit that could not be substantiated. But in fact, there was little need for the funds provided by these loans, either on balance of payments or on financial sector grounds.11 and the additional resource transfer may -- albeit in a very small way -- have contributed to aggravate the macro prob- lems (PPAM para. 87). Xxv. Why, then, did the Bank proceed with these loans when it had no expectation of helping to correct inappropriate policies, both at the macro and at the sector level? Part of the answer undoubtedly lies in the desire to continue helping FONEI to carry out its worthwhile pioneering and pr"motional DFC activities. Also, despite the fact that many Mexican enterprises were obtaining foreign borrowings, not all of them had easy access to these sources of funds, and the FONEI loans did assist those that did not have access. But the staff may have been motivated by the urge to lend for the sake of meeting regional lending targets (PPAM para. 88). xxvi. Bank Supervision and Sustainability. Supervision missions were infrequent and brief. OED found in the records that supervision tended to give a high profile to loan implementation, with emphasis on accelerating disbursements. Thus, the adverse macroeconomic framework, the excessive capital intensive and large size of the operations, and the questionable profitability of some of the sub-projects, were rarely mentioned. More important, the fact that higher inflation than originally projected, negative real interest rates and unforeseen devaluations were eroding FONEI's equity in real terms and threatenirg its sustainability were not raised as important issues requiring urgent attention. These problems may have beem overlooked because the staff's attention was drawn more to new lending activities than to supervision of on-going loans. But there was also an organizational reason. Since most of the questions had to do with the deteriorating macroeconomic framework, it should have been up to the Programs Department to bring these matters to the attention of Projects. Once again, there seems to have been a lack of coordination between Programs -- responsible for the macro dialogue -- and Projects -- charged with responsibility for loan design and execution. It is expected that the placement of *projects* and *programs' responsibilities in the same Department, following the Reorganization, should make it possible to improve staff coordination in the future. Nevertheless, an inescapable conclusion is that management needs to assign higler priority to loan supervision, and to give clear signals to the staff -- particularly to middle-level managers -- that this is the case (PPAM, para. 89). 1/ Mexican private firms borrowed abroad an average US$14 billion per annum net in 1979-82, at maturities of up to seven years. PROJECT PERFORMANCE AUDIT MEMORANDUM MEXICO THIRD AND FOURTH INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (Loans 1560-HE and 1712-ME) I. BACKGROUND 1. The Mexican economy expanded rapidly in the post World War II period. The average real annual GDP growth rate until 1980 was 6.4%. Inflation was low throughout most of this period averaging less than 5? per annum until 1974, but accelerating in the second half of the seventies. The relatively long period of price stability allowed Mexico to maintain a fixed exchange rate with the US dollar since 1954 until 1976. After the devaluation of 1976 thq Government introduced a stabilization program. The program included measures to cut the public deficit, increase interest rates and maintain a floating exchange rate. The stabilization program was also accompanied by an attempt to introduce economic reform measures that would include a tax reform, the liberalization of trade and the promotion of non-oil exports. 2. New large oil discoveries in 1977 changed the focus of the Government away from economic reform to the resumption of growth based on these newly acquired resources. As proven reserves rose quickly, coupled with an increasing world oil price, the level of real public expenditures almost doubled. Oil exports increased from US$540 million in 1976 to US$3.7 billion in 1979 and US$13.8 billion in 1981, and the capital account of the balance of payments increased from US$2.9 billion in 1976 to US$5.2 billion in 1979 and US$13.5 in 1981. The external public debt rose rapidly to reach the equivalent of 30? of GDP. The Government also increased its demand for domestic credit, and the private sector came to rely heavily on foreign financing. Private foreign debt went from US$5.4 billion in 1977 to US$22.9 billion in 1982. Within a setting of a strong real appreciation of the peso, eroding confidence and a public sector deficit reaching 17.6? of GDP in 1982, capital flight turned massive. Estimations for the 1976-82 outflow hover around US$30 billion. 3. In 1982-83 the economy went through a severe crisis that brought about a large reduction in domestic demand. A new stabilization program was put into effect, and GDP fell in 1982 and 1983 by 0.6Z and 5.3? respec- tively. The exchange rate depreciated rapidly and import restrictions were tightened, causing imports to drop by over 20?, while non-oil exports rose sharply. The public expenditure share in GDP was reduced from its 1982 high of 42.5? to 33? and real wages by 1984 dropped to only two thirds of their peak. -2- The Industrial Sector 4. The growth pattern of Mexican industry since 1960 paralleled that of the whole economy. Until the mid-seventies industrial growth averaged an annual rate of 82; it slowed down after the 1976 crisis, recuperated during the oil boom, but later during the 1982-83 crisis, its average annual rate was -5.1Z. 5. The industrial sector developed under an import-substitution strategy, behind relatively high tariffs and other import restrictions, and supported by an incentive system designed to transfer resources to the manufacturing activity through fiscal and regulatory measures. The major source of growth for the sector was domestic demand and, therefore, indus- trial growth performance has been particularly sensitive to the gyrations of aggregate GDP and foreign exchange availability. This strategy began to change in 1985 and at present is more export-oriented (c.f. para. 7). Trade Policy1 6. Mexico entered the 1950's with a relatively open economy, charac- terized by few quantitative restrictions on imports and low to moderate tariffs. But with the increasing overvaluation of the peso pressures emerged to increase protection levels. Tariffs were raised in 1956, in 1960, and again in 1965. Average tariff protection and the dispersion of the tariff structure continued to increase rapidly until 1978 and, at a slower rate, until 1982. Changes in the coverage of import quota restric- tions and price controls, combined with the gradual overvaluation of the peso, contributed to increase further effective protection to Mexican industry, which in the case of Capital Goods and Durable Consumer Goods rose from 77.2% in 1970 to 128.0 in 1980. (See Table 1). Despite a short-lived attempt to reduce protection in 1978-79, the overall level and dispersion of effective protection increased further until 1981, primarily because of a rapid expansion of the quota regime. In the period following the large 1982 devaluation, levels of effective protection diminished owing to the temporary fall in domestic prices below their peso equivalent international prices, but started to rise again prior to 1985. 1/ The description of trade policies prior to 1982 is based on the President's Report for the First Trade Policy Loan (Loan No. 2745-ME), Report No. 4366-ME dated July 14, 1986, pp. 81-82, 'Trade Policy and Effective Protection, 1960-1982.0 See also IBRD, Mexico, Trade Policy, Industrial Performance and Adjustment, Report No. 6215a-ME, June 1986 and IBRD, Mexico, Trade Policy Reform and Economic Adjustment, Report No. 7314-ME, August 1988. - 3 - Table 1: EFFECTIVE RATES OF PROTECTION BY TYPE OF ECONOMIC ACTTVITY 1960-80 1960 1970 1980 PRIMARY PRODUCTS Agriculture, Fishing, Forestry 3.0 -1.4 18.0 Mining -0.3 -12.3 -2.0 INTERMEDIATE GOODS 13.2 16.8 43.0 CAPITAL GOODS AND DURABLE CONSUMER GOODS 64.6 77.2 128.0 NON-DURABLE CONSUMER GOODS 13.2 31.6 9.0 Source: Report 4366-ME dated July 14, 1986, pp. 81-82, *Trade Policy and Effective Protection, 1960-1982.8 cit.) p. 96. 7. In 1985 Mexico started a far reaching trade reform effort that is being sustained through the present. From mid-1985 to mid-1987 the cover- age of import licensing was reduced from 92.2% of 1986 production to 35.8Z. Likewise average tariffs have been reduced. At present the coverage of import licensing is equal to 23.22 of production while the average tariff rate weighed by 1986 production is 11%. Further, the use of reference prices that existed in the past as a protective tool has been abolished.2 The Financial Sector 8. The Mexican financial sector is characterized by a high degree of seSmentation, low efficiency and small resource mobilization. The long period of price stability enjoyed by Mexico helped to increase the depth of the financial sector. Private sector deposits as a proportion of dispos- able income rose rapidly during the sixties and early seventies from 27Z of GDP in 1967 to 36Z of GDP in 1972. But the onset of inflation with inflex- ible interest rates and exchange controls led to capital flight and a 2/ The authorities of the Bank of Mexico have indicated that the number of tariff subheadings subject to prior authorization requirements has dropped sharply from 5,214 in December 1984 (accounting for 78.4? of the total value of Mexican imports) to only 315 in December 1988 (accounting for 23? of the value of imports). -4- process of disintermediation. In September of 1982 the commercial banking system was nationalized. Since 1978 the number of non-public banks has been reduced by a process of mergers that accelerated after the national- ization, from 132 banks to 51 in 1982 and 19 at present. 9. The growing public sector deficits since 1978 have placed increas- ing demands on the financial sector, absorbing a growing proportion of the system's total lending, estimated by the Government at 77.4% in 1986. This continuing process of crowding-out forced the private sector to resort in- creasingly to foreign borrowing, up to 1982. On the other hand, excessive segmentation resulted from the widespread use of directed credit and the creation by the Government of a large number of trust funds (Fideicomisos) designed to bring subsidized credit to many different sectors and activ- ities. As a result of these constraints, banks are only free to allocate loans equivalent to 30Z of their deposits. 10. Budget appropriations and credit from the Bank of Mexico have served as a source of funds for these trust funds. Also, the Government has channelled foreign borrowing to the funds. The process of directing credit through trust funds had resulted in the creation of over 200 such institutions by 1978, some of them relatively large. The administration of the most important funds is under the Banco de Mexico and Nacional Financiera (NAINSA). Many of these funds have come to serve similar activities, thus creating conflicts between them (see para. 77). FONEI was established in 1971 as a trust fund of the Bank of Mexico. It was one of the first apex development banks promoted by the Bank. Its primary objective was to channel funds, through commercial banks, to industrial projects producing for export or for efficient import-substitution. Although its loan portfolio is relatively small--less than 2Z of the banking system industrial portfolio--FONEI has been a leader in efforts to involve commercial banks in development finance, systematic project analysis and innovative financial techniques. Fiscal Incentives to Industry 11. The tax system has been widely used in Mexico to favor manufactur- ing activity, while at the same time to try to influence industrial loca- tion, enhance employment and promote manufacturing exports. In addition, industrial fiscal incentives are currently used for other purposes, such as fostering technology development and pollution control. 12. Most of these objectives were at the center of the Decrees of Industrial Decentralization and Regional Development of 1971 and 1973, both of which essentially granted tax holidays for periods ranging from 5 to 10 years. The main export promotion incentive, the CEDI (Certificate of Tax Reimbursement) was instituted in 1971. The CEDI is basically a drawback scheme to reimburse exporters of manufactures for the duties paid on their imports. In addition, the Government granted ad hoc tariff exemptions on imports to qualifying industrial firms. These agreements became the most important tool for promoting the automobile industry. 13. By 1979 the system of fiscal incentives in industry had become cumbersome and some of its specific provisions run against the objectives of other economic policies. This situation was characterized as follows in a 1986 Bank reports "...The array of fiscal incentive measures implemented during the seventies caused a number of problems which ultimately led to a rather profound revision of fiscal incentives in 1979. The *piece-meal" implementation of each measure led to a lack of coordination among objectives and also among imple- menting agencies. Diverging objectives were also pursued and conflicts vith other policy measures (e.g., tariff policies and price subsidies) ensued. The diversity of the measures also tended to favor large companies, which could afford the administrative staff to keep track of the various schemes, and to cope with their lack of transparency and bureaucratic red tape. The lack of selectivity in terms of branches as well as regions, although recognized and tackled, continued to reduce the general effectiveness of the fiscal incentive regime and to contribute to the growing concentration in the metropolitan areas. At the same time, the problems of dis- cretionality and lack of control further added to the sys- tem's overall lack vi effectiveness. Other problems were the inherent bias towards capital-intensive techniques rather than labor-intensive ones, and a bias towards the use of imported rather than domestic capital equipment..3 Although the system was reformed in 1979, the reform maintained many of the existing incentives and introduced new ones, such as the Certificate of Fiscal Promotion (CEPROFI), a scheme of tax credits designed to achieve a number of different industrial policy objectives such as the establishment of new firms in priority activities, investment in small-scale enterprises, purchases of locally made machinery and equipment, development of priority areas and the fuller utilization of productive capacity. Notwithstanding the 1979 reform, the incentive system remained complicated, lacking in transparency and retaining its strong anti-export bias. The anti-export bias was further confirmed in 1979 with the publishing of the National Industrial Development Plan (see paras. 56-57). 14. Finally, as inflation and nominal interest rates gradually increased, the tax system generated a bias in favor of debt-financed investment and against equity financing. This bias arose because the tax system allowed full deduction of nominal interest payments in calculating a firm's tax liability. Thus, all interest paid was deductible, while interest earnings were largely tax-exempted. In addition, the bias against equity financing was increased by the fact that dividends were subject to higher taxes than interest for the personal income tax purposes. These distortions, however, were corrected in 1987 (para. 49). 3/ IBRD, Mexico, Trade Policy, Industrial Performance and Adjustment, op. cit., paras. 3.11-3.12. -6- II. BANK AD LOAN OBJECTIVES AND THE FONEI PROJECTS 15. The general Bank objectives for Mexico at the time the two FONEI operations were approved were stated in the President's Reports, were rather broad, not sharply defined, and possibly conflicting with each other. They included: to support policies and programs leading to a wider distribution of the benefits of economic growth; to strengthen policies and programs leading to continued economic growth by helping to finance projects that are to make directly or indirectly significant contributions to output, exports, and employment; and to help resolve critical adjustment problems that Mexico is currently facing. To achieve these objectives, the Bank would support projects that *make relatively modest demands on budgetary resources and have a strong positive balance of payments effect, projects of high social priority that help the rural or urban poor, projects that promote higher levels of employment and those that help decentralize economic activity.04 16. The two projects under review appear to respond to an extensive list of objectives. The main stated purpose of the FONEI III loan, how- ever, was the provision of financial support to efficient import substitu- tion and export projects in Mexico's industrial sector. This support was in turn justified by a number of weaknesses of the financial sector, among them that it did not provide adequate term-financing, that the traditional behavior of commercial banking which required excessive collateral and allocated term credit only to the well established firms in detriment of the more innovative, and also the observed decline in savings mobilization.5 17. The FONEI III loan sought also to support the Mexican efforts to "take advantage of remaining opportunities for efficient import substitu- tion (particularly in the capital goods and chemical sectors), diversifying and expanding manufactured exports and promoting more rapid development of industrial and related activities outside the present areas or industrial concentration.'6 Thus, the project also tried to support Mexico's decen- tralization efforts, and at the same time finance investment for backward linkages into intermediate inputs and capital goods and hence continue the path of import substitution. Surprisingly, the Staff Appraisal Report and the President's Report for the FONEI IV loan did not include, as an A/ IBRD, Third Industrial Equipment Fund Loan Project, Report and Recom- mendations of the President to the Executive Directors, Report No. P- 2295-ME, April 1978, para. 18, and IBRD, Fourth Industrial Equipment Fund Loan Project, Report and Recommendations of the President to the Executive Directors, Report No. P-2555-ME, May 1979, para. 19. 5/ IBRD, Staff Appraisal Report, Third FONEI Project, Report No. 1941b-NE, paras. 2.01-2.06 and IBRD, Staff Appraisal Report, Fourth FONEI Project, Report No. 2473b-ME, para. 4.11. 6/ IBRD. Staff Appraisal Report, Third FONEI Project, op. cit., para. 1.07. -7- objective of the project, the earlier references to efficient import substitution and promotion of manufactured exports. The focus shifted to *efficient projects expected to have a substantial economic and employment impact, and increasingly those sponsored by medium-sized enterprises and enterprises located outside of Mexico's three principal ci%ies.87 18. At appraisal of the FONEI III loan, the average rate of private investment growth for the period 1970-76 had decreased to 3.22 per annum as compared with a rate of growth of 91 in the sixties. It was then argued that the government was projecting real investment to grow at 8-101 p.a. while available funds for investment in industrial firms had declined due to the low profits in the recessionary period. Hence the achievement of such rates of growth in investment would depend on the access by industrial firms to sufficient volumes of credit.8 The credit shortage was explained by the 1976 devaluation, capital flight and the contraction of savings in the months prior to and after the devaluation, and the increased banking reserve requirements. The credit scarcity was also explained by the shift of credit demand by large firms from foreign to domestic sources, after they suffered heavy losses associated with the devaluation of 1976. Also, because of the increased liquidity preference, bank liabilities were mostly of the short-term maturity, forcing a greater degree of term transformation in order to finance investment projects. Thus, an important objective of the project was to help alleviate the credit scarcity constraining industrial investment.9 (See discussion of this objective in paras. 60-64). 19. Another important set of objectives in both projects dealt with the need to continue to support FONEI's development as an apex institution. The Bank was hoping, through FONEI, to induce commercial banks to get more involved in term lending and to develop their o- project appraisal capabilities. This, in turn, was expected to have .ill-over effects on both financial intermediaries and industrial firms. By increasing its training and promotion efforts FONEI was expected to assist commercial banks to lend increasingly on the basis of project appraisal, thus bringing about the reduction in collateral requirements. Promotion activities were to be conducted to identify projects and clients, helping both banks and firms to solve loan processing problems. 20. Finally, the FONEI IV loan also had the objective to finance, at subsidized rates, the development of new technology and projects for pollution control. However, these two new components took up, in dollar terms, a small proportion of the loan. 7/ Staff Appraisal Report for FONEI IV, para. 4.01, and President's Report for FONEI IV, para. 44. 8/ Appraisal Report for FONEI III, para. 1.14. 9/ Ibid, para. 2.05. III. PROJECT IMPLEMENTATION A. Characteristics of FONEI Operations The Distribution of Subloans 21. FONEI has operated as a second-tier institution, rediscounting loans of commercial banks. These banks--a total of 26 in 1979-86--assume the creJit risk in most cases and therefore are free to carry out their own creditworthiness evaluations and to establish collateral req.irements. Since 1978 FONEI has introduced a aumber of financial programs, thus diversifying from its original activity of equipment financing. New programs includes technology development (1978), pollution control (1979), special program for firms with cash flow problems (1982), optimization of productive capacity (1983), financing of working capital (1986), and productivity enhancement and financial restructuring (1987). The most successful program other than equipment financing has been technology development, whose share in total FONEI financing increased from less than 3 in 1979 to 24Z in 1987 (see Attachment 1). However, of the 226 firms supervised in 1987, there was only one firm being financed with Bank funds. Most firms with Bank financing had obtained funds under the equipment or capacity optimization programs (see Attachment 2). 22. FONEI continued to finance larger firms. The average subloan under the two BPnk projects has been equivalent to US$1.1 million.10 While this was in line with the projections presented in the Staff Appraisal Report, there was a strong cotcentration in larger subloans, with 73Z of the total financing under the two loans going to only about 392 of the projects. Three quarters of the firms financed had a labor force greater than 100 workers and over 602 employed more than 250 workers. The sectoral concentration of the subloans was strong, with the well-established metal products and chemical subsectors accounting for over two thirds of the total number of subloans financed under the two Bank loans.11 23. The generally large size of FONEI's clients is revealed by the number--found in a sample provided to the OED mission by FONEI--that belongs in the list of Mexico's largest 500 firms (see Attachment 3). It is also usual to find various subloans for different firms belonging to one of the large Mexican conglomerates (see Attachment 4). Finally, a large proportion (582) of the projects belong to firms that have more than one project with FONEI financing. This is especially the case of technological development projects with one firm (IRSA) having as many as 52 projects (see Attachment 5). Thus, despite efforts by both the Bank and FONEI, subloans have been granted mainly to large firms and in fact the present- day market perception of FONEI is that of a DFC catering mainly to the 10/ On average projects under the two Bank loans financed 302 of the total cost of fixed investment. 11/ Details in PCR, paras. 3.03-3.10. larger end of the firm size spectrum.12 The borrower has indicated that the sample may not be representative of the total number of firms financed by FONEI throughout its existence. Furthermore, the borrower pointed out that micro, small and medium scale industries in Mexico have access to various sources of preferential credit for equipment and working capital on better terms than what FONET can offer. Also, the administrative cost of lending to smaller firms would be too high for FONEI, given its limited staff and resources (Attachment 15). On the other hand, FONEI has indicated that 80% of the firms that borrow for technological development are small or medium scale. 24. Insofar as the decentralization objective is concerned, the expectation contained in the FONEI IV Staff Appraisal Report was that about 60-70% of funds would go to projects located outside the three main industrial areas of Mexico City, Nuevo Leon and Jalisco.13 Instead, that proportion declined from 53.2Z in the third loan to 50.1Z in the fourth loan (see Attachment 6). 25. A relatively small proportion of subloans in the equipment pro- grams under both FONEI III AND IV vent to finance exports projects (382 and 292 respectively). However, by 1987 FONEI firms appeared to export a lar- ger share of their production than the average share of their corresponding industry sub-sector. Table 2s EXPORT SHARE IN TOTAL OUTPUT, 1987 FONEI Firms Industry Average /a Food, Beverage and Tobacco 10.3 5.6 Textile and Clothing 17.4 5.0 Wood Products 15.4 3.6 Paper and Printing 21.3 4.9 Chemical Products 46.1 13.6 Non-Metallic Minerals 23.8 15.2 Basic Metals 41.8 14.6 Metal Products 34.9 28.7 fa As of last quarter of 1987. Sources Attachment 7. 12/ For a description of past efforts to lend to smaller firms, see PCR paras. 3.03 and 3.04. 13/ Para. 4.11. - 10 - Utilization of Bank Funds 26. The proceeds of the FON1 III loan were allocated within a period of 18 months, an impressive performance. In contrast, the disbursement of the fourth loan took more than seven years, and an undisbursed balance of US$11 million was cancelled. The projects were affected by a high rate of cancelXations of authorized subloans. This phenomenon took place in a period that includes the 1982-1983 economic crisis. Between 1974 and 1987 there were 103 subloan cancellations, 69 of which belonged to the equipment program. Most of the cancelled equipment subloans were large investment projects and in all of them the reason given for cancellation was the contraction of demand and/or bank collateral problems. The earthquake of September 1985 does not seem to have been an important factor explaining the observed pattern of disbursements. Over 50Z of cancellations occurred in the 1982-83 crisis period. One-fifth of the cancellee rojects were exporc projects, 48Z were import-substitution projects, and tae rest were projects geared towards both the domestic market and exports. Operations 27. FONEI's financial structure and profitability are described in the PCR (paras. 4.21-4.22). Although in current prices FONEI appears to have been profitable, with net earnings increasing from 3.6Z of equity in 1979 to 302 in 1984 and declining slightly to 28% in 1986, inflation in this period averaged 57.5Z per annum, so in real terms the return on equity was highly negative. Government capital transfers helped to compensate for the resultiong erosion in its capital, so that measured in constant pesos at 1980 prices, FONEI's equity rose from pesos 2,914 million in 1979 to pesos 4,088 in 1986 (Table 6). However, if all the capital transfers and retained earnings in the period 1980-1986 are also valued at constant 1980 prices, FONEI's equity at the end of 1986 should have been pesos 11,761 rather than 4,088. This is equivalent to a real capital erosion of almost two-thirds. A similar calculation carried out in US dollar results in a capital loss of over four-fifths over the same period. This real capital erosion was not due to portfolio losses because FONEI, as a second-tier institution, did not sha.-s with the participating banks the risk of default in the sub-loans.14 Rather, it was the result of charging interest rates that were negative in real terms, and of absorbing the foreign exchange risk on foreign loans. A fuller discussion of this issue is presented in Section IV C, OFONEI's Sustainability'. 28. The actual economic and financial performance of the subprojects financed under the two loans was significantly worse than had been projected. As the PCR indicates based on a random sample (para. 3.16), cost overruns were common, actual sales were just over one-half of the projected volumes, and actual rates of return were significantly lower than originally projected, with over two-fifths showing losses (PCR Annex 5). 141 The participating banks reported a low level of arrears on FONEI subloans, equivalent to 3.92 of their total FONEI loan portfolio for principal and to 4.5Z for interest payments, as of July 31, 1986. - 11 - This disappointing performance can be explained largely by the financial and economic crisis of 1982-1983, as suggested by the PCR. However, the large devaluation and severe contraction in domestic demand associated with the crisis benefitted export-oriented firma, and manufactured exports soared in 1983-1984. Similarly, efficient import-substituting industries were able to take advantage of the drastic cutback in imports following the crisis, and thus improved their market share.15 Therefore, had FONEI's lending been limited to those types of subprojects, as was the original Bank iatent, the actual performance should have been much better. Institutional Development 29. FONEI's training program has been quite successful. Between 1979 and 1986 FONEI organized 395 courses attended by 8,135 individuals primarily coming from banks, firms and FONEI.16 These covered a variety of topics with emphasis on project preparation, appraisal and supervision. FONEI's project appraisal capabilities improved over time to meet Bank standards fully. Thus, the Bank approved all but one of the submitted subloans. Also, FONEI has transferred a large part of the appraisal responsibilities to the participating financial intermediaries. 30. The spreading of project appraisal capabilities is often mentioned as one of FONEI's main accomplishments. In fact, FONEI has built an impor- tant and efficient in-house project appraisal unit and in addition it devotes substantial resources to training. FONEI's training programs are well regarded among banks, industrial and consulting firms. However, the spill-over effects have been somewhat overrated. Most project appraisal units within commercial banks were only set up after the banking system nationalization of 1982 and at present there is substantial duplication in appraisal tasks between FONEI and banks. The borrower, however, has indicated that this apparent duplication in reality represents a complementarity of analysis which is useful in the process of decision- making (c.f. Attachment 15). In addition, bank managers still attribute overriding importance to personal risk evaluations and to obtaining what they judge to be adequate collateral. Further, appraisal units within commercial banks remain relatively small and yet to develop the required capabilities.17 Reportedly, the project appraisal reports required by FONEI 151 IBRD, 'Mexicos Trade Policy, Industrial Performance and Adjustment, June 24, 1986 (Report No. 6215a-ME), Part II: The Analytical Report, pp. 60-61. 16/ For details see PCR, Annex 14. 17/ The CEM of 1987 concluded that: 'the commercial banking sector faces increasingly serious portfolio problems. Internal bank systems for evaluating the viability of projects being financed and borrower performance after loan drawdown are generally weak., IBRD, Mexico After the Oil Booms Refashioning a Development Strategy, Report No. 6659-ME. - 12 - are viewed by the clients as necessary formalities, which do not contribute significantly to their own assessment of the projects. Nevertheless, it should be recognized that the process of disseminating and enlarging appraisal knowledge is necessarily slow. There were indeed some instances in which banks did mention the importance of project appraisal lending to a gradual process of lowering collateral requirements because of better access to project information. Similar references are also found on some of the Bank's Loan Supervision Reports.18 31. The collateral requirement is an element of credit access more difficult to evaluate. Collaterals have in recent years been considered by industrial firms as excessive, and have been limiting the access to term- lending by medium and small firms, albeit being reduced with improving project appraisal. Nevertheless, hard data on collateral and other requirements are both unreliable and difficult to obtain in Mexico. During 1980 FONEI started collecting data on collateral, but in 1981 the collection was interrupted. Since then, all Supervision Reports on the two FONEI loans included among their recommendations the preparation by FONEI of information on collateral. However, this information is not yet available. A sample taken on subloans from 1977 to 1988 by the OED miesion confirmed the gradual reduction of collateral requirements for FONEI projects. Table 3: AVERAGE COLLATERAL ON FONEI SUBLOANS 1977-88 Period Collateral (in relation to loan amount) 1977 - 1981 8:1 1982 - 1984 4:1 1985 - 1988* 2:1 * July Source: FONEI 18/ *In 1980, FONEI started to collect data on whether or not the banks that had appraised projects had actually lowered their collateral requirements. The first evidence showed that although the process of reduction of collateral requirements on the part of the banks is slow, an increasing number of banks are, in their credit decisions, taking into account project merits. Of the 30 projects approved by the banks in the last quarter of 1980, 9 were made with no real collateral requirements at all and an additional 5 with a minimum collateral." IBRD Project Files, Loan Supervision Report on Loan 1712-ME, March 31, 1982. -13- 32. A more active participation of financial intermediaries in the project appraisal process only started in 1983 and is limited to projects on the equipment financing program, while FONEI evaluates all other projects. According to FONEI officials some two-thirds of project appraisals are accepted as adequate while the rest have to be reformulated in cooperation with FONEI. The borrower has indicated that its small staff has a limited capacity to plan better its activities and to cater to other segments of the market, widening the scope of its activities (c.f. Attachment 15). 33. Monitoring of subloans has increasingly been performed by finan- cial intermediaries under the supervision of FONEI staff. As in the case of appraisals, it started with only the equipment financing program. Grad- ually, FONEI has shifted monitoring tasks to participating banks in sub- loans for pollution control, productive capacity optimization, permanent working capital and recently technology development. Monitoring is per- formed by banks aided by *monitoring manuals' prepared by FONEI. Since 1983, the spread that financial intermediaries are allowed to charge on FONEI subloans includes payment for both evaluation and monitoring of the projects. 34. It is important to stress the fact that despite FONEI's relatively small size, it has been Pn innovative institution, having introduced in Mexico many new financial programs, particularly the funding of technological development projects within the firm as well as the financing of projects geared towards the restructuring of industrial plants to better compete under the new incentives framework created by the recent opening of the economy and the change in relative prices. FONEI clients seemed to respond rapidly to the changing economic conditions. In one metal-working plant, which was originally designed to serve entirely the highly protected local motor vehicle market (it produced truck and bus chassis), the share of exports in production rose quickly from 5% to 50%. after modifying the plant to produce small car body parts when the system of incentives moved in favor of exports. B. Bank Supervision 35. Because of staff constraints, Bank supervision missions were rather infrequent and brief, making it difficult to cover all important areas and to ensure adequate follow up at Headquarters. Thus, following the major financial crisis of 1982, fifteen months elapsed between the 1982 and 1983 missions, and the latter was staffed by only one person who spent altogether about three days supervising FONEI. The Supervision Report pointed out that this was not enough to analyze in detail weak areas of human resource development and training of FONEI and financial intermediary staff. FONEI's financial projections, at a time of mounting foreign exchange losses, were similarly treated only superficially. Early supervision reports were brief and focused mainly on procedures for - 14 - accelerating disbursements,19 but their coverage and quality improved over time. However, they made no references to the worsening macroeconomic situation insofar as it affected the projects' objectives and sustainability. Comments on the economy were only made in relation to loan disbursement flows. Important aspects such as the continuing concentration of lending in medium and large borrowers, and the slower than planned progress in achieving regional decentralization were seldom analyzed. 36. The 1983 Supervision Mission Report also pointed out that the average investment cost of each job generated by PONEI's loans in 1982 would be much higher than had been projected in the Staff Appraisal Report for the Fourth Loan, i.e., US$63,000 versus a range of US$27,000 to US$34,000. There are no indications, however, of attempts by the Bank to reverse this trend towards excessive capital intensity. This pattern, how- ever, changed as the financial crisis evolved in later years (c.f., 'The Response to the Crisis,* below). 37. All supervision reports since 1980 recommended to FONEI the improvement of the data gathering process by participating commercirl banks on subloan characteristics, particularly on collateral requirements. There appears to have been no adequate follow-up on this issue, since FONEI did not resume collecting data on collateral after it discontinued this practice in 1981. 38. Finally, no systematic supervision vas made of the quality of project appraisal by FONEI and the banks. One supervision report made a few favorable comments on the appraisal process.20 According to the Staff Appraisal Report for FONEI III, FONEI used comprehensive economic rate of return calculations using international prices for both inputs and outputs in all its projects.21 But a sample of subproject appraisal reports submitted by FONEI to the Bank for approval did not provide sufficient data to verify these calculations. Furthermore, the OED mission, upon reviewing a sample of the appraisals (of visited projects), found their quality to be uneven. 39. The last substantive supervision mission for the FONEI IV project was in mid-1984, although the loan continued disbursing until June 1986. The ONS indicates that supervisions should be conducted at least once a year.22 A brief Bank supervision did visit Mexico in July 1985, but it 19/ For example, the Supervision Report for FONEI III, dated December 1978 (before the loan was effective), has as a sole recommendation, the prompt appraisal of a fourth loan since 'it is likely that Loan 1560-ME (FONEI III) would be fully committed by about September/October 1979...' 20/ FONEI IV Supervision Report, July 1984, Annex I, para. 9. 21/ Staff Appraisal Report for FONEI III, para. 3.07. 22/ Operational Manual Statement 3.50, dated June 1985, para. 41. - 15 - focused narrowly on a review of disbursement procedures under six different Bank loans, including Loan No. 1712, and on the introduction of revised sub-project formats. 40. Although there is no record in the files, the Bank decided, in January 1985, to stop disbursements on thirteen credit loans to Mexico, including Loan No. 1712, owing to generalized lack of compliance with the interest rate provisions of the General Interest Rate Agreement (GIRA). This was not, however, a formal suspension of disbursements. Rather, the borrower was advised informally not to submit disbursement applications until the non-compliance was resolved. It appears that PONEI itself was in compliance with GIRA and that it was included in the suspension because there were other defaulting loans in the industrial sector. The OED mission did not carry out a review of the GIRA experience. C. The Response to the Crisis 41. The 1982-1983 crisis brought about a general deterioration in the financial situation of the firms. Those that suffered the most were firms selling primarily to the domestic market and firms with high levels of debt denominated in foreign exchange debt, for the crisis meant a drastic contraction in domestic demand and a massive devaluation of the peso. In the period before the crisis there was already a credit squeeze due to the increasing credit demand of the government to finance large public sector deficits. The latter situation forced private sector firms to rely increasingly on foreign financing. Thus, the effects of the devaluation and the higher credit demands to finance inventories given the slack in demand, greatly exacerbated the problem of credit availability. 42. Profits in manufacturing dropped to unprecedented low levels in 1982 and 1983. For manufacturing as a whole the profits to eales ratio fell in real terms from 72 in 1980 to less than 2Z in 1962. In some industrial subsectors the profit ratio fell abruptly and became negative. In the inward-looking textiles and clothing sector, the profit ratio fell as low as -51.3%, while most other subsectors showed ne-ative ratios in at least one quarter of 1983 (see Attachment 9). Some recovery took place in 1984 and 1985, when industrial production increased at about 52 per year in real terms. In contrast with the generalized decline in the sector as a whole, manufactured exports boomed, stimulated by the devaluation and the contraction in domestic demand. Manufactured expDrts rose in real terms by 632 in 1983 and by 28Z in 1984. Some efficient inward-oriented industrial sectors, such as chemical industries (partic,larly those based on petrochemicals), also continued to expand. 43. Firms' liquidity position, as measured by the ratio of short-term assets to short-term liabilities, also deteriorated for manufacturing as a whole by more than 30Z between 1980 and 1983. Again the drop was sharper in textiles and clothing and above average in other subsectors such as basic metals. Leverage ratios increased for manufacturing as a whole by more than 252 between the first quarter of 1980 and the third quarter of 1983 and sales as a proportion of total assets dropped to less than a half in the same period. - 16 - 44. Faced with the situation described above, FONEI's operations slowed down sharply, as the number of subloan cancellations increased dramatically. FONEI's fourth loan suffered so many subloan cancellations that in spite of being fully committed by the first quarter of 1982, it could not allocate its proceeds until late 1986. FONEI has indicated, however, that its borrowers performed better than the average for the respective subsectors (c.f. Attachment 15). FONEI reacted to the new situation with imagination and flexibility. In cooperation with the Bank and under the Special Action Program FONEI increased disbursement percentages for eligible payments and started to finance working capital requirements. In addition, a new financial program for productive capacity optimization was introduced to help firms adjust to the new situation.23 45. As inflation accelerated the nominal interest rate charged by FONEI rose from 22.7 in 1980 to 58.7 in 1983, thus creating the additional cash-flow problems that are typically present in term lending under an inflationary environment. Given the Mexican authorities' decision to avoid standard indexation, FONEI introduced a new repayment mechanism called PVP (Sistema de Pagos Variables al Valor Presente). The system essentially capitalizes interest payments, thus reducing the cash drain on borrowers during the early maturities.24 Finally, beginning in the last quarter of 1982, FONEI channelled Mex$7 billion, using a rediscount facility of the Banco de Mexico, to firms in need of working capital financing. 46. The adoption of these measures by FONEI proved that it could adjust to a new situation, resume lending and also protect the commercial banks' portfolio for which FONEI was a source of funds. During the OED mission visit to industrial plants managers expressed wide acceptance of the programs and new payment schemes introduced by FONEI. 47. However, more important than FONEI's portfolio, Mexico had to confront the generalized financial deterioration which was described earlier. This deterioration affected both private and public sector firms. After the 1982 devaluation and amidst a generalized recession, the peso value of firms' foreign liabilities quadrupled while interest rates also increased sharply. Further, there were no foreign exchange futures markets. In 1983 the Government fixed the exchange rate at 95 pesos per dollar and proceeded to create a system to permit firms to meet their foreign obligations. The system was called Fideicomiso para la Cobertura de Riesgos Cambiarios (FICORCA). Firms were allowed to change the denomination of their foreign liabilities into peso liabilities at a fixed exchange rate. By 1983-84 FICORCA had operations for over US$13 billion. 23/ See PCR para. 3.01. 24/ For an explanation of the PVP system and a numerical comparison between regular amortization, indexation and the PVP system see Attachment 12. - 17 - 48. The largest proportion of FICORCA payments were rescheduled for 20 years with a 7 year grace period. Following the rescheduling agreement, smaller foreign banks began to offer discounts for prepayment, and firms which had available liquidity decided to prepay and thus substantially improve their balance sheets. Later the large foreign banks also accorded similar discounts. 49. A major tax reform in 1987 added a strong incentive for the pre- payment of private sector debt. As discussed in para. 14, under the earlier tax system total interest payments, which included a large inflationary component embodied in the high nominal interest rate, were tax deductible. Thus, corporations had a strong incentive to use debt rather than equity financing. Under the reform, only the real component of interest payments is allowed tc be deducted from the firm's income in calculating tax liabilities. The effect of the massive pre-payment that took place after the tax reform is clearly reflected on the leverage ratios data (see Attachment 9). FICORCA's debt was thus reduced from US$13 billion to US$5-6 billion dollars, especially in the second semester of 1987. 50. The FICORCA scheme was far more important, given its size and characteristics, than the relief that FONEI could provide by itself. All firms interviewed by the OED mission (FONEI clients) had in fact entered into the FICORCA scheme, which managers expressed was the only alternative they had to alleviate an otherwise devastating financial crisis. FONEI borrowers resorted to a mechanism designed by the Government primarily to help firms that did not export and were hence particularly hurt by the 1982 crisis. Thus, it is difficult to isolate the relative impact of FONEI's very positive actions in confronting the crisis. This is so because both FICORCA and the then prevailing tax rules provided a large blanket relief to the Mexican private sector as a whole. In any case, the relative small size of FONEI within the financial sector did not allow its programs to have a more widespread impact on Mexico's industrial sector. - 18 - IV. MAIN ISSUES A. Consistency Between Project Objectives and the Macroeconomic Framework 51. The FONEI operations were expressed in terms of perceived objec- tives that went beyond the capabilities of a relatively small sized DFC such as FONE!. Channelling extra resources to the industrial sector through FONEI cannot solve the weaknesses of the financial sector. Problems such to decline in savings mobilization, capital flight, or the absence of an adequate supply of term lending have to be dealt with mone- tary and fiscal policy instruments. Without addressing the underlying causes of the problem, such as the public sector deficit, the inadequacy of the exchange rate policy, or the absence of an appropriate structure of real interest rates, the increased resources made available to Mexico's DFCs could well have contributed to finance capital flight. Moreover, the argument about credit shortages resulting from devaluation, recession, low profits and capital flight was flawed since it was made without reference to credit demand for industrial investment. 52. There is abundant evidence of FONEI's efforts to allocate its resources to export projects and efficient import substitution, but these efforts had to be conducted within an economic environment that did not foster the choice of such projects. The large number of cancellations under the fourth loan has been attributed to the 1982-1983 crisis. How- ever, the fact that the onset of a recession in domestic demand and the event of a massive devaluation of the peso provoked so many subloan cancellations, (FONEI IV was fully committed by March 1982) suggests prima facie that many of the projects that were being financed did not have the characteristics set forth by FONEI. In spita of the sharp decline in domestic demand and the devaluation of the pesu by more than 1502 between 1982 and 1983, an efficient import-substitution project could still have been profitable (particularly in the intermediate goods industries) and an export project might have benefitted enormously. Nevertheless, the framework of incentives in place before the crisis was biased against export projects. Thus the proportion of *purely exports projects financed under FONEI IV was lower than under FONEI III (22.4Z vs. 37.4Z) (see Attachment 10). This is not to say that FONEI did not finance sound projects; in fact in both loans the proportion of firms that exported at least part of their production was over 71% in the third loan and 50% in the fourth. And while with the advent of the crish the FONEI projects showed on average less than expected results, most p.ojects had room for accommodation to the post-1982 period.25 53. Although FONEI's objective was to finance efficient import substitution and export projects, the prevalent macroeconomic policies ran 25/ Details on projected and actual financial and economic rates of return can be found in PCR para. 3.16 and Annex 6. See Bank of Mexico's comments in Attachment 14. - 19 - against such objectives. Thus, not only industrial and trade policies were inadequate but the developments in the macro scene that were described earlier compounded the adverse effects of the incentives system through negative interest rates and an overvalued exchange rate. Growth was sustained mainly by an artificial increase in demand fueled by increased public expenditure and foreign b4rrowing. 54. The prevalent system of incentives as well as the macro policies thus reinforced each other making FONZI's objective difficult to achieve. The economic environment at the time the two loans were put into effect, was therefore not conducive to the development of neither export projects nor efficient import substitution. Rather, the existing policies fostered the establishment of productive operations that could only be feasible with a high level of protection and demand-driven growth. 55. Also, the tax system, by permitting firms to deduct fully the nominal interest payments as inflation and nominal interest were increas- ing, created a strong incentive to favor debt as opposed to equity in the financing of investment projects. Thus, while FONEI's loans were, as in any DFC operation, designed to complement and not substitute the equity contribution, prevalent economic forces ran against healthy financing practices of all DFCs, particularly those competing in industrial financing.26 56. One serious problem of the two loans under review was originated by the apparent lack of a coherent set of industrial sector policies. The publishing of the National Industrial Development Plan in March 1979 (coin- ciding with the appraisal of FONEI IV) represented an implicit announcement on the part of the Mexican government, of the renewed impetus with wAich the capital-intensive and import-substitution strategy was going to be adopted using the large new resources mide available by the oil boom.27 The Plan also gave greater emphasis to public sector productive activity. 57. The main instruments set out to accomplish the Plan's objectives were a substantial increase in public investment, particularly infrastruc- ture, petroleum and petrochemicals; and the setting of a list of sectoral and geographical priorities according to which a number of direct fiscal and price incentives were to be granted. Given Mexico's increased import capacity the Plan projected annual industrial growth rates in the 10-122 range with industrial employment growing at 52 per annum. Achievement of these objectives seemed to rely fundamentally on the availability of large foreign exchange resources. However, in light of a growing fiscal imbal- ance, the appreciation of peso, the inadequate interest rate policy, the 26/ Average leverage ratios measured as total liabilities over total assets increased one-fourth from the first quarter of 1980 to the third quarter of 1983 (see Attachment 9). 27/ For a discussion of the Plan's scope see IBRD, FONI Industrial Equipment Fund Project, Staff Appraisal Report No. 2473b-ME, paras. 1.11-1.20. - 20 - growing rate of inflation and deterioration of business confidence and capital flight, the chosen strategy carried a strong built-in element of self-exhaustion. 58. Even without the benefit of hindsight, the juctification for channelling Bank's resources into Mexico remains weak in view of the fact that--in addition to the weak policy framework--the country had sufficient amounts of foreign exchange provided by oil exports. The figures for proven reserves and the oil export projections were revised upward by approximately 1002 in January of 1979 while FONEI IV was in the appraisal process.28 In addition, Mexico was at the time receiving massive inflows of foreign capital from foreign commercial banks. Oil exports increased from US$540 million in 1976 to US$3.7 billion in 1979 and US$13.8 billion in 1981, and the capital account of the balance of payments increased from US$2.9 billion in 1976 to US$5.2 billion in 1979 and US$13.5 billion in 1981. 59. More fundamentally, Mexico's industrial and macroeconomic policies were inadequate to achieve the objectives expressed in the National Industrial Development Plan. In fact, the Bank had sufficient knowledge about Mexico's industrial sector policies and was recommending a different set of industrial and macroeconomic policies than those prevalent in Mexico. The Bank's views on industrial policy were expressed after the completion of a major industrial sector study.29 The study stressed the role of the maintenance of a higher and stable real exchange rate and low protection and commensurately adequate export incentives for manufacturers, with low dispersion among products: "The possibility of greatly increased exports of petroleum and petrochemicals opens up a new option for Mexico's foreign trade policy. The increased revenues from these exports can be used to relax constraints on demand and investment and hence to facilitate faster growth of GDP and employment. To do this, the pesoldollar exchange rate must be maintained at or near its present level in real terms (end of 1976), and other export incentives must also be maintained. Then not only petroleum products but other exports will grow, the total increase in foreign exchange will be larger, GDP and employment will increase and the additional foreign exchange can be used to pay for the additional imports that will be demanded. The danger to avoid is allowing incentives to increase other exports, to weaken. This weakening would occur if the increased foreign exchange earnings from petroleum induced the authorities to allow the dollar value 28/ See IBRD, Fourth Industrial Equipment Loans Project, Report and Recommendation of the President to the Executive Directors, op. cit., para. 10. 29/ IBRD, Mexico - Manufacturing Sector: Situation, Prospects and Policies, Report No. 1671-HE, May 1, 1977. - 21 - of the peso to appreciate in real terms, to reduce CEDIs (Indirect Tax Rebate Certificate.), etc. Such actions would reduce the profitability of other exports with the net effect of substituting petroleum for other exports with no gain in GDP or employment.*30 Likewise, the study dealt with the enlarged public sector deficit and the ensuing crowding-out effect on private sector in the credit market. The Appraisal and President's Reports on the FONEI operations did not fully reflect these concerns and policy recomendations on both the macroeconomic framework as well as the system of incentives affecting Mexican industry. B. Availability of Term Credit and the Financial Sector 60. A basic assumption underlying the two Bank loans was that the recovery of private industrial investment in the country was constrained by a scarcity of term credit. The Staff Appraisal Report for the third loan stateds 'The proposed project would reinforce the Government's efforts to stimulate the recovery of industrial investment during a period of consid- erable credit scarcity....31 and again, the Staff Appraisal Report for the fourth loan: 'The proposed project would help fill a gap in the financing of efficient industrial projects in Mexico at a time when the financial system lacks sufficient long-term resources to cover industrial investment needs..32 61. Because of the perceived scarcity of funds, both Staff Appraisal Reports concluded that the appropriate strategy should be for the Bank to support the Government's policy to increasingly segment the financial market through the creation of Trust Funds and the allocation of increasing resources to these funds: 'The trust funds have a vital role to play in the recovery of the financial system and the alleviation of credit short- age. Over the next several years they must provide a significant proportion of the credit needs of the sectors in which they operate.'33 and also: gThe banking system is not yet in a position to properly allocate and provide significant long-term financial resources, and the securities market, although growing at a fast rate, has not yet developed into an important source of finaw.e for industrial firms. In this situation, the trust funds have a crucial role to play in sulementing and guiding industrial credit provided by the financial system.0 30/ Ibid, paras. 5-7. 31/ Staff Appraisal Report, FONEI III, op. cit., p. 30, para. 5.12. 32/ Staff Appraisal Report, FONEI IV, page 38, para. 4.11, op. cit. 33/ Staff Appraisal Report, FONEI III, op. cit., paras. 2.04 and 2.06. 341 Staff Appraisal Report, FONEI IV, para. 2.18, op. cit. - 22 - 62. But this crucial assumption of term credit scarcity does not appear to have been based on any detailed analysis of the financial sector. Indeed, it is remarkable that throughout the period when these two loans were carried out, the Bank was devoting two-thirds of its lending to Mexico to operations channelled through the financial system without carrying out a thorough financial sector study. Of 29 loans to Mexico that were under execution as of November 30, 1983, for a total amount of US$3,599 million, 16 loans for a total of US$2,432 million involved sub-lending with interest rate components (Attachment 13). Because of the Bank's inadequate knowl- edge of the financial sector at the time the two loans were prepared and implemented, it is difficult to substantiate the Bank's assumption regard- ing scarcity of term credit. 63. Local commercial banks were in fact providing term financing to the bulk of FONEI's clients, given their size and group relations. This was noted in an internal memo transmitting the draft Staff Appraisal Report and President's Report for FONEI IV for approval, noting that large and established firms could borrow abroad *somewhat cheaper than FONEI funds.-35 Indeed, the segment of the industrial sector that FONEI financed had, at least until 1982, easy access to foreign term loans as it can be inferred from the dramatic increase in the private sector foreign debt in the period prior to the 1982 crisis. Bankers interviewed during the OED mission did mention that prior to 1982, five to seven years term-lending was available from foreign banks. Furthermore, businessmen pointed out that any good project promoted by an important firm or group could easily obtain financing on adequate terms. Table 4: PRIVATE LONG-TERM DEBT, 1975-1982 (Year-end outstanding balances) YEAR END US$ BILLION 1975 4.9 1976 5.5 1977 5.4 1978 5.5 1979 7.2 1980 11.0 1981 14.9 1982 22.9 Source: Banco de Mexico. NOTE: These figures exclude trade credits and all private debt with an original maturity of less than one year. 35/ Apparently the memo was making the implicit assumption that the exchange rate of the Mexican peso to the dollar would remain unchanged. - 23 - 64. Harder evidence on the term structure of this private debt confirming the ample availability of term credit prior to 1983 was obtained by the OED mission from the Br-aco de Mexico, which in 1983 collected data on the original amortization :chedules of the private debt. Table 5: AMORTIZATION AS ORIGINALLY SCHEDULED ON PRIVATE FOREIGN DEBT OUTSTANDING AS OF DECEMBER 1982 (millions of dollars) Banks Suppliers Total 1982 5,175 773 5,948 1983 5,774 3,522 9,296 1984 1,471 299 1,700 1985 1,325 115 1,440 1986 1,035 72 1,107 1987 962 24 986 1988 944 14 958 After 1988 1,471 24 1,495 Total 18,157 4,843 22,930 Source: Banco de Mexico, on the basis of FICORCA records. 65. Most Bank credit operations in Mexico specified ad hoc procedures for setting interest rates. Many of these operations resulted in negative on-lending real rates, and contributed to the great dispersion of rates. These problems moved the Bank in 1984 to negotiate with the Mexican Govern- ment a General Interest Rate Agreement (GIRA). GIRA's objectives were basically to raise the overall level of interest rates while reducing their dispersion and the implicit credit subsidies. The Agreement sought to relate all interest rates to a referential rate, the Average Cost of Funds (ACF) of the funds borrowed by Mexican banks. The expectation of Bank staff was that the ACF would not be below the rate of inflation. This expectation, however, was not always borne out, as is discussed below (Section C). The Bank imposed an informal and temporary suspension of disbursements on various loans, including FONEI IV, in January 1965, owing to general lack of compliance with the GIRA provisions in several loans, but there is no evidence that FONEI itself was not in compliance. Disbursements were resumed in April 1985. 66. The Mexican financial sector has a large degree of segmentation, owing in part to the growing importance of the unregulated financial intermediaries which have become major suppliers of credit to private sector firms. The proliferation of development banks and special purpose trust funds has served to transfer large credit subsidies to the favored borrowers. There are wide differences in the quantification of financial system subsidies, depending on which components are included in the - 24 - calculations. Estimates range from those that include only the explicit budgetary allocations to those that incorporate also the unrecorded or hidden opportunity costs of lending at below market rates. Bank of Mexico calculations fluctuate around 1% and 1.6? of GDP in 1984-86. Other conservative estimates of these subsidies in the early 1980s ranged around 4.0% of GDP. Bank staff estimates of financial subsidies channelled through development finance institutions show a peak in 1983 at 6.6? of GDP.30 In addition, the nationalized banking sector was forced to allocate a growing proportion (more than 60?) of its credit to the public sector, and served on balance to transfer investible resources from the private sector to the public sector. Information on the composition, degree of industrial concentration and quality of the portfolio of the Mexican banking sector has been inadequate and supervision practices are relatively poor. A positive development in recent months has been the Government's agreement to have the Bank carry out a thorough financial sector review. C. FONEI'S SUSTAINABILITY 67. Since FONEI's inception in 1971, the Bank supported its operations with five direct loans (FONEI I-IV plus the Industrial Recovery Project, Loan 2746-ME) and with part of the proceeds of other loans (the Capital Goods Project, Loan 2142-ME, the Pollution Control Pro4mct, Loan 2154-ME, the Export Development Project, Loan 2331-HE, and the Industrial Technology Development Project, Loan 2747-HE). As of year-end 1986 cumulative dis- bursements channeled to FONEI under these loans totalled approximately US$450 million and, except for a small amount under the Capital Goods Project, FONEI had not repaid any principal on those loans. FONEI was profitable throughout those years and did not suffer losses due to bad loans. Still, the peso value of FONEI's total assets as of year-end 1986 was equivalent to only US$111 million. This shrinkage in the dollar value of FONEI's assets was accompanied by an even sharper loss in its net worth. 68. FONEI's net worth as of December 31, 1979 was equivalent to US$102.6 million.37 This should have grown over time as a result of fresh 36/ IBRD: Mexico - General Interest Rate Agreement. Progress Report and Review of Issues, January 13, 1987 (mimeo). Figures for other years are: Financial Subsidies through DFIs, 1978-85 (As I of GDP) 1978 1979 1980 1981 1982 1983 1984 0.6 0.7 0.9 1.3 5.4 6.6 4.3 37/ Pesos 2,340 million converted at the exchange rate on that date, which was Pesos 22.80 - US$ 1.00. Details of these calculations are presented in Table 6. - 25 - governmental capital transfers --largely the channeling of Bank loans--and of ploughed-back profits. The cumulative dollar value of the annual cap- ital transfers from the Mexican Government to FONEI in the period 1980-1986 totalled US$220 million, when converted at the average exchange rates of each year. In addition, FONEI's annual retained net earnings in the same seven-year period, also converted into dollars at each year's average exchange rate, totalled US$123.4 million. The sum of these three dollar amounts, i.e., US$452 million, should have been the dollar value of FONEI's equity as of year-end 1986 had FONEI succeeded in maintaining the dollar value of its lending over time. Instead, FONEI's equity as of December 31, 1986 was equivalent to only US$86 million,38 a loss of over 80%. A similar calculation in terms of constant pesos results in a real loss of over 65% in FONEI's equity between 1980 and 1986.39 69. The sustainability of FONEI as a development finance institution depends--inter alia--on its ability to maintain the real value of its assets and equity over time. The observed erosion of its capital represents a hidden subsidy paid by the Government of Mexico--which is responsible for repaying the Bank loans in hard currencies--to the firms that borrowed from FONEI. This subsidy, furthermore, went largely to major well established firms, which are part of Mexico's industrial-financial groups. To the extent that these firms borrowed to acquire capital goods for the production of tradeable goods --as was the original intent of the operations-- the maintenance of the foreign currency value of the loans would have been particularly justified. Alternatively, the interest rates and other charges on the loans should have been high enough to compensate fully for the foreign exchange risk. 70. Because FONEI is particularly well managed, and as an apex institution was protected from loan losses, and it complied well with the Loan Agreement covenants regarding interest rates, it is important to identify the causes of its large capital losses. Beginning with the Loan 1560, FONEI charged floating rates adjustable every six months. These rates were several points below the average cost of funds to the banking system (ACF), which was projected by the Bank to remain above the rate of inflation. This expectation was clearly stated in Bank documents presented 38/ Pesos 78,995 million at the exchange rate on that date, i.e., Pesos 923.50US$1.00. 39/ Calculated in constant pesos at 1980 prices (See Table 6). FONEI's equity as of year-end 1979 of Pesos 2,340 million was equivalent to P(1980) 2,914 million ( 2,340 : .803 - 2,914 ). To this was added the sum of the Government capital transfers during 1980-1986, P(1980) 5,638 million, and the sum of the retained profits in the same period, P(1980) 3.209 million, giving a total expected year-end 1986 equity of P(1980) 11,761 million. This compares to the actual year-end 1986 equity of only P(1980) 4,088 million ( 78,995 : 19.324 - 4,088). TaleJ: FIE - SB.EI FDIAIAL FLO101 1979-196 TOTAL WEM-MN __A GQVNI CAPITAL T ~RAF AMIAL NUT IEE IMT ) fRATE ~ig|LA mT EF Men I al llHona Next UR Cr-tant 1M0 Men* 1.8 Cmnetant 19M (Annual Average) (1 Incrano) (Annual Rim Inde (Au"l Averart , mili ows mil ion= Mx811ikona miliona miffle Mellmillione WN11x1 In CP01 111 ia_ % 197 2,840 22.8 ja 0.2 18.1 90.3 11.4 1980 4,2~3 1,8~7 68.4 1,567 88 3.7 8 22.9 0.4 26.4 109.0 0.7 1911 6,67 1,1 1 47.0 926 m84 14.4 2M 24.5 7.0 27.9 114.4 1.6 19 10,140 1,742 30.9 897 651 11.8 8a8 56.4 130.2 5W.0 194.2 40.4 18 17,084 2,711 22.6 67 2,834 19.4 60 120.1 112.9 101.9 401.7 36.7 1914 26,674 3,051 15.2 448 4,110 24.9 609 167.8 89.7 6W.C 46.0 61.1 198 4s,22 3,492 A 13.6 331 8,919 34.7 847 256.9 a3.1 57.7 2068.4 11.1 196 78,998 15,4o8 -ma _gg 9,06s -16I -. 611.8 s 13N.1 8.1 106.4 0.9 TOTAL KMB, 1900-6 nu L. ja The 1970 y*ar-ond onchange rat* van almo Mx 22.8 a US 61.00. & Adjuted for reclasiflcatlmn of =0 lan 2142 (capital good ) from euoity to long-tera liablIity (max 61,416 million). ja The 196 year-ond *tehang rate vn Mon 8923.5 - US 1.00. Annual averag* of nominal monthly ratoa, casomunded monthly. Different compounding methoda eauld reault in higher effoctivo ratos for individuai lsa. Sourcsa: E Auditad Financial Statemfnit. IM, International Financial Statltica, 1087 Yearbook, g. 49. - 27 - to the Board in connection with the FONEI III loan. Thus, the Staff Appraisal Report for the Third Loan, after an extensive analysis of prospective interest rates and inflation in Mexico, concluded: a...It is likely, therefore, that FONEI's lending rate --to final beneficiaries--set 2 points above the ACF would be positive in real terms over the life of a sub-loan, starting in 1978. There is, of course, no guarantee that deposit rates and the ACF would not again become negative in real terms as they were in 1973-76, but having had such a clear, recent example of the damage this does to the financial system, the authorities are not likely to contravene their stated policies by permitting this to occur again.*40 71. But actual inflation during the second half of 1978 exceeded the ACF by about 2 percentage points. Bank staff became aware of the prospects for accelerating inflation implicit in the Government's economic policies at the time when the FONEI IV loan was being put together. Thus, the Economic Report which was in preparation at the same time warned that, given the government's economic strategy, "...the inflationary pressures could be substantial" and I...the decline of price iaflation in Mexico cannot be predicted with any degree of likelihood.'41 In spite of these warnings, the Staff Appraisal Report for FONEI IV continued to be optimistic about inflation and the prospects that FONEI's lending rate would be above future inflation: "The rate of inflation, which reached 22? in 1976 and 29% in 1977, is expected to decline progressively to 15? in 1979, 12? in 1980, and to international levels by 1982. As the inflation rate decreases, FONEI's on-lending interest rate is expected to rise gradually in real terms. In the unlikely event that inflation rises, the ACF should still be a suitable yardstick for determining FONEI's lending interest rates, given the government's announced intention of maintaining borrowing interest rate levels which would permit adequate resource mobilization in the financial system.*42 72. As it turned out during the life of FONEI IV, the concerns raised in the Economic Report were more justified than the optimism of the Staff 40/ Staff Appraisal Report, Third FONEI Project, Report No. 1941b-ME dated April 11, 1978, Annex I, page 3. 41/ Special Study of the Mexican Economy: Major Policy Issues and Prospects, Volume I, Main Report (No. 2307-ME) dated May 30, 1979, pp. vJii and ix. 42/ Staff Appraisal Report, Fourth FONEI project; (Report No. 2473b- NE, dated May 10, 1979), pp. 20-21. - 28 - Appraisal Reports. In 1980-1986 inflation in Mexico accelerated sharply, and the peso suffered strong devaluations. Between 1981 and 1985 the ACF lagged behind both inflation and the exchange rate: Table 7: INFLATION, EXCHANGE RATES AND INTEREST RATES INDEX NUMBERS, 1980 - 100 YEARS 1980 1981 1982 1983 1984 1985 1986 A C F /a 100.0 128.6 180.6 282.9 427.5 667.3 1207.2 INFLATION (CPI) 100.0 124.4 194.2 402.7 686.0 1053.4 1932.4 EXCHANGE RATE (Annual Average) 100.0 107.0 246.0 524.0 733.0 1122.0 2671.0 /a Based on annual average nominal rates, compounded monthly. Different compounding by individual banks may have resulted in higher effective annual rates for individual loans. 73. Excessive optimism by Bank staff regarding future inflation trends, in spite of clear signals of concern on the macro-economic front, led the Bank to accept an interest rate structure for FONEI that, by lagging behind inflation--particularly prior to 1985--and the exchange rate, was bound to lead to real capital losses.43 This was aggravated by the fact that FONEI was required to assume the foreign exchange risk on interest and other charges payable on the World Bank loans, and to fully service in foreign currency two loans from an international commercial bank for a total of US$ 15 million. The risks inherent in requiring a financial intermediary to -ervice foreign loans in foreign currency, while relending in local currency without adequate coverage for devaluations, should have been apparent to the staff, particularly since the previously mentioned Economic Report contained ample warnings about the mounting inflationary pressures and the approaching need to devalue the peso, and the President's Report recognized that FONEI had suffered exchange-rate losses in 1976 and 1977, after the devaluation.44 But instead of recognizing the likelihood of future devaluations, the.staff's financial projections for FONEI IV were based on the assumption that the exchange rate would remain constant at 43/ The Bank of Mexico has pointed out that different techniques of compounding by individual banks could result in higher effective lending rates. The Loan Agreements and the GIRA did not require FONEI to compound its lending rates in any particular way (c.f. Attachment 14). 44/ President's Report for FONEI IV, Report No. P-2555-ME, dated May 15, 1979, p. 18. - 29 - Pesos 22.72 to the dollar throughout 1979-1983.45 This assumption led the staff to project interest expenses on the Bank loans III and IV in current pesos at annual rates of only 7.5% and 8.05? respectively (plus 0.5Z p.a. commission payable to NAFINSA). Furthermore, the financial projections did not include any amounts for future foreign exchange losses.46 It seems reasonable to conclude that, had the financial projections for FONEI been better integrated with the macroeconomic analysis of the Economic Report, and based on a deeper knowledge of Mexico's financial sector, the likelihood of sharp capital losses could have been foreseen and prevented. D. Government Policy on Trust Funds 74. In line with the new economic orientation of the Mexican authorities in favor of structural change, liberalization, more effective development of the country's comparative advantages and more efficient resource allocation, the authorities have expressed the need to develop a new policy on trust funds. Their number is considered to have become unmanageable, with an undesirable effect of segmenting the financial market. Additionally, the existence of such a large number of trust funds makes it difficult to assess with adequate transparency the extent of the fiscal burden placed on the budget at a time when the reduction of the budget deficit carries a very high priority. 75. The underlying basic elements of this new policy are (a) gradual elimination of credit subsidies including the transfer of foreign exchange risks, (b) assumption by the funds of the full service of the foreign debt channelled through them; (c) merger of all trust funds in probably not more than four funds serving to industry (broadly defined), trade, agriculture and infrastructure (including housing) and (d) a gradual reduction of the role of selective credit policies. 76. The main trust funds serving the industrial sector are FONEI, which is a trust fund of the Bank of Mexico (accounting for almost two- fifths of the portfolio of industrial sector trust funds), and the trust funds of Nacional Financiera S.A.: FOGAIN, which rediscounts credits for small and medium scale enterprise (over one-half of the portfolio); FOMIN, which makes equity investment in small and medium-sized firms (5Z of the portfolio); FIDEIN, which finances industrial parks and FONEP, which finances studies of projects in industry (about 2Z each). In addition, Nacional Financiera S.A. has two programs that channel resources to industry: PAI and PROFIRI. 77. Since many of these funds cater to the same industrial clients, a number of conflicts have emerged, mainly between FONEI and NAFINSA's funds. The financial conditions and the time necessary to comply with the required 451 Report 2473b-ME, Table 38, OFONEI: Principal Assumptions Used in the Financial Projections.* 46/ Ibid., Table 33, "FONEI Past and Projected Sources and Applications of Funds,' in current pesos. - 30 - procedures of appraisal, approval and subloan signing vary widely between FONEI and NAFINSA. Also, there are a number of conflicts of interest within NAFINSA itself, since it acts both as a second-tier DFC as well as a commercial bank and as an investment bank. In addition, NAFINSA runs and owns a number of industrial firms, which have actually borrowed from FONEI itself. FONEI has been negatively affected by what can be considered an unfair competition by NAFINSA, which, at times, has charged substantially lower rates on subloans, and normally approves the loans rapidly, without requiring detailed justification (particularly under the PROFIRI facility). There are also problems created within commercial banks when deciding which of the competing Government funds they should direct their clients to. Finally, there is an underlying conflict of competition between NAFINSA and the banks, insofar as the former also acts as a first-tier bank. 78. A straightforward solution for these conflicts would seem to be merging all industrial funds under one DFC that would operate solely as a second-tier institution. There is, however, a problem in selecting where such a DFC would be located, a problem which also carries important political considerations. The funds under the Banco de Mexico and particularly FONEI, have performed with greater efficiency and appear to be less subject to discretionary influence. On the other hand, the administration of more funds under the country's central bank remains an undesirable option since the monetary authority should not be involved in managing numerous trust funds, thus detracting from its basic function. 79. The relative efficiency of FONEI among all industrial funds is widely recognized by Mexican authorities, financial intermediaries and industrial firms. FONEI has (a) a more market-oriented interest rate policy than the other funds; (b) introduced over the years a number of innovative financial programs for industry such as preinvestment financing, technological development, pollution control, liquidity assistance programs, productive capacity optimization, permanent working capital and temporary minority ownership participation in industrial firms; (c) a much greater efficiency and productivity. Measured as the ratio of outstanding portfolio over employment FONEI's productivity is six times greater than the other major industrial fund. FONEI also was the first to introduce in Mexico new repayment schemes to solve the cash flow problems of firms when the nominal interest rate was raised. Finally, the Contraloria Secretariat, Mexico's highest public sector administrative supervising body, commends FONEI as a model among all trust funds. 80. One possible solution to the conflicts detailed above is the merger of all NAFINSA industrial trust funds into a single second-tier DFC which could then be subjected to a process of substantial reorganization in order to improve its efficiency, while FONEI would be left to operate as an independent fund. Another, perhaps more desirable alternative, would be to bring all industrial funds under FONEI's administration, providing there is an adequate level of autonomy with respect to NAFINSA. 81. Notwithstanding the crucial importance of policy actions on the trust funds, it should be stressed that the proliferation of trust funds in - 31 - Mexico with the conflicts and problems described are just one problem to be tackled within a broader policy decision to reform the country's financial sector. Such reform becomes all the more necessary in the context of the present economic stabilization and restructuring process. In such a process it becomes crucial to allocate financial resources to firms in a less directed fashion, thus allowing the flow of credit to efficient production. This will require not only reducing the public sector deficit, which at present absorbs more than 602 of the credit resources of the banking system, but also diminishing drastically the present credit segmentation to which the trust funds contribute. The Bank of Mexico has indicated that the final decisions regarding trust funds will depend on the outcome of the new Government's policies, and on the plans drawn up for the necessary detailed restructuring (c.f. Attachment 14). Lessons of Experience 82. The FONEI III and IV operations succeeded in consolidating FONEI as a mature apex financial institution with a record of efficient perform- ance. FONEI has encouraged the participating commercial banks to develop a technical capacity to do project appraisal and supervision, relying less on personal links and on collateral requirements. FONEI has also helped to introduce in Mexico innovative financial techniques, beginning with flex- ible interest rates and including new loan amortization mechanisms designed to facilitate the borrowers' cash management at a time of high inflation and nominal interest rates. Although a relatively small actor within the Mexican financial sector, FONEI can be considered a model of a well man- aged, competent and lean DFC. The borrower has indicated that, while the PPAR is correct in pointing out the inconsistencies between the country's macroeconomic policies and the objectives of the loans to FONEI, the World Bank's support for this model institution had a positive demonstration effect on the rest of the Mexican development finance sector, and eventually helped to bring about the desired structural changes in the country (Attachment 16). These accomplishments, however, are clouded by other, more substantial aspects of the operations. First, the bulk of the lending under the two loans did not reach firms that were marginal under the commercial banks' traditional requirements regarding personal connections and/or high collateral, as was originally intended by the Bank and had been recommended by the PPAM of the first two FONEI operations. Instead, much of the funds benefitted firms that could have found easily other sources of financing because of their connections with industrial and banking groups. Second, the financial and economic performance of the subprojects was much worse than had been projected, and the fourth loan was plagued by losses and loan cancellations. The economic and financial crisis of 1982-83 does not fully explain this poor performance, because industrial exports, which the projects were originally meant to promote, boomed following the crisis. This export growth originally resulted from a shift in production from local to export markets, but it gradually required new investments to redirect productive capacity in line with the new relative prices. Third, in spite of its frugal management, FONEI was unable to conserve the real value of the cumulative resources that it received from the Government and its own re-invested profits: its equity - 32 - at the end 1986 had lost between two-thirds and four-fifths of the real value of those cumulative resources. Such capital losses are a threat to its sustainability as a financial institution. 83. The mixed results serve to illustrate a number of weaknesses dur- ing the design and execution of the two loans, some of which have come up repeatedly in earlier ORD reports. First, the bank objectives in lending to Mexico were vague, internally inconsistent and not well based on thor- ough and up-to-date economic analysis. Second, the Bank had insufficient knowledge of the financial sector, and seemed to ignore the findings and recommendations of a recent industrial sector report. Third, as a conse- quence of the first two, and of the absence of a productive policy dia- logue, the two loans were designed on the basis of optimistic assumptions regarding the demand for investment credit, and were expected to succeed in spite of a hostile macroeconomic environment. Fourth, the Bank supervision focused more on ways to accelerate disbursements than on the weaknesses of the unfolding operations, and the recommendations of supervision missions did not receive adequate follow-up in headquarters. 84. Bank Objectives and Country Economic Knowledge. As listed in the two President's Reports, these objectives seemed to call for primarily labor intensive investments, making small budgetary demands, but the Government's announced development plans at the time signaled large capital intensive projects, to be financed largely by the public sector.U The fiscal and macr.economic policies being pursued by the authorities were in conflict with other Bank objectives. How could the Bank have ignored these conflicts? In part because the regular economic reporting had been neglected. When the two loans were presented to the Board in 1978 and 1979, there had not been a full economic report on Mexico for several years, and the latest updating report was dated March 23, 1976.48 A large economic mission visited the country in April/May 1977, but its report was only distributed more than two years later.49 Although internal reports continued to be prepared throughout this critical period, they were restricted in circulation, even within the Bank, and did not reach the Board. This neglect of formal economic reporting during a period when fundamental changes were tAing place in the country, such as the major oil windfall and associated expansive fiscal policies, was bound to be 47/ This capital intensity was also reflected in part in FONEI's own sub- projects. 48/ IBRD: 'An Updating Report on the Economy of Mexico', (Report No. 1110-ME). 49/ IBRD: 'Special Study of the Mexican Economy - Major Policy Issues and Prospects" (Report No. 2307-ME, dated May 30, 1979). An earlier draft was not distributed because the Mexican authorities disagreed with its findings and recommendations. -33 - reflected in problems of inappropriate country assistance strategy, poor design of projects, unproductive policy dialogue and weak conditionality. Furthermore, in approving the loans, the Board did not have access to the full information available to the staff. Stricter enforcement of guidelines calling for frequent economic monitoring and reporting, particularly for large borrowers and for countries undergoing significant economic changes, could help the Bank to target its country objectives better and to design projects and conditionality with greater realism. 85. Sector Inowledge and Consistency with Proiect Design. The Bank went on for years making loans to Mexico that were to be channeled through the financial sector -- US$2.4 billion, or about two-thirds of total lend- ing to Mexico in the period of execution of the FONEI III & IV loans -- without carrying out a single financial sector study. Major problems in the sector, such as excessive segmentation, proliferation of directed credit and special funds, wasteful competition among different official credit windows, integrated industrial-banking cartels, high cost of inter- est rate subsidies, massive arrears and negative interest rates, were either ignored or overlooked, even though these problems were plaguing the Bank's own operations. Even the FONEI operations, although well conceived in themselves, contributed to aggravate some of these problems. Deeper knowl -3 of the sector should undoubtedly have helped to better design the operatiuas and to formulate a stronger conditionality. The lack of financial sector work, however, was not due to an absence of interest on the part of the Bank but rather to thu Government's reluctance to allow the Bank to carry out such studies. Under such conditions, why did the Bank agree to lend massively in a sector without the expectation of effectively influencing its policies? The LAC Region has indicated that, while the attitude of the Mexican authorities of preventing the Bank from carrying out a financial sector report was very regrettable, it was felt that the Bank should not raise this as an important enough issue to stop lending through intermediaries which constituted the bulk of Bank lending operations to Mexico. 86. As regards the industrial sector, equally critical to the success of the FONEI operations, the Bank had recently carried out a major review.50 This report raised major concerns regarding excessive industrial protec- tion, over-valuation of the currency, crowding out of private investment by the public sector, undesirable bias towards capital-intensive investment in both the public and the private sectors, and general discrimination of incentives against the growth of manufactured exports. These concerns, 50/ IBRDs 'Mexico - Manufacturing Sectors Situation, Prospects and Policies (Report No. 1671-ME, dated May 1, 1977). -34 - however, were virtually ignored in the appraisal of the two loans.51 As a result, these operations had little hope of influencing the government' industrial policies or of re-orienting private investment towards manufac- tured exports. In fact, the Bank did not even enforce its own objective of re-directing FONEI's lending towards the less well connected borrowers. The lesson that emerges from this experience is that the existence of adequate sector work is a necessary !ut not a sufficient condition for the appropriate design of a lending strategy and sector conditionality. There is a need as well for management intervention, preferably at a level removed from the normal operational pressures to lend, to ensure that the findings and recommendations of sector work are fully reflected in the loan design and conditionality. 87. Policy Dialogue. Throughout the period of preparation and implementation of the two loans, the Government's general economic policies were not only not conducive to the success of these operations but, more important, started to lead Mexico towards the grave crisis of 1982. In addition to the financial and industrial sector policies discussed in the preceding paragraphs, the tax system encouraged corporations to maximize their borrowing rather than re-invest their own earnings, and fiscal policy was becoming dangerously expansionary. Easy access to massive foreign borrowing by both the Government and the private sector --encouraged in turn by official policies and by the crowding out of domestic credit -- aggravated the over-heating of the economy, contributed to the over- valuation of the peso, discouraged exports and eventually resulted in private capital flight and an untenable balance of payments and foreign debt situation. The Bank was aware of these danger signals, in spite of the long delay in economic reporting. Indeed, the 1979 Economic Report, which was in preparation since 1977, gave ample warning. The Government, however, seems to have ignored the Bank's advice and continued the expan- sionary policies as long as it was able to obtain foreign financing. In spite of the lack of a productive policy dialogue, the Bank continued to lend, and its President's Reports voiced an unjustified optimism about future policies, the decline of inflation, and private sector investment demand. The need for the FONEI loans was explained on the basis of a supposed scarcity of term credit that could not be substantiated. But in fact, there was little need for the funds provided by these loans, either 51/ Commenting on this point, the LAC Region has indicated: 'The PPAR is correct in pointing out that the findings and recommendations of a recent industrial sector report had almost been ignored in designing the loans. The sector report had been prepared by the Programs Department without any input by the responsible Projects Division and many of its conclusions and recommendations were not shared by the latter. However, while there clearly was a lack of coordination between Programs and Projects, at the time both loans were made "formulating a stronger conditionality" was hardly a realistic scenario in the context of Bank lending operations to Mexico.' - 35 - on balance of payments or on financial sector grounds, and the additional resource transfer may -- albeit in a very small way -- have contributed to aggravate the macro problems. 88. Why, then, did the Bank proceed with these loans when it had no expectation of helping to correct inappropriate policies, both at the macro and at the sector level? Part of the answer undoubtedly lies in the desire to continue helping FONEI to carry out its worthwhile pioneering and promo- tional DFC activities. After all, FONEI was seen by the staff in part as the Bank's own creation, and the institution was responding well and deserved further support (in part to compensate for the on-going erosion in its real equity). Also, despite the fact that many Mexican enterprises were obtaining foreign loans, not all of them had easy access to these sources of funds, and the FONEI loans did assist those firms that did not have access. But the staff may have been motivated by the urge to lend for the sake of meeting regional lending targets.52 89. Bank Supervision and Sustainability. Because of staff con- straints, supervision missions were infrequent and brief. They seemed to focus on ways to expedite loan implementation and disbursements and to have overlooked the major problems affecting the loan. Thus, the adverse macroeconomic framework, the excessLve capital intensive and large size of the operations, the questionable profitability of some of the sub-projects were rarely mentioned. More important, the fact that higher inflation than originally projected, negative real interest rates and unforeseen devaluations were eroding FONEI's equity in real terms and threatening its sustainability were not raised as an important issue requiring urgent attention. Why were these problems overlooked? In part because the staff's attention may have been drawn more to new lending activities than to supervision of on-going loans. But there was also an organizational reason. Since most of the questions had to do with the deteriorating macroeconomic framework, it should have been up to the Programs Department to bring these matters to the attention of Projects. Once again, and as seen in the case of the over-optimistic assumptions at appraisal, there seems to have been a lack of coordination between Programs -- responsible for the macro dialogue -- and Projects charged with responsibility for loan design and execution. It is possible that the placement of "projectsm and 'programs' responsibilities in the same Department, following the Reorganization, will make it possible to improve staff coordination in the future. Nevertheless, an inescapable conclusion is that management needs to assign higher priority to loan supervision, and to give clear signals to the staff -- particularly to middle-level managers -- that this is the case. 521 This is illustrated by the rapidly rising amount of the fourth loan, which was originally included in the FY79 lending program for US$100 million, proposed by the appraisal mission to raise it to US$150 million and finally submitted by the Region for US$175 million. ATAM!B 1 -36- MEXICO THIRD AND FOURTH INDUSTRIAL EQUIPMNT FUND (FONEI) PROJECTS (Loans 1560-ME and 1712-1E) AUTHORIZED EQUIPMENT CREDITS BY MARIET 1560-ME 1712-HE NO. OF PESOS NO. OF PESOS CREDITS (million) Z CREDITS (million) I Exports 28 1307.68 37.38 44 4680.07 29.38 Import-Substitution 26 1010.81 28.90 66 7939.24 49.84 Exports & Import Substitution 24 1179.69 33.72 24 3308.72 20.77 Total * 78 3498.18 100.00 134 15928.03 100.00 * Other projects financed with this loan have been classified in other categories. Differences in total projects vith respect to PCR Annex 3 reflect more recent information collected during audit. Source: FONEI. ATTACHEWT 2 - 37 - MEXICO THIRD AND POURTH INDUSTRIAL EQUIPMENT FUND (F01) PROJECTS (Loans 1560-ME and 1712-MR) AUTHORIZED SUBLOANS BY REGION 1560-IE 1712-HE NO. OF PESOS NO. OF PESOS STATE CREDITS (million) I CREDITS (million) I NUEVO LEON 20 981.29 23.43 50 6996.14 26.74 MEXICO 13 629.68 15.03 29 2962.30 11.32 JALISCO 8 251.47 6.00 27 2483.23 9.49 VERACRUZ 5 283.32 6.76 13 2058.15 7.87 COAHUILA 2 61.94 1.48 10 1782.22 6.81 GUANAJUATO 5 309.78 7.40 5 1464.15 5.60 QUERETARO 8 360.11 8.60 15 1328.86 5.08 DURANGO 0 0.00 0.00 5 1136.01 4.34 TAMAULIPAS 1 77.87 1.86 6 951.25 3.64 HIDALGO 0 0.00 0.00 4 731.80 2.80 DISTRITO FEDERAL 3 99.98 2.39 13 618.20 2.36 SONORA 2 123.66 2.95 6 599.30 2.29 SINALOA 0 0.00 0.00 4 583.00 2.23 SAN LUIS POTOSI 2 110.00 2.63 8 550.19 2.10 PUEBLA 3 159.45 3.81 6 452.91 1.73 BAJA CALIFORNIA N. 7 202.85 4.84 5 441.20 1.69 MICHOACAN 0 0.00 0.00 3 292.06 1.12 TLAXCALA 2 194.60 4.65 5 248.07 0.95 CHIHUAHUA 3 214.65 5.12 4 224.72 0.86 ZACATECAS 0 0.00 0.00 1 92.03 0.35 AGUASCALIENTES 1 50.00 1.19 1 89.00 0.34 MORELOS 1 60.00 1.43 4 44.74 0.17 YUCATAN 1 18.00 0.43 2 32.64 0.12 QUINTANA R00 0 0.00 0.00 0 0.00 0.00 BAJA CALIFORNIA S. 0 0.00 0.00 0 0.00 0.00 TOTAL * 87 4188.65 100.00 226 26162.17 100.00 * Differences in total projects with respect to PCR Annez 3 reflect more recent information collected during audit. Source: FONEI. - 38 - ATTACHMENT 3 MEXICO THIRD AND FOURTH INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (Loans 1560-ME and 1712-ME) FIRMS WITH FONEI FINANCING BELONGING TO MEXICO'S 500 LARGEST FIRMS FIRM RANK GROUP Celanese Mexicana 10 Subsidiary of Celanese Hylsa 12 Alfa IRSA-PDT 17 DESC Industrias Negromex 32 DESC Cementos Tolteca 39 ICA Industrias Monterrey 40 IMSH Unicarb Industrial 53 Union Carbide Cia. Siderurgica de Guad. 63 Asturiano-CIDOSA Cementos Anahuac del Golfo 79 Cementos Anahuac-Gpo. Anah. Conductores Monterrey 80 Conductores Monterrey Cementos Anahuac 85 Cementos Anahuac Kenworth Mexicana 98 Local Subsidiary, N.A. Cementos Portland Moctezuma 103 Local Subsidiary, N.A. Cia. Papelera Maldonado 115 Grupo Maldonado Pigmentos y Oxidos 123 Estatal Cementos de Chihuahua 150 Chihuahua Industria Automotriz 152 Grupo Ramirez Industrias Astral 156 Local Subsidiary, N.A. Fenoquimia 164 DESC Nemak 168 Alfa Trailers de Monterrey 212 Individual Marhino 222 Individual Telectra 225 Individual Pinturas Aerolin Hermosillo 229 Individual Electro Optica 235 German Subsidiary Sintesis Organica 239 Local Subsidiary, N.A. Aralmex 251 Local Subsidiary, N.A. Texel 270 Pliana Protomex 273 Individual Avante Ingenieros 332 Individual Mexicana de Electronica Ind. 336 Individual Productora de Papel 362 Individual Polietileno Nacional 395 Local Subsidiary, N.A. Super Diesel 420 Individual Industrias Helder 434 Individual Acabados Automotrices 457 Individual Sources: FONEI Reports: Revista Expansion, August 1987. E. Jacobs in Economia Mexicana, No. 3-1981. - 39 - ATTACHMENT 4 MEXICO TRIRD AND FOURTH INDUSTRIAL EQUIPMENT FUND (PONEI) PROJECTS (Loana 1560-ME and 1712-HE> FIRMS WITE FONEI FIANCING BELONGINO TO MEXICO'S MAIN INDUSTILAL GROUPS FIRM A GROUP - Automagneto 6 DESC - Industrias Resistol-IRSA - Negromex - Ferroguimia - Hils 1 ALFA - Nemac - Motocicletas Carabela - Bicicleta Windsor - Cementos de Chihuahua ** Chihuahua - Industrias polifil ** Mexico - Fabricacion de Maquinaria 2 Vitro - Vidriera Mexico - Vidrio Neutro - Industria Automotriz 53 Ramirez - Trailere de Monterrey - Cementos Tolteca 17 ICH (Empresas Tolteca) - Texel 67 Pliana - Cementos Anahuac 29 Concretos Anahuac (Grupo Anahuac) - Focos 11 Concretos Mexicanos - Indetelec 46 Indetel - Cia. Papelera Maldonado 74 Grupo Maldonado - Conductores Monterrey 48 Conductores Monterrey (Garza) - Compania Siderurgica de Guadalajara * Asturiano-SIDOSA - Compania Industrial de Orizaba - Industrias Monterrey 23 IMSA - Sosa Texcoco S.A. ** Industrias Unidas * According to ranking by Luna y Tirado. ** According to ranking by Jacobs. Sources: FONEI Reports 1987. Revista Expansion, August 1987. Eduardo Jacobs, "La Evolucion Reciente de los Grupos de Capital Privado Nacional* in Economia Mexicana. CIDE No. 3-1981. Matilde Luna and Ricardo Tirado, "Los Grupos Privados Nacionales y las Empresas Estatales en los Setentas*. In Grupos Economicos y Organizaciones Empresariales en Mexico. Alianza Editorial Mexicana. Mexico 1986. - 40 - ATTACOM~T o MCD THM AND FOIT D~BBTRIAL EW5VPloT FM (F~gt) POCTS (L~n 111110aE ~n 1712-wE FWEI FIM WITH M THAN E VULOAN (by Type of Fwaneing) TOTAL M. OF TE~- EiP- OPTIMI- OMIN POMLUTIM IN FIn PO5CTS LOGICAL IT ZATICO CAPITAL Cm^ L PROMESu American Wheele a 5 Automagn~o 2 2 ECISA Construcciones 2 2 Desarrollo y Construccida Mceniea 2 2 Celan~.. 2 2 Camentos Anahuac 2 1 2 CGetog Chihuahua 8 1 1 1 Comentos Portland 2 1 1 Cia. deVidrio Industrial 2 2 Cio. Industrial de Orizaba 2 2 Cia. Industrial Rio gravo 8 2 1 Cia. Papelera Maldonado 2 1 1 Cia. siderurgica Quadalajara 4 1 2 1 Focus 8 8 Flsacero 2 2 Fabricacién de Maquinaria 11 11 0. Voraetegul 2 2 Hirlon 2 2 Industrial Astral 2 1 1 Industrias de Cordoba 2 1 1 Industrias Monterrey 2 1 1 Industrias Negrmex 2 1 1 Industrias Tiffany 2 1 1 Industrias Tuck 4 8 1 Industrlas Tremo. 8 2 1 Instrumend de México 2 2 Industrias Polfil 18 18 Indetel 24 24 IRSA 52 62 Laboratorios Pica 8 1 1 1 Multipilcadidad Technolégica 9 Multipanel 8 1 2 Napko 2 1 1 Nsmak 2 1 1 Pigmentos y Oxidos 15 16 Rovitex 5 2 1 1 1 Super DIeeel 2 1 1 Nylsa 2 1 1 Special 2 2 SIstemas Computacionales Avanzados 4 4 Tableros de Yeso Monterrey 2 1 1 Texel a U XGnik 2 1 1 Total 222 11 8 5 4 14 Source: FOE Supervision Report during 191?. - 41 - ATTACOIT 6 uXIco Tiom Am PmMi IIMUBRIAL IIPmit FW (FOhI) PMO.ECTS (LeM-m 1600'E end 1712-im) E~PMT 9HAE IN TOTAL uMIFACMlEIN PRUODCTIM, 1990 Pri~se (PM~en) TOTAL FOO, TEXTILE PAPM ilm- vEAR NI~iWAC- EV. & a w= a CMICAL TALLIC IAsiC HETAL (RM.) TIN TMACCO CLOITHDUN PRU~CTS PRNN PUCTS UnXS HETALS PMUCT8 OTER 1m 8.8 4.4 4.0 1.5 1.6 6.6 2.9 1.1 8.8 2.9 I 4.1 4.5 5.4 1.7 1.6 6.9 2.5 1.9 3.2 3.1 II 8.6 4.8 2.6 1.4 1.6 6.4 3.1 0.9 4.6 2.7 III 8.5 8.0 2.8 1.6 1.8 5.6 3.1 0.9 4.1 3.1 IV 4.0 6.0 6.0 1.6 1.5 6.7 2.7 0.7 3.2 2.8 1Ul 8.7 8.6 8.6 1.6 1.4 7.0 2.0 0.9 8.4 8.1 1 8.6 8.9 4.6 1.6 1.0 6.4 2.0 1.2 2.7 2.6 II 8.1 8.4 2.6 1.4 1.1 5.2 2.0 0.8 3.2 2.1 III 4.0 8.8 3.1 1.9 1.6 9.0 2.2 0.9 8.8 8.9 IV 4.1 8.9 4.1 1.8 2.0 7.8 1.9 0.6 4.3 8.6 1982 8.6 8.8 2.7 1.4 1.4 5.2 2.7 2.4 6.1 8.1 1 2.9 2.8 8.1 1.0 2.1 4.0 1.7 0.6 3.8 2.6 II 8.4 8.1 3.5 1.1 1.2 5.9 2.2 1.9 8.8 2.6 III 8.9 8.1 2.0 1.0 1.8 0.1 2.7 2.6 6.1 3.7 IV 6.2 0.8 2.4 1.9 1.1 4.8 4.6 5.2 8.5 4.0 1e" 6.4 4.6 2.4 2.6 1.6 9.5 7.8 10.4 10.8 7.1 1 4.9 4.0 3.6 1.8 1.4 6.0 6.4 6.9 6.9 7.9 II 5.6 4.6 1.7 2.2 1.0 6.9 7.0 9.0 9.7 7.6 III 6.7 4.8 1.1 8.4 1.4 9.9 7.6 18.3 11.0 6.0 IV 9.6 5.0 8.6 8.0 2.1 15.4 8.9 12.3 14.4 7.1 1984 7.5 4.4 8.8 2.9 1.6 12.7 9.0 9.5 12.0 6.6 1 7.8 4.8 4.5 8.8 2.0 12.9 9.8 13.8 12.2 6.8 II 7.6 4.8 4.0 2.9 1.6 11.9 9.8 10.9 12.2 4.7 III 7.2 4.6 2.4 8.1 1.6 12.8 8.2 8.2 11.8 6.2 IV 7.6 4.6 4.2 2.5 1.8 18.7 8.6 5.8 12.4 6.2 198 7.2 4.8 2.5 1.7 1.3 18.1 8.7 6.6 12.6 6.9 1 6.9 3.8 8.2 1.8 0.8 14.6 7,7 6.0 10.4 6.4 II 7.2 4.0 2.8 1.6 1.0 13.7 10.3 4.6 12.8 6.6 III 6.9 4.1 1.4 1.7 1.8 12.6 8.7 4.1 12.4 6.7 IV 7.9 6.8 3.3 1.9 1.6 11.7 8.2 7.1 16.8 6.9 1m 9.6 6.1 8.2 2.9 1.8 14.9 11.9 11.6 19.8 7.6 1 7.6 4.4 4.2 2.0 1.6 11.4 11.8 7.8 14.4 4.9 II 8.9 4.6 2.4 2.7 1.5 15.2 12.0 12.6 16.2 7.6 III 10.2 6.6 2.1 3.6 1.7 15.8 12.3 12.0 21.6 8.7 IV 11.9 5.9 4.1 8.4 4.6 17.8 11.9 14.6 29.5 9.5 1987 11.2 6.2 4.6 8.6 4.0 14.0 18.2 14.8 26.5 8.7 1 11.0 6.6 6.4 8.2 3.6 14.2 12.6 17.8 26.8 7.3 II 11.2 7.0 8.8 8.2 8.4 14.1 11.8 18.1 24.5 7.8 III 11.8 7.0 4.2 4.0 8.9 14.2 13.1 14.2 28.6 9.1 IV 11.4 5.7 5.0 8.0 4.9 13.6 15.2 14.6 28.7 11.8 FONEI Fl r 1967 10.3 17.4 15.4 21.8 46.1 23.8 41.8 84.9 Sourc.: Banco de ioxlco, unpublished dato, and FOEI. - 42 - ATTACHMENT 7 MEXICO THIRD AND FOURTH INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (Loans 1560-ME and 1712-ME) SHARE OF EXPORTS IN TOTAL PRODUCTION. MAIN PRODUCTS 1986 1987 Petroleum 45.7 45.5 Silver 74.9 66.0 Sulfur 51.1 62.7 Artificial Yarn 26.9 32.3 Gasoline 2.5 2.3 Fuel Oil 10.3 8.9 Ammonia 5.8 8.1 Sodium Sulfate 34.5 28.9 Cement 18.9 19.6 Iron 0.8 0.8 Steel 7.3 ' 7.7 Iron & Steel Manufacturing 9.6 10.4 Commercial & Structural Profiles 8.0 7.4 Steel Tubes 32.9 50.0 Automobiles 19.3 48.8 Trucks 24.3 23.4 Automobile Motors 80.9 81.5 Beer 10.9 17.9 Toilet & Facial Tissues 12.1 15.6 Sources Banco de Mexico, unpublished data. 43 - ATTACHMNT 8 MEXICO THIRD AND FOURTH INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (Loans 1560-NE and 1712-ME) BALANCE OF BANK LOANS AS OF NOVEBER 30, 1983 (US$ Millions) Loan Vndisbursed Loan Project Name Amount Balance Number Total, all 82 loans (A + 3) 6,486 2,553 A. 53 Loans Fully Disbursed 2,887 ----- B. 29 Loans Ongoing 3,599 2,553 C. 15 ongoin loans with sub-lending 2.257 1.740 interest rate components Medium Cities Water Supply 40 9 1186-ME Tropical Agriculture 56 10 1153-ME Small-Medium Mining 40 35 1820-ME Second Small-Medium Industry 100 21 1881-ME Seventh Agricultural Credit 325 145 1891-ME Medium Cities Water Supply 125 103 1913-ME Rainfed Agriculture 280 204 1945-ME Urban II 164 128 1990-ME PIDER III 175 157 2943-ME Capital Goods Industries 152 130 2142-HE Pollution Control 60 59 2154-HE Agricultural Marketing for Perishables 115 115 2262-ME Third Medium Cities & Sinaloa State Water Project 100 100 2281-HE Third Small-Medium Indastry 175 175 2325-HE Export Development 350 350 2331-ME D. 14 Other Ongoing Loans 1,342 812 Share of C as Z of B (62.7) (68.2) Sources Memo by Frederick E. Berger et. al. to GIRA Working Party, dated November 3, 1986. ATTACHMENT 9 Page 1 of 8 MEXICO THIRD AND FOURTH INDUSTRIAL EQUIPMENT FUND (ONsI) PROJECTS (Loans 1560-M and 1712-M) FINANCIAL RATIOS IN MANUFACTURING TOTAL MANUFACTURING 11 PROFIT- LIQUIDITY LEVERAGE LEVEL OF ACTIVITY ABILITY CURRENT ASSETS SHORT-TERM PROFITS SHORT-TERK TOTAL LIAB. LIABILITIES SALES SALES LIABILITIES TOTAL ASSETS TOTAL LIAB. TOTAL ASSETS (Z) (I) (2) (2) 1180 6.8 1.58 49.5 52.6 98.0 11180 6.8 1.49 51.5 54.3 93.4 111/80 7.0 1.52 50.5 53.7 91.8 IV/80 8.0 1.81 46.3 48.5 79.2 1/81 6.8 1.61 47.9 48.3 86.3 11/81 7.4 1.59 50.2 48.3 82.3 111/81 7.0 1.55 51.8 48.2 81.1 IV/81 7.4 1.52 50.8 46.6 71.3 1/82 -1.2 1.29 59.4 44.5 66.0 11/82 1.1 1.30 60.6 43.1 65.5 111/82 2.9 1.20 61.1 46.0 62.3 IV/82 0.8 0.91 59.6 45.3 42.4 1183 0.3 0.94 61.1 41.8 54.2 11183 2.6 0.99 61.2 40.2 53.3 111/83 1.5 0.96 62.1 41.8 52.1 IV183 3.5 1.66 53.9 26.9 43.9 1/84 1.8 1.77 52.1 28.3 66.8 11184 2.1 1.84 56.3 28.3 70.4 111/84 2.0 1.87 53.8 29.0 64.4 IVI84 4.1 1.94 51.8 28.7 59.2 1/85 6.8 1.89 48.6 32.2 76.6 11/85 6.8 1.84 49.9 33.0 71.0 ii/85 9.8 1.78 49.9 34.6 64.6 IV185 8.1 1.81 50.7 34.0 61.3 1/86 2.5 1.88 46.0 34.5 68.2 11186 4.0 1.18 45.2 35.2 63.7 111/86 2.6 1.72 45.6 36.1 55.7 IV/86 2.6 1.76 44.8 36.3 54.4 1/87 5.6 1.61 45.4 38.9 70.9 11/87 10.3 1.77 39.6 41.8 68.2 111/87 13.3 1.83 37.9 44.5 61.9 IV/87 13.0 1.49 33.7 59.8 52.7 If For firms listed on the Stock Exchange. 21 Annualized Figures Sources Mexican Stock Exchange and Banco de Mexico. - ATTACHMENT 9 Page 2 of 8 MEXICO THIRD AND FOURTH INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (Loans 1560-HE and 1712-ME) TEXTILES, CLOTHING & FOOTWEAR 11 PROFIT- LIQUIDITY LEVERAGE LEVEL OF ACTIVITY ABILITY CURRENT ASSETS SHORT-TERM PROFITS SHORT-TERM TOTAL LIAB. LIABILITIES SALES 2 SALES LIABILITIES TOTAL ASSETS TOTAL LIAB. TOTAL ASSETS I/80 11.9 1.85 48.9 69.7 92.3 11/80 12.8 2.02 49.6 61.9 85.7 111/80 13.6 1.77 52.7 65.6 77.4 IV/80 14.7 1.81 52.8 64.0 78.0 1/81 11.6 1.73 54.3 62.9 102.0 11181 12.7 1.66 52.8 62.9 77.6 111/81 13.5 1.72 48.3 70.0 75.2 IV/81 12.4 1.57 52.0 66.9 72.8 1/82 0.9 1.42 57.5 61.1 66.3 11182 -2.4 0.99 61.5 74.1 64.8 111/82 5.0 0.96 62.2 76.8 67.7 IV/82 -8.9 0.74 70.8 73.6 49.7 1/83 -11.2 0.64 73.2 79.1 57.9 11/83 10.3 0.64 75.0 84.8 55.0 111/83 -51.3 0.65 81.3 72.7 50.0 IV/83 -42.2 0.66 78.6 70.1 41.2 1/84 6.0 1.89 50.8 35.1 74.9 11/84 -0.6 1.91 51.0 36.6 70.6 111/84 -5.4 1.90 49.4 40.6 59.5 IV/84 -2.0 1.97 49.2 42.6 63.7 1/85 7.7 2.29 50.0 35.8 101.1 11/85 8.7 2.09 45.9 39.4 82.8 111/85 10.2 1.81 49.1 44.9 65.3 IV/85 10.0 1.83 51.5 46.3 70.3 1/86 7.5 1.98 48.3 40.5 94.5 11/86 8.8 1.69 47.3 44.7 78.5 111/86 7.5 1.54 48.6 45.6 56.7 IV/86 9.1 1.48 50.5 45.0 53.7 1/87 16.3 1.48 42.6 48.7 83.6 11/87 1.5 1.54 29.9 68.9 73.8 111/87 15.0 1.48 31.3 69.5 65.7 IV/87 15.5 1.59 30.0 70.9 60.6 1/ For firms listed on the Pl3ck Exchange. 21 Annualized Figures Sources Mexican Stock Exchange and Banco de Mexico. -46 - A?TACIMT 9 Page 3 of 8 MEXICO THIRD AND FOURTH INDUSTRIAL EQUIPMENT FUND (FOURI) PROJECTS (Loans 1560-MB and 1712-MB) METAL PRODUCTS, MACHINERY & EQUIPMENT IL PROFIT- LIQUIDITY LEVERAGE LEVEL OF ACTIVITY ABILITY CURRENT ASSETS SHORT-TERH PROFITS SHORT-TEM TOTAL LIAB. LIABILITIES SALES SALES LIABILITIES TOTAL ASSETS TOTAL LIA2. TOTAL ASSETS I/80 4.6 1.40 56.1 78.1 146.0 11180 5.2 1.42 56.7 78.1 142.9 111/80 5.0 1.42 57.0 74.6 133.6 IV/80 5.8 1.90 54.1 73.2 119.4 1/81 4.2 1.42 52.5 71.2 127.8 11181 5.1 1.41 55.6 71.8 131.4 111181 5.0 1.42 56.1 69.9 132.6 IV/81 5.2 1.41 55.1 70.1 118.7 1/82 -5.5 1.17 60.9 72.3 104.1 11182 -0.9 1.24 63.5 66.2 104.4 111182 -2.5 1.20 66.7 66.1 95.2 IV/82 -2.8 1.10 60.8 56.4 61.8 1/83 -2.4 1.09 61.7 57.3 71.5 11183 1.4 1.20 61.3 51.3 70.4 111/83 0.5 1.26 62.5 47.1 68.7 V1/83 4.8 1.54 53.6 40.7 61.4 1/84 -4.4 1.36 60.8 42.8 89.9 11/84 2.1 1.42 58.9 42.8 92.2 111/84 1.2 1.54 58.9 41.8 88.1 IV/84 5.1 1.61 53.7 46.4 86.8 1/85 5.1 1.45 55.3 48.6 108.2 11/85 3.5 1.46 56.3 50.5 104.0 111/85 3.4 1.42 58.8 49.5 88.2 IV/85 2.0 1.58 56.6 43.4 86.4 1186 -7.3 1.49 55.1 43.6 90.4 11/86 -5.8 1.44 55.9 43.5 82.0 111/86 -7.4 1.43 59.8 42.9 71.9 IV/86 -7.3 1.54 56.2 41.9 69.3 1/87 -2.5 1.51 51.6 46.2 99.8 11/87 6.0 1.80 43.5 51.6 94.8 111/87 6.6 1.75 38.7 55.0 87.7 IV/87 7.9 1.61 38.3 66.0 75.0 l/ For firms listed on the Stock Exchange. 2/ Annualized Figures Source: Mexican Stock Exchange and Banco de Mexico. - 47 - ATTACOMGNT 9 Page 4 of 8 MEXICO THIRD AND FOURTH INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (Loans 1560-HE and 1712-ME) BASIC METALS 11 PROFIT- LIQUIDITY LEVERAGE LEVEL OF ACTIVITY ABILITY CURRENT ASSETS SHORT-TIRM PROFITS SHORT-TERM TOTAL LIAB. LIABILITIES SALES 21 SALES LIABILITIES TOTAL ASSETS TOTAL LIAB. TOTAL ASSETS (2) (2) (Z) (Z) 1/80 7.5 1.74 53.5 40.7 73.4 11180 6.2 1.55 56.0 45.5 67.5 III/80 7.0 1.60 52.2 48.3 70.2 IV/80 7.9 1.99 46.8 40.2 61.5 1/81 8.9 1.87 48.6 41.8 69.8 11/81 7.4 1.67 51.2 45.1 64.2 III/81 6.7 1.64 53.7 44.5 60.3 IV/81 7.3 1.37 54.1 47.5 52.3 1/82 -9.4 1.19 63.4 46.4 44.1 11/82 -4.8 1.16 64.7 46.4 45.9 111/82 1.3 0.96 65.4 48.6 41.7 IV/82 -0.9 0.57 63.1 56.3 28.0 1/83 -5.4 0.70 63.1 44.7 36.2 11/83 -0.1 0.70 64.6 43.2 34.4 111/83 -0.3 0.64 65.5 45.5 33.6 IV/83 9.6 1.35 64.0 24.9 28.2 1/84 6.6 1.90 60.0 21.9 55.8 11/84 2.1 2.00 62.5 21.8 56.7 111/84 2.4 1.87 64.8 24.7 54.5 IV/84 2.1 1.68 62.8 25.2 42.9 1/85 4.0 1.89 58.4 27.2 59.6 11/85 3.8 1.73 62.1 26.5 50.2 111/85 11.6 1.60 62.5 28.6 46.8 IV/85 6.1 1.52 61.8 29.3 42.9 1/86 2.1 1.93 54.1 25.7 48.3 11/86 1.9 1.72 51.4 27.0 45.1 111/86 0.2 1.57 49.1 27.2 36.1 IV/86 2.4 1.49 50.4 29.6 36.0 I/87 1.5 1.11 59.9 34.2 45.2 11/87 7.6 1.42 47.2 31.9 48.5 111/87 9.3 1.40 47.4 35.4 44.7 IV/87 11.1 1.49 34.2 44.4 37.7 1L For firms listed on the Stock Exchange. 2L Annualized Figures Source: Mexican Stock Exchange and Banco de Mexico. 48 - ATTACIROT 9 Page 5 of 8 MEXICO THIRD AMD FOURTH INDUSTRIAL EQUIPMENT FUND (FOMEI) PROJECTS (Loans 1560-Mg and 1712-ME) NON-NETALLIC MINERAL PRODUCTS 1/ PROFIT- LIQUIDITY LEVERAGE LEVEL OF ACTIVITY ABILITY CURRENT ASSETS SBORT-TERM PROFITS SHORT-TERM TOTAL LIAB. LIABILITIES SALES 2l SALES LIABILITIES TOTAL ASSETS TOTAL LIAR. TOTAL ASSETS (2) (2) (2) (2) I/80 10.8 1.52 45.3 35.3 63.2 11/0 10.3 1.39 47.4 36.8 59.1 III/80 9.7 1.58 48.3 32.6 57.7 IV/80 11.7 1.77 44.1 30.5 50.3 1/81 11.1 1.67 44.5 31.1 58.6 11/81 13.7 1.76 44.9 30.7 57.4 III/81 12.2 1.73 45.5 31.3 57.3 IV/81 11.7 1.76 48.0 29.0 51.7 1/82 7.5 1.58 54.5 26.0 52.1 11/82 6.5 1.52 54.4 26.0 48.9 111/82 7.6 1.39 52.9 31.0 46.9 IV/82 6.6 1.08 54.5 27.8 29.5 1/83 0.4 1.09 54.6 29.2 36.5 11/83 3.7 1.14 54.1 27.8 36.8 111/83 4.9 1.17 54.0 30.1 37.3 IV/83 2.6 2.18 45.5 18.3 32.7 1/84 -2.2 2.90 43.2 15.7 39.2 11/84 0.6 3.12 50.1 15.8 44.6 111/84 -0.3 3.03 42.8 16.8 39.3 IV/84 2.3 3.24 45.2 15.9 41.1 1/85 11.4 3.20 38.8 17.9 46.7 11/85 12.3 3.08 38.8 19.2 46.0 III/85 13.7 3.00 36.6 21.4 41.5 IV/85 16.1 2.94 38.8 21.8 39.9 1/86 13.7 2.59 34.7 25.3 42.5 11/86 13.8 2.60 33.8 26.6 40.3 111/86 13.3 2.54 32.3 27.6 35.9 IV/86 13.4 2.82 31.7 26.7 33.2 1/87 16.8 2.86 30.6 27.4 46.7 11/87 21.9 2.34 32.3 31.6 43.4 111/87 27.4 2.60 29.7 34.6 39.7 IV/87 25.3 1.97 25.7 50.3 35.6 1 For firms listed on the Stock Exchange. 2/ Annualized Figures Sources Mexican Stock Exchange and Banco de Mexico. ATTACNENT 9 - 49 - ATCM Page 6 of 8 MEXICO THIRD AND FOURTH INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (Loans 1560-MB and 1712-m3) CHE1ICALS, PETROLEUM DERIVATIVES, RUBBER & PLASTICS 11 PROFIT- LIQUIDITY LEVERAGE LEVEL OF ACTIVITY ABILITY CURRENT ASSETS SHORT-TERM PROFITS SNORT-TERM TOTAL LIAS. LIABILITIES SALES 21 SALES LIABILITIES TOTAL ASSETS TOTAL LIAM. TOTAL ASSETS (2) (2) (1) (2) Ii80 8.3 1.73 46.6 51.3 108.0 11/80 8.1 1.65 48.9 51.0 102.8 Illi80 8.9 1.70 47.4 49.3 95.2 IViso 9.0 1.73 44.0 41.9 73.9 1/81 6.9 1.73 46.5 39.3 70.1 11/81 7.2 1.72 48.6 38.1 68.1 III/81 8.0 1.74 51.9 35.3 69.0 1V/81 8.7 1.62 51.0 36.5 64.1 1/82 5.6 1.44 61.7 31.9 63.6 11/82 6.6 1.54 60.1 29.5 63.4 111182 6.8 1.51 60.9 32.6 61.9 IVIS2 5.1 1.18 66.7 32.3 45.8 1/83 7.4 1.17 67.5 34.0 64.6 11/83 9.0 1.20 64.8 35.4 64.8 111/83 8.2 1.35 63.5 33.6 63.7 IV/83 6.8 2.23 50.5 21.0 58.1 1/84 -0.3 2.01 49.1 22.7 66.3 11/84 4.5 2.28 55.5 21.5 75.9 111/84 4.4 2.30 47.7 22.2 63.8 IV184 4.7 2.39 46.6 23.8 66.5 1/85 9.1 2.15 46.0 26.3 77.0 11/85 8.9 2.25 43.2 27.5 72.6 111/85 14.3 2.21 44.6 29.7 72.2 IVI85 12.5 2.12 45.6 33.5 67.5 1/86 7.9 2.19 42.1 34.4 79.0 11/86 10.4 2.10 41.4 35.8 73.7 111/86 10.2 2.02 41.2 38.9 66.5 IV/86 9.3 1.93 42.2 39.9 62.2 1/87 11.6 1.85 40.3 44.3 86.9 11/87 12.6 1.90 38.7 48.0 80.5 111/87 12.7 1.93 38.1 51.8 75.9 IV/87 13.0 1.92 36.7 54.7 65.7 If For firms listed on the Stock Exchange. 21 Annualized Figures Sources Mexican Stock Exchange and Banco de Mexico. ATTACIMINT 9 -50- Page 7 of 8 MEXICO THIRD AND FOURTS INDUSTRIAL EQUIPMENT FUND (FON21) PROJECTS (Loans 1560-NE and 1712-NE) PAPER. PAPER PRODUCTS & PRINTING 1L PROFIT- LIQUIDITY LEVERAGE LEVEL OF ACTIVITY ABILITY CURRENT ASSETS SEORT-TERN PROFITS SHORT-TERM TOTAL LIAS. LIABILITIES SALES 2L SALES LIABILITIES TOTAL ASSETS TOTAL LIA3. TOTAL ASSETS (2) (2) (Z) (2) 1/80 9.0 1.94 44.7 47.9 79.0 11/80 9.4 1.80 47.0 50.2 82.2 111/80 10.0 1.80 47.7 48.0 83.5 IV/80 12.3 2.03 45.4 37.9 71.9 1/81 7.6 1.69 49.8 44.1 73.1 11/81 8.9 1.87 53.4 40.3 68.1 111181 9.6 1.71 51.6 44.8 68.0 IV81 10.9 1.76 48.2 37.9 56.5 1/82 -3.4 1.44 57.1 36.9 57.8 11/82 2.9 1.55 59.5 36.9 61.3 111/82 5.5 1.41 58.1 40.8 62.9 IV/82 -4.2 1.28 50.2 37.3 43.2 1/83 5.9 1.19 53.0 40.0 53.2 11/83 -2.3 1.17 57.1 42.0 58.2 111/83 7.5 1.06 53.6 57.1 63.1 IV/83 3.5 1.83 46.4 28.3 49.7 1/84 -4.5 1.40 59.3 36.8 70.5 11/84 -1.3 1.50 55.5 36.6 67.2 111/84 0.7 1.51 62.5 38.0 75.8 IV/84 3.6 1.80 44.3 32.9 55.6 1/85 6.2 1.64 46.5 37.9 74.4 11/85 5.9 1.67 46.1 45.4 78.9 11185 8.0 1.84 48.1 38.9 71.2 IV/85 9.1 2.13 41.5 35.9 60.1 1/86 4.2 2.29 39.0 34.6 64.4 11/86 6.4 2.31 34.4 34.8 56.7 111/86 6.2 1.70 38.6 42.4 55.6 IV/86 4.4 2.37 32.9 26.5 47.7 1/87 9.7 2.06 33.7 40.7 68.4 11/87 12.9 2.07 32.8 45.2 71.8 111/87 12.9 2.33 30.5 44.4 63.6 IV/87 19.1 2.21 22.9 55.8 32.8 If For firms listed on the Stock Exchange. 21 Annualized Figures Source: Mexican Stock Exchange and Banco de Mexico. - 51 - ATTACIMNT 9 Page 8 of 8 MEXICO THIRD AND FOURTH INDUSTRIAL QUIIPMT FUND (FONRI) PROJECTS (Loans 1560-HB and 1712-NR) FOOD, BEVERAGES & TOSACCO I PROFIT- LIQUIDITY LEVERAGZ LEVEL OF ACTIVITY ABILITY CURRENT ASSETS SNORT-TEM PROFITS SNORT-TIE TOTAL LIAS. LIABILITIES SALES iL SALES LIABILITIES TOTAL ASSETS TOTAL LIAR. TOTAL ASSETS (2) (2) (2) (2) 1/80 3.7 1.36 45.0 60.0 159.9 II/80 4.6 1.26 47.6 79.9 151.5 111/80 4.3 1.23 47.4 61.0 154.1 . IViso 4.9 1.41 42.0 77.0 131.4 1/81 3.5 1.33 45.9 75.0 155.5 11/81 4.2 1.31 48.9 71.4 143.7 III1S6 3.0 1.18 53.5 73.7 140.5 IV/81 3.7 1.62 44.9 60.2 131.1 1182 -0.7 1.21 56.4 59.6 112.3 11/82 -0.4 1.26 59.1 51.4 106.0 111/82 1.5 1.26 60.7 53.8 107.1 IV/82 1.8 1.19 54.5 51.1 78.2 1/83 0.4 0.94 62.6 40.8 99.7 11/83 1.3 0.89 66.2 42.3 93.7 111/83 0.5 0.91 67.3 44.1 91.3 . IV/83 -4.3 1.97 54.2 28.7 58.2 1184 19.1 1.50 40.0 52.6 147.2 11/84 2.8 1.38 58.4 38.1 103.0 111/84 3.7 1.46 59.8 35.9 91.7 IV/84 7.3 1.59 52.0 42.1 95.0 1/85 4.7 1.64 50.0 41.4 123.5 11/85 7.9 1.59 48.1 44.3 117.1 111/85 8.3 1.51 45.2 48.4 105.9 IV/85 7.5 1.38 54.4 46.5 98.9 1/86 3.4 1.48 51.2 44.3 99.4 11/86 5.4 1.50 53.6 42.9 105.4 111186 2.3 1.47 54.0 39.6 94.2 IV/86 2.7 1.44 49.7 45.8 94.9 1/87 4.4 1.45 47.4 43.8 101.7 11/87 4.5 1.31 47.2 47.t, 97.0 111/87 9.1 1.34 49.6 0.5 89.0 IV/87 5.5 1.30 47.3 50.0 82.4 i1 For firms listed on the Stock Exchange. 21 Annualized Figures Sourcet Mexican Stock Exchange and Banco de Mexico. - 52 - ATTACHNENT 10 NXICO THIRD AND FOURTH INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (Loans 1560-M and 1712-MB) PARTICIPATION OF BANK-FUNDED SUBLOANS IN FOMEI OPERATIONS (Subloans Supervised During 1987) 1 2 3 4 Participation Total Total No. of of No. of No. of Firms with Bank-financed Projects Firms Bank-financin Firms 312 2 Technological Development 184 42 1 2.38 Equipment 110 99 50 50.5 Optimization 18 18 12 66.6 Working Capital 14 14 5 35.7 Pollution Control 18 17 3 17.6 TOTAL 383 226 76 33.6 Source: FONEI Annual Report of 1987. - 53 - ATTACHMENT 11 MEXICO - FONEI III and IV (Loans 1560-HE and 1712-HE) AUTHORIZED SUBLOANS BY ECONOMIC RATES OF RETURN Loan 1712-ME Loan 1560-HE No. Amount No. Amount of Mex $ of mex $ Credits (Millions) z Credits (Millions) I Less than 15? 23 9007.34 8.60 9 404.14 10.56 From 162 to 202 4 419.53 1.80 7 424.08 11.08 From 212 to 25? 16 2540.09 10.88 4 204.91 5.36 From 262 to 30? 14 2372.34 10.16 8 397.11 10.38 From 31? to 35Z 15 1819.09 7.79 6 353.54 9.24 Greater than 35? 103 14187.10 60.77 40 2042.48 53.38 TOTAL 175 23345.49 100.00 74 3826.26 100.00 AUTHORIZED SUBLOANS BY FINANCIAL RATES OF RETURN Loan 1712-ME Loan 1560-HE No. Amount No. Amount of Mex $ of Mez $ Credits (Millions) ? Credits (Millions) 2 Less than 15? 28 2375.09 10.17 17 1025.61 26.80 From 16? to 20? 44 5898.86 25.27 27 1529.55 39.98 From 21? to 25? 24 3665.04 15.70 8 440.30 11.51 From 26? to 30? 23 2361.76 10.12 8 350.87 9.17 From 31? to 352 21 4014.35 17.20 8 278.03 7.27 Greater than 35? 35 5030.39 21.55 6 201.89 5.28 TOTAL 175 23345.49 100.00 74 3826.25 100.00 - 54 - ATTACHMENT 12 Page 1 of 2 HEXICO INDUSTRIAL RECOVERY PROJECT Summary of the Sistema do Pagos al Valor Presente (PVP) In an inflationary environment such as that in Mexico, in which high nominal interest rates prevail, long-term loans, if available at all, have--in real terms--only short maturities. The attached table shows an example which explains this phenomenon as well as two different ways to deal with it--an indexing mechanism and the PVP scheme. - In a regular loan (section 1 of the table), the outstanding balance (column 2) declines with the principal payments (column 3); the interest payments (column 4) are being based on the outstanding principal. Deflating the total annual payments in nominal terms (column 5) with the accumulated inflation rate results in the total payments in constant prices of year zero (column 6). This column does not repre- sent a net present value; rather, it contains an undiscounted cash flow in real terms. In the example, the borrower would, in real terms, have to repay some 80 of the 10-year loan after three years. Even the introduction of a grace period would not solve the problem; the real maturity of the loan remains short. - An indexing mechanism (section 2 of the table) solves this problem through the adjustment of the principal with an inflation index. Thus the outstanding balance of the loan and, with it, the principal repayments grow with inflation while the interest payments are being based on the real (deflated) interest rate. The distribution of the annual total payments in constant prices is, therefore, as it would be without inflation. - The PVP scheme represents a different solution to the cash flow problem (section 3 of the table). Instead of adjusting the outstanding balance with the inflation rate, it capital- izes interest payments. A loan is being split into its indi- vidual maturities; for each of these maturities, interest is being accumulated over time and paid only once the respective maturity becomes due. Thus interest is not being paid on the average outstanding balance in a given period, but is accrued and paid for each maturity individually. As a result, pay- ments in real terms increase slowly and would therefore correspond better to the cash flow of an investment project. To avoid a period without payments for the borrower, a PVP loan does not carry any grace period. Sourcet Staff Appraisal Report, Industrial Recovery Project, Loan No. 2746 (Report No. 5904-ME), pp. 15-16. -55 - ATTACMENT 12 Page 2 of 2 NEUICO INDUSTIIAL RECOVERY PROJECT Cmparison of Kegular, Indexed and PVP Loans ASSIPTIONS Grace Period (leg. Loan) 0 Inflation Rate 502 Grace Period (PVP Loan) 0 Nominal Interest Rate 602 Maturity (Years) 10 Real Interest lat* 7Z OUTSTANDING PRINCIPAL INTERST TOTAL REAL PAYMENT YEAR BALANCE PAYMENT PAYMENT PAYMENT PAYMENT DTFFERENCE (1) (2) (3) (4) (5) (6) (7) 0 100 0 0 0 0 0 RZ~LOMN 1 100 10 60 70 47 0 2 90 10 54 64 28 0 3 80 10 48 58 17 0 4 70 10 42 52 10 0 5 60 10 36 46 6 0 6 50 10 30 40 4 0 7 40 10 24 34 2 0 8 30 10 18 28 1 0 9 20 10 12 22 1 0 10 10 10 6 16 0 0 IN==n LOAR 1 150 15 10 25 17 30 2 203 23 13 36 16 12 3 270 34 18 52 15 2 4 354 51 24 74 15 -4 5 456 76 30 106 14 -8 6 570 114 38 152 13 -10 7 683 171 46 216 13 -11 8 769 256 51 308 12 -11 9 769 384 51 436 11 -11 10 577 577 38 615 11 -10 PVP LOAN 1 100 10 6 16 11 36 2 90 10 16 26 11 17 3 80 10 31 41 12 5 4 70 10 56 66 13 -3 5 60 10 95 105 14 -8 6 50 10 158 168 15 -11 7 40 10 258 268 16 -14 8 30 10 419 429 17 -16 9 20 10 677 687 18 -17 10 10 10 1090 1100 19 -19 -56 - ATTACUNRT 13 MEXICO THIRD AND FOURTH INDUSTRIAL sQUIPMENT FUND (F01) PROJECTS (LOANS 1560-NM AND 1712-1H) BALANCE OF RANE LOANS AS OF NOVEMBER 30, 1983 (US$ Millions) Loan Loan Amount Number Total, all 82 loans (A + B) 6,486 A. 53 Loans Fully Disbursed 2,887 B. 29 Loans Ongoing 3,599 C. 16 ongoing loans with sub-lending 2,432 interest rate components Medium Cities Water Supply 40 1186-ME Tropicai Agriculture 56 1153-ME FONEI IV 175 1712-ME Small-Medium Mining 40 1820-ME Second Small-Medium Industry 100 1881-ME Seventh Agricultural Credit 325 1891-NE Medium Cities Water Supply 125 1913-ME Rainfed Agriculture 280 1945-1E Urban II 164 1990-MB PIDER III 175 2943-1E Capital Goods Industries 152 2142-NE Pollution Control 60 2154-1E Agricultural Marketing for Perishables 115 2262-1E Third Medium Cities & Sinaloa State Water Project 100 2281-ME Third Small-Medium Industry 175 2325-1E Export Development 350 2331-ME D. 13 Other Ongoing Loans 1,167 Share of C as Z of B 67.6% Source: IBRD Statements of Loans. -7 - ATTACHMENT 14 Page 1 of 2 I BAN K 0 F MEXIC 0 1 I Mexico, D.F. . April 25, 1989 I Mr. Alexander Nowicki The World Bank Washington, D.C. Dear Mr. Nowicki: Thank you for the copy of the draft version of the PPAR on Mexico's third and fourth Industrial Equipment Fund (FONEI) projects, loans 1560-ME and 1712-ME, and for your request for my comments. In general, I regard the report as a good one, although the country has in many senses moved beyond the circumstances it depicts. In the last few years, Mexico's economic structure has gone through far-reaching changes that will put it on more solid foundations and result in an early return to the path of sustainable growth. As the last few lines of the Preface correctly note, the Government has instituted new policies designed to correct the problems identified in the report. Accordingly, it should be pointed out that the recommendations made will depend on the success of such policies, especially those that affect delimitation of the functions of the development banks. For the rest, I would like to refer to specific points made at different stages in the text of the report: Paras. iv and 5-7: To ensure that the Summary gives a clearer picture of Mexico's circumstances, para. iv should quote paras. 5-7, which give the history of our process of trade deregulation. Some recent changes should also be noted: Whereas 5,214 Tariff subheadings (accounting for 78.4% of the total value of Mexican imports) out of a total of 8,000 were subject to prior authorization requirements in December 1984, by the end of 1988 such requirements affected only 315 subheadings (accounting for 23% of the value of imports) out of the new total of 12,000. Paras. v and 9-10: These paragraphs contain a number of erroneous statements. For one thing, Mexico's trtst funds are financed not from legal reserves but with budget appropriations. The credit the Bank of Mexico directs through trust funds does not necessarily come from the proceeds of legal reserve requirements; and instead of being channeled to a growing number of funds, it is actually limited to a shrinking number of them. Furthermore, the trust funds, regarded as second-tier banks, do not number 204; there are fewer (FOPROBA and FOSOC were eliminated). - 58 - ATTACHMENT 14 Page 2 of 2 Paras. vii and 14: The report should note that tax measures have been introduced recently to eliminate the old bias in favor of debt-financed 4nvestment and against equity financing. Since 1987, it has not been possible to deduct nominal interest when calculating income-tax liability. Paras. xii and 52: Para. xii of the Summary closes with the statement that if FONEI lending had been limited to, or largely concentrated on, export-oriented or import-substitution projects, as was the Bank's original intent, then the results would have been much better. This assertion contradicts not only the facts but something that is corroborated in the report itself, namely that there is abundant evidence of FONEI's efforts to promote efficient export and import-substitution ventures. There is no justification for casting doubt on that evidence (para. 52) by pointing to the many subloan cancellations; to state that they were cancelled because they were not in line with FONEI's real objectives, or because they were not actually profitable, is to be unaware that investment decisions always have an element of uncertainty and that this was very much the case in the years in question here. Para. 66: The proliferation of development banks and trust funds is said to have served to transfer large credit subsidies, "conservatively" estimated at around 4% of GDP, to favored borrowers. Although no generally accepted method exists for making such estimates, this one is clearly an exaggeration: Bank of Mexico calculations put the figure at between 1% and 1.6% for the period 1984-1986, less than half that given in the report. Paras. 65 and 70-73 (among others): According to the report, FONEI interest rates were based on the average cost of funds (ACF) and were expected not to log behind inflation, but in actual fact they did lag, with the result that large capital losses ensued. However, there is every indication that the report compares the "nominal" ACF directly with the annual inflation rate (Table 7, para. 72), without adjusting for the compounding of interest rates that banks regard as usual and which should be indicated in FONEI's case. (For instance, the monthly or quarterly compounding of an interest rate equal to the ACF shows no accumulated lag with respect to inflation for 1980-1986, contrary to Table 7.) These figures should be reconsidered, as should the analyses underlying the statement that the real ACF was negative and of the capital losses sustained by FONEI. Paras. xvii, xviii and 74-81: With regard to the options for altering the structure of Mexico's development banking and trust fund sector and redefining its functions, it should be made clear that appraisal and final selection will depend on the outcome of the new Government's policies and on the plans drawn up for the necessary detailed restructuring. Yours, etc. /s/ Marin Mayd6n Garza Director, Trust Fund Development and Operations ATTACHMENT 15 59 - Page 1 of 3 COMMENTS RECEIVED FROM FONEI (Translation from Spanish original) F 0 N E I FONDO DE EQUIPAMIENTO INDUSTRIAL Mexico, D.F. May 2, 1989 Mr. Alexander Nowicki Chief, Division II, Policy-Based Lending Industry, Public Utilities & Urban Sectors Operations Evaluation Department The World Bank Washington, D.C. Dear Mr. Novicki: Herewith our comments on the draft of the Project Performance Audit Report on Loans 1560-ME and 1712-ME, which we trust will be of use to you in preparing the final version. We should first like to say that we find the PPAR a valuable document and in general terms consider its observations to be pertinent, thorough and penetrating. FONEI proposes to use the observations as guides in its own evaluation of its use of funds obtained from the World Bank and other sources, an exercise that is expected to be revealing and to pay dividends in the near future by providing it with firmer foundations on which to design and carry out its own lending operations. Since the macroeconomic environment prevailing at the time these two projects were being implemented is discussed only in very general terms in the PPAR, we would also like to see an analysis of factors that had a direct impact on project results, and a clear distinction drawn betwzen those with objective links to the economic and financial crisis and those associated with operational and policy questions. Although the results of both projects were less satisfactory than expected, given the sharp devaluations and severe cont'action of the domestic market produced by the crisis, they were nevertheless better than the averages in their sector. Obviously, the general difficulties substantially altered the environment in which the projects were carried out, making it very different from what the World Bank's appraisal reports had envisaged. This created a situation that FONEI had to respond to imaginatively and carefully, ATaIUnT 15 -60 - Page 2 of 3 which it did by fostering new financial support programs that met the borrowing needs of a major segment of the industrial sector and were focused from a market rather than a product standpoint. Through this approach, FONEI was able, first, to identify borrowing requirements and characteristics in its own natural market, and then to design a response that could be fine-tuned as experience dictated -- instead of the reverse process. Consequently, the programs developed to meet the 1982 crisis possessed great flexibility both in the design sense and as operating tools. It is our view that this capacity to respond would not have materialized had FONEI been governed by a rigid set of laws supposedly able to accommodate all eventualities in territory that was still unfamiliar. Instead, the agency is governed by its own Operating Rules and Regulations, which define objectives and policies but contain no details as to procedure. While it is this flexibility that has enabled FONEI to advance with purpose and direction and give concrete form to some of the proposals mapped out in its various programs, its management nevertheless recognizes the need for improved activities planning, a goal not yet satisfactorily achieved becau-e of a shortage of staff, which has also to some extent prevented the agency from servicing other segments of the market and/or expanding its field of action. There now follows a series of specific comments on the characteristics of FONEI's operations and its development as an institution: The reference in para. x of the Summary to the "excessive" (sic] concentration on financing well-established medium and large firms in certain sectors needs to be put in the right context. The sample of firms listed in Attachments 3, 4 and 5 does not cover the group of firms assisted through loans 1560-ME and 1712-ME and is not representative of the universe of firms FONEI has financed since its beginnings. Although Attachment 5 does indicate that a very small number of firms carry out a high proportion (52%) of all projects financed by FONEI, this is reasonable considering the extensive portfolios of R & D programs maintained by such firms as Fabricaci6n de M4quinas, S.A. (FAMA), Industrias Polifil, S.A. de C.V., Zndetelec, Industrias Resistol, S.A. (IRSA), and Pigmentos y Oxidos, S.A. (PYOSA). As the data provided by Attachment 5 do not correspond to loans 1560-ME and 17?.2-ME, sound evaluation would require that attention be restricted solely to distribution of their proceeds as reflected in subloan activity during the disbursement period in the fields under scrutiny. Thus, if the aim is to analyze distribution of the proceeds of loans 1560-ME and 1712-ME by size of recipient firm, branch of activity, location and/or industrial group, the best way -- methodologically speaking - is to look at volume of resources and not number of projects. Accordingly, We are forwarding a list of the subloans authorized and their key features. ATTACMNT 15 -61 - Page 3 of 3 Certainly, FONEI's Operating Rules and Regulations provide that firms of all sizes should be able to obtain assistance. However, given the variety of financial support instruments available in Mexico, FONEI has concentrated mainly on medium and large firms where its traditional equipment and working capital program-is concerned, but in the area of technological development about 80% of the firms it finances are small or medium in size. Financial support on preferential conditions tailored to their needs is available to very small, small and medium firms through other instruments. Even supposing that FONEI proposed to support this segment of the market, it would prove very costly given the staffing constraints under which the agency operates: as firms of this type require considerable technical assistance, FONEI would have to expand its appraisal staff accordingly. Lastly, in connection with para. xiii of the Summary, we wish to draw attention to some aspects of FONEI's efforts to persuade commercial banks to base their decisions on project feasibility rather than on the collateral a loan applicant is able to offer. It has done this through its own Training Department by offering specialized instruction in systematic appraisal of investment projects. The effects of this training and the increasingly widespread use of the appraisal methodology developed by FONEI itself, rather than duplicating appraisal functions, have added a complementary dimension to the process of analysis on which decisions are based. We trust these comments and information will prove useful and would be happy to provide any clarifications you might find necessary. Yours, etc. FONDO DE EQUIPAMIENTO INDUSTRIAL Copies to: Secretariat of Treasury and Public Credit: Messrs. Antonio Cervera Sandoval & Jorge Espinosa de los Reyes NAFINSA: Mr. J6sus Villaseior Gonzalez Bank of Mexico Dr. Marin Mayd6n Garza - 62 - )DIECION AGlAJNTA FINANEA ATTACHINT 16 Page 1 of 1 COMENTS RCIVED FRCH NACIONAL FIZAnCIERA (Translation from Spanish original) April 23, 1989 Mr. Alexander Nowicki Division Chief Policy-Based Lending, Industry Public Utilities & Urban Sectors The World Bank This is in response to your letter of March 10 requesting comments on the audit report on the results of the projects known as FONEI III and IV. I agree with the general contents of the document and, particularly, with its observation about the lack of consistency between the country's macroeconomic policies during those years and the objectives of the projects supported by PON1. Otherwise, it could have been interpreted as failures of this institution what was merely a demonstration of its capacity to respond. It was that inconsistency that led the authors of the report to rightly recommend that the World Bank should in the future adopt a global perspective. If, however, I mnst be critical, I would say that the report does not seem to recognize how right the Bank was in supporting an institution recognized as a model, even though the macroeconomic environment went in the opposite direction, because this support brought about a demonstration effect of what should be the desirable behavior for the rest of the sector. I have no doubts that the World Bank's support to an entity committed to structural change, such as was always the case with FONZI, gave positive results which today are evident. Sincerely, LIC. JESUS VILLASEAOR Deputy General Manager - 63 - PROJECT COMPLETION REPORT MEXICO THIRC AND FOURTH INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (LOANS 1560-ME AND 1712-ME) November 30, 1987 Trade, Finance and Industry Division Country Department II Latin America and the Caribbean - 65 - PROJECT COMPLETION REPORT MEXICO - THIRD AND FOURTH INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (LOANS 1560-ME AND 1712-ME) I. INTRODUCTION 1.01 Industrial Sector Lending Activity. The Bank has assisted Mexico's industrial sector with a number of operations, addressing the financial needs of specific target groups. These operations include four loans, totalling US$507 million, to assist small and medium industry; a loan of US$152.3 million for the capital goods industry; two loans totalling US$600 million for export promotinn (EDP-I and EDP II); a Loan of US$60 million to help reducu environmet;a contamination; and the five loans, amounting to US$510 million, to provide supplemental medium- and long-term financing for investment projects through Fondo de _qnipamiento Industrial (FONEI). In addition, in 1986 and 1987, the Bank approved two loans totalling US$ 1.0 billion for TPT I and TPL II to support Mexico's policy reforms to liberalize trade and , prove economic efficiency including the efficiency of the industrial sector. 1.02 FONEI was established in 1971 following intensive discussions betwee t Mexican authorities and the Bank on the design of appropriate mechanisms that would have a positive impact on the efficiency of the industrial sector as well as on the country's balance of payments. FONEI was set up as a trust fund managed by Banco de Mexico (BdM), Mexico's Central Bank, to provide financing, through commercial banks, for investment projects designed to increase exports and/or efficientky substitute imports. FONEI's operational objectives, as it became a more mature institution, also include contributions to more efficient allocation of resources through the financial system by inducing banks to make their lending decisions increasingly on the basis of comprehensive project appraisal, and promotion of industrial efficiency by encouraging enterprises to prepare detailed feasibility studies. 1.03 To help achieve the above objectives, the Bank has made Eive Loans to FONEI, totalling US$510 million. The first Bank loan was made to FONEI in May 1972 for US$35 million, followed by another loan for US$50 million in February 1976. This completion report reviews the third loan (1560-ME) of US$100 million, approved in May 1978, and the fourth loan (1712-ME) of US$175 million, approved in May 1979. A fifth loan for US$150 million was approved in 1986.1/ Because the impacts and effectiveness of 1/ FONEI also acts as implementing agency for Bank-supported projects for Capital Goods Industries (Loan 2142-ME), Pollution Control (Loan 2154-ME) and Technology Development (Loan 2747-ML). It also participates in the two Export Development loan& (2331-ME and 2777-ME). - 66 - FONEI's operations have been influenced by the prior and subsequent loans, this report deals not only with the results of the two loans under review but also examines the developments that have taken place in the operations of FONEI and in the strategy of the Bank during most of the disbursement period of the loans, i.e., 1979-1985. 1.04 The OED Performance Audit Report for the first and second FONEI loans, prepared in 1979, concluded that FONEI had been an effective mechanism for allocating and channeling resources to sound projects. Rowever, the report suggested that FONEI should address itself to projects which are marginal under the participating banks' traditional requirements, intensifying FONEI's promotional activities to reach smaller firms. In the context of the third and fourth loans, understandings were reached with FONEI on the measures that would be taken to address this particular shortcoming identified by the Bank (paras. 3.03 and 3.04). 1.05 Macro-Economic Setting and Sectoral Performance.2/ After a period of rapid growth during 1978-1981, the Mexican economy came to an abrupt halt in 1982, when the two loans were disbursing. GDP growth, which had averaged 8% p.a. between 1978-1981, declined by 0.5%. Production dropped 11% from the 1981 level, and gross fixed investment, which had been growing in real terms by 25% to 30% during 1978-1980 and some 15% in 1981, fell strongly by about 16% in 1982 (Annex 1). At the same time, the fall in imports (by about 38%), reflecting both the imposition of controls and decline in demand, led to a substantial trade surplus. Further difficulties were, however, experienced in obtaining external funds so that the Government was forced to introduce major policy and institutional changes, the most salient being rigorous control of foreign exchange transactions, a dual exchange rate system, nationalization of the domestic commercial banks, and the mandatory conversion into pesos of the U.S. dollar accounts held in Mexico as they matured. 1.06 The most significant factors that adversely affected Mexico's industrial sector during the economic crisis, -had been the (a) deterioration of the cash flow position of enterprises because of foreign debt service, higher inventory cost and increasing accounts receivable, all leading to a general squeeze on liquidity; (b) major changes in cost structure of investment projects as accumulated inflation during 1982-1983 exceeded 150% and successive devaluations amounted to some 450%; and (c) slackening of demand for industrial investment as the grcwth in GDP slowed down in 1982 and dropped by some 4% in 1983- 1.07 To alleviate the difficult situation, the Government took several measures in favor of industrial activity, including the provision of emergency liquidity to affected companies through special assistance programs, via various agencies, including FONEI, and the introduction of an accelerated depreciation scheme for new investments. The Government also 2/ Source: Mexico, Industrial Recovery Project, Staff Appraisal Report No. 5904-ME, July 10, 1986. -67- established the Fideicomiso para Ia Cobertura de Riesgos de Cambios (FICORCA) in 1983, with a long-term currency and interest swap mechanism that enabled private companies to pay their foreign debt in pesos at domestic interest rates and, at the sam time, to capitalize a portion of the interest payments. Complementing Government efforts, the Bank introduced a Special Action Program (SAP) for Mexico in 1983-1985, involving modifications of various Bank-assisted loans. This included the amendment of the fourth loan, which suffered substantial cancellations of previously approved subloans during the crisis, to increase disbursement percentages of eligible expenditures and allow working capital financing. Although the recovery began in 1984, the industrial sector still faces some constraints, including the weak financial condition of industrial companies, and the need to upgrade the competitiveness and efficiency of Mexican firms. 1I. PREPARATION AND APPRAISAL OBJECTIVES Loan Preparation 2.01 The continued economic recovery during 1978-1979 had spurred considerably industrial investments in Mexico, as reflected by FONEI's large pipeline of subprojects. Given this situation, the preparation of the fourth loan was started in October 1978, a month after the signing of the third loan. Several issues identified during the appraisal of the respective projects in November 1977 and January 1979, including increased financing for medium-sized enterprises and the introduction of special components for technology improvement and pollution control subprojects, as well as financing of service export subprojects, were dealt with properly, and the projects advanced smoothly through the Loan Committee stages and negotiations. Appraisal Objectives 2.02 The third loan of US$100 million and the fourth loan of US$175 million were made in May 1978 and May 1979, respectively. The Bank's main objectives in making the third and fourth loans were basically similar and reflected the concerns of the Bank under the previous two loans. Primarily, the Bank sought to continue supporting efficient projects expected to have a substantial economic and employment impact, and increasingly those sponsored by medium-sized enterprises and enterprises located outside of Mexico's three principal cities (4exico City, Guadalajara and Monterrey). In addition, under the fourth loan, the Bank expected to help upgrade the competitiveness and efficiency of Mexican firms through technology development projects, and help reduce pollutioA from existing industrial plants and equipment. The Bank also expected to continue helping FONEI achieve institutional improvement, including increased involvement of Mexican banks in project - 68 - appraisal and project supervision; increasing the scope of FONEI's operations and promotional activities; and strengthening the project appraisal and supervision capacity of the FONEI system.3/ 2.03 During negotiations of the fourth loan (1712-HE), understandings were reached with FONEI on the arrangements that would be made to encourage a wide distribution of FONEI's resources among industrial enterprises. First, as in the third loan, an upper limit of USS5 million was set for the amount of Bank financing that could be used in any one subproject to avoid an excessive concentration of Bank resources and to encourage those sponsoring large subprojects to seek alternative sources of financing. Second, FONEI would also establish a normal limit of Mex$ 300 million for loans to a single enterprise, and revise its system of spreads to give an additional margin to intermediaries for loans to medium-sized and smaller enterprises (para. 3.03). With the above measures, it was expected chat about 40% of total financing under the fourth loan would be utilized for medium-sized enterprises, defined as enterprises with equity below MexS 50 million. Also, about 60-80% of the funds under the two loans was expected to go to projects outside Mexico City, Guadalajara and Monterrey, thus contributing to industrial decentralization and regional development. 2.04 The socio-economic impact of both projects under review was expected to be substantial. It was estimated that the third loan would help FONEI partially to finance 80..aubprojects, generating 13,000 to 16,000 new direct jobs at an average investment cost per job in the range of US$26,000 to USS33,000. The subprojects financed under the third loan were also expected to generate foreign exchange earnings or savings of about Mex$ 3 billion annually (about US$130 million equivalent). Under the fourth loan, some 22,000 to 26,500 new direct jobs were expected to be created by 150-160 subprojects at an investment cost per job of US$27,000 to USS34,000. The economic rates of return on the investment subprojects financed under the fourth loan were expected to average between 15-40%. Foreign exchange savings or earnings of about US$2 billion during the first five years of operation of subprojects were expected to be generated. 2.05 The extent to which the appraisal objectives, including the specific institutional building objectives, were achieved, is described and reviewed in the following two chapters. 3/ Originally, the fourth loan was also expected to finance a human resource study aimed at improving the planning process to help ensure availability of adequate manpower in the future for Mexico's industrial development.. However, subsequent to loan signing, in July 1979, the Government decided it would be more practical to assign other resources to meet the costs of studies, and requested a reallocation of the USS2 million to FONEI's general operations. -69- III. UTILIZATION OF LOAN PROCEEDS Resource Transfer 3.01 After a four-month delay due to legal problems, the third loan was signed in September 1978, and became effective in January 1979. To accoemodate a large backlog of subprojects, retroactive financing of up to US$15 million was allowed under the loan. The utilization of the proceeds of the third loan was in line with expectations. It was practically committed by the target date of June 30, 1980. Nearly 98% of the loan funds were disbursed as of the original closing date of June 30, 1982, with final disbursements made in November 1982 (Annex 2). The fourth loan, for USS175 million, was approved in May 1979, and became effective in October 1979. It was fully committed as of March 31, 1982, about nine months after the original terminal date for submission of subprojects. However, due to the subsequent high level of cancellaticns, resulting from the economic crisis in 1982, the final date for submission of subprojects was extended five more times to June 30, 1985, to allow full commitment of loan proceeds. Disbursements also proceeded behind appraisal estimates. The original closing date was extended twice from June 30, 1984 to June 30, 1986. To help alleviate the difficulties slowing down project implementation, under a Special Action Program (SAP), which was undertaken by the Bank for Mexico in 1983-1985, the fourth loan was modified to increase disbursement percentages for eligible payments (from 25%/50% to 70% of total expenditures for civil works, locally produced goods, technology improvement projects and training activities) made under the loan between July 1, 1983 and June 30, 1985. Financing of working capital requirements was also allowed under the loan. In addition, a special account was established under the loan in 1984-1985 to further speed up the disbursement process. Nearly 93% of the proceeds of the fourth loan were disbursed by December 1986. The undisbursed balance of US$11.1 million equivalent was cancelled in March, 1987. Characteristics of Lending 3.02 FONE1 financed, through the Bank's four loans, a total of 363 subprojects, of which 266 (73%) represent the share of the two loans under review. The US$262.5 million finally disbursed under the two loans were spread among 78 subprojects under the third loan, and 188 subprojects under the fourth loan, with a total investment cost of MexS 96.0 billion (USS1.1 oillion equivalent, 4/ of which 82% was for fixed assets and the balancefor permanent working capital. Annex 3 provides the major characteristics of these subprojects, which are further analyzed below (paras. 3.03-3.18). 3.03 Size of Subloans and Sponsoring Enterprises. Standard subloan amounts under the two loans ranged from US$10,000 to US$5 million, with the average size amounting to USS1.1 million. About 10% of total financing went into 128 subprojects (39% of total), each of a size lower than *IexS 50 4/ At average exchange rates for the period 1979-1985 when the loans were being commited. - 70 - million. Together with subloan size of up to Hex$ 100 million, total financing amounted to about 39% for 237 subprojects (73% of total). Using the "free limits" established under the third loan of US$1.5 million and US$2 million under the fourth loan, about 44% of the number of Bank-financed subprojects, involving US$80.2 million, under the third loan, was subject to prior Bank approval; the corresponding figures for the fourth loan were 31% and US$98.9 million, respectively. However, FONEI's efforts to increase lending to medium-sized enterprises had moderate success. If the firm sizes are classified according to equity, as provided under the third and fourth loans, about 11% of total disbursements under the two loans were accounted for by firms with equity below Hex$ 50 million, as compared with 40% estimated to be lent to medium-sized enterprises at the time of project appraisal. 3.04 The predominance of larger companies among sub-borrowers was also a characteristic of the first two FONEI loans. Arrangements were included in the subsequent two loans to ensure a greater dispersion of Bank funds and to encourage lending to medium-sized enterprises. To encourage intermediaries to reorient their lending somewhat toward medium-sized enterprises, FONEI amended its Operating Regulations, as a condition of effectiveness of the fourth loan, to include a system of differential spreads to intermediaries bAsed on size of borrowing enterprises and appraisal responsibility (para. 4.05).5/ It also introduced credit risk sharing arrangements for medium-sized and smaller enterprises, subordinating its portion of individual subloans to that of the intermediary's.ob. FONEI's Promotion Department was created in 1979 to achieve wider geographical dispersion of FONEI-financed subprojects and help reach more medium-sized and less-established enterprises (para. 4.11). FONEI established limitations for loans to a single enterprise and for a single subproject, which currently amount to 5% and 31 of FONEI's total assets, respectively. An upper limit of US$5 million of Bank funds for subloans to a single subproject was also established under the two loans. 3.05 Subiroject Investment Cost. The total investment cost under the third project amounted to nex$ 12.5 billion as compared to Mex$ 9.7 billion estimated at project appraisal; under the fourth loan, the corresponding figures were Mex$ 83.6 billion and Mex$ 16.8 billion (Annex 4). This unusual 5/ FONEI provides the intermediary an additional spread of 0.25% for loans to larger enterprises, and 0.5% for subprojects evaluated for medium-sized and smaller enterprises. Total spreads to financial intermediaries range from 2% to 2.75%. 6/ During 1980-1981, FONEI collected data on how many banks had lowered their collateral requirements, which showed that, while the process of reduction was slow,.there was a.growing number of banks which based their financing on credit risk. - 71 - increase in the actual investment cost over appraisal estimate under the fourth loan is largely explained by the effects of high level of inflation and successive devaluations of the Mexican peso during the implementation of most of the subprojects (pares. 3.06), as well as by the 66% increase in the number of subprojects financed over appraisal estimate. Consequently, the average investment cost of FONEI-financed subprojects grew from MexS 141 million under the third loan to Mex$ 363 million under the fourth loan, as compared to MexS 51.1 million under the first loan and MexS 109.1 million under the second loan. 3.06 As can be seen from Annex 5, which provides actual data on a sample of 35 subprojects financed under the two loans, there.was a wide range of dispersion between estimated investment cost at the time the subprojects were approved and at the time of subproject completion. Only three of these subprojects were completed without exceeding estimated fixed tnvestment costs, with the actual investment costs of the 35 subprojects exceeding by 103%, on average, the original forecast. Although price contingencies were included in the cost estimates, these proved inadequate since inflation exceeded considerably projected levels. FONEI provided additional financing to partly cover these cost overruns. Only two of the subprojects were implemented within the period contemplated at appraisal, with more than one-fifth showing delays exceeding one year. 3.07 The Bank subloans under the two loans financed 30% of the cost of fixed investments of Mex$ 78.3 billion (Annex 4). The remainder was financed by FONET (10%), the sponsors' own resources (32%), the participating banks (11%), by FONEI (10%) and by other sources (17%). Overall, the distribution of funds used to finance the actual investment cost was well in line with appraisal expectations. 3.08 Subproject Types. More than 50% of the equipment subloans financed under the two loans were export-oriented, while the rest were purely import-substitution subprojects. The significant number of export-oriented subprojects reflects the upsurge of Mexican industrial exports as a result of a suppressed local demand and a drastic currency devaluation. In relation to total financing, the share of export-oriented subprojects amounted to 54% under both loans, while the remainder was accounted fjr by purely import substitution subprojects (para. 3.17). 3.09 Mainly because of the economic and financial crisis, only about one-third of the equipment subloans were for new enterpri3es under the two loans. FONEI concentrated its financing in expansion and modernization type of subprojects (159 subprojects, involving 58% of total financing); financing of new enterprises (97 subprojects) accounted for 33% of total financing. Additional equipment financing was made for 20 subprojects (6% of total), involving 4% of total value, to cover cost overruns. 3.L0 Sectoral. Distribution. The metal products subsector, as under the first two loans, was the most behefited, with 46 credits under the-third loan and 102 under the fourth loan (52% and 44% of the respective total subloans). The second largest group of subprojects financed was in the -72- chemicals subsector, accounting for-15% in number and 10% in value tnder the third loan, and 19% and 21%, respectively, under the fourth loan. Together, under the two loans, these two subsectors covered 64% of the number of subprojects and total financini. 3.11 Industrial Decentralization. Under the two loans, FONEI continued to support the Government policies to decentralize industrial growth. Over 80% of total financing under the third loan was approved for subprojects located outside Mexico City, which is well in line with appraisal estimate. Under the fourth loan, only 13% of total financing were made to subprojects located in Mexico City, with 26% in Nuevo Leon (including Monterrey), 10% in Jalisco (including Guadalajara) and 51% in other areas. Special Components 3.12 Under the first two loans, FONEI had only provided fixed asset financing for subprojects involving new or expanded capacity to produce industrial goods. Additional components were included in the subsequent two loans to (a) support the Government's border assembly industry program, (b) help upgrade the competitiveness and efficiency of Mexican firms and (c) help reduce pollution from existing industrial plants and equipment. 3.13 Service Export Subprojects. In support of the Government's objective to promote and assist selected projects designed to expand exports of services from the northern border zone of Mexico, the Bank established a maximunt amount of US$10 million under the third loan, which was maintained under the fourth loan, to allow FDNEI to finance the construction of factory buildings for lease to border industries, commercial centers and automotive service centers in border areas. Given its innovative nature, there were only five subprojects, involving commercial centers, that were financed under the two loans for US$3.6 million. Also, upon the establishment of the Fondo de Desarrollo Comercial (FIDEC), FONEI ceased financing service export subprojects. 3.14 Technology Development Component. The US$5 million technology component was introduced under the fourth loan to help fill the financing gap for enterprises with technology improvement projects relatively close to commercialization and with the capability to implement particular technical solutions either with internal resources or some external help. A total of US$0.8 million were disbursed for 17 subprojects, involving development of new products and production processes. Demand was restrained in part because of limited promotion by FONEI and the general slackening of industrial investment. Although the total amount of subloans committed under the component was small (mainly because of the small average size of the technology improvement subprojects), FONEI and the Bank have strongly -73- supported the continuation of such assistance under a "free standing" technology development project.7/ 3.15 Pollution Control Component. Another US$5 million was provided under the fourth loan to cover the purchase of equipment to control existing industrial pollution control probiems and the technical assistance required in the design and/or selection of such equipment. Ten pollution control subloans were financed under the loan for US$2.8 million. The experience under this component proved valuable in the preparation of the Bank's Industrial Pollution Control Project in 1982, in which FONEI is a major implementing agency.8/ Impact of Subprojects 3.16 Profitability and Efficiency. On an a priori basis, FONEI financed economically sound and efficient subprojects under the third and fourth loans. The ex-ante financial and economic rates of return (FRR and ERR) estimated forthe subprojects financed under the two loans vary from 15% to over 35%. The overall actual subproject performance, however, has been adversely affected by the financial and economic difficulties facing the Mexican industrial sector in general. With the accelerating rate of inflation and the depressed level of domestic and international markets, cost overruns and unsatisfactory sales performance were common among the suprojects financed under the two loans (Annex 5). The actual annual sales that can be attributed to the 35 subprojects in the sample amounted to only 55% of the expected value. More than 41% of the enterprises financed showed losses; while over 44% reported actual returns on equity less than expected. On average, the actual FRR of 12% and the ERR of 20% calculated for a sample of 20-randomly-selected subprojects were 40% and 52% lower than respective estimates (Annex 6). However, the actual ERR of 20% was well within the overall range of 15% and 40% estimated during appraisal of the fourth loan. 3.17 Balance of Payments IMpact. As indicated earlier, export-oriented firms accounted for over 50% of both the number of subprojects and total financing under the two loans. Based on a sample of 60 companies that exported during 1982-1986, the actual export performance of the subprojects financed, while less than expected, has been rather satisfactory, realizirg 7/ A technology development project (Loan 2747-ME) was approved for US$48 million in July 1986. 8/ Following the economic crisis, the Government has been reluctant to enforce existing pollution control legislation. Because of inadequate demand, of the total US$60 million approved in 1982, US$35 million was cancelled in August 1985. At the request of the texican Government, the undisbursed balance of the loan (US$11.9 million) was cancelled on September 30, 1987 after the Bank agreed to finance up to US$10 million of subloans for pollution control projects under the Industrial Recovery Loan (2746-ME). - 74 - about 84% of export targets (Annex 7). While 34 companies did not fully meet their export targets or failed to export at all, LO exceeded their export targets by over 60%, on average, and 16, with no export plans, started to export their products. Another sample of 20 enterprises producing import substitution goods during 1984 showed that they were able to substitute about Hex$ 22,347 million of imports, over 50% below the original forecast of Hex$ 49,862 million (Annex 8). Notwithstanding the less-than-expected performance of the above samples of firms, the overall results appear to have achieved a positive impact on the country's balance of payments. 3.18 Employment. In addition to their favorable impact on 1exico's balance of payments and industrial decentralization, the subprojects financed under the two loans contributed significantly to employment generation in Mexico. Based on the data for subprojects, for which estimates are available, 30,812 jobs were expected to be created, 15,464 under the third loan and 15,348 under the fourth loan. The average investment cost per job created of about US$26,000 under the third loan is well within the US$33,000 appraisal estimate; while US$43,500 under the fourth loan was relatively high compared to the US$34,000 forecast. Also, the total employment effect of Bank-assistea subprojects is probably higher than indicated by the direct employment geners .ion since indirect employment effects (through backward and forward linkages) had not been included. IV. INSTITUTIONAL DEVELOPMENT 4.01 In the third and fourth loans, the Bank continued to focus on building the institutional capabilities of FONEI, supporting itR efforts to improve the project appraisal and supervision capabilities of participating intermediaries. This section reviews the institutional developments that have taken place during 1979-1985, concentrating mainly on those aspects about which the Bank expressed concern during the course of project implementation. In line with the emphasis of the Bank over the period under review, this section will give relatively more attention to the adequacy of FONEI's support and promotional role vis-a-vis the participating intermediaries and sub-borrowers. The Institution: FONEI 4.02 Through the successive four Bank loans, FONEI has developed into a stronger and more mature financial institution, highly regarded by industrialists and banks in Mexico. It contributed to efficient allocation. of resources and promoted industrial efficiency by pushing to encourage the financial intermediaries to make their lending decisions on the basis of comprehensive project appraisal and the sponsoring enterprises to prepare detailed feasibility studies (para. 4.07). It has become an important source (if technical assistance for banks and industrialists through external training programs on project preparation, appraisal and supervision as well as a variety of special topics (para. 4.12). With the resource gap in Mexico, which has persisted- since the 1982 economic crisis, and the related -75- need to reorient the country's industrial structure and development strategy, FONEI played a- particularly important role in the development of the industrial sector, with the various initiatives it took over the years. FONEI has become an efficient instrument in implementing new subsector development strategies, including technology improvement, pollution control and capital goods industries development. To better address the financial needs of its clients, FONEI introduced financial restructuring programs, including working capital, optimization installed capacity and, more recently, equity financing (paras. 4.18 and 4.19). Recognizing the importance of increasing the competitiveness of the Mexican industry, FONEI intensified its technology development program, inducing increased interest among entrepreneurs in developing technological mastery (para. 4.19). 4.03 FONEI introduced an adjustable interest rate mechanism which for practical purposes, served as a model for establishing a broad interst rate structure for Bank operations in Mexico (para. 4.20). More recently, FONEI also introduced the payment-by-present value system ("sistemas de pagos al valor presente") for subloans. With these financial policies and its careful management of its lending programs, which have significant subsidy elements, FONEI was able to maintain a sound financial standing. Management, Staffing and Organization 4.04 During the period under review, FONEI has continued to operate effectively under the competent and dynamic leadership of its Director, who has held-the position since 1976 and the close direction and guidance of its Board (called Technical Committee), which is FONEI's highest decision-making body. To cope with its expanding operations, FONEI staff increased from 59 in 1981 to 81 (including 44 professionals) in 19P'. Rowever, due to the austerity program imposed in 1982-1983, several authorized positions and vacancies, arising from staff attrition, were not filled. The understanding affected the overall operational performance of FONEI during the period. The Bank was particularly concerned about the need to strengthen FONEI's Technology Development Division and the work under its Pollution Control Program. While efforts were made in 1984 to remedy the situation, no further increase in the number of FONEI staff was made until early 1987, when the new organizational scheme was approved by BdM, involving a total of 98 staff positions, 57 of which are professional (Annex 9). FONEI's recruitment efforts, however, have been hampered by salary restrictions within BdM as well as by limited internal career prospects, which make it difficult for FONEI to compete with the private sector and the commercial banks in personnel recruitment and retention. Given these constraints, FONEI is reviewing its recruitment and personnel management strategy. Project Monitoring and the Role of Financial Intermediaries 4.0-5 - A total of 26 banks discounted loans with FONEI during 1979-1986. Over 50% of the loans were made to five banks--Banco Nacional de Kexico, Banco Internacional, Banco Mexicano Somex, Bancomer and Banco de - 76 - Cedulas Hipotecarias (Annex 10). These five institutions also held almost 50% of FONEI's outstanding portfolio, which is shared by 28 financial intermediaries (Annex 11). Banco Nacional de Mexico, the largest bank in Mexico, and Banco laternacional, a medium-sized bank by Mexican standards, were the most active ones, accounting for over 27% of all operations during 1979-1986. 4.06 Subproject Appraisal and Supervision. Through the successive FONEI loans, the quality of subproject appraisals has evolved satisfactorily. Its current appraisal procedures are well developed and fully meet Bank standards for subproject evaluation. The Bank approved 91 subloans which were above the respective free limits under the two loans. Overall, FONEI took the Bank's comments on these subprojects seriously and the Bank only declined to approve one subproject (REPSA) for technical reasons under the third loan. The Bank was helpful in alerting FONEI to potential problems, providing greater influence on the thoroughness and coverage of the appraisal submitted by FONEI. In recognition of the improvement in FONEI's subproject appraisdl capabilities, FOEI's limit vis-a-vis the Bank was raised from US$1.5 million under the third loan to US$2 million under the fourth loan for standard investment subprojects. 4.07 Under the two loans, the Bank has also continued to support FONEI's efforts to encourage participating financial intermediaries to make an important contribution to effective resource allocation through sound evaluation of investment projects. While this task turned out to be more difficult than anticipated under the first two loans, FONEI's efforts under the subsequent two loans have proved effective in strengthening the appraisal and supervision capabilities of participating intermediaries. Since the appraisal of the fourth loan, FONEI started granting higher spreads to intermediaries undertaking full appraisal of subprojects (para. 3.04). FONEI has also carried out a comprehensive external training program, covering project appraisal and supervision (para. 4.12). Since 1979, the participation 'f financial intermediaries in subproject appraisal has increased considerably; so that, starting in 1983, the participating banks have assumed full responsibility for the appraisal of all equipment subprojects, while the responsibility for the evaluation of technology development and pollution control subprojects still remains with FONEI.9/ The quality of appraisal submitted by intermediaries is generally satisfactory. 4.08 Practically, all banks that rediscount loans with FOMI accepted the responsibility to supervise their projects in accordance with the criteria set by FONEI. The participating intermediaries are required to provide FONEI with semi-annual supervision reports. Normally, FONEI concentrated on subprojects with implementation problems leaving to the intermediaries the follow up of problem-free subprojects. The quality of 9/ In reviewing technology and pollution control subprojects, FONEI draws on the-technical expertise of IMIT (Instituto Mexicano de Investigaciodes TeenoLogicas), CONACYT (Consejo Nacional de Ciencia y Tecnologia), etc. - 77 - their supervision reports has improved since the supervision program started in 1980. The number of reports received by FONEI from the intermediaries grew from 72 in 1981 to 354 in 1986, representing 73X of the total visits made during 1986 and 58% of the total clients (Annex 12). 4.09 Subproject Processing Time. Based on a sample of 16 subprojects that were approved by FONEI during 1980-1982 under the fourth loan, the average total processing time of subprojects, from the initial decision to loan signing, takes about 15 months, including 4 months from initial decision to the submission of the appraisal report, 2 months from receipt of the appraisal report to approval by FONEI, and another 9 months from FONEI's approval to loan signing (Annex 13). During the visits made by the PCR mission, the considerable delay in loan signing, arising mainly from completion of collateral requirements, has emerged as an issue with FONEI's client-enterprises. Recognizing this problem, FONEI has amended its Operating Regulations, allowing financial intermediaries up to six months to complete the loan signing, after which, FONEI cancels the loan.10/ 4.10 To further speed up the subproject appraisal process, and take advantage of the increased appraisal and supervision capabilities of many of 'the commercial banks, FONEI, in the context of the Industrial Recovery Loan, would simplify its appraisal and supervision process and delegate more responsibilities to participating intermediaries. 11/ 4.11 Repo.ting Requirements. During the course of project implementation, the Bank discussed with FONEI the need to further strengthen its project monitoring process by collecting, analyzing and reporting on overdue payments, supervision visits, collateral requirements and subproject processing time. FONEI found this information to be quite useful together with the other operational and financial information submitted to the Bank in the form of periodic reports. However, given the expanding activities and the development of its electronic data processing system, (para. 4.14), the Bank is carrying out a thorough review and modification of FONEI's reporting requirements, in the context of the Industrial Recovery Loan, to ensure that the frequency, timing and content of reports are in line with the Bank's project supervision needs. 10/ Previously, FONEI allowed the intermediaries nine months to complete loan signing. 11/ Under the riw procedure, if the subproject appraisal has been carried out by a project evaluator who has participated successfully in FONEI's training programs, FONEI would receive only a summary evaluation from the intermediary. FONEI would also simplify its supervision procedure by reducing general reporting requirements for smaller subpr.ojects,..as aell as the supervision of problem-free subprojects. * 78 Training 4.12 FONEI's institutional objectives include the development of the skills of financial intermediaries, consultants and companies involved in the appraisal and supervision of investment projects. FONEI has developed a rather comprehensive training program which was supported through a US*250,000 training comtp*nent under Loan 1712-ME. During 1979-1986, a total of 395 courses on industrial project preparation, appraisal and supervision, as well as other special topics, were given to 8,135 participants from banks (43%), industrial enterprises (21%), FONEI staff (17%), consultants (9%) and other (10%) (Annex 14). Certificates were issued to persons who have completed FONEI's project evaluation courses and submitted an appraisal report of acceptable quality. This certificate came to be highly respected by companies and financial intermediaries. The initiative of FONEI in designing and offering training courses enhanced FONEI's prestige and visibility and served as an effective promotional tool. 2/ Promotion 4.13 FONEI's promotion is undertaken through close contacts with financial Intermediaries, regular visits to companies eligible for FONEI financing and symposia to promote FONEI's credit lines. To help achieve a wider geographical dispersion of FONEI-financed subprojects, and reach nore medium-sized and less established enterprises, FONEI's Promotion Department was created in 1979. Headed by a subdirector, the department is directly involved in promotional activities and oversees the two promotional offices established in 1981 in Guadalajara and Monterrey. The promotional offices pay frequent visits to groups of bankers and industrialists in their respective regions to help identify and formulate projects, and to provide some assistance to intermediaries and clients experiencing minor project processing problems. However, despite current promotional activities stressing the full range of FONEI's services, FONEI is still perceived predominantly as a leader for fixe- asset financing. During project implementation, the Bank raised with FONEI the need for intensified promotional efforts for its non-traditional lending programs, including technology development (para. 4.19). In the context of FONEI's institutional development program under the Industrial Recovery Loan, FONEI will carry out an intensive promotion program.13/ 12/ In the context of FONEI's institutior.al developmert program under the Industrial Recovery Loan (2746-ME), a training program to develop FONEI's financial restructuring and engineering skills is being carried out. 13/ FONEI will implement a promotion program, consisting of the establishment of a promotion data base, design and implementation of a relationship nanagement program for its target clients, as well as monitoring of promotion effectiveness. - 79 - Management Information Systems 4.14 With the creation of its Information Systems Givision within the Technical Department in 1981, FONEI started to introduce a computerized data processing system. Basic data are now available on computers, and operattonal reports are generated on dis.,.sements, evaluation and supervision and other relevant statistical data. However, a number of systems are still operated manually, including the bulk of the finaucial planning and control process. evaluation and processing tools are still rudimentary and do not allow a comprehensive and decision-oriented evaluation process. Recognizing that improvements in this area are necessary, FONEI intends to expand considerably its electronic data processing system. The Bank would support FONEI's efforts in improving its information systems with a technical assistance component under the Industrial Recovery Loan.14/ 4.15 Accounting and Auditing. FONEI has continued to maintain satisfactory accounting records, including the documentation supporting disbursement applications processed under the statement of expenditure (SOE) procedure. In line with Bank requirements, FONEI has submitted an annual audit of its accounts and financial statements by an independent auditor (Alfonso Ochoa Ravize, a reputable Mexican auditing firm) within the six-month period proided by the Bank, except for a three-month delay in 1983. Over the period 1979-1985, FONEI's audit reports have been unqualified and consistently satisfacLory to the Bank. Operations 4.16 FONEI's loan approvals grew at an annual avarage rate of 35% in real terms in 1979-1981 (Annex 15). After declining by 16% in 1982-1983, due to the financial and economic crisis, FONEI's approvals picked up considerably in 1985-1986. With the ongoing industrial recovery, approvals grew in real terms by 32% in 1985 and 1986, while disbursements increased by 26%. 4.17 The high level of FONEI's activity and demand for its funds during 1979-1981 could be attributed to the buoyancy of the industrial sector, the liquidity constraints imposed on the banking sector as the Government attempted to contain inflation, the relatively attractive interest rates and terms available under FONEI loans and the increasing efficiency of FONEI staff and participating enterprises and commercial banks in preparing and processing projects. However, with the break-out of the economic crisis in 1982, FONEI's lending operations during 1982-1983 had been characterized by an unusually high leiel of cancellations of previously approved subloans, reflecting, above all, the falling demand and uncertainties about the '4/ The technical assistance component of US$1.5 million under Loan 2746-AHE covers costs o consultants' services, staff training and computer equipment. - 80 - recovery of the Mexican economy, as well as lack of internal resources among client enterprises. Due to devaluation and depreciation of the Mexican peso, as well as high inflation, insufficient working capital financing was one of the most serious constraints that faced the bulk of FONEI-financed enterprises. 4.18 As a follow-up of the special financial program to alteviate the above liquidity difficulties, which formed part of the Government program of financial restructuring of industrial enterprises, FONEI introduced in early 1983 two additional programs to provide working capital for financial restructuring (Working Capital Financial Programs), and minor equipment financing for upgrading, replacement and elimination of bottlenecks (Program for Optimization of Installed Capacity). 4.19 Equipment financing has continued to dominate FONEI's operations, w*th 70% of total 1979-1986 lending.* However, its non-traditional lending activities have had a significant impact on FONREI's orientation and structure of its operations (Annex 16). FONEI intensified its t2chnology development and pollution control programs. However, as a result of the economic crisis and the concomitant financial strains, many firms had been reluctant to invest in anti-pollution equipment. On the other hand, the economic crisis, the shortage of foreign exchange and the need to increase the competitiveness df the Mexican industry induced increased interest among entrepreneurs in developing technological mastery. The financial programs for working capital and optimization of installed capacity represented 10% and 3%, respectively, of FONEI's 1986 approvals. FONEI's technology development financing has also grown in importance, 15% of total FONEI's approvals in 1986 versus 3% in 1979, given the favorable terms and FONEI's risk sharing in theae instruments. 4.20 Interest Rates. Under the second loan, FONEI introduced the use of variable interest rates based on the average cost of funds (ACF or CPP)15/(Annex 17). This adjustable interest rate mechanism has been implemented successfully. FONEI loans were initially made at a cost of ACF + 2 to final beneficiaries.16/ In 1984, however, taking account of increases in market interest rates, FONEI's equipment lending --te was increased to ACF + 5. Subsidized rates are charged for other programs: ACF - 3 for both 15/ The ACF (CPP) index is an indicator of financial costs calculated monthly by Banco de Mexico. It is a weighted average of-interest rate (before tax) paid on financial bonds and certificates of deposit, instruments whose maturity varies from sight to one year. 16/ For practical purposes, FONREI's adjustabe interest rate mechanism served as a model for setting a more uniform and flexible interest rate structure for Bank's credit operations in Mexico under the General Agreement on Interest Rates Applicable to Credit Operations of Fondos de Fomento Financed by the International Bank for Reconstruction and Development (GIRA), signed in August 1984. - 81- pre-investment studies and technology development; 7/ ACF for pollation control; and ACF + 2 for capacity optimization and working capital.18/ Financial Performance -,nd Results 4.21 Financial Structure and Profitability. The 1979-1986 financial statements of FONEI are shown in Annexes 18 and 19. During the period under review, FONEI's overall financial performance has been satisfactory. A rapid gr wth in FONEI's total assets, portfolio and income can be observed during 1979-1981 due, primarily, to its dynamic credit expansion before the 1982 economic crisis. FONEI's total assets and loan portfolio grew at about the same rate, with the latter representing about 94Z of total assets over 1979-1985. Total assets grew considerably in real terms by 31% it 1979-1980; however, due mainly to the financial and ec -omic crisis, growth slowed in 1981 to 5%, and declined by an annual average of 16% in 1982-1985. Given FONEI's role in financing higher risk loans and recently, equity participations, the Government has been capitalizing the principal repayments of Bank funds channelled through FONEI. As a result, the increasing share of equity in total asset funding, increased from 47% in 1979 to 81% in 1985. FONEI's net earnings in relation to equity increased throughout the period from 3.6% in 1979 to 30% in 1984 in nominal terms. 1owever, the return on equity declined from 30% in 1984 to 25% in 1985 and 28% in 1986. In real terms, however, the above rates of return on equity were highly negative, with inflation rate increasing from 19.2% in 1979 to 105.7% in 1986. Although the interest rates on FONEI's lending are based in most cases on the average cost of funds to the commercial banks they have only recently reached positive levels in real terms on average. As a result, FONEI's net income after interest expenses and administrative costs has provided a return on equity which is below inflation. Nevertheless, the real value of FONEI's equity has been maintained, and increased slightly since 1979, by the capital increases from the capitalization of the principal repayments of Bank funds channelled through FONEI. 4.22 Arrears Position. Reflecting its position as a second-tier institution, FONEI has suffered no losses in its loan portfolio. The participating intermediaries are responsible for making principal and interest payments to FOMEI en time, whether or not they receive payment from 17/ In addition to providing subsidized interest rates for technology development projects, FONEI offers credit guarantees of up to 90% of a loan under its technology development program. 18/ These interest rates were further revised in 1986, and now range from 94% to 113% of ACF for pre-investment and equipment lending. Permanent working capital is financed at market rates. To diminish the cash flow implications of high nominal interest rates, sub-borrowers, with the agreement of their commercial banks, have the option of choosing the "traditional" repayment schedule or one based on the present value (PVP) scheme. - 82- their clients. Consequently, FONEI does not show any subloans in arrears and makes no provision for possible losses in its lending operations.19/ FONEI requires its intermediaries, as part of its supervision requirements, to submit periodic reports on the arrears position of FONEI-financed subloans. An analysis of FONEI's loan portfolio by participating intermediary shows that principal in arrears amounted to only 4% of total loan portfolio as of July 31, 1986 (Annex 11). V. CONCLUSIONS 5.01 With the third and fourth FONEI loans, the Bank built upon the institutional development efforts under the previous loans, and continued to support the development of FONEI as an effective channel for transferring resources to the Mexican industrial sector, through its involvement in project preparation, appraisal and implementation. It has become a mature second tier institution for long-term industrial financing, highly regarded by industrialists and banks in Mexico. FONEI has become an important source of technical assistance, organizing training programs in project appraisal and supervision, as well as a variety of special topics. It pushed to encourage more methodical project appraisal by intermediaries and sponsors. It played a particularly important rate in the development of the Mexican industrial sector, becoming an effective instrument in implementing new subsector development strategies, including technology development, pollution control, capital goods industries, subsector development, etc. With FONEI's broadening role in financial intermediation, it introduced financial restructuring programs, including working capital and equity financing. 5.02 A major event that occurred during these two loans was the financial and economic crisis experienced by Mexico beginning in 1982, which adversely affected the industrial sector, and affected the overall performance of FONEI-financed subprojects under the two loans. Nevertheless, FONEI channelled Bank funds to generally efficient subprojects, providing a significant impact on the balance of payments, employment generation and industrial decentralization. 5.03 On the other hand, FONEL's efforts to increase support to medium-sized enterprises have had only moderate success. The bulk of its loans has been directed towards large companies in the context of the definition provided during project appraisal. 5.04 The Technology Development and Pollution Control components introduced under the fourth loan were modestly utilized because of their novelty and the particular country conditions. However, the subprojects for which they were used benefited from their special features. These components 19/ The additional 0.5% interest rate on the subordinated portion of FONEI's loans is passed on by the intermediary to FONEI, which holds it in a fund to cover possible loan defaults. kLL Loan service payments are channelled through the intermediary. -83- were instrumental in development of the Bank's Pollution Control and Technology Development Projects (Loans 2154-ME of 1982 anO 2747-ME of 1986, respectively), in which FONEI participates as implementing agency. 5.05 The Bank's relaticas with FONEI have been excellent throughout the implementation of the two loans. In addition to providing FONEI with resources to respond to the needs of industrial enterprises, with the Bank's assistance, FONEI has strengthened its policies and procedures and provided training to its staff. After some initial difficulties under the first two loans, FONEI's efforts, including its comprehensive training programs, during the implementaton of the third and fourth loans, have proved effective in strengthening the project appraisal and supervision capabilities of participating intermediaries, and have achieved considerable progress in shifting to them project appraisal and supervision responsibilities. 5.06 The dialogue between FONEI and the Bank that took place in the context of the supervision of the two loans was a significant factor in encouraging FONEI to identify alternative lending strategies to address the critical gaps and issues in the industrial sector. in addition to the technology development program, FONEI's working capital financial program, which was initially introduced during the 1982 crisis, has shown an increasing importance in FONEI's operations. However, FONEI is still predominantly perceived as a fixed asset lender. It needs to intensify its promotional efforts for its above non-traditional lending programs. With the support of the Industrial Recovery Loan, FONEI intends to play a more active role in industrial sector development by broadening the coverage of its financial assistance, combined with an intensive promotion and training program. 5.07 Although the Bank's main institution building objectives were attained, FONEI is still hampered in its growth and effectiveness by a few problem areas in which there is still ample room for improvement. First, personnel management policies are rigid and provide limited career prospects. Second, an inadequate management information system, particularly at the working level, is still hampering a more efficient use of professional capabilities. These problems are being addressed by FONEI through its institutional development program under the Industry Recovery Loan. 5.08 FONEI has generally complied with the Bank's reporting requirements. However, there appears to be some lack of clarity on the part of FONEI on the relevant information, particularly on subproject data, that the Bank would like to receive in the form of periodic reports. Given FONEI's expanding activities and the development of its electronic processing system, the Bank is undertaking a thorough review and modification of FONEI's reporting requirements, in the context of the Industrial Recovery Loan, to ensure that the content, frequency and timing of reports are in line with the Bank's needs, as well as FONEI's own internal information requirements. -84- HM - MHM AND M l lWI W1Hfr IMM UMMt) PiW IS (LONG 1560-WE Ale 17124) Mumacturlm erfiorame nicators Amual Growth Rate in 1975 1980 1981 1982 1983 1984 1975-1980 1910-198 CDP (1970 mxS biLions) 617.0 841.8 90R.8 qn.8 869.2 899.6 6.4 1.7 nmfacturing value acdd (1970MO billio) 148.1 206.6 224.3 217.8 202.0 211.4 6.9 0.6 Gross Fxed Invesumnt (1970 mxS billion) 132.3 197.4 226.4 190.3 37.2 164.8 8.4 4.6 aufacturing Exports (USS Millions) N.A. 3,570.7 4,096.5 3,386.0 5,447.9 6,843.2 N.A. 17.7 Total Exports (USS millions) 3,655.5 15,511.9 20,102.1 21,229.7 22,312.8 24,055.6 27.0 11.6 Manufacturing la9orts (USS millions) 5,561.7 16,406.8 21,036.9 12,971.4 6,644.2 9,121.6 24.1 -15.8 (Private Sector) N.A. (10,719.2) (13,860.1) (8,445.5) (3,938.7) (5,937.8) %.A. -15.9 Total Inports (USS Millions) 6,512.3 18,896.6 23,947.2 14,437.0 8,950.8 11,254.3 23.4 -11.8 ftrudacturing value adled as Z of GDP 24.0 24.5 24.7 24.1 23.2 23.5 M*arnfacturing Exports/ Total Exports - N.A. 23.0 20.4 15.9 24.4 28.4 Marfaccuring Inports/ Total Inports 85.4 86.8 87.8 89.8 74.2 81.0 Gross Fixed Investent as Z of GDP 21.4 23.4 24.9 21.0 15.8 16.1 Source: Banco de ,edco LC12 March 1987 - 85- kNeNEX 2 7= an mm umfi OM4f im(m)mm (151 I$604< MG 17124M) Esimte ad ABtumL ^f*±w km01tnrmma U8 fl""J " of U) Fia Ye 154 17124 -d QIUartrU glsa actual MrIan cta %Pu~ 30. 1978 0.25 0.25 • - D~ 31. 1978 1.0 1.0 - Mr 31. 1979 3.4 3.4 4.2 4.2 ung 30, 1979 7.6 7.6 10.7 10.7 FM - - h~ 30. 1979 14.8 14.8 22.6 22.6 D-h 31. 1979 23.8 23.8 28.8 28.8 Mardh 31. 1980 33.8 33.8 36.3 36.3 2.0 1.1 - June 30, 198 t/ 42.2 42.2 52.6 52.6 5.0 2.9 7.2 4.1 mi Sp~r 30. 19e0 50.0 50.0 63.8 61.8 9.0 5.1 17.6 10.1 n h 31, 196 66.0 66.0 67.8 67.8 17.6 10.1 22.7 13.0 Mrch 31. 1961 75.5 75.5 73.7 73.7 32.6 19.6 34.5 19.7 Ju 30. 1961 1/ 84.0 84.0 80.0 80.0 60.0 34.3 42.2 24.1 FY2 9*pc~ 30, 191 90.5 90.5 86.4 6.4 9.0 51.4 49.8 28.5 ohm 31. 1981 95.5 J5.5 94.0 94.0 114.4 65.4 57.0 32.6 March 31. 1962 99.0 99.0 132.4 75.7 77.7 44.4 Jun 30. 1962 V 100.0 L.0 97.8 97.8 146.4 93.7 92.0 52.6 m3 iSPC 30. 1962 15.4 90.5 QR.5 %.3 Dn~ 31, 1962 10.0 100.0 167.4 95.5 101.3 57.9 March 31. 1963 17n.2 97.3 101.3 57.9 Juna 30. 1983 172.2 qR.4 110.5 63.1 FM epc~ 30. 1963 171.2 9.0 122.0 69.7 Dec r 31. 1%3 174.2 94.5 122.9 7.2 ~.rch 31. 1964 174.8 44.9 !27.6 7?.9 Ju 30. 1984 3/ 175.0 tm.n 131.2 73.n MS §rpr 30. 1964 114.9 7.1 Oem~ 3t. 1984 141.1 pn.7 Marc 31. I9M 1.1.2 41.8 Jun~ 30. 1985 2/ 147.7 4.4 n8 9 ~ 30. 1965 152.4 A7.1 De ~ 34. L985 155.9 84.1 Marh 31. 1986 157.0 69.7 Ju 30. 1986 163.4 91.4 rM7 Squ~ 30. 196 163.7 91.5 De~e 31. 1966 163.74/ 93.5 March 31. 1967 162.5 5/ Q.9 1/ Ortg~nal ter~ita dats for ok 'sutn of gup ecte r Lam 154E and£ 17124. res istt v. ~ Fina m ~ te nal dat for *sumUn of sub eomects wdr ~ m 17124. Orgl c~ostW datu ta r Lan- 1560 t ad 17124E. ructvuly. 4/ mii a nicIlland bal~ of USS1.3 MUmi to be renurrd to the Scial Accome. 1/ 1k a beJi~ of U 12.5 iltan to be cancelled. Lat2 Ap~ 1987 間••‘••■•開••■••．■•••開―一 叫！〕〕〕斤〕〕〕〕！ MIOD - TIM W) MRN MUMM MM~ KM (~) PRWW. -N (10M 1560-M AND 1712-W) Pir~cial C<!Eý!tion of F~fina~ %bpmiects 1/ (in nållions of -- - ----- ---------- 1560-NE: 1712-W. jwfiiw--- Y nxed Investnent Project Sponsors 35.8 2,190 22.5 4,473 4,6M ParticipattrW Intenælisries 6.2 %7 7.8 2," 1r1.0 7,4114 A.Q nflier Local and Foreigi 1,235 12,7 PM 6.9 2," 15.(1 12,~ lci.4 EtkJEI 3,820 39.3 4,216 33.8 712s 42.4 27,217 of which ~ Læn (2,m) (23.5) (3.18D) (25.5) (3:c65) (23.6) (20 Fixed Ime~ 7,850 8D.7 10,514 84.3 RI.2 Wo!ýýý Capital 1,880 19.3 1,q60 15.7 l" - Total Irrvestment 9,730 10DA 12,474 ikm.0 16,FØ> im.n =Men~ azcm~ -latione~ ---------- - --------- - ---------- - - --- - ------------ - -------------- - 1/ Appraisal estimates Incltde boUi fixed Invest~t aM w~ capital Maimæts. Sourre: Frfflff WP12 Memh 19Eý7 〕方”! Pmmcr ONPLETION REPORT H-11Q) - THIRD AND FOURTH TWXISTRIAL EMIPMENT FUND (FONEI) PROJECTS (LOANS 1560-M AND 1712-M) Projected and Actual Rates of Return 9f a Sample of FONEI-Financed Subprojects (1) Company Financial Rate of Return (FRR) Economic Rate of Return (AW IA-an no. Projected Actual Projected Artual Celfimex 21.2 12.7 65.7 43.2 1 Papelera Kildonado, 19.2 12.4 42.1 23.3 1 Protexa 36.0 10.8 99.9 39.3 PoLifil. 18.7 8.2 30.3 16.4 Kmerias Primas Monterrey 17.3 6.2 24.8 19.6 Ceramics del Yaqui 17.8 -9.9 41.0 -15.7 Colteco 20,9 8.9 30.5 16.7 Mt-gatek 12.6 -10.4 13.7 -13.1 Polivin 20.9 -3.6 37.2 -5.1 Fisacero 18.0 30.2 72.5 47.0 Repr;y -sadora Industrial 28.0 -6.1 51.0 -8.2 it Plasticel 13.0 7.3 36.0 7.1 Lnvases Plegadizos Gatim 18.0 2.7 65.0 -1.3 Industria del. Hierro 17.0 42.3 40.0 79.9 if Zinc Ind%JSLrial 30.0 15.4 38.0 19.4 11 Relmestos para MiNidna Tndustrial. 16.2 9.3 37.0 12.9 it Ditemsa 1910 34.3 51.1 42.9 if Tisamatic 10.3 17.0 20.0 22.7 it Tasmi 18.0 16.1 34.0 19.6 It Frimex 16.0 29.9 26.0 42.1 it Average 19.4 11.7 42.8 20.4 I - LAWin I 560-t1E 11 - Lmin 1712-W *mrce: &“·！‘〕、付！！〕！黝―! M.K10) - '1111RD AND F191RD1 INOUNIRIAL F(AlIPMEW RIND WMKI) PROJI-AMS (u)ANS 1560-W. AND 1712-M) PEoJected and Actual Import Substitution in 1984 by a %ample of FON91-finonced EnteEMtsas (in millions of Mex$) Variation IWJD Company Projected Actual (Amount) (Percent) Wan No. I/ Reimiestos para Laqtsinarta Industrial 521 259 - 262 50 T1 Ftindacion Mnclova 965 104 - 861 to if Alitomigneco 2,529 45 -2,484 2 1-gatek 3,784 909 -2,875 24 Omiercial Mexicana 610 536 - 74 88 .%cerlan 3,831 803 -3,028 21 It inditstria-, de Rile Galgo 5,013 3,071 -1,942 66 11 Tre f i I ados Ft nos 2,078 1.414 - 664 68 H I Zinc Industrial 1,145 6 -1,139 1 %D Papeles Poniierosa 5,131 4,536 - 595 84 Precitubo 1.362 991 - 371 73 if Iekano 528 239 - 289 45 Riberias y Estructuras 1,525 1,120 - 405 73 Fmva-.es Plegattizos Gamma 1,452 1,210 - 242 83 Polivin 2,306 528 -1,778 23 Reprocesadora Industrial 1,255 715 - 540 57 11ovamex 1,237 701 - 536 16 Aceros RM It,407 752 -10,655 7 Industria del Hierro 2,337 3,395 1,o58 145 Laseasiana 846 1,013 167 120 it 49,862 22,347 27,515 45 I/ I = Wall 15m)-ttr Ji I I = Loan 1712-W Smirce: FONF.F t1arch 1987 Lrp I -92- NNEX 9 PMtfECr COMPLETON REPORT mICO - 11tD AND FoUR INDUSTuAL- Ent NnPMEstrU (FM%EZ) PMrEMq (LOANS 1560-ME AND 1712-ME) FOE.'q Ortanizational Mhart nirector (3) Informacian CIDM System (5) Office of Internal Co8plaints Audic (2) F-Projects F stnce Rnd Proleotion Department Administratinn Deparment Department D)evartnt Direcor(3)Director (2) Directo(2 Direcor 2 F~o T F I ~~ 1F ~ i1IDirector (3)) -tulustrial Assistance -Training (7) -Evaluation (14) -Loan rafitracts (4) -Tecirnolowy *Finance and -Regional Offices: Develoapent (13) Treasurv (15) 'est (3) - -Suoervtsion (8) -Ad"inistrative East (3) office (a) Note: Figures in parentheses indicate the number of staff in the res"ective Units. Source: FONEt April 1987 PniTr auimyim FomT m- 1noimp FM m I ,mI. ~ 4,MUlfflr INV (i3) PInffrN (0~W 15~E AM 1712.~ MWT's DIerdwh ents by PInmtal Intenwitary: 1979-1W6 (In M IlI ~nniefMRn) 1979 Iw 10185 1982 061 144 15^ Ilm htal 1474-IQM AMii Amnt iw- Amint z int I ts~~ ~ ano Naconal de ItxIco 235 lI 621 19 1,018 21 1,4M4 22 1, IM 14 1,45 15 anj 6 5,??R 14 11,7" 11.7 Banmo Internacional 59 3 285 9 714 16 1,211 19 1,071 14 1,217 l1 ?.457 17 4,6% I 11,~i 11.6 banco de e&,las Ntpotecartas - - 15 1 - - - - 72 l .41 1,51 11 1,176 9 1,444 6.4 fano de Credito y Seivtcia - - - - I06 2 142 2 216 1 154 4 7% 5 4,415 12 6.%4 7.1 Baas 284 14 SS 2 52 l 81 B 812 10 %4 6 1,182 a 1,167 1 4,1^ 4.0 8ancuuer 201 10 255 7 51M 12 61 k0 41M 6 78 8 7,11 15 7,211 6 7,77 X.5 Bmeo Ix1car^ Sax 427 21 619 58 575 1l 714 11 516 7 647 7 291 2 5,014 11 8,101 10.1 Lno Nacional de Cmercio baterior - - - - 83 2 4501 7 1,47 17 1N7 4 826 6 I1,46 1 4,114 5.1 ther Banks 845 40 1,295 14 982 23 1.142 21 1,116 17 2,417 26 1,4o 21 4,01 7% 20,7,1 74.7 lurm. 2,062 IM 3,328 Im1 4,405 IM 6,161 im 7,8i im 9,211 lix) 14,511 In 17,941 IM m5,6 in.n Smurce:. RWtI IXP12 March 1987 PROJECT CO1PLETION.REPORT wExiC - ThIRD ANw ratItti INDiSTRIa. Eoilwir FUD (VilE) PRaIFOMR- (IANS 1560-MW AN 1712-.) Arrears Position under FONWI-tinanced Subloans by ParticlMtina Interwdiary an of .Ily It. 1486 (in millions of Mexha Outstandita Portfolio Principal In Arrears Interest Io Arrears Participating Intermediary Amnunt (2) Amint (1) 11 Annt (II Banco Internacional 7,609 11.2 1,020 11.4 966 12.7 Banco Nacional de Mexico 7,551 11.1 219 2.9 212 7.8 Banco HeXicano Somex 6.448 9.5 227 I.5 617 0.6 Bancomer 6,354 9.1 - - - - Banco Cedulas Hipotecarlas 5,146 7.6 18 0.4 5 0.1 Banco de Credito y Serviclos 4,925 7.1 - - Banca Serfin 4,717 6.9 - - - Multibanco Comermex 4,506 6.6 27 0.6 n? 4.5 Banpais 4.056 6.0 3 9.0 122 7.* Nacional Financiers 1.968 5.8 - - - - Banco Nacional do Comercto Exterior 3,249 4.8 276 8.5 - - Banca Creal 1,511 2.2 - - - - Multibanco Mercantil ie Mexico 1,501 2.2 198 1.6 S 17.0 Credito Nexicono 1,421 2.1 46 1.2 174 IP.2 Banco del Atlantico 1,319 1.9 111 10.0 1A ).4 hultibanco Hercantil del Norte 1,114 1.6 - - - - Banca Confla 1,107 1.6 .5 1. - - Banoro 573 0.8 4 7.5 4 14.8 Agroindustria 161 0.5 - - - - Banco Obrero 249 0.4 11 11.1 151 61.4 Hanpesca 168 0.1 - - - - Banco del Centro 81 0.1 - - - - Banobras 55 0.08 - - - - Citibank 52 0.08 10 18.8 1 11.0 banrural i5 0.05 - * - - Banco Prowux 31 0.05 - - - - Banco de Oriente 14 0.02 - - - Unionti de Credito Industrial Vallejo 10 0.01 - - - - Total 68,139 100.0 2,467 1.9 \ft 4.5 1/ As a percentage of respective outstanding portfolios. Source: FOWEl LCPI2 Malch 1987 PROJECT COMPLETION REPORT MEXICO - THIRD AND FOURTH INDUSTkIAL EQUIPMENT FUND (PONEI) PROJECTS LOANS 1560-KE AND 1712-ME Summary of Supervision Activities: 1979-1986 Total Intermediary FONEI Total Year Clients No. of Visits as % No. of Vsitsas8 8ooialts as Visits of Total Visits of Total Visits of Total Clients Clients Clients I 1979 117 42 35.9 42 35.9 198U 147 - - 60 40.8 60 40.8 1981 178 72 40.4 40 22.5 112 62.9 1982 270 128 47.4 '5 20.4 183 67.8 1983 386 196 50.8 92 23.8 288 74.6 1984 407 215 52.8 90 22.1 305 74.9 1985 500 296 59.2 94 18.8 390 78.0 1986 615 354 57.6 131 21.3 485 78.9 Source: FONEL LCPI2 March 1987 -96- - 13 Page I of Mwj~ æum WYMT mEo •1 MD ii AMRUM ZDC AL EMMMr swV (Fem) PRECMS (U~6 15604 AM 17124<) Subproject Processing Tim Feasibility - Apprajsal Loan 1712-ME 2B 2 18 15 0.5 2.5 4.5 6.5 8.5 10.5 Months -97.-..r. 13 Page 2 of 3 - THD M m D1RM1RA lmbi~ RM 6(i< PRaCiS (MM6 15604 M 17124M) Appraisal - Approval Loan 1712-ME 12 30 223 28- 24 22 20 18 2 10 45 2 Months 13 -98- Page 3 öl 3 wIJC cMeizrta IEnr M • =0 DnEZIRIAL Bi=Iir M PM (=MMEMV PRJEES (TB 15604 AM 17124M) Approval - Loan Signing Loan 1712-ME 40- 30 25- 20 u15 10 4.5 8.5 8.5 10.5 Months Je3E 14 -99- M!XE - 'fHIll 400 101 DEXEIAL 5p!40r 10 (FIE) Pll!I (DE1560-te Ml 1712-ME) =y of Trainit Actvtile: 1979-1986 t.h~r of 'tal 1Mber of Particit as of T.al Year Courses 1/ Participents Entrepreers B~ns Con~ultats RM!I Staff <ther 1979 4 34 11.8 14.7 14.7 44.1 14.7 1980 26 469 17.1 48.8 14.9 3.2 16.0 1981 48 902 15.7 80.9 1.2 2.1 0.0 1982 49 826 21.4 39.3 11.4 10.9 16.9 1983 47 890 16.3 29.8 7.2 40.9 6.7 1984 61 1,114 26.9 .,.9 10.8 9.0 13.5 1985 78 1,865 30.3 49.0 7.0 7.3 6.4 1986 82 2,035 28.7 41.4 5.6 16.5 7.9 Total 395 8,135 21.0 43.0 9.1 16.6 10.3 1/ Iwudr s aurss an project prepratio, evalu~tnn ad superviion, and othr specal topics. Source: arch 1987 Plfr GPhiETrit RmmT lI(IM - 11IIRD M R MR IfiMIRIAL ErDRiWffr RM> (W»I1) inrIS (UW6I5&>IY AM 17124W) R1's Prolecta and kteal OpraLins: 1974-1986 1/ 1979 I9M 198i 19R2 m81 M 1%5 Om Proj. ktuad Proj. ctail Prol. khem PWin. itäal iProj. Aciml A~1 Antl Atwii APPKNALS ~ber of ~dbprojects 102 66 131 al 146 10%s 161 119 176 79 11 119 151 AverCe Slae 34 48 34 58 34 X) 34 82 4 589 IfVl 22n 462 Total (Wn$ ffilikm) 3.500 3.1% 4,50 4,649 5,jo 7,204 5,51x) 11,418 6,«t» 9,655 1i,914 26.121 70,742 DISILLMNffi_ 2,^0 2,062 3,530 3,128 4,525 4,405 5,yn 6.163 5,610 7,811 9,211 14,513 17,^7 UMI^sDEn lMN RnLjo 5,242 4,447 8,279 7,144 11,464 10.573 14,3 17,17 16,919 26,911 16,112 47,fm M,9~11 5/ Projectos at apprasal of Ini 1712-tE in 1979; exclatig oprattnua uter RtEI's apecl prq ~ initiatit in 1q82. sce: Wli March 1597 rit me=wr a ~ CHia REPM MMD - M ID M 1Hl IMUI'tRALIEw <r FÐ (EWE~) Mm m ~WS (WAIs 15604E M 1712-W) S~ry of IS lendire qpratons by Program: 1978-1986 / (in illons of M$) 1978 1979 1%0 1981 1982 1983 1984 1985 196 cn1MNIS 2,288.4 3,193.9 4,648.7 7,283.71 11,437.8 9,654.3 11,917.7 26,121.4 70,741.6 Equipmnt 2,284.2 3,004.5 4,598.1 6,624.7 9,785.0 7,477.1 7,976.1 16,858.8 45,076.1 New Projects 1,375.6 1,093.4 1,263.5 2,409.9 3,587.7 3,495.1 3,944.9 4,^2.9 8,97.4 Eaqnston 908.6 1,911.1 3,334.6 4,222.8 6,197.3 3,982.0 4,031.2 12,855.9 36,078.7 Pollution Ctrol - IM.0 43.3 464.0 1,152.7 195.7 175.2 .m0?.9 6,(L.6 1d1lcgy Deeopent 2.0 88.7 4.6 185.6 487.9 1,682.7 1,602.9 4,811.1 10,657.4 Capacty Optiizatim - - - - - 29.7 1,154.2 I,IM.1 1.825.2 brking Capital - - - - - - nIR.3 1,291.2 6,95.8 Other 2.2 0.7 2.7 9.4 12.2 8.6 1.1 315.3 157.5 DISKE S 1,282.2 2,062.4 3,327.8 4,405.4 6,363.1 7,810.6 9,231.2 14,512.7 17.891.7 M I OF OPERATIGS 61 66 80 104 139 79 II1 19 153 MER 0C PArICIPATIC 15 16 21 19 22 26 23 19 20 1/ • Ecludise operation under FM[s speial pr initiatet in 19g2 Source: ((DEI 14P12 ftrch 5987 PROJECT COMPLETION REPORT MEXICO - THIRD PND FOURTH INDUSTRIAL EQUIPMENT FUND (FONEI) PROJECTS (LOANS 1560-ME AND 1712-ME) FONEI'S Onlending Interest Rates 09/77 to 07/78 to 07/79 to 07/81 to 08/83 to 08/84 to LENDING PROGRAM 06/78 06/79 06/81 07/83 07/84 01/86 Equipment CPP + 2 CPP + 2 CPP + 2 CPP + 2 CPP + 5 CPP + 5 Preinvestment Studies CPP - 5 CPP - 5 CPP - 3 CPP - 3 CPP - 3 Technology Development CPP - 5 CPP - 5 CPP - 3 CPP - I CPP - 3 Pollution Control CPP - 2 CPP CPP CPP Capacity Optimization CPP + 2 Working Capital CPP + 2 (for capital goods) 1978 1979 1980 1981 1982 1983 1984 1985 19R6 CPP Rates (Annual Averages Z) 15.4 16.5 20.7 28.6 40.4 56.7 51.2 56.1 80.0 1/ Annual Inflation Rates(%) 15.2 19.2 29.2 28.7 89.5 91.7 61.3 61.4 105.7 1/ October 1986 annualized. Source: FONKI MIa 8FrT cneu FT . . .0r MFli - Tieen AMD FItITH INixis.UtIA. ~ wIiPMFIT fnim JFoFB) VJIFM LANS 11n-HE Aff 172-00 FONE*, A4stOMPd alance Shets n979-mIN. Il C1 IT Iimi oriic7r-. l979 9j912 19«1 19*4 1401 19*4 1 ASETS rovernment Randa 112 RA6 in 1 5 47 '.119 5.74 eceivable 146 107 625 1.21 49 7. is1 14, Loans 4.447 7.141 10.573 1.RI7 pt.9006 16,414 %0.517 9DU h Other Asets _ 2 4 4 4 1 74 2.>78 TOTAL ASSETS 4.925 A a I140 19,1t3 2ft910 I-n72 1.?1M B0.687 I!AlIITIES Payablea 0149 64 2n4 179 .27n 8. 740 2.227 %.Oklok Ianco de 1,exico Loans 2.40 178 4,162 5 7.240 #4,4n7 5.764 I,'A1 - World Bank Loans 2842-fe and 2331-Xt - - - - - 12 9% 9,~9 Other Liabktites 6 128 4_1 O9 22.17.2 .61_ _6 TOTAL LIABILITIES 2.15i 6 4671 29t5 ktk6 VLIM 99_ !N S 71.67 Pald-in CapItal ./ 2.2513 3.20 4.971 6,711 9,424 92.47% ilsI.7 11.41% Reataed Earnings 2 7 448 e,n97 1.42n 7.OK 14.574 7,~0 Current Tear'a mt enencm* _S 1_% 1.151 §.a1 A44 .91 1.14. ?.0m TOTAL EQUIT . 2I4-k 4.261 6.500 .In.14 0 7._ 2_A 74 41.72a 71._ TOTAL LABILITIES AND EQUITT 4,925 8.12n I1.240 19,^6 2x,910 16.472 1.70t1 $07.M? Retiern on Total Assetn (2) 1.7 4.1 10.1 9..6 14.6 71.4 70.1 21.4 metufrn on Equity (1> 3.6 8.4 17.6 14.1 24.7 10.0 7å.ft 71.4 Annual Grouth *ates (') - Total laset* 69.7 69.1 15.0 69.5 151.4 76.4 41.1 92.4 Ltan Portfotto 62.6 60.6 41.0 oka.l 62.2 26.11 4.1 94.6 Equity 82.2 99.2 54.4 69.1 68.n 11.1 97.1 et Income 118.9 224.4 129.2 129.6 101.9 174.9 1014.9 I/ In 1979. FN011 started treattna 1BRD laana as paid-i capital rather than IlahIlltert. for the rel;aynent ,1 iIth the Government. rather than FO1E. han the responnthlilty. 21 Annual Itlation rate durkng period: 1979-19.22 t940-29.2t; 191-21.7t; 1M2-19.1: I9A1-9I.72: 1914-61.12 1eas-4..t and 1986-05.711, 1 Unaudited CA, Source: M0el LCPI2 M..gch 1417 -104- FUECr (D T» vlr E D- 'mM) Me I IBRIL Z (iE) Wm (Ii61560-M AM 1712-M) iEI's Adited Inm Statmnts: 1979-1986 (in mullns of x) 1/ 1979 1960 1981 12 1983 1984 1985 196 2/ Interet In 513 1,044 2,188 4,682 12,155 16,543 21.191 51,123 nte~r t Expnse 391 646 934 2,052 6,710 6,936 7,126 18,343 ~nitrativ E'r".. 37 42 69 795 1,231 1,014 3,329 2,375 Other Expnse 8,405 Total E ue 428 68 1,033 2,847 7,941 7.950 1n,455 29.123 NET DEC 85 356 1,155 1,835 4,214 8,593 10,736 22,n00 / Anl inflaIor rate duri~a period: 1979-19.2%; 1980-29.2%; 1981-28.7%; 1982-89.5%; 1983-91.72: 1984-61.3Z; 1985-61.4%; and 1985-105.7. 2/ Unaudited. Souce: EGil 21 1=7 Mrbch 1987