China - Fifth Industrial Credit Project

Docmet of The World Bank FOR OFFICIAL USE ONLY 4A.A/ 30o7S- C^A Rpjioft No. P-5017-CHA MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO $300 MILLION TO THE PEOPLE'S REPUZZLIC OF CHINA FOR A FIFTH INDUSTRIAL CREDIT PROJECT APRIL 28, 1989 This document has a rested diribution and may be uwd by recipients only in the perfornaoe of their offiial duties Its contents may not otherwise be disclosed witbout World Bank authorization.  CURRENCY EQUIVALENTS (As of December 31, 1988) 1 Yuan D 100 Fens $1.00 Y 3.72 Y 1.00 - $0.27 (In this report $ refers to US$) WEIGHTS AND MEASURES Metric System FISCAL YEAR January 1 to December 31 LIST OF ABBREVIATIONS AND ACRONYMS CIB - China Investment Bank DFC - Development Finance Company COC - Government of China EDI - Economic Development Institute PBC - People's Bank of China (the Central Bank) TA - Technical Assistance  FOR OMCIUL USE ONLY CHINA FIFTH INDUSTRIAL CREDIT PROJECT Loan and Protect Susmary Borrowers People's Republic of China Beneficiary: China Investment Bank (CIB) Amountt $300.0 million equivalent Termst Twenty years, including five years' grace, at the Bank's standard variable interest rate Onlending Terms: The proceeds of the loan would be onlent to CIB for a 20- year term, including a 5-year grace period, at a variable rate equal to the Bank rate; CIB would pay a commitment fee equal to that under the loan. Subborrowers would pay a variable interest rate equal to the Bank rate plus a minimu= spread of 1.51 and vould carry the foreign exchange risk between the Bank's currency pool and the yuan. However, subborrowers with a loan of less than $1 million would have the option of only carrying the foreign exchange risk between the US dollar and the yuan subject to payment of an appropriate fee to CIB for carrying the exchange risk between the currency pool and the US dollar. Finaneing Plan: Local Foreign Total - - - - (S million) - - - - IBRD -_ 300.0 300.0 CIB, other banks and enterprises '60.0 -- 160.0 Total 160.0 300.0 460.0 Economic Rate of Return: Not applicable Staff Appraisal Report: Report No. 7659-CHA, dated April 28, 1989 map: IBRD-21327 Tbis document has a meticed distributin and may be used by ri*nts only in the perforance of their offical duties. Its contents may not otherwie be disclosed without World Bank authorzation.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE PEOPLE'S REPUBLIC OF CHINA FOR A FIFTH INDUSTRIAL CREDIT PROJECT 1. The following memorandum and recommendation on a proposed loan to the People's Republic of China for the equivalent of $300 million are submitted for approval. The proposed loan would have a repayment term of 20 years, including 5 years' grace, with interest at the standard variable rate and would help finance a fifth industrial credit project through the China Investment Bank (CIB). 2. Background. Reflecting the past priority given ta the industrial sector and the high rates of capital accumulation, China's gross industrial output has grown at an impressive annual average rate of close to 11Z since the early 1950s. Industry now makes up about half of China's GDP and employs 18S of the total labor force. Gross industrial output is shared almost equally by light and heavy industry, although in recent years the former has been growing substantially faster than the latter. However, China's industry his suffered from distorted economic policies, outdated equipment and technology, uneconomic scale of operations, and a lack of autonomy for enterprise management. Its development has been further hampered by a weak financial sector and lack of suitable intermediaries for delivering medium- and long-term finance. Indeed, until 1984 banks in China were little more than fiscal agents for the government. 3. Since 1979, GOC has systematically attempted to remove fundamental weaknesses in the economy. The development strategy for the industrial sector has emphasized modernization of equipment, development of more efficient light industry, promotion of manufactured exports, and material and energy conservation. The main thrust of the reforms adopted in 1984, and designed to add greater impetus to the effort, has been two-fold. First, one series of measures has been aimed at reducing the role of mandatory planning, correcting the major price distortions and enhancing the role of markets in setting prices and determining industrial outputs. Second, another set of measures has been aimed at changing the incentive structure and enlarging the scope for managerial autonomy at the enterprise level. The 1980s, particularly the period since 1984, has also seen major and significant financial reforms. The People's Bank of China (PBC) has shed its commercial and investment banking role and is evolving into a genuine central bank. The gradual removal of interest rate subsidies and the increasing uniformity of the interest rate structure (these instruments were previously not seen as mechanisms for resource allocation or mobilization), together with the increased use of monetary instruments, have also served to enhance PBC's role Several large specialized and universal banks have been estsblished and as the restrictions on market segmentation have gradually been removed, competition has begun to emerge. The last few years have also seen the establishment of several hundred investment companies, particularly at the local and provincial levels, and the emergence of some 1,500 urban credit cooperatives. Not surprisingly, this rapid progress has created its own problems. For example, development of procedures within PBC for financial management and the expansion of its supervisory and regulatory capability have lagged behind the overall growth of the financial system; many real interest rates still remain negative; experiments with the capital markets have only just begun; and the degree of autonomy of the banks from the central and provincial governmental authorities remains limited.  - 2 - 4. One key element of the Bank's own operational strategy for China's financial sector has been to help GOC focus on the need for institutional broadening and deepening; prerequisites for the success of the ongoing reform program. The Bank's Finance and Investment Report (June, 1987) made significant and specific recommendations on ways to strengthen the supervision and regulation of the banking system and to develop a competitive framework within which customer-oriented banking institutions can develop. To support GOC's efforts to strengthen financial intermediation, the Bank provided advice and assistance for the establishment of CIB in 1982. Four IBRD/IDA operations (totalling $645.6 million) have contributed to CIB's rapid growth as a financial intermediary specializing in investment loans for small- and medium-sized restructuring projects sponsored mainly by enterprises in the light industry sector. The Bank is currently preparing a Financial Institutions Development Loan (FIDL) to support and strengthen two of the largest banks in China. In addition, the Bank is helping develop a technical assistance program (which may be supported under the FIDL) mainly to strengthen the supervision and regulation of the banking system. Further major financial sector work to assist GOC in the next stage of its reform program, which would in turn provide the overall framework for the Bank's continued support to the sector, is planned for FY90. 5. CIB commenced operations in 1983 as a government-owned development finance institution. It has paid-in capital of Y 1,159 million ($312 million equivalent). Its organization consists of: (a) a head office in Beijing, which performs an administrative and supervisory role for all its operations; and (b) 31 provincial branch offices, which have direct responsibility for screening, appraisal and supervision of subprojects. To allow greater autonomy to the branches and to expedite decision-making, CIB has started delegating loan approval authority to the branches; however, the head office still makes decisions on larger loans. At the end of 1988, CIB's total staff was 1,338 and included 173 engineers and 455 economists/financial analysts. A large number of staff has received training--both inside and outside China--under the technical assistance (TA) component of the Bank Group's first and fourth credits to CIB, through programs of the Economic Development Institute (EDI), and through assistance provided by other financial institutions. However, middle-level managers and professional staff still need to enhance further their advanced financial skills, for which they require continued intensive training and more experience. 6. CIB's project appraisal work is being undertaken in accordance with its Project Appraisal Manual, which was prepared with Bank assistance. In the snort time since its inception, CIB has made considerable progress in evaluating and appraising investment projects. However, there is need for further improvement, particularly in the areas of economic and market analysis. Project superv:sion by CIB follows its Project Supervision Manual and is quite intensive. CIB plans to implement an electronic data processing system to improve its accounting and financial management information system and to coordinate better and monitor operational and financial data and information between the head office and the branches. 7. CIB's loan approvals increased seven-fold between 1983-88, reaching $430 million in foreign currency and Y 514 million in local currency (total of $565 million equivalent) in 1988. A slight decline in CIB's term loan approvals is expected in 1989 because of current restraints on credit expansion in China designed to combat inflation. However, lending growth is expected to regain its momentum by 1990-91. CIB is diversifying its sources of both foreign and local currency funds. In 1986-88, it borrowed $210 million from international  - 3 - commercial sources, and in 1987, received the first Asian Development Bank loan of $100 million. The quality of CIB's portfolio and financial position is satisfactory. During its relatively short existence, CIB has made rapid progress in developing its staff and operating systems and has adopted a more commercially-oriented style. However, its institutional deepening has sometimes lagged behind the expansion in its organizational structure and operations. Thus there is a need for continued and vigorous efforts to strengthen its staff and procedures. 8. Rationale for Bank Involvement. Consistent with the reform process in China, CIB has prepared a new development strategy and operational and financial plans based thereon for 1989-92. Its main focus is on continued investment financing of its traditional clientele, i.e., state enterprises in the light industry sector, where, over the years, CIB has developed a special expertise. However, a modest diversification toward collective enterprises, justified in view of their growing importance in China and the relative dynamism of the nonstate sector, is also planned. In addition, CIB intends to diversify its financial resources further and to introduce, although on a limited scale in the beginning, new products (mainly working capital financing and eqvuity investments, including leasing operations) and services (guarantees, managed loans, letters of credits, etc.) for its clients. 9. Bank assistance for the proposed project would help implement CIB's new development strategy and operational plan. Particular emphasis would be given to its further institutional strengthening, including development of the new products, which will in turn strengthen its ability to compete and survive in the rapidly changing financial environment in China. During the project preparation stage, the Bank provided CIB management and staff with substantial advice and guidance in planning new products and services. For example, key CIB staff visited merchant and commercial banks in other countries, and senior staff of two such banks participated in the pre-appraisal of the project. 10. Proiect Obiectives. The proposed project would support: (a) continued institutional strengthening of CIB in both its traditional and new areas of activity; (b) expansion and diversification of CIB's resource base; and (c) financing of investment in the modernization and restructuring of light industry and removal of its operational bottlenecks. 11. Proiect Description. The project includes the following components to be financed under the proposed Bank loan: (a) industrial credit of $299.0 million for CIB for (i) term lending ($244 million) to help continue CIB's main financial intermediation function for the import of modern equipment and technology by the light industry sector; (ii) workint canital loans ($50 million) to allow CIB to fund the working capital needs of eligible enterprises (CIB would also provide local currency funds for working capital through its own resources); and (iii) equity financing ($5 million) to provide CIB a source of funds for equity participation in suitable projects and enterprise restructuring programs and for equipment leasing; and (b) technical assistance of $1 million for (i) an expanded training program ($300,000) for CIB staff in existing and new financial products and services to include specific training for the development of sound credit evaluation and supervision techniques, trade financing arrangements and international settlements; and (ii) computer hardware and software ($700,000) for CIB's proposed electronic data processing system and for related training. 12. The total cost of the CIB V project is tentatively estimated at about $460 million equivalent, with a foreign exchange component of $300.0 million  - 4 - (652). Final cost estimates will depend on the individual subprojects that CIB finances under the industrial credit component. A breakdown of the tentative cost estimates and the financing plan are shown in Schedule A. Amounts and methods of procurement and of disbursements ard the disbursement schedule are shown in Schedule B. A timetable of key project processing events and the status of Bank Group operations in China are given in Schedules C and D respectively. A map is also attached. The Staff Appraisal Report, No. 1659-CHA, dated April 28, 1989, is being distributed separately. 13. Agreed Actions. GOC has agreed to onlend the loan proceeds to CIB on the same terms and conditions as those applicable to the proposed Bank loan. CIB has agreed to she following major actions and conditions. (a) CIB will onlend to subborrowers at the Bank's standard variable interest rate plus a minimum spread of 1.5Z p.a. (b) Subborrowers will carry the foreign exchange risk between the Bank's currency pool and the yuan except that Cc) subborrowere with a loan amount of less than $1 million will have the option of carrying the foreign exchange risk between the US dollar and the yuan only, subject to payment of an appropriate fee to CIB for carrying the risk between the currency pool and the US dollar. The fee will not be less than 0.5Z p.a., and CIB will have the right to increase the fee up to 22 p.a. if, during the life of the subloan, CIB considers an increase necessary to protect itself adequately against the exchange risk. (d) The maximum subloan size will be $20 million. (e) Eligible subprojects will be in the light industry sector and will be sponso-ed by enterprises with a satisfactory projected financial position; in additIon, the subprojects will have minimum economic rates of return (ERRs) and financial rates of return (FRRs) of 122. (f) Subprojects will comply with Bank guidelines on pollution control. (g) CIB's debt/equity ratio will not exceed 5:1. (h) CIB will implement a resource mobilization plan agreed to by GOC and the Bink. Ci) CIB will increase its accumulated provision for bad debts to a min=mum of 22 of its portfolio by 1992. (j) CIB will exchange views with the Bank on its interest rates and the fee for foreign exchange risk. 14. Benefits. The project will further the institutional development of CIB, including the introduction of new products and services. Thit strengthening will help prepare CIB to face the newly emerging competition effectiveiy and will support the institutional deepening that is critical to the success of the reforms. The project will also help upgrade the productivity and efficiency of about 200 small- and medium-sized projects in the light industry sector by supporting imports of modern technology and other inputs. 15. Risks. The project risks relate mainly to CIB's sustaitned and successful institution-building and its future role in development financing. The assurances obtained from CIB management and GOC's commitment to financial sector reform should ensure successful implementation of the project and realization of its objectives. 16. Recommendation. I am satisfied that the proposed loan woUld comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loan. Barber B. Conable President Attachments Wasbington, D.C. April 28, 1989  -5- Schedfle A CHINA uIm fN U$TRIAL CREDiT PvOJECT Estimated Costs and Financina Plan ($ million) Local Foreign Total Estimated costs a/ 160.0 300.0 460.0 Financing plan Proposed IBRD loan -- 300.0 300.0 CIB, other banks and enterprises 160.0 -- 160.0 Total 160.0 300.0 460.0 a; Tentative estimates inclusive of taxes, duties and contingencies. Final estimates would depend on individual subproject cost estimates, which CIB would prepare at the time of subproject appraisal.  -6 - Schedule B CHINK FIFTH INDUSTRIAL CREDIT PROJECT Procurement. Method and Disbursements ($ million) Procurement Method Project Element ICB LCB Other a/ Total Cost a/ Industrial credit 459.0 459.0 (299.0) (299.0) Technical assistance -- -- 1.0 1.0 (1.0) (1.0) Ilotes The figures in parentheses are the amounts to be financed by the Bank. aI Contracts above $5 million vill require ICB. However, contracts are normally expected to be below $5 million each and, consistent with the principles for Bank financing through financial intermediaries, would be awarded after evaluation and comparison of quotations solicited from at least three qualified suppliers. Disbursements ($ m?.llion) Category Amount Percentage to be Financed Industrial credit component 299.0 1001 of foreign expenditures (including interest during construction) and 1002 of local expenditures (ex-factory) for goods procured through ICB Technical assistance: Goods 0.7 100Z of foreign expenditures, 10O? of local expenditures (exfactory), and 75Z of expenditures fer other items procured locally Consultants' services and training 0.3 100X of expenditures Estimated IBRD Disbursements ($ million) IBRD FY 1990 1991 1992 1993 1994 1995 Annual 15.0 81.0 96.0 60.0 33.0 15.0 Cumulative 15.0 96.0 192.0 252.0 285.0 300.0  -7- Schedule C ,CB PIPTE IEDPSTRIAL CREDIT PROJECT Tmetable of KeY Proiect Processiap Events (a) Time taken to prepare s One year (b) Prepared by s Government with Bank assistance (c) Plivt Bank mission : April 1988 (d) Appraisal mission departure t January 1989 (e) Negotiations s April 17 - 21, 1989 (f) Planned date of effectiveness : September 1989 Li) W st of relevant PCRs and PPARs : None to date  - 8 - Schedule D Page 1 of 3 STATUS OF BN GROUP OPERATIONS IN THE PEOPLE S REPUBLIC OF CHINA A. STATEMENT OF BANK LOANS AND IDA CREDITS a/ (as of March 31. 1989) 1/ Loan/ Amount (USS million) Credit Fiscal (net of cancellations) Number Year Borrower Purpose Bank IDA Undisbursed b/ Two loans and four credits have been fully disbursed 167.97 233.SO - 1297 83 PRC Agric. Education & Research - 75.40 0.50 222611313 83 PRC Industrial Credit I (CIB I) 40.60 30.00 1.22 2231 83 PRC Petroleum I (Daqing) 162.40 - 16.64 2252 83 PRC Petroleum II (Zhongyuan-Venliu) 100.80 - 20.52 226111347 83 PRC State Farms I (Heilongjiang) 25.30 45.00 0.42 1411 84 PRC Polytechnic/TV University - 85.00 21.04 1412 84 PRC Technical Cooperation - 10.00 1.03 1417 84 PRC Rubber Development - 100.00 20.53 2382 84 PRC Lubuge Hydroelectric 145.40 - 36.26 2394 84 PRC Railvay 220.00 - - 26.10 1472 84 PRC Rural Health & Medical Educ. - 85.00 19.30 2426 84 PRC Petroleum III (Raramay) 99.50 - 24.56 2434/1491 84 PRC Industrial Credit II (CIB II) 105.00 70.00 20.43 2444/1500 84 PRC Agricultural Education II 45.30 (23.50)1I 14.61 1516 85 PRC Agricultural Research II - 25.00 10.06 1551 85 PRC University Development II - 145.00 53.34 2493 85 PRC Power II 117.00 - 28.94 2501 85 PRC Changcun (Luan) Coal Mining 120.50 - 101.76 1577 85 PRC Seeds - 40.00 12.08 1578 85 PRC Rural Vater Supply - 80.00 44.48 253911594 85 PRC Highway I 42.60 30.00 27.27 2540 85 PRC Railway II 235.00 - 190.40 2541 85 PRC Fertilizer Rehabilitation & 97.00 - 15.11 Energy Saving 1605 8S PRC Forestry Development - 47.30 32. 3 2579/1606 8S PRC PiShiHang-Chaohu Area Development 17.00 75.00 47.57 2580 85 PRC Weiyuan Gas Field Technical 25.00 - 11.74 Assistance 1642 86 PRC Rural Credit II - 90.00 14.19 265911663 86 PRC Industrial Credit III (CIB III) 75.00 25.00 17.77 1664 86 PRC Technical Cooperation Credit II - 20.00 19.36 1671 86 PRC Provincial Universities - 120.00 69.76 2678/1680 86 PRC Third Railway 160.00 70.00 217.16 2689 86 PRC Tianjin Port 130.00 - 114.37 1689 86 PRC Freshwater Fisheries - 60.00 17.41 2706 86 PRC Beilungang Thermal Power 225.00 - 132.30 2707 86 PRC Yantan Hydroelectric 52.00 - 25.86 2708 86 PRC Liaodong Bay Petroleum Appraisal 30.00 - 16.35 2723/1713 86 PRC Rural Health & Preventive Med. 15.00 65.00 68.22 1733 87 PRC Red Soils - 40.00 14.30 2775 87 PRC Shuikou Hydroelectric 140.00 - 93.65 2783/1763 87 PRC Industrial Credit IV (CIB IV) 250.00 50.00 188.80 2784 87 PRC Shanghai Machine Tools 100.00 - 98.16  ~ 9 ~ Schedule D Page 2 of 3 Loan/ Amount (US$ million) Credit Fiscal (net of cancellations) Nwuber Year Borrower Purpose Bank IDA Undisbursed bl 1764 87 PRC Xinjiang Agricultural Development - 70.00 57.19 2811/1792 87 PRC Beijing-Tianjin-Tanggu Expressway 25.00 125.00 131.59 2812/1793 87 PlC Gansu Provincial Development 20.00 150.50 146.78 1835 87 PRC Planning Support & Special Studies - 20.70 18.56 2794/1779 87 PRC Shanghai Sewerage 45.00 100.00 132.86 2838 87 PRC Fertilizer Rationalization 97.40 - 93.85 2852 87 PRC Wujing Thermal Power 190.00 - 172.11 1871 88 PRC Rural Credit III - 170.00 88.01 2877/1845 88 PRC Huangpu Port 63.0 25.00 82.40 290711875 88 PRC Dalian Port 71.0 25.00 88.03 1885 88 PRC Northern Irrigation - 103.00 88.71 2924/1887 88 PRC Coastal Lands Development 40.00 60.00 81.94 1908 88 PRC Teacher Training - 50.00 42.85 2943 88 PRC Pharmaceuticals 127.00 - 127.00 2951/1917 88 PRC Sichuan Highway 75.00 50.00 121.63 2952 88 PRC Shaanxi Highway 50.00 - 50.00 1918 88 PRC Daxing An Ling Forestry - 56.90 44.37 2955 88 PRC Beilungang I' 165.00 - 165.00 2958 88 PRC Phosphate Development 62.7 - 62.70 2967/1932 88 PRC RSAL 200.00 100.00 57.01 2968 88 PRC Railway IV 200.00 - 200.00 1984 89 PRC Jiangxi Provincial Highway 41 - 61.00 57.74 1997 89 PRC Shaanxi Agricultural Dev. 31 - 106.00 101.79 3006 89 PRC Ningbo & Shanghai Ports 41 76.40 76.40 3007 89 PRC Xiamen Port 31 36.00 - 36.00 3022 89 PRC Tianjin Light Industry 31 154.00 - 154.00 Total 4,640.87 2.989.30 of which has been repaid 100.43 - Total now held by Bank and IDA 4,540.44 2,989.30 Amount sold: Of which repaid - - Total Undisbursed 2,928.33 1,456.39 4,384.72 al The status of the projects listed in Part A is described in a separate report on all Bank/IDA financed projects in execution, which is updated twice yearly and circulated to the Executive Directors on April 30 and October 31. bl As credits are denominated in SDRs (since IDA Replenishment VI), undisbursed SDR credit balances are converted to dollars at the current exchange rate between the dollar and the SDR. In some cases, therefore, the undisbursed balance indicatks a dollar amount greater than the original principal credit amount expressed in aollars. Notes: 1J Since March 31, 1989. a credit of SDR 41.8 million ($57.0 million equivalent) for Textbook Development Project has been approved. 2/ Credit fully disbursed. 3/ Not yet signed. 4/ Not yet effective.  - 10 - Schedule D Page 3 of 3 B. STATEMENT OF IUC INVESTMENTS (as of March 31. 1989) Invest- Fiscal Type of Loan Equity Total ment no. year Obligor business -- (US$ million) -- 813 1985 Guangzhou and Peugeot Automobile 15.00 2.00 17.00 974 1987 China Investment Co. Investment 3.00 0.04 3.04 1020 1987 Shenzen China Bicycle 5.00 - 5.00 Bicycles Co. Ltd. Manufacture 1066 1988 Crown Electronics Electronics 15.00 - 15.00 Total Gross Commitments 38.00 2.04 40.04 Less cancellations, terminations repayment and sales - - - Total Commitments now Held by IFC 38.00 2.04 40.04 Total Disbursed 37.40 2.04 39.44 Total Undisbursed .60 0 .6 4/28/89 AS3CO  IBRD 2132 CHINA FIFTH INDUSTRIAL CREDIT PROJECT ( U.S.S.R. CHINA INVESTMENT BANK V J ( ._ cm f" MN-.o11 g ,N - *~~~ CIB BWach offmce ft*Wince Bwfutes 7 ^t2A; } / - Inlrnbnal 8oundariub \..e' A *Han _ 1 MONGOLIA A) /&wZA~ EPSLC OF 0~ I j IAOMWW uC:a 2 -- , W , KO JAPAN 4< I Seo ,uI\ 0 ~~~~~~~~~~~'REP. < J~ SHANZ 'B < OF Q l~~~~~ AfUf KORII I~~~~~~~~ YELLOW A l 4L \/ "T oN_S t '~~~~EA -T SN~V~ L