Philippines - Private Development Corporation Project

RESTRICTED Report No. P-301 FILE Cut, This report was prepared for use within the Bank and its affiliated organizations. They do. not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL FINANCE CORPORATION REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE BOARDS OF THE BANK AND THE CORPORATION ON A .PROPOSED BANK LOAN TO THE PHILIPPINE NATIONAL BANK FOR THE DEVELOPMENT CORPORATION PROJECT AND ON A PROPOSED IFC INVESTMENT IN THE SAME PROJECT October 25, 1962  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELDYTINT INTERNATIONAL FINANCE CORPORATION REPORT AND RECOif,4ENDATIONS OF THE PRESIDENT TO THE BOARDS OF THE BANK AND THE CORPORATION ON A PROPOSED BANK LOAN TO THE PHILIPPINE NATIONAL BANK FOR THE DEVELOP,ENT CORPORATION PROJECT AND OM A PROPOSED IFC INVEST.ENT IN THE SAIE PROJECT 1. I submit herewith the following report and recommendations with respect to the proposed loan, in various currencies amounting to the equivalent of US$15 million, to the Philippine National Bank (P1\NB) for relending to the Private Development Corporation of the Philippines and a proposed IFC investment (including standby commitments) in the Private Development Corporation of the Fhilippines. PART I - HISTORICAL 2. At the beginning of 1961, the suggestion of organizing a privately- owned development financing corporation was discussed in Mlanila between Mr. Knapp and the then President of the Republic (President Garcia) and other prominent officials and private contacts, and received encouraging support. I then invited Mr. George D. Woods, Chairman of the First Boston Corporation, to serve as a special consultant to the Bank and IFC to investi- gate the need and desirability of setting up such a corporation in the Philippines, and to assist, if the facts warranted, in the creation of such an institution. 3. Hr. Woods visited the Plhilippines in July 1961 and reached the conclusion that the creation of a private development corporation would be of important assistance to the Philippines and would comnand widespread local support in the country. This conclusion was supported by the 1961 Bank Economic Mission to the Philippines wlhich recommended that the highest priority should be accorded to this project. 4. However, no further action was taken in 1961 because elections were to be held in November and all important decisions were being deferred. President I;Iacapagal of the Liberal Party was then elected in the place of President Garcia, and after taking office in January 1962, his Administration confirmed its support for the proposal to establish a private development corporation. Accordingly, Hr. Woods returned to the Philippines in HIay. His report, dated June 4, 1962, wras circulated to the members of the Board as an annex to R 62-59 dated July 20, 1962.  - 2 - 5. In brief, Mr. Woods reaffirmed his previous conclusion that the establishment of a private development corporation was well justified. After discussions in Manila, and in Washington with the Bank and IFC and with the U.S. Agency for International Development (AID), he made the following specific recommendations: (a) the corporation should start with y id-up equity of P25 million (about US$6.4 million)_7, 60 to 70% of this stock to be subscribed by Philippine investors, and the balance by foreign investors. He also considered that an investment by IFC in the equity of the new corporation would be desirable. (b) P37.5 million (about p9.6 million), should be provided by the U.S. Government as a long-term loan with a term of 30 years, repayments to be made in equal amounts from the 16th to the 30th years; free of interest or at a nominal rate of interest; and in the event of the liquidation of the corporation, any part of the loan not then due for repayment to rank subordinate to the equity. (c) the Bank should make a loan to the corporation in the amount of US$15 million. The Government of the Philippines submitted a request to the U.S. Government to make available the long-term loan on the terms required, and in due course the U.S. Government agreed to do so subject to negotiation on the final terms. 6. During Mr. Woods' last visit in ilanila, a Steering Committee of prominent Filipino businessmen was formed to take over the primary responsi- bility of working up this project. The members of the Steering Committee are: Messrs. Francisco Ortigas, Jr., Chairman, a well knowm lawyer identified with a number of important charitable and community projects in the Philippines; Jesus Cabarrus, a prominent mining industrialist, President of the Mining Association of the Philippines; Manuel J. Marquez, President of the Bankers Association of the Philippines; Aurelio Montinola, a former Secretary of Finance and Chairman of several corporations in the construction industry. Mr. Washington SyCip, of SyCip, Gorres, Velayo and Company, Certified Public Accountants, is acting as Secretary of the Steer- ing Committee, and Mr. Sixto Roxas, at that time Executive Vice President of Filoil, agreed to serve as Consultant to the Committee. 7. Early in September, the Bank and IFC invited for negotiations the Steering Committee and representatives of the Government. Representatives of the PNB were also invited since the proposed loan is to be made through the PNB (see paragraph 27). The Steering Committee simultaneously started negotiations with AID. The suggestions made by l4r. Woods were accepted by all parties concerned as a basis for negotiations. The negotiations were concluded on October 11, 1962. 1/ At P3.9:351 which is the prevailing market rate.  - 3 - 8. The proposed loan would be the Bank's fourth loan in the Philippines. It would increase the total amount lent by the Bank to that country to about $76.0 million, net of cancellations. Loans previously made are: Amount of Loan Year Borrower Purpose Net of Cancellations 1957 National Power Corpcraticn Electric power (Binga) 4j18,500,000!/ 1961 Govermment Dredging 8,500,000 1961 National Power Corporation Electric power (Angat) 34,000,000 2/ Total net of cancellations 61,000,000- of which has been repaid 987,000 Total now outstanding 60,013,000 Amount sold 1`3,533,300 of which has been repaid 987,000 2 ,56 300 Net amount held by Bank $57 466,700 1/ Original principal amount $21 million. 2/ Undisbursed balance as of September 30, 1962, !38,040,h33. PART II - THE PRIVATE DEVELOPi1q,1T CORPORATION OF THE PHILIPPINES 9. Purposes. The proposed Private Development Corporation of the Philippines (hereinafter called the Corporation) will be incorpDrated in the Philippines for the purpose of assisting privately-controlled industrial and other productive enterprises in the Philippines. The objectives of the proposed Corporation are stated in its Articles of Incorporation, a draft of which is attached hereto (No., 8). It will make medium and long-term loans, provide underwriting fahulities and invest in the equity of private industrial enterprises. 10. Resources. The share capital and loans proposed for the Corporation are as follows: Equity P 25 million U.S. AID loan 37.5 " Bank loan US$15 million equivalent-/to 58.5 " Total resources P121.0 million 1/ At P3.9:Z1 which is the prevailing market rate.  11. The equity of P25 million will be divided into 2,500,000 shares of P10 each. In order to assure that the control of the Corporation will remain in Filipino hands, the capital stock is divided into two classes, namely, Class A shares, which shall comprise not less than 70% of the authorized capital stock, to be subscribed and owned exclusively by citizens of the Philippines and IFC, and Class B shares, which shall comprise the balance of the authorized capital stock, to be subscribed and owned by anyone, but initially intended to be subscribed and held mainly by a number of foreign banking and investment institutions. Subscribers to the share capital wfill be required to pay 40% of the nominal value of the shares upon subscription, and, thereafter, 15% every sixty days until the stock is fully paid up. 12. IFC is proposing to help raise the equity of the Corporation by (a) subscribing up to 80,000 Class A shares, (b) giving a standby commitment in respect of 500,000 Class A shares less the amount alloted to it pursuant to the foregoing subscription and (c) giving a further standby commitment with respect to shares not fully paid up. The details of the proposed IFC investment and standby commitments are described in Part III. That part also describes the situation with regard to the expected purchase of Class B shares by overseas investors. 13. Reserve policy. The Articles of Incorporation of the Corporation provide that the Board of Directors shall set aside annually a minimum of 20% of the net profits after taxes in a reserve account until the same shall equal the amount of outstanding loans subordinated to equity. Monies in the reserve account would not be available for cash, bond or stock dividends. In addition, the Corporation is to agree with the Bank that at the outset the minimum to be set aside in the reserve accotnt shall be 50% of net profits after taxes until the account shall have reached the amount of P3 million (see Project Agreement, Section 2.15 and Attachment No. 5). Under the proposed loan agreement with AID, the Corporation will make a similar agreement with respect to reserves and is also to agree that if the net profits after taxes of the Corporation exceed an amount equal to 20% of the sum of paid in unimpaired capital and surplus of the Corp6ration (not includ- ing the amount in the reserve account) as of the beginning of the year in which the profits were earned, the Corporation shall set aside additional reserves amounting to 50% of such excess until the amount in the reserve account equals the amount of the AID loan which at the time is outstanding but not due and payable. 14. Foreign exchange risk. The Steering Committee of the Corporation agrees with the usually accepted practice that the exchange risk on all foreign exchange loans should be passed on to the borrowers from the Corporation. However, under Republic Act No. 529 of the Philippines, there is a prohibition against the use of a gold, dollar or other currency equiva- lent clause in agreements contracted in the Philippines. Therefore, it. has been agreed that PNB, to which the proposed Bank- loan would be made for relending to the Corporation, will assume that risk as long as Republic Act No. 529 remains in force. PNB will make a single charge to the Corporation, for carrying the foreign exchange risk, of 2.96% on the cumulative amnounts which shall have been disbursed under the Loan.  15. The Government has advised us that it proposes to seek an amend- ment to or repeal of Republic Act No. 529 early next year, when the Philip- pine Congress comes back into session, so as to permit PNB and the Corporation to enter into an obligation measured by a currency other than Philippine currency. After this amendment or repeal has become effective, the exchange risk will be passed on to the Corporation which in turn intends to pass it on to the ultimate beneficiaries. 16. Directors and management. The Articles of Incorporation provide that the Directors of the Corporation shall be five until the first annual meeting of stockholders, (to be held not later than sixty days after full subscription and allotment of the capital stock) and thereafter shall be eleven. Of the eleven Directors elected at the first annual meeting, eight must be citizens of the Philippines and holders of Class A shares and shall be elected solely by holders of Class A shares; the remaining three Directors, who must be holders of Class B shares, shall be elected only by the holders of Class B shares. It is expected that one of the eight Directors elected by the Class A shares will be a representative of PuJB. The Steering Committee has agreed to propose to the Board of Directors the appointment as Executive Vice President of the Corporation of a highly qualified and experienced person who has had more than thirty years experience in international and investment banking and industrial development in the United States, Europe and Latin America. 17. Business policies. The Steering Committee has informed the Bank that they will recommend to the Board of Directors of the Corporation the adoption of the Statement of General Business Policies hereto attached (No. 10). Under the policies, the Corporation would undertake, inter alia: (a) to assist in the economic development of the Philippines by encouraging the growth of productive enterprises in the private sector. (b) to define the "privately-controlled industrial and other productive enterprises" as enterprises which are privately operated and managed and in which private ownership is of controlling interest (at least 2/3 of the voting stock). (c) not to seek to control any of the enterprises that the Corporation finances. (d) to diversify its investments. (e) to set up a maximum amount of investment in any one enter- prise being financed as a percentage both of the Corporation's total assets (10%) and of the total assets of the investment enterprise (50%). (f) to dispose of its equity investment in any one enterprise being financed as soon as this becomes feasible.  - 6 - (g) to distribute the ownership of the Corporation as widely as possible. (h) to base the decision to assist in any project or enterprise solely on economic and business merits. 18. U.S. AID loan. The U.S. Agency for International Development is to lend to the Corporation the sum of P37.5 million with a term of 30 years, repayments beginning in the 16th year. The interest on the outstanding balance of the loan will be 1/2 of 1% per annum. The main provisions of the draft AID agreement are the following: (a) Separate fund: the proceeds of the loan shall be maintained by the Corporation as a separate fund and commitments and investments made from this fund, with certain exceptions, shall not be made if disapproved by AID after consultation with the Corporation. In this connection, AID has informed the Corporation that it would not propose to review invest- ments already reviewed and approved by the Bank. (b) Reserves: special provisions are included, as described in paragraph 13 above. (c) Required prepayment: in any year after the amount in the reserve account described above (see paragraph 13) equals the amount of the loan which at the time is outstanding but not due and payable, 50% of the amount by which the net profits after taxes exceed 25% of the paid-in unimpaired capital and surplus of the Corporation (not including the amount in the reserve account) shall be applied to prepayment of the loan. (d) Subordination: in the event of liquidation, the amount of the loan not then due and payable shall have a position subordinate to equity, provided, however, that any amount payable because the loan shall have been accelerated for breach of a covenant (other than covenant of payment) shall rank before any payment to shareholders but after payment of all other outstanding debts and liabilities of the Corporation. (e) Impairment of capital: if at any time the assets of the Corporation exceed the liabilities (not including the paid-in unimpaired capital, surplus and reserves of the Corporation and the amount of the loan which at the time is outstanding but not due and payable) by an amount equal to or less than the sum of (1) P25,000,000 and (2) one-half of the amount of the loan which at the time is outstanding but not due and payable, AID may declare all or any part of such outstanding balance and interest thereon to be due and payable immediately.  - 7 - PART III - PRCPOSKD IFC IIMVSTIENT 19. The Steering Conmittee has expressed a strong desire for IFC to take a moderate stake in the equity of the Corporation as evidence of its confidence in the project. The Steering Committee considers that such IFC investment will assist in ensuring a good response to the proposed public offering of shares. 20. Overseas investors are impressed with the prospects for the continued industrial development of the Philippines and the role that a private financing corporation, such as the Private Development Corporation of the Philippines, can play in assisting the continued expansion of the private industrial sector. The high quality of the local sponsors of the Corporation, as reflected in the composition of the Steering Co)mmittee, has drawn a great deal of overseas support to this project. The shares available to be held by overseas investors (investors who are not citizens of the Philippines) are the Class B shares iThich comprise 750,000 shares of 10 each (approximately US;l.9 million). Prominent overseas investors wlho have indicated their intention to make application for these shares include 13 United States financing institutions, primarily Edge Act subsidiaries of leading United States banks, a German bank, two British banks and possibly others. It is expected, accordingly,, that the Class B share issue will be fully subscribed and, in fact, certain overseas investors will not be able to obtain the full nunber of shares desired. In view of this position, it would be undesirable for IFC to seek an allocation out of the Class B share issue and it is proposed that IFC -jill subscribe to the Class A shares. 21. The Class A shares, which comprise 1,75O,000 shares of P10 each (approximately US6h.5 million), will be offered to, and can be held by, citizens of the Philippines and also by IFC; an IFC investment in these shares wTould not have the wider market available to the Class B shares. It is the intention of the sponsors, fully supported by the Philippine Government, the Bank and IFC, to attempt to spread shareholdings among the largest possible number of shareholders in the Philippines, and this will require an extensive selling campaign to inform the smaller investors regarding this opportunity. As there may be some lag in these shareholders coming forward, the Steering Committee feels it desirable to arrange some standby commitment for a part of the local share issue. The Steering Committee has asked IFC to enter into this conmitment. 22. It is proposed that, subject to certain conditions,: (a) IFC will subscribe firm to 80,000 Class A share of P 10 each (approximately USL:`2050O0), on the terms of the Prospectus, on the understanding that IFCts application will be scaled down as appropriate in accordance iwith the allotment procedure adopted by the Corporation. IFC has informed the Steering Commnittee that it would expect IFC1s application to be scaled down so that the IFC allotment would be no greater than the largest allotment  - 8 - given to a Class B subscriber and, preferably, no greater than the largest allotment given to a Class A subscriber. (b) IFC will also give a standby commitment for 500,000 Class A shares of P 10 each (approximately US'Pl.28 million), less the amount of shares allotted to IFC under (a) above. For this standby commitment IFC would receive a commission of - 105,000. If IFC has to take up any shares under this standby commitment, it would be IFCts intention to sell these shares to investors in the Philippines at an early date. 23. In order to simplify the complex legal arrangements armong the parties, it has been felt essential to obtain some assurance that, if subscribers default in paying in the remaining 60% of the value of these shares, after payment of the initial 40% on subscription (see paragraph 11), there are satisfactory arrangements to ensure that the shares on wJhich there are such defaults are taken over and paid for in full. To meet this requirement, it is proposed that IFC enter into a standby commitment with the Corporation to the effect that IFC pay in the amount unpaid on such shares (after the initial 40% on subscription has been paid), with interest and expenses relative thereto, in exchange for transfer to IFC of all such unpaid shares, provided that no other person is prepared to make an equally favorable or more favorable bid for such shares. For this standby commit- ment, IFC would receive a commission of P 60,000. 24. In my opinion, the risk involved in this latter standby commitment is very small. Before IFC would be obliged to take over any shares under this comnitment, subscribers would have to have forfeited the hLO%o or more of the price of the shares already paid by them; even in such cases, it is likely that other buyers would be prepared to buy these defaulted shares under the procedure set out in the Philippine law at a lesser discount than is represented by IFC's offer under this proposed commitment. However, the sponsors of the Corporation are arnxious to have this ultimate safeguard and a commitment by IFC of this nature will greatly simplifyr the legal arrangements by insuring full eventual subscription of the shares to be issued. 25. Full details of the above arrangements are contained in the draft Letter Agreement between IFC and the Corporation attached (No. 7). PART IV - THE PROPOSED BANK LOAN 26. The main features of the proposed Bank loan are: Borrower: Philippine National Bank (PNI3). Guarantor: Reoublic of the Philippines.  9 - Amount: In various currencies equivalent to $15 million. Purpose: Proceeds of the loan to be relent by the Philippine National Bank to the proposed privately-owned and managed Private Development Corporation of the Philippines, which would (a) make medium and long-term loans, (b) provide under- writing facilities, and (c) invest in the equity of private industrial enterprises. Amortization: At the time each part of the loan is credited to the Loan Account, the Bank and the Corporation will agree on an amortization schedule for repayment of that part. These amortization schedules will provide for semi-annual repayments on January 1 and July 1 in each year and for final repayment not later than January 1, 1978. Interest Rate: Wfhen a part of the loan is credited to the Loan Account, the rate of interest charged on that part will be the Bank's rate current at the time the credit is made. Commitment Charge: 3/4 of 1% per annum from the time the Loan Account is credited, on the amount so credited. 27. Under existing legislation the Philippine Government is not authorized to guarantee a Bank loan to a private corporation, although it is expected that new legislation to authorize such a guarantee will be enacted at a later date. Therefore, in order to avoid delaying the project and since the Philippine Government may guarantee loans to corporations owned or controlled by the Government, it is proposed to make the loan to PNB, a corporation the shares of which are almost wholly (99.7%) owned by the Philippine Government (see Note on the Philippine National Bank,attached (No. 11)); PNB in turn would relend the funds to the Corporation. 28. Since the loan is for the benefit of the Corporation, a direct working relationship between the Bank and the Corporation has been es- tablished by means of the Project Agreement. Insofar as the carrying out of the Project and the operation of the Corporation are concerned, this  - 10 - Agreement gives the Bank substantially the same rights it normally obtains in its agreements with similar financing corporations. Among other things, it provides that: (a) investment projects (requiring finance from the Bank) whose foreign exchange costs shall equal or exceed a limit to be agreed from time to time between the Bank and the Corporation are subject to the Bank's approval (Loan Agreement, Section 2.02(b) and (c), and Project Agreement, Section 2.03(b) and (c).) For the time being, it is proposed to set that limit at $100,000. (b) the Corporation shall not incur, assume or guarantee any debt in excess of three times the aggregate of (a) the equity and (b) the outstanding portion of the AID loan not due for payment (Project Agreement, Section 2.09). 29. PNB will, under the terms of the Subsidiary Loan Agreement, give the Corporation the greatest freedom possible in the use and administration of the proceeds of the loan; as a consequence, PNB is to delegate to the Corporation most of its rights under the Loan Agreement (Subsidiary Loan Agreement, Section 3), including the right to withdraw moneys under the Bank loan. 30. Other important conditions under which PNB would relend the proceeds of the Bank loan to the Corporation are the following: (a) Until Republic Act No. 529 is appropriately amended or repealed (see paragraphs 14 and 15 above), the amounts withdrawn under the Bank loan will be reloaned in pesos equivalent to such amounts. (b) If and when Republic Act No. 529 is appropriately amended or repealed PNB will relend to the Corporation the amounts withdrawn from the Loan Account in the various currencies so withdrawn. (c) Arrangements for repayment by the Corporation to PNB will be such that the foreign exchange risk will be borne by PNB until Republic Act No. 529 is so amended or repealed; thereafter the foreign exchange risk will be passed on to the Corporation. (As noted above (paragraph 15) the Corporation would pass it on to the ultimate beneficiaries.) (d) To cover its expenses, PNB will charge the Corporation 0.443% per annum over and above the rate of interest which PNB has to pay to the Bank. As already mentioned (see paragraph 14 above), PNB will further charge the Corporation for carrying the foreign exchange risk. These charges will be subject to review when appropriate.  PART V - LEGAL INSTRUMENTS AMD LEGAL AUTHORITY 31. The following draft documents are attached: 1. Loan Agreement between the Bank and PNB (No. 1). 2. Guarantee Agreement between the Republic of the Philippines and the Bank (No. 2). 3. Project Agreement between the Bank and the Corporation (No. 3). 4. Subsidiary Loan Agreement between PNB and the Corporation (No. 4). 5. Letter from the Corporation to the Bank regarding the reserves policy (Section 2.15 of the Project Agreement), (No. 5). 6. Letter from the Corporation to the Bank regarding the limit applicable for approval of investment projects by the Bank (Section 2.02(b)(ii) and (c) of the Loan Agreement), (No. 6). 7. Letter agreement between IFC and the Corporation (No. 7). In addition, drafts of the following documents concerning the Corporation are attached: Articles of Incorporation (No. 8), By-Laws (No. 9), Statement of General Business Policies (No. 10). Also attached are a Note on the Philippine National Bank (No. 11), and the report of the Committee provided for in Article III, Section (iii) of the Articles of Agreement of the Bank (No. 12). 32. Conditions of effectiveness of the Bank Loan Agreement include, among other things, (i) that the Corporation shall have been incorporated, (ii) that the share capital shall have been fully subscribed and at least 40% paid in cash at par, and (iii) that the AID agreement shall be satisfactory to the Bank and that conditions precedent to disbursement thereunder shall have been fulfilled. Disbursements under the AID loan in turn are conditional among other things upon the effectiveness of the Bank Loan Agreement. 33. Subscriptions to the share capital of the Corporation, includilg subscriptions by IFC, will be accepted only if certain conditions are ful- filled, namely, the Bank and AID loan agreements shall have become effective and the share capital shall have been subscribed in full. It is expected that the offering of the shares of the Corporation will be made during the latter part of this year and that upon successful completion of the offering the Bank Loan Agreement and the AID agreement will become effective. 34. The Guarantee Agreement follows the normal pattern of the Bank's guarantee agreements.  - 12 - PART VI - APPRAISAL OF ThE PROJECT Economic Situation 35. The economic background against which the proposed loan should be considered is described in the attached "Memorandum on the Economic Situation" dated October 25, 1962 (No. 13). As indicated there, the past year has witnessed several major changes in the Philippine economic policy. The new Government which was elected last November took action in January to dis- mantle fully the system of foreign exchange controls which had been in force for over ten years. Simultaneously, credit restrictions were introduced and steps taken to eliminate the Government's budget deficit. The peso was allowed to float and has now stabilized at a realistic rate for the first time since the war. These measures reversed the decline in exchange reserves which started in 1961, and they promise to lead to a further strengthening of the external position in the coming year. 36. The Government has also adopted a new Five-Year Economic Program and, for the first time, has taken vigorous administrative action to ensure effective implementation of such a program. This Program incorporates recom- mendations made by the Bank Economic Mission which visited the Philippines in the summer of 1961 at the request of the previous Administration. The Mission's preliminary reportl/ was submitted to the Government last January and was published as an annex to the President's State of the Nation Message. The Bank has also been providing technical assistance in implementing the Program. 37. These initiatives are directed at meeting the Philippines' basic economic development problem, which is essentially one of maintaining adequate growth rates of per capita income and employment in the face of a rapidly expanding population and a stagnation in the traditional sources of external earnings. Its solution will require a substantial increase in investment to help diversify production and increase productivity. The manufacturing sector will have to play a key role in this process. Justification of the Project 38. The past decade has witnessed a remarkable growth in Philippine manufacturing. Output tripled in the ten year period 1950-60, and now accounts for around 17% of the national product - a comparatively high pro- portion for a country whose per capita income is about P150 Private foreign investors have played a significant role in this development, but the great part has taken place under private Filipino initiative and ownership. In the early 1950's, the Government set up a number of manufacturing establish- ments, but started selling them in 1957, and now is practically out of the field altogether. 39. The great part of manufacturing investment since the war has been financed with short and medium-term loans. The equity base has been small and long-term loan capital has been quite limited. About the only domestic 1/ Report No. FE-23, dated January 19, 1962, "ECONONIIC GROWTH OF THiE PHILIP- PJIES - A Preliminary Report Prepared by the Bank Staff" which was distributed to the Executive Directors of the Bank on January 19, 1962 (Secm62-20).  - 13 - sources of long-term loan capital have been the Government-ouned Development Bank of the Philippines (DBP) and the U&S. sponsored Tndustrial Developnent Center. In 1956-60, it is estimated that these sources financed 15-20% of industrial investments, which were around - 1.2 billion for the five year period, Financing through short and medium-term loans was made possible by high profit rates resulting from the very favorable treatment given domestic producers by the Government tax and import licensing policies. In the past three years, however, these privileges have been progressively reduced, and by 1960 many firms started to experience serious problems as the result of their financing arrangements. In 1961, as the squeeze became more general, the DBP extended industrial loans of over P 00 million, an amount which approximately equalled total investment in manufacturing for the year. A large part of this consisted of refinancing commercial bank loans and foreign suppliers' credits. In 1962, the DBP has been able to provide very little further help because it has reached the limit of its authorized capital. 40. WJith profits now at more normal rates, an increase in the supply of long-term risk capital for industry would be necessary just to mqaintain investment at its past rate. But the requirements will be very much higher if manufacturing investment is increased on the scale envisaged both by the Governmient's Five-Year Program and by the Bank Economic .Mission. 1/ The Itission estimated that to maintain an adequate growth rate for the economy as a whole, manufacturing investment of more than P3 billion would be necessary in the next five years, or about twice the 1956-60 level in real terms. A major consideration underlying this projection is that industrial development has now reached a point where it has become economic to substantially increase the proportion of investment going into capital- intensive types of production based on domestic raw materials, such as mineral processing, fertilizer, industrial chemicals, wood products, etc. The likelihood that such a shift will talce place has been greatly increased by the recent change in the exchange rate, which will make such investment more profitable than in the past, and at the same time reduces the profita- bility of light manufacturing based on imported raw materials. 41. The Droposed Private Development Corporation can play a Ikey role in meeting these expanded financial requirements. First of all, it would directly increase the supply of long-term loan capital and equity funds for industry. Second, and perhaps more important, it would help to widen the capital market in the country and thereby to stimulate the inflotr of equity and long-term funds from other sources - both domestic and foreign. Finally, as its management gains experience, it will be in a better position than almost any other institution in the country to provide guidance on both the opportunities and pitfalls associated with the shift away from the simpler manufacturing technoloQr of the past to the more complex and capital-intensive activity likely to dominate future development. 1/ See "ECONOMIC GROWiTH OF THE PHILIPPINE,S" especially pp. 19-30.  - 14 - Prospect of Fulfillment of Obligations 42. I believe that the proposed resources, the management and the policies of the Corporation are such as to ensure a significant and valuable contribution by the Corporation to the development of private industry in the Philippines and at the same time to ensure a profitable employment of its resources. I also believe that P\B is an acceptable borrower as an intermediary for the proposed Bank loan. 43. Present external debt of the Philippines amounts to I.h30 million most of which consists of medium term credits to the private sector. The bulk of these will be repaid in the next several years, and total service on present debt will drop from an estimated peak of 10% of export earnings in 1964 to 5% by 1968. Thus, there remains considerable scope for additional debt on conventional terms, provided it is of a reasonably long-term nature. The repayment of the proposed 3l5 million Bank loan should be within the capacity of the Philippine economy. PART VI - COMPLIANCE WIJITH THE ARTICLES OF AGREENELET 44. I am satisfied that the proposed Bank loan complies with the requirements of the Articles of Agreement of the Bank and that the proposed investment by IFC complies with the requirements of the Articles of Agreement of IFC. The Philippine Government has advised IFC that it has no objection to the proposed investment by IFC. PART VII - RECOISHvMDATIONS 45. There is still a number of legal and procedural matters which have to be taken care of before the Corporation can be organized and the Prospectus issued. In addition, while we have agreed in substance with the terms of the AID loan agreement, there are still several drafting points remaining to be agreed. For these reasons it is not intended to sign the Bank's Loan and Guarantee Agreements until arrangements regard- ing these matters have substantially been completed. Furthermore, it may be necessary, because of changes in certain documents relating to these transactions, to make consequential changes in the Bank's draft agreements presented herewith; accordingly under the draft Bank Resolution proposed here for adoption (No. 1h) we would have the power to make changes in these documents which would not be substantial.  46. I recommend (a) that the Bank make a loan to the Philippine National Bank, with the guarantee of the Republic of the Philippines, for relending to the Private Development Corporation of the Philippines upon its incorporation, in an amount in various currencies equivalent to 15 million for a term of 15 years at such rates of interest and substantially on such other terms and subject to such other conditions as are specif.ed in the draft Loan, Guarantee, Project and Subsid..-