Colombia - Development Finance Companies Project

RESTRICTED FILE' COPY Report No. P-476 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 The report may not be published nor may it be quoted as representing their views.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 RECONSTRUCIION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PR ESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO BANCO DE LA REPUBLICA IN COLOMBIA FOR THE DEVELOPMENT FINANCE COMPANIES PROJECT April 22, 1966  INTERNATIONAL BANK FOR RECONSTRUCTIONi AND DEVELOPiENT REPORT AND RECOI-2MNDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO BANCO DE LA REPUBLICA IN COLOMBIA FOR THE DEVELOPHENT FINANCE COIPANIES PROJECT 1. *I submit the following report and recommendation on a proposed loan in an amount in various currencies equivalent to US$25 million to Banco de la Republica, the proceeds of which are to be made available to five Colombian Private Development Finance Companies (Financieras). PART I - HISTORICAL 2. Of the five Financieras, the two largest, Corporacion Financiera Colombiana (CF Colombiana, established in Bogota in 1959) and Corporacion Financiera Nacional (CF Nacional, established in Medellin in 1960) have a national scope. The three others, Corporacion Financiera de Caldas (CF de Caldas, established in Manizales in 1961), Corporacion Financiera del Valle (CF del Valle, established in Cali in 1962) and Corporacion Financiera del Norte (CF del Norte, established in Barranquilla in 1964) operate on a regional basis. IFC made investments in three of them as follows: a $2 mil- lion convertible loan to CF Nacional in 1961 (converted into common stock in 1961-63), a $2 million convertible loan to CF Colombiana in 1961 (con- verted into common stock in 1961-62), and a $700,000 equity investment in CF Caldas in 1964. 3. In order to help increase the pace of investments in the private sector which has been suffering from a lack of medium and long-term financing facilities, the Bank, since 1963, had been considering making a loan to the Financieras. Moreover, the Bank had also actively supported the creation of a Private Investment Fund (PIF) within Banco de la Republica, the Central Bank, as a means of inducing and facilitating a substantial flow of external credits for financing productive investments in industry and agriculture.  - 2 - 4. As requested by the Financieras, the Bank would have been willing to make the loan directly to them but, in this case, the Government was un- willing to guarantee a loan which would be made directly to private companies. It became necessary therefore to find an intermediary channel which would be acceptable to the Government for the purpose of giving its guarantee. Because of the inflationary tendencies of the Colombian economy, neither the Financieras nor the ultimate beneficiaries could prudently have assumed the foreign exchange risk on a long-term loan. On the other hand, the Government was unwilling to cover this risk in favor of a special group of private companies. Again, an intermediary had to be found which could assume the foreign exchange risk and which would be acceptable to the Government as well as to the Financieras. 5. The solution finally arrived at in late 1964 was to use PIF as the vehicle for channeling the Bank loan to the Financieras. The loan would be made to Banco de la Republica for relending to the Financieras through PIF, and it would be guaranteed by the Government. Banco de la Republica would assume the foreign exchange risk at a cost to the Financieras of a 3 percent annual interest surcharge which would also cover administrative expenses. 6. An IFC mission visited Colombia in early 1965 to appraise this project. In December 1965 the Bank invited representatives of the Financieras, the Banco de la Republica, and the Government for negotiations. The principal Colombian negotiators were: Mr. Uribe Botero, Ambassador of Colombia; Mr. Arias-Robledo, General Manager of Banco de la Republica; and Messrs. Ocampo, Herrera Carrizosa, Gutierrez Gomez, Jaramillo and Salcedo, Presidents of the five Financieras. The negotiations were completed in late February 1966. 7. The proposed loan would be the 26th made to Colombia and it would increase the total of Bank loans to Colombia to $413.9 million (net of can- cellations). IDA has made one credit of $19.5 million to Colombia. The following is a summary statement of Bank loans and IDA credits to Colombia as of March 31, 1966:  -3- Amount (US $ Million) Year Borrower Purpose Bank IDA Undisbursed Fully disbursed Total (less cancellations) 187.4 1961 Empresas Publicas de Medellin Power 22.0 2.2 1961 Government Roads 19.5 5.1 1961 Government Roads 19.50 8.3 1962 Empresa de Energia Electrica de Bogota Power 50.0 6.2 1963 Ferrocarriles Nacionales de Colombia Railways 30.0 5.0 1963 Acerias Paz del Rio, S.A. Steel 30.0 22.9 1963 Electrificadora de Bolivar, S.A. Power 5.0 2.1 1964 Empresas Publicas de Medellin Power 45.0 41.2 Total (less cancellations) 388.9 19.50 of which has been repaid 75.3 Total now outstanding 313.6 Amount sold 14.4 of which has been repaid 12.3 2.1 Total now held by Bank and IDA 311.5 19.50 = Total undisbursed 84.7 8.3 93.0 8. Eighteen loans have been completely disbursed. On the remainder, disbursements are proceeding normally with the following exception: Disbursement of the 1961 road loan and credit has been delayed because of administrative difficulties in the Ministry of Public WVorks. This project is four years behind schedule and the Govern- ment has now undertaken to retain management consultants to improve the administrative performance of this Ministry. The situation is being kept under close review by the Bank. I am planning to send shortly a memorandum to the Executive Directors on the project. 9. Together with this report, I am submitting to the Executive Directors a proposed loan of $16.7 million to the Republic of Colombia for livestock development, the proceeds of which are to be made available to the Caja de Credito Agrario, Industrial y Minero. 10. In the next few months the following loans are expected to be presented to the Executive Directors for approval: a loan for a telecom- munications project of about $23 million to the Empresa Nacional de Tele- comunicaciones, and a loan for electric power development of about $10.5 million to Central Hidroelectrica del Rio Anchicaya, Ltda (CHIDRAL).  - 4 - PART II - DESCRIPTION OF THE PROFOSED LOAN 11. The main features of the proposed loan are as follows: Borrower: Banco de la Republica Guarantor: Republic of Colombia Beneficiaries: The proceeds of the loan to be re-lent by Banco de la Republica to the following Financieras: CF de Caldas, CF Colombiana, CF Nacional, CF del Norte, and CF del Valle. After repayment by the Financieras, these proceeds will be mnade available to PIF (see paragraph 12 below). Amount: The equivalent in various currencies of $25 million. Purpose: To assist the private sector in Colombia by providing medium and long-term finance to cover the foreign exchange portion of investments primarily in industry, said investments to be made by the Financieras in the form of loans or equity participations. Amortization: Term of 20 years, with semi-annual payment dates of June 1 and December 1, and payments beginning on December 1, 1970 and ending on December 1, 1986. Interest rate: 6 percent per annum. Commitment charge: 3/8 of 1 percent per annum accruing from the time the Loan Account is credited with portions of the loan for individual investment projects. Relending terms: Banco de la Republica wjill charge 3% additional interest to the Financieras for assuming the foreign exchange risk and to cover administra- tive expenses. The Financieras will repay the funds they receive from Banco de la Republica in accordance with the amortization schedules appili- cable to their loans to the ultimate benefi- ciaries, which cannot exceed 15 years. 12. The proposed loan would have a fixed amortization schedule and a fixed interest rate. The amounts repaid to Banco de la Republica by the Financieras which are not yet required to service the Bank loan would be used by Banco de la Republica for the normal operations of PIF.  PART III - THE PROJECT 13. An appraisal report entitled "Appraisal of five Colombian Private Development Finance Cori,panies" (No.DB-28a) is attached. 14. Colombia has a long experience in industry and has developed her own managerial class of highly trained and dynamic entrepreneurs. Colombian labor is readily susceptible to training and responds well to incentives. 15. Manufacturing accounts for approximately 19 percent of Colombia's domestic product, and is the second largest sector of the economy after agriculture. Within the manufacturing sector the two traditional branches, namely, food processing and beverages, and textiles and clothing, are domin- ant. They contribute almost half of the value added by the sector and employ about 48 percent of the industrial labor force. Colombia has, how- ever, made great efforts in diversifying its industrial production and other branches like chemicals or non-metallic minerals have also become significant. 16. Following a period of rapid development in the 1950's when annual growth rates of over 9 percent were not unusual, the pace of industrial growth in Colombia slackened considerably in recent years to annual rates of about 6 percent. This was primarily due to inflationary pressures and balance of payment difficulties. Recently, however, the Colombian Govern- ment has adopted an effective stabilization program and has taken measures to improve the climate for industrial development. As a result, it is expected that the rate of increase of manufacturing output will accelerate in 1966 and may again average about 9 to 10 percent per annum in the next few years. The level of investments is also likely to increase substantially. 17. In Colombia, the principal institutional sources of industrial fi- nancing in share capital are the insurance and allied savings companies and the Financieras. The Banco de la Republica, through its rediscounting facil- ities to the banking system, through the special credit lines which it makes available to the Financieras and through the funds which are channeled through PIF, provides most of the loan capital. 18. PIF is regulated by Resolution No. 11 of February 1963. It is an account within Banco de la Republica out of which medium and long-term credits are made available to financial institutions, including the Finan- cieras, to finance private investment projects of high economic priority in industry and agriculture. PIP has been a useful instrument for channeling resources to the private sector and has become a major source of medium and long-term industrial financing. About half of the U.S. program loan counterpart funds and about 20 percent of the foreign exchange resources going to the private sector from official sources have been channeled through PIF ($53 million equivalent and $14 million respectively). 19. Since 1963 and up to September 30, 1965, PIF has committed credits in a total amount of Co1$479 million. Of these, Col$415 million were lent for industrial projects representing a total investment of about Col$1.6 billion. About 80 percent of these commitments were made up to September 1964 at which time PIF had almost exhausted its resources.  - 6 - Since these committed funds were disbursed over a 2 to 3 year period, it may be judged that PIF contributed about 15 to 20 percent of net fixed industrial investment during that period. 20. The Financieras were established to provide medium and long-term capital to private industry. Under their statutes, the Financieras are engaged in a wide variety of operations which include medium and long-term lending, import-export financing, equity participations, promotions, under- writing and guarantees. The nature of their ownership varies, but on the whole it consists of the large Colombian banking, insurance and industrial companies; regional interests and small individual shareholders are also represented. Foreign participation is particularly important in the two larger institutions: CF Colombiana and CF Nacional. IFC's present holdings are as follows: 1,812,000 shares of CF Colombiana with a total par value of Col$18.1 million, 1,069,091 shares of CF Nacional with a par value of Col$10.7 million, and 70,000 shares of CF de Caldas with a par value of Col$7.0 million, representing respectively about 15, 13 and 12 percent of their share capital. 21. The Financieras have been profitable and their financial position is sound. Return on average share capital in 1965 ranged from about 13 to about 25 percent l/ All five companies have followed prudent reserve policies. They have, however, had difficulties in protecting their equity from erosion through inflation. In agreement with the Bank, the Financieras have accepted to limit their borrowings to five times their equity for CF Colombiana and CF Nacional, and to four times for the three others. 22. Since their inception the Financieras have had a significant impact on the industrial development of Colombia. In the years 1963-64, for example, they contributed about 16 percent of the total investment in manufacturing. The Financieras have become the principal private institu- tions providing medium and long-term capital to the private sector and they are expected to increase this role in the future. 23. In the light of their recent performance and in view of the en- couraging prospects for industrial investment, the Financieras should require, through the end of 1968, foreign exchange funds substantially in excess of the US$25 million which the proposed Bank loan would provide. According to the Financieras and their prospective clients, sufficient local currency resources would be available in the next two years to comple- ment the Bank loan. 24. The past record of all five companies and their future prospects make the five Financieras suitable recipients for the proposed Bank loan. They fulfill an important role in the Colombian economy by providing long- term financing facilities which are necessary for a healthy development of the private sector and they have the capacity to make good use of these additional resources. 1/ Net income before taxes as percentage of average share capital (in current values).  - 7 - 25. In view of Colombiats economic situation (see paragraph 28 below and paragraph 17 of the attached economic memorandum), it would be desir- able to provide in this particular case, longer terms than would be justi- fied on project grounds alone. The Bank loan would thus have a term of 20 years including a four-year grace period. As the maximum term of the sub-loans would only be for 15 years and the average term much less, local currency funds would accrue to PIF for use in its normal operations thereby extending the usefulness of the proposed loan. PART IV - LEGAL INSTRUIENTS AND AUTHORITY 26. The Draft Loan Agreement between the Bank and the Banco de la Republica, the Draft Guarantee Agreement between the Republic of Colombia and the Bank, the Draft form of Project Agreement betixeen the Bank and each Financiera, the Draft form of Subsidiary Loan Agreement between the Banco de la Republica and each Financiera and the Report of the Committee pro- vided for in Article III, Section h(iii) of the Articles of Agreement are being distributed to the Executive Directors separately. 27. These Draft Agreements contain covenants normally included in agreements with development finance companies. Attention is drawn to the following provisions: i. pursuant to Section 2.09 of the Loan Agreement Banco de la Republica will submit applications for crediting the Loan Account only if it is satisfied that the respective investment project is of significance to the economic development of Colombia; ii. in Section 5.02(b) of the Loan Agreement it is provided that the amounts repaid by the Financieras to Banco de la Republica shall be credited to the PIF and shall be used in PIF's normal lending operations; iii. the Loan Agreement provides that if a Financiera is in de- fault under its Project Agreement with the Bank, the Bank has the right to premature that part of the Loan which has been re-lent to the defaulting Financiera and is outstanding (Section 6.01); iv. the Loan Agreement can be made effective at the option of the Bank even if one or more of the Financieras shall not have complied with the conditions established for effectiveness (Section 7.01); the Subsidiary Loan Agreements and the Project Agreements will become effec- tive on the effective date of the Loan Agreement, but only for those Financieras that have complied with the conditions of effectiveness on their part (Section 5.01 of the Subsidiary Loan Agreements and Section 3.01 of the Project Agreements).  - 8 - PART V - THE ECONO!WlY 28. An economic memorandum giving a summary review of the economic situation is attached. As stated in that review, Colombia is credit- worthy for the limited amounts of external borroTuing proposed in 1966, preferably with longer repayment terms and extended periods of grace. PART VI - COIiPLIANCE 11ITH ARTICLES OF AGREE1,ENT 29. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PAPT VII - RECOi'I,DAT ION 30. I recommend -that the Executive Directors adopt the following resolution: RESOLUTIONT NO. Approval of Loan to the Banco de la Republica (Development Finance Companies Project) in the amount of the equivalent of US' 25,000,000 to be guaranteed by the Republic of Colombia RESOLVED: THAT the Dank shall grant a loan to the Banco de la Republica, to be guaranteed by the Republic of Colombia, in an amount in various currencies equivalent to twenty five million United States dollars (US'; 25,000,000), to mature on and prior to December 1, 1986, to bear interest at the rate of six per cent (659) per annum, and to be upon such other terms and conditions as shall be substantially in accordance with the terms and conditions set forth in the form of Loan Agreement (Development Finance Companies Project) between the Bank and Banco de la Republica, the form of Guarantee Agreement (Development Finance Companies Project) between the Republic of Colombia and the Bank, the form of Sub- sidiary Loan Agreements (Development Finance Companies Project) between the Banco de la Republica and Corporacion Financiera de Caldas, Corpora- cion Financiera Colombiana, Corporacion Financiera Nacional, Corporacion Financiera del Norte and Corporacion Financiera del Valle and the form of Project Agreements (Development Finance Companies Project) between the Bank and Corporacion Financiera de Caldas, Corporacion Financiera Colom- biana, Corporacion Financiera Nacional, Corporacion Financiera del 1Torte and Corporacion `inanciera del Valle, which have been presented to this meeting. George D. IWToods WTashington, D.C. President April 22,1966.