Israel - Second Industrial Development Bank Project

RESTRICTED Report No. DB-33a 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 The report may not be published nor may it be quoted as representing their views.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 INTERNATIONAL DEVELOPMENT ASSOCIATION APPRAISAL OF INDUSTRIAL DEVELOPMENT BANK OF ISRAEL LIMITED April 6, 1967 Development Finance Companies  CURRENCY EQUIVALENTS Currency Unit = Israel Pound (Ib) US $1 = IL 3 IL 1= US $0. 333 US $1 million = IL 3 million IL 1 million = US $333, 333  This report is based on the findings of a mission to Israel in June/July 1966, composed of Messrs. Powell, Hilton and Bose of IFC and information subsequently obtained in December 1966 in Israel by Mr. Bose. INDUSTRIAL DEVELOPMENT BANK OF ISRAEL LIMITED TABLE OF CONTENTS Page Paragraphs SUMMARY i i - x I. INTRODJCTION 1 1 - 2 II. INDUSTRY AND FINANCE 1 3 - 10 III. THE COMPANY 3 11 - 23 History and Powers 3 11 Ownership 3 12 - 13 Organization and Management 3 14 - 19 Project Appraisal and Fbllow-Up 5 20 - 23 IV. FIhANCIAL RESOURCES 6 24 - 35 Share Capital 6 25 - 27 Debentures 7 28 AID Loans 7 29 IBRD Loan 7 30 Government Deposits 7 31 - 32 Government Finds and German Loan 8 33 Short-term Borrowing 8 34 Managed Funds 8 35 V. POLICIES AND OPERAIIONS 8 36 - 59 Loan and Guarantee Operations 9 39 - 51 Investment in Shares 12 52 - 54 The Investment Company of IDBI 13 55 - 59 VI. FINANCIAL RECORD AND POLICIES 14 60 - 77 Capital Structure 14 60 - 63 Financial Results 15 64 - 66 Allocation of Income 16 67 - 71 Delinquent Loans and Investments 17 72 Portfolio 18 73 - 75 Share Values 18 76 Audit 18 77  Table of Contents continued Page Paragraph VII. PROSPECTS AND PROJECTIONS 19 78 - 86 Estimate of Future Operations, 1967 and 1968 19 78 - 81 Resources, 1967 and 1968 20 82 Estimate of Additional Requirement 20 83 Prospective Sources 21 84 - 85 Estinated Results 21 86 VIII. CONCLUSIONS AND RECOMENDATIONS 22 87 - 95 Conclusions 22 87 - 590 Recommendations 22 91 - 95  INDUSTRIAL DEVELOPNENT 3ANK OF ISRAEL LIMITED List of Annexes 1. Shareholders 2. Sumnary of Share Capital 3. Directors, Committees and Organization 4. Debentures Issued 5. Operations 6. Investment Company of IDBI 7. Balance Sheets 8. Income Statements 9. Dividends Paid 10. Delinquent Investments 11. A Forecast Balance Sheets B Forecast Income Statements C Financial Projections  INDUSTRIAL DEVELOPMENT BANK OF ISRAEL LIMITED SUMRY i. The Industrial Development Bank of Israel Ltd. (IDBI) is an institution of national importance. As of December 31, 1966, its issued share capita:L was IL339 million ($113 million equivalent). In addition, IDBI had loan funds of IT225 million, including a Bank loan of $20 million (I6O0 million). ii. Only IT15 million of IDBI's capital carries full voting right. 54j% of the voting shares are held by private domestic investors, 26% by the Government and 20% by foreign investors. IDBI's Board of Directors numbers 56, and its functions have largely been delegated to three committees on which the main shareholding groups are represented. Through its Board and committees, IDBI is closely integrated with the commercial banking system of Israel and with the financial and economic decision-making machinery of the Government. iii. Since IDBI was appraised in 1964 for the first Bank loan, it has succeeded in remedying some of the weaknesses then apparent. The staff has been increased and now embodies a wider range of professional skills. Project appraisals have been improved and IDBI's investment decisions are no longer as heavily reliant on appraisals made by the Ministry of Commerce and Industry as they used to be. IDBI appraisals are still uneven in quality but the best have reached a satisfactory standard. IDBI has set up a project supervision department, the lack of which had been a major deficiency. iv. ID13I has concerned itself almost exclusively with lending, and by the end of 1966 had approved loans to a cumulative total of IT770 million ($256.7 mill-Lon equivalent). About 42% of the loan portfolio is partially guaranteed by the Government. Such guarantees have reduced the risk of IDBI's operations, but may have encouraged some laxity in its project appraisals. IDBI has financed some poor projects which had been spconsored by the Government on political considerations and were guaranteed by it.. The proportion of such poor projects in IDBI's portfolio is judged to be less than 5%. v. ID3I's equity investments amount only to 6% of its portfolio, and appear to be overvalued in the books. They include an investment in a subsidiary, the Investment Company of IDBI Ltd., which has a share capital of IT20 million and is owned 75% by IDBI and 25% by the Government. It is operated as a department of IDBI. The Investment Company has a complex portfolio but has not been very active. IDBI's present policy is tco abstain from making equity investments, and to simplify the subsidiary's portfolio by liquidation of the latter's subsidiaries.  vi. ID3I's pre-tax income in 1965 and 1966 amounted to 10.5% and 9.7%, respectively, of average net worth. In the past years, administrative expenses were relatively stable, between 0.3% and 0.4% of average portfolio, but these increased to nearly 0.5% in 1966. The high cost to IDBI of share capital raised from the public is partly offset by the low-yield Government- held shares, but the overall cost of resources is now about 6.4% as against an average yiLeld from loans and investments of 8.3%. vii. IDHI has financed on the average between one-fifth and one-quarter of gross industrial investment in Israel. During 1966 industrial investment declined to IL380 million from 1h500 million in 1965. The latest Bank Economic M4ission provisionally estimates that industrial investment will improve in 1967 and 1968 to about h1440 million and 11500 million, respec- tively. IDBI will continue to be the chief institutional source of long-term finance for private and cooperative industry. In each of 1965 and 1966 IDBI's loan approvals amounted to about IT98 million. It is very probable that approvals in 1967 will be no less than in those two years, i.e. about IT100 million, especially as total industrial investment is expected to increase in 1967 over that in 1966. Moreover, at the end of 1966, IDBI had pending loan applications of I199 million. An estimate of loan approvals of 16100 million and 11110 million in 1967 and 1968, respectively (together with total equity investments of Ii6 million) appears to be justified. To make approvals of the order of I216 million ($72 million equivalent) during these two years, IDBI is likely to need additional resources of the order of I75 million ($25 million equivalent) all of which could be applied to foreign exchange expenditure. viii. IDBI continues to be a suitable borrower and should be able to put a second Bank loan to productive use. Such a loan, unlike the first, should be available only for expenditures in foreign currencies, and its other terms should also be those currently applied to Bank loans to development iinance companies. ix. For the proposed loan, IDBI should be required to submit to the Bank for prior approval: (a) projects to which IDBI intends to lend 11.5 million or mcre from the Bank funds; (b) projects to which the total amount of IDBI assistance is to equal or exceed IL2.5 million and for which the use of Bank funds in any amount is proposed; and (c) all projects, regard- less of size, which use Bank funds and for which IDBI expects to receive a Government guarantee. The aggregate of all IDBI's sub-loans requiring prior approval should be at least half the amount of the proposed Bank loan. x. Sirnce in future IDBI and its subsidiary are expected to remain inactive in the field of equity investment, it is recommended that I:DBI's maximum total investment (loan and equity) in the subsidiary be set at 7Y- of IDBI's share capital and reserves, reduced from the 20% limit provided in the first Bank Loan Agreement.  REAPPRAISAL OF INDUSTRIAL DEVELOPNENT BANK OF ISRAEL LIMITED I. INTRODUCTION 1. The Bank made a loan of $20 million to the Industrial Develop- ment Bank of Israel Limited (IDBI) in September 1965. The loan is now almost fully committed; as of February -28, 1967, the loan account had been credited with about $19.2 million for 67 projects, and $14.8 million had been disbursed. 2. In March 1966 the Government of Israel requested the Bank to consider a further loan to ImBI. A mission visited Israel for three weeks in June and July 1966, and was followed up by a brief mission in December. This report is based on the findings of those missions, and focuses on developments during the past two years. II. INDUSTRY AND FINANCE 3. The diminished pace of growth of the economy from 1965 has been reflected in industrial production, which advanced by 10% and an estimated 3% to 4% in 1965 and 1966 respectively, as against the phenomenal rates of 14% to 15% per amnum during 1958-1964. The lower rate of increase wa,s apparently due to the Government's disinflationary monetary and fiscal policies, a fLattening of demand (arising from stabilization of consumption) and a drop in overall investment, notably in the construction industry. 4. In contrast to steady increases in industrial investment in 1964 and earlier, lthere has been a decline in 1965 and 1966. Gross investment in industry (the bulk of it in private and co-operative enterprises) was estimated at :W500 million and IT380 million in 1965 and 1966 respectively, down from a peak of about I.520 million in 1964 (all amounts at current prices). 5. The Government is making efforts to arrest the recession and the increase in unemployment. It believes that this is the opportune time to achieve a clesired transfer of resources, including manpower, to the more productive sectors of the economy, especially industry. With this in view, the Government is preparing an industrial program for the next few years, partly to replace the earlier "1964-1970 Program." For 1967 and 1968, it hopes for a large increase in industrial investment. 6. The Government's hopes are based in part on the establishment and rapid progress of science-based "growth" industries, such as petro-chemicals, electronics, scientific instruments, phosphates and others. However, apparently the Government also wants progress in a wide range of the estab- lished industries including textiles, by putting pressure on firms to export, and contemplates reinforcing the various incentives to industrial investment,  production and exports. It is considering changes in the Law for the Encouragement of Capital Investment to provide grants for the purchase of machinery for export or import-substitution ventures, and higher depreci- ation allowances. Development area industries may be given increased subsidies. Export premiums are available for a large number of products, at rates frcm 4% to 8% of value added. Greater assistance is proposed for research, an,d the Government is in the process of setting up an Israel Research and Development Corporation. Measures are contemplated for attracting nmore foreign investors. 7. The prices of industrial products continued upwards in 1965 and 1966, in a wage-price spiral, despite the fact that the levelling off of demand and the decline in investment made possible better labor discipline, fewer wage demands and redeployment of labor. Since early 1965 labor productivity is estimated to have improved. Export earnings continled to increase in 1965 and 1966, largely because of bigger exports of diamonds and potash. The Government reduced certain import duties in November ,1966, as part of a liberalization program, which should expose more and more industrial products to foreign competition. 8. IDBI continued to be the most important institutional source of medium- and long-term finance to private industry. Between 1960) and 1966, DBI's loan approvals were on the average 22.6% of estimated gross investment in industry. Over the period, IDBI's annual share fluctuated between about 13% and 31%j but in the three latest years the fluctuations have been smaller, with 19.7% the lowest and 25% the highest. In 1966, IDBI's share was 23.6%. In that year about one-fifth of its approvals were made in the closing month. 9. In 1965 the Bank of Israel tightened controls on bank credit, but demand for credit rose continuously, for a wide variety of purposes. Bill discounting swelled further, despite a cost to the borrower of 15% to 20%. Increases in bank credit were mostly on account of directed loans and earmarked funds, such as the Government's Export Fund. Monetary controls have been eased from mid-1966. 10. The Tel Aviv Stock Exchange has not been a significant source of funds for industry; real estate, bank and finance company issues have predominated. In 1962/1963 there was a big boom on the market, but it slumped in 1964. Prices of shares continued to be depressed, the volume of trading is small and there have been hardly any new issues. Contributing to the depressed condition of the market have been the absorption of funds by the high-yield short-term Government loan, better yields from linked debentures, the failure of share prices to act as a hedge against irnflation, the unloadinig on the market of substantial quantities of shares initially issued outside the market, the diminished interest of foreign investors and the decline in personal restitution payments from Germany. In 1965 the Government appointed a committee to advise on measures to revive the market. Among its recommendations subsequently accepted were the aboliton of capital gains tax on profits on share sales, and the establishment of investment funds. So far these measures have failed to infuse new life into the market.  III. THE COMPANY History and Powers 11. The Industrial Development Bank of Israel was established in 1