Ceylon - Second Development Finance Corporation Project

RESTRICTED FILE COPY Report No. P - 7 31 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 The report may not be published nor may it be quoted as representing their views.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 REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE DEVELOPMENT FINANCE CORPORATION OF CEYLON (DFCC) UNDER THE GUARANTEE OF CEYLON July 2, 1969  REPORT AND RECOMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED SECOND LOAN TO THE DEVELOPMENT FINANCE CORPORATION OF CEYLON UNDER THE GUARANTEE OF CEYLON 1. I submit the following report and recommendation on a proposed loan in an amount in various currencies equivalent to US$8.0 million to the Development Finance Corporation of Ceylon (DFCC). PART I - HISTORICAL 2. In November 1967, the Bank made its first loan of $4 million to the Development Finance Corporation of Ceylon. This loan will be fully committed for sub-projects in the near future. 3. Negotiations for a second loan took place in Washington between June 9 and Juine 17. DFCC was represented by Mr. G.B.S. Gomes (Chairman) and Mr. L.A. Weerasinghe (General Manager). Mr. C. Loganathan (General Manager designate of DFCC) also attended the negotiations. The Government was represented by Mr. David Loos of the Ministry of Planning and Economic Affairs. 4. The following is a summary statement of Bank loans and IDA credits to Ceylon as of May 31, 1969: Amount (US$ million) Year N\o. Borrower Purpose Bank IDA Undisbursed 1954 101-CE Government of Ceylon Power 15.9 - _ 1958 209-CE Government of Ceylon Power 7.3 - 1961 283-CE Government of Ceylon Power 14.1 - - 1967 520-CE Development Finance Industrial Corporation of Ceylon Finance 4.0 - 3.4 1968 121-CE Government of Ceylon Irrigation 2.0 2.0 1968 569-CE Government of Ceylon Highways 4.9 - 4.9 1968 133-CE Government of Ceylon Highways 4.9 4.9 Total (less cancellations) 46.2 6.9 15.2 Of which has been repaid to Bank and others 11.0 Total now outstanding 35.2 Amount sold 3.3 Of which has been repaid 2.6 0.7 Total now held by Bank and IDA 34.5 Total undisbursed 8.3 6.9 15.2  - 2 - 5. The irrigation and highway projects approved last year are progressing satisfactorily. There have been no disbursements on these projects todate because the Goverrmnnt could nct begin to prepare tender documents until after the loan and credit documents were negotiated. The intervening months have been taken up wfith the usual bidding, evaluation and ordering pToceaures. 6. Other lending operations coming up in Ceylon are a loan of $21 million for a power project (for Which negotiations have been substantially completed), a land reclamation and drainage project and the first stage of the Nahaweli Ganga nulti-purpose irrigation and power project. 7. IFC has made no investments in Ceylon. However, it is considering an investment in both loan and equity in a textile project to be jointly financed with DFCC and the Bank of Ceylon. Ibst of the uncommitted balance of $1.5 million under the first DFCO loan is earmarked for this project. PAiRT II - ESCRIPTION OF PROPOSED LQAN 8. Borrower: Davelo-pment Finance Corporation of Ceylon. Guarantor: Goverrernt of Ceylon. Amount: Various currencies equivalent to $8.0 million. Purpose: To enable DFW to finance the foreign exchange costs of specific investment projects under- taken by private industrial, agricultural and conmercial enterprises in Ceylon. Amrtization: The initial amortization schedule provides for repayment over 15 yzars, in 31 semi-annual paymnents beginning May 1, 1972 and ending iA-y 1, 1467, but is sabject to change in order ultimately to conform substantially to the aggregate of the amortization schedules for subloans and investments financed from the proceeds of the loan. Interest Rate: 6* percent per annum. Commitment Charge: 3/4 of 1 percent per annum. Prior Approval of All subloans for projects requiring more than Projects: $100,000 in foreign exchange and all share investments will require the Bank's prior approval. Subloans for projects requiring $100,000 or less will not require the Bank's prior approval, subject to an aggregate limit of $2 million.  PART III - THE PhDJECT 9. An appraisal report entitled "Appraisal of the Development Finance Corporation of Ceylon" (No. DB-50a, dated June 30, 1969) is atbache6. 10. In the first 12 years following its establishment by Act of Parliament in 1955, DFCC remained a small-scale, cautious institution, providing limited amounts of long-term development finance mainly for the expansion of private industry. DFCO's slow growth during these years was largely due to general conditions prevailing in Ceylon. In the early part of the period, industry in Ceylon had little or no protection from imports. Later, Government policy favored public rather than private sector industrial development, and when foreign exchange became scarce and import controls were imposed in the early 1960's, private industrial investment almost ceased, because the Government allotted little foreign exchange for that purpose. 11. The Bank loan to DFCC in 1967 followed an improvement in the investment climate resulting from a recovery in the econonm, together with efforts by the Government to encourage private sector investment. Since 1967 more foreign exchange has become available for private industry, and the Government has resumed processing investment proposals from the private sector, of which there was a large backlog. Industrial production has grown rapidly in the past two years and efficiency has increased, mainly because of fuller use of existing capacity. Investment in private industry has also been increasing. DFCC has had no difficulty in finding suitable projects to finance and, in fact, its recent level of business has been determined largely by its capacity to process applications. DFCC is expected to commit the full $4 million of the 1967 Bmnk loan in less than the twzo years originally envisaged. 12. By March 1969 DFCC had made a cumulative total of 1h2 loans amounting to Rs.72.8 million (US$12.2 million) and 30 share investments amounting to Rs.9.1 million (US$1.5 million). Its profitability has been satisfactory. DFCC's project appraisals have been improving in quality. Its portfolio is judged to be good, and debt recovery has presented few problems. 13. The investment climate in Ceylon is likely to continue to improve, and there are clearly opportunities for DFCC to increase its volume of business significantly as soon as the organization is strengthened. Toward this end DFCC's Board of Directors recently appointed Mr. C. Loganathan (formerly General Manager of the Bank of Ceylon) to succeed the retiring General Manager. Mr. Loganathan is expected to provide DFCC with the leadership needed to respond to the growing opportunities. 14. On the basis of financing applications at present under consideration or expected in future, it is estimated that over the next two years DFCC will be able to commit about $16 million equivalent, of which about $10 million to $11 million will be in foreign exchange. DFCC has negotiated a loan of DM 6 million ($1.5 million equivalent) with Kreditanstalt fu!r Wiederaufbau of Germany, for which the formalities are expected to be  completed in the near future. Taking into account this loan and funds already in hand, DFCC will need an additional amount of about $8 million in foreign exchange resources to cover anticipated commitments over this period. The proiosed Bank loan wouldJ meet this neecl. DFCC's lending in local currency will be financed mainly from the repayments of earlier loans, supplemented by borrowing under a refinancing scheme operated by the Central Bank of Ceylon. DFCC is also contemplating an issue of share capital before the end of 1970. 15. In future both the average and minimum size of loans made by DFCC are likely to increase. To reflect this, and also the growing strength of the institution, we propose to raise the size of subloans which can be made out of the Bank loan without the Bank's prior approval from $30,000 to 1100,000. PART IV - LEGAL INSTRUMETNTS AND AUTHORITY 16. The draft Loan Agreement between the Bank and DFCC, the draft Guarantee Agreement between Ceylon and the Bank, the Report of the Committee Drovided for in Article III Section L(iii) of the Articles of Agreement and the text of a Resolution approving the proposed Loan are being distributed to the Executive Directors separately. The agreements follow closely the forms currently in use for loans to oevelopment finance companies. PART V - THE ECONOMY 17. The economic report entitled "Current Economic Position and Prospects of Ceylon" (SA2a) was distributed to the Executive Directors on February 7, 1969. 18. The report describes the continuec progress of the economy in 1968. This progress followed three years during which the severe crisis of 1965 was overcome and a soundly-based development effort launched. Ceylon's success in these three years, despite falling export earnings, was made possible partly by inflows of foreign assistance. During this period the available foreign exchange has been carefully allocated to permit substantial increases in imports of raw materials, spare parts and current agricultural inputs. Dbmestic food production, particularly rice, also increased impressively. 19. Progress in 1968 was assisted by a 20% devaluation in November 1967, followed by an exchange reform in May 1968 whereby nearly half of Ceylon's payments transactions now take place at a still higher rate. This exchange reform permitted some liberalization of inports, and most industrial raw materials and spare parts are now permitted under open general licence. This resulted in the private sector being willing to run down stocks of these items and contributed to the remarkable 45% increase in industrial production recorded in 1968. 1968 also saw a larger allocation of foreign  exchange for imported capital goods for :nrivate industry, thus permitting an increase in private manufacturing investment from the very low levels of earlier years. Economic growth in 1968 turned out to be higher than estimated in the report, and GDP in real terms was more than 8% above the 1967 level. This increase was achieved almost entirely by the growth of production for domestic use. 20. Members of the Ceylon Aid Group, meeting in Paris in 1March, recognized the achievements of the recent past but noted that Ceylon's foreign exchange shortage would continue to be acute owirng to the poor prospects for Ceylon's major export crops. Indications of aic. by member countries at that meeting suggested that commitments in 1969 would be some- what higher than the 1968 commitments of $53 million. Aid disbursements from these countries in 1969 are also expected to be greater than the $46 million level achieved in 1968. 21. Over the longer term Ceylon will continue to need substantial inflows of foreign assistance. In addition to falling prices for the three major export crops (tea, rubber and coconuts), heavy debt repayments fall due in the next few years. This means that debt service could well rise above 20% of export earnings between now and 1973, the exact level depending on the amount and terms of future external borrowing. To look beyond 1973 is difficult but with present export prospects, it is unlikely that debt service will fall much below 20% if the average terms of aid remain at present levels and if Ceylon is to obtain the necessary gross inflows of foreign assistance. It is there- fore inmortant that Ceylon continue and intensify efforts to stimulate non- traditional export earnings, including tourism. In this connection a further increase last month in the exchange rate governing nearly half of all payments transactions, including these newer exports, should have positive results. 22. Ceylon's recent economic performance has shown what good economic policies can accomplish, even in the face of unfavorable export price trends. Provided that present standards of economic management continue, I consider Ceylon creditworthy for limited amounts of Bank lending. PART VI - OOMPLIANCE WITH ARTICLES OF AGREEtNT 23. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VII - REGOIMMENDATION 24. I recommend that the Executive Directors approve the proposed loan. Attachments Robert S. McNamara President July 2, 1969