Document of The World Bank FOR OFFICIAL USE ONLY Report No. 18&3a-YU STAFF APPRAISAL REPORT ON A THIRD AND FOURTH INDUSTRIAL CREDIT PROJECT YUGOSLAVIA June 23, 1978 Industrial Development and Finance Division Projects Department Europe, Middle East and North Africa Regional Office This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. 4~~~~~~~~~~~~~~ CURRENCY EQUIVALENTS US$1.00 Din 18.20 Din 1.00 = US$0.055 GLOSSARY OF ABBREVIATIONS IBT - Investiciona Banka Titograd KBP - Kosovska Banka Pristina PBS - Privredna Banka Sarajevo SBS - Stopanska Banka Skopje BOAL - Basic Organization of Associated Labor DFC - Development Finance Company ERR - Economic Rate of Return FRR - Financial Rate of Return GMP - Gross Material Product ICB - International Competitive Bidding LDRs - Less Developed Regions (of Yugoslavia) MDRs - More Developed Regions (of Yugoslavia) SDK - Sluzba Drustvenog Knjigovodstva or Social Accounting Service FISCAL YEAR January 1 - December 31 FOR OFFICIAL USE ONLY STAFF APPRAISAL REPORT ON A THIRD AND FOURTH INDUSTRIAL CREDIT PROJECT YUGOSLAVIA Table of Contents Page No. PREFACE ................................................ 1 I. THE INDUSTRIAL SECTOR .................................. 1 A. Institutional Framework ..... .............. 1 B. Structure of Industry ..... ............... 3 C. Past Performance .................................. 5 D. The Role of Industry ..... ............... 6 E. Development Issues ...... ............... 7 F. Prospects: The 1976-80 Plan ...................... 10 II. THE FINANCIAL SECTOR ................................... 14 A. Financial Institutions ............................ 14 B. The New Banking Law ............................... 15 C. Interest Rates .................................... 16 D. The Role of the Borrowing Banks ................... 17 III. THE BORROWING BANKS .................................... 18 A. The Banks' Structure .............................. 18 B. Policies and Procedures ........................... 20 C. The Banks' Operations ............................. 21 D. The Banks' Financial Situation .................... 22 E. Performance Under the Previous Industrial Credit Projects ................................ 26 F. Forecast of the Banks' Operations and Financial Performance .................................... 27 IV. THE PROJECTS ......................................... 28 A. Objectives ...................................... 28 B. Use of the Proceeds of the Proposed Loans ....... 29 C. Economic Justification .......................... 31 D. Main Features of the Loans ...................... 32 V. AGREEMENTS REACHED AND RECOMMENDATIONS .... ........... 35 This report is based on the findings of an appraisal mission composed of Messrs. H.B. Thomas, J.M.R. Feige, M. Takahashi, S.Z. Husain and C. Chittle (Consultant), which visited Yugoslavia in October 1977. L This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Table of Contents (Continued) Page No. ANNEXES Annex 1 Statements of Income and Expenses: 1975-June 30, 1977 ....................................... 36 Annex 2 Balance Sheets: 1975-June 30, 1977 ....................................... 37 Annex 3 Projected Statements of Sources and Applications of Funds: 1978-82 .................................................. 38 Annex 4 Projected Statements of Income and Expenses: 1978-82 .................................................. 39 Annex 5 Projected Balance Sheets: 1978-82 .................................................. 40 Annex 6 Projected Schedule of Disbursements ........................ 41 Annex 7 Selected Documents and Data Available in the Project File ............................................. 42 STAFF APPRAISAL REPORT ON A THIRD AND FOURTH INDUSTRIAL CREDIT PROJECT YUGOSLAVIA PREFACE This report appraises a proposed third and fourth industrial credit project in Yugoslavia. The projects are similar in many respects to the first and second industrial credit projects approved in 1974 and 1976. Under the proposal $100 million equivalent would be lent to the four major multi-purpose banks in the less developed regions (LDRs) of Yugoslavia for on-lending to industrial projects, including labor intensive projects. The four banks and the LDRs in which they are located are the Kosovska Banka Pristina in Kosovo (KBP), Investiciona Banka Titograd in Montenegro (IBT), Privredna Banka Sarajevo in Bosnia-Herzegovina (PBS) and Stopanska Banka Skopje in Macedonia (SBS). The third project comprises a loan to KBP of $40 million equivalent and incorporates two features which are designed to meet the special needs of Kosovo. The fourth project comprises three loans of $20 million equivalent each to IBT, PBS and SBS. The general terms and conditions of the proposed loans would be those normal for DFC loans. I. THE INDUSTRIAL SECTOR A. Institutional Framework 1.01 A comprehensive review and analysis of the past performance, prob- lems and prospects of the Yugoslav economy is contained in the IBRD report "Yugoslavia - Self Management Socialism and the Challenges of Development" (No. 1615a-YU, dated March 21, 1978), distributed to the Board in April 1978. Yugoslavia's economic system is characterized by social ownership and con- trol of the means of production, decentralization of political and economic decision-making and the principle of workers' self-management. Since 1946 Yugoslavia has passed through three constitutions which reflect an essentially evolutionary process in reconciling the aim of increased workers' autonomy with the need to evolve adequate policy instruments for economic management. In 1950 workers' self-management was initiated. However, macro-economic management remained with the State through the use of such conventional instruments as planning, prices and incomes policy, fiscal and monetary policy. The 1965 reforms reduced the role of the State organs. The central allocation of investment funds was abandoned in favor of a self-managed banking sector and a greatly increased role for the market was envisaged through a realignment of prices, abolition of multiple exchange rates and a general liberalization of foreign trade. However, the system as applied weakened macro-economic management and resulted in or exacerbated some economic problems particularly relating to inflation, balance of payments and resource allocation. 1.02 The disenchantment with the market system and the indicative plan- ning introduced by the 1965 reforms is reflected in the 1974 Constitution which envisaged major revisions in the system of economic management. The most important feature is the extension of the principle of workers' self- management to macro-economic decision-making. The new planning mechanism (self-management planning) will principally affect the allocation of resources. In addition, contractual agreements (Social Compacts and Self-Management Agreements) 1/ to deal with such diverse areas as prices, incomes and employ- ment have also been introduced. The agreements are publicly negotiated and legally binding for the signatories. The new system of planning includes long-term, medium-term (5-year) and annual plans. All economic and socio- political entities have an input in the planning process. Planning is char- acterized as being simultaneous (i.e. involvement in planning takes place concurrently at all levels from the Basic Organization of Associated Labor (BOAL) 2/ at the "bottom" to socio-political communities at the "top" or federal level) and continuous (i.e. assessment of Plans takes place periodic- ally through annual evaluations and revisions). Intra- and inter-enterprise planning is referred to as self-management planning; planning of socio- political communities is termed social planning. The plans of all planning agents are harmonized through an iterative process. Industry associations and Economic Chambers facilitate this harmonization and coordination procedure. For the priority sectors, complete harmonization must be achieved within a fixed time period; in case of an impasse, the Government authorities can inter- vene. The harmonized agreements are then codified in Social Compacts and Self-Management Agreements which have the force of law. Although the system is not as rigid for the non-priority sectors, harmonization is strongly encouraged. Planning, e.g. short- and medium-term plans for enterprises, is, however, compulsory for economic and socio-political entities. 1.03 The participation of individual BOALs in various aspects of planning, including the source of investment funds, the ultimate disposition of retained earnings, foreign exchange distribution, and integration in the production process, is viewed as an important and positive feature of the new planning mechanism. Enterprise integration is strongly encouraged. Thus, the various BOALs and enterprises from the lowest to the highest degree of processing of a product are encouraged to integrate through Self-Management Agreements. Purchase, supply, and marketing relationships together with decisions on the 1/ Social Compacts regulate rights and obligations affecting broader economic issues and policies and are concluded among socio-political communities (Federal Government, Governments of Republics and Autono- mous Provinces and Communes) and also among Economic Chambers, Trade Unions and Associations of Enterprises. Self-Management Agreements are more specific and regulate rights, obligations, etc. within and between economic organizations like BOALS, enterprises and banks. 2/ Technically and organizationally, the smallest identifiable unit of operation. - 3 - pooling of resources (primarily capital), income and foreign exchange sharing are to be spelled out in these Self-Management Agreements. The emphasis on inter-enterprise integration may increase resource mobility, both within and between Republics and Provinces, and thus potentially have a positive effect on the flow of capital and technology to the LDRs. B. The Structure of Industry Yugoslavia 1.04 Generally, Yugoslavia's industrial enterprises are large and those with more than 1,000 workers account for more than 60% of industrial value added. Small-scale industrial establishments (defined as those employing less than 200 workers and having fixed assets of less than 30 million Dinars or $1.7 million equivalent) constituted only 18% of total industrial establish- ments and accounted for only 2.3% of total industrial fixed assets and 3.1% of total industrial employment in 1974. The preponderance of large estab- lishments is the result of the past industrialization policy and pattern of industrial growth: the emphasis placed on growth of energy production, the stress on exploitation of existing natural resources and the attempt to build up new branches with material bases in the newly exploited natural resources. In 1974 basic industries, namely energy (electricity, coal and petroleum), ferrous and non-ferrous metals, chemicals and pulp and paper, accounted for 53% of industrial fixed assets but only 34% of industrial value added and 20% of industrial employment (see Table 1). In contrast, other industries, namely non-metallic minerals, metal products, shipbuilding, electrical products, building materials, wood products, textiles, leather and footwear, rubber products, food products, printing and publishing, tobacco products, etc., accounted for only 47% of industrial fixed assets but 66% of industrial value added and 80% of industrial employment. This reveals not only the domination of basic industries in the industrial structure of Yugoslavia but also their relatively higher capital-output and capital-labor ratios. Industrial exports, on the other hand, are quite diversified: metal and engineering products account for about one-third of the total; non-ferrous metals, textiles, leather, clothing and footwear contribute another one-third; forest products, food products and chemicals account for the balance. Table 1: STRUCTURE OF INDUSTRY, 1974 Share of Industry Share of Industry Share of Industrial Value Added Fixed Assets Employment Basic Other Basic Other Basic Other Indus- Indus- Indus- Indus- Indus- Indus- tries tries tries tries tries tries Bosnia- Herzegovina 46 54 62 38 30 70 Montenegro 52 48 82 18 33 67 Macedonia 35 65 54 46 18 82 Kosovo 59 41 65 35 41 59 Less Developed Regions 45 55 61 39 29 71 More Developed Regions 28 72 52 48 17 83 Yugoslavia 34 66 53 47 20 80 Basic Industries: Energy (electricity, coal and petroleum), ferrous metals, non-ferrous metals, chemicals, paper. Other Industries: Non-metallic minerals, metal products, shipbuilding, electrical products, building materials, wood products, textiles, leather and footwear, rubber products, food products, printing and publishing, tobacco products, and other. The Less Developed Regions 1.05 Over the past 20 years the share of industry in GMP in the LDRs grew faster than in the other regions. Though the LDRs started with a con- siderably lower share of industry in GMP 1/ after the Second World War, by 1975 the share was 37.3% in the LDRs compared to 36.8% in the MDRs. Bosnia- Herzegovina had the highest share of the four regions with almost 40%, and Montenegro the lowest with 31.2%. The LDRs, more than the rest of Yugoslavia, have a considerable wealth of natural resources in mining and energy. Basic industry (including mining) was, therefore, given top priority. This strategy was aimed at providing power, minerals and raw materials for processing industries in developed regions and for export. Moreover, compared with the requirements of promoting light industries, basic industries economized on scarce management, technical and marketing expertise. Mining and production 1/ Gross Material Product or Social Product excludes "nonproductive" (in Yugoslav terminology) services such as education, health, administration, defense and other public services. GDP has been approximately 14% higher than GMP. - 5 - of basic metals now play an important role in the four LDRs. Approximately half of Yugoslavia's total steel capacity is located in Bosnia-Herzegovina, Montenegro and Macedonia. Considerable deposits of bauxite have enabled a rapid expansion of the aluminum industry, centered in Bosnia-Herzegovina and Montenegro, which produces aluminum for domestic use and significant quanti- ties of alumina for export. Yugoslavia's main lead and zinc ore deposits are mined and processed in Macedonia and Kosovo. In 1974, the share of basic industries in total industrial fixed assets in the LDRs was 61%, in indus- trial value added, 45%, and in industrial employment, 29%, compared to the respective shares of 52%, 28% and 17% in the MDRs. Because of the dominance of basic industries in the four LDRs, the industrial pattern in these regions is more capital-intensive than in the MDRs. The share of processing or fabricating industries like metal products and textiles, which are more labor-intensive, is substantially below the Yugoslav average. C. Past Performance 1.06 Over the postwar period as a whole, Yugoslavia has been remarkably successful in achieving its objectives of rapid economic growth and trans- formation of the economy from a preponderantly agrarian into a modern diver- sified economy with a high degree of income equality and a growing integration into the international division of labor. Between 1954-74 the growth in real GMP averaged 7.2% p.a. (in 1972 prices) which, in conjunction with a low and declining population growth rate averaging 1.1%, led to significant gains in per capita income estimated at $1,680 in 1976. However, since the 1965 reforms there has been some tendency for the growth rate of output, employment, personal incomes and commodity exports to decline. 1.07 Growth rates in the 1971-75 Plan period exceeded the planned rate for some sectors and fell short for others. Although real GMP grew at an impressive rate of 6.3% p.a., it still fell short of the 7.5% targeted rate, having been adversely affected by the considerable slowdown in investment and output in 1972 and 1973, as a result of the stabilization measures adopted and the attempt of the Yugoslav authorities to impose financial discipline over enterprises and socio-political units. World and domestic inflation, economic recession in the West and the banning of beef imports by the EEC also affected economic performance adversely. The inflation rate averaged 19% p.a. (measured by the GMP deflator) during 1971-75 compared to 8.5% during 1965-70. Lower exports due to the recession in Western Europe, increased imports as a result of the rise in the oil bill and the resurgent domestic demand, and the unfavor- able shift in the terms of trade resulted in a sharp reversal of the current account from a surplus of US$0.5 billion equivalent in 1973 to a deficit of US$1.1 billion equivalent in 1974. The balance of payments crisis and the explosive rate of inflation experienced in 1974 (29% increase in industrial producer price index) resulted in painful adjustment policies during 1975 and 1976 which had an adverse impact on economic growth. Although social sector employment during 1971-75 grew at 4.3% p.a. (forecast rate 3%), registered unemployment rose (in part due to the reflux of emigrant workers in 1974-75) from 320,000 or 7.7% in 1970 to 540,000 or 10.2% of the labor force (excluding self-employed and migrant workers) in 1975, particularly affecting the LDRs. 1/ 1.08 The economic growth of the LDRs during 1971-75, with the exception of Montenegro, was for the first time above the national average. The esti- mated growth of GMP was 18% higher, of industrial production 10% higher, of fixed investment 16% higher and of employment 32% higher than the national average. This superior performance should not, however, conceal the fact that plan implementation in the LDRs fell short of projected targets. There was a shortfall in investment due to inadequate accumulation by enterprises and banks and to high rates of inflation at home and abroad. There was also a shortfall in production, due to delays in construction and start-up of new facilities stemming from cost overruns and shortage of funds, difficulties in obtaining imported semi-finished products due to balance of payments dif- ficulties, imbalanced internal capacities, weak foreign markets and lack of technical and managerial staff. 1.09 The major objectives of economic policy in Yugoslavia during 1976 were further reductions in the balance of payments deficit and in the infla- tionary pressures in the economy. Both objectives were met. A current account surplus of US$150 million equivalent was registered in 1976. The rate of inflation in terms of the GMP deflator declined to 13.7% in 1976 compared to 19% in 1975 and in terms of industrial producer prices declined even more remarkably to 6% compared to 22% in 1975. However, these restrictive policies halted economic growth during the first half of 1976. By the middle of the year, industrial production started to expand again, mainly as a result of an expansion of investment and exports. This upsurge contributed to a real increase of GMP by about 3.9% for the year as a whole (compared to the planned growth of 5.5%). The GMP of the LDRs grew at about the same rate while GMP per capita in the LDRs failed to show any improvement and remained at about 60% of the national average. Employment growth in Yugoslavia as a whole was 3.5% but unemployment reached 11.9%. 1.10 The growth momentum built up in the second half of 1976 continued into 1977. However, the more rapid economic growth (estimated at 7%) was accompanied by a current account deficit estimated to be over US$1 billion equivalent and by moderate inflation (13% in terms of retail price index), necessitating more restrictive policies for 1978. D. The Role of Industry 1.11 Industry has been the principal engine of Yugoslavia's impressive economic growth since 1954; it has opened up the country to the world economy 1/ In Yugoslavia unemployment is measured in terms of registered job seekers actually unemployed as well as those employed but seeking new jobs. Actual unemployment is estimated to be about 60% of registered unemployment. - 7 - and provided employment to the growing labor force. The industrial value- added growth rate of 9.4% p.a. during 1956-75 exceeded the GMP growth rate of 7.2% p.a. (in 1972 prices), resulting in an increase in the share of industry in GMP from 23% in 1955 to 37% in 1976. In the same period, indus- trial investment grew at the rate of 7% p.a. in real terms, accounting for about one-half of total social sector investment; industrial exports, which grew at 10.3% p.a., accounted for about 90% of total commodity exports by 1975; industrial employment grew at the rate of 5% p.a. compared to the social sector employment growth rate of 4% p.a. Industry now accounts for 39% of total social sector employment. Gains in productivity were noteworthy during the same time span, averaging 5% p.a. The performance of the industrial sector in the 1971-75 Plan period was consistent with the past record: the growth rate of industrial production of 8.1% p.a. equalled the Plan target. E. Development Issues 1.12 The issues of unemployment and inter-regional disparities, which are particularly relevant for the proposed project, are discussed below. Unemployment 1.13 The progress in employment generation has been disappointing. The present dimensions of the unemployment problem are shown in Table 2. The unemployment rate reached 17.6% in the LDRs compared to 9.6% in the MDRs and 11.9% in the country as a whole in 1976. The highest unemployment rate was in Kosovo (25.4%), followed by Macedonia (22.7%). In addition, there is considerable underemployment in the agricultural sector, particularly in the LDRs. Several factors have contributed to the growth in unemployment. The higher incomes in the social sector acted as a strong pull inducing a rapid migration out of the traditional agricultural sector. External migra- tion, which became an extremely important vent for surplus labor, absorbed between 1969-73 over 500,000 workers, which was nearly twice the natural increase in the labor force and almost equal to the increase in social sector employment during the period. However, after 1973, the situation dramatically reversed itself. The net reflux of workers between 1973-75 equalled the natural increase in the labor force. The problem in the LDRs is accentuated by the much faster natural increase in population and labor force (particularly in Kosovo with a population growth of 2.6% p.a. compared to 0.6% in the MDRs during 1961-71), limited inter-regional migration and capital-intensive indus- trial structure (see para. 1.05). -8- Table 2: EMPLOYMENT SITUATION - 1976 Registered Unemployment /2 Employment /1 (4) (1) (2) (3) (3) as % of 000 % 000 (1)+(3) Bosnia-Herzegovina 707 14 109 13.4 Montenegro 105 2 19 15.3 Macedonia 351 7 103 22.7 Kosovo 144 3 49 25.4 Less Developed Regions 1,307 26 280 17.6 More Developed Regions 3,618 74 385 9.6 Yugoslavia 4,925 100 665 11.9 /1 Paid Employment (excludes self-employed and migrant workers) annual average. /2 As of the end of the year. Source: Statistical Yearbook Yugoslavia, 1977, pp. 388, 400. Inter-regional Disparities 1.14 Progress toward reduction of inter-regional disparities of income has been below expectations. The current situation as regards inter-regional per capita income disparity is shown in Table 3. Whether measured in current or constant prices, the relative per capita income position of the LDRs has not improved since 1970, although the earlier declining trend has largely been stopped. Per capita GNP in 1976 was only US$1,008 for the LDRs compared with US$2,066 for the MDRs (the Yugoslav average was US$1,680). Furthermore, the structural weaknesses of the economies of the LDRs persist: higher capital- output ratio, lower employment per unit of capital (in Kosovo and Montenegro), higher unit labor costs and lower accumulation rate (compared to those in the MDRs). The disparities have remained not because of stagnation in the LDRs; in fact, the rate of growth in the LDRs has been quite satisfactory. The GMP growth of 6.7% p.a. of the LDRs during 1953-71 was only slightly less than that of the MDRs (7.4%); during 1971-75 the growth of 7.1% p.a. of the LDRs surpassed that of the MDRs (6.7%). This growth was achieved through high rates of investment in the social sector (the investment rate in the LDRs was 42% of GMP in 1975 compared to 29% in the MDRs), supported by transfers of resources through the Federal Budget and the "Federal Fund for the Accelerated Development of the LDRs" (Federal Fund). The principal obstacle to bridging the gap between the LDRs and the MDRs has been the high population growth rate in the former (1.25% p.a. compared to 0.58% in the latter during 1970-75). Thus, despite the high rate of total investment, the per capita investment in - 9 - the LDRs (with the exception of Montenegro) remained below the national average (81% compared to 111% in the MDRs in 1975) and, as a result, it was insufficient to close the gap. Further, there is higher incidence of intra- regional disparities in the LDRs manifested in a large proportion of the population dependent upon private agriculture, the average productivity and personal incomes of which significantly lag behind that of the social sector. Thus, the lower social sector employment/population ratio in the LDRs (16% compared to 25% in the MDRs and about 22% in Yugoslavia as a whole in 1975) is an important factor behind inter-regional disparity. The more disadvantageous industrial structure in the LDRs characterized by higher concentration in industrial branches with higher capital-output and capital-labor ratios and lower profitability is another significant factor. The higher unemployment rates in the LDRs (see Table 2 and para 1.13) are also important in this context. Finally, the LDRs have certain institutional weaknesses--shortage of managerial skills and technical know-how--and infrastructure deficiencies. Table 3: REGIONAL DISPARITIES IN PER CAPITA INCOME AND OPERATIONAL FEATURES GNP GROSS MATERIAL PRODUCT- (US$) /1 /OC 3 /4 /5 /6 1954 1964 1970 1975 1976/ 1976 OCR- PL- ULC- AR/ Bosnia- Herzegovina 82 69 67 69 66 1,109 95 87 105 74 Montenegro 53 72 78 70 69 1,159 71 93 96 108 Macedonia 69 73 64 69 67 1,126 91 81 101 70 Kosovo 48 37 34 33 29 487 70 77 106 48 Less Devel- oped Regions 71 65 61 62 60 1,008 87 85 105 74 More Devel- oped Regions 110 118 121 121 123 2,066 104 105 96 111 Yugoslavia 100 100 100 100 100 1,680 100 100 100 100 /1 Provisional data. /2 Calculated on the basis of current prices; Yugoslavia average = 100. /3 Output/capital ratio (GMP/fixed assets), 1974. /4 Productivity of labor (GMP per worker), 1974. /5 Unit labor cost index (ratio of gross personal income per worker to GMP per worker), 1974. /6 Accumulation Rate [ratio of depreciation plus allocation to enterprise funds (undistributed profits) to fixed assets], 1974. Source: World Bank (Yugoslavia--Self Management Socialism and the Challenges of Development); Statistical Year Book of Yugoslavia, 1977, pp. 375, 413; Statistical Year Book of Yugoslavia, 1976, p. 410. - 10 - F. Prospects: The 1976-80 Plan Industrial Strategy, Objectives and Policy 1.15 The 1976-80 Plans of Yugoslavia and the four LDRs continue to empha- size rapid industrialization as pivotal to achieving high rates of economic growth and desired structural changes. While the GMP of Yugoslavia is pro- jected to grow at 7% p.a. during 1976-80, industry is expected to grow at 8% p.a. The share of industry in GMP is planned to increase from 40.4% in 1975 to 42.4% in 1980 and its share in social sector fixed investment from 51% in 1971-75 to 56% in 1976-80. The highlights of the plans of the four LDRs are similar and are summarized in the following table: Table 4: INDUSTRIAL GROWTH TARGETS IN THE 1976-80 PLAN (IN %) Growth rate p.a. Share of Industry (1976-80) In Social Sector Industrial In GMP Fixed Investment GMP Production (1980) (1976-80) Yugoslavia 7.0 8.0 42.4 56.0 Bosnia-Herzegovina 8.0 9.0 to 9.5 42.7 63.9 Montenegro 8.3 12.1 37.8 63.8 Macedonia 8.0 9.0 39.0 58.0 Kosovo 9.5 11.8 43.1 61.4 Source: Social Plans of Yugoslavia and the Republics/Province for 1976-80. 1.16 Within industry, basic industries will continue to be the highest priority sub-sectors. In Yugoslavia as a whole, the share of energy, basic metallurgy and basic chemicals is expected to increase from 45.8% of total industrial fixed investment during 1971-75 to 63.3% during 1976-80; the share of energy and ferrous and non-ferrous metallurgy is expected to be 56.5% in Bosnia-Herzegovina and 77.6% in Montenegro and the share of electrical energy, coal and non-ferrous metallurgy in Kosovo is expected to be 58% of industrial fixed investment during 1976-80. For Macedonia, the investment figures are not available but the share of basic industry in total industrial production is expected to be 68.1% during 1976-80. 1.17 The choice of the priority sectors was dictated by the need to remove "structural imbalances" in the Yugoslav economy. The dependence of the economy on imports of raw materials and equipment was considered excessive and certain domestic growth constraints, particularly in energy, agriculture and transportation, considered serious. This consideration was based on the experience with the balance of payments. The fourfold increase in the price of oil in 1973/74 added nearly $600 million to the country's annual import bill. More importantly, with the trend of external migration of Yugoslav workers reversed, the prospects of growth of workers' remittances dwindled. Thus, balance of payments became a potentially serious constraint on the growth of the econormy. For the 1976-80 Plan, the Yugoslavs could have opted for the strategy of either export promotion or import substitution, or both. They opted primarily for import substitution since it offers a more certain path to external balancing of the economy, at the same time reducing the vulnerability of the economy to future externally induced oscillations. Since 90% of Yugoslavia's imports consist of intermediate and capital goods, the 1976-83 Plan strategy is aimed at achieving a significant import sub- stitution in those very sectors and branches (mainly producing intermediate goods) which have tended to lag behind since 1965. 1.18 Other industrial objectives of the 1976-80 Plan are the removal of internal imbalances in industry, the better utilization of productive facili- ties, modernization, promotion of exports through adoption of modern tech- nology, attainment of international competitiveness and reduction of technical and technological dependence on foreign partners. Among non-basic industries, the Bosnia-Herzegovina Plan anticipates significant investment in manufacturing industries especially in metal products, electrical appliances, chemical products, food manufacturing, textiles, wood products and cellulose and paper. In Montenegro, metal products and electrical machinery and appliances will be allocated 11% of total industrial investment. The Macedonia Plan allocates 5% of Federal Fund resources to the development of small-scale industries (defined in para 1.04) and labor-intensive activities to increase employment. The Kosovo Plan recognizes unemployment as the most serious problem for the future development of Kosovo and, therefore, gives emphasis to the growth of those sectors and branches (such as construction, trade and arts and crafts which have a low capital-output ratio) which can secure a faster rate of growth of income and employment. The Kosovo Plan also emphasizes the diver- sification of industrial structure which at present is dominated by capital- intensive energy and non-ferrous metallurgy sectors. Nevertheless, the dominant share of investment will be channelled to capital-intensive basic industries. 1.19 While the choice of priority sectors is understandable, the impact of this strategy on employment generation and reduction of regional dispari- ties will be limited. Since the average capital-labor ratio in priority sectors is more than twice as high as the industrial average, 1/ the Plan resource allocation pattern implies a relatively high investment-per-job created and, by implication, limited additional employment opportunities. Moreover, to the extent that the priority sectors are concentrated in the LDRs which are characterized by higher unemployment rates (compared to the MDRs), the Plan industrial strategy is hardly conducive to reduction of regional disparities either. 1/ Electric power, petroleum, ferrous metallurgy, non-ferrous metallurgy and chemicals ranked in the top six in terms of the magnitude of the total capital/labor ratio in 1972. - 12 - 1.20 The problem of unemployment may worsen further if there is a down- ward revision of Plan targets, which appears likely. The Yugoslav Plan is based on an optimistic assumption about reduced import dependency. The import elasticity of 0.64 implied by the Federal Plan is only about 60% of the actual elasticity during 1971-75. Since the priority sectors are among the most imported-input-intensive 1/, a net import substitution in these sectors will require a substantial change in the past trend. Increasing import restrictions could increase the difficulty in reaching the growth targets of the Plan (and by implication the employment targets). Moreover, the dependence of the four LDRs on foreign sources of financing for social sector fixed investment during 1976-80 ranges from 18% for Bosnia-Herzegovina to 42% for Montenegro (see Table 5). Thus, the availability of foreign exchange will be a crucial ingredient in the achievement of Plan targets. In case of a shortfall in investible resources, the non-priority sectors are likely to bear the brunt of adjustment. These being the relatively labor-intensive sectors, the implications for employment growth may be serious. Table 5: SOURCES OF FINANCING OF 1976-80 Plan (in %) Federal Funds Republic Resources Foreign Total Bosnia-Herzegovina 11 71 18 100 Macedonia 25 50 25 100 Montenegro 28 30 42 100 Kosovo 45 29 26 100 Source: Five-Year Plan of the Republics/Province. 1.21 The priority sectors, in addition to being relatively capital- intensive, also tend to be skilled labor-intensive. However, the LDRs would be expected to have a comparative advantage in unskilled labor-intensive products. Thus the priority sectors, into which industrial investment is being concentrated, do not appear to follow closely the comparative advantage of the LDRs. However, the argument cannot be carried further because raw material endowments dominate capital and labor in the determination of com- parative advantage in the case of the LDRs. Low interest rates (in absolute terms as well as in relation to the MDRs as a result of Federal Fund credits) provide an artificial incentive to the development of capital-intensive industry. The tax system also has been biased toward capital-intensive production. The decision-making process of the labor-managed enterprises may also have a capital-intensive bias. 2/ Thus, in this setting it is important to encourage the development of projects which have a low cost per job created and which economize on the use of skilled labor to the extent possible. 1/ Shipbuilding, non-ferrous metals, petroleum and chemicals ranked 1, 3, 4 and 5 respectively out of twenty industrial branches in imported input (direct plus indirect) requirements of production in 1972. 2/ Working against this bias is the political pressure on the enterprises to employ a greater than optimum quantity of labor. - 13 - Employment Policy and Prospects 1.22 In view of the limited impact of the priority sectors on employment generation, the need to increase employment opportunities is recognized in the 1976-80 Plan. The strategy adopted is to place greater emphasis on labor intensive and small-scale industries. Social Compacts on small-scale indus- tries, which specify promotional measures such as tax incentives and prefer- ential credit facilities, have been adopted. Social Compacts on employment in the social sector have also been concluded within and between the regions. Communities of Interest for employment, consisting of representatives of job-seekers and employers, have been created to coordinate inter- and intra- republic employment policy. Policies to encourage private sector employment include fiscal incentives and the creation of a new legal concept, the Contractual Organization of Associated Labor, which can be private or mixed private-social in terms of ownership and circumvents the five-employee limi- tation that has applied to privately owned business. This form of enterprise may facilitate absorption of returning migrants and the underemployed in the agricultural sector. It may also act as a stimulus to the flow of migrant workers' remittances into productive investment. The extent of effectiveness of the new employment policies is, however, not yet clear. 1.23 Given its present dimensions and the development strategy of the 1976-80 Plan, the problem of unemployment, particularly in the LDRs, will per- sist in the near future. Even if the target growth rates of social sector employment in the LDRs during 1976-80 were realized (see Table 6), they would be barely sufficient to absorb the natural increase in labor force and returning migrants and to reduce registered unemployment by 25% in Bosnia- Herzegovina, Macedonia and Montenegro while in Kosovo it would be barely sufficient to absorb the natural increase and returning migrants. The problem of agricultural underemployment would remain untouched in both cases. Table 6: REQUIRED AND TARGETED ANNUAL EMPLOYMENT GROWTH RATES (%) 1976-80 Target Growth in Social Sector Growth of Employment Needed to Social Sector Absorb Natural Inc yase Employment in Labor Force - Bosnia-Herzegovina 4.0 4.9 Montenegro 3.8 4.0 Macedonia 4.5 5.1 Kosovo 7.5 9.4 /1 Including returning migrants and a reduction of registered unemployment of about one-quarter. Source: Five-Year Plans and IBRD Estimates. - 14 - Regional Development Policy and Prospects 1.24 The 1976-80 Plan continues the past emphasis on reduction of inter- regional disparities and projects the GMP growth rate in Bosnia-Herzegovina, Montenegro and Macedonia to exceed the national growth rate by 20-25% and that in Kosovo by 60%. To achieve this objective, the Federal Fund's re- sources will be enlarged by increasing the share of social sector GMP paid into the Fund by enterprises from 1.94 to 1.97%. In addition, budgetary transfers have been increased from the equivalent of 0.83% of total GMP during 1971-75 to 0.93% for 1976-80. An innovation in the 1976-80 Plan concerning Federal Fund resources is that the entire 1.97% (or any part thereof) obligation of the enterprises can be fulfilled by direct investment in a LDR. In this way it is hoped to improve the transfer of technology, skilled workers and managerial and marketing expertise to the LDRs. Such investment is also encouraged by the policy of stimulating vertically linked enterprises to pool their resources. The Plan also specifies that the major share of IBRD loans will be channelled to the LDRs. 1.25 Despite the determined efforts of the country to reduce inter- regional disparities, the issue will remain significant in the near future. The higher rate of population growth in the LDRs would dilute the differential growth impact and only a modest reduction of the inter-regional per capita in- come disparity (from 69 to 71% of the national average for Bosnia-Herzegovina, Montenegro and Macedonia combined and from 33 to 36% for Kosovo) would be achieved. Role of the Bank 1.26 The need to alleviate the problems of unemployment and inter- regional disparities is thus serious enough to justify continued Bank involvement in the process of economic growth of the LDRs. The essential element of the Bank strategy in the industrial development of the LDRs, that is, the attempt to diversify the industrial structure by encouraging invest- ment in medium- and small-scale processing industries, retains its importance. However, the second element of this strategy, that is, promotion of labor- intensive projects, requires a much more vigorous emphasis than it has been given in the past. II. THE FINANCIAL SECTOR A. Financial Institutions 2.01 Multi-purpose banks are the dominant form of financial intermediaries in Yugoslavia, carrying out all commercial and investment banking functions for all sectors of the economy. Each region of Yugoslavia has such a bank, though these banks can also be active in other regions. The four proposed borrowers are in this category and handle some 80% of investment and commercial banking - 15 - in their respective regions. In addition to these banks the financial sector includes the National Banks, savings institutions, investment loan funds and insurance institutions. 2.02 The National Banks essentially perform the role of central banks at the Federal and regional levels; they do not lend directly to industrial or other enterprises. The main institution devoted solely to attracting savings is the Post Office Saving Bank. It accepts savings throughout the country, depositing the funds with the banks according to agreements reached between the Republics and Autonomous Provinces. The investment loan funds consist primarily of the Federal Fund (see paras 1.19 and 1.24) and similar funds within the regions. As these funds derive their resources from obligatory loans levied on enterprise income and transfer these resources to the banks, they are mainly a media for collecting and channeling resources rather than decision-making bodies. Insurance institutions have a limited role in view of the prevalence of comprehensive social insurance coverage. The vast majority of their resources are deposited in the banks. 2.03 There are few financial instruments available to potential savers other than short and medium term bonds issued to finance the Federal budget deficit and, to a lesser extent, to finance major investments such as power plants and highways. The returns on these bonds have been comparable to those paid on bank deposits with similar terms, but they are almost always fully subscribed to by the population as an expression of patriotic sentiment. B. The New Banking Law 2.04 A new Federal Banking Law became effective on January 15, 1977. The main emphasis is on integrating the banks more closely with the needs of their founders (which are their depositors and borrowers). This Law estab- lishes a three-tier banking structure consisting of internal banks, basic banks and associated banks. While the organization and structure of the four proposed borrowers is affected by the new Law, there is expected to be little change in the manner and ability of the banks in carrying out the proposed third and fourth industrial credit projects. The banks must conform to the new Law within one year of its effectiveness. 2.05 An internal bank in essence is a centralized financial information unit and internal payments clearing center in a large enterprise or kombinat. It collects surplus capital of the organizations making up the kombinat (its members) and channels these resources into projects forming the kombinat's development plan. It can perform all banking transactions on account of its members but cannot accept sight deposits. 2.06 Basic banks are the core of the banking system, performing all com- mercial and investment banking functions on a local basis. Their founders or members are organizations of associated labor, enterprises and other social - 16 - legal entities in the immediate area, including internal banks. Basic banks typically are unit operations and are expected to be formed from the branches of the existing banks. 2.07 Associated banks are formed by two or more basic banks in order to concentrate resources for financing large investment projects. Associated banks also carry out foreign business transactions on behalf of their member basic banks, including IBRD projects. In practice, associated banks with their basic bank members will replace the head offices and branches of existing banks. 2.08 All three types of banks are required to prepare annual and five- year plans which are consolidated with the plans of their members. Their plans in turn are integrated into the overall planning framework described in Chapter I. C. Interest Rates 2.09 In conjunction with the second agricultural credit project, approved by the Board on July 5, 1977, the Association of Yugoslav Banks has agreed to do a study on the role of interest rates in Yugoslavia. The terms of reference for the study will be sent to the Bank for review. This study will involve several institutes and banks and is expected to be completed during the commitment of the proposed loan. If properly conceived and carried out, this study should throw more light on what effect interest rates have on resource mobilization and allocation in Yugoslavia. 2.10 It would appear, though, that given the current planning mechanism in Yugoslavia interest rates have a limited role in resource mobilization and allocation. This reflects the Marxist theoretical premise that capital is not a separate factor of production but "past labor", and that the workers should have exclusive control over it. 1/ The need for financial intermediation is accepted, however, along with interest rates. 2.11 Each bank's founders establish the bank's borrowing and lending rates each year. As the banks are not profit-oriented but service-oriented, the spread is kept as low as possible. The rates vary between the banks as well as between types of deposits and loans. Public time deposits earn between 7.5% and 10% while deposits by enterprises earn half as much. Long-term loans made from the banks' regular resources carry interest rates between 4% and 10%. In recent years these rates have been negative as a result of the high inflation 1/ See Section B, "Market and Planning in the Yugoslav System", in Part II of the report entitled "Yugoslavia - Self-Management Socialism and the Challenges of Development" for a fuller treatment of this subject. - 17 - rates (20.1% in 1975). While efforts to contain inflation through stern sta- bilization measures brought the rate down to 13.7% 1/ in 1976, it remains to be seen whether this rate can be further improved upon in the future. 2.12 Long-term loans using IBRD resources are made at the rates agreed upon in the Loan Agreement; for both the second industrial and second agri- cultural credit projects the rate is 11%. The same rate will apply to the proposed projects. Borrowers bear the foreign exchange risk on all funds raised abroad. D. The Role of the Borrowing Banks Resource Allocation 2.13 Within the framework of the regional development plans and their own plans the four proposed borrowing banks play a key role in allocating funds to sound projects. Each bank is the major lender in its region, espe- cially for industrial projects; about 80% of institutional industrial financ- ing has been channeled through these banks in recent years. This share is expected to be maintained in the future. 2.14 The demand on the banks for financing has consistently exceeded the supply of resources available to the banks. This has allowed the banks to be selective in choosing the projects they will support. They have the authority, working in cooperation with the Economic Chambers, to approve, modify or reject specific investment proposals, whether they are included in the Plan or not. Between 10% and 30% of the projects brought to the banks either undergo major modifications or are shelved indefinitely. The banks' impact on project preparation, however, is even larger than this would sug- gest as many projects, especially the larger ones, are brought to the banks' attention at an early stage. If the proposal is unattractive it is dropped at that point or is reformulated with the assistance of the banks' experi- enced project appraisal staff into a viable project. 2.15 The banks are keenly aware of the unemployment situation and the disparities between developed and underdeveloped communes in their regions. They therefore give priority to labor intensive projects, not only to reduce unemployment but also to provide job opportunities for emigrant workers returning from Western Europe. They encourage new enterprises whenever pos- sible to locate in the underdeveloped communes, and such communes are given advice and assistance by the banks in formulating their own investment proj- ects. The current Plan may, however, impede these efforts to some extent as priority sectors are now specifically identified and have first call on investment resources; these projects tend to be more capital intensive. 1/ This rate is based on the GMP deflator. The increase in retail prices has been reduced from 22% in 1975 to 9% in 1976, and in wholesale prices, from 22% to 6%. - 18 - Resource Mobilization 2.16 Domestic resource mobilization efforts are limited to attracting deposits from households, enterprises and other organizations. While the four banks compete with each other and other banks in Yugoslavia, each is dominant in its respective region. Total deposits have increased substan- tially in the two and a half years up to the middle of 1977, ranging from 92% for SBS to 189% for IBT. To a large extent this reflects the recent practice of depositing wages and salaries directly in the banks and a 1976 law requiring an annual revaluation of fixed assets by enterprises to in- crease their savings rate. 2.17 The banks' efforts in mobilizing foreign resources are directed at guaranteeing suppliers' credits, attracting deposits of Yugoslav workers abroad and obtaining foreign loans. The most important of these activities in terms of amounts involved is guarantees; at the end of 1976 outstanding guarantees in foreign currency, including letters of credit, ranged from $103 million equivalent by KBP to $1,161 million equivalent by PBS. Foreign exchange deposits (demand as well as savings and time) on the same date ranged from $24 million equivalent with IBT to $391 million equivalent with PBS. Outstanding foreign loan balances varied from $10 million equivalent at KBP (including $9 million equivalent from IBRD) to $101 million equivalent at SBS (including $29 million equivalent from IBRD). 2.18 It should be mentioned that foreign exchange borrowing by enter- prises from abroad is generally subject to a 75% non-interest bearing dinar deposit at the National Bank of Yugoslavia for the duration of the loan. Exempt from this deposit requirement are loans from IBRD and IFC, and from international (non-commercial) organizations in which Yugoslavia has deposits, e.g. the IICY. Also exempt are borrowings related to projects receiving finance from these institutions (up to the amount of those loans), priority sector projects and enterprises which will export one-third of their produc- tion when at full capacity. III. THE BORROWING BANKS A. The Banks' Structure Legal Framework 3.01 The basic legal framework for the banks was provided by the Federal Banking Law of 1971 until January 15, 1978, when the new Federal Banking Law applied. As noted in the previous chapter, application of the new Law is not expected to result in significant changes as far as these and the previous industrial credit lines are concerned. Each bank has its own Self-Management Agreement and Statutes. The banks' operations are regulated by the National Bank and various Federal directives, and conformity with various laws and - 19 - regulations is ensured through supervision by the National Bank and the Social Accounting Service (Sluzba Drustvenog Knjigovodstva or SDK). Ownership 3.02 Yugoslav enterprises in general are owned by "the society" and do not have share capital or shareholders. Banks, however, have shareholders (founders or members) and share capital (founders fund). Members include organizations of associated labor from most of the enterprises in the region served by the bank, including the largest. The number varies from about 400 for IBT up to over 1,200 for SBS. Each member has an unlimited liability for the obligations of his bank. Assembly and Committees 3.03 The Assembly of a bank is its highest governing body in which each member has one vote (regardless of the amount contributed to the founders fund). The Assembly approves the bank's medium range plan, annual plan and business policy (including interest rates) and elects from among its members the Executive and Credit Committees. It also decides on the distribution of the bank's income to employees (in aggregate) and members. 3.04 The Executive Committee is responsible for executing the plans and policies approved by the Assembly and for approving lending and borrowing operations. In each bank the Executive Committee has delegated authority to the Credit Committee to approve smaller loans. Management and Staff 3.05 The chief executive of each bank is its General Manager who is appointed for a four-year term by the bank's Assembly 1/. Assistant General Managers each supervise two or more department Directors. Senior management of each bank is competent. Managers are typically university graduates (mostly in economics) with many years experience, often in both banking and industry. Changes of top managers are infrequent, and professional competence is the main criterion for selection and appointment at all levels. 3.06 In mid-1977 the number of employees ranged from 585 in KBP to 4,270 in PBS. The rate of growth over the previous two years varied from 5% p.a. for KBP to 21% p.a. for IBT. About one-quarter of the staff in each bank are professional, defined as those with a minimum of two years college education. Organization 3.07 All four banks have a similar organization. Their head offices are functionally organized with departments for such activities as resource plan- ning, investment and administration. The investment activity is subdivided 1/ Except in the case of PBS, where a President, also appointed by the Assembly, shares the responsibility with the General Manager. - 20 - into groups for industry, agriculture, etc., with a common engineering group. Each bank has several branches, ranging from eight for IBT to 22 for SBS. As noted earlier, these are each likely to become a basic bank with increased autonomy, but will remain linked to the present head office which will become an associated bank. B. Policies and Procedures Policies 3.08 The annual business policy of each bank, approved by the Assembly as an integral part of the bank's annual plan, is prepared against the background of the regional development plan, the bank's own medium range plan and the plans of the bank's founders who are also its borrowers. The business policy covers the mobilization and allocation of resources, the budget and the finan- cial plan for the forthcoming year. 3.09 The banks do not have formal financial policies concerning their operations such as exposure limits and maximum debt to equity ratio. Never- theless, the banks generally follow prudent practices. The members of the banks ensure a distribution of loans among themselves; any substantial allo- cation of funds to a particular project or enterprise would have to be in accordance with the plan. Debt to equity ratios are not very meaningful in the Yugoslav context and in view of the large amount of Federal and Republic/ Provincial Funds available to the banks which, while treated as debt, have more the character of managed funds. Appraisal Procedures 3.10 The four banks use similar procedures for project appraisal. Local branches appraise those projects which they can finance from their own re- sources, and call for Head Office assistance only when required. Projects involving Federal or Republic/Provincial Funds, or foreign exchange, are always handled by the Head Offices; these include all projects under the IBRD lines of credit. 3.11 All banks have qualified project appraisal and supervision staff. However, staff shortages exist. One problem is that highly qualified eco- nomic and financial staff familiar with IBRD methods tend to leave the banks to accept senior posts with enterprises; KBP lost four out of five such staff members during a recent 18 month period. There is also a shortage of engi- neers, particularly serious in KBP which has only one civil engineer on its staff and thus relies completely on outside consultants for a technical judge- ment on industrial projects. As a temporary measure, SBS and PBS are "lending" some of their own project appraisal staff to KBP for short periods of time. All banks are actively trying to recruit additional experienced staff. In addition, a seminar on appraisal methods was held in February 1978 and additional ones are contemplated. - 21 - 3.12 The quality of appraisal reports received from the banks, while generally acceptable in the past, has continued to improve. However, a fur- ther upgrading is desirable, particularly regarding marketing aspects and translation of technical terms into English. The financial rate of return (FRR) and the economic rate of return (ERR) is calculated for all "A" type sub-projects, whether submitted to the Bank or not, and for some of the smaller projects. For internal use all banks employ a standard Yugoslav methodology for these calculations, which is similar to, but not identical with, the method advocated by the Bank; a revision of the Yugoslav method, to be published in 1978, is expected to minimize the differences between the two procedures. Supervision, Procurement and Disbursement 3.13 Supervision work in general is satisfactory, with the sites of major projects being visited by technical and financial staff at least every three months, and by some banks more frequently. Financial supervision relies on monthly reports and quarterly financial statements. Staff shortages some- times interfere with regular supervision schedules. 3.14 Procurement procedures followed by the banks are uniform and gener- ally acceptable. The borrower must obtain at least three bids for all equip- ment and services. Exceptions to this requirement are allowed in special circumstances, for example for Yugoslav contractors for specialized instal- lation work when there are less than three firms capable of doing the work. Large projects require international tendering. Equipment similar to that manufactured in Yugoslavia can only be imported with special permission of the Federal Chamber of Economy. In considering the most appropriate procurement procedure for any sub-project the borrowing banks should include international competitive bidding as one possibility. Under the proposed projects they will have to justify to the Bank the use of any other procurement method for large contracts (see para 4.22). 3.15 Disbursements are made on the basis of invoices from suppliers and contractors or similar evidence of deliveries, or on the execution of contracts. The disbursement procedures are in line with and up to the standards of other DFCs financed by the Bank. C. The Banks' Operations 3.16 The main areas of operation of the banks are loans and guarantees; equity investments are negligible. Each bank manages large amounts of funds on behalf of local government and other socio-political organizations at no risk to itself. 3.17 Short-Term Loans. Short-term commitments during 1976 ranged from Din. 0.9 billion ($49.5 million equivalent) (IBT) to Din. 42.8 billion ($2,351.6 million equivalent) (PBS), accounting for 31% (IBT) to 76% (PBS) of their total loan commitments in 1976. The majority of these short-term loans are three- month revolving credits to provide working capital to enterprises. - 22 - 3.18 Long-Term Loans. Long-term loan commitments of the four banks to all sectors amounted to Din. 56.1 billion ($3,084.3 million equivalent) during 1975 and 1976. This was double the amount of commitments made during 1973 and 1974. In 1976, commitments by three banks (excluding SBS) were about a third greater than in 1975, mainly due to commitments for a few large projects. SBS's commitments in 1976 dropped to about half of the level attained in 1975. Industrial loans accounted for between 49% (SBS) and 81% (PBS) of the total long-term loan commitments made in 1976. The average foreign exchange portion of these loans is small, being at most 20% of the total loan amount, with the remaining foreign exchange requirements covered by suppliers' credits and the enterprises' own foreign resources. None of the four banks takes security for their long-term loans except for housing loans to individuals. However, the banks take promissory notes along with loan agreements which can be used as more efficient instruments for collection in case of defaults. 3.19 Guarantees. The total amount of guarantees given by the four banks in favor of enterprises during 1975 and 1976 amounted to Dinar 53.6 billion ($2,945.1 million) compared with Dinar 27.6 billion ($1,516.5 million) given during the previous two years. Guarantees in local currency include those given to SDK in favor of enterprises to assure that the portion of the enter- prises' own funds need for a project is available. Guarantees in foreign exchange deal mostly with letters of credit and suppliers' credits. D. The Bank's Financial Situation Resource Position 3.20 A summary of the long-term resource position as of June 30, 1977, is given below: Table 7: LONG-TERM RESOURCE POSITION AS OF JUNE 30, 1977 (in Millions of Dinars) PBS SES IBT KBP Equity 2,052 2,839 674 1,141 Federal and regional Funds 14,520 12,294 5,072 14,705 Long-term domestic borrowings 6,819 7,992 2,843 1,055 Long-term foreign borrowings 2,724 2,785 2,620 1,676 Long-term deposits 7,098 4,472 2,275 843 Total resources available 33,214 30,382 13,484 19,420 Long-term loan portfolio as per balance sheet 36,572 28,501 11,124 17,252 Undisbursed resources (3,358)/1 1,881 2,360 2,169 Undisbursed long-term commitments 12,924 15,985 4,122 2,776 Uncommitted resources (over- commitments) (16,282) (14,104) (1,762) (607) /1 Covered with short-term funds. - 23 - Federal and Republic/Provincial Funds are the largest source for any of the four banks accounting for between 40% (IBT) and 75% (KBP) of their total long-term resources. Prudent usage of short-term funds for long-term loans is allowed under Yugoslav law. In PBS's case, about 10% of long-term loans outstanding as of June 30, 1977, were financed by short-term resources. Each bank had substantially overcommitted itself as of June 30, 1977. This re- flects the fact that the four banks plan their operations on a disbursement basis rather than a commitment basis. A substantial part of the overcommit- ment will be covered by Federal Fund resources, which the banks will receive in accordance with the Plan. Financial Performance 3.21 The income statements of the four banks are given in Annex 1. The financial performance of the banks has to be viewed in the Yugoslav context. Banks are not considered to be profit generators; they are expected to earn only enough to cover their expenses and make prescribed allocations to reserves. During the past two years, the administrative expenses of the four banks as a percentage of average total loans outstanding ranged from 0.5% (SBS, KBP) to 1.5% (PBS), and the total amount allocated to reserves as a percentage of average loans outstanding was about 1%. Therefore, it would have been sufficient if each bank had earned a spread of 1.5-2.5% on their loans. However, the actual margin during the past two years was somewhat higher, with PBS reaching a spread of 2.9% in 1976. This reflects the diffi- culty the banks have in finding their break-even point due to the large vari- eties of borrowing and lending rates. Because of this "excess" spread the founders of the four banks as well as the Federal Governments have been pressing each bank to reduce lending rates. Since the beginning of 1976 the maximum lending rate for long-term loans has been reduced by 1.0-2.5 percent- age points. Financial Position 3.22 The balance sheets of the four banks are given in Annex 2. Total assets increased by 60% (SBS) to 125% (KBP) during the 30 months period ending June 30, 1977. As of that date total assets ranged from Din. 17.0 billion ($934.1 million equivalent) (IBT) to Din. 64.9 billion ($3,565.9 million equivalent) (PBS) of which the long-term portfolio accounted for 56% (PBS) to 69% (KBP). The liquidity position of the four banks is generally satisfactory, and each bank is subject to close supervision by the National Bank of Yugoslavia in this respect. Long-term debt/equity ratios 1/ as of December 31, 1976, were high in the case of IBT and KBP (14.2:1 and 16.2:1) while those of PBS and SBS were 8.9:1 and 7.8:1. However, if the Federal and Republic/Provincial Funds are excluded from the debt/equity calculations in view of their special nature (see para 3.09), the ratios would drop to a maximum of 7.7:1 (IBT). 1/ The Reserve Fund, which has the character of provisions for doubtful debts, is excluded from equity in this calculation. - 24 - Arrears 3.23 The arrears on long-term loans of the four banks are presented in Table 8 below: Table 8: LONG-TERM LOANS IN ARREARS (in Millions of Dinars) Long-Term Loans (1) as % of Principal in Arrears Affected Total Long- Total by Term Loans over 3 - 6 6 - 12 Over 12 As of: Arrears (1) Outstanding 3 months months months months PBS June 30, 1975 8,128 40.3 117 93 13 11 Dec. 31, 1976 11,774 36.0 207 166 16 26 June 30, 1977 8,754 23.9 175 103 49 23 SBS June 30, 1975 7,099 36.6 256 172 49 35 Dec. 31, 1976 8,357 35.1 761 525 71 165 June 30, 1977 6,078 21.3 482 272 70 150 IBT June 30, 1975 1,379 20.1 33 18 13 2 Dec. 31, 1976 532 5.5 29 10 10 10 June 30, 1977 677 6.1 41 18 15 3 KBP June 30, 1975 1,934 21.3 81 37 32 12 Dec. 31, 1976 5,622 38.6 139 66 55 18 June 30, 1977 2,773 16.1 70 30 36 4 The four banks' arrears position has generally improved over the two years from June 1975 to June 1977. Long-term loans affected by arrears of over three months as a percentage of the total long-term loan portfolio dropped from 40% to 24% for PBS and from 37% to 21% for SBS. The main reasons for the improvement were the improved liquidity position of enterprises and the intensified collection procedures followed by the four banks. 3.24 None of the four banks have experienced significant write-offs in the past and reschedulings have been few. In view of the past experience the management of each of the four banks believes that there will not be any significant loss in the future. In addition, each bank maintains by law a reserve to cover losses. However, it is difficult to assess the quality of the long-term loan portfolio due to the limited availability of data and because the audit reports do not cover this aspect of the banks' situation in the detail usual for DFCs due to the multi-purpose nature of the banks. - 25 - The four banks have undertaken that they will each carry out an annual port- folio analysis coverin-, loan arrears and reschedulings and, on the basis of this analysis, assess the risk and magnitude of possible losses. This under- taking is similar to the one reached in connection with the second agricul- tural credit project. Audit 3.25 At the time of negotiations for the Second Industrial Credit in April 1976, the four banks set a target period of two to three years during which SDK's audits were to be gradually. broadened to full audits following, to the extent possible, generally accepted accounting standards. SDK's audit work in this respect has made satisfactory progress, helped to a great extent by a Bank-supported training program within SDK which began in 1974. For the year 1976 SDK produced full audit reports on PBS and SBS and partial audit reports on IBT and KBP. The scope of audit work and the coverage of branch operations for these audit reports were expanded from the previous year. The opinions given in the PBS and SBS reports are not qualified. SDK intends to prepare full audits on all four banks for 1977 and later years. Creditworthiness 3.26 Each of the four banks is considered creditworthy for Bank lending. However, conventional assessment of creditworthiness is neither fully possible nor entirely appropriate in view of the unique Yugoslav banking system. The assesssment of creditworthiness is based on the same arguments that were advanced for the previous two Industrial Credits which are the following: (1) There have been no significant loan losses in the past and the arrears position is manageable. Reserves for doubtful debts are generally adequate. (2) The management of each bank observes sound banking principles in respect to resource management and project selection. (3) The continued solvency of each bank is virtually assured because: (i) The founders of the banks each have unlimited liability for the banks' obligations. These founders form the backbone of each region's economic structure. (ii) Under the existing Yugoslav economic system each bank's creditworthiness is closely tied to that of the Yugoslav economy itself. A bank failure is not conceivable without a concurrent failure of the whole economic system. - 26 - E. Performance Under the Previous Industrial Credit Projects 3.27 The previous two industrial credit projects had the dual objectives of (1) financing small- and medium-size projects in manufacturing and process- ing industry and (2) institution building. Overall, the banks have made satisfactory progress in achieving these objectives. 3.28 Under the second industrial credit project co-financing of sub- projects with other foreign exchange resources was encouraged by providing a higher limit for a project's total cost and a longer grace period for such co-financed projects. This arrangement generally worked effectively. Five of PBS's projects above the free limit and seven below the free limit received co-financing totalling $10.4 million equivalent, almost equalling IBRD's com- mitment to these projects of $11.1 million equivalent, while five of SBS's projects above the free limit and one below the free limit received co- financing totalling $3.3 million equivalent, representing 63% of IBRD's commitments. In the case of IBT, one project above and one project below the free limit received co-financing almost equal to IBRD's commitment of $2.6 million equivalent. So far only one of KBP's projects has received co- financing slightly exceeding IBRD's commitment of $2.5 million equivalent; however, KBP still has some $11 million of its $16.6 million portion to commit. In view of the above results it is recommende& that the Bank continue to provide encouragement for co-financing, though under the proposed projects this will be limited to providing a longer grace period (see para 4.21). 3.29 The financial rate of return (FRR) estimated by the banks for proj- ects above the free limit financed under the two industrial credit projects ranged from 15% to over 45%, while the estimated economic rate of return (ERR) ranged from 12% to above 40%; the agreed minimum for both was 10% under the first industrial credit project and 11% under the second industrial credit project. The estimated average total cost per job created by these projects was $39,400 equivalent in 1977 prices, which is a satisfactory average in view of the advanced stage of economic development of Yugoslavia. The average fixed investment 1/ cost per job created in the industrial sector (excluding the capital intensive, basic industry subsectors of electricity, coal and petroleum) in the LDRs during 1974 and 1975 was $52,100 equivalent in 1977 prices. 3.30 The quality of appraisal work has improved; FRR and ERR calculations are now widely employed and correctly interpreted in most cases. Audit work by SDK has made good progress (see para 3.25). However, each bank could fur- ther strengthen its management information system, particularly information regarding the loan portfolio and their borrowers' financial condition (see para 3.24). 1/ Excludes permanent working capital for which figures are not available. - 27 - 3.31 The first industrial credit line is expected to be fully disbursed by the end of 1978, at which time a project completion report should be pre- pared. The four banks through the Unit will provide the Bank with the basic data needed for this purpose. The four banks have undertaken to prepare a project completion report on the proposed projects (as well as basic data on the second project) some five years later. F. Forecast of the Banks' Operations and Financial Performance 3.32 Each bank will be obliged to prepare a medium-term plan under the new Banking Law, which they will do after each bank is reorganized during the first half of 1978 to conform to the new Law. The five-year projections (1978-82) discussed below were prepared to facilitate the appraisal of the proposed loan and may be modified once the banks' plans are approved. Pro- jected cash flows, income statements and balance sheets are given in Annexes 3-5. 3.33 Short-term Lending Operations. KBP's, PBS's and SBS's short-term loans are projected to grow at about 20% p.a. compared with the 30-40% p.a. growth realized during the 1974-76 period. The volume of IBT's short-term loans fluctuated in the past and is expected to continue to do so until 1979 when it is projected to increase at about 20% p.a. 3.34 Long-term Lending Operations. Projected long-term lending opera- tions are summarized below (in current prices): Table 9: SUMMARY OF PROJECTED TOTAL LONG-TERM LENDING OPERATIONS (Commitments, Millions of Dinar) Annual Annual Annual Growth Average for Average for Rate for 1973-76 (1) 1977 1978-82 (2) (2)/(1) 1978-82 (Actual) (Estimate) (Forecast) % % (Forecast) PBS 7,078 10,200 15,465 218 19 SBS 6,878 7,800 13,240 192 16 IBT 3,242 5,513 4,145 128 - /1 KBP 3,608 7,318 13,726 380 20 /1 IBT's forecast for long-term lending operations fluctuates yearly and stays below the estimated level of 1977. Each bank's projections are largely based on its region's Plan. Loans for industrial projects account for between 60% (SBS) and 82% (PBS) of the total. It is assumed that prices will increase at a rate of 8-10% p.a. For 1978 the projections are mainly based on the project pipeline and for the period - 28 - 1979-82 commitments are projected to grow at an annual rate of between 12% (SBS) and 20% (PBS and KBP). IBT's commitment projection during the 1979-82 period is about three-quarters of the average level for 1977-78 as a number of large projects are included in this earlier period. 3.35 Resource Requirements. The four banks' resource mobilization plans appear reasonable in general. Each bank except KBP expects to receive Federal and Republic Funds in the same proportion to total long-term resource require- ments as in the past (40%-55%). KBP expects Federal and Provincial Funds to represent a smaller proportion than before, hence its unidentified resource gap is the largest of all four banks (about 20% of total resource require- ments). The unidentified resource gap of the other three banks ranges from about 5% (PBS) to 15% (SBS, IBT). PBS and SBS expect to use about 20% of total short-term funds to finance long-term loans. In view of the increasing trend of short-term deposits the usage of short-term funds to this degree would not pose a problem for the two banks. 3.36 Financial Projections. Each bank intends to maintain a spread just sufficient to cover administrative expenses and mandatory provisions, about 2%. The projected liquidity position appears satisfactory with the current ratio ranging between 0.9 and 1.9. 1/ The long-term debt/equity ratio will continue to rise since none of the banks expects to build up its equity more than is required by law. However, in the context of the Yugoslav economic system, the crucial question is not the size of the banks' own funds (equity) but the financial strength of the borrowing banks in a wider sense, as dis- cussed in para 3.26. Under these premises the four banks are expected to remain creditworthy in future years. IV. THE PROJECTS A. Objectives 4.01 The objectives of the proposed projects are similar to those of the previous two. In addition to providing foreign exchange resources to Yugoslavia to finance industrial development, they will (1) help alleviate unemployment; (2) assist in the development of the LDRs; and (3) assist the four banks to continue to strengthen their institutions. 4.02 In order to more actively attack the problem of unemployment in the LDRs, part of the proposed loan funds will be specifically allocated to labor intensive projects, defined as projects providing employment at a maximum cost 1/ PBS's and SBS's current ratios are projected to be 0.9 during the 1978-82 period because some short-term funds will be used to finance long-term loans. - 29 - per job of $23,000 equivalent. This cost is based on the threshold figure for Yugoslavia developed for the urban poverty program ($13,700/job using 1976 figures) adjusted to account for real growth and inflation that will take place between 1976 and the time the projects are actually implemented. It should be noted that this is the first project in Yugoslavia to have a specific labor intensive component and thus should serve to heighten awareness of the need to, and desirability of, providing jobs at as low a cost as possible. The focus on smaller manufacturing and industrial processing projects (see para 4.03), continued from the previous industrial credit projects, reinforces this emphasis. 4.03 The second objective is achieved by limiting the proposed projects to the four LDRs. In addition, to promote diversification within the indus- trial sectors of the LDRs away from large, capital intensive basic industries, which have attracted the bulk of investment capital in the past, the majority of the funds could be used only to finance small- and medium-size projects in manufacturing, processing or small basic industries. (Agro-industrial proj- ects are excluded since such projects are being financed under other Bank loans.) Assistance in institution building will be provided through review of the banks' appraisal reports on the larger projects as well as through periodic visits and consultations. In view of KBP's particularly acute needs in this area, a portion of its loan would be specifically allocated to tech- nical assistance (see para 4.09). 4.04 As was the case with the second industrial credit project, co- financing will be encouraged by allowing somewhat longer grace periods on sub- loans when the project is also being financed from other foreign sources. These other sources typically require repayment in five to six years with a grace period of only one to two years, so a longer grace period on Bank sub- loans will provide a more appropriate cash flow pattern for the project. B. Use of the Proceeds of the Proposed Loans 4.05 Four loans are proposed, three of $20 million each to IBT, SBS and PBS and one of $40 million to KBP. The loan to KBP incorporates two features unique to KBP. The proceeds of the loans would be allocated as follows (in $ million): KBP IBT SBS PBS Total Labor intensive projects 5.0 5.0 5.0 5.0 20.0 Normal projects 14.7 15.0 15.0 15.0 59.7 Special projects 20.0 - - - 20.0 Technical assistance 0.3 - - - 0.3 40.0 20.0 20.0 20.0 100.0 Reallocation between the components of the loan to KBP would be permissible with Bank approval. - 30 - 4.06 Five million dollars of the funds loaned to each bank would be allocated to labor intensive projects. As the main purpose of these projects is to provide low cost jobs, there would be no limitations on the size of projects or sub-loans or on the type of projects; the only criterion (besides the usual technical, financial and economic criteria) would be that the projects provide jobs at a cost per job of no more than $23,000 equivalent. 4.07 Normal projects would be small- and medium-sized industrial projects, the same types of projects as were financed under the previous industrial credit lines. There would be a limit on the size of sub-loans and a restric- tion on the size of sub-projects, though the latter would be of a different type than under the previous projects (see paras 4.16 and 4.17). 4.08 One of the characteristics of projects in Kosovo is that they tend to be large. This reflects the past pattern of industrial development in the Province where the primary focus was on exploiting large mineral deposits and on the processing and utilization of such minerals; this type of industry tends to consist of large enterprises. As a result, KBP experienced diffi- culty under the first two industrial credit projects in identifying suitable projects that did not exceed the normal maximum size limitations imposed in the Loan Agreement, and this has led to delays in committing the earlier loans. To help avoid this situation and in response to the Government's request, $20.0 million of KBP's proposed loan would be allocated in advance for three specific projects already tentatively identified. These projects are larger 1/ than other projects that are expected to be submitted under the proposed loan but otherwise meet all of the usual criteria. One is the modernization and expansion of a lead smelter and refining plant. Without the project the plant would have to close and over 1,000 jobs would be lost. A second is the establishment of a heavy duty battery plant which is expected to export some 70% of its production. The third is a plant to produce casing and plastic parts for the heavy duty battery plant. All three are being prepared by the Trepca Kombinat and are expected to involve foreign co-financing. The projects will include the installation of suitable anti-pollution devices, especially needed at the lead smelter. These projects will use local raw material, will be located in underdeveloped communes in Kosovo and will help to diversify the industrial sector. Each will be reviewed by the Bank in a more intensive fashion than normal, including field missions. Procurement procedures must meet the requirements discussed in para 4.22. If one or more of these projects proves to be unacceptable, it could be replaced by another provided the substitute project creates or retains jobs at a cost per job of no more than $60,000 equivalent. 4.09 In recognition of the special difficulties faced in Kosovo by enter- prises and by KBP in identifying, preparing and then operating projects in new fields (for example, diversifying from basic industries to processing 1/ While these projects are likely to be the largest financed under the proposed loan, they are still smaller than typical projects that attract direct Bank lending. - 31 - industries), a part of KBP's proposed loan would be allocated to technical assistance. KBP has indicated four areas where it and its clients could use such assistance. One is marketing advice covering individual subsectors, for example textiles or wood products, to help identify promising new project ideas. The second is assistance by foreign specialists in reviewing large projects prepared by large enterprises such as Trepca. The third is technical advice for projects already in production but which are experiencing oper- ational dit7ficulties. The fourth is training for KBP's staff, or the staff of a project already in production; such training would be in appropriate foreign industries rather than in academic institutions. C. Economic Justification 4.10 The proposed loans are justifiable at the macro level on the grounds that they will lead to the creation of badly needed job opportunities in the LDRs while helping to correct the regional disparities in development and standard of living. Based on the projects identified by the four banks at the time of appraisal as being eligible for financing under the proposed loans, some 11,200 jobs would be created or retained. The new emphasis on maximizing the number of jobs created per dollar invested is expected to result in approximately 4,400 of these jobs being created at a cost of less than $23,000 equivalent each, the urban poverty program threshold as adjusted to forecast 1979 costs. The proceeds of the proposed loans will not be used to finance projects in basic industry, which are relatively capital intensive 1/, but instead will facilitate badly needed diversification of the industrial sectors of the LDRs which are skewed towards basic industry. 4.11 At the micro level, the ERR of sub-projects to be financed from the proposed loans is not known at this time, as is usual for DFC projects. How- ever, the estimated ERR of sub-projects financed under the past two loans has ranged from 12% to above 40%, on average well above the minimum acceptable rate of 11% established in the second Loan Agreement (10% in the first). Sub-projects financed under the proposed loans are expected to yield similar results. A third of the projects identified by the four banks would involve foreign co-financing to cover part of the foreign exchange costs; an unknown number of projects would involve foreign co-financing to cover part of the local costs, allowed under Yugoslav regulations. 1/ The "special" lead smelter project is an exception. However, because it will lead to the retention of over 1,000 jobs, it is relatively labor intensive; the cost per job retained or created is currently estimated at $37,000 equivalent. - 32 - D. Main Features of the Loans Loan Amount and Period of Commitment 4.12 The amount of the proposed loans, $100 million, has been established in the context of competing demands of other Yugoslav projects for the neces- sarily limited amount of Bank funds allocated to Yugoslavia. Were it to be committed evenly over the usual two-year period for DFC loans, it would cover only a fraction of the banks' foreign exchange needs for projects which meet the criteria established for the proposed loans. In view of the fact that the banks had already tentatively identified at the time of appraisal sufficient projects to utilize most of the loan proceeds, it is likely that the loans will be committed in a shorter period than the usual two years. The banks understand that additional industrial credit lines in less than two years is unlikely. However this time gap will not pose a serious problem in the Bank's institu- tion-building efforts as staff visits and consultations will continue without interruption. Use of Proceeds 4.13 The proceeds of the proposed loans will be used to help finance the foreign exchange costs (and in rare instances the local costs--see para 4.22) of fixed assets and permanent working capital for projects that meet the agreed criteria. These criteria are set out in a "Statement of Operations and Poli- cies for the Project" and attached as a Schedule to the Loan Agreements as was done in the earlier industrial credit projects. As with the second industrial credit project, sub-projects must meet a minimum FRR and ERR of 11%. The proposed loan to KBP will also cover the foreign exchange costs of technical assistance, mainly foreign consultants. Administrative Arrangements 4.14 Administrative functions will be handled by a joint Unit consisting of four Sub-Units, one from each bank. Each Sub-Unit will consist of three appropriate staff members from its bank acceptable to IBRD. The Unit will coordinate those activities under the proposed projects and the two previous industrial credit projects which involve all four banks. These include ensuring systematic and consistent preparation of progress reports and the promotion within the banks of improved appraisal and supervision methodology, including the organization of periodic seminars. The individual Sub-Units will handle those matters which affect only one bank. 4.15 Sub-loan applications to IBRD for sub-projects under the proposed loans will be submitted directly by each bank. The Sub-Unit of the bank sub- mitting a sub-loan application will ensure that the sub-loan request and the sub-project satisfy the criteria established under the proposed loans; a statement to this effect by the Sub-Unit will accompany each application. These arrangements are the same as for the second industrial credit project. - 33 - Sub-Loan and Sub-Project Size Limitations 4.16 For those portions of the proposed loans allocated to "normal" proj- ects sub-loans will normally not exceed $3.0 million equivalent (the limit under the second industrial credit project was $2.5 million equivalent), ensuring the financing of a reasonably large number of projects. Under the second industrial credit project the total cost of sub-projects was limited to $6.0 million equivalent unless there was foreign co-financing involved when a higher limit of $10.0 million equivalent applied. This higher limit was introduced in order to induce more co-financing as it was felt that larger sub-projects would tend to have more need for, and be better able to absorb, such co-financing. In the event, the smaller sub-projects seem to have attrached co-financing with more or less equal ease as Bank funds lent to any sub-project can be "matched" with foreign funds without the borrower having to meet the deposit requirement (see para 2.18). The extra inducement of a higher total sub-project cost limit therefore is no longer needed. 4.17 These limits on total sub-project cost were imposed under the two previous projects to help ensure that small- and medium-size sub-projects were financed as they tend to be more labor intensive than large sub-projects. To allow, however, for the possibility that a larger sub-project may also be relatively labor intensive, sub-projects whose total cost exceeds $10 million equivalent will be considered for financing under the proposed projects if they create jobs at a total cost per job of $40,000 equivalent or less. This figure is two-thirds of the average fixed investment cost per new job in the industrial sector in the LDRs in 1979 prices ($60,500 equivalent), based on the average for 1974-75 discussed in para 3.29. It is less than the average cost per job created by sub-projects above the free limit under the previous two projects, again adjusted for past and expected inflation ($45,750 equivalent). Free Limit and Aggregate Free Limit 4.18 In recognition of the improvements in each bank's project appraisal work and because of IBRD's growing familiarity with and greater confidence in these institutions, the free limit on individual sub-loans will be raised from the $500,000 established under the second industrial credit project to $1.0 million. The aggregate free limit for each bank will also be raised from around 40% to 60% of its proposed loan (in the case of KBP, only those parts allocated to "normal" and labor intensive projects). This will allow the Bank to review for approval between 12 and 16 appraisal reports (three or four sub-projects per bank), a reasonable number. In addition, the appraisal reports on the three "special" KBP projects will be reviewed (see para 4.08). Loan and Sub-Loan Terms 4.19 The proposed loans will be made on the Bank's normal terms and con- ditions as applicable to DFC loans, including the standard commitment charge, with adjustable repayment schedules reflecting the composite repayments of - 34 - sub-loans. The repayment of that part of KBP's loan allocated for technical assistance will be prorated over the repayment schedule for the rest of KBP's loan. 4.20 The repayment period of individual sub-loans will not exceed 15 years from the date of signing of the proposed loans. (Under the second industrial credit project a repayment period of up to 15 years from the date of Bank approval of the sub-loan was allowed.) Grace periods can normally be up to three years (as before). To encourage blending of Bank funds with other foreign exchange resources, which are expected to be mainly medium-term credits, grace periods of up to five years (six years before) will be allowed when there is co-financing and the need for such a longer grace period can be demonstrated. 4.21 The on-lending rate to be charged by the banks on IBRD funds will be 11% with the sub-borrowers assuming the foreign exchange risk; this is the same as under the second industrial credit project. This rate approximates current market costs of foreign borrowings to Yugoslav investors and will provide the banks an adequate spread. In addition, domestic resources lent to social sector sub-projects receiving IBRD funds will carry an interest rate of at least 6%, and to private sector sub-projects, at least 5% (there may be exceptions in Kosovo). This is the same condition as imposed under the second agricultural credit project and is a step towards unifying lending rates country-wide. Procurement 4.22 Some sub-projects may be received under the proposed projects that are of such a size and nature that international competitive bidding (ICB) using the Bank's Guidelines for Procurement might be the most economical and efficient method of procurement. While the detailed criteria identifying such sub-projects cannot be established in advance, the total cost of an individual contract is a reasonable proxy. Under the proposed projects, therefore, while the appropriateness of ICB should be considered for all foreign procurement, any individual contract for imported goods that is expected to exceed $2.0 million equivalent and to be financed in whole or in part from the proposed loans will be considered a candidate for procurement under ICB. For such contracts the borrowing bank and its sub-borrower will be required to explore the appropriateness of ICB. If they decide that ICB is not appropriate, this decision must be justified satisfactorily to the Bank before the sub-project will be considered as eligible for Bank financing. If they do follow ICB, and a Yugoslav supplier wins the bid, the ex-factory cost of these goods will be eligible for financing with Bank funds; this situation is expected to arise only in rare instances. The Bank will undertake a full review of all procure- ment documents and procedures for contracts expected to exceed $4.0 million equivalent that are procured under ICB and will selectively review smaller contracts. - 35 - V. AGREEMENTS REACHED AND RECOMMENDATIONS 5.01 During negotiations agreement was reached with the four banks on the following principal issues: (a) the four banks through the Unit will provide the Bank with the basic data needed to prepare a project completion report on the first industrial credit project once it is fully disbursed and will prepare a project completion report on the proposed projects (as well as basic data on the second project) some five years later (para 3.31); (b) sub-projects whose total cost exceeds $10.0 million equivalent will not be eligible for financing unless they create employ- ment at a total cost per job of $40,000 equivalent or less (para 4.17); (c) domestic resources lent to social sector sub-projects receiving IBRD funds will carry an interest rate of at least 6%, and to private sector sub-projects, at least 5% (para 4.21); (d) any individual contract for imported goods that is expected to exceed $2.0 million equivalent will be procured following ICB procedures unless an alternative procedure is satisfac- torily justified (para 4.22); and (e) the four banks will each carry out an annual portfolio analysis (para 3.24). 5.02 The projects are suitable for four Bank loans totalling $100 million equivalent on the terms and conditions outlined in Chapter IV. YUGOSLAVIA - INDUSTRIAL CREDIT PROJECTS III & IV Stateaent- of Inc-,e and EUpene.s, 1975 - June 30, 1977 (in Millions of Diners) P91S lBS IBT __ _ _ __ _ _ _ __ _ _ __ _ _ _ Jan. - June Jan. - Ju.n Jan. - June P Jan, - une 1975 1976 1977 1975 1976 1977 1975 1976 1977 1975 1976 1977 INCOME (----Audited-- ) (Proviaional) (----Audited ----) (Peevi.ional) (----Audited----) (Provisional) (----Audited----) (Provisional) Interest on loons 1.990 2,674 2,028 1,766 2,344 1,305 558 761 4a3 639 940 608 Interent on bank deposits 150 27 - 50 150 183 22 26 48 32 37 16 Fees. coaainsionn and charges 184 232 100 45 64 35 17 25 12 31 46 13 Other 223 218 123 160 167 68 88 79 40 67 - - 80 30 Oro.n Inco=e 2.547 3,151 2,251 2,201 2,725 16591 685 899 563 769 1,103 667 EXPERSES Interent on: Individual deposits 522 757 474 466 631 384 36 52 63 46 65 42 Other deposits and borrowingn 865 884 955 683 1,119 694 343 480 328 405 606 376 Debts witten off 1 7 2 7 55 18 2 - - - - - Other. 212 149 138 190 128 66 136 97 42 67 41 23 Total Financial inpenena 1,600 1,797 1,429 1,346 1,933 1,162 517 629 433 518 712 441 Administrative Expeses: Salarina and personnel 213 293 172 99 134 80 36 42 23 41 51 31 Others 137 182 82 56 73 40 18 26 13 27 40 11 Total Administrative Enpensas 350 475 254 155 207 120 54 68 36 68 91 42 e Total E.pensea 1.950 2.272 1,683 1,501 2,140 1,282 571 697 469 586 803 483 Income Deftrn Statutory Obligations 597 879 568 520 585 309 114 202 94 183 300 184 Statutory Obligation. (Tax) 94 118 62 52 60 29 13 15 19 6 S Net 503oe - _761 506 468 525 280 101 187 164 294 179 APPROPRIATIONS- Founders Pund 89 114 139 188 18 45 31 I1I Referve Fund 163 223 154 132 46 65 69 91 Boniness Fund 193 ) 21 27 25 64 60 11 Fund of the Bank's Working Cosaunity 58 424 154 178 12 13 4 81 503 761 468 525 101 587 164 294 1/ The net income as shown is not net of provisinsa for doabtful debta since nu specific provison against portfolio losses is nade. The appronpgation to thn keeeree Fund is a legal requirment and can be considered as a prov-iio for doubtful debts. Under the new Federal Banking Lxw which is to be applied after January 15, 1978 the Founders Fund would be-one provisions for doubtful debta with the Reserve Funds being regarded an reserves for liquidity. 2/ As stated by the banks (iofoormtion on appropriations is not included in the audit reports prepared by SDK). EMENA/IDF Dec-mber 1977 YOGOSLAVIA - INDUSTRIAL CREDIT PROJECTS III 6 IV I/ Balance Sheets5 1975 - June 30. 1977 - (in Slillona of Dinara PUS lS ]IT e.3 e.3 oe3 Dec. 31 Dec. 31 1e77 31975 IS36 June 30 Dec. 31 Dec. 31 June 30 Dec. 31 Dee. 31 1977 1973 '1976 1977 11935 1936 1977 1973 1976 1977 1975 1976 17 ASSETS (----AudiAed----) (Provisiasalj =-Y-- Nd::d i (Pro_iadonalj (----Aadited----) (ProwiCiunOl) --- udi$ed----) I oh Cash and due frc bank 1,609 2.800 3,216 1,058 1,562 1,772 464 803 1,084 577 971 1,115 Depoaita with National Bank 2,632 3.645 4,378 1,040 1,447 1,678 315 507 648 424 687 799 Short-ten loans up to one year and current Shatucitlel of lanp-teo Loan d 15,641 1851 17,576 11,329 1,0335 11,718 2,746 3,355 3,758 4,564 6,085 4,981 Long-tenr loan over one year less currant osturities 17,585 28,71 34,23 14,987 21,545 25,843 6,267 9,201 10,601 8,783 12,445 16,127 Loans for hou.ing and connunal constructioi legs current aaturities 1.971 2,066 2,289 1,937 2,252 2,658 310 419 523 759 980 1,124 Property and equipment 450 563 638 194 254 288 70 60 80 104 150 194 Ac-vued interest and other ..setC 1,725 2.846 2.510 906 1,117 1,176 200 271 320 544 694 626 41586 54 64,892 3L17 41,212 45,133 10412 14.676 17_014 15.755 22 012 24_966 Ilsaged Fund 12.201 13,789 1_5506 9 44 7,368 7_564 3_005 3,201 3,250 4,232 4.314 4,087 LIABILITIIOS AND FUNDS EMPLOYED Desand deposita 10,345 16,522 19,296 3,935 6,239 6,541 1,311 2,109 2,536 1,432 2,292 2,704 Savinge and abort-tern dspocits up to ane year 7,628 10.527 9,935 4,925 6,409 8,777 587 775 941 914 1,365 1,320 Savinga and long-tenr depoSIt. ner one year 4.955 6,880 7,098 5,415 6,880 4,473 1,193 1,771 2,275 979 1,302 843 __ Borrosinge fran Federal, Republic and Incal authority. 9,647 13,139 14,520 8,387 10,661 ) 19,899 3,024 4,189 4,659 8,59 12,668 34,6i4 Sorruwlogs fron bsnk. 4,622 8,189 9,096 4,952 6,836 ' ,280 4,635 5,319 2,073 2,861 3,634 Accrued i.terest and other liabilities 907 789 _I984 549 528 1_868 304 280 307 803 427 756 2/ 38,104 56,046 61,929 28,163 37,553 41,468 9,699 13,759 16,037 14,800 20,715 23,477 -, Fund. ecaployed -4 Feemletil funde 1,995 1,479 1,040 1,961 1,991 2,023 362 419 449 521 682 693 Reserve fund 686 913 910 687 790 826 207 273 303 156 239 3484 Business food 673 1,013 3 59 789 816 125 197 225 258 28 ) _ Fund, of the MeA a. working coess.ofnty 128 19 75) 89 3 __ 19 .28 )___50 ..3 3,482 3_596 2,963 3.308 3,659 ,66 713 ___17 977 955 1,297 1,4839 41,586 59_642 64s892 21 t471 _41,22 45,133 10_41-2 1_4,67 6 17,014 15,755 22 012 24.%N6 llanaged 8und 12,201 13,789 15506 9,449 "39 7,564 3.05 3_201 3,250 4,212 4 114 4.je7 Guaranteea outstanding 42,923 61,960 na. 10,225 19,201 na 3,449 8,799 n.e.5,081 6,509 . n c / These balance sheet, have been prepared by S11 following, to the eat.nt possible, accounting practices of Western countries which differ fr-u enceal accounting practices in Yugoslavia. frovicinal figuren as of Juno 30, 1977, were prepared by the banka and did sot conply with SDK forcat i0 smne reepectel especially It Is to be noted that "ohort-te- loane O to one year and currant .Aturitl*s of lnsg.tew loansa included am. twe-yesr loans and xe.luded current etotritiso. 2/ Under the new Federal Banking Law which will bec e applicable on January 15, 1978, the folving charge will take place with repFect to equity Foundera' fund. Would serve an reserves for doubtful debta under the new na.me of Fends *( Joint Liability, M.d Reserve Fund will becoue reserves for maintalning banks' liquidity; 8usine* FuPnd and Fundo of the Bank'e Working Conounity .o.Id be called Fund of FIxed Assets, vhich is used for acquisition of the Bank's yr5{e.a and other fi.ed assets needed for their operations. EPINAI/DF Decuesber 1977 -38- ANNEX 3 YUGOSLAVIA - INDUSTRIAL CREDIT PROJECTS III & IV Projected Statements of Sources and Applications of Funds: 1978 - 1982 (in Millions of Dinars) Total for 1978 - 1982 Sources PBS SBS IBT KBP Net increase in short-term resources 35,448 29,622 3,520 13,828 Net increase in long-term deposits 23,349 15,378 116 4,548 Collection of long-term loans 15,310 12,515 2,810 13,942 Borrowings from Federal and Republic Funds 27,300 21,142 8,182 26,699 Other domestic or foreign identified borrowings 1,785 1,400 3,500 4,040 IBRD loans 1,680 581 500 1,712 Unidentified sources 2,085 9,286 2,110 9,800 Total 106,957 89,924 20,738 74,569 Applications Net increase in short-term assets 29,660 23,959 3,586 22,915 Long-term loan disbursements 68,100 59,969 14,784 42,599 Repayment of long-term borrowings 9,197 5,996 2,368 9,055 Total 106,957 89,924 20,738 74,569 Assumptions for the Financial Projections (Annexes 3 - 5): 1. Financial projections (Annexes 3 - 5) have been prepared on the basis of operational projections (Table 9, para 3.35). 2. Projections are in current prices and it is assumed that the prices will increase at an annual rate of 8 - 10% p.a. 3. It is assumed that PBS, SBS and IBT will receive the Federal and Republic Funds in the same proportion (40 - 55%) to total long-term resource requirements as in the past. KBP expects these funds to represent about 50% of total long-term resources requirements, a smaller proportion than before (79%). 4. Projected income statements have been prepared to produce no additional net income than what is required for the mandatory services. YUJGOSIAVIA - INDUSTRIAL CREDIT PROJECTS Ill & IV Projected lncome Statemento: 1977 - 82 (in .illion. of ..oat.) PBS DSB 1977 1978 1979 1980 1981 1982 1977 1978 1979 1980 1981 1982 INCOME (8etiate) (Estimate) Interant 3,429 3,770 4,155 4,620 4,850 5,080 3,017 3,577 4,254 5,025 5,922 6,990 Fe.& and nnienion chargen 176 200 220 250 275 300 74 89 107 128 153 191 Other income 135 150 155 160 175 190 133 166 208 260 325 405 Groan Inctme 3.740 4,120 4.530 5.030 5.300 5570 3.224 3.832 4.569 5.413 6.400 7 EXPENSES Financial enpennee 2,537 2,779 3,058 3,375 3,440 3,515 2,204 2,642 3,185 3,806 4,526 5,385 Admi.nitrative and other onpenses 715 790 885 1,005 1,150 1,270 443 554 693 866 1,083 1,354 Statutory obligation. (tae..) 138 151 167 185 200 220 55 70 81 93 106 122 Total empensen 3.390 3.720 4,110 4 565 4,790 5,005 2.702 3 266 3 959 4.705 5.715 6.861 NET INCOME 350 400 420 465 510 565 522 566 610 648 685 725 ApPmprnitfonn 1' Fosnder. fund and fund of the bank's working co,annity 172 190 200 215 235 250 371 386 410 428 445 465 Reserve fund 178 210 220 250 275 315 151 180 200 220 240 260 -We 400 420 465 510 565 522 566 610 648 685 725 IRT lip 1977 1978 1979 1980 1981 1982 7 1978 1979 1980 1981 1962 INCOtE (Estimte) (Estitate) Intereat 976 1,090 1,220 1,365 1,530 1,680 1,310 1,709 2,204 2,776 3,449 4,100 Faes *nd coatilsnion charges 20 20 29 30 35 40 42 38 33 30 28 25 Other inonme 70 60 65 70 75 80 87 95 103 110 117 120 Groas Inctme 1,046 1,170 1 310 1,465 1,640 1,800 1.439 1.842 2.340 2.916 3.594 4.245 EXPENSES Financial enpensee 809 905 1,003 1,115 1,250 1,300 1,019 1,329 1,714 2,159 2,683 3,100 Administrativn and other e"panses 104 115 137 160 180 200 98 108 119 131 144 165 Statutory obligation. (taese) 33 40 50 60 70 75 6 7 8 9 10 12 Total expen-aa 946 1,060 1,190 1,335 1,500 1,655 1,123 1,444 1,841 2,299 2,837 3,277 NET INCOM E 1OO 110 120 130 140 245 316 398 499 617 757 968 Anprfrattion: I Founders fund and fund of the bank's wrking ca.-unity 30 35 40 45 50 60 158 213 258 332 431 550 Reserve fund 70 75 80 85 90 85 158 185 241 285 326 418 100 110 120 130 140 145 316 398 499 617 757 968 1/ Sen footnote 1 of Annex I and footnote 2 of Annen 2. EMEMA/IDF December 1977 YU(COSLAVIA - INDUSTRIAL CREDIT PROJECTS III & IV Fro.ected elance Sheets: 1977 - 82 (in Milliona of Dfnrhe) PBS 885 Dec. 31 Dec. 31 Dec. 31 Dec. 31 leo. 31 le -31 Dec' 31 Dec. 31 Dec. 31 Dec. 31 De.. 31 Dec. 31 1977 1978 1979 1980 1981 1982 1977 1978 1979 1980 1981 1982 ASSETS (Estimate) (Estite) Short-trem loans and depositt 28,762 33,892 39,387 45,292 51,602 58,422 18,851 22,071 25,935 30,571 *36,134 42.810 Loog-term loans 40,219 48,499 58,149 68,749 80,349 93,019 30,668 37,721 45,824 55,130 65,819 78,092 Liquid f.nda end other as.eta 3.937 4,522 4 654 4.218 5_138 4,928 1,575 1,231 1.737 2.297 2;912 3.592 Total A..eto 72,918 86.913 102,190 118.259 137.089 156,369 51.094 61.023 73.496 87.998 104.865 124.494 LIABILITIES AND EQUITY Short-tem borrowinge and deposits 33,118 39,616 46,510 53,552 60,876 68,566 20,007 23,987 28,763 34,495 41.375 49.029 Loog-ter- deposits 8,729 11,582 15,592 20,18i 25,868 32,078 8,623 10,868 13,472 16,492 19,Y96 24,061 LonE-tore borrowings 25,731 29.780 34,021 38,398 43,299 48,889 17,828 21.521 25,718 30.503 35,953 42,168 Other liabllities 1 586 1.781 1,493 1,087 1,497 722 1.739 1.240 1.570 1.925 2 310 3.320 69.164 82,759 97.616 113.220 131,540 150,255 48.197 57.616 69.523 83.415 99,634 118.378 Rquity, Feenudrer'fmad, htb.iexs toed sod funds I/ of the bank as working c-anity 2,663 2,853 3,053 3,268 3,503 2,753 2,070 2,421 2,807 3,217 3,645 4,085 Reserve Fund 1,091 1,301 1,521 1.771 2,046 2,361 827 986 1.166 1.366 .586 1.831 3.754 4.154 4,574 5.039 5.549 6.114 2,897 3,407 3.973 4,583 5,231 5.916 Total Liabilities and Equity 72,918 86.913 102,190 118.259 137.089 156,369 51.094 61.023 73.496 87.998 104.6 124494 SOT REB Den. 31 Dec. 31 Dec. 31 De.. 31 leo. 31 ec. 31 Dec. 31 De.. 31 Dec. 31 Dec. 31 Dec. 31 Dec. 31 1977 1978 1979 1980 1981 1982 1977 1978 1979 1980 1981 t182 AST8 (tatimate) (EstImate) Shoot-trom loans and deposits 4,786 5.336 5,946 6,646 7,426 8,306 9,079 12,009 15,644 19,993 25,393 31,173 Long-tem losesi 13.866 17,057 19,521 22,160 23,930 25,850 24,077 28,446 33.751 39,502 45,882 51 739 Liquid feeds and ether assets 578 768 1,616 1.896 1,728 1.983 801 770 720 691 672 648 Total Assets 19230 2 7,083 30.702 33,084 36,139 33,957 41.225 50.115 60.186 71,727 84.560 LIABILITIES AND EQUITY Shoet-term borrowings end depesits 3,132 3,682 4,292 4,992 5,772 6,652 5,385 7,263 9,413 12,124 15,134 19,213 Leng-tam deposits 1,788 1,807 1,827 1,849 1,874 1,904 1,577 1,975 2,526 3,326 4,526 6,126 Long-teom bortuwings 13,060 16,291 19,453 22,072 23,922 25,922 19,969 25,173 31,413 38,002 45,333 533945 Other liabilitiee 234 255 365 413 - - 5,441 4832 4,282 3.635 2.858 992 18.214 22.035 25.837 29,326 31,568 34,478 32,372 39,243 47.634 57.087 67,371 79.676, Equf ty: Founde.r' fend, bheIness fend and fonds of the bank as working cosnenity 674 709 749 794 844 904 1,079 1,291 1,549 1,881 2,312 2,862 Reserv- Fend 342 417 497 582 672 757 506 691 932 1,218 1,544 2.022 1@016 1,126 1,246 1.376 1,516 1,661 1,585 1_982 2,481 3.099 3,856 4,884 Total Liabilities and Equity 19,230 23,161 27.083 30_702 33.084 36,139 33.957 50,115 60,186 71.727 84,S60 Iil. 12j The e pected decrese from the previvne year if doe to the withdrawal of Fo-ndce.' funds pertaining to the local goverenat. ENIIERIDF aeamber 1977 ANNEX 6 -41 - YUGOSLAVIA - INDUSTRIAL CREDIT PROJECTS III & IV Schedule of Estimated Disbursements of the IBRD Loans (in US$ million) ------------During Quarter----------- Loans to: For the four loans: Calendar Year Quarter IBT PBS SBS KBP Total Cumulative 1979 1 0.5 0.5 0.5 0.5 2.0 2.0 2 0.5 0.5 0.5 1.0 2.5 4.5 3 1.0 1.0 1.0 2.0 5.0 9.5 4 1.0 1.0 1.0 2.5 5.5 15.0 1980 1 1.5 1.0 1.5 3.5 7.5 22.5 2 2.0 1.5 2.0 4.5 10.0 32.5 3 2.5 2.0 2.5 5.5 12.5 45.0 4 3.0 2.5 3.0 6.0 14.5 59.5 1981 1 2.5 3.0 3.0 5.0 13.5 73.0 2 2.0 2.5 2.5 4.0 11.0 84.0 3 1.5 2.0 1.0 2.5 7.0 91.0 4 1.0 1.5 0.5 1.5 4.5 95.5 1982 1 0.5 0.5 0.5 1.0 2.5 98.0 2 0.5 0.5 0.5 0.5 2.0 100.0 - 42 - ANNEX 7 SELECTED DOCUMENTS AND DATA AVAILABLE IN THE PROJECT FILE 1. Economic Tables Table 1. Annual Growth Rates of Industrial Production in Yugoslavia Selected Periods from 1952 to 1975 Table 2. Sectoral Structure of GMP by Region, 1975 Table 3. Regional Investment Characteristics, 1975 Table 4. Labor Force Composition by Region, 1971 Table 5. Economic Indicators by Region, 1976 and 1977 Table 6. Main Indicators of the 1971-75 Five Year Plan Table 7. Industrial Concentration by Region, 1974-75 Table 8. Growth Rates of Industrial Branches (Actual 1971-75; Target 1976-80) for Yugoslavia and LDRs Table 9. Yugoslavia - Social Plan for 1976-80 Principal Growth Targets Table 10. Yugoslavia - Investment in Fixed Assets (Actual 1971-75; Planned 1976-80) by Industrial Sub-Sectors Table 11. Yugoslavia - Growth of Industrial Output (Actual 1966-70 and 1971-75 and Planned 1976-80) and Change in Industrial Structure (1970, 1975 and 1980) by Sub-Sectors and Branches 2. Tables Relating to the Banks Table 1. Borrowing and Lending Rates Table 2. Summary of the Banks' Operations: 1975-June 30, 1977 Table 3. Classification of the Banks' Long-Term Loans: 1975-June 30, 1977 Table 4. Financial Ratios Table 5. Forecast of the Banks' Long-Term Loans: 1978-82 Table 6. List of Projects Under Consideration Table 7. Basic Data EMENA/IDF December 1977