FILE CO Y R E S T R I C T E D R e p o r t N o. P-161 This report was prepared for use within the Bank. In making it available to others, the Bank assumes no responsibility to them for the accuracy or completeness of the information contained herein. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE FEDERATION OF RHODESIA AND NYASALAND May 29, 1958 REPORT AND RECODMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE FEDERATrQN' OF RHODESIA A'_D 'YASALAIND 1. I submit a report and recomnendations on a proposed loan of $15 million equivalent to the Federation of Rhodesia and Nyasaland to help finance the devel- opment program of Rhodesia Railways. The outlines of the joint operation of which the proposed loan would be a part were given in a previous memorandum (R58-h6) considered by the Executive Directors on May 8, 1958. Since there have been no substantial changes in the substance of the proposed operation, much of the report which follows is a repetition of infornation contained in the previous memorandum. PART I - HISTORICAL 2. In the fall of l957 the Government of the Federation consulted with Dillon, Read & Co., Inc., their New York bankers, and the Bank about the possi- bility of obtaining funds in the United States to assist in financing their development program. After further discussions, it was decided that the Federa- tion would seek to float an issue in the New York market, which would be timed simultaneously with a loan from the Bank. 3. A Bank mission went to Rhodesia in March, when representatives of Dillon, Read were also there, and negotiations were carried forward in Salisbury and com- pleted in Washington. 4. The Bank has already m,ade the following loans in the constituent Terri- tories of the Federation: No. Borrower Purpose Amount i/ 58 SR Colony of Southern Rhodesia Power $ 28.0 million 74 NR Territory of Northern Rhodesia Railroad development 1h.0 million 1h5 RN Federal Power Board Power 80.0 million Total (net of cancellations and refundings) $122.0 million Amount sold 19.1 million $102.9 million Amount repaid $L.1 million Less repayments to third parties 4.O million 0.1 million Net amount held by Bank (includes $56.1 million not yet disbursed) $102.8 million 1/ As of May 15, 1958 - 2 - PART II - THE PUBLIC BOND ISSUE 5. Negotiations on the public issue have also progressed and the Federation plans to issue shortly in New York &10 million principal amount of fifteen-year sinking fund bonds. Sinking fund payments would be at a low rate from May 1959 to May 1961 and thereafter at an increased rate sufficient to retire the entire issue by maturity. The proceeds of the bond issue would provide part of the funds required for the development programs of the Federal and Territorial Governments but would not be allocated to any specific project. The underwriters filed a Registration Statement with the Securities and Exchange Commission on May 8, 1958 and this would become effective in time for the public offering to be made on June 10. PART III - DESCRIPTION OF THE BANK LOAN 6. The main characteristics of the proposed loan would be as follows: Borrower: The Federation of Rhodesia and Nyasaland Guarantor: The United Kingdom Amount: The equivalent in various currencies of $15 million Amortization: In 30 semi-annual installments, coRmencing on November 1, 1961 and terminating on May 1, 1976 Interest Rate: 5-3/8%, including 1% commission Commitment Charge: 3/4 of 1% per annum Use of Proceeds: For imported equipment and goods required for the development program of Rhodesia Railways PART IV - LEGAL INSTRUiJENTS AND AUTHORITY 7. Drafts of the following documents are attached: a) Loan Agreement between Federation of Rhodesia and Nyasaland and the Bank (No. 1) b) Guarantee Agreement between the United Kingdom and the Bank (No. 2) 8. The loan is being made to the Federation, but the proceeds are to be relent to the Rhodesia Railways on terms and conditions satisfactory to the Bank. The draft Loan Agreement provides for this (Section 5.01 (b)). The Loan Agree- ment would not become effective until the Borrower had delivered and received payment for the bonds issued under the public bond issue (Section 7.01). In all - 3 - other material respects the draft Loan Agreement conforms to the normal pattern of the Bank's loan agreements in the case of loans to dependent territories. 9. The draft Guarantee Agreement is in form similar to previous guarantee agreements with the United Kingdom. It is proposed that an understanding between the Bank and the United Kingdom as to the interpretation of Section 2.02 of the draft Guarantee Agreement in the circumstances of this loan be in the form of the draft attached (No, 3). This is in conformity with the procedure followed in the case of previous guarantee agreements with the United Kingdom. As regards Section 3.01 the Bank is informing the United Kingdom that no action is required by reason of any pledge of securities effected under the terms of the Agreement dated February 25, 1957 between the United Kingdom and the Eximbank (circulated to the Executive Directors on April 29, 1957 under reference SM57-69). 10. Also attached is the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement of the Bank (No. 4). PART V - APPRAISAL OF THE PROPOSED LOAN 11. Attached are a technical report on the railway project (No. 5). A report on the economic position and prospects of the Federation (R58-56) dated May 23, 1958 has already been circulated. The Rhodesia Railways 12. The Rhodesia Railways, an agency of the Federal Government, owns and operates the railroad system in Southern and Northern Rhodesia. Its lines con- nect the main industrial and commercial centers of the two Territories and link the Federation with the railroads of the neighboring countries and thereby with the principal ports of Portuguese East Africa (Mozambique), the Union of South Africa and Portuguese West Africa (Angola). Its properties are now valued at about £70 million and comprise about 2,700 miles of track, of which 2,200 are in the Federation, almost 400 locomotives, over 550 passenger coaches and nearly 12,000 freight cars. The management of the Rhodesia Railways is experienced and the technical staff competent. The Railways have a favorable earnings record and their financial position is sound. The Need for Railway Development 13. The long postwar boom in Rhodesia has put a tremendous burden on the Railways and has required continuing expansion and modernization of facilities. To help finance the Railways' development program the Bank made a loan of $14 million to Northern Rhodesia in March 1953. The change in the economic climate in the last six months or so has, however, naturally affected the traffic picture in several important respects. Whereas until recently one of the major problems was to move enough coal by rail from Wankie to the--Coppe?beZt, the copper mines are now using less coal and importing more electric power from-the>Belgian Congo. Moreover, when power becomes available from Kariba, the demand for Warl&ie coal will be further reduced not only in the Copperbelt but throughout the couztmry. - 4 - Current expectations are that over the next five years freight traffic (in net ton miles) will grow by only about 15% compared with an increase of over 50% in the period 1952-1957. 14. The Railwayst management is accordingly not planning a massive increase in carrying capacity. Their current development program takes account of the changes in expected traffic and they are making a continuing review of traffic trends so as to keep capital expenditure adequate to meet foreseeable needs and yet avoid excessive investment. The program which they have submitted to the Bank appears well-balanced. Only small additions are to be made to the stock of freight cars which was increased sharply over the last five years, and such cars as are to be purchased are mainly of special types, e.g. refrigerator cars. Locomotives on order are of larger sizes, and can pull longer, heavier trains. The permanent way is to be kept in good condition, with heavier rail being used as replacements. Centralized traffic control will be extended over the principal sections in order to increase capacity and improve operations. The Project 15. The project in respect of which the Bank loan would be made would consist of the acquisition of locomotives and rolling stock, the strengthening and improve- ment of the permanent way, the extension of centralized traffic control over addi- tional sections of the main line, the remodeling, modernization and expansion of yards, sidings and crossings, and the construction of staff quarters and other buildings. The execution of the project would run to the end of 1960. Its total cost is now estimated at £25 million, more than half of which would be ,,pent out- side the Federation. The Bank loan of $15 million (approximately £5.36 million equivalent) would be used to purchase diesel and steam locomotives (for different sections of the line), coaches, refrigerator wagons, permanent way material, ma- chine tools and other equipment. The remainder of the funds required would be provided from the Railways' own resources and by borrowing mainly from the Federal Government. Procurement 16. The new diesels are additional units of a type initially bought in the United Kingdom under international competitive bidding and now being adopted as standard by Rhodesia Railways. Apart from these, all the items have been or will be purchased on the basis of international competition. The Need for External Borrowing 17. During the last decade the real national output of the Territories now comprising the Federation has more than doubled. This extraordinarily rapid growth has been made possible by a very high rate of investment in mining, indus- try and agriculture. This in turn has been due in large measure to exceptionally favorable export prices, to a high level both of internal savings and capital inflow, and to the continued immigration of people with technical and managerial skills. To keep pace with the rise in production the Federal and Territorial authorities have undertaken a substantial expansion of the basic services, parti- cularly power, transport and housing, which, however, has barely been sufficient. - 5 - 18. The fall in the price of copper from over £hOO a ton in spring 1956 to £170-180 a ton today has now changed the situation very substantially. Last year the deterioration in the terms of trade caused a substantial import surplus to appear for the first time in years, and the current account deficit rose from £33 million in 1956 to £71 million in 1957. Moreover, while the inflow of capital had been very nearly sufficient to cover that deficit in 1956, in the second half of 1957 drafts of about £h0 million on the country's sterling reserves were re- quired to meet it. At the end of March 1958 these stood at £99 million, equiva- lent to rather more than six months' imports. The fall in copper prices also affects public revenue, though here the full effect has not yet been felt since most of the impact comes through lower income tax collections with a delay of a year or more. 19. To some extent the situation is self-correcting. Tmmigration falls auto- matically as employment opportunities shrink and importers reduce their orders as sales fall off. But the authorities have also taken measures to redress the balance. To curb expansion in the private sector, and by the same token, imports, they are restricting credit to business, which had grown very considerably last year. The Federal and Territorial Governments have also put a brake on public expenditures and their budget estimates show a balance of current revenue and expenditure based on copper prices slightly below the level now prevailing. They have also cut back somewhat their planned capital expenditures (other than on Kariba, for which finance has been secured) to bring them into line both with their smaller resources and with the reduced rate of growth expected in the near future. Nevertheless, as is illustrated by the railway program, the investment needs in the public sector are still high and the Federation is justifi':d in covering part of them from external sources rather than in risking too heavy drafts on her reserves. Prospect of Fulfillment of Obligations 20. With the fall in copper prices the economy of Rhodesia and Nyasaland is now facing its first real test since Federation. Yet the present phase is not likely to be unique, for the development of base-metal mining typically proceeds by bursts, and such discontinuous progress is more or less inevitable in a country so dependent on a few exports subject to such wide price fluctuations. The fall in external reserves has now been stemmed but it is still too early to say whether the steps taken are in themselves sufficient to restore balance of payments equi- librium. Of this the authorities are fully aware. They are watching the situa- tion carefully and have announced that further measures will be taken should the situation require them. The next year or two will not be easy but provided there is no major depression in the industrial countries there is no reason to doubt the Federation's ability to weather the storm. 21. In the longer run the prospects for the continuing growth of the Federa- tion's economy are good. Its reserves of copper are very large and its costs of production still low and competitive with most of the world's output. The qual- ity of Rhodesian tobacco is improving and the prospects of increasing exports reasonably good. There is also a growing number of lesser exports, such as chrome and asbestos, for which the long-run outlook is favorable. And, on the other side, most of the industrial development of the boom years is sound and should, by diversifying the economy, make it less vulnerable, and thereby reduce its depend- ence on imports. - 6 - 22. The proposed borroting will bring the external debt of the Federation to about $540 million equivalent and service on it in the early 1960's represents 6-7% of 1957 external earnings. Even if copper prices should s';ay at present levels and foreign exchange earnings should drop back to the 195$t level, service would be equiv lent to 8% of the reduced ear,-i-inrs, uhich should not be an unmanage- able burden. 23. One of the major areas of risk in lending in Central Africa is that inter- racial tensions may disrurt. the economy or hinder its growvh. Ra2ial tension does exist in the Federation and it may increase, e-necially if the present Less favor- able economic conditions should continue for loIg. It is not possible to predict with any degree of aFsuranv_ the course of race relations, particularly for a number of years ahead, But on the whole, the record of the cons' ituent Terri- tories of the Federat-on in these matters is good and I do not believe that the future course of race relations is likely to be such as to interfere with the due execution by the Federation of its obligations in connection with the proposed borrowing. The United Kingdom 24. The United Kingdom, as C-uarantor of the proposed Bank loan, is assuming a contingent financial liability to the Bank. An analysis of the economic posi- tion of the United Kingdom was presented very recently in connection with the loan to the Federation of Nigeria. Including the loan to Nigeria, the United Kingdom has existing contingent obligations - all arising out of Bank loans to British dependent territories - amounting to $170 million equivalent, of which $119 million are still held by the Bank. Including service on the present borrow- ing, dollar payments for the United Kingdom's own debts and debts guaranteed by her would fluctuate around $270 million a year in the next decade. This is not large in relation to her external earnings and the magnitude of the obligations being assumed by the United Kingdom in guaranteeing debt of British overseas ter- ritories to the Bank is not such as to give cause for concern. PART VI - COMPLIANICE WITH ARTICLES OF AGREENENT 25. I am satisfied that the proposed loan will comply with the requirements of the Articles of Agreement of the Bank. PART VII - RECOMMENDATIONS 26. I recommend that the Bank at this time make a loan to the Federation of Rhodesia and Nyasaland in an amount in various currencies equivalent to $15 million for a total term of 18 years, with interest (including commission) at 5-3/8% and on such terms as are specified in the draft loan documents and that the Executive Directors adopt a Resolution to that effect in the form attached (No. 6). Eugene R. Black Washington, D. C. May 29, 1958