RESTRICTED FILE COPy Report No. P-325 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE YUGOSLAV INVESTMENT BANK June 13, 1963 REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE YUGOSLAV INVESTMENT BANK 1. I submit the following report and recommendations with regard to a pro- posed loan in an amount in various currencies equivalent to U.S. `35 million to the Yugoslav Investment Bank. PART I - INTRODUCTION 2. The Bank has made five loans to Yugoslavia for a total of $p120.7 million. The two most recent loans, one in 1961 and one in 1962, were both for the construction of hydro-electric power plants and transmission lines. At the time the last loan was negotiated, in June 1962, the Yugoslav authori- ties requested the Bank to consider lending for transport and provided infor- mation on their programs for road construction and railway improvement. The Bank agreed to examine these projects in more detail and a mission visited Yugoslavia early this year to appraise the road project. Negotiations for the loan were completed in Washington in May. A mission to appraise a railway project requiring assistance in the amount of $25 million has just returned from Yugoslavia and is now preparing its report. 3. The proposed loan would increase the amount of Bank loans to Yugoslavia to jl55.7 million, and the railway loan if made, would increase the total to 80i307 million. The status of the previous loans as at April 30, 1963 was as follows: Year No. Borrower Purpose Amount (equivalent in $ million) 1949 20 YU Federal Peoplels Republic Equipment for 2.7 of Yugoslavia timber production 1951 51 YU Federal People's Republic (Electric power, 28.0 of Yugoslavia (mining, transport, (industry, agricul- 1953 73 YU Federal Peoplels Republic (ture and forestry 30.0 of Yugoslavia 1961 277 YU Yugoslav Investment Bank Electric power 30.0 1962 318 YU Yugoslav Investment Bank Electric power 30.0 Total (including `40.0 million not yet disbursed): 120.7 of which has been repaid: 16.8 Total now outstanding: 103.9 Amount sold: 0.7 Net amount now held by Bank: 103.2 - 2 - PART II - DESCRIPTION OF PROPQUSED LOAN 4. The main chatacteristics of the loan would be as follows: Borrower: The Yugoslav Investment Bank. Guarantort Socialist Federal Republic of Yugoslavia. Amount: The equivalent in various currencies of r35 million. PurDose: To help finance the construction of parts of the Central Highway and the Adriatic Highway. Amortization: In 34 semi-annual installments, beginning December 1, 1966 and ending June 1, 1983. Each payment of principal and interest taken together would be approximately equal. Interest Rate: 5-1/2% including 1% cormission. Commitment Charge: 3/4 of 1%. PART III - THE PROJECT TleYu oslav Highwav Svstem 5. An appraisal report on the project is attached (No. 1). 6. Road transport in Yugoslavia is still in its early stages when com- pared to that in most other European countries. There are, for example, only 0.32 km. of highways per sq. km. and in 1961 there were only 12 vehi- cles per 1000 inhabitants. However, road transport is growing rapidly. The number of motor vehicles increased from 61,0CO to 280,000 between 1955 and 1962. Also during this period the inter-city passenger traffic travelling by road increased by 175% and the freight traffic doubled. This growth has required a corresponding increase in investment in road transport, which now accounts for about 10% of gross capital expenditure in Yugoslavia. Utilization of the Loan 7. One of the objectives of Yugoslavia's transport policy since the war has been to open the country to western European road traffic by improving the Central Highway from Italy and Austria to Greece via Belgrade, and the highway along the Adriatic coast. - 3 - The proposed loan would be used for this purpose. The project con- sists of the construction of 422 km. of the highway down the Adriatic coast and 174 km. of the Central Highway. After the project has been carried out the Adriatic Highway will be complete from Rijecka down to Bar and the Central Highway from Ljubelj on the Austrian border as far down as Skopje. At the northern end of the Central Highway a tunnel is being driven through the mountains to connect with the road system in Austria. 9. The cost of the project is estimated to be "?98 million equivalent of wV.ich i;68.2 million would be for the Adriatic Highway and Sp29.8 million for the Central Highway. The amount of the loan would thus correspond to just over one-third of the total cost of the project. Until contracts have been awarded under the procedure described in paragraph 13 below, it is not possible to determine what part of the loan would represent local expenditure. There is a well-organized contracting industry in Yugoslavia and much of the equip- ment used in road construction can be supplied by Yugoslav enterprises. It is estimated, howiever that between 'PlO-`2O million would represent the foreign exchange component of the loan. 10. The Central Highway is the backbone of Yugoslavia's highway network, connecting four of the countryts largest cities--Ljubljana, Zagreb, Belgrade, and Slopje--and passing through the most important areas of the country. The completion of this highway will effectively link Yugoslavia and Greece to Italy, Austria and other western European countries. It will facilitate exports and encourage tourist traffic. On the two sections included in the project, the benefit from reduced transport costs alone is calculated to produce returns on investment of 10 and 15% respectively. 11. The Adriatic Highway is the second most important highway in Yugoslavia. It is the only land transport link between the various parts of this region and also serves as a feeder to and distributor of railway traffic at Rijecka, Split and Ploce, where the railroad connects the coast with the rest of the country. It should be particularly important in expanding the tourist traffic to the well-known scenic areas of the Dalmatian coast. It is calculated that reduced costs of transport and maintenance will provide a return of about 11% on the investment. Execution of the Project 12. The Federal Secretariat for Transport would have the overall responsi- bility for the execution of the project. In accordance with Yugoslav practice the construction work will be the immediate responsibility of "investors" in the republics in which the roads are situated. These "investors" are either an association of road maintenance enterprises or the Secretariat of Transport of the republic concerned. They prepare plans and specifications and award contracts. Engineering work is generally awarded to specialized enterprises which act as consultants to the investors. -4- Competitive Bidding 13. No foreign contractors have yet worked in Yugoslavia. There are a number of Yugoslav construction enterprises which compete among themselves for work such as road building. Although their work appears to be generally satisfactory, it seems to be somewhat expensive when compared with similar work in other countries. For the proposed project, the Yugoslav Government has agreed to submit those road sections which might be of interest to foreign contractors to international competitive bidding. The contracts for these sections will amount to about $38 million equivalent. For those sections which are too small to be of interest to foreign contractors, bids will be requested from the domestic construction industry as in the past. The Borrower 14. The Yugoslav Investment Bank is the principal instrument of the Federal Government for providing investment funds for development and is the main chan- nel for foreign development loans. The proposed loan would be made to the Yugoslav Investment Bank which would pass on the proceeds as grants to the investors concerned with carrying out the project. PART IV - LEGAL INSTRUMENTS AND AUTHORITY 15. Attached are a draft Loan Agreement between the Bank and the Yugoslav Investment Bank (No. 2), a draft Guarantee Agreement between the Socialist Federal Republic of Yugoslavia and the Bank (No. 3) and the report of the Coimit4ee provided in Article III, section 4 (iii) of the Articles of Agreement (No. 4) The draft Loan and Guarantee Agreements are substantially similar to those of previous loans to the Yugoslav Investment Bank with certain adjustments appropriate to a road project. 16. Sections 4.01 to 4.03 contain provisions relating to the agreements to be entered into by the Yugoslav Investment Bank with each of the investors. The conclusion of these agreements is an additional condition of effectiveness of the Loan Agreement (Sections 8.01 and 8.02). PART V - ECONOMIC SITUATION 17. A report entitled "Current Economic Position and Prospects of Yugoslavia" is attached (No. 5). 18. It describes the evolution of the Yugoslav economic system since the break with the Cominform in 1948 and gives an account of recent economic developments. A previous economic report (see R 62-53 dated July 2, 1962) described in some detail the various economic reforms which were made in 1961 and the economic difficulties which were encountered during 1961 and early 1962. The present report describes the steps taken by the Government to ovei- come these difficulties and to speed up the rate of growth which had slackened off in 1961 and 1962. - 5 - 19. The deterioration in the balance of payments which occurred in 1961 was remedied in 1962 largely by a 20% rise in exports. Exchange reserves increased by $33 million to $75 million wrhich, although still low in relation to imports, is higher than has been reached before. The total external debt amounts to $797 million of which $488 million has been disbursed and its service corresponds to about 16% of total export and net invisible earnings. 20. Although Yugoslav exports face some uncertainty in the near future owing to the development of the European Common Market and possible changes in U. S. tariff policy, they can be expected, if past experience is any guide, to increase fairly steadily and thus provide the economy with additional earnings wsith wrhich to service higher levels of debt. Moreover, the Govern- ment has demonstrated its wzillingness and ability to take any corrective measures that may be required in order to maintain its capacity to service external debt. Yugoslavia can therefore be regarded as creditworthy for the proposed loan. MART VI - COMPLIANCE WITH ARTICLES OF AGREEMENT 21. I am satisfied that the proposed loan complies with the Articles of Agreement of the Bank. PART VII - RECOIMENDATIONS 22, I recommend that the Bank at this time lend to the Yugoslav Investment Ban1 an amount in various currencies equivalent to $35 million for a term of 20 years, on such terms as are specified in the form of the Loan and Guarantee Agreements attached, and that the Executive Directors adopt a resolution to that effect in the form attached (No. 6). Attachments WIashington, D. C. George D. Woods June 13, 1963 President