R E S T R I C T E-D FILL COPYReport 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 SUEZ CANAL AUTHORITY Decemnber 8, 1959 Ii\ITERPIATIO\TAL BANK FOR 0 - 1OSTRUCTION AND DE'FLOPHiENT REPORT AND RECOITIE-NDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS CONCERNING A PROPOSED LOAN TO THE SUEZ CANAL AUTHORITY 1. I submit herewith the following report and recommendations on a proposed loan in various currencies equivalent to $56.5 million to the Suez Canal Authority for the development of the Suez Canal. PART I - FESTORICAL 2. Egypt wuas an original memrber of thne Bank and Syria joined in 1947. After the two countries united on February 22, 1958 the Egyptian and Syrian memberships were merged into that of the United Arab Republic. 3, The Bank has had extensive discussions at-various times regard- ing the financing of -orojects- in both Egypt and-Syria, but no loan has been made. 4. In 1958 the Government of the United Arab Republic asked the Bank to study the plans prepared by the Suez Canal Authority for irmroving the Canal to meet frture needs. In January 1959 the Government formal2y asked the Bank to c-rcsidcr a loan for this purpose. 5. An economic mission visited the U.A.R. during April and May, 1959 and was followed in July 1959 by a technical mission to appraise the Suez Canal project. Subsequently discussions took place in Cairo and in lWashington on various aspects of the proposed loan and negotiations were completed early in December 1959. - 2 - PART II - DESCRIPTION OF THE PROPOSED LOAN 6. The main features of the loan are: Borrower: The Suez Canal Authority Guarantor: The United Arab Republic Amount: Equivalent of $56.5 million in various currencies. Purpose: The proceeds of the Loan would be used to meet the foreign exchange costs of widening and deepening various sections of the Canal, improving port facilities at Port Said, providing buildings and other facilities, and ourchasing cons- truction, operating and rnaintenance equipment for the Authority. Amortization: 26 semi-annual instalments beginning March 15, 1962 and ending September 15, 1974. Interest Rate: 6% per annum, including 1% commission. Commitment Charge: 3/4 of 1% per annum. Special Payment Arrangements will be made for payment Arrangements: of debt service from the Borrower's current revenues as described in paragraph 8 below. PART III LEGAL INSTRUoENTS Ai'JD LEGAL AUTHORITY 7. Attached are draftsof a Loan Agreement (No. 1) and of a Guarantee Agreement (No. 2), and the report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement (N1o, 3) in respect of the proposed loan. 8. The draft Loan and Guarantee Agreements follow the forms gener- ally used by the Bank with the following additions: (a) Section 5.07 (a) and (b) of the Loan Agreement provide for the payment into a reserve, from the Borrower's local currency receipts during each semi-annual period, of amounts sufficient to pay debt service on the Loan during such period, - 3 - pursuant to arrangements satisfactory to the Bank, and for the making of arrangexents, also satisfactory to the Bank, for the conversion af local currency into the currencies reqruired for such debt service paynents., The malcing of these arrangements rould be a condition of effectiveness of the Loan Agreement under Sect..cns 7.0l and 7.02 of the draXt Loan Agreement. Drafts o-f letters which w-ould effect the above arrangements are attached (Numbers 4, 5 and 6)n (b) Paragraph (b) of Schedule 3 to the Loan Agreement makes it an event of default if the amounts subject to the abo-e arrangements become insufficient for the payment of debt service. (c) The above arrangements would not in any way diminish the general obligations of the Borrower to pay debt service on the Loan (see Section 2.08 of the Loan Agreement). (d) Paragraph (b) of Schedule 3 also makes an event of default the disapproval by the National Assembly of the Guarantor, pursuant to the Provisional Constitution, of either (i) the amendment of the Public Organizations Law specifically authorizing, inter alia, borrowing from inter- national organizations, or7(ii) the decision of the President of the Guarantor granting legislative approval to the Guarantee Agreement. The Provisional Constitution provides for such action by the President in the absence of the National Assembly, subject to its disapproval by a twio-thirds vote when it next meets, but provides that such disapproval shall not have retroactive effect, The Bank has received satisfactory assurances that in the event of such disapproval both the Borrower and the Guarantor would remain fully bound by the Loan and Grarantee Agreements with respect to amounts there- tofore dis. irsed. PART IV - APPRAISAL OF THE PROPOSED LOAN 9. A detailed appraisal of the Suez Canal development project (TO.232a, dated December 8, 1959) is attached (No. 7,). Justification of the Project 10. The Suez Canal was completed in 1869 by a private company, Compagnie Universelle du Canal Maritime de Suez, which operated it until 1956 when the Egyptian Government took over the Canal and set up a public body, the Suez Canal Authority, to manage, operate and maintain the Canal. In 1957 the Authority was constituted as a public organization under the Public Organizations Law, with its Board of Directors and principal officers appointed oy the President of the Republic. The Authority collects Canal tolls and charges fo:: other services it renders. The management of the Authority has demonstrated its ability to conduct its operations efficiently. 11. The Canal provides a permanent passage for ocean-going vessels between the Red Sea and the Aediterranean, shortening the sea voyage between Asia and Wlestern Europe by about 5,000 miles. Throughout the ninety years of its existence the traffic has increased steadily. During the period 1910-58 the number of shins nassing thrlugh in a year increased almost fourfold to about 18,000 and the cargo tonnage sixfold to nearly lhO million tons. WJith the expansion of iliddle East oil production, particu- larly since the war, the volume of tanker traffic has become increasingly important and now comprises about 70',t of total tonnage. 12. Originally built to accommodate shins of 21.6 feet draft, the Canal has been progressively widened, deepened and otherwise inTroved as the size and number of vessels passing through ithave increased, until today ships having a maximum draft of 35 feet can pass. In 1958 more than one third of all ocean-going vessels and three fifths of all tankers exceed- ing 4,000 gross tons made at least one trip through the Canal. 13. The discovery of new oil fields outside the i4iddle East -ad notably in the Sahara may modify the trendd-of traffic somewihat in the coming years. ,Dry cargo tonniage should continue to increase as it has done in the rast but the growth of petroleum sahipnents may well be slowTed. But as history has shown, the need to enlarge the Canal stems not only from rising traffic but also from the increase in the average size of ships seeking transitG Should the present draft limit of the Canal remain at 35 feet many of the tankers now coming-into serw ze could not use it, or could pass only partially loaded, In these circumstances the Authority would not be able to offer adequate service and its financial position would be adversely affected. Il. To cope iath prospective traffic developments, a series of im- provements known as the "Eighth Program" were in progress or planned at the time of nationalization. The Authority has continued work on this program, has modified it in certain respects, and has drawn up an additional "Nasser Program" for further development to follow the Eighth Program. 15. The project presented to the Bank for financing involves complet- ing the modified Eighth Program and carrying out parts of the Nasser Program. It is scheduled to be com-lpleted by the end of 1961 and consists of widen- ing and deepening various sections of the Canal by dredging and other civil works so as to permit the passage of vessels having a maximum draft of 37 feet, providing various buildings and other facilities in the Canal such as berths for the Authority tugs and other vessels, iniroroving port facilities at Port Said so as to reduce congestion and increase capacity, and purchas- ing construction, operation and maintenance equipment to replace obsolescent - 5 - equipment and to meet future needs. These improvements are soundly conceived and are urgently required not only to provide for increased traffic but to enable the Canal to keep abreast of ship design and so retain much of the Persian Gulf oil traffic which now uses it. The remainder of the Nasser Program is not scheduled to be put in hand until 1962. The Authority does not intend to undertake these works unless expectations as to future traffic increases justify them. 16. The Suez Ca,.al, which is an important foreign exchange earner for the United Arab Republic, has regularly been operated at a profit and the financial position of the Authority is sound. On very conservative assump- tions its earnings should be amply sufficient to carry out the project and service thne proposed loan. 17. On April 214, 1957 the Government of Egypt made, and deposited with the Secretariat of the United Nations, a declaration on the Suez Canal which stated in Paragraph 5 (c) that the Suez Canal Authority would establish a special Suez Canal Capital and Development Fund into which would be paid 25/O of all gross receipts. The objective of setting up this Fund was to assure that adequate resources would be available to the Authority to meet its needs of development and capital expenditure. Since the proposed Bank loan for the Suez Canal Development Project would allo provide funds for this purpose, the Government of the' U.A,R. will, after the proposed Loan is appioved by the Executive Directors, but before it has been signed, deposit with the Secretariat of the United Nations a supplementary declaration in the form attached temporarily suspending the operation of Paragraph 5 (c) of the Declaration of April 24, 1957. (No. 8) Procurement 18. The purchase of goods and services required for the project will be generally on the basis of international competitive bidding. Econonmc Situation 19. A report on the present economic position and prospects of the United Arab Republic ~ras circulated to the Executive Directors on December 4, 1959 (R 59-95). It discusses the Syrian and Egyptian regions of the United Arab Republic separately because the economic integration of the two regions undertaken recently has not yet been completed. 20. The Egyptian Regionts basic long-term problems stem from the pressure of population on limited resources. Construction of the High AsTwTan Dam is just starting - with Soviet aid - and its completion should ulti- mately add over one third to Egypt' s cropped area and generally improve irrigation conditions in the Nile delta; there are some other possibilities of expanding agricultural output and employment but these are limited. And although the Government is seeking vigorously to open up new employment opportunities in industry, it will be difficult to keep pace with the grow- ing population. 21. W^[ithin this framework, however, the ELyptian authorities have managed their economic and financial affairs quite effectively, at the same time intensifying their efforts toward economic development. in recent years the economqy has adjusted without too rmch strain to the adverse effects both of the Suez crisis and, subsequently, of the steep drop in wTorld mrices for long staple cotton. 22,. The impact of these developments wjas absorbed partially by the gold and foreign exchange reserves which fell from lvE 237 million to LE 137 million or about seven months imDorts between the end of 1955 and the middle of 1959. In addition, the net balance against Egypt on payments agreement accourts rose by ŁE 26 raillion, and ŁE 23eh million w-as pledged to meet the payment due in 1960 under the terms of the financial agreement reached with the United Kingdom in 1959. To ease the strain on the reserves, the Goverrmlent introduced various changes in the exchange system (imports now pay a premium of 27.5%). As a result of a rapprochement between Egypt and the Soviet bloc a substantial portion of the country's foreign trade shifted towqard tnat area. Internally, fiscal policies were readjusted so as to avoid serious inflation. The substantial treasury cash deficit of 1956-57 was changed to a sturplus in the next fiscal year; a deficit occurred in the first half of 1959, but was largely due to temporary financing of government cotton stocks which are slowly be-i liquidated. Because of surplus production of long staple cotton, the Government has reduced the area clanted with long staple varieties by 17% this year. 23. Egypt's medium term balance of payments prospects are reasonably favorable. The next 8 years or so may witness an increase of something like 25% in total foreign exchange earnings, provided that internal monetary stability is maintained. Since there will almost inevitably be continued pressure to increase development expenditures, this will need careful manage- ment, in particular now that foreign exchange reserves have diminished considerably. On the other side, the resumption of substantial American aid to the Egyptian region - including, over hlhe past year, transfers of surplus agricultural commodities to the value of $106 million and two Export-Import Bank loans totalling .'4l7 million - is a favorable factor as are the recent new oil strikes, especially in the Sinai peninsula, which give ground for hope that Egypt may soon become self-sufficient in petroleum. 24. The possibilities for economic growth in the Syrian Region are quite favorable particularly in agriculture, and consequently its position is inherently less difficult than that of the Egyptian Region. However, Syria has serious immediate economic and financial nroblems. Inflation resulting from several years of deficit financing by the Government, combined with a poor grain crop, led to a substantial loss of foreign exchange reserves in 1958. Since the economic report was written the situation does not appear to have improved. Deficient rainfall last winter brought another sub-normal cereals crop in 1959, while the indications are that in the first seven months of the year the treasury deficit was larger than in the same period of 1958. At the same time, U.S. aid to Syria has only just started and is still on a small scale. Foreig-C exchange reserves do not show rmuch change in the first half of 1959. - 7 - 25. Given the Region's favorable development prospects, Syria should be able to manage its balance of payments problems wzhen agricultural produc- tion returns to normal. Very much will depend, however, on careful management of internal and external resources. Prosoects of Fulfillment of Obligations 26. The disbursed and outstanding external debt of the United Arab Republic - exclusive of debt for military purposes - amounts to about $224 million equivalent upon which the service reaches a peak of 1i)h3 million in 1960 and falls to $27 million by 1963. In addition, the Republic has unutilized external credits amounting to $5h7 million equivalent. If these lines of credit were fully used by their respective closing dates, service payments on the Republic's non-military debt would reach a peak of about $90 million in 1963, about 10% of current foreign exchange earnings of the Republic, and would fall off rapidly after 1967. Of these amounts more than half is payable in kind and not in convertible currencies. There is in addition a financial obligation resulting from the new Nile Waters agreement, which calls for payments from the Republic to the Sudan of ME 15 million ($h3 million) between 1960 and 1963, which would raise the Republic's total service payments to a peak of about $103 million equivalent in 1963, or about 12% of total current foreign ex- change receipts. If, as seems possible, some of the credits, particularly those from Soviet-bloc countries, should be drawn down more slowly than originally contemplated or allowed to lapse, peak service payments would, of course, be lower. 27. The United Arab Republic's total service payments on external debt - including 'debt for militaiy purposes the amount and terms of which have been communicated to me in confidence _ will in any case be heavy in the early 196CYs and the authorities should take great care in assuming additional debt which would substantially increase the service burden during these critical years. However, I am satisfied that taking account of the country's balance of payments orospects, and also of the special arrangements to pay debt service on the Droposed loan, a loan in the amount under consideration for the develc!a-ent of the Suez Canal . peak service on which would be about i7 Taillion per year - uould be within the Reoublic' s capacity to pay. - 8 - PART V - COM4PLIA\ITCE IITH THE ARTICLES OF AGREEMENT 28. I am satisfied that the proposed loan complies with the Articles of Agreement of the Bank. PART VI - RECOavETHDATIONS 29. I recommend that the Bank make a loan to the Suez Canal Authority guaranteed by the United Arab Republic, of the equivalent in various curren- cies of ',j;6.5 million for a total term of 15 years, with interest (including commission) at 6% per annum and on such other terms as are specified in the attached draft Loan and Guarantee Agreements, and that the Executive Directors adopt a resolution to that effect in the form attached (No. 9). Eugene R. Black Attachments Washington, D.C. December 8, 1959