RESTRICTED FILE COPY Report No. P-592 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO BANCO DE LA REPUBLICA IN COLOMBIA FOR THE DEVELOPMENT FINANCE COMPANIES PROJECT May 2, 1968 INTERNATIONAL BANIK FOR RECOMSTRUCTION AND DEVELOR&EIT REPORT AND RECOI'iiENDATION OF THE PRESIDENT TO TIE EXECUTIVE DIRECTORS ON A PROPOSED LQAN TO BANCO DE IA REPUBLICA IN CW.OIBIA FOR TIE DEVEIOPDENiT FINANCE COMtPANIES PROJECT 1. I submit the following report and recommendation on a proposed loan in an amount in various currencies equivalent to US$12.5 million to Banco de la Republica, the proceeds of which are to be made available to five Colombian Private Development Finance Companies (Financieras). PART I - HISTORICAL 2* The five Financieras are the same companies that are participating in Loan 451 CO, which was made in INlay 1966. The two largest of the five, Corporacion Financiera Colombiana and Corporacion Financiera Nacional (established, respectively, in Bogota in 1959 and in Medellin in 2960) operate on a national basis. The three others, Corporacion Financiera de Caldas, Corporacion Financiera del Valle and Corporacion Financiera del Norte (established, respectively, in lanizales in 1961, in Cali in 1962 and in Barranquilla in 1964) put greater emphasis on tlhe regions in which they are located. IFC has invested in three of the companies as follows: A $2 million convertible loan to Nacional made in 1961 and later converted into common stock during 1961-63, a $2 million convertible loan to Colombiana made in 1961 and converted into common stock during 1961-62, and a $700,000 equity investment in Caldas made in 1964. 3. The private sector has long suffered from a shortage of medium- and long-term financing facilities. To help alleviate this situation the Bank actively supported the creation of a Private Investment Fund (PIF) within the Banco de la Republica, the Central Bank, which was conceived as a means to induce and facilitate a substantial flow of external credits for medium-and long-term financing of productive investments in industry and agriculture. PIF was established in 1963 and attracted financial support from the U.S., Holland, and Germany, as well as the Inter-American Develop- ment Bank. In may 1966, the Bank in turn participated in this effort by making a loan of $25 million (Loan 451 CO) to the Banco de la Republica, repayable over a period of twenty years, to be relent to the five Financieras and to be used by them to finance the direct foreign exchange costs of investment projects in the private sector. In less than 18 months the Loan had been almost fully committed. As of March 31, 1968, $24.9 million had been credited to the loan account for 72 projects and $12.2 million had been disbursed. - 2 - 4. Confronted with tile ra;-id uti_ization of loan 451 CO, 3anco de la Republica asked the Bank for a second loan to be made on a basis similar to the first. "Lissions to Colombia in November/December 1966 and July 1967 appraised the proposed loan, and negotiations were held in Washington from lSarch 18 through Mlarch 21, 1968. The Government was represented by Dr. Hernan Echavarria Olozaga (Colombian Ambassador in Washington), and Banco de la Republica by Dr. Eduardo Arias Robledo (General Ivlanager) and Dr. Jose Miguel Vargas (Director, Private Investment Fund). The Financieras were represented by Dr. Ignacio Copete (President, CF Colombiana), Dr. Carlos Restrepo (Vice President, CF Nacional), Dr. Guillermo Sanint (Vice President, CF Caldas), Dr. Benjamin Iviartinez Mioriones (President, CF Valle), and Dr. A'Lvaro Jaramillo Vengoechea (President, CF Norte). 5. The proposed loan, which would be the 30th made to Colombia, would increase the total amount of Bank loans to Colombia to $468 million (net of cancellations). IDA has made one credit of $19.5 million for highways to Colombia. The following is a summary statement of Bank loans and IDA credits to Colombia as of Pviarch 31, 1968: Loan or Amount (US$ million) Credit Undis- No. Year Borrower Purpose Bank IDA bursed Fully disbursed Total (less cancellations) 313.8 5 1961 Government Roads 19.5 1.1 345 1963 Acerias Paz del. Rio, S.A. Steel 30.0 8.5 369 1964 Empresas Publicas de IMedellin Power 45.0 29.1 h48 1966 Government Agriculture 16.7 13.2 451 1966 Banco de la Republica Industry 25.0 12.8 499 1967 Empresa Nacional de Tele- Communica- comunicaciones tions 16.0 15.6 502 1967 Instituto Colombiano de Reforma Agraria Irrigation 9.0 _ 9,0 Total (less cancellations) 455.5 19.5 89.3 of which has been repaid 97.2 Total now outstanding 358.3 Amount sold 16.7 of which has been repaid 13.6 3.1 Total now held by Bank and IDA 355.2 19.5 Total undisbursed 88.2 1.1 89.3 6. Twenty-three loans have been completely disbursed. On the remain- der, disbursements are proceeding normally. - 3 - 7, In the near future, I shall submit to the Executive Directors also a proposed loan of $18 million to the Empresa de Energia Electrica de Bogota and a proposed loan of $14 million to Empresa de Acueducto y Alcantarillado de Bogota. 80 In the next few months the following loans are expected to be presented to the Executive Directors for approval: A loan of about $8 mil- lion to the Government for Secondary Education, a loan of $16 million to the Government for Highways, a loan of $15 million for Railway Rehabilitation, and a loan of about $16 million for National Power Interconnection. 9. IFC has made 21 investments and underwriting commitments in 13 enterprises in Colombia totalling $14.7 million. PART II - DESCRIPTION OF THE PROPCSED LOAI 10. The main features of the proposed loan are as follows: Borrower: Banco de la Republica (Central Bank of Colombia). Guarantor: Republic of Colombia. Beneficiaries: The five Private Development Finance Companies which participated in Loan 451 CO (Corporacion Financiera Colombiana, Corporacion Financiera Nacional, Corporacion Financiera de Caldas, Corporacion Financiera del Norte, and Corporacion Financiera del Valle). Amount: The equivalent in various currencies of $12e5 mil- lion. Purpose: The financing of development in Colombia through credits and other investments for productive purposes to privately controlled enterprisea, for specific projects in accordance with the Estatutos of the Financieras. The Bank loan would cover the direct foreign exchange cost of projects. Amortization: In semi-annual installments, expected to begin on February 15, 1969 and end on February 15, 1985. Payments will be based on a composite amortization schedule made up of the schedules of the investment projects. Terms for individual investment projects will be up to 15 years and grace periods are not expected to exceed 3 years. 'nterest rate: Current Bank interest rate at time of crediting of each investment project. Commitment charge: Standard charge. Relending terms: Current Bank interest rate plus not more than one percent to the Borrower for administrative costs, plus no less than 3 percent to the Financieras; in addition, 8 percent to the Borrower, to cover the exchange risk in those cases in which the ultimate beneficiary does not wish to bear this risk. PART III - THE PROJECT 11. An appraisal report entitled "Appraisal of Five Finance Companies in Colombia" (DB-40a)on the project is attached. 12e Industry represents one of the dynamic sectors of the Colombian economy. Manufacturing, which is the second largest sector of the economy after agriculture, accounted for nearly 20 percent of the gross domestic product in 1966 compared to 14.8 percent in 1950. Within the manufacturing sector the two traditional branches, namel r, food processing and beverages, and textiles and clothing, are dorinant. They contribute almost half of the value added by the sector and employ about 48 percent of the industrial labor force. Colombia has, however, made considerable efforts in diversify- ing its industrial production, and consequently other branches such as chemicals and non-metallic minerals have also become significant. 130 The present policies affecting industry were dictated mainly by the need to deal with the chronic balance of payments difficulties of the last decade, which were caused in large part by the steady erosion of world coffee prices. They include quantitative import restrictions and price controls. Despite these policies, industrial output grew by an average of 6 percent per year in real terms between 1957 and 19660 140 However, the need to subordinate economic policy to balance of payments considerations has affected the quality of economic development and the prospects for future growth, The Government is now embarked on a major review of industrial development policy, including a basic revision of the tariff structure, the selective exemption of key commodities from price control, and the reform of income tax legislation. This review is expected to result in policy changes which will help undo the distortions and rigidities that have developed in the industrial sector over the last decade. The Bank is assisting this review. i5. The Financieras have played a major role in the development of the industrial sector in Colombia by providing medium- and long-term. financing as well as equity financing. They have also been active in promotion of new enterprises and in underwriting, On December 31, 1967, the aggregate value of their portfolios amounted to Col$1.8 billion; their equity portfolios increased from a mere Col$13 million at the end of 1961 to Col$318.3 million at the end of 1967. 16. The principal resources of the Colombian Financieras have been their owm equity, credit lines with Banco de la Republica and foreign com- mercial banks, the Private Investment Fund (PIF) and the $25 million Bank loan granted in May 1966. As of December 31, 1967, the Banco de la Republicats credit lines were fully utilized, the Bank loan almost fully committed and total unutilized funds available in PIF for the Financieras and commercial banks amounted to only Col$66 million in counterpart funds and US$3 million in foreign exchange funds. Therefore, the Financieras find their operations limited by a shortage of long-term funds. Efforts to obtain additional lines of credit to replenish PIF have met with an encouraging response among Consultative Group member countries, but without firm results to date, On the basis of reasonable estimates the foreign exchange component of the business of the Financieras forecast for the next two years or so, amounts to perhaps $35 million. The Financieras should therefore have no difficulty in utilizing, for foreign currency expenditures, the full amount of the proposed $12.5 million Bank loan within a one to one- and-a-half year period. 17. The performance of the Financieras has been generally satisfactory, although there have, of course, been variations among the companies with respect to personnel, portfolio and profit. Their staffs are by and large well trained and are gaining experience; and appraisal techniques, reflected in projects submitted for financing under the first Bank loan, have shown steady improvement. The principal strength of all the Financieras in this regard has been the quality and experience of their Boards of Directors and Presidents. Their portfolios are in general of satisfactory quality, despite recent difficulties in the Colombian economy, which have resulted in putting some clients in trouble. Loans are well secured by collateral and arrears are now low. In some of the companies, the portfolios of in- vestments in share capital are not as strong as they should be, in large part because, as a result of the companiest promotional activities, much of their equity investment is in new, still unproven or troubled enterprises. Finally, the companies are playing an increasingly important role in the financing of industry in Colombia, and particularly in the promotion of new enterprises. All things considered, and despite adverse factors, the companies are basically creditworthy, with strong equity positions and earning power. The business prospects of the Financieras appear good, due both to the continuing improvement in the business climate and to their own developing experience. They are suitable recipients of the proposed Bank loan, and should be in a position to service the new loan without difficulty. 18. The total amount of the loan will be allocated among the Financie- ras as agreed during negotiations by the Bank and Banco de la Republica in the following manner: Colombiana and Nacional 30 percent each, Caldas, Valle and Norte 13-1/3 percent each. The limit for projects not needing - 6 - the Bankls prior approval was agreed as follows: US$250,000 each for Colombiana and Nacional, to an aggregate total of US$1.5 million each; US$100,000 for each of the other Financieras, to an aggregate total of US$750,000 each. 19. In order for the Financieras to be able to build up a portfolio of securities which could later be sold to the public and to provide a possibility for increasing its returns beyond the mrinimum 3 percent they have agreed with the Government to charge the ultimate borrower, the Financieras have agreed to add equity features to loans to their clients whenever possible. PART IV - LEGAL INSTRUMENTS AND AUTHORITY 20. The Draft Loan Agreement between the Bank and the Banco de la Republica, the Draft Guarantee Agreement between the Republic of Colombia and the Bank, the Draft form of Project Agreement between the Bank and each Financiera, the Draft form of Subsidiary Loan Agreement between the Banco de la Republica and each Financiera and the Report of the Committee provided for in Article III, Section 4(iii) of the Articles of Agreement are being distributed to the Executive Directors separately. 21. These Draft Agreements contain covenants normally included in agreements writh development finance companies. Attention is drawn to the following provisions: i, pursuant to Section 2.11 of tlhe Loan Agreement, Banco de la Republica will submit applications for crediting the Loan Account only if it is satisfied that the respective investment project is of significance to the economic development of Colombia; ~i, the Loan Agreement provides that if a Financiera is in default under its Project Agreement with the Bank, the Bank has the right to premature that part of the Loan which has been relent to the defaulting Financiera and is outstanding (Section 6.01); iii. the Loan Agreement can be made effective at the option of the Ban;; even if one or more of the Financieras shall not have complied with the conditions established for effectiveness (Section 7,01); the Subsidiary Loan Agreements and the Project Agreements will become effective on the effective date of the Loan Agreement, but only for those Financieras that have complied with the conditions of effectiveness on their part (Section 5.01 of the Subsidiary Loan Agreements and Section 3.01 of the Project Agreements) - 7 - PART V - THIE ECONONY 22. Colombia's population of nearly 20 million, ranking third in size in Iatin America is growing at over 3 percent on average and at 4 to 10 per- cent in the principal cities. Agricultural land is the country's principal resource, and agriculture is still the largest sector of the economy, accounting for 30 percent of gross domestic product. The industrial sector, based on the large and expanding urban population, has been growing twice as fast as agriculture and today accounts for nearly 20 percent of GDP. Income of $250 per head is relatively low by Latin American standards. GDP has been growing at annual rates ranging between 3 and 6 percent and averaging 4.4 per- cent since 1950. 23. For the past decade Colombia has been governed by the National Front, a coalition of the two major political parties, with the presidency alternating between the parties every four years. The system, designed primarily to heal serious political divisions within Colombia, has succeeded in this objective, but until recently at the price of checks and balances tending to inhibit desirable legislative and andministrative action. However, these defects have been progressively overcome to make the Government more capable of carrying out the urgent tasks of economic development. The present administration, which assumed office in 1966, has shown itself to be particu- larly strong and serious in the pursuit of development objectives and in the maintenance of sound financial and sectoral policies. Price increases have been sharply reduced; in 1967 prices increased by 7 percent or less than half the rate of increase of earlier years. Public savings in real terms increased by 60 percent in 1966, 25 percent in 1967 and are expected to rise by another 25 percent in the current year. There have been notable improve- ments in a wide range of sector policies, including the introduction of officially financed population control programs for the first time in Colombia's history. 24. Colombia's recent economic experience and prospects have been analyzed fully in the last two IBRD reports: "Current Economic Position and Prospects of Colombia" (WH-172a) dated May 23, 1967, and "Economic Developments in Colombia during 1967" (WH-177) dated February 14, 1968. The major conclusion of these reports is that the economic performance in all major respects has improved markedly in the last few years but that inadequate exchange earnings still remain the principal constraint upon economic growth. Coffee is still the major export (60 percent of commodity exports) but its price has halved since 1954. While exports other than coffee and petroleum have grown from US$40 million in 1954 to US$120 million in 1967, this increase was insufficient to compensate for the fall in coffee prices. For this reason, policies that will stimulate exports remain the critical element of Colombia's economic performance. A year ago, along with other measures, the Government introduced a flexible exchange rate system. In the past 12 months the Government has effected a real deprecia- tion of the rate, and recognizing the importance of an appropriate exchange rate in the management of the balance of payments, has indicated its - 8 - intention to continue a flexible exchange rate policy in the future. With such policies, Colombia can undertake the substantial external borrowing now being planned within the context of the Consultative Grcup in support of an accelerated development effort, without increasing materially the present debt service ratio of about 16 percent. PART VJ - COMPITANCE WITH ARE CLES OF AGREEMMIT 25. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VII - RECOMENDATION 26. I recommend that the Executive Directors adopt the following resolution: RESOIUTION NO. Approval of Loan to the Banco de la Republica (Development Finance Companies Project) in the amount of the equivalen' of US$12,500,000 to be guaranteed by the Republic of Colombia. RESOLVED: THAT the Bank shall grant a loan to the Banco de la Republica, to be guaranteed by the Republic of Colombia, in an amount in various currencies equi-valent to twelve million five hundred thousand United States dollars (US$12,500,000), to mature on and prior to February 15, 1985, to bear interest at the rate in effect on the date each investment project is credited, and to be upon such other terms and conditions as shall be sub- stantially in accordance with the terms and conditions set forth in the form of Loan Agreement (Development Finance Companies Project) between the Bank and Banco de la Republica, the form of Guarantee Agreement (Development Finance Companies Project) between tlle Republic of Colombia and the Bank, the form of Subsidiary Loan Agreements (Development Finance Companies Project) between the Banco de la Republica and Corporacion Financiera de Caldas, Corporacion Financiera Colombiana, Corporacion Financiera Nacional, Corporacion Financiera del Norte and Corporacion Financiera del Valle, and the form of Project Agreements (Development Finance Companies Project) between the Bank and Corporacion Financiera de Caldas, Corporacion Finan- ciera Colombiana, Corporacion Financiera Nacional, Corporacion Financiera del Norte and Corporacion Financiera del Valle, which have been presented to this meeting. Robert S. McNamara President Attachments Washington, D.C. May 2, 1968