Document of The World Bank FOR OFFICIAL USE ONLY Report No. 4637-PAK STAFF APPRAISAL REPORT PAKISTAN INDUSTRIAL INVESTMENT CREDIT PROJECT December 30, 1983 Industrial Development & Finance Division South Asia Projects Department 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. C_RRENCY EOUIVALENTS Currency Unit = Pakistan Rupees (Rs) US$1 = Rs 12.7 Rs I = US,$ 0.0787 ABBREVIATIONS USED AML Allied Bank Limited ADB Asian Development Bank ADBP Agricultural Development Bank of Pakistan BEL Banker's Equity Limited TFIs Development Finance Institutions DSCR Debt Service Coverage Ratio EPF Equity PartiLcipation Fund FBC Federal Bank for Cooperatives GOP Government of Pakistsn HBL Habib Bank Limited ICP Investment Corporation of Pakistan IDBP Industrial Development Bank of Pak:istan IIC Industrial lnvestment Credit MCB Muslim COommercial Rank NBP National. Bank of Pakistan NCBs National. Conmmercial Banks NDFC National. Development Finance Corporation NIT National Investment Trust PBC Pakistan Bainking Council PICIC Pakistan Indlustrial Credit and Investment Corporation PFIs Participating Financial Institutions PPCB Punjab Provincial CooDerative Bank PSEs Public Sector Enterprises SALs Structural Adjustment Loans SBFC Small Business Finance Corporation SBP State Bank of Pakistan SFYP Sixth Fi,ve Year Plan - FY83-FYV7 TJRL United PBank Limited FOR OFFICIAI, USE ONLY PAKISTAN STAFF APPRAISAL REPORT INDUSTRIAL INVESTMENT CREDIT (IIC) PROJECT TABLE OF CONTENTS Page No. PROJECT SUMMARY ............................................ iii-iv I. INTRODUCTION ........... , . ..... 1 II. THE INDUSTRIAL SECTOR . ...................... . . . . . 2 A. Economic Setting ......................... ... ..... 2 B. Industrial Structure and Performance 3......... .......... 3 C. Industrial Strategy and the Sixth Five-Year Plan ........ 3 D. Prospects *.............................o...o... 5 III. THE FINANCIAL SECTOR .................... .. . ...... ........ 6 A. Background ... .. - ......... . . . 6 B. Structure of the Financial System ....................... 6 C. Industrial Finance ............... o ....................... 9 D. Policy Framework .......... ............................. 11 IV. THE PROJECT ........................... . . 13 A. Lending Strategy ......................................... 13 B. Project Objectives ........................... ......... 15 C. Strengthening Credit Delivery for Industry ......... ....... 15 D. Technical Assistance ............... .. . ....... 16 E. Project Cost, Components and Financing Plan ............O.. 17 V. PARTICIPATING FINANCIAL INSTITUTIONS (PFIs) ................. 17 A. Participating NCBs .......... ..... 17 B. Participating DFIs .......... .......... .................... 18 C. Summary Eligibility Criteria ............................. 23 VI. THE PROPOSED LOAN AND CREDIT .............................. O. 24 A. Amount and Allocation of Funds ........................... 24 B. Financial Package . .. * .. . ............... 25 C. Administration . . ..................................... . 26 VII. PROJECT BENEFITS AND RISKS ... .................... .... .. . 27 VIII. RECOMMENDATIONS ...................... . .......... 28 This report was prepared by Messrs. Dalla, Bannon, Groves, Pernia, Vivado, and Van Bakel (consultant) following an appraisal mission to Pakistan in March 1983. Mr. H. Qureshi from the Resident Mission participated in the appraisal mission. The report was finalized after the visit of a post- appraisal mission consisting of Messrs. Dalla and Groves in August 1983. 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. ANNEXES 1. The Commercial Banking System 2. Islamization of Pakistan's Financial System 3. Nationalized Commercial Banks 4. The Industrial Development Bank of Pakistan (IDBP) 5. National Development Finance Corporation (NDFC) 6. The Pakistan Industrial Credit and Investment Corporation (PICIC) 7. Pipeline of Projects 8. Estimated Commitments and Disbursements Schedule 9. Selected Documents and Data Available in Project File -iii- PAKISTAN INDUSTRIAL INVESTMENT CREDIT (IIC) PROJECT PROJECT SUMMARY Borrower: Islamic Republic of Pakistan Amount: US$100 million (Loan of US$50 million and Credit of SDR 47.3 million) US$98.0 million for financing subloans; and US$2.0 million for technical assistance. Project The proposed project aims at: (a) financing industrial Description: projects in high-priority sectors through the financial system; (b) improving the credit delivery system of industrial finance; (c) strengthening the term lending capability of the Participating Financing Institutions (PFIs), especially commercial banks; and (d) continuing the institution building programs for the development finance institutions (DFIs). Implementing Three development finance institutions -- Industrial Agencies: Development Bank of Pakistan (IDBP), National Development Finance Corporation (NDFC) and Pakistan Industrial Credit and Investment Corporation (PICIC) and two commercial banks (Habib Bank Limited (HBL) and United Bank Limited (UBL)) under the supervision of the Pakistan Banking Council (PBC). Beneficiaries: All productive activities in the private industrial sector and related services will be eligible for financing under the Project. The Bank/IDA funds will be used to finance both fixed assets and permanent working capital. Up to US$10 million is allocated for financing balancing, modernization and rehabilitation of public sector projects through NDFC. Use of Loans and One hundred percent of foreign exchange cost of direct Credit Proceeds: imports of goods and services and up to 60% of local expenditures for the cost of locally procured goods (corresponding to the estimated foreign exchange content of these goods). Local currency financing will be made available by participating financial institutions or the sponsors. - iv- Onlending Terms: (a) World Eank/IDA to Government of Pakistan (GOP): Standard; (b) GOP to PICIC and IDBP; interest rate of 10% p.a. for 15 years including a grace period of 3 years; (c) GOP to NDFC and NCBs; interest: rat:e of 11% p.a. up to 15 years including a grace period of 3 years; and (d) PFIs to Borrowers: 14% p.a. Foreign Exchange and Interest Rate Risks: GOP Subloan Limits: Maximum per project: US$4.0 million Minimum per project: US$1.0 million (Exceptions would be considered on a case-by-case basis.) Technical Up to US$2.0 million for training of FPFIs' officers in Assistance: project evaluation, preparation of project appraisal manuals, and other related activities, organization and system studies, and sectoral studies. PAKISTAN INDUSTRIAL INVESTMENT CREDIT (IIC) PROJECT STAFF APPRAISAL REPORT I. INTRODUCTION 1.01 Since 1977, GOP has given greater emphasis to the role of the private sector. This change is reflected in GOP's decisions to: divest a number of industrial units nationalized in 1972; open restricted industries to private investment; limit further investment in public sector manufacturing enterprises to balancing, modernizing or rehabilitation, and increase domestic resources for investment in private industry. These actions have been complemented by liberalization measures including revision of investment sanctioning requirements, enhanced investment and export incentives, and removal of a number of controls which had constrained industrial development. As a result there has been a significant increase in the level of private investment and in the performance of private sector units. However, wlhile GOP's actions have helped improve private sector performance, there are a number of policy and procedural areas where further action is necessary if GOP's own plans for a greater contribution by the private sector to the economy are to be achieved (Chapter II). 1.02 The Project. The proposed project addresses a number of the issues affecting industrial financing, and seeks to improve the efficiency with which funds for industrial investment are delivered by focussing on both the system and individual institutions. The project's scope would extend beyond the Bank Group's traditional contacts--the development banks--for industrial term lending by including two major commercial banks as participating financial institutions. The Project would incorporate a program to strengthen the appraisal and supervision capabilities of these institutions and to continue the action programs initiated under earlier Bank Group assisted projects for two development financing institutions (DFIs)--the Industrial Development Bank of Pakistan (IDBP) and the Pakistan Industrial Credit and Investment Corporation (PICIC). The Project would build on the work of the Bank Group's FY82 Financial Sector Mlission which identified the need to address, inter alia, overlapping operations of the DFIs and weaknesses in the term lending operations of the commercial banking system. This report outlines a US$250 million project with foreign exchange requirements of US$100 million, of which it is proposed that US$50 million be provided by IBRD and US$50 million (SDR 47.3 million) by IDA. The Project has two components: US$98 million to meet part of the foreign exchange credit requirements of industry; and US$2 million in a technical assistance component to help meet the desired policy and institutional objectives. The proposed Project forms an integral part of the Bank Group's lending program of possible future SALs, sector credits and project loans aimed at greater private sector involvement in industry, improved efficiency of the public sector enterprises and expanded export orientation of Pakistan's industry. 1.03 Other Bank Group Operations. Over the past few years, the Bank Group has had a substantial involvement with GOP on industrial development through policy dialogue and lending operations. Under the Structural Adjustment -2- Program (Ln. 2166-PAY and Cr. 3255-PAK), priority has been given to the reform of the incentive structure and improve-ments in the efficiency of the public manufacturing sector. Improvements in the provision of infrastructure necessary for industrial develcpment are being supported through ongoing and proposed projects in the energy, water, telecommunications and transportation sectors, while some initial improvements in the credit delivery system for industrial finance are being pursued through the proposed Project. During FY82, Bank Group staff completed a review of the financial system and, at the request of GOP, undertook a number of industrial subsector studies to provide input for the Sixth Five-Year Plan, FY83-FY87 (SFYP) and COP's FY84 budget. In the immediate future, policies for the promotion of manufacture exports will be reviewed. 1.04 To complement the ongoing policy dialogue, the BarLk Group has made 14 loans and credits totalling US$354 million for project investment in the private industrial (manufacturing) sector. Eleven loans and credits totalling US$274 million have been made to PICIC for onlending to medium- and large-scale private sector projects. Three loans and crecits totalling US$80 million have been made to IDBP to provide term loans directly and through commercial banks to a large number of small scale industrial projects. In addition, a line of credit of US$30 mil:Lion has been channeled through the National Development Finance Corporation (NDFC) for large-scale projects in the public manufact:uring sector. Under each of these operations, technical assistance has been provided to strengthen institutional capacity and project promotion activities. II. THE INDUSTRIAL SECTOR A. Economic Setting 2.01 In 1977, GOP embarked on a program of reforms to achieve financia:L stability and the revival of economic growth and private sector confidence. Despite generally adverse external circumstances, considerable progress has been made toward meeting these obiectives. GOP has restored financial discipline and, through improved fiscal performance, has reduced considerably reliance of the banking system on borrowing from the State Bank of Pakistan (SBP), the central bank. Improved financial management has been combined with a wide range of price adjustments aimed at correcting economic distortions, and a program of lDnger-term reforms in key productive sectors. As a result of these actions, GDP has grown at an average rate of over 6% p.a., accompanied by a gradual reduction in domestic inflation, a higher degree of private sector confidence and, since FY80, a manageable balance of payments situation. Improved eronomic performance has been broad-based wi.th high growth in industry, agriculture, energy and exports. 2.02 The major constraints facing Pakistan's economy relate to its balance of payments prospects and the need to increase domestic private and public savings. Bank projections indicate that beyond FY85, Pakistan will require considerable improvements in export and import substitution performance if- GDP growth of 6% is to be maintained. The same applies to resource mobilization where severe restraints on current and capital expenditures, required over the past years to meet the GOP's objective of fiscal discip:Line are now causing considerable difficulties in thie face of expansionary -3- pressure for higher GOP allocations. Without a substantial resource mobilizatior effort, it will be difficult for GOP to meet the expenditures on economic and social infrastructure implied by a 6% growth in GDP. B. Industrial Structure and Performance 2.03 In FY82 industry 1/ accounted for about 23% of GDP and employed 19% of the economically active population. Ilanufactured and semi-manufactured products accounted for 55% of total exports, of which textiles accounted for 40'%- Textiles and food processing industries, which are estimated to account for more than half of manufacturing value added; other maior sectors are engineering and chemicals. In large scale industry, public sector enterprises (PSEs) produce about 15/% of value added and monopolize or have substantial shares in a number of key industries (cement, fertilizers, chemicals and heavy engineering). 2.04 During the 1970s, GOP nationalized a large part of industry. The present Government, which took office in 1977, has taken measures to reverse these policies giving the private sector a lead role in industrial development by denationalizing most agricultural processing and a few industrial units; introducing a constitutional guarantee against nationalization; widening areas open to the private sector; restricting public sector industrial investment to the completion of ongoing projects and necessary marginal investment in existing plants; adopting a more liberal trade policy; and introduced a range of exports and investment incentives. As a result, real annual growth since FY77 averaged 9% for industrial value added, 10% for private fixed industrial investment, 10% for manufactured exports, and 4% for industrial employment. C. Industrial Strategy and the Sixth Five-Year Plan (SFYP) 2.05 GOP's industrial strategy for the SFYP sustains the strategy and policies pursued since 1977: a leading role for the private sector; efficient import substitution; and rapid growth in exports. The Plan envisages a continued removal of infrastructured bottlenecks; a substantial increase in the output of engineering goods and reduced dependence on imports in sectors such as cement, fertilizers and edible oils. The drive to expand and diversify exports will focus on agro-based industries, with other sectors such as engineering, and selected textiles making major contributions. The Plan targets strong growth in the industrial sector. Real growth of industrial output and value added is expected to be 9% p.a. Ilanufactured exports are projected to grow by about 11% in real terms which would increase the share of manufactured exports fron 55% to 64% of total exports by FY88. Private industrial investment is projected to grow at 29% p.a. in terms and 22% in real terms. The ratio of industrial investment to GDP is projected to increase from 4% in FY83 to 5.3% by FY88. 2.06 The success of the Plan's industrial strategy will depend, to a large extent, on GOP'S ability to address weaknesses in industrial policy and procedures including the incentive structure, industrial regulations and 1/ Including construction. -4_ controls, the efficiency of PSEs, and infrastrijcture deficiencies. The system of incentives favors import substitution industries. The tariff structure requires rationalization to provide a more uniform degree of effective protection, and industry is hampered by excessive bureaucratic restrictions on investment: sanctioning, imports, access to foreign exchange, company formation and pricing. Industries affected by price controls (including cement, fertil:Lzers and petroleum refining) operate under "cost plus" arrangements which cliscourage operational efficiency and energy conservation. Industrial investment is affected by inefficiencies in the financial delivery system and shortages of foreign exchange. Given the expansion of private industrial investment envisaged in the Plan and the low levels of corporate savings and self-financing in Pakistan, improvements in the system of industrial .-inance will be an important complement to increase productive efficiency for the attainment of Plan objectives. Except for the completion of ongoing projects, GOP will requlire PSEs to initiate major improvements in efficiencv and resource generation to meet most of their investment needs through self-financing and commercial borrowing. However, while PSE performance has improved in recent years, it remains constrairLed by lack of autonomy at the enterprise level, the absence of performance-tied incentives and low managerial salaries. Infrastructure deficiencies (including lack of water, roads, transport, and telecommunications) are a major cause of project delays and impose substantial costs on industrial efficiency. Over recent years, severe load-shedding of both gas and electricity has disrupted industrial production and increased costs. 2.07 The Bank Group is supporting GOP's industrial strategy through its SAL program, technical assistance and project lending. The industrial component of the current SAL program focuses on rationalizing industrial incentives and improving the efficiency of the public manufacturing sector. Under SAL I, GOP commissioned a comprehensive study of effective protection to guide it in a simplification and reform of industrial incentives. Bank Group financing of technical assistance is now being used to convert the results of the study into a reform program and in develoiping institutional capabilities to use effect:ive protection principles in incentive reform. For public enterprises, the BaLnk Group is supporting the implementation of a performance evaluation and incentive system to reward performance on the basis of agreed targets. Deregulation will be incorporated in the focus of future Industrial Sector Credits while the issue of "cost plus" pricing highlighted in the Cement Subsector Report will be a key issue in the proposed Cement Rehabilitation and Refinery Projects. Infrastructure improvements are being implemented through ongoing projects, such as the Fourth Telecommunications Project (Ln. 2122-PAX), Second Lahore Water Supply Project (Cr. 630-PAK), Third Highways Project (Cr. 974-PAK), Lahore Urban Development (Cr. 1348-PAK'i, Karachi Water Supply Project (Cr. 1374-PAK) and proposed projects such as the Fourth WAPDA Power Project. Energy conservation is being addressed through the Refinery Engineering and Energy Efficiency Project, Fertilizer Rehabilitation Project and a proposed Cement Rehabilitation Project. This proposed Project will help strengthen the delivery system for industrial finance (para. 4.07). -5- D. Prospects 2.08 With the changed environment for private sector involvement and GOP's policy of restricting public industrial investment (para. 2.04), since 1977 there has been a marked improvement in large-scale private industrial investment. During FY77-FY82, large- and medium-scale private investment grew at about 13% p.a. in real terms. Investment sanctions grew rapidly, increasing from Rs 1.4 billion (US$110 million) in FY77 to Rs 9.4 billion (US$740 million) in FY82, with cumulative investment of Rs 37.8 billion (US$3.0 billion). However, the Investment Promotion Bureau estimates that only 38% of these sanctions have been implemented due largely to serious bottlenecks in infrastructural facilities and in the system of industrial finance. 2.09 For the Sixth Plan period, GOP projects a substantial acceleration of private industrial investment. Large-scale fixed private investment, of about US$378 million in FY83, is projected to grow by 36% p.a. (28% in real terms) during the Plan period. This compares with the average growth rate of 20% in nominal and about 9% in real terms during the first four years of the Fifth Plan (FY78-FY82). Based on Plan assumptions, large-scale fixed private investment for the next three years (FY84-86) is projected at US$2.1 billion, of which about US$700 million would be in foreign exchange. However, even assuming that large-scale fixed private investment increases at the current average rate of 20%, the investment level would be about US$1.7 billion, with US$600 million in foreign exchange. This assessment appears realistic and is supported by the existing pipeline of projects of IDBP, NDFC and PICIC, which together had pipelines of projects with foreign exchange requirements of about US$316 million (Annex 7). The proposed project of US$100 million would meet part of these requirements. 2.10 The financing plan for such an ambitious expansion in private investment calls for foreign agencies to provide 34% of the planned investment while the rest will be contributed by commercial banks (34%), local sponsors (20%), and non-bank financial institutions (12%). For the financial system to meet these targets, industrial lending will have to increase at an annual rate of 37% which can only be met within GOP's credit ceilings if debt repayments to the banks are maintained at a high level. -6- III. THE FINANCIAL SECTOR A. Background 3.01 Given the present low level of corporate savings in Pakistan, the planned expansion of private investment will exert considerable pressures on the system of industrial financing. While domestic currency term financing has not been a constraint in recent years, industrial investment has bee!n hampered by weaknesses in the financial delivery system which is constrELined by a fragmented institutional structure; a detailed and centralized system of credit allocation; and a somewhat distorted interest rate structure. The proposed project is an int:egral part of the Bank Group's overall strategy to address these issues and a dialogue of foreign exchange and in particular to streamline the structure and substantially strengthen the industrial financing aspects of the financial system. This chapter focusses on the structure of the financial system, the policy framework, industrial finance, and the role of the capital market. B. Structure of the Financial System 3.02 Overview. The financial system in Pakistan cons:ists of: (i) five nationalized commercial banks (NCBs); (ii) eighteen foreign commercial banks (FCBs); (iii) two specialized commercial banks; (iv) eight development financing institutions (DFIs); (v) several insurance companies; (vi) two stock exchanges; and (vii) a housing finance corporation. The State Bank of Pakistan (SBP), the central bank, regulates and directs t:he financial system. Within the overall policies set by GOP and the SBP, the Pakistan Banking Council (PBC), a de facto regulatory agency of GOP, guides and regulates the functions of and flow of funds to the NCBs, while the Ministry of Finance monitors the operations of the other financial institutions. 3.03 The Commercial Banking System. 1/ With total assets of Rs 194.6 billion, or 80% of the assets of the financial system 2/ as of June 30, 1982, and a branch network of around 7,200, commercial banks play a dominant role. The five nationalized commercial banks (NCBs) together accounted for about 91% of deposits; 85% of advances; and 82% of commercial bank net profit after taxes: 1/ Annex 1 provides a comprehensive discussion of thie comnmercial banking system. 2/ Financial system in this context includes all commercial banks, stock exchanges, the Investment Corporation of Pakistan (ICP), NDFC and the National Investment Trust (NIT). -7- Table 1: The Commercial Banking System Key Statistics (1978, 1982) For the period ended June 30 NCBs FCBs December 31 1978 1982 1978 1982 Deposits (Rs billion) 63.2 117.1 3.6 9.1 Advances (Rs billion) 37.0 72.3 3.3 9.1 Total assets 95.6 171.6 9.6 23.0 Advance/deposit (%) 58.5 61.7 92.0 100.0 Capital & reserves (Rs billion) 1.0 3.5 0.2 0.6 Capital/deposit ratio (%) 1.6 3.0 4.9 9.2 Net Profit (Rs billion) 0.15 0.45 0.06 0.10 Branches N.A. 7,246 N.A. 47 Operating cost /a as percentage of average total deposits 3.8 3.4 5.2 5.5 /a Operating costs = staff costs and other costs. Source: An analysis of bank's balance sheets, Grindlays Bank, June 30, 1982. 3.04 The share of the NCBs in total commercial bank profitability has increased from 72% of the total profits of the system in FY78 to 81.1% in FY82. However, the profits of NCBs are still low and performance is mixed. The average return on risk assets in 1982 ranged from 0.09% for Allied Bank to 1.0% for Habib Bank, about one-third of the average returns by foreign banks. While part of the problem is overstaffing in the NCBs, low salary levels reduce the impact of overstaffing; operating costs (staff and other expenses) as a percentage of average deposits of NCBs were 3.8% in FY78 and 3.4% in FY82 compared with 5.2% and 5.5% for the foreign banks. 1/ The low profitability of the NCBs is caused mainly by: GOP's credit allocation policies which direct the NCBs to finance priority sectors at low interest rates; the establishment and expansion of "low profit" branches in rural areas; non-payment of interest on loans to the public sector; and overstaffing. Foreign banks, however, are able to increase their profitability by catering to selected corporate clients and providing fee based business such as export finance where profit margins are greater. 3.05 Since 1979, a number of steps have been taken to improve the overall performance of the NCBs: branch expansion is no longer automatic and in 1981 and 1982 a number of branches which were considered uneconomical were closed down; hiring of staff, except for middle level management, 2/ has been 1/ The cost structure of the FCBs is higher because their ability to mobi- lize deposits is limited by a ceiling on the number of branches they can establish, and high compensation packages for their expatriate staff. 2/ In 1983, every NCB will be required to employ about 100 MBAs who, after appropriate training, will fill the middle level jobs. -8- stopped, a performance revriew system has been introduced and bank employees can now be fired after three tmonths' notice; promotion is now based more on merit than on seniority; NCBs will be allowed to build up their capital to a prudent level, by limiting dividends to GOP for the next three years; and central training institutes (e.g., Institute of Bankers) are being strengthened. These actions resulted in a 91% increase in NCBs' profitability in FY82, with further improvements projected in FY83. 3.06 In the area of term lending operations, commercial bank long-term lending to the manufacturing sector (37% of total advancess) is well above the level observed in other developing countries. Thlis is due in large part to GOP's policy of encouraging commercial banks to provide term loans for industry through consortium lending led by ICP, Bankers Equity Ltd. (BEL) and NDFC. From FY78 to FY81, advances by the commercial banlcs increased from Rs 28.5 billion to Rs 57.4 billion, with the manufacturing sector receiving the major share (Table 2). Table 2: Sectoral Advances of the Commercial Banks /a (1978-1981) (Rs billion) Sector 1978 1982 /b % Agriculture 2.4 8.4 3.6 6.3 Mining and quarrying 0.2 0.9 0.5 0.9 Manufacturing 11.5 40.2 21.1 36.8 Construction 0.9 3.2 1.1 1.9 Utilities 0.2 0.7 0.5 0.9 Commerce 7.9 27.7 16.1 28.1 Transport 0.4 1.2 0.7 1.2 Services 2.8 10.0 8.5 14.8 Others 2.2 7.7 5.3 9.1 Total 28.5 100.0 57.4 10(.0 /a Excludes IDBP and Agricultural Development Bank of Pakistan. /b March 31, 1982. Source: SBP--1983. 3.07 Specialized Banks. Four specialized banks: the Agricultural Development Bank of Pakistan (ADBP), IDBP, the Federal Bank for Cooperatives (FBC), and the Punjab Provincial Cooperative Bank (PPCB) also fund medium and large industry. ADBP is the largest single financial institution lending to the agricultural sector, while IDBP lends to small- and medium-scale manufacturing units. The Federal Cooperative Bank acts as a central bank for provincial cooperative bani and agricultural cooperative credit societies in the provinces. 3.08 A number of specialized financial institutions also provide assistance to industry, small businesses and housing. PICIC, the only financial institution with majority private ownership, malces foreign exchange loans to medium- and large-scale industry. NDFC provides term financing and -9- working capital to the public and private industrial sectors. Three joint venture companies, Pak-Kuwait, Pak-Libya and Pak-Saudi, have been established recently to provide loans and venture capital to industry. The Small Business Finance Corporation (SBFC) mainly provides short- and long-term loans to small scale industries and businesses. The lnvestment Corporation of Pakistan (ICP) specializes primarily in arranging equity financing for industrial enterprises and National Investment Trust (NIT) operates mutual funds and unit trust savings schemes respectively. ICP also underwrites equity issues and arranges industrial financing through consortia of NCBs. Banker Equity Ltd. (BEL) provides risk capital to private industry by underwriting equity issues and arranging consortia finance participation from NCBs while the Equity Participation Fund (EPF) provides direct equity support to small-scale projects mainly in underdeveloped areas. The need for housing finance is met by the House Building Finance Corporation. C. Industrial Finance 3.09 The Financing System. Notable changes in the industrial financing system during the last decade have been, inter alia: the creation of a number of non-bank financial institutions; the decline in the relative importance of established institutions and the emergence of the NCBs as a major force in term lending. Initially, PICIC and IDBP were the main institutions providing term financing for industrial development. Hlowever, in 1982 NDFC was allowed to diversify its activities to include lending to the large- and medium-scale private sector. NDFC is now the largest industrial lending institution in Pakistan. Other institutions such as BEL, ICP and the joint venture companies have also increased their role in term financing for private industry. As a result of these changes, PICIC and IDBP's share of private sector term financing has decreased considerably. 3.10 In FY79-FY80 GOP through the SBP assigned mandatory fixed investment lending targets to the commercial banks to prevent them from discriminating against term loans for industry bearing the concessional 11% interest rate. The targets were discontinued in FY81 because the banks found it difficult to meet their allocations due to other constraints on industrial investnent, particularly shortages of foreign exchange, and the banks' limited capacity to urndertake feasibility studies. In FY82, based on the Annual Credit Plan for private investment, the SBP provided an allocation for private sector fixed industrial investment lending of Rs 1.7 billion (US$134 million). Although the target was not mandatory, unused amounts could not be utili-zed for other purposes. In FY82 about 80% of the target was met. For FY83 the target has again been set at Rs 1.7 billion (US$134 million). 3.11 Although the increase in the number of institutions involved in term-financing means more outlets, institutional imbalances and anomalies have been created in the process. NDFC, while not a scheduled bank, has been allowed to perform most commercial banking functions and its growth has outperformed IDBP and PICIC. IDBP is a scheduled bank but has chosen not to perform full banking operations; while empowered to raise short term deposits. IDBP's Charter restricted its working capital financing. 1/ PICIC 1/ IDBP's Charter was amended in November 1983 and the restriction was removed. -1.0- is restricted by the Nationalization Act of 1974 from performing banking functions such as deposit taking, export finance, ana participating in the inter-bank market. Thus, PICIC is forced to rely almost exclusively on multilateral lines of credit for its resources. PICT.C also is subject to corporate tax whereas NDFC, and the three Pak-Middle East: joint investment companies are exempt, although they compete in the same market. Several of these anomalies are addressed under this project. 3.12 In spite of the NCBs' increasing involvement in industrial term financing, most have not fully developed their project appraisal capabilities. About 80% of the NCBs' lending for fixed industrial investment has been carried out through consortia organized by EEL, ICP and NDFC. lWhile these institutions will continue to provide appraisal and supervision services for large scale consortium financing, the NCBs' increasing involvement project financing warrants an upgrading of the NCBs project evaluation and supervision capabilities. GOP and the PBC agree on the need to build this expertise for large industrial project appraised. 3.13 Capital Market Financing. After a good start in the late 1950s, when substantial savings were invested in new equity issues and dividend rates were high, the capital market experienced a period of stagnation from the late 1960s to the end of the 1970s and played a limited role in providing industrial financing. At present, in spite of GOP's emphasis on private investment, the capital market has not become a significant source of funds for industrial investment. Of all listed shares, 85% are controlled by management groups or by public investment institutions. Highly concentrated asset holding is eased only marginally through floatation of mutual funds. However, most new issues f:Loated in 1982 and early 1983 were oversubscribed and trading volume has increased indicating renewed public confidence. 3.14 Public companies have only tapped general savings through issuance of appropriate marketable debt. instruments for investment financing to a limaited extent. Most issues - debentures - were privately placed with financial institutions and even if listed, their placement has prevented any active trading. Low interest rates have restricted take up and the major reason for Bank participation in these issues is achievement of credit targets. Thus, public companies, faced with financial institutions reluctant to lend, and an absence of a secondary markcet for corporate bonds are occasionally forced to borrow in the unofficial credit market. Thus changes, (using monetary policy tools), in the existing institutional framework to impart flexibility and responsiveness are necessary. Independent money market trading houses should be established to make markets in corporate commercial papers and debentures; these should have the ability 1o raise term deposits as well as limited resort to SBP. The introduction of leasing as a supplementary source of project finance through independent companies will add to the flexibility of the system as will setting up of independent venture capital companies to complement the role of existing financing institutions. GOP is aware that the capital market has not been a major source of funds for industrial development and is studying appropriate measures to resolve the situation-0 -1L-- D. Policy Framework 3.15 The growth and distribution of domestic credit in Pakistan is regulated by the SBP through traditional instruments such as liquidity ratios, the rediscount rate and credit ceilings (which, at present, are set in conjunction with the IMF under the Extended Fund Facility Agreement). The Bank rate has not been used significantly to influence credit expansion or allocation, except in the case of priority schemes and refinancing. 3.16 Islamization. I/ Since 1981, GOP has introduced a number of changes in the financial system as part of its Islamization process including the planned abolition of interest through a gradual shifting from an interest-based financial system to one operating on the principle of profit and loss sharing (PLS). Changes in the financial sy stem relevant to industrial finance include the introduction of: (i) PLS working capital loans (Musharika); (ii) participating term. certificates (PTCs) based on the PTLS principle, to replace debenture financing; (iii) Modaraba companies, which operate as investment funds in accordance with Islamic tenets; and (iv) the conversion of a few non-banking financial institutions (NIT and i-BFC) to a non-interest basis of operation. 3.17 Since the process of Islamization is being implemented gradually and pragmatically, it is too early to evaluate its full economic and financial implicatioris. However, indications are that, on the whole, Islamization has had a positive impact. By not imposing restrictions on the terms and conditions which can be negotiated between lenders and borrowers using the new instruments, GOP is in effect freeing financial rates of return. This applies in particular to term financing through PTCs, and the arrangements for hire purchase and leasing currently under consideration. As PTCs are expected to carry effective rates of 15% p.a., they will provide considerable incentive for financial institutions to engage in industrial term lending. Since there are a number of potential problems in the operation of a parallel interest and PLS-based system, GOP will remain heavily involved in the reguliation of the financial system for some time. During this process, GOP may fi-nd it difficult to adjust interest rates on traditional term lending and, without the flexibility afforded by interest rates, may have to resort to direct intervention in financial markets to meet its macroeconomic and developmental objectives. 3.18 Credit Allocation. An important feature of the growth and distribution of domestic credit is the centralized system of credit allocation. This system presupposes a highly sophisticated and precise Annual Credit Plan, a large amount of data and information to predict sectoral investment and working capital needs, and fine tuning by way of a constant and timely flow of accurate information. Also it acquires a mandatory character, particularly as the performance of financial institutions is judged in relation to their fulfillment of Plan targets. GOP has monitored the impact of this approach and has improved coordination to make the system flexible. To date, it has functioned reasonably well, 1/ Annex 2 provides a detailed discussion of the Islamization of Pakistan's Financial System. -12- meeting adequately the credit requirements of the private sector. Howeve!r the system will need to be made more responsive to changing market conditions as it is difficult to transfer unused public enterprise allocations to the private sector, and the more dynamic and aggressive banks are not permitted to utilize the unused allocations of other banks. GOP is aware of the need to increase the flexibility of the system and reallocate funds based on actual requirements. Action in this area would be monitored closely during implementation of the proposed Project. 3.19 Interest Rates. The interest rate structure for deposit-taking institutions is characterized by a crossing of rates; deposit rates rise with maturity while domestic lending rates fall with maturity. Interest rates on domestic term loans are fixed at 11%, while working capital loans carry a rate of 14%. Deposit rates, oni the other hand, rise with maturity from 5.5% p.a. for 7 to 29 day deposits t:o 13.0% p.a. for five-year deposits. Foreign exchange loans made by the DFIs are normally made at 14%, including a 3% foreign exchange risk fee payable to the Government. 3.20 The interest rate structure was one of the main issues raised by the Financial Sector Review Mission in February 1982, and was discussed extensively in December 1982 and again during the course of the March 1983 appraisal mission for the proposed Project. GOP agrees that indirect subsidized lending for selected sectors and the crossing of deposit and term lending rates, which leads to a negative spread on term lending, acts as a disincentives to industrial lending. However, GOP does nDt consider immediate revision of interest rates necessary as market interest rates are expected to decline rapidly in response to low inflation. At present, the official lending rate of 11% for term lending is positive and considered a realistic indicator of the cost: of capital, and the net lending rate of 14% for foreign currency term loans is substantially positive. The inflation rate in Pakistan is currently about 7% and is projectesd to remain below 10% for the next few years. Additionally the process of Islamization is making the cost of funds more responsive to market conditions. ]?TCs presently have a coupon rate of 15% p.a., compared with the local currency term lending rate of 11% p.a. Since the bulk of new term lending is in local currency, the disincentive to lend is being eliminated. 3.21 Given GOP's commitment to liberalize interest rates through the use of Islamic instruments which carry a "market" rate of return, it is not appropriate to use the proposed Project to resolve the issue of crossed lending and deposit rates. Lowering interest rates on time deposits alone would only constrain the mobilization of savings whiclh are already low. Moreover, the 11% p.a. official rate for term lending to industry does not now have a real impact, as only nominal amounts of term lending are made at that rate. However, to facilitate reform of the structure which would be contingent upon the speed of the Islamization process, agreement was reached with GOP during negotiations that it would take all necessary measures to ensure that onlending rates to industrial enterprises under the project remain positive. -13- IV. THE PROJECT A. Lending Strategy 4.01 Past Operations. As of December 31, 1982, the Bank Group had made 15 loans/credits totalling US$384 million to industry through IDBP, NDFC and PICIC (Table 3). Table 3: Bank Group Lending to DFIs in Pakistan (up to 1982)- Institution No. of Loans Total Amount % ($ millions) PICIC 11 274 71.4 IDBP /a 3 80 20.8 NDFC 1 30 7.8 15 384 100.0 Ia Including US$30 million SSI loan for onlending through commercial bank. 4.02 Among the three DFIs 1/ associated with the Bank Group, involvement with PICIC has been the longest and largest in volume (para. 1.04). PICIC was set up in 1957 with the assistance of the International Finance Corporation as a privately owned investment bank to provide long-term finance, especially foreign currencies, to private industry. With the devaluation of the rupee by 131% in 1972, and subsequent nationalization of major private industries including the commercial banks and insurance companies, PICIC, ran into severe financial problems. The Bank Group continued to work with GOP to revitalize PICIC and granted three loans and credits to PICIC. Under its new management PICIC has made considerable progress in recent years in resolving its operational difficulties, and its medium term prospects are reasonably good. 4.03 IDBP was established by GOP in 1961 to provide financial assistance to small- and medium-scale industrial units. In line with GOP policy of promoting industries in East Pakistan at the time its headquarters were in Dhaka, IDBP performed well during its initial years of operations, and up to the early 1970s was an important source of foreign exchange for small scale industrial development. In 1970, to assist in the development of SSI, IDA granted a credit (Cr. 177-PAK) of US$20.0 million to IDBP. With the independence of Bangladesh (formerly East Pakistan) and the loss of its assets in the country, and the devaluation of the rupee in 1972, IDBP ran into severe financial problems and became uncreditworthy for Bank Group assistance. However, the Bank Group and the Asian Development Bank (ADB) worked closely with GOP during the 1970s to revitalize IDBP. By 1981 sufficient progress had been made to enable the Bank Group to use IDBP as the 1/ For a detailed review of the operations of IDBP, NDFC and PICIC see Annexes 4, 5 and 6. -14- administrating agency for a furLher line of credit--Cr. 1186-PAK --for SSI development. 4.04 GOP set up NDFC in 1973 to provide term and working capital financing for the public sector enterprises. Unlike IDBP and PICIC, NDFC was authorized to perform many commercial banking functions including deposit mobilization. In 1975 IDA granted NDFC a credit of US$30 million (Cr. 546-PAK). The role of NDFC became unclear in 1977 when GOP adopted a, new industrial development policy limiting the growth of the public sector industry; however, this uncertainty was eliminated in [982 when NDFC was authorized to finance private industries without restriction. Despite these uncertainties, NDFC's performance has been the strongest of the DFIs, and it is now the largest and most prof'itable DFI (Table 4): Table 4: DFIs Associated with the Banc Group Structure of Assets and Liabilities (Rs billion) Loan Total Borrowed Net Portfolio Assets Deposits Funds Equity Income IDBP (06/30/83) 2.5 2.7 0.3 2.2 0.2 0.03 NDFC (12/31/82) 3.2 4.3 2.1 1.5 0.5 0.10 PICIC (12/31/82) 2.6 2.8 - 2.3 0.4 0..004 TOTAL 8.3 9.8 2.4 6.0 1.1 0.17 Source: IDBP, NDFC, PICIC. 4.05 Proposed Strategy. U3ntil 1981, the rationale for dealing individually with the DFIs was t'heir clearly defined roles in different market segments. IDBP concentrated on SSIs, PICIC catered to medium and large private industries, and ND]FC dealt with the public sector. However, there is now considerable overlap in the client base of the DFIs. IDBP and PICIC now both concentrate on direct lending to medium- and large-scale private industries, while lending to SSIs is handled mainly by the NCBs. Also the NCBs were instructed by GOP to fill the gap in industrial term lending created by the resurgence in credit demand and the financial probletms of IDBP and PICIC. By FY82, annual term lending to industry by NCBs was about Rs 1.4 billion. Under the SFYP, the NCBs are expected to finance 34% of private industrial investment or about three times the combined lending of all DFIs including the three joinit venture finance companies. Because of the factors discussed above, the roles of PICIC and IDBP in industrial finance have become less significant. 1/ 4.06 Given these changes in the environment and the decline in the share of industrial financing by the DFIs, the Bank Group needs to reorient its lending strategy to focus on the system of industrial fjinancing as a whole. 1/ In FY82, total approvals by IDBP and PICIC were Rs 888 million or about 10% of the total private industrial investment. -15- By doing so, the Bank Group would be positioned to discuss general financial sector issues with the GOP, and to influence the roles and performance of key institutions in the financial sector. The Bank Group can, at the same time, continue to assist in strengthening the DFIs by establishing eligibility criteria to bring about necessary institutional reforms without affecting the flow of credit to private industry. B. Project Objectives 4.07 The proposed project is designed to: (i) improve credit delivery for industrial finance by focussing on the system as well as individual institutions; (ii) reduce the possibility of jeopardizing industry's access to term finance as a result of a participating institution's non-compliance with conditionality/eligibility criteria by expanding the sources of financing; (iii) remove operating anomalies which hamper competition among DFIs; (iv) encourage competition among PFIs by expanding and improving the services offered by them; (v) strengthen individual institutions through technical assistance programs; and (vi) develop a more consistent and continuous method of providing foreign exchange financing for industry in Pakistan. C. Strengthening Credit Delivery for Industry 4.08 Institutional Upgrading. The design of the Project would enable the. Bank Group to work with GOP in a systematic manner to address the problems affecting the flows of industrial credit. The capabilities of IDBP and PICIC would be reinforced by instituting a number of operational and institutional improvements, and upgrading programs would be implemented in the other institutions to enable their participation in the proposed Project. Funds would also be channeled through NCBs which have become an important source of private industry investment, and whose role is expected to increase further under the Sixth Plan. Under the proposed Project, appraisal and supervision capabilities of the NCBs would be strengthened and their participation would enable them to provide clients with a full range of banking services including foreign exchange term loans. By involving the NCBs, which are major sources of industrial finance, the Bank Group would be in a better position to discuss issues relating to the entire system of industrial finance. 4.09 Rationalization of Regulations Affecting DF.Is. Although IDBP, NDFC and PICIC lend to similar target groups, each is subject to different regulatory controls. IDBP is a scheduled bank and falls under the supervision of the SBP. PICIC is a private company, although 49% of its share capital is held by public sector institutions, and is supposed to -16- operate independently. NDFC was set up as an autonomous agency under the jurisdiction of the Ministry of Finance. For these historical reasons and their different legal structures, the DFIs operate under different parameters which have created anomalies both in the services they can provide and in the fiscal treatment of their profits: NDFC PICIC IDB]' Deposits /a yes no yes Export Finance and Foreign Exchange yes no yes Working Capital /b yes yes yes Corporate Tax no yes yes Sanctioning Authority no yes yes /a IDBP, as a scheduled bank, can take deposits, but has not done so. PICIC, as a private compiany, is prevented from taking deposits by the Bank's Nationalization A:t of 1974. /b Only NDFC has been active in working capital financing. PICIC has lim:ited local currency resources. 4.10 There is a need to rationalise DFI regulations so that they can provide their clients with more zomprehensive financial services, thus facilitating project implementation. The conditions under which NDFC operates should be considered as a model for PICIC and IDBP to allow them to diversify and provide a full range of banking services. Following discussions with the Bank Group in March 1983, GOP took a number of measures to rectify IDBP's and PICIC's operating anomalies. PICIC's is now allowed to mobilize local currency resources in the form of debentures, interbank deposits and credit lines from the SBP for onlending purposes. PICIC management has taken full advantage of these facilities and has already made a substantial volume of workiing capital loans. An amendment to IDBP's Act to allow it to carry out a wider range of loan operations was made in November 1983. With the amendment in place, IDBP can lend more flexibly for working capital. GOP is reluctant to exempt PICIC - a private corporation - from corporate tax, as it fears that exemption from taxes will create an undesirable pr,ecedent. However during negotiations, GOP agreed that IDBP and PICIC would be given a spread of 4% compared with 3% for NDFC and the NCBs. This is a partial solution to the problem and provides a basis for further action under subsequent projects.. D. Technical Assistance 4.11 The proposed Project include a technical assistance component of US$2.0 million, divided into three subcomponents: (i) organization and system studies (US$750,000); (ii) training (US$750,000); and (iii) subsector studies (US$500,000). Funds would be reallocated based on the demand for services. A major part of the training component will be used by the participating NCBs and DFIs to fund their programs to upgrade their appraisal capabilities while it is anticipated that IDBP, NDFC and PICIC will take up the funds earmarked for organization and systems studies. FLBL, NDFC and PICIC are expected to utilize the funds for subsector studies in accordance with programs agreed upon during negotiations. The technical assistance funds will be made available to the PFIs as development expenditure on a first-come-first-served basis. Training program proposals from the PFIs were -17- reviewed and agreed upon during negotiations. The Bank Group will review and approve all technical assistance subprojects. E. Project Cost, Components and Financing Plan 4.12 As of June 30, 1983, the foreign exchange requirements of the DFIs totalled US$316 million (para. 2.10) while that of the NCBs (HBL and UBL) is estimated at US$300 million. To partially finance these requirements, a loan and credit package of US$100.0 million (including a front end fee of US$125,000) through a 50:50 blending of IBRD and IDA funds is recommended. The remaining gap would be financed by a US$100 million parallel ADB Credit which has been modelled after this project, 1/ export credits (US$100 million), bilateral sources, and from other foreign sources arranged by the sponsors. 4.13 Project Components. The proposed Project will consist of two components, US$98.0 million for onlending and US$2.0 million for technical assistance (para 4.11). The US$98 million proposed for onlending to industry through eligible PFIs would represent about 18% of the estimated foreign exchange requirements of the projected level of investments in the medium- and large-scale private industrial investment over the next two-three years. V. PARTICIPATING FINANCIAL INSTITUTIONS (PFIs) A. The Participating NCBs 2/ 5.01 Although all five NCBs (para. 3.03) are involved in term lending operations, the bulk of term lending to industry is made by the HBL and UBL, with the National Bank of Pakistan (NBP), the Muslim Commercial Bank (MCB), and Allied Bank Ltd. (ABL) involved to a lesser extent. HBL and UBL have developed financial and technical appraisal capabilities, recruiting staff from the DFIs for this purpose while NBP, MCL and ABL rely upon DFIs for appraisals. HBL, with a long history of industrial financing, is the better equipped of the two. HBL already has taken a number of steps to expand its capabilities by creating a separate project appraisal/end use section, recruiting suitable staff and implementing training program in project appraisal techniques. Thus its Corporate Credit Division has the staff to prepare term loan proposals for financing and dealing with consortia lending, and HBL would be able to participate in the Project and draw funds from the pool as soon as the subsidiary loan agreement becomes effective. While UBL has been active in term finance, it would need to establish a suitable project appraisal section and employ staff capable of carrying out project appraisals to Bank Group standards. Under the proposed Project, HBL and UBL 1/ ADB appraised an Industrial Investment Project in July 1983. Nego- tiations were completed in November and Board approval is expected in December 1983. 2/ Annex 3 gives a more detailed coverage of the operations of the NCBs. -18- would be participating financial institutions subject to fulfilling conditions of eligibility. Eligibility Criteria 5.02 As a condition for effectiveness of their subsidiary loan agreements, eligible NCBs would be required to establish suitably staffed project appraisal sections for industrial term lending operations within their Head Office Corporate Finance Departments. Initially, each section should have at least three officers (financial analyst, economist and engineer) with qualifications and experience acceptable to the Bank Group. HBL has already established an appraisal secticn with nine officers. 5.03 The participating NCBs would continue to train their staff in project appraisal with financing for external training provided under the Project. This training would include secondment of staff to DFIs oi- to commercial banks with strong appraisal capabilities in other countries. The secondment for at least two officers would be for a minimum of two months of on-the-job training. All officers in the project appraisal section of the participating NCBs would attend local courses on project evaluation and project supervision. The PBC which already has taken concrete measures to upgrade the capabilities of the NCBs will be responsible for coordinating training programs for NCB officers. 5.04 HBL submitted a strategy and policy statement: (i) outlining its credit policies regarding term lending especially with regards to the proposed Bank operations; (ii) quantifying its expected irnvolvement in this area of lending over the project implementation period; (iii) outlining its priorities in project selection; (iv) describing expected developments in its staffing for industrial term financing; and (v) describing intended appraisal and follow-up procedures, role of branches, and training plans. The draft strategy statement was agreed upon during negotiations. Approval of thes,e statements by HBL's Board of Directors will be a condition of effectiveness of its subsidiary loan agreement. The participation of UBL in the project would be subject to the same conditions as those set for HBL. B. Participating DFIs Introduction 5.05 Subject to fulfillmient of conditions of eligibility (paras. 5.24-5.25), IDBP, NDFC and 'PICIC have been selected to participate in the proposed Project. A detailed analysis of the operations and prospects of each institution is given in Annexes 4 to 6. Industrial Development Bank of Pakistan (IDBP) 1/ 5.06 At the time of the appraisal of Credit 1186-PAK to IDBP in 1981, it was recognized that the institution faced a number of major problems, the most serious of which were the absence of an effective organization 1/ See Annex 4 for a detai:Led discussion of IDBP's operations and prospects. -19- structure, extremely low levels of collections and resulting high levels of arrears and infected portfolio. The poor repayment performance of many of IDBP's loans arose in part from the loss of related investments in East Pakistan and the significant devaluations of the rupee in 1972 and 1975. Under Credit 1186-PAK, GOP initiated an action program of measures to facilitate the collection of arrears by IDBP, and to improve IDBP's institutional structure, strengthen senior management capabilities, and halt IDBP's deteriorating financial position. 1/ By June 30, 1981, a new managing director had been appointed, senior staff vacancies had been filled, a Special Studies Department established to reappraise and reschedule repayments on problem projects, and GOP had rescheduled about Rs 1.0 billion of loans, subordinated credits, etc., to give IDBP a debt/equity ratio of 5:1 and a Debt Service Coverage Ratio (DSCR) of 1:1. 5.07 More recently, actions taken by GOP and IDBP under a recent ADB credit included: (i) rescheduling of SBP cash credits and GOP loans; (ii) provision of an interest rate subsidy on SBP credits for five years; and (iii) conversion of some of GOP's loans into subordinated debt is now in place. The net results of this action is that IDBP's financial position has improved materially with its debt servicing ratio improving to 1:1 and debt/equity ratio to 4.6:1. GOP has also accepted the Bank Group recommendation to allow IDBP more flexibility in making working capital loans. An amendment to IDBP's Charter to this effect was made in November 1983. IDBP also expects to mobilize deposits of Rs 25.0 million in FY84, rising to about Rs 200 million p.a. from FY85 onward. This will enhance its profitability and balance its asset structure. GOP has also allowed IDBP to further diversify its domestic resource mobilization and strengthen its capital base by issuing up to Rs 200.0 million in subordinated debentures which will be eligible for reserve requirements. The debentures are to be taken up by the NCBs. 5.08 IDBP has revised its Strategy and Policy Statements to reflect the above changes. Projected financial statements for FY84-FY88 show that the DSCR will remain above 1.1:1 and the debt/equity ratio below 5:1. Collections are targeted to increase from Rs 314 million in FY83 to Rs 530 million by FY86. This will increase its collection ratio from 20% to 36% and its cash collection ratio on current dues from 58% in FY83 to 74% in FY86. IDBP's collection targets for FY84-86 were reviewed and agreed as follows: FY84, Rs 365 million, FY85, Rs 425 million and FY86, Rs 530 million. 5.09 Despite the above improvements, IDBP's management needs to intensify its monitoring efforts to further improve the quality of its portfolio and strengthen the sectoral aspects of its appraisals. Assistance from consultants, experienced in portfolio reviews and restructuring, to review IDBP's portfolio could be beneficial. IDBP's management feels that with the recent strengthening in its staffing, it is now in a position to carry out such a review with its own resources. However, if the need for consultants emerges during the review, IDBP would request financing from the technical assistance fund (para. 4.11). In the area of sectoral analysis, the long 1/ As PICIC was affected by the same problem a similar action program was undertaken for it also. -20- vacant position of economic adviser has been filled and the advisor is expected to join IDBP in early 1984. This should have a positive impact on the standard of IDBP's appraisals. 5.10 Eligibility Criteria. IDBP has been included as a participating institution in the proposed Project. During negotiations agreement was with IDBP on: (a) the Strategy Statement and Operating Policies which reflected IDBP's changed operatinig environment, appropriate sectoral exposure limits, and areas of investment growth potential; (b) detailed regional/sectoral collection targets for FY84-FY86; (c) a staff training program, particularly for project appraisal and end-use staff; (d) the formula for determining IDBP's debt/equity rai:io and DSCR; and (e) a program for portfolio restructuring, based on its portfolio review. 5.11 As a condition of effectiveness for the subloan agreement between GOP and IDBP, IDBP would be recuired to fulfill the following conditions: (a) IDBP's Board approval of the revised Statement of Strategy and Operating Policies; (b) initiation of the agreed training program; (c) IDBP's Board approval of collections targets. 5.12 To participate in the pool of unallocated funds, I]DBP would be required to: (a) maintain a DSCR of 1.1:1; (b) maintain an agreed debt/equity ratio of not less t:han 5:1; and (c) meet agreed collection targets. National Development Finance Corporation (NDFC) 1/ 5.13 Established in 1973, NDFC's growth has been credit:able, its operations profitable, and its financial position satisfactory. This situation is in large part a result of NDFC's aggressive rmarketing which enabled it to obtain a major part of public sector non-Annual Development Program term financing. However, GOP's new industrial investment emphasis has required NDFC to develop a new operating strategy for term lending to the private sector and to test its creditworthiness in mobilizing medium- and long-term foreign exchange from international private sources. NDFC projects 1/ For a detailed review of NDFC's operations, see Annex 5. -21- a shortfall of available foreign exchange resources from FY85 to FY87, and will take appropriate action to meet this need in the Euro-currency market when the conditions become more favorable. 5.14 Although NDFC has carried out term transformation and improved the mix of its long-/short-term loans to some 65:35, it has been unable to carry out more term transformation and lending due to the distorted interest rate structure (para 3.19) which prevents the matching of maturities of deposits and loans. The emergence of PTCs with market rate interest has eased the situation, but the removal of this constraint, which applies to all DFIs and term financing institutions, is necessary in terms of an overall strategy to mobilize the resources necessary to meet investment targetted levels by GOP (para 3.22). 5.15 Eligibility Criteria. During negotiations agreement was reached on: (a) NDFC's Statement of Strategy and Operating Policies, reflecting entry into private sector lending; (b) a staff training program for economic staff (particularly those engaged in subsectoral analysis); and (c) NDFC's debt/equity ratio and DSCR. 5.16 Effectiveness of the subloan agreement between GOP and NDFC would be dependent upon: (a) approval by NDFC's Board of the revised Statement of Strategy and Operating Policies; and (b) initiation of the agreed training program. 5.17 NDFC's participation in the pool of unallocated funds would be dependent upon maintenance of (i) a DSCR of not less than 1.1:1; and (ii) an agreed debt/equity ratio of 7:1. Pakistan Industrial Credit and Investment Corporation Limited (PICIC) 1/ 5.18 From FY70 until FY80, PICIC's financial and operating position deteriorated significantly (para. 4.02). However, as a result of measures taken by GOP, PBC, the NCBs during FY81-FY82, and concerted efforts by PICIC's new top management, PICIC's liquidity position and debt servicing capability improved considerably. 2/ To supplement PICIC's local resources, SBP has recently allowed PICIC to borrow from the interbank market at 7% and lend for working capital. PICIC has also made a number of working capital loans, supported by guarantees of foreign commercial banks at 13%, receiving a net spread of 6%, and has repaid SBP credits which carry an interest of 10% 1/ Annex 6 details PICIC's operations and prospects. 2/ Because of the improvement in recoveries, PICIC has not been relying on SBP for liquidity supports. -z22- p.a., furthler improving its profitability which increased from Rs 19 million An 1982, to RPs 48.6 million (or by 156%) in the first half 1983. Recoveries also improved. As of June 30, 1983, PICIC had collected Rs 249 million, and for FY83 expects to collecd: Rs 450 million compared with a target of Rs 400 million. Through these improved collects, PICIC's portfolio affected by arrears was reduced to Rs 1.0 billion or 40% of its outstanding portfolio, compared to 67% in early l981. PICIC's DSCR, which remained below 1.0 till 1982, is now i.15 and is projected to be above 1.1:1 over the next five years. As a result of these improvements, PICIC's share price has recovered and shares are now traded at Rs 9X25 per share compared with Rs 6.50 in early 1983. 5.19 The financial restructuring of PICIC is now practically complete and this has given PICIC's management an opportunity to focus on its lending operations. Since March 1983, PICIC has strengthened its Project Department an.i created a Proiect Promotion and Development Division. The Chief Economist who was appointecd in early 1983 has begun to make a positive contributioni to PICIC's sector work. Salary adjustments and promotions are beginning to reflect performance and not only seniority. PICIC's management has also taken steps to make PlCIC's compensation package more competitive with other DFIs. A new business strategy is being developed and will be ready for discussion and agreement during negotiations. 5.20 The unwieldly structure and composition of PICIC's Board, and some lack of clarity in the dec-ision-making process, had until 1982 adversely affected the effectiveness of PICIC's new management. However action by GOP to strengthen the authoritv of PICIC's Executive Committee and Managing Director, have removed the operational difficulties. Steps taken this far, are as follows: (i) the loan approval authority of the Executive Committee, which is now chaired by the Managing Director, has been increased to Rs 15 million and could be increased further if needed; and (ii) PICIC's Board of Directors in its resolution of June 1, 1983, confirmed the Managing Director, as the Chief Executive of PIICIC. The new Managing Director has made a positive contribution to PICIC and his departure would be a major setback for PICIC. During negotiations, an understanding was reached with GOP that GOP wil1 consult the Bank Group in the event that a new Managing Director is to be appointed. 5.21 Eligibility Criteria. During negotiations, agreement was reached with PICIC on: (a) the Statement of St:rategy and Operating Policy; (b) a staff training program for operational staff; (c) revised collection targets for FY83-FY85; 1/ and (d) the formula for deltermining PICIC's debt/equity ratio and DSCR. 1/ PICIC's collection targets for 1983-85 were reviewed and agreed as fol- lows: 1983, Rs 430 million; 1984, Rs 460 million; and 1985, Rs 500 million. -23- 5.22 Effectiveness of the subloan agreement between GOP and PICIC would be dependent upon: (a) PICIC Board approval of the Statement of Strategy and Operating Policies; and (b) initiation of the agreed training program. 5.23 PICIC's access to the pool of unallocated funds would be conditional upon: (a) maintenance of the agreed debt/equity ratio; (b) maintenance of an agreed DSCR of 1.1:1; and (c) achievement of the agreed collection targets. C. Summary Eligibility Criteria 5.24 During negotiations, agreement was reached with GOP and the PFIs on the form and content of each institution's: HBL IDBP NDFC PICIC Policy Statement x x x x Strategy Statement x x x x Sector Work Program x x Training Programs FY84 - FY86 x x x x Collection Targets--FY84 - FY86 x x Conditions of Board Presentation 1/ 5.25 Prior to Board presentation, at least three PFI's including HBL should have established their eligibility to participate in the project, by: (a) adopting a Statement of Strategy and Operating Policies; (b) initiating a training program satisfactory to the Bank Group; (c) agreeing with GOP on a subsidiary loan agreement; and (d) for HBL) establishing a project section at its head office. Access to Funds 5.26 During negotiations, agreement was reached with GOP and the PFIs that signing of a subsidiary loan agreement by at least one PFI would be a condition of effectiveness of the Loan/Credit. An agreement was also reached on the conditions for access to the funds. They are as follows: 1/ All the conditions in para 5.25 have been met. -24- HBL IDBP NDFC PICIC Conditions to) Access Initial Allocations Board Approval--Policy Statement x x x x Board Approval--Strategy Statement x x x x Initiation of Training Program x x x x Board Approval--Collection Target x x Conditions for Access to Unallocated Funds Maintain Agreed Debt'Equity Ratio x x x Maintain Debt Service Coverage Ratio of 1.1:1 x x x Achievement of Collection Targets x x VI. "HE PROPOSED LOAN AND CREDIT A. Amount and Allocatior. of Funds 6.01 The proposed IBRD loan of US$50.0 million (including a capitalized front-end fee of US$125,000) and IDA credit of US$50 million equivalent (SDR 47.3 million) would finance about 6.1% of the projected total fixed private industrial investmenlt ia medium- and large-scale industries during, FY84-FY86 and provide US$200 million for technical assistance. In terms of foreign exchange cost, the Bank Group's share will be around 18.0%. Based on the existing pipeline of the projects and the minimum and maximum limit size of eligible subloans of US$:1.0 millicn and US$4.0 million, about 40-50 projects will be financed under the proposed Project. The necessary locaL currency funds will be provided by the sponsors and PFIs. IDBP and PICIC will in most cases co-finance their projects with NCBs. The net foreign exchange gap will be financid by a US$100 million parallel ADB Credit line, suppliers' credits of US$100.0 million, other bilateral funds, and from the general foreign exchange pool of the SBP. 1/ In addition, NCBs, which have overseas branches and fur.ding cqpability, will blend their resources with the Bank Group funds, The loan/credit funds are expected to be fully committed within 24-36 months after Board approval. Therefore, PFIs could submit subprojects to the Bank Grouip fDr approval until 1985. 6.02 Allocation of Funds}, Initially, IDBP, NDFC and PICIC will be allocated US$15 million each, with US$53 million placed in a pool of unallocated funds. Although thie NCBs would not have an initial allocation of funds, they would have immediata access to the unallocated pool once they meet their eligibility criteria (paras. 5.02-5.04). The rationale of this allocation is to ensure rapid commitment and disbursement of the Project funds, Each DFI will be given six months from the time of signing of the Loan/CrediL to fulfill participation conditions, and twelve months from the time of Loan/Credit effectiveness to utilize its initial allocation of US$15 i/ For projects involving a total irvestment not exceeding Rs 60 million and needing foreign exchange less than Rs 30 million, the investor can rai:Lse foreign exchange directLy from SBP under general license scheme. -25- million after which any unutilized portion of their initial allocations would be transferred to the pool of funds. PFIs which do not meet eligibility criteria or fail to make satisfactory progress in implementing agreed action programs would be excluded from access to the pool of funds. B. Financial Package 6.03 The financial package for the proposed Project would consist of a blend of Bank and IDA funds in a mix of 50:50. The package would be made available to GOP on standard Bank Group terms and conditions. GOP would onlend the funds to the PFIs through subsidiary loan agreements with each institution. Signing of subsidiary loan agreements of at least one PFI will be a condition of effectiveness of the Loan/Credit. Signing of subsidiary loan agreements on terms and conditions acceptable to the Bank Group will be a condition of disbursement for each respective PFI. 6.04 Onlending Rates and Spread. As GOP is reluctant, for fiscal reasons, to introduce uniform tax treatment for IDBP, NDFC and PICIC, a mix of onlending rates is proposed for the Project. GOP has agreed to an onlending rate of 14% p.a. with a spread of 4% for PICIC and IDBP and a spread of 3% for NDFC and the NCBs. In line with its present policy, GOP will bear the foreign exchange and interest rate risk. The technical assistance funds of US$2.0 million would be passed to PFIs as grants. The proposed onlending arrangement is reasonable as the local currency term lending rate of 11% p.a. reflects the cost of capital in Pakistan and is positive. The net lending rate of 14% p.a. for foreign currency term loan is also substantially positive. The inflation rate as measured by the Consumer Price Index is about 7% and is projected to remain well below 10% over the next few years. Although the present rate level and structure is reasonable, it is possible that GOP may not be able to control inflation and the lending rate may become negative. Thus, during negotiations, agreement was reached with GOP that it will take all necessary measures to ensure that onlending rates for industrial term financing remains positive. 6.05 Free Limits and Subproject Reviews. As the Bank Group has not previously dealt simultaneously with some of the PFIs selected to participate in the Project, it was agreed during negotiations that the Bank Group would review all subprojects from each PFI to ensure satisfactory appraisal standards and to minimize the risk of premature approval of subloans. Based on review experience, an appropriate free limit for each PFI would be established on a case-by-case basis. Agreement was reached at negotiations that each PFI would submit its project appraisals in form and content satisfactory to the Bank Group, with the appraisal reports including the economic viability of the subproject, value added, domestic resource cost, financial and economic rates of return. No sectoral allocation of funds is proposed under the Project. 6.06 Beneficiaries. Although the proposed IIC Project is aimed at financing private sector projects, NDFC is involved in public sector financing, and wishes to have some flexibility in financing expansion and BMR projects. Thus during negotiations it was agreed that US$10 million, of NDFC's allocation, could be used for expansion and BMR projects in the public sector. "-2 6- 66Q7 Amortization Scheduile. Since GOP will bear the foreign and interest rate risk and There is a need to augment local currency resources of DFIs, it is recommended that the Loan/Cr-edit be made to GOP on standard terms and conditions. GOP would onlend the funds to PFIs for a period of 15 years, including a grace period ol- 3 years. PFIs would repay GOP on the basis of a composite amortization schedule of subloans. This would provide a rollov;er of funds which will augment local currency resources of DFIs and enable them to provide working capital finance to their clients. PFIs would onlend the funds to industrial projects based on the cash flow requirements. However, the maximum maturity will rormally be limited to 10 yiears including the grace period. C. Administration 6.08 Procurement. The five proposed PFIs have sounLd procurement prc-edures which require evaluation of procurement on the basis of at least three bids submitted under Limited International Tendering (LIT). Under the Project, LIT would be required for individual contracl:s above USS2.0 million. In these cases, the PFIs would require project sponsors toD contact embassies and trade representatives of Bank Group member countries and Switzerland represented in Pakistan; however, they would riot be required to advertise in international publications as reflected in Section 1.02 of the Bank Group Procurement Guidelines. Fcr smaller contracts, the PFIs would employ their existing procurement procedures which generally conform to the Bank Group's standard practices. In most cases, machinery and equipment would be procured by obtaining at least three competitive quotations from established sources. The PFIs would be expected to maintain records of the method of procurement and to monitor utilization of subloans through regular supervision activities. 6.09 Disbursement Procedures. The estimated disbursement schedule is shown in Annex 8, together with the profile of actual disbursements of Bank-wide DFC projects. The proceeds of the Loan and Creclit would be disbursed at the rate of 100% cf the foreign exchange costs for machinery and equipment of eligible subloans and 60% of local expenditures (corresponding to the estimated foreign exchange content of these items)., As in prior Bank Group loans and credits to DFIs, full documentation of expenditures would be submitted to the Bank Group. For the technical assistance component, the credit proceeds would be disbursed at the rate of 100% for consultants' services and overseas training. 6.10 Reporting, Accounts and Auditing. PFIs would be required to submit quarterly progress reports covering their operations under the Project acceptable to the Bank Group. Financial statements would be submitted annually by the NCBs and the DFIs. These would be required to conform with the Bank Group standard reporting requirements with submission of audited financial statements within six months after the end cf each fiscal year. -27- VII. PROJECT BENEFITS AND RISKS 7.01 Benefits. The major benefit arising from the proposed Project would be the strategic positioning of the Bank Group to enable it to work closely with GOP and financial institutions on the upgrading of the credit delivery system. The Project would also contribute directly as well as indirectly to filling the gap in term financing available for private investment in the industrial sector, In the short term, the proposed Project would allow: a continuation of the Bank Group support for the process of industrial and financial sector reforms; the reorientation of the Bank Group's involvement from focussing on single institutions to a broader focus on the system of industrial finance; and the broadening of the Bank Group institution building assistance to cover, not only the institutions financed in the past, but also other institutions in the financial sector including the commercial banks. The broad range of institutions participating in the proposed Project would enable the Bank Group to expand its institution building efforts and assist the institutions concerned in development oriented lending. 7.02 The proposed Project is expected to have a positive impact on resource generation and help GOP's efforts to stimulate an inflow of external resources. It is projected that the Bank Group funding would generate additional resources of about US$300 million. 7.03 The proposed Project would finance about 40-50 projects involving a total investment cost of US$250 million. Based on past Bank Group experience, the subprojects to be financed are expected to be relatively labor intensive, efficient in terms of resource utilization, and to have economic and financial rates of return of at least 15%. 7.04 Risks. While the DFIs have had many years of project appraisal experience, the NCBs have only recently embarked on term lending operations based on project viability as distinct from collateral support. Thus, there is a risk that the NCBs will be slower than expected in moving from collateral to appraisal based lending and that their participation in the project will be limited, defeating the objective of establishing viable alternatives to the DFIs, which up to now have not performed with any real drive. However, it is anticipated that the risk will be negated by the relatively rapid establishment of effective term lending policies, procedures and appraisal capabilities within the NCBs. 7.05 Success of the action programs to improve the operation and financial viability of IDBP and PICIC will require strong commitment by GOP and by the management of both institutions. The commitment has been given and evidence indicates that GOP will translate it into effect. If however, the actions taken by GOP, IDBP and PICIC do not prove effective, there could be delays in utilizing, first, allocated funds and, subsequently, the pool of unallocated funds. 7.06 A risk of the lending component of the proposed Project is that an adequate number of eligible subprojects might not materialize due to political uncertainties and the slowly recovering economic environment. However, the pipelines of the PFIs indicate credit demand well in excess of the amount proposed for the Project. It is probable that full commitment of -28- the US$98.0 million subloan component would be achieved in less than the three years provided under the Project. 7,07 Finally, the rapid development of the NCBs as effective complements to the DFI as envisioned under this Project depends cn the continuation of a favorable private sector investment climate. GOP has taken a number of steps to remove controls inhibiting industrial development; more needs to be done, however. If progress in liberalizing industrial policy is slow, industrial investment will also be slowed. However, this is unlikely in view of GOP' s recent poliicy announcements. VIII. RECOMMENDATIONS 8.01 During negotiations, agreements or understandings between the Bank Group and GOP were reached on: (a) an annual review and appropriate adjustment of onlending rates (paras. 3.21 and 6.04); (b) contents of Statements of Strategy and Operating Policies for PFIs (paras. 5.04, 5.10, 5.15, and 5.21); (c) the formula for determining debt/equity and debt service coverage ratios to be applied under the proposed project (paras. 5.10, 5.15, and 5.21); (d) time limits for each PFI to fulfill conditions of participation (para. 6.02); (e) onlending terms, conditions and spreads (para. 6.04); (f) free limits and subproject reviews (para. 6.05); (g) limit on financing pubLic sector projects (para. 5.06); and (h) procedures for procurement, disbursement reporting, accounting and auditing (paras. 6.08-6.10). 8,02 It is recommended that, as a conditions of effectiveness a subsidiary loan agreement satisfactory to the Bank Group, be signed 'by GOP and at least one PFI whose Board has adopted Statements of Strategy and Operating Policy acceptable to the Bank Group (para. 6.03). 8.03 For each PFI, the f-ollowing are recommended as conditions of disbursement: (a) adoption of revised Statements of Strategy and Operating Policies (para. 5.26 and 6.03); and (b) adoption of a subsidiary loan agreement acceptablea to the Bank Group (para. E.03). -29- 8.04 The following are recommended as conditions for access to the pool of unallocated funds: (a) for the NCBs, establishment of appropriately staffed project sections at the head office and initiation of a training program, for project appraisal staff, acceptable to the Bank Group (para. 5.02); and (b) for the DFIs, maintenance of a debt/equity ratio and debt service coverage ratio acceptable to the Bank Group (para. 5.26). 8.05 It is recommended that the eligibility of an institution to participate in the Project be withdrawn if: (a) six months after signing of the Loan and Credit Agreements between GOP and the Bank Group, the institution has not fulfilled its conditions of effectiveness (paras. 5.26 and 6.02); and (b) twelve months after Loan and Credit effectiveness and institution has not utilized fully its initial allocation of funds (para. 6.02). 8.06 The proposed Project constitutes a suitable basis for a Bank loan of US$50 million (inclusive of a US$125,000 front-end fee) and an IDA credit of US$50 million (SDR 47.3 million) to the Government of Pakistan. -30- ANNEX 1 Page 1 PAKISTAN INDUSTRIAL INVESTMENT CREDIT PROJECT THE COWf4ERCIAL BANKING SYSTEM Background 1. The commercial bank:Lng ,ystem in Pakistan predates the country's independence. The oldest Pakistani bank was established in 1942 by the Habib group of entrepreneurs and ihe Australasia Bank (now forming the Allied Bank) was established in Lahore early in 1947. Most banking functions before Independence, however, were carried out by numerous branches of banks having their main offices in Bombay, Calcutta, and Delhi. Most of these closed their offices upon partition, so that Pakistan had to build up its banking system practically from the ground up. In July 1948, the State Bank of Pakistan (SBP) was establislhed as the central bank of the country. One of its first functions was the issuance of currency to replace Indian currency notes in circulation as a transition measure. The first issue of Pakistani notes was made in October of 1948. The second important function was the promotion of banking companies. A Banking Companies Act was passed in 1948, and the first new bank to be established, with government participation, was the National Bank of Pakistan in November 1949. The existing Pakistani banks were also encouraged to expand and the branches of foreign banks allowed to continue their activities undisturbed. 2. In the 1950s, banking expanded rapidly and important new private banking institutions were created. Important among these were the National Commercial Bank in 1957 and the United Bank Ltd. (UBL) in 1959.' In the 1960s, two other important banks were established -- Commerce Bank and Standard Bank. All during this time SBP carried out its central functions by inspecting banking institutions. It also contributed to the formation of professional bankers throug'h a centralized training scheme. 3. As banking grew, GO'P felt the need to review the effectiveness of banks in promoting economic development. Already in 1959 a Credit Enquiry Commission was appointed to examine the provision of credit to agriculture, business, and industry, wit'h particular emphasis on primary producers and small and medium sized establishments. The Commission found that there was a tendency for credit to gravitate towards small groups of entrepreneurs and to be unavailable to small industrial and primary producers, and recommended that measures be taken to redistribute financing resources. Acting on these general recommendations, during the sixties, GOP sought to channel credit to targeted sectors mainly through specialized institutions and other schemes -31- ANNEX L Page 2 financed by SBP. However, within the commercial banking system, little was changed and in 1972 GOP saw the need to enact a Banking Reforms Act which expanded significantly SBP's control authority over the banks; to the extent of removing directors and management if necessary. Capital and reserve requirements were raised and the reinvestment of a percentage of profits was made compulsory. GOP felt that the banks were failing to play an effective part in ensuring a wider and more equitable dispersal of the benefits of economic growth. On the contrary, it accused the banks of concentrating credit in favor of selected clients in urban areas, and neglecting the strengthening of their capital base. Together with the banking reforms, SBP introduced more specialized credit schemes for small producers in agriculture and industry, but this time enjoining greater commercial bank participation. These measures proved to be transitional and a prelude to the Nationalization of Banks Act of 1974, whereby the SBP and all the commercial banks incor- porated in Pakistan were brought under direct government ownership. The directors and management of the banks were removed and replaced by government appointees. The Pakistan Banking Council (PBC) was established to coordinate the activities of the nationalized banks, which were merged to form the presently existing five banks. 1/ 4. Since nationalization, the banking system has continued to expand its operations and geographical presence, but this time under more direct govern- ment control. Since then, GOP has also has continued to permit the estab- lishment of foreign banks. As recently as in 1982, three additional foreign banks entered the Pakistani banking industry. Present Structure 5. Presently, the commercial banking system in Pakistan comprises five nationalized commercial banks (NCBs) and eighteen foreign commercial banks (Attachment 1). The system covers the entire country through an extensive branch network, which at the end of 1981 totalled 7,305 banking offices throughout the country, of which 59 in the main cities corresponded to in-country branches of foreign banks. 2/ Because of their national character and the number of their branches throughout the country, the five NCBs have the biggest share of banking operations -- around 90% in recent years. Foreign banks, however, are allowed to perform all the banking functions and 1/ Bank of Nahawalpur was merged with National Bank; Habib Bank Overseas and Standard Bank with Habib Bank; Commerce Bank with the United Bank; Premier Bank with the Muslim Commercial Bank; and the Pak Bank, Sarhad Bank, Lahore Commercial Bank and Australasia Bank to form the Allied Bank. 2/ Under an SBP regulation enacted in 1981 foreign banks are now limited to three branches in the country. Branches existing prior to the regula- tion are allowed to continue operating. -32- ANNEX 1 Page 3 services carried out by the NCBs, including the use of SBP refinance facilities under specific credil: lines. 6. Most of the foreign banlks specialize in foreign trade operations and financing of foreign corporations, joint venture companies, and the larger domestic firms. In this respect, they also make proportionately greater use of the SBPs export finance credit lines than the NCBs, 44% against 56% of total refinance granted by SBP in 1981. For these reasons, operational results of the foreign banks have been proportionately more favorable than those of the NCBs, although in 1980 and 1981 the difference has been reduced as indicated in Table 1. Table 1: Commercial Banks - Comparative Sharess of Operations and Financial Results (in percentages) 1978 1979 1980 1981 Foreign Foreign Foreign Foreign Banks NCBs Banks NCBs Ban'ks NCBs Banks NCBs Deposit 5.4 - 94.6 5.8 - 94.2 6.3 - 93.7 6;8 - 93.2 Risk assets 8.1 91.9 9.7 - 90.3 9.9 - 90.1 10.3 - 89.7 Revenue before operating expenses 11.7 - 88.3 12.9 - 87.1 13.1 - 86.9 13.4 - 86.6 Non-funds based revenue 15.3 - 84.7 17.4 - 82.6 19.2 - 80.8 20.4 - 79.6 A.fter tax profits 28.4 - 71.6 31.0 - 69.0 39.5 - 60.5 25.7 - 74.3 Source: Grindlays Bank Important in the activity of the foreign banks is that of the Middle Eastern banks, which although relative newcommers have been very aggressive in their operations with very satisfactory results. 1/ 7, The NCBs -while not as profitable as the foreign banks are operating with satisfactory results. Being state owned, they have been charged with broader socio-economic functions, the most important of which has been resource mobilization. Results obtained in this respect have been commen- dable, but have required a significant expansion of the NCB's branch system. In 1974, at thle time of nationalization, the number of domestic branch offices was 3,705. By 1982, the NCBs had a total of 7,246 branches in the country. This expansion has not been without problems. Some operating costs have increased, some urban areas are probably overbanked, and there is futile banking competition in some remote areas. The PBC is aware of these problems and corrective measures have been adopted to rationalize tne branch expansion 1/ Their combined profits account for 43% of all foreign banks' profit. If ECCI is included this percentage increases to 74%. -33_ ANNEX 1 Page 4 process, to stabilize staff recruitment at present levels, and to introduce performance review methods at management and staff levels. 8. Traditionally, Pakistani banks have also had a branch system abroad. Branches were first established in the United Kingdom with which trade rela- tions have always been important. More recently, the branch system abroad has expanded as Pakistan's foreign trade diversified and as increasing num- bers of Pakistani laborers migrated to Europe, the Middle East, Europe, and Africa. By 1982, the NCBs had 199 branches abroad that contribute sig-- nificantly to deposits via workers' remittances and to profits through foreign exchange and trade operations. 9. Another important role assigned to the NCBs since 1979 is the alloca- tion of specified amounts of their term financing to lending in consortium arrangements sponsored by BEL and ICP (paragraphs 19 and 20). 10. The NCBs' boards and chief executives are nominated by GOP. In recent years, care has been taken to maintain continuity of direction where possible and justified. Overall the banks are well managed and free from direct government intervention in their administration and credit decisions. In fact, internally, banks have adopted different administrative structures. Some are quite centrally managed while others are significantly decentral- ized. Some emphasize foreign trade activities, others domestic operations. These different management styles, freedom of operation, and traditional different clientele, have made for diversity and healthy competition within the system. However, three of the five banks are undisputably more important--Habib, National, and United--in terms of the volume of their operations and their impact on the economy. Of the remaining two--Allied and Muslim--the latter is more aggressive and efficient. Allied is the smallest accounting for about 5% of the operations of the NCBs. The following table presents the comparative situation in 1981 (Table 2): Table 2: Comparative Position of the NCBs (1931) Capital Net and Reserves Deposits Advances Profit Branches (No.) (Rs billion) (Rs billion) (Rs million) Habib Bank 1.1 31.0 19.1 122 1,845 National Bank 0.8 24.2 13.7 31 1,381 United Bank 0.7 23.3 16.0 44 1,670 Muslim Bank 0.4 10.9 7.2 5 1,341 Allied Bank 0.2 4.7 3.5 7 698 Source: PBC. 11. The PBC plays an important coordinating role in the NCB system. It is also the communications link with the Government, as it permits the banks to put before the Government proposals on banking legislation and regulation. Additionally, the PBC formulates policy guidelines for the banks, reviews their performance, and determines areas where corrections or greater coor- dination is needed. The PBC, however, has no legislative or regulatory -34- ANNEX 1 Page 5 functions. The first remair. wit:h GOP authorities, and are essentially con- tained in the Banking Companies Ordinance of 1962. The latter are the province of the SBP which lays down reserve requirements, credit controls and allocation, interest rate levels and structure, commission charges guidelines, etc. Recent Performance 12. Deposits. The following table presents comparaitivE! deposit figures for the commercial banking system for the years 1978-1982: Table 3: Commercial Banks - Deposits (Rs billion) 1978 1979 1980 1981 1982 Demand Deposits 17.7 21.6 24.0 25.6 28.3 Savings Deposits 22.0 25.3 28.6 34.2 33.1 Fixed term under one year 6.7 7.2 8.4 10.5 10.3 Fixed term over one year 6.7 7.5 8.9 10.4 12.4 Total 53.1 61.6 69.9 80.7 84.1 Source: SBP Bulletin. Wqhile the overall growth in depcsits demonstrated by these figures is sig- nificant in itself at 58% for the period, there are other salient aspects in the pattern of bank deposits. Cine is the source of deposits. The banks have traditionally tapped personal savings, and through the years have expanded the base of personal deposits from 64% of the total in 1978, to 70% in 1982. On the other hand, the importance of government deposits has been reduced from 7.5% to 6%. Corporate savings have remained relatively constant at around 18%. Other deposits from foreign and domestic constitutents have reduced importance, down from 10.5% to 6%. 13. The second important development is the savings promotion effort of the commercial banks in recent years to reach larger numbers of depositors, even in the remotest areas of the country. Between 1978 and 1982 the numbder of depositors increased from 13.3 million to 18.1 million while the average size of account rose from Rs 4,COO to Rs 4,600. The growth in deposits was, achieved without significant increases in the average rate of interest paid, still around 6.25%, but rather through branching and marketing efforts, -35- ANNEX 1 Page 6 14. The third important development with respect to deposits in recent years is the growing importance of fixed long term deposits, 1/ which have increased by 85% between 1978 and 1982 (i.e. at a higher rate than other deposits). There has been a distinct shift in preference from savings and short term time deposits to long term deposits. Noteworthy is the develop- ment of time deposits over four years maturity, which since having been introduced in the third quarter of 1981 have grown to Rs 6,192 million or 7.4% of total deposits at June 30, 1982. 15. With respect to other resources, the noticeable variations are in increased borrowings from the SBP representing greater use of specialized credit lines, particularly for export financing. In 1978, borrowings from SBP represented 8.3% of total resources while in 1982 they stand at 11.8%. The other important change in the resource base of the commercial banking system is the continuous growth of the capital and reserve accounts, and the important equity contribution to the NCBs by GOP during 1981. While in 1978 capital and reserves of the system stood at only Rs 1.9 billion, in 1982 this figure increased to Rs 4.9 billion due to increase in paid-in capital sub- scribed by GOP and SBP. Also, the NCBs have been allowed to strengthen their capital by retaining net profit after tax; in the past they were required to remit all profit to the Government (paragraph 30). An important improvement has taken place in the gearing ratio, increasing the stability of the system and of the individual banks. 16. Advances. In the period under analysis, bank credit grew at an even faster rate than deposits, reflecting greater use of State Bank refinance credit lines, and some relaxation of credit ceilings by the State Bank. In 1978, total credit was 69.7% of bank deposits, while in 1982 it constituted 78.4%. Under the credit allocation guidelines issued by the SBP the expan- sion of credit was directed to the different sectors of the economy in about the same proportion as in previous years. The following table compares the development of the commercial banks portfolio by sector between 1978 and 1982. 1/ ?laturities over one to five years. These deposits totalled Rs 6,723 million in 1978 and Rs 12,425 million in 1932 -36- ANNEX 1 Page 7 Table 4: Commercial Banks - Advances by Economic. Sector For June 30 1978 1979 1980 1981 1932 (Rs billion) Agriculture, forestry, hunt4ng and fishing 2,7 2.0 3.5 4,3 3.7 Mlining and quarrying 0.2 0.3 0.5 0.7 0.5 Manufacturing 13.0 16.1 16.9 20.6 21.1 Construction 1.0 0.9 1.1 1.2 1.2 Electricity, gas, water, and sanitary services 0.3 0.2 0.4 0.5 0.5 Commerce 9.0 11.( 12.9 13.9 16.1 Transport, storage and communication 0.5 0.5 1.1 0.7 0.7 Services 2.9 3.9 6.3 7.5 8.5 Others 2.5 3.7 4.2 4.8 5.1 Total 32.1 38.7 46.7 54.3 57.4 Source: SBP. 17. These figures show the continued predominance of the manufacturing secLor with 37% of bank credit. The second most important sector is com- merce, absorbing 28% of bank advances. In recent years, the service sector has developed and now receives 15% of commercial bank credit assistance. The figures show some uneven treatment of the manufacturing sector and an overall a rate of expansion of credit tc the sector slightly below the overall expan- sion of credit, This is explained by the reduction of government investment in manufacturing in the past three years because of its policy of limiting public sector investment to BMR projects and promoting private investment in the sector. The slack in public industrial investment was picked up by the private sector only gradually, and even then the demands for bank finance from private industrialists will not match in the short run the very large demands made for public industrial enterprises in the past. Profitability 180 With the expansion of the earning asset base and the consolidation of the branch expansion effort, bank profits have increased from Rs 153 million in 1978 to Rs 235 million in 1981. These figures also represent a favorable position in excess of the growth in deposits or in total assets. This is explained in terms both of proportionately higher income and -37- ANNEX 1 Page 8 proportionately lower expenditures. With respect to expenditures, between 1978 and 1981 staff and other operating costs 1/ increased 53% while earning assets increased 78%. 19. On the revenue side, it is important to note that while average effective interest charged on loans dropped during 1980 and 1981 because of greater allocations of concessional credit to financial sectors. In 1982 there has been a recovery to an effective average rate of 11.28%, largely because of the use of Islamic instruments and other operations which permit flexible interest charges. As interest rates, both on deposits and loans, are freed within the context of Islamization and as leasing and other service activities by banks gain in importance, revenues can be expected to increase further. Also, bank charges have recently been decontrolled and should have a position impact on profitability. Role in Industrial Financing 20. Since 1979, the SB? has allocated a term industrial financing role to the NCBs by assigning to them specific allocations for this purpose within the overall credit ceilings. These allocations, if not utilized, cannot be channeled to other credit purposes by the banks. Initially there was some reluctance by the banks to actively participate in the scheme. This reluc- tance was based not on risk considerations or fundamental operational con- straints, but on the low interest spread obtained. By regulation these loans could only earn 11% p.a. while working capital loans normally earn 14%. Still, the more cost efficient banks found that even with a reduced margin these operations were profitable as they attracted or maintained other bank- ing business which would be lost without term financing, e.g. letters of credit, working capital, collections, foreign exchange, etc. The SBP through the PBC also encouraged the banks to participate in the scheme, with the following results: Table 5: Commercial Banks - Credit Utilization for Fixed Industrial Investments Allocation Utilization Percent ----------(Rs billion)--- …() FY79 0.6 0.4 78 FY80 0.9 0.8 90 FY81 0.6 0.4 67 FY82 1.7 1.4 79 Source: SBP. 1/ Not including cost of funds. ANNEX 1 Page 9 21. In FY1983, it is expected that actual disbursemlents of term loans to industry during the year will be Rs 1.5 billion. The rapidl growth of this portfolio was also aided by the partial liberalization of interest rates through the adoption of participation term certificates. In parallel, the banks 'have sought, and SBP has allowed, the reception of time deposits with fixed maturities of five and more years, which have gained acceptance rapidly, without significani: cost increases. This factor has reduced the risk of conversion of short term deposits into longer term loans. 22. Attachment 2 presents a breakdown of expected disbursements of term industrial loans by the commercial banks during 1983. This indicates a rapid rate of disbursement of projects sponsored by the banks themselves for more than 30% of the amount allocated1 for the year for independent term opera- tions. Consortium projects have a lower rate of disbursement. This would seem to suggest that, in future, a greater percentage of industrial term financing could be done directly and independently by the banks. Prospects 23. Prospects for the development of the commerciaL bantking sector in Pakistan will be shaped by at least four major factors. The first of these will be the overall performance of the Pakistan economy and the demands that the different sectors will make on the banks for funds and services. At present, the prospects in this respect are for continued growth and a widen- ing of the services demanded. The second factor has to do with the future rate of savings as Pakistan presently has a relatively low rate of domestic savings at 7% of national income. There is scope for increased savings particularly as income increases, becomes more widely distributed, and infla- tion is checked. The third factor is the introduction of 'Islamic concepts into the economy, particularly :Ln the financial sector, and the related issue of freeing interest rates as a result of participation schemes. Results of the limited experiments carried out seem to be satisfactory and as GOP is committed to the idea, it is lilcely that this process will continue and will be expanded. In this case, there is scope for increased bank deposits attracted by higher yields and there is the possibility for the banks to match these resources with credit demands maintaining adequate spreads. I'he fourth factor that will directly influence the development of the commercial banks is constituted by the policies that the SBP will pursue, particularly with respect to reserve requirements, credit ceilings, credit allocation, and other regulatory functions. Recent experience and statements point to the likelihood of relatively flexibLe and judicious management of the system with a tendency to free up regulationls as needed. An exampLe in point is the recent freeing up of service charges, on which banks can now compete freely. This kind of attitude and actions will allow the system to develop in accord- ance with the needs of the economy and permit it greater internal efficiency. 24. Additionally, two other aspects can be expected to be continuing features of the commercial banking scene in the future. The first is the banks involvement in industrial term financing, which is dealt with in more _39_ ANNEX 1 Page 10 detail in a separate chapter of this report. The second of these aspects is the continuing role of the PBC in guiding and coordinating the NCB's activities. In spite of the banks' improving performance that would seem to justify a greater degree of independence and competition, this will most likely not be the case particularly in new areas of banks' involvement such as Islamic instruments, leasing, or industrial term financing. However, it is felt that continued PBC action should not mean a departure from the soft-glove approach utilized until now with much success. The relationship between the PBC and the banks will continue to depend much on the per- sonalities involved. Some Aspects Relevant to the Project 25. The aspects discussed below affect the commercial banking system in relation both to policy decisions imposed on the system, as well as to the internal operational efficiency of the individual banks. 26. The two important policy issues are those of the interest rate levels and structure and of the credit ceilings and allocation. SBP is charged with regulating both. In the past, the levels and structure of the interest rate have been utilized by SBP to pursue two contradictory objectives: increase the rate of savings through attractive deposit interest rates and promote investment in certain sectors and activities by offering low cost financing for them through the commercial banks. The result has been a crossed interest rate structure that had to be subsidized, either by GOP, the non-preferred sectors, or the banks. The financial authorities have come to recognize the problem, but are nevertheless reluctant to address this issue directly and publicly in view of GOP's commitment to Islamization of the economy. Rather, some relief was offered to the banks through low cost refinance lines for specific purposes, e.g. exports. [fore recently, with the adoption of Islamic instruments both for deposits and loans, the lid has been taken off interest rate levels, at least on part of banking activity, and the crossing effect partially eliminated. GOP is committed to proceed in this direction, so that the interest rate as such cannot be discussed at present. As long as the result is that of rationalizing interest rates to reflect current price movements and market interplay between savers and users, GOP's approach can be considered adequate. This, however, is an aspect to be monitored carefully in the future and one on which a continued dialogue with GOP is needed. 27. The banking system in Pakistan has traditionally been subject to quantitative credit controls. These have basically taken the form of credit ceilings and credit allocation measures. GOP argues that because of the interest rate distortions of the recent past and the predictable moves away from interest rates, it needs to manage credit on the basis of quantitative assignments. It further argues that this policy is in keeping with the needs of a developing economy with limited resources and the need of maintaining fiscal stability. The SBP monitors credit limits and allocations closely and re-adjusts amounts assigned periodically. In practice this is the case; and, ANNEX 1 Page 1 1 wnile the system appears rigid and cumbersome, so far no convincing arguments can be made for inefficiency or distortions in making credit available as demanded, particularly in the industrial sector. Again, however, this matter will need to be monitored closely. 28. Five aspects of bank operations are of considerable interest in the context- of the proposed project. The first is the quality of the banks' portfolio as translated in recovery ratios and/or percentage of non-performing assets. At present, the percentage of non-performing assets is reportedly around 15% of total portfolio, The bulk of non-performing assets are in the public sector corporations and projects which were affected by nationalization. Although the level of non-performing assets is not high, PK -as taken a number of measures to reduce them. A Committee on Sick Public Project has been established to address the financial problems faced by the public manufacturing enterprises. Also NCBs are no longer accruing interest on non-performing asset:s in the public sector and GOP has set up a signal-Ling system with the objective of monitoring and improving the finan- cial performance of public enterprises. 29. The second issue internal to bank operations is that of operating margins. Even though these have improved because of the growth of earning assets, the freeing of the interest rate, and a relative reduction in expen- citures, the incentive to develop service income was not of fered because of tight regulations on service fees. These have now been lif ted and greater com-petition for fee-based sE:rvices is envisaged which should improve operat- ing margins of the more efficient banks. Modernization of systems and proce- dures (paragraph 30) should also contribute to more comfort:able margins. _On The third internal factor affecting bank operations is the gearing ratio which in the recent past had declined to very low levels because of GOP's earlier policy requiring NCBs to pay as dividend their entire after tax profit, This policy was changed in 1981, when GOP increased massively paid-up capital of the NCBs to i mprove the gearing rati o and to enable the foreign branches of NCBs to operate more freely in overseas markets. GOP will now only require Rs 50 mill-ion in total from the NCBs as dividend with toe balance being retained as reserves to strengthen their capital base. In the future, however, as bank operations grow it will be necessary to see if these measures are sufficient to maintain adequate capi tali zation. 31 The fourth issue internal to the banks, and of part:icular relevance to -he IIC project, is the banks' project appraisal capability. Since 1979, the banks have found it necessary to adopt appraisal criteria and procedures in the work of their corporate credit units to deal wit:h te!rm lending proposals coming from ICP and BEL. The experience initially obtained has enabled the more aggressive banks to engage in term lending operations on their own, Again here, the role of the PBC has been important as BEL and ICP proposals are channeled through the Council to form the consortium and the banks' agreement with or observations to proposed projects are discussed in t'ne Council, At present, banks do not have separate project appraisal units -41- ANNEX 1 Page 12 as such, but there is interest in forming them under the auspices of the PBC and with external assistance. 32. The final issue internal to the banks is the question of staffing and modernization of systems and procedures to improve services and produc- tivity. In this area, there is a wide range of differences with some banks using efficient computerized systems and others employing outdated processing and accounting methods. Even within a bank there are differences. The Head Office and the principal branch offices have better systems and facilities than the smaller branch offices and rural agencies. This is in a way unavoidable, but the banks must constantly move to integrate and modernize their systems and procedures. Since most banks are overstaffed their ability to move in this direction will need the full support of PBC, SBP and GOP. -42- ANNEX 1 Attachment I PAKISTAN INDUSTRIAI. INVESTMENT CREDIT (IIC) PROJECT Foreign Banks Established in Pakistan 1. Grindlays Bank 2. Bank of America 3. American Express InternatiLonal Banking Corporation 4. Citibank 5. Bank of Credit and Commerce International 6. Chartered Bank 7. European Asian Bank 8. Algemene Bank 9. Bank of Tokyo 10. Indo-Suez Bank 11. Bank of Dubai 12. Bank of Oman 13. Middle East Bank 14. Union Bank of the Mliddle East 15. Rupali Bank 16. Chase Manhattan Bank 17. HongKong and Shanghai Banking Corporation 18. Banque Nationale de Paris -43- ANNEX 1 Attachment 2 Nationalized Commercial Banks Fixed Industrial Investment Financing Projected Disbursements during FY83 (Rs million) Projects sponsored by: ICP BEL NDFC NCBs Other Banks Total Habib Bank 229.0 199.8 21.8 122.3 - 572.9 National Bank 15.5 16.3 40.5 15.2 - 87.5 United Bank 197.7 226.8 - 42.7 - 467.2 Muslim Bank 75.0 95.0 27.4 - 15.4 212.8 Allied Commercial Bank 66.0 79.2 8.7 12.2 - 166.1 Totals 583.2 617.1 98.4 192.4 15.4 1,506.5 Source: PBC. -44- ANNEX 2 Page 1 PAKISTAN INDUSTRIAL INVESTMENT CREDIT (IIC) PROJECT ISLAMIZATION OF PAKISTAN'S FINANCIAL SYSTEM Introduction 1. Although the Constit:ution of Pakistan (1973) requires that all exist- ina laws conform with the injunctions of Islam, only since 1977 when the present Government took office, has the creation of an Islamic economic system become a major governmenl: objective. A Council of Islamic Ideology is charged with preserving orthodoxy in religious matters, or:ienting public affairs towards Islamic tenets and advilsing the Government on Islamization of the economy. For the last few years the Council hlas been reviewing the country's laws to determine whether they are in accordance with the Shari'ah or Islamic cannon law and in June 1980 produced a blueprint: for the elimina- tion of interest from the econorny. 1/ Although the abolitLon of interest occupies a key position in t:he establishment of an Islamic order, it must be seen as an integral part of a wlder attempt to establish an ideal Islamic society based on the principle of social justice. 2/ Islamization of the Financial Svstem 2. A central objective of :he financial Islamization process is the abolition of riba or interest. Although there is disagreement among Islamic scholars as to whether the injunction on riba refers only 1:o usury or applies to any form of interest, the Government has adopted thes view that interest, defined as a predetermined fixedi return for the use of money, is inconsistent with the Islamic system. The injunction against riba involves a rejection of a particular mode of capital pricing, namely fixed interest: rates, which offends the Islamic philosophy and should therefore nol: form part of the policy instruments available to policy-makers in an IsLamic economy. The 1/i Report of the Council of- Islamic Ideology on the ELiminiation of Interest from the Economy, June L980,, 2/ As part of the process of economic Islamization, the Government also introduced two religious levies, Zakat and Ushr. Zakal is a levy of 2.5% p.a. on wealth, and Ushr a 'Levy of 5% p.a. on agricultural income of landowners in irrigated and barani areas. -45- ANNEX 2 Page 2 focus of the reform is not simply on abolishing interest but on replacing it with financial mechanisms acceptable to Islam in the short run, and by a more fundamental readjustment of all basic social and economic relations in the long run. The abolition of interest is then regarded as a necessary but not sufficient condition for the establishment of an Islamic system. 3. To enforce the Islamic injunction against interest, alternative means must be developed to price capital appropriately. In the economics of Islam, capital is not considered a separate factor of production, but is inex- tricably linked with enterprise in a profit and loss sharing arrangement; capital shares both the profits and the losses of the enterprise in which it participates. The concept of profit and loss sharing (PLS) becomes the guiding principle of Islamic reform and in different forms seeks to replace the traditional concept of interest as the means of pricing capital. In accordance with this principle, the Government has introduced the following changes in Pakistan's financial system: (i) PLS deposit counters in commer- cial banks; (ii) interest-free loans for agriculture and students; (iii) Musharika financing for working capital needs; (iv) Participation Term Certificates (PTCs) to replace debentures; (v) Modaraba companies to replace mutual funds; and (vi) a number of financial institutions operating on an interest-free basis. Since GOP is introducing these changes gradually, Pakistan's financial system is presently operating under both conventional interest-based principles and new Islamic modes of financing. 4. Bank Deposits. On January 1, 1981, interest-free counters were opened in most branches of Pakistani banks and one foreign bank. These counters function in parallel with conventional bank operations, giving depositors the choice of operating an interest-free or an interest-bearing account. Depositors choosing the interest-free or PLS option share in the profits/losses of investments financed with funds deposited in the PLS accounts of each bank. Since funds deposited in PLS accounts can only be invested in non-interest bearing operations. The SBP has stipulated that a number of operations such as commodity financing, trading operations and import bills can only be transacted on a mark-up or commission basis, which are consistent with Islamic principles using funds from PLS accounts. Five to ten percent of the profits of such operations are kept in a reserve fund to offset possible future losses and equalize rates of return over time. An important incentive to savers is the income tax exemption of up to Rs 15,000 p.a. on PLS accounts. 5. Since their creation PLS deposits have grown rapidly. On June 25, 1981, total PLS deposits amounted to Rs 2.6 billion and a year later stood at Rs 7.9 billion, with Rs 3.3 billion in savings deposits and Rs 4.6 billion in time deposits and accounting for 10.3% of total deposits in Pakistani banks. 1/ Rates of return on PLS accounts are declared every six months and 1/ As of March 31, 1983 total PLS deposits increased further to Rs 14.2 billion, or 14.3% of total deposits with the banks. -46- ANNEX 2 Page 3 have been consistently higher than the minimum rates OnI conventional deposits prescribed by the SBP. Annualized rates of return on PLS accounts during FY82 varied among banks and ranged from 10.75%-12% for six month deposits to 14.5%-15.5% for deposits of five years or more. HIinimum annual rates on interest-bearing deposits of equal maturity range from 9.0% to 12.75%, respectively. 6. Bank lending. Since October 9, 1979, banks have extended a small amount of interest-free production loans to subsistences farmers and fishermen for the purchase of seasonal. inputs and to cover maintenance costs. These loans which have a ceiling of Rs 6,000 are mostly disbursed in kind. Borrowers who fail to repay within two months of harvesting have to pay the ongoing interest rate. Since July 1, 1981, the banks have also made interest-free loans to deserving students who must repay when they complete their studies and find employment. 7. On June 1, 1982, the nal:ionalized commercial banks launched the Musharika financing scheme designed to meet the working capital requirements of trade and industry on a ]PLS basis. A Musharika can be defined as a business arrangement whereby thes parties contribute capital and/or entrepreneurial skills and share the profits according to a pre-agreed formula. A loss, however, -is shared in proportion to the funds contributed by each party. As with any other contract the conduct of a MIusharika is governed by the terms and condit:ions of the agreement freely reached by the parties. Use of the Musharika funds, however, must be consistent with Islamic principles. Banks will restrict their role to monitoring the com- panies' performance and Bank funds shall not form part of the companies' equity. In order to reward management performance, the banks allow a manage- ment bonus to be paid out oE realized profits. The pre-agreed bonus is payable upon achievement of projected profits and may vary according to performance. In cases of shortfall, banks may pay the management bonus at a reduced rate instead of forfeiting it completely. 8. The SBP is encouraging banks to extend Musharika financing to selected customers and so far about 20 agreements have been announced. Although there is considerable uncertainty as to how Musharikas will operate in practice, expectations are that, at least initially the rate of return for banks will tend to be around 14%, which is the current rate of interest on working capital loans. Thus, in terms of return on funds, Musharikas will not differ from conventional working capital loans. 9. In addition to Musharikas, two other financing arrangements conform- ing to Islamic principles are being introduced gradually: hire purchase (Bai Salam) and leasing (Baj Muajjal). Under an interest-free hire purchase agreement, in addition to repayment of the principal the financial institu- tion receives a net imputed rental value in place of interest. In the case -47- ANNEX 2 Page 4 of leasing, 1/ Islamic financial principles are likely to be incorporated by providing for variable and adiustable lease rentals. 10. On June 26, 1980, the legal framework of Pakistan's financial and corporate system was modified to permit the introduction of a new financial instrument and a new form of company, both conforming to Islamic principles; the Participation Term Certificate and the MIodaraba company. 11. Participation Term Certificates (PTCs) are transferable corporate instruments based on the PLS principle and are intended to replace debentures for raising medium and long-term local financing for industry and trade. Tnstead of receiving interest, as in the case of debentures, PTC holders will share in the profits/losses of the issuing companies. PTCs can be issued for up to ten years, are secured by a fixed mortgage on company assets, and the claim on company profits supersedes the shareholders' claim. Although the PTC share of profits should be based on the ratio of PTCs to the company's paid-up capital plus reserves, PTC agreements so far have specified a fixed share of profits. PTC holders are only being allowed to retain an amount of profit equivalent to 17% of the face value of the PTCs in each accounting year. Furthermore, if the company pays the share of profit within 30 days of the close of its annual accounts, the company will be allowed a rebate of 2% and PTC holders will retain a share of profit equivalent to only 15%. Losses in one year can be made up by the company out of profits earned in subsequent years. A small sample of the financial projections of projects requesting PTC financing, however, indicates that project sponsors take 15% p.a. as the cost of PTC funds. One feasibility report, for instance, warns that "... the project is not expected to pay full return of 15% to PTC holders in the first year 12. PTC financing was initially restricted to the operations of the ICP, the NIT and BEL, but has been extended to include the NCBs. As a result, most of the NCB consortium term financing is now being done by PTCs. Although this type of lending technically represents higher risk for the banks, returns will be substantially higher than the 11% ceiling imposed by the SBP on conventional term lending. During 1982, PTC financing through ICP and BEL-led consortia amounted to Rs 1.2 billion. 13. A ?lodaraba is defined as a business in which one party participates with capital and another with effort and skills, and profits are distributed in agreed proportions. A M'odaraba company can also be a company engaged in the business of floating and managing Miodarabas. Modaraba companies can be floated only for purposes permitted under the Shari'ah and must be approved by a Religious Board. Income is tax exempt provided 90% of the income is distributed to Mlodaraba certificate holders while losses are shared among 1/ IFC is currently assisting GOP in setting up the legal framework neces- sary for the introduction of leasing, -48- ANNEX 2 Page 5 cer __ f`cate holders after recourse to reserves and unappropriated profits. If accumriulated losses exceed. 50% of subscribed capital, the Modaraba company must be wound up. 14. In addition to the introduction of financial instrulments consistent with Islamic principles, the Government has converted the operations of a number of financial intermecLiari-es to a non-interest basis, On July 1, 1979, the NIT, the House Building Finance Corporation and IC?, began divesting themselves of their interest-bearing financial operations and from January 1, 1980 began to operate entirely on an interest-free basiLs. On June 26, 1980, the Small Business Finance Corporation was fully converted to interest-free operations F BEL was establi-shed on October 10, 1979, and registered as the first Iodaraba company in Pakist:an. Evalation 15: The Government is tread:ing a careful path between the need to intro- duce new financial practices consistent with Islamic tenets and the need to avoid a disruption of the flnancial flows required by a modern industrializ- ing economy. For institutions dealing with foreign loans and credits, the Co-verrument has given an assurance that they will continue to function on the basis of interest. The Government has continuously ernphasized its determina- -c oa o continue the process of Islamization but has underlLined the need to proceed gradually and cautiously. As a result, Pakistan's financial system s undergoing a process of change which no doubt will continue as Islamization proceeds further and as experience with the new system grows. Islamization of the financial system has been in operation for too short a period to permit a full evaluation of its economic impact, but some potential effects can be discerned already. 160 The rmost important and noticeable effect of Islamization so far has been the freeing of financial rates of return, particularly for term lending. Since GOP has chosen not to impose restrictions on the tenns and conditions that can be negotiated between Lender and borrower, the new instruments are more responsive to market condii:ions in the financial sector. This applies Darticularly to PTCs, hire-purchase and leasing. In a(ddition, evidence gathered frormL interviews with managers of financial institutions dealing with Islamlic instruments, indicates That they have evolved business practices which. while consistent with Is Lamic principles, reduce considerably the uncertainty inherent in a PLS system. It appears that every effort is made by financial institutions to prevent borrowers from declaring returns which woruld be lower than the equ:ivalent return obtained under an interest-based ope at ionn At the same time, indications are that in the case of short-term leinding, institutions will expect returns not higher than returns available on working capital loans (i.e. 14% p.a.). Returns for term funds are expected to be set at 15% pDa., (possibly higher for leasing), which repre- sencs a more realistic pricing of capital than the controlled rate of 11% for interest-based term lending, This development represents a major improvement fo-r the NCBs, which before lhe introduction of PTCs were directed to provide -49- ANNEX 2 Page 6 increasing amounts of term financing for industry at the unprofitable rate of 11% p.a. 17. Lending and investing on a PLS basis will require considerable strengthening of the project appraisal and supervision capabilities of finan- cial intermediaries, particularly the commercial banks. Since a lender's return technically depends on the borrower's profitability, the commercial banks, which currently provide most of the working capital financing of trade and industry and a substantial proportion of term financing, will be forced to focus more on the viability of particular projects rather than relying almost exclusively on their clients' creditworthiness. At the same time, because of the higher risk inherent in this participatory mode of financing, lenders are likely to demand greater accountability from the corporate sec- tor. Greater accountability, tighter accounting and auditing requirements, and an improved flow of information from the corporate sector would be a welcome development in Pakistan. 18. In its desire to move to an interest-free system, GOP has precluded the use of interest rates as a policy instrument, even though most of the financial system continues to operate on the basis of interest. Although the system seems to be evolving alternative means to price capital--which need not be inconsistent with efficient financial intermediation and resource allocation--the Government has reduced its policy flexibility by abandoning interest rates during this transition period. As a result, the Government is likely to want to continue to rely on a highly centralized and regulated system of credit allocation to meet its developmental objectives. 19. There is considerable danger that during this transition period, in which both systems work in parallel, companies with high rates of profit and investors with profitable projects will opt for interest-based financing, while less profitable and more risky ventures will prefer PLS arrangements. Unless considerable control is exercised by the authorities, the PLS segment of the financial system could be burdened with a high concentration of less profitable or more risky operations. The need to prevent this segmentation of portfolios will require the continuation of a high degree of regulation and government intervention in financial markets. In addition, it is possible that the higher involvement of lenders in project appraisal and supervision, as well as the higher risk implicit in the PLS system, could increase the cost of financial intermediation. 20. A further potential problem relates to the term transformation possibilities of a PLS system. If the use of funds is strictly separated according to their origin, the provision of term lending for investment would be limited by the volume of term deposits and the banks' function of trans- forming short-term liabilities into long-term advances would be severely constrained. Even where term transformation takes place, because of the need to declare returns every six months and the strong competition between banks to attract PLS deposits, the system has a potential bias in favor of short-term quick-yielding investments. Thus, it is possible that long- -50- ANNEX 2 Page 7 gestation industrial projects would be disadvantaged in relation to trade financing. In order to prevent this, the Government will continue to inter- vene directly in financial markets and maintain a tight control on the system of credit allocation. Conclusion 21. Pakistan's limited experience with financial Islamization appears to be having a generally positive e!ffect on the financial system by allowing rates of return to reflect more accurately market conditions, particularly for term lending. Although some of the potentially negative effects appear to be more a result of the transition phase taking plac:e in the system, it is likely that one of the consequer.ces of the-process of Islanmization will be a continuation of government intervention and control of financial markets and crer4{t allocation. Government aLuthorities, however, appear to be approaching the process of Islamization caut;iously and responsibly. Financial institu- tions, in turn, seem to be adept at evolving financial mechanisms which, while consistent with Islamic principles, enable them to operate under condli- tions very similar to those prevailing in a conventional financial system. -51- ANNEX 3 Page 1 PXKISTAN INDUSTRIAL INVESTMENT CREDIT PROJECT PARTICIPATING FINANCIAL INSTITUTIONS (PFIs) NATIONALIZED COMMlERCIAL BANKS A. HABIB BANK LTD. (HBL) 1. Background. The Habib Bank Ltd. (HBL) is Pakistan's largest nation- alized commercial bank (NCB). As of December 31, 1982, HBL's total assets amounted to Rs 63.9 billion (US$4.9 billion) compared with Rs 41.5 billion of the National Bank of Pakistan (NBP) and Rs 38.6 billion of the United Bank Ltd. (UBL). HBL has 1845 branches in Pakistan and 83 established overseas, including 77 full branches. In 1981, HBL was rated as 484th largest bank in the world based on the size of its deposits. Unlike other NCBs at the time of nationalization in 1972, HBL was able to retain the core of its original staff and has operated more on a commercial basis. Table 1 below provides statistical highlights of HBL's operations for FY78-FY82. Habib Bank Ltd Key Ratios (FY78-FY82) Total Net Return on Return on Deposits Advances Assets Profit Equity (%) Assets (X) -------- (Rs billions) ------- (Rs millions) FY78 20.1 10.8 30.6 91 21 0,3 FY79 23.2 13.5 34.9 99 21 0.3 FY80 27.9 16.2 41.7 105 20 0.3 FY81 31.0 19.1 48.1 122 15 0.3 FY82 40.8 23.1 63.9 273 24 0.5 Source: Habib Bank Ltd. 2. While HBL performed well in terms of mobilizing deposits (26.9% p.a. growth) its profitability as measured by return on assets has been marginal. This is due to SBP policy of maintaining high reserve requirements and credit allocation to priority sectors at lower interest rates. However, GOP has recently allowed the banks to keep most of the profit after tax. Conse- quently, HBL's profit increased dramatically in FY82. There is also a -52- ANNEX 3 Page 2 ge.s ~imDrovement in effficiency as the higher growth levels in FY82 were re a," _ d .ithout any net increase in staff, 3 Oro-zanization. HBL's organization chart is provided in Attachment L. nBL Is ma age&y7 an executive board consisting of the president of the bank andc thiee executive vice presidents. Each senior executive looks after a portfolio of departments. The Executive Board is assisted by a Central Credit Gomlaittee, which is chaired by a senior member of the Board. The Credit Committee is empowered to approve transactions of up to Rs 40 million w1hen aceacuate Ifunding is available, or Rs 20 m:illion when funding is -required- Lending over and above these limits must be sanctioned by the Executive Credi7t Committee, which is chaired by the president of the bank. Also, a'll textile loans, loans to the public sector and major loans to cus- tomers overseas are decided by the Executive Board. Both committees normally meet twice ea-h week and decisions are fairly rapid. Althcugh HBL appears central-zed, there is significant delegation of authority t:o the regional and branch level managers to enable them to provide good services to their cus- tamers. The mission's review shows that HBL's internal credit procedures, 4X f:ranci1 evaluaton, supervision, Inspection, auditing are satisfactory even by American standards. Overall, HBL is relatively well managed. 4. , Medium and Long Tem Project Financing, Applications for medium and longDJ tarm loans are handled in the Corporate Credit Division (CCD) of HBL. Suc'h Loans are limited by amount to not more than 20% of the paid-up capital an' general reserves of the bank, as stipulated in the official credit regule.tions for commercial banks, established by the PEC. Very large loan anpliuations are handled in the Syndicated Loans Division (SLD) where all syndication propositions. which reach the bank from BEL, or one of the devielopment banks (e.g. NDFC, PICIC) are researched, processed, judged and when necessary commented upon. Both the Corporate Credit and Syndicated Lo ns Divislions are supervised by a Senior Executive Vice President, who is also a Member of the Executive Board of the Bank. 5. nThe CCD and SLD work closely together; they are well staffed with qualaired and experienced officers 1/ and the Senior Vice Presidents in chsn ue of all the respective Divisions can avail themselves of the services of the staff zoncerned. . FoHistorically HBL has been a prominent financier of textile mills and other 1arge and mediuim size induLstries in the country. It has built up an expert ose for Judging performance, appraising capabilities of Managers and promoters, identifying managerieLl and financial weaknesses in industry and industrial investment projects. However for term lending operations, HBL needs to strengthen its capability of economic analysis through training and ! ic`llectively the two divisions have 32 qualified profecsionals includinrig cananical analysts, economist, lawyers and banking specialists. -53- ANNEX 3 Page 3 secondment of staff overseas. The cost of such training will be funded under the technical assistance component of the proposed project. B. UNITED BANK LTD. (TJBL) 7. Background. UBL was set up as a private bank in 1960 and exDanded very rapidly. It was extremely well managed and had a cadre of highly qualified professionals. However, following the nationalization of commer- cial banks in 1974, UBL lost a large number of its first and second tier managers (including the president) to the Bank of Credit and Commerce Inter- national (BCCI). 1/ The situation was further exacerbated by the great demand for Pakistani bankers in the Middle East following the establishment of many new financial institutions to invest the substantial funds available following the oil price increases in the early and mid 1970s. Because of the departure of the chief executive and poor operational performance of UBL, GOP and the PBC recently appointed Mr. T. Hussain, Senior Executive Vice President of Habib Bank Ltd., as the new president. 8. UBL is now the third largest bank in Pakistan. is of December 31, 1982 its total assets were Rs 38.6 billion (US$3.1 billion). As of same date, UBL had a total branch network of 1722 branches including 52 overseas units, he network of banking facilities overseas consists of 25 full branches in Middle Eastern countries, a subsidiary with six branches in Lebanon, a joint venture bank in the Sultanate of Oman, with ten branches: 26 branches in the United Kingdom, one branch in New York and one branch in Switzerland. 9. Because of the exodus of professionals and lack of leadership, UBL's financial results during the last five years (FY7B-FY82) have been erratic as indicated by its key operational ratios (Table 2). 1/ BCCI is a multinational bank with headquarters in Luxemburg established by the ex-president of UBL. BCCI is managed mainly by ex-UBL Pakistan and South Asian bankers. -54- ANNEX 3 Page 4 Table 2: Key Ratios (FY78-FY82) Total Net Return on Return on Deposits Advances Assets Profit Equity (%) Assets (%) …(Rs billions) -- (Rs millions) FY78 17.3 10.2 24.4 36 17.2 0.16 FY79 20.1 12.1 28.1 37 15.7 0.14 FY80 21.1 13.9 30.4 17 6.3 0.06 FY81 23.3 16.0 33.6 44 8.4 0.14 FY82 27.1 18.5 38.7 38 3.9 0.10 Source: United Bank Ltd. 10. Organization. UBL's organization chart is shown in Attachment 2. UBL is completely decentralized reflecting the style of its founder. UBL's management control the operations of the bank through a comprehensive manage- ment information system (MIS) anti by control of major lending decisions, including all applications for working capital and term loans. UBL has an Executive Board and an Executive Credit Committee which approve all loans above Rs 40 million. Branch, zone and regional managers have varying degrees of delegated authority. The system works well due to the effective manage- ment information system. However, over the next few years, UBL proposes to consolidate its operations and improve productivity which will mean tighter control from the head office. 11. ledium and Long-Term Project Financing. UBL has been actively involved in term lending and is the major user of the IDA Credit for SSEs. Since UBL is highly decentralized, loan applications for both working capital and term loans are processed at branch, zone or regional level. Applications which require approval at Head Office are prepared in the regional offices, which directs the loan application to the senior officer in charge of the corresponding region circle at Head Office and in turn to the Credit Committee. 12. Syndicated loans are directed to the Coordination Division which studies how UBL will be affected by participating in the syndication. Feasibility studies are reviewed by the Research Department. 1/ Disbursement of funds are handled by the Finance Division as soon as participation in a syndicated loan has been approved in the Coordination Division. 1/ UBL has an effective Research Department, which has carried out many sector and market studies. -55- ANNEX 3 Page 5 13. UBL's management is interested in participating in the proposed project and has agreed to set up a unit at Hiead Office with the respon- sibility for handling project loans. The unit will be headed by an officer with experience in project finance acceptable to the Bank/IDA and will be staffed by at least three professionals (financial analyst, engineer, economist). UBL will further strengthen its staff capability in the areas of economic and financial analysis through training and secondment of staff overseas. The cost of such training will be funded under the technical assistance component of the project. Although UBL's management is keen to participate in the project, UBL will need at least a year to build up the capability to the level, which will meet the eligibility criteria. However, if UBL could build up the capability faster, then the Bank Group should allow UBL to participate in the project sooner. -56- ANNEX 3 Attachmnet.t 1 s 'rHabib Thank Limited ORGANISATION CHART PRESIDENT Abdul Jabber Khan KoOO Ci _'l. Olrel C,I _~~~Eh . _...I= lolOo e o.1, 0000 -1 ,oloidln* C.0't,oI Oooo:l, - oJC .C Kf'' OpoooOo. K- roehO |.| KoroIEd . ! ... hi i I _-t:E-~1' _ C Lo0ol 0101- Kcro. = Cilo ' Co,00o 0jr _ 90000 010:1* - - 05,00000 COOO: 10 F 00.0100.} -_ _ cl 0 *.oloooi Cootro 1.r KEl 0,ooi,ig l 00 Rn inc oK1- _ OOOr * K ,,d.oI,*0 01001.5 _ BuO$SIO0 Frolo:0110 101 100000, t 0.abt11 _ 0* 0,00Oret d -l j 01 _0 C _ Kond S.1o*ooIlnc A00*I I I I Koos*ooO *100 00,. 0.11 I ~ ~ ~ ~ ~ ~ ~ ~ . lll p_ rSonnel Division, 01 no,, | lodiO4 0oj O.ooo*o,oo,* Ho,oroJAcohiKo.lror C1001 K:oebO i COo,|. ond C.o*rcl oosa Coo,, | o l |oVxrs@O~00.-., 0ro000*n/Jo10S o*oo K FFt10 GIvsbn Kooro,h i OI Oe..s 10 nhl7 0 f1s[ wro Clo. C ock| 0* ooo, hr '| 4etr/ersttv CIKI 0 0*- 0500od] |A_0lidigdpopss - 0*110,. ............hrdt| hR o _______ 01015ntinlGNiio l l _4 Cust=|w-z S*rvC I ~~~~OsIKo _i,101. |~~~~~~K,*o *0*0O0.*v.010 005*0.00 5.rOlo. 50K,. BooKlo0 0*,.flloo,O .,*,o* lrc~~~~~ ~o .. 1¢ L c ool okn yocosn rot.' |,o*o K7mmn o T.T,l.o. K Ko0*. D 7por7m0nt 0001 | l Koro 0.,t D,,,.,on* C.*0 Mox*L.l l 0.0-00 1 s.o,1 (0.00 01110 | Olh Fioroll*l0 01000sa Kollymn 000000 |0000. | d 0*dnoinCl H vlo Prepared by: Dt .27-2-1 983 Personnel Division, Head Of fice ,Kraeshi, UNITED BANK LIMITED OrganizatFon Chart (As of March 1, 4983) PRESIDENT Mr. Tajammal Hussaln SEVP/MEB SEVP/MEB 1 SEVP/MEB Mr, A Majid Khan Mr. Muhamnmad Usman Mr. M. Sahrem Malk R ISTRTIO INTERNATIONAL DMSION 1 PERSONNEL & ADMINISTRATlON] KARACHI CIRCLE 'A' (OVERSEAS WING) _ DMSION VP Mr. M. Yusuf Shalkh, EVP J Mr. Ikramullah Mir. EVP Mr. . S (IDrMETIC WMION R FINANCE DMSION FAISALABAD CIRCLE (DMr.SMIH WING)sh.~ Mr. A Razlq SIddIqI. EM'P Mr. Qayyum AJ-Makky. S.IP LAH-ORE CIRCLE 1KARACHI CIRCLE B' MULTAN CIRCLEP Mr. M. Yusuf Shah. EVP ] Mr. AH. Farooqul, SVP Mr. S. Talat Hussaln. SP RAWALPINDI & PESHAWA 1 INSPECTION DMSION HYDERABAD & QUETTA CIRCLES CIRCLE Mr. M. Shamim Naziri, EVP Mr. Ikhlas Ahmed, VP Mr. Athar Hameed, SVP AZAD KASHMIR CIRCLE 1 COORDINATiON DMSION 1 COMPUTER DMSION Mr. Z.A Khan, VP j Mr. S. Mollb Raza. EVP Mr. Khald Sherwanl, EM CREDIT|DIVISION LEGAL DMSION C STOMER SERViCES DMSION |t CREDIT DMSION j ~~~~~~Mr. B.K. Soyany, SM' Mr. Molnudcdln Ahmed, FVP r Mr. M. M. Sabir, EVO j ___________ ___ FRAUDS & FORGERIES CELL IPLANNING & DEVELOPMENT1 or Mr. M. Osman, SVP WIMN. G Mr. Rashid A Nagra. SVPj World Bank-25235 -58- ANNEX 4 Page 1 PAKI STAN INDUSTRIAL INVESTMENT CREDIT (IIC) PROJECT INDUSTRIAL DEVELOPMENT BANK OF PAKISTAN (IDBP) I. INTRODUCTION Background (1961 - 1980) 1. IDBP was established in August 1961, to finance small- and medium- sized enterprises through the reorganization of the Pakistan Industrial Finance Corporation (PIFCO). In, 1969, it was 58% owned by the Government and Government institutions, and 42% by private institutiortal and individual investors. In 1974, the private shareholdings were taken over by GOP under the nationalization of the domestic banks. The private shareholders received interest-bearing compensation bcnds based on estimated break-up value. TDBP's initial share capital of Rs 20 million was increased to Rs 50 million in 1970 and in FY81 was doubled to Rs 100 million with GOP owning 90% directly, and the remainder being held by the four provincial governments and various government-owned institutions. 2. Although initially profitable and financially sound, the overall position of IDBP began to deteriorate after 1970, due in large extent to tlhe series of political and economic changes in Pakistan. Having transferred its head office to Dhaka in 1970, IDBP had to re-establish itself in Karachi in 1971 as a functioning institution, following the independence of Bangladesh. Its organization had to be drast:ically restructured; new management was appointed at all levels and the system of accounts had to be reconstituted. The operational difficulties faced by many of IDBP's projects, caused to a large extent by the loss of assets in Bangladesh, created further problems for IDBP in terms of loan collections and consequently in its liquidity position and debt servicing capacity. 3. IDBP's operational difficulties were exacerbated irn 1972 by a massive devaluation of the rupee (from Rs 4.76:$1.00 to Rs 9.90:$1.00), which more than doubled the debt service burden of IDBP's foreign currency borrowers. In addition, the industrial sector was also negatively affected by the effects of the oil crisis, the general rise in price levels that followed, and the nationalization measures undertaken by the Government up till 1977, which made a number of industrialists reluctant to invest further funds in their industries, thus reducing demand for new 1oans. At the same time, the textile sector, which then accotunted for about half of IDBP's portfolio as _59_ ANNEX 4 Page 2 well as arrears, suffered from several years of low international prices and slack demand. 4. In the early 1970s, GOP and IDBP took steps to overcome the problems created by these events, which were virtually beyond IDBP's control. Most of these steps were aimed at strengthening IDBP's institutional structure. Competent management was appointed and qualified individuals recruited to fill vacant senior staff positions, and a training unit was established to provide in-house training. IDBP hired a local consulting firm, which under- took a review of IDBP's organization and operational procedures. The con- sultants' recommendations were subsequently implemented by IDBP. 5. However, the improvement in IDBP's overall position expected from these measures did not materialize. The political and overall economic uncertainties after the 1977 elections, which continued until mid-1979, contributed to a great extent to the continued deterioration in IDBP's over- all position. In addition, the worldwide economic recession adversely affected Pakistan's cotton textile sector, which in turn created difficulties throughout the domestic economy. By the late 1970s, the major part of IDBP's textile loans were in arrears. 6. Another factor that contributed to the difficulties of IDBP (and of other financial institutions in Pakistan) in reducing its arrears was the inadequate legal procedures to expedite the recovery of debts. While 80% of IDBP's total arrears in the private sector were due to operational difficul- ties, the remaining 20% was considered to be wilful defaulters. This unwill- ingness to repay arose because some industrialists did not honor their obligations since they knew that IDBP was unable to institute effective legal recourse and that further loans could not be granted due to IDBP's lack of foreign exchange resources. There was also the widespread feeling that it was unfair of IDBP to require sub-borrowers to repay their loans at exchange rates under which IDBP stood to make a foreign exchange gain on overdues. The right of IDBP to collect devaluation gains was challenged before the courts. 1/ As it took several years to resolve litigation, IDBP found that 1/ In December 1981, the Sind High Court ruled that the foreign currency obligation to a financial institution would be settled by the payment by the borrower of the rupee equivalent based on the exchange rate prevail- ing on due date, as indicated in the relevant amortization schedule. However, in order to resolve once and for all the issue regarding the exchange rate basis of sub-borrowers' repayment, a presidential order dated February 28, 1982 was issued, ruling that repayment of foreign currency loans would be based on the rate of exchange prevailing on the date of actual payment by sub-borrowers and that all court decisions inconsistent with the Presidential Order were declared null and void and of no effect. With this order, the ruling of the Sind High Court was nullified. -60- ANNEX 4 Page 3 the moment a suit was filed, even borrowers who previously, paid some amounts, no loniger continued their payments; even if a judgment favorable to IDBP was obtained, laquidation procedures were protracted. As a result, IDBP found it disadvantageous to resort to litigation and did so only as a last measure when negotiations failed. 7, By 1980, the impact of economic and financial difficulties was such, that the institutional and operational fabric of IDBP had been severely weakened. IDBP lost a number of experienced and capable senior staff, par-' tlcularly to the Middle East, and also suffered from an acute shortage of tecnnzcal staff such as engineers and financial. analysts. As a consequence, the quality of appraisal procedures deteriorated and supervision of projects becaTme inadequate. IDEP's Role in the Economy 8. Since its inception iin 1961, IDBP has provided Rs 5.5 billion of financial assistance (foreign and local currency) to about 4,400 sub-borrowers. IDBP's impact on the development of small and medium industries in Pakistan is underscored by its emphasis in granting small industrial loans. Some 68% of all loans approved were for Rs 1.25 million or less (with an average loan size of Rs 0.5 million), another 11% were for loans between Rs 1.25 million and Rs 2.5 million (with an average loan size cf RPs 1.9 million), and the remaining 21% for more than Rs 1.25 million (with an average loan size of Rs 10.0 million). Becauise of the concentration of activities on smaller loans, IDBP has a relatively large staff compared to the total value of its processed loans, and in terms of percentage to average loar; portfolio, its administrative expenses are understandably higher (1.4% in FY83) than a DPI which lends to medium and large industries. 9.a Of the loans approved since inception, 46% have! been to cotton and ot'her textile enterprises; 12% to food processing industries, with the remaining 42% spread over 24 industrial subsectors includiclng engineering, chemicals and electrical goods. The bulk of TDRP's lending (72%) has been Lor new enterprises, with the balance (28%) applied to the balancing, modeirn- izing or rehabilitation of existing units. In line with GCP policies, TDBP has directed lending operations to the less developed provinces. This effort is translated in terms of the regional distribution of its lending activities: 42% of total approvals were for projects in Purnjab Province, 42% in Sind Province, 12% in Northwest Frontier Provinc.e (NW;FP) and 4% in Baluchistan Province. While this geographical lending pattern is consistenit -wi-i-h -he population distribution among the four provinces, IDBP is expanding i-s lernding operations in NWFP and Baluchistan. -61- ANNEX $ Page 4 II. INSTITUTIONAL ASPECTS Board and Organization 10. Board. The overall control and direction of IDBP is entrusted to a Board of Directors consisting of six members, including the MKanaging Director of IDBP who is also Chairman of the Board. All members of the current IDRP Board are high-ranking Government officials; while the composition of IDBP's Board reflects the level and orientation of its activities (i.e., assisting small- and medium-sized projects in the four provinces), apart from the Managing Director, who is experienced in development banking, all the other directors are experts in the field of government industrial policy. In June 1983, GOP added two directors to IDBP's Board. One of them is the Chief Executive of a DFI and the other is the Joint Secretary, Ministry of Finance. This action should strengthen IDBP's capability in deal 1i4g with a more com- petitive environment. 11. Organization. In 1974 consultants reviewed IDBP's organization and proposed a restructuring of IDBP's functions. The recommendations were slightly amended by IDBP and subsequently, with considerable delay, imple- mented in 1981. Under the reorganization, three functional groups were created - Operations, End-Use and Planning. The End-Use Group is responsible for implementing IDBPs' "Arrears Recovery Program"; and the "Planning" Group is responsible for providing the necessary staff/research support to the two operational groups and to IDBP's management on planning and strategy formula- tion (this Group has absorbed IDBP's research and statistics sections). While the organization structure proposed for IDBP's operations in 1974 was simple, functional and appropriate to that time, the financing needs of industry - and IDBP's relevant organizational needs - had changed sig- nificantly by 1982. To meet these requirements, there is now a need for IDBP to capitalize on its status as a scheduled bank and identify and promote new instruments for generating local currency resources, to create an appropriate functional grouping for this purpose and to recruit necessary staff. Given IDBP's current operating position and the need to adapt its operations to the needs of its borrowers, IDBP should carry out a review of its operations. IDBP will be able to finance the review from technical assistance funds under the IIC project. 12. As part of the needed review of IDBP's organization structure, emphasis should be given to the role of the Planning Group and in particular, the role of the Economics and Research Department, which is now part of the new Planning Department. This department is staffed with competent officers, but is burdened with many routine tasks and its work program has no focus. It has been in charge of (a) preparing the annual report; (b) financial projections and planning; (c) project identification and subsector work; and (d) reviewing subprojects (loan applications) as part of the appraisal proce- dure. In practice, little is done on economic research work (pro4ject iden- tification and subsector work). Instead of its concentration on project work, the Economics Department should be consulted only on relatively large -62- ANNEX 4 Page 5 or difficult subprojects. Other subprojects need not be reviewed since they -an be handled by the Loan Department which prepares the appraisal report and normally undertakes economic analysis (ERR, Bruno ratio). This adjust- ment of procedures would release a considerable amount of staff time in the Economics Department for subsector work and/or other economic work. IDBP's economic/sector work, could be further improved by encouraging the participa- tion of staff from the Statistical UJnit. The Unit, which is staffed with 15 professionals, including many trained statisticians, is presently attached' to the Economics and Research Department, but has functioned quite independently and has been assigned to co'Llect and process only data on IDRP's operations. It would be beneficial for -[DBP to consider using part of the statistical staff's time to collect and/or p)rocess economic/industrial data within the framework of a better integration of the unit with the Economics and ReseaLrch Department. This aspect has been discussed with IDBP and would be incor- por-ted in the implementation of the Department's work program. 13. Branches. IDBP has four regional offices: (i) Karachi (with three branches) covering Sind and Baluchistan; (ii) Lahore (with two branches) covering the Punjab; (iii) Rawalpindi (with two branchs) covering the Rawalpindi-Islamabad area and Azad Kashmir; and (iv) Peshawar (with two information counters), covering the North West Frontier Province (NWFP). The regional offices are organized on lines similar to the Head Office and the departments in the regional offices are answerable to the respective depart- ments in the Head Office. The regional offices process and sanction loan applications of up to Rs 1.25 million and process loan applications for Rs 1.25 million to Rs 2.5 million for sanctioning at t'he Head Office. On the whole, the relationship between the Head Office and the regional offices ensures operational efficiency without sacrificing control from the Head Office. Management and Staff 14. Management. The present Managing Director, Mr. Bashir Ahmad, was appointed in May 1981, prior to which he had been Managing Director of PICIC. He is assisted by three Depu-ty Managing Directors (DMD), each heading one of the three major groups in IDBP, i.e. Operations, End-Use and Planning. 15. Staff. As of December 31, 1982, IDBP had a professional staff of about 330. The percentage turnover of professional staff has been high, but has dropped from 14% in FY77 to 5% in FY82 partly as a result of the recent increases in benefits. However, despite the FY79-FY80 review of compensation for IDBP staff, their benefits are still not equivalent to those paid by the NCBs and this is still one of the main causes of staff resignations. IDBIP has recently taken a number of measures to improve the compensation package for its middle level management. Salary and grade adjustments are now more frequent and are no longer strictly tied to seniority. This has resulted in a general improvements in morale, and lower turnover, among staff. -63- ANNEX 4 Page 6 16. Training. IDBP has an adequate and well-balanced training program. It includes in-service training, courses organized with the cooperation of local training institutes and universities, and sending staff to interna- tional seminars conducted by EDI, ADB, Industrial Bank of Japan, etc. In addition, the DID and other officers have undergone "on-the-job" training in institutions abroad with ongoing successful activities in subsector/economic research and corporate planning. Training programs for FYg4-FYS6 have been agreed with IDBP. Under these programs, IDBP plans to intensify training of its professional staff and would utilize technical assistance funds under the project for this purpose. III. POLICIES, PROCEDURES AND STANDARDS 17. Strategy. IDEP operates within the framework of a Strategy Statement prepared in 1981 and a policy statement prepared in 1970. The main features of the Strategy Statement are that IDBP should: (a) diversify its lending operations by emphasizing sectors other than textile such as engineering, chemicals, cement, sugar, electronics, sports goods and handicrafts; (b) emphasis on priority projects which are export-oriented, agro-based, labor-intensive or located in less-developed areas; (c) intensify its project identification/promotion efforts in line with its portfolio diversification objective; and (d) implement an "arrears recovery program" which seeks col- lection targets and actions geared towards improving the quality of its portfolio in the private sector. In this regard, improvements in its project appraisals would be sought and would include better "feedback" of experience with defaulting clients and projects experiencing difficulties; ne-w loans would not be made to clients in default and more importantly, IDBP would ensure that identified problems of client/project would have been resolved as part of its approval of loans to enterprises in the same industry. 18. Policy Statement. IDBP has recently adopted a new Statement of Financial and Operational Policies. The strategy was discussed and agreed upon during negotiations. The major features of the Statement are that: (a) IDBP will aim at (i) generating a 12% net return on equity; (ii) maintaining a debt service coverage ratio of not less than 1.1:1; (iii) maintaining a debt/equity ratio of not more than 5:1, and a return of 1.25% on its assets; (b) IDRP's total exposure to a single enterprise shall not normally exceed 15% of IDBP's networth (including GOP subordinated loans); (c) IDBP's total equity investment would not exceed its networth; and (d) the minimum equity contribution of borrowers would normally not be less than 30% of the borrower's total fixed assets after completion of IDBP's financed project. -64- ANNEX 4 Page 7 19. Appraisal Standards. Under Cr. 117-PAK and subsequently under Cr' 1186-PRK , IDBP took action to improve its appraisa:L standards and proce- dures. These actions included project appraisal by project: teams and the caic-ulation of economic/financial rates of return and domestic resource Costs. Hcwever, since 1980 the need has been noted for TD13P to: (a) improve the presenta-tion of appraisal reports 7ny detailing the teasiS of assumptions; andl using more annexes as needed; (b) re.3ort on procurement wiLth a summary of the analysis and just1-iEcation of procurement procedure followed/tenaders received; tc2 uipdat:e appraisal reports prior to submission to IDA or execution of loan agreements; and (d) adopt a policy of caution in financing new applications in projects/industries which are experi4encing difficulties, indicating the observed problems and how the sponsors of new projects expect to resolve them; particular attention being given to market, management and economic aspects. 7D31P' exoosure limits and lending policies are prudent and appropriate, but ihas been agreed that TDBIP shall obtain the prior approval of the Bank b'efore making any amendment in its Policy Statement. zO. There is also a considerable need for improvement in IDBP's subsector work a,d project promotion, particularly as IDBP plans to diversify its portfolio further beyond textiles. IDBP's intention to strengthen subsector work and project promotion is commendable and should be supported. Under Cr. 1186-PAK TDA has agreed to Fund the services of an external consultant as well as trhe 'on-the-Aob" training of some IDBP officers. The consultant would be expected to: (a) review the work program and recommend priority subsectors to be studied, takin,g into account IDBP's Strategy Statement, arrears position, and pipel:ine of projects; (b) participate and guide the preparation of subsector studies/surveys, and project profiles; (c) recommtend imnrovemer!ts in the role/functions of IDBP's Planning Department including its organization, staffing, and training program. IDBP has recently final- ized negotiations with a candidate for the post of the Economic Advisor and he is expected to join IDBP in early 1984. 21. Tnvestment Policies. A large part of IDBP's portfolio is still at risk and reflects the historical concentration in sectors such as textiles. Thu 9 t1here is a need for IDBP to redirect its lending strategy and achieve greater diversification of its portfolio. Provision was made under Cr '136-PAPK for technical assistance in the area of subsector analyses to help TDBP identify economic growth sectors (paragraph 20). As part of its strategy on portfolio diversification, IDBP should establish exposure guidelines limiting lending to certain sectors. -65- ANNEX b Page 8 22. Project Supervision. IDBP's End-Use Department (hUD) whTic is responsible for follow-up and collection activities, has a satisfactory organization and procedures. Regional offices/branches are responsible for follow-up of clients and with adequate feedback to head office throughl a regular reporting system. In this regard, IDBP's accounts are classified into retail and wholesale projects and into four categories. Ti.is class-- ification provides guidelines for the frequency of visits and type of reports to be prepared, given the size of loans, amount and age of arrears, and status of account (inspection reports for projects under construction/disbursement, project completion reports and operation rep' orts also cover problem Drojects, under litigation or under rescheduling arrange- ments). IDBP uses the "inspection" reports in monitoring and authorizing loan disbursements; the reports are based on quarterly visits (more often if a project is in difficulty) and includes verification of assets, mortgage and utilization of disbursements; as a policy, IDBP disburses directly to sup- pliers of goods ad services and based on satisfactory reports on loan utilization. EUD in head office concentrates on special studies of problem projects, debt rescheduling of companies with large arrears including public sector accounts, overall monitoring, control, planning, and strategy formulation. IV. OPERATIONAL PERFORMANCE Resource Mobilization 23. IDBP's foreign currency resources have come from bilateral credits and borrowings from IDA and ADB. From its inception up to June 30, 1983, IDBP mobilized a total of $480 million, of which $395 million had been dis- bursed, leaving $85.0 million available for disbursement. This unallocated amount was mainly composed of the second IDA credit of $30 million, 1/ a credit line of US$40 million was made available by ADB in June 1983. The balance was in the form of bilateral credit lines from the Federal German Republic, Belgium, France, Denmark and Italy. Availability of foreign cur- rency resources will enable IDBP to accelerate the pace of lending and implementation of approved projects in the coming year. 24. IDBP's rupee resources for financing of fixed investment come mainly from SBP's refinancing credit lines for buyers of locally fahricated machinery. As of June 30, 1983, IDBP's credit lines from SBP for this pur- pose totalled Rs 500 million, of which Rs 350 million had been utilized. 1/ As of September 1, 1983, Cr. 1186-PAK, was fully committerl -66- ANNEX 4 Page 9 Lending Operations 25. General. Since its inception in 1961, through June 30, 1983, UDBIP has provided Rs 6.1 billion of funding for 4,600 projects. From FY61, andg more particularly since FY715, IDBP's level of activity has been uneven, reaching a low in FY77 with cancellations exceeding approvals, and a record 'nigh of Rs 600 million in FY83. In IDBP's approach, a loan becomes approved once funds have been allocated and the borrower has fulfilled the formalities and effectiveness conditions to IDBP's satisfaction. Because of a lack oi- forei-gn currency resources, only 45% of IDBP's foreign currency approvals from FY76-FYB2 have been co-mnitted, while about 75% of its commitments have been disbursed. 26. Industrial Lending. Since its inceDtion, about 66% of IDBP's loans hav- been to new enterprises and 32% to existing enterprises for BMR projects. The average size of a loan has been about Rs 1.3 million although loans above Rs 10.0 million account for about 50% of total lendings. The sectoral distribution of lending has been biased heavily to the textile sector which has received 22% by number and about 45% by value. In this regard, IDBP's Strategy Statement contains a policy of diversification, with financing of the textile sector now limited to BMR prcjects. During FY83, industrial lending was mainly for food industries (28%), textile (18%), non-metal minerals (7%). Therefore, it is clear that IDBF' has been making a conscious effort to diversify its portfolio. In making its recent industrial loans, TDBP has followed the major financial guidelines Set out in paragraph 18. 27. Equity Investments. IDBP can make equity investment in its assisted projects. However, it has not been active in this area since FY78. As of J.une 30, 1983, IDBP's equity investments totalled Rs 24.9 million, accounted for by nine public sector companies, i.e., Rs 3.6 million in ICP, NIT, Equity Participation Fund, and Rs 21.3 million in six manufacturing enterprises. 28. Developmental Impact. IDBP has received two IDA credits and a numnber of loans/credits from ADRg and other donor agencies. Through these loans, and particularly those in the mid 197Os, IDBP has played a positive role in the development of small- and medium-scale industry, although more recently in line with the changes in the financial sector, it has tended to concentrate its lending operations on medium- to large-scale capital intensive projects. Since FY76, IDB;P's financial assistance has averaged 5% of total fixed investment in the private manufacturing sector and 60% of the fixed invest- ment cost of TDBP financed pro!ects. From vY76, IDBP's projects have gerer- ated about 20,000 new jobs at an average job cost ratio of Rs 87,200. Gross foreign exchange earned/saved by IDBP's projects accounted for about 0.9% of total exports during the same rperiod, with export earnings of Rs 112.0 mil- lion annually by projects completed during FY81 and FY82. A sample of sub- projects financed under Cr. 177-PAK showed ex-ante IFF'Rs of 14% to 35% and ex-post IFRRs of an average of 24%. On a sample of 42 projects approved in FY80-FY82, IVRRs range from 12% to 40%; IERRs range from 13% to 50%; DRCs -67- AN7EX A Pa-ge 1b calculated for 16 prolects were below the exchange rate, ranging froin 's 5.0 Lo Rs 8,6. The ex-poost IERR calculated for nine projects (14% ol tihe r;zlej financed under Cr. 177-PAK had a mninimum of 16% which is satisfactory. V. FINANCIAL ASPECTS Financial Position 29. IDBP?s Balance Sheets for FY79-FY83 are shown in Attachment 1. During the period, total assets increase by 10% per annum, networtn increased at 14% r.a. including the increase ifn paid-in capital of Rs 50 mlillion in FY81, while total borrowings grew at 12% p.a.; due to increasing arrears, IDBP resorted to SBP cash credits to meet its liquidity requirements, resulcl- ing in an increasing debt/equity ratio which in FY80 was 11:1; the contrac- tual debt/equity ratio 1; of 5:1 was exceeded in FY80, necessitating an additional equity infusion of Rs 50.0 million by GOP in FY81. Since FY78 there has been an appreciable increase in IDBP's borrowings which. have risen from Rs 1.4 billion in FY79, to Rs 2.2 billion in FY83, of which 30% was in foreign currency and 70% in local currency. The local currency borrowings included (i) SBP refinance facilities for the procurement of locallv manufac- tured capital goods; (ii) subordinated Government loans; and (iii) SBP cash credits for liquidity support. Section 3.04 of the Project Agreement far Cr. 1186-AKY requires ID1P to maintain a debt/equity ratio of 5:1. As of June 30, 1982, TDBP had a debt/equity ratio of 5.6:1. In December 1982, GOP provided IDBP with additional equitY of Rs 50 million, rescheduled cash credits of Rs 648 million over five years, extended the maturity of an exist- ing subordinated loan of Rs 151 million_ and converted maturing debts to GOP of Rs 336 million into subordinated loans. This arrangement broughnt IDBP's debt/equity ratio down to 4.1:1 by June 30, 1983, which complies with IDA's prescribed limit. Profitability 30. Attachment 2 shows IDBP?s summarized profit and loss statements for FY79-FY83. On an accrual basis, IDBP has achieved an average growth of 7% p.a. with its gross income reaching Rs 261 million in FY83. Net profits for FY79-FY83 average Rs 11.7 million. IDBP's profitability was marginal until FY83 when it earned 16% on equity. Administrative expenses were Rs 37.0 1/ Under Credits 177-PAK and 1186-PAK, debt is defined as all debts, includ- ing deposits, but excluding (a) accounts payable and similar liabilities; (b) debts guaranteed maturing not more than one year at the time they were originally incurred; equity is defined as the aggregate of (a) total unimpaired capital surplus, and free reserves: (b) IDBP's Special Development Fund; and (c) loans subordinated to other debts and ID)BP's share capital. -68- ANNEX 4 Page 11 milon fr F7Y83, re-presenting 1.4% of total assets which is reasonable; 1/ acc1M-.!17ated provisions of Rs 178 million were 7% of total portfolio. IDRP ;- aes r7: p-'ovs-ion annually, lbased on a case-by-case review of its accounts and cca:ares amounts due to estimated realizable values of collaterals inC'ldu1ng an assess7.ent of potential collections. Based on the results of its arrears r .ecoverl program, IDBP reviews the adequacy of its provision anrnualiv The provisions together with the unaccrued interest booked in the suspe.ee account are adequaite to cover potential losses. Liqu i'dl_vPonsition, 31 D'ue -.o l ow collections, IDBP has not been able to service its debts from internal cash generation (paragraph 35), but has had to rely on cash credlis froi SBP. These credits increase(d froim Rs 151 million in FY76 to Rs 61i7 rd 1 lion at the end oF FYB2 and have stabilized at that level due to th oprovements in collectton. Also, under Cr. 1186-PXK and the recent ADB c-edit 7new cash credit linas from SBP are to be provided to IDBP at half the aink rate (5%) unti` 1987. This will have a very positive impact on IDBP`s capital base and debt service capacity (paragraph 29). 32 Messrs. A. F. Ferguson and Co., and Ford, Rhodes, Robson, Morrow Chartered- Accountants - continue to be IDBP's auditors. The quality of the audit repcrt is satisfactory although submission to IDA of the long-form audt has been. beyond the required period of six months. IDBP's "short-form" audit is prepared within four months of the fiscal year and should be sub-- iltied to IDA -within this period. VI. PORTFOLIO MANAGEMENT '9ualitv of Portfolio 33, Foreign exchange fluctuations have created special problems for -D321Pas collection activities. These in turn have resulted in a serious deterioration in the quality of the portfolio. In 1972, the rupee was *-.alued from' Rs 4,76:US$1.00 to Rs 9.90:US$1lO00; more than doubling the ru,pee e,.uivalJnt of debt obligations of IDBP's clients who carried the for- eigr slckange risk and resulting in more clients incapable and sometimes 1-inwlllig to pay the larger amounts due. IDEP's loan documents stipulated thaL rp'enavmert by clients should be made at the foreign excbange rate p a g at -he time of repayment. Since IDBP had mLet its foreign debt i/ Comnared to NDFC and PICIC, this ratio is high. However, it compares favorably to the ratios of other development banks; in Asia with similar Operations, i.e., small and medium scaled industries. -69- ANNEX 4 Page 12 obligations as these fell due at the pre-devaluation rate prior to receiving repayment from its sub-borrowers, IDBP showed an initial gain of Rs 214 million, which increased to about Rs 800 million as of June 30, 1982 In this regard, IDBP's policy is to recognize these amounts as income only wnen they are actually collected. This is appropriate since many of its clients have disputed IDBP's rights to collect these amounts and the problem is still before the courts. GOP's position has been to declare that the matter of repayment will be left between the sub-borrowers and financial institutions. Under the repayment arrangements on IDBP's public sector companies and based on a case-by-case review, it has been agreed that foreign exchange loans would be converted into rupee equivalent at rates prevailing at the time they fell due and thereafter treated as IDBP rupee loans; in effect, this meant that a higher interest rate would be charged in lieu of the foreign exchange gains. 34. Under agreements with GOP, IDBP's public sector portfolio is not at risk as GOP has guaranteed payment of accounts due or has allowed IDBP to offset arrears against amounts due by IDBP to GOP. On the portfolio at risk the trend in arrears and infection of the portfolio has been as follows (Table 1): Table 1: TREND IN ARREAR FY79 FY80 FY81 FY82 FY83 Arrears (Rs million) 1. Total arrears 722 776 711 907 877 2. Total at risk 1261 1351 1296 1652 1615 3. Total portfolio 1444 1478 1643 2019 2357 Arrears Ratios % Arrears 50 57 55 55 54 Portfolio Infection 87 80 79 82 69 Collections 35. An analysis of IDBP's recoveries for the last four years is provided in the Attachment 4. A summary is given in Table 2. IDBP's recoveries performance for the last two years is in line with the target set under Cr. 1186-PAK. However, the recovery level is still very low and IDBP will need to achieve much higher levels if it is to become financially independent and not subject to continued support of GOP or the SBP. As cases under litiga- tion are beyond IDBP's controls, it is more realistic to assess IDBP's per- formance by using the ratio of cash collections on current dues to current dues. This ratio shows that collections have increased from 30% in FY8O to 58% in FY83. However, as this ratio reflects the quality of loans approved in the last three to five years, the ratio should be at least 75% to arrest an increase in the level of arrears. Under the proposed project, IDBP has ANNEX 4 -70- Page 13 agreed to initiate actions that should enable it to reach t:his level by FY86 (Daragranh 51). Table 2: TREND IN RECOVERIES (Rs million) Cash collec- Cash collec- Current Total Resched- Cash collection tion/total tion/current dues dues uling Past: dues Current Total dues (%) dues t%_ FY8O 74 2,102 98 119 74 193 9 30 FY81 97 2,018 943 115 97 212 11 47 FY82 159 1,369 24 89 159 248 18 51 FYR3 216 1,614 258 98 216 314 19 58 Arrc ,rs Recovery Program 36. GOP Measures FY81-FY82. During FY81-FY82, GOP in close cooperation with IDA has taken the following, measures to support collection efforts in the private sector by IDBP and other financial institutions in Pakistan. These measures include: (i) a Special Recovery Ordinance; (ii) credit cur- tailment by NCBs; (iii) restriction on investment sanctions; (iv) establishment of a GOP pro-ject review committee for sick projects headed by Secretary, Ministry of Finance; and (v) a joint GOP/IDA review of sub- projects and of IDBP's collection performance. 37. Special Recovery Ordinarnce. GOP has passed a Special Recovery Ordinance which facilitates settlement of collection claims by the commercial banks, PICIC and IDRP through the following major provisions: (i) establishment of spEtcial courts to handle onlv col:Lection cases: (ii) simplified and continuous court procedures; (iii) no appeals allowed unless a cash deposit equal to amount decreed is made; (iv) public officers asked to assist in collecting decreed amounts; (v) additional security on existing loan if original security is inadequate; and (vi) contractual interest rat:es charged from the date of decree until date of payment. GOP has appointed two special iudges in Sind Province, and one special judge for each of the other three provinces. While the mechanism for the implemen- tation of the Ordinance is in place, its full effects are still to be real- ized since the special courts are not yet fully operative and the rules and -71- KA`;NTEX 4 Page 14 procedures are still being improved. GOP has confirmed that IDBP has the option to opursue Its cases under th is Special Recovery Ordinance or under provisions of its own Ordinance as amended. in some instances, the latter has more advantageous provisions such as lower court fees, amounts due cer- tified by TDBP are final, designated IDBP officers have the authority of I'public" (government) officers in enforcing collections, etc. 38. Credit Curtailment. GOP and the SBP have curtailed commercial bank advances to borrowers irn default in their repayment to TDBP/PICIC. The Pakistan Banking Council has issued corresponding instructions to commercial banks with emphasis on clients with arrears of over six months and cases filed in court; overall objective of this procedure is to arrive at satisfac- tory rehabilitation settlement. 39. Investment Sanctions. GOP has imposed restriction on companies or groups of companies in default with IDBP and PICIC from getting investment sanctions under the non-repatriable investment (NRI), Pay-As-You-Earn (PAYE), suppliers' credit or any other schemes until the arrears are cleared or an arrangement is made with IDFP to meet the liabilities. 40. Project Review Committee. GOP has established a committee headed by Mr. H. U. Beg, Secretary, Ministry of Finance, to carry out reviews and decide on actions to be taken on sick units in the private sector whicil are in default with IDBP. These units include medium/large projects wnich have remained closed for more than one year, or operating units with substantial accumulated losses, and small units with foreign currency loans of up to Rs 1.0 million. 41, GOP/IDA Review. One of the special conditions of Credit 1186-PAK is thar IDA would have the option to withhold authorization of subprojects if It considers that measures and performance of IDBP are inadequate under its arrears recovery program. In 1ine with this condition, a GOP committee in consultation with IDBP and IDA, has commenced a formal review of IDBP's arrears recoverv program starting with the period ending December 31, 1q81. GOP now holds semi-annual meetings. For this purpose, IDEP submits progress reports to IDA containing actual performance versus targets on: (i) cash collections for public sector and private sector accounts broken down into existing loans as of June 30, 1981 and new loans; (ii) special studies completed on problem projects, indicating recommended action and timetable of actions taken or to be taken. (iii) number and amount of rescheduling and write-off; (iv) number and amount of court cases filed and resolved (decreed) during period, including outstanding cases at the end of the period (wilful defaulters under separate classification); ANNEX 4 7w ~~~~~~Page 19 (v) number and amount of cases l`c.uidated, actual and expected collections or write offsf (viq suirniary statement of collections and arrears for the period ro'k.en down into Public Private sectioons; and vi i' proposed new actions/raeasures of IDBP's arrears recovery program. 4?- LProDosed Measures - Y83. Additional to the measures already in place IDA has proposed the following actions to help IDBP improve its operating capabilities and arrest the continuing increase of arrears in its portfolio (i) revision of its Strategy Statement and Operating Policies to reflect the changed operating environment, the need for appropriate sectoral exposure limits, and identification of areas of investmentt growth potential; (ii) determination of staff levels appropri.ate to TDBP's operation with particular reference to the needs of end-use operations; (ioi 3completion of a portfolio review by negotiations; and ;iv) Dreparation of detailed regional/sectoral collection targets for FY84-nv5. VII. PROSPECTS 43 The general business prospects for DFIs in Pakistan are like'-, to be good due to the continued improvement in the investment climate and GOP's policy of promoting private industrial investment. With its new busirness strategy and restructured balance sheet (paragraph 45), IDRP should be able to perf-orm much better over the next two to three years; than in the past. Until 1931, IDEfP did not h2ave adequate resources, neither the management str-uctu.re to expand its operations. It was mainly prec,cupied with the £ouem.s of ar-rears and was unable to grow and diversify. Barring any major political upheavals and economic downturns, IDBP shoulH be able to grow and gradually regain its market shares. P roected %Daratiofns 44. A summary of IDBP's projected level of operations for the FY84-88 is provided in Table 3 below. ANNEx 4 Page 1- Table 3. Summary of Projected Operations (FY84-88) (Rs million) FY83 FY84 FY85 FY86 FY87 FY88 (Actual) Loan approvals (net) 460 542 611 689 777 876 - Local currency (270) (287) (330) (380) (437) (502) - Foreign currency (190) (255) (281) (309) (349) (374) Commitments 425 261 297 332 382 440 Disbursements 373 541 718 640 663 749 TWTorking capital loans - 25 225 275 400 400 Deposits - 25 150 200 200 200 Source: IDBP; FY: July I-June 30. IDBP's term lending operations are projected to grow from Rs 460 million in FY83 to Rs 876 million in FY88. This assumes a nominal growth rate of 13.8%, or a real growth of around 6% p.a. Given that under the SFYP the private industrial investments are projected to grow in real term by 22% p.a., TDBP's projected operations are modest and achievable. IDBP also has a good pipeline of projects (Annex 7). 45. One of the main objectives of IDBP's new business strategy is to increase the volume of working capital loans and finance these loans by deposits. IDBP has so far been constrained from doing so by its Charter, which restricts working capital lending. The Charter was amended in Novem- ber 1983 and the restriction has not been removed. IDBP is planning to provide Rs 35 million in working capital loans in FY84 and increase the volume at a more rapid rate in subsequent years to reach a level of Rs 400 million p.a. by FY88 (Table 3). To support this increase IDBP is preparing a campaign to attract at least Rs 200 million in additional deposits. This is a rather ambitious objective but with an appropriate organizational structure and management commitment, an achievable one. Resource requirements 46. During FY84-86, IDBP plans to lend at least Rs 1.8 billion with about Rs n.8 billion in foreign exchange. As of June 30, 1983 IDBP's untied for- eign exchange resources available for new commitments consisted of a credit line of US$40.0 million from ADB and about IJS$5.0 million from IDA Cr. 1186-PAK. With the allocation of US$15.0 million under the proposed lTIC project, IDRP will have adequate resources to meet its foreign exchange requirements until FY86 unless it expands its lending program more rapidly than presently envisaged. 47. IDBP's local currency operations are expected to be around Rs 10 billion during the same period. In addition, IDBP plans to lend Rs 0.5 ANNEX 4 Page 17 billion for working capital loans. Local currency requirements would be met mainly by the expected increase in deposits, retained earnings, suppliers credits from SBP, and proceeds cf the proposed subordinated debenture issues of Rs 100 million in FY85 in that order. Projected Financial Results 48. IDBP's projected financial statements are given in Attachment 3 and a summary is presented in Table 4 below. Table 4. Summary of Projectedl Financial Results and Conditions (FY84-88) (Rs million) FY84 FY85 FY86 FY87 FY88 Fin,- cial Positions Local currency loans 1,740 2,224 2,559 2,919 3,290 Foreign currency loans 1,598 1,839 2,074 2,314 2,524 Working capital loans 35 290 575 975 1,290 Less: Provision for losses (221) (271) (323) (380) (439) Loan portfolio (net) 3,152 4,082 4,88'5 5,828 6,665 Commercial deposits 140 290 565 865 1,190 Rupee borrowings 1,983 2,465 2,790 3,178 3,525 Foreign currency borrowings 822 1,016 1,174 1,294 1,401 Subordinate debentures - 100 1o0 200 200 Paid-in capital 100 100 100 100 100 Reserves 171 225 290 367 433 Total Assets = Total Liabilities 3,417 4,407 5,239 6,235 7,137 Net Profit (Rs million) 49 59 73 88 70 Financial Ratios Net profit/average networth (X) 19.6 19.7 20.2 20.4 14.1 Administrative expenses/ average total assets (x) 1.4 1.3 1.2 1.0 1ol Debt/equity ratio 4.5:1 4.1:1 3.9:1 3.5:1 3.7:1 Debt service coverage ratio 1.23 1.22 1.11 1.12 1.10 Source: IDBP and mission estimates. 49. Projected Profitabi:Lity. Because of GOP's measures (paragraph 29), a higher level of activities, and expected improvement in recoveries, IDBP's ANNEX 4 -75- Page 18 net profit is projected to grow from Rs 33 million in FY83 to Rs 88 million in FY87 and decline In FY8S to Rs 70 million, when subsidies are expected to be withdrawn. Net profit as a percentage of networth is projected at 19.6% in FY84 and to remain over 15% until FY88. Debt/equity ratio is projected to be well below 5:1 throughout the period. With higher operating volume and an expected increase in loan size, administrative expenses as a percentage of total assets are projected to gradually decline from 1.4% in FY84 to 1.1% by FY88. 50. Projected Financial Position. IDBP's asset base is projected to grow at an annual rate of 21% from Rs 2.7 billion in FY83 to Rs 7.1 billion by FY88. Ahout half of the prolected growth is expected to come from working capital loans. If TDBP can implement its stated strategy, its working capital loan portfolio will account for about one third of its total port- folio, which will be a healthy mix enabling it to carry out its developmental activities and remains financially sound. The expansion will be financed largely by an increase in foreign currency borrowings, deposits, retained earnings and debenture issues in that order. 51. Portfolio and Arrears. IDBP' major problem so far has been the poor quality of its portfolio, which led to severe liquidity problems. For IDBP to survive and prosper, it has no other obvious choice but to vigorously address its arrears problems and ensure that its new loans are of higher quality. Furthermore, to maintain its liquidity position, IDBP will need to collect at least 75% of the amount falling dues on new loans i.e. loans made from FY81 onward. IDBP has little control on litigation cases on the older portfolio and will have to pay much closer attention to the new loans, which are recent and the direct responsibility of the present management. 76 ANNEX 4 Page 19 52. IDBP'3 projected trenld in arrears over FYP4-86 is shown below. Table 5. Projected Trends in Arrears (Rs in million) Projected FY83 FY84 FY85 FY86 FY87 (Actual) A. Opening balance 1,097 1,039 908 746 771 B. Amount Fallen Due (i) Againlst past dues 93 101 125 151 183 (ii) Current 372 433 488 604 719 (iii) Total 465 534 613 755 902 C. Foreign exchange aciustment 53 - - 119 D. Total dues (A+B+C) 1,615 1,573 1,521 1,501 1,673 E. Cash Collections (i) Against past dues 98 85 85 82 85 (ii) Current 216 280 340 448 520 (iii) Total 314 365 425 530 605 F. Rescheduling/Adjustment 262 300 350 200 175 G. Closing balance 1,039 908 736 771 893 Ratios (%) Cash collection current as 59 65 70 74 72 % of current amount fallen due [(E (ii)/B (ii)] Cash collection as 7/ to 20 23 28 35 36 total dues (E/D) The projected trend in arrears indicates that if IDBP c:an nmaintain the tempo in recoveries and make new good loans, it should be able to arrest the trend in arrears by FY85. Total arrears in nominal terms would decline if the cash collection of current amount falling due reaches 74%. Based on the assump- tion that IDBP can meet its recovery targets, the DSCR woul-d remain around 1.1, which will enable IDBP to have access to the pool of funds under the proposed project. INDUSTRIAL DEVELOPMENT BANK OF PAKISTAN Organizatlon Chart (As of June 30, 1983) BOARD OF DIRECTORS MANAGING DIRECTOR Mr. BashirAhmad DE-PUTY MANAGING DIRECTOP (END-USE) DEPUITY MANAGING DIRECTOP (OPERATION) DEPUJTY MANAGING DIRECTOR (PLANNING) Mr. M.W erTvon Mr S.AA Zaidl Mr S.M Yusuif ._ ~~~~~~~~~~~~~~ ~~PRE-INVESTMENT . ENDIJSE DEPARTMENT ESTABLISHMENT DEPARTMENT STUDIES & PROMOTION _ ~~~~~~~~~~~~~~~~~~DEPARTMENT Mr. S. Iqboluddin Mr MA A n Haeed Khan Mr Hlimoyat Al Khran SPECiAL STUDIES PROJECT EVALUATION PLANNING ..A._.TDEPARTMENT DEPARTMENT Mr. G A Khcjn Mr. K M. Nagra Mr MujlbuIliah Siddiqui CENTRAL ACCOUNTS BOARD DEPARTMENT & DEPARTMENT LEGAI CORPORATE CELL SMALL INDUSTRY _ ~~~~~~~~REFINANCE DEPAR1IMENT Mr. AzhauIlIah Khan Mr Muhammad Rqbal E N ______________ [~Mr Fazolur Rehman ENGINEERINGF DEPOSIT MOBLIZATION DEPARTMENT STATISTICS Mr M Sirajul . safl SECTION Mr. S.A. Harsan Mr Miotj ao Mr iitRkhon Hasan AUDiT, INSPECTiON &j METHODS DEPARTMENT [ SUMMARY OF STAFF STRENGTH Mri M.M Ahmed (AS OF JUNE 30. 1983) Head OfTice Regioral Offices Total ACAS 2 - 2 MBAs 24 26 50 Fnglneers 17 25 | 42 Economists 16 9 25 Statisticlans 4 -- 4 Bankers 84 154 238 tThers 131 212 3 3 Toald 27842 J 70 J World Bank-256459 r-E rt rFI -78- AMNEX 4 Attachment 2 Page 1 PAKISTAN INDIJSTRIAL DEVELOPMENT BANK OF PAKISTAN (IDBP) Income Statements (FY79-FY83) (Rs Million) Audited (FY--July 1 - June 30) FY79 FY80 FY81 FY82 FY83 INCOME Interest and other charges on loans 177 179 190 204 229 Other Income 23 25 20 23 32 Total Income 200 204 210 227 261 EXPENSES Interest on borrowings 127 138 142 157 153 Administrative Expenses 26 27 29 34 37 Other expenses including provisions for doubtful debt 26 21 25 19 30 Total Expenses 179 186 196 210 220 PROFIT BEFORE TAX 21 18 14 17 41 Less: Provision for tax 13 12 9 11 7 NET PROFIT 8 6 5 6 34 FINANCIAL RATIOS (% average total assets) Gross Income 11.2 10.6 10.3 10.3 10.4 Financial Expenses 7.1 7.2 6.9 7.1 6.1 Spread 4.1 3.4 3.4 3.2 4.3 Administrative Expenses 1.4 1.4 1.4 1.5 1.5 NET PROFIT 0.4 0.3 0,2 0.3 1.3 Net Profit/average total netwcrth 6.2 4.4 3.0 3.1 16.0 Source: IDBP AJNNE3Y 4.~ -79- At t,;,nnt, Page 2 PAKISTAN INDUSTRIAL DEVELOPMENT BANK OF PAKISTAN (IDBP) Balance Sheets (FY79-FY83) (Rs Million) Audited Ended June 30 FY79 FY80 FY81 FY82 FY83 ASSETS Liquid assets 30 33 31 44 32 Investments 113 73 75 75 91 Loan portfolio 1,078 2,019 2,058 2,304 2,658 Less: Provisions (161) (190) (178) (194) (178) 1,617 1,829 1,880 2,110 2,480 Other assets 82 85 90 115 92 Total Assets a/ 1,842 2,020 2,076 2,344 2,695 LIABILITIES AND NETWORTH Current Liabilities b/ 125 136 143 107 142 Mobilized deposits 156 149 125 125 115 Borrowings Foreign currency 560 615 512 554 652 Foreign currency loans re- yable in Rupees 119 100 89 84 81 State Bank - industrial loans 206 228 325 479 653 State Bank - cash credits 326 434 511 617 509 Federal Government loans 151 151 151 151 252 IDBP debentures 10 - - - - Others 3 3 3 3 15 1,375 1,537 1,591 1,888 2,162 Other Liabilities 52 60 25 28 48 Paid-in capital 50 50 100 100 100 Reserves 84 88 92 96 128 Total networth 134 138 192 196 228 Total Liabilities and Networth 1,842 2,020 2,076 2,344 2,695 Debt/Equity Ratio c/ 4.7 5.0 4.5 5.6 4.1 a! Net of assest and liabilities in Bangladesh. b/ Excluding current maturity. c! Including subordinated debts. Source: IDBP -80- ANNEX 4 Attachment Page 1 PAKISTAN INDUSTRIAL DEVELOPMENT BANK OF PAKISTAN (IDBP) Projected Income Statements (FY84 - FY88) (Rs Million) P R O J E C T E D (FY---July 1 - June 30) FY83 FY84 FY85 FY86 FY87 FY88 (Actual) INCOME Interest on Loans 229 317 410 519 637 757 Interest on Short-term Investment 7 10 16 20 24 30 Fees & Other Income 25 25 28 30 33 37 Total Income 261 352 453 569 _94 824 EXPENSES interest on F.C. Loans 53 57 71 85 96 105 Other Financial Expenses 100 142 195 259 325 419 Administrative Expenses 37 _43 49 56 65 75 Provision for Doubtful Debt 30 43 50 52 58 59 Total Expenses 220 285 365 452 543 657 Profit before Tax 41 67 88 117 150 167 Taxation 7 18 29 44 63 97 NET PROFIT 34 49 59 73 88 70 FINANCIAL RATIOS (% average total assets) Gross Income 10.0 10.8 10.9 11.1 11.4 11.6 Financial Expenses 5.9 6.5 6.8 7.1 7.3 7.8 Spread 4.1 4.3 4.1 4.0 4.1 3.8 Administrative Expenses 1.4 1.4 1.3 1.2 1.0 1.1 NET PROFIT 0.4 1.6 1.5 1.5 1.5 1.1 Provisions/year end portfolio 6.7 7.0 7.3 7.5 7.8 8.0 Net profit/average total networth 16.0 19.6 19.7 20.2 20.4 14.1 ANNEX 4 -81- Attachment 3 Page 2 PAKISTAN INDUSTRIAL DEVELOPMENT BANK OF PAKISTAN (IPBP) Projected Balance Sheets (FY84 - FY88) (Rs Million) P R O J E C T E D (FY--July 1 - June 30) FY83 FY84 FY85 FY86 FY87 FY88 (Actual) ASSETS Cash & Bank Balances 32 29 34 39 41 42 Accrued Interest & Other Assets 77 77 77 77 77 77 Govt. Bonds & Unit Trust, Etc. 91 134 184 262 249 308 Local Currency Loans 1,261 1,740 2,224 2,S59 2,920 3,290 Foreign Currency Loans 1/ 1,396 1,598 1,839 2,074 2,315 2,524 Working Capital Loans - 35 290 576 975 1,290 Total Loan Portfolio 2,658 3,374 4,353 5,2O- 6,209 7,104 Less: Provisions for doubtful debts (178) (221) (271) (323) (380) (439) Net Loan Portfolio 2,480 3,153 4,082 4,886 5,829 6,665 Fixed Assets (Net) 12 21 27 32 37 42 Amount Recoverable from Govt. 2 2 2 2 2 Contingent Rupee Assets 1 1 1 1 1 1 Total Assets 2,695 3,418 4,407 5,239 6,236 7,137 LIABILITIES & NETWORTH: Commercial Deposits 115 139 290 565 865 1,189 Accounts Payables 237 246 257 267 277 287 Provision for Income Tax (47) (47) (47) (47) (47) - Rupee Borrowings 1,459 1,877 2,284 2,517 2,820 3,167 Rescheduled Borrowings 51 106 181 273 358 358 Foreign Currency Borrowing 652 822 1,015 1,174 1,294 1,401 Subordinated Debentures - - 100 100 200 200 Total L.T. Borrowings 2,162 2,805 3,581 4,064 4,673 5,126 Share Capital 100 100 100 100 100 100 Reserves 128 172 219 278 349 403 Debenture Redemption Fund - - 6 12 18 30 Total Networth 228 272 325 390 467 533 Contingent Rupee Liabilities I 1 1 1 1 1 Total Liabilities & Networth 2,695 3,418 4,4n7 5,239 6,236 7,137 Debt/Equity Ratio 4.1:1 4.5:1 4.1:1 3.9:1 3.5:1 3.7:1 1/ Including guarantees. ANNEX 4 Attachment 3 -82- Page 3 PAKISTAN INDUSTRIAL DEVELOPMENT BANK OF PAKISI'AN (IDBP) Projected ("ash Flow Statements (FY84 - FY88) (Rs Million) P R O J E C T E D (FY--July 1 - June 30) FY84 FY85 FY86 FY87 FY88 SOURCES Net Profit 67 88 117 150 167 Add: Non-cash transaction -- Depreciation 1 1 1 1 1 -- Provision for Doubtful Debts 43 50 52 58 59 Less: Income credited to profit & loss account but not received (112) (126) (127) (151) (137) Add: Expenditure debited to profit & loss account but not paid 52 67 76 72 30 Collection of Advances (Prin.) 169 182 222 255 317 Income Tax Paid (18) (29) (47) (68) (50) Interest Expenses 199 266 344 421 524 AVAILABLE FOR DEBT SERVICING 401 499 637 738 911 Drawn Down on Borrowings -- Local Currency 266 325 340 373 423 -- Foreign Currency 287 315 325 332 337 -- IDA Credit for SIRD 185 140 - - - Increase in Comm. Deposits 25 150 275 300 325 Subordinated Debentures - 100 - 100 - Total 1,164 1,529 1,577 1,843 1,996 APPLICATIONS Repayment of Borrowing -- Local Currency 34 58 108 70 76 -- Foreign Currency 93 84 120 169 231 Interest Expenses 199 266 344 421 524 REQUIRED FOR DEBT SERVICING 326 408 57:2 660 830 Disbursement of Loans -- Local Currency 266 325 340 373 423 -- Foreign Currency 287 315 325 332 337 -- Working Capital Loan 25 255 286 399 315 -- IDA Credit for SIRD 185 140 - - - Payment of Other Liabilities 25 25 25 25 25 Increase in Fixed Assets 9 7 65 6 6 Increase in Investment 43 50 18 47 59 Total 1,166 1,525 1,572 1,842 1,995 Surplus/(Deficit) 2 4 5 1 1 Opening Cash & Bank Balance 32 29 34 39 41 Closing Cash & Bank Balance 29 34 39 41 42 Debt Service Coverage Ratio (DSCR) 1.23 1.22 1.11 1.12 1.10 ANNEX 4 -83- Attachment 4 PAKISTAN INDUSTRIAL DEVELOPMENT BANK OF PAKISTAN (IDBP) ANALYSIS OF AMOUNTS DUE AND RECOVERIES (Rs Million) FY FY FY FY FY FY 1981 1982 1983 1984 1985 1986 A. Opening Balance 1,811 863 1,097 1,039 908 746 B. Amount Fallen Due: i) Against past dues 150 73 93 101 125 151 ii) Current 207 314 372 433 488 604 iii) Total Fallen Due 357 387 465 534 613 755 C. Foreign Exchange Adjustment (150) 119 53 - - - D. Total Dues (A+B+C) 2,018 1,369 1,615 1,573 1,521 1,501 E. Cash Collection: i) Arrears 115 89 98 .85 85 82 ii) Current 97 159 216 280 340 448 iii) Total 212 248 314 365 425 530 F. Rescheduling/Adjustment 943 24 262 300 350 200 G. Closing Balance (D-E-F) 863 1,097 1,039 908 746 771 RATIOS (%): i. Cash collection - current 27 41 47 52 55 59 to total Fallen due E(ii) as % to B. ii. Cash collection - Arrears 6 10 9 8 9 11 to opening balance E(i) as % to A. iii. Cash collection as % to 11 18 20 23 28 35 total dues (E as % to D) iv. Rescheduling & Adjustment 47 2 16 19 23 13 as % to total dues (F as % to D) v. Total collection & Adjust- 58 20 36 42 51 48 ment Rescheduling as % to total dues (E+F as x to D) vi. Cash collection current 47 51 59 65 70 74 as % to Amount Fallen due Current E(ii) as % to B(ii). -84- ANNEX 5 Page 1 PAKISTAN INDUSTRIAL INVESTMENT CREDIT (IIC) PROJECT NATIONAL nEVELOPHENT FINANCE CORPORATION :[. INTRODUCTION Rackground 1. The National Development Finance fornoration (NDFC) was established by GOP in January 1973, as a wholly owned government financial institution for the purpose of providing f:inancial and technical assistance to nublic sector industrial undertak-'ngs, defined as those which arP7 (i) whollv or partly owned by the Government:; (ii) wholly or partly owned by enterprises referred to in (i); and (iii) declared by the Government to he eligible for NDFC assistance. 2. Subsequently in October 1979, as GOP's industrial policy shifted over the years in favor of private sector undertakings, and in order to promot:e complementary and cooperation between the public and private sectors, NDFC was authorised by GOP to finance private sector ventures which fulfilled any of the following criteria: (i) procuring at least 40% of the value of machinery requirements from a public sector enterprise: (ii) procuring machinery and equipment worth at least Rs 10 million from a public sector enterprise; (iii) belonging to an industrial subsector orginally reserved for the public sector but subsequently opened to private investment. 3. In January 1983 an Administrative Order was issued by GOP to permit NDFC to (i) assist the private sector without any limitation but with a f'ocus on less developed areas of the country; (ii) finance undertakings of locEll governments and local authorities without need of prior approval by GOP; and (iii) form financial subsidiaries to expand its financial services (in this connection, a leasing subsidiary and a Regional Development Finance Corporation are being established). 4. With an initial authorized caDital of Rs 100 million (fully Daid-up as of September 1974), NDTFC quickly expanded and developed over the years into a "mixed bank". It was empowered to raise deposits of varying maturities and to borrow from international multilateral and bilateral sources as well as from the SBP. With the availability of short, medium and long term funds, NDFC acqu:ired a mixed portfolio, following a prudent practice of maturity matching. Aside from flexibility 4n lending as well. as borrowing and deposit takinag, NDFC benefi.ted from an exemption of liquidity reserve requirements and interest rate ceilings imposed on commercial banks. -85- ANNEX 5 Page 2 Unlike other DFIs, NDFC was exempted from income tax; and this facility, coupled with a policy of low dividend payments, allowed it to build-up a strong reserve position. More recently, however, NDFC has begun to pay dividends to GOP. 5. NDFC has benefited not only from preferred treatment under its Act, but also from maintaining close working relationships with Government, which allowed NDFC to issue Rs 200 million; 1/ of reservable bonds and expand into the private sector market. Over the years NDFC has proved itself worthy of Government support. While other DFIs encountered severe operational problems during this period, NDFC's operations proved to be sound and Drofitable allowing it to expand rapidly while still maintaining a healthy financial position. This was achieved by competent, innovative management and high professionalism among its staff. II. INSTITUTIONAL ASPECTS Board, Management and Staffing 6. Board. While NDFC falls under the general supervision of the Ministry of Finance, it has operating autonomy under its Board of Directors. The Board meets regularly to establish NDFC's overall policies and approve all direct lending proposals. Mr. Zafar Iqbal is Chairman and Chief Executive Officer. The other five members of the Board are appointed by GOP. The members represent the SBP, the Ministry of Finance, the Ministry ot Production and one from each of two other specialised financing instituLtions. 7. Organization and Management. Under the guidance of the Chairman, NDFC's organizational structure (Attachment 1) has evolved in response to NDFC's expansion, changing roles and the changing financial environment. Given the present level of operations, the structure is appropriate. However, based on NDFC's projected operations, some streamlining might be required to: (i) reduce the number of units reporting directly to the Chairman; (ii) group under the same executive vice presidencies related functional units, e.g. accounts and controllers could be both under Administration, project monitoring could be placed under End-use; (iii) breaking up credit and finance under two senior vice presidencies, one for credit and another for finance in order to decentralize these two major tunctions. 8. Staffing. As of June 30, 1983, NDFC had a total staff of 299, of which 162 were professionals and 137 were support staff, which is remarkable in the Pakistani context where support staff usually outnumber professionals 1/ NDFC's bond issue is classified as eligible assets tor reserve require- ments of commercial banks. -86- ANNEX 5 Page 3 by a large ratio. Personnel records of NDFC indicate that staff turnover, which was a malor nroblem, has been partly arrested; with staff turnover reduced from 15% in FY78 to 3% in FY83 (Attachment 2), and the average length of service of Drofessional staff increasing from 3.7 years to 4 years. This reduction has been achieved by providing an attractive benefit package and using other staff retention schemes. NDFC's remuneration is now considered reasonablv competitive with that offered by the NCBs. However, NlDFC needs to review its compensation structure to ensure that it remains reasonably competition with the foreign banking sector and the reviving private industrial sector. 9. Training. To compensate for loss of competent staff through turnover and to upgrade the capabilities of retained staff, NDFC operates a comprehensive staff training program covering development banking, working capital operations, small business operations, sectoral analysis and businiess prciaotion. Arrangements are in hand to develop training courses with ADB and EDI. Under the proposed IIC project, technical assistance/funding would be provided to NDFC to strengthen its proiect financing operations, build up the second and third tier management, and assist in structuring and launching a series of courses in subsectoral analysis. III. OPERATING POLICIES, PROCEDIJRES AND STANDARDS Operating Policies and Strategy 10. MDFC's Policy Statement, approved by its Board in January 1981, establishes clear guidelines for direct project financing, financial exposure limits and other appropriate financial nolicies. Following discussions wLth ADB and IDA, NDFC's Management prepared a draft Corporate Strategy Statement for FY83 - FY87 which outlines NDFC's objectives, sectoral. priorities, major operational Dlans and resource mobilisation goals during the period. DuriLng the appraisal of the IIC project, minor modifications to the draft were discussed with NDFC and agreement in substance reachedl on the revised draft. The adoption of the Strategy Statement by NDFC's Board. would be a condition for NDFC's participation in the project. Any subsequent c.hanges in the Policv Statement or Strategy Statement would require prior consultation with IDA and in the case of the Policy Statement, IDA's prior approval. Procedures and Standards 11. Appraisal Standards. In the initial period of its operations, NDFC placed considerable emphasis upon the development of a high level of appraisal standards. In large part, this emphasis has resulted in appraisals of good quality, providing adequate coverage of technical, market and financial aspects. For all projects receiving direct assistance, NDFC calculates the internal financial rates of return and the projects' debt servicing ratio; for projects above Rs. 10.0 million (US$0.8 million), NDFFC calculates the internal economic rates of return and normatlly, the domestic -87- ANNEX 5 Page 4 resource cost (DRC) ratio. While most projects have substantially higher economic rates of return, 10% is used as a normal minimum cut-off point. Appraisals and management reviews are usually completed witbin six months of initiation, wbicn is satisfactory. 12. Implementation and Supervision. NDFC has satisfactory procedures for project implementation and supervision. Supervision responsibility for short-term working capital loans has been decentralised to NDFC's branches. Supervision of long-term loans is carried out by the Hlead Office staff. Supervision priority is given to projects which are behind schedule or operating below the expected level of performance. Projects which have been operational for three years are subject to a detailed analysis to verify economic and other benefits vis-a-vis the appraisal data. 13. Procurement, Legal and Accounting. NDFC's procurement procedures are sound and conform to the Bank Group's recommended practice for development banks. Three competitive quotations are required for both domestic and foreign nrocurement, and procurement decisions are reviewed for price and quality adequacy. NDFC's accounting procedures and standards are also satisfactory. NOFC is considering the use of computer facilities to strengthen its operations through the introduction of a Data Management System (UMS). Technical assistance funding would be available under the proposed project, to assist NDFC in the design and implementation of the proposed system. IV. OPERATING PERFORMANCE Past Operations 14. As of March 31, 1983, NDFC had approved financing totalling Rs 9.6 billion (IJS$756.0 million) for 783 projects (net of cancellations). Projects were well distributed by sector, with agro-based industries accounting for 20%, energy 19%, steel and engineering 15%, cement 13%, automobiles 12%, chemicals 8%4 and other industries 13%. About 56% of the projects approved were in Sind, 39% in the Punjab and 5% in Baluchistan and NWFP. Since its involvement in private sector lending in FY82, NDPC has made 31 loans totallinR Rs 963 million (US$68 million). Resource Mobilization 15. Deposit mobilization is an activity that clearly illustrates NDFC's capacity for innovation. Without the extensive branch network of a NCB, NDFC succeeded in raising substantial amounts of deposits of varying matuirities. From FY78-FY82 NDFC's deposits grew at a compound rate of 17% p.a., slightly higher than the growth of overall denosits of the banking system (Attachment 3). NDFC has built its deposit base by soliciting deposits from its public sector clients, although more recently, NDFC has begun tapping the retail deposit market on a selective and targeted basis, -88- ANNEX 5 Page 5 creating special schemes to suiLt the requirements of target groups. NT)FC's newest scheme is bearer CD's whlich are expected to talp large amounts of funds from the unorganized capital markets. The strategy hag heen good market research on different market segments, creation of innovative instruments to reach these sub-markets effect.ively, and extensive market promotion. 16. Recently, NDFC. successfully raised long term funds by floating two bond issues of Rs. 100 million each with a coupon rate of 1O% p.a., which were quickly taken up by commercial banks. Considering the breadth and depth of the local capital markel:, this is an indication that NDFC has been accepted as a mature instit:ution. NDFC has also been able to generate short term foreign currency resources for specific clients through its correspondent banks, in connection with its import financing activities. While these facilities were provided to clients rather than to NDFC itself, the initiatives were taken by TIDFC for which it received either a finder's fee or management fee depending on its involvement. 17. To date, NDFC has not raised foreign currency term funds on its own account in the international market. In the past, NTD:FG had solicited and was offered a 1DM 20 million credit which it did not avail of since the terms were not sufficiently attractive, especially considering the interest rate constraint on the lending side. With the background of successful resource mobilization in the domest'ic market, the time seems appropriate for NDFC to test the international marlcet by raising a medium term foreign currency credit. NDFC's management con3iders this move an important sten in the maturation of the institution. The Bank Group should encourage NDFC to take this step at the appropriate time. Lending Activities 18. NDFC's lending operations consist mainly of term loans in local and foreign currencies; and to a lesser extent, working capital loans in local currency. To a limited degree, NDFC also provides equity capital, is involved in consortium financing, and arranges short term foreign currency loans for its clients. As of 4arch 31, 1983, DTFC had approved 371 local. currency working capital loans worth Rs 5.3 billion, 297 local currency term loans worth Rs 2.5 billion., an, 115 foreign currency term loans worth Rs 1.8 billion. Working capital loans accounted for about 65% of cumulative disbursements while foreigni currency term loans about 12% (Attachment 4). From FY78-FY83, tDFC's total loan portfolio grew at a comnound rate of 30% p.a. On average about 55% of NDFC's loan portfolio is medium and long term loans which increased sligihtly from 52% in FY78 to 587 in FY83 (Table 1). -89- ANTEX 5 Page 6 Table 1: Loan Portfolio by Maturity FY78-FY82 (Rs million) December 31 FY78 FY79 FY80 FY81 FYR2 Short Term 531 666 R45 PO 1311 Medium Term 84 108 133 217 283 Long Term 499 687 Q26 1117 1 548 Total 1114 1461 1904 22n3 3142 Source: NDFC. 19. Understandably, the bulk of NDFC's lending has been for public sector enterprises. As of March 31, 1983, only 8% in number and 22% in valuie of its term loans have been for private sector projects. TDFC's operations have concentrated on growth industrial subsectors reserved for the public sector. The five major subsectors covered were sugar, energy, chemicals, cement and machinery. While TDFC's clientele has been mainly large scale nublic sector enterprises, its average loan size is relatively small, with working capital loans of about Rs 14 million, term loans of Rs 9.0 million and foreign currency term loans of about Rs 16 million. NDFC's share in the total fixed investment of its projects has been only about 10%. Other Development Activities 20. Until recently, NDFC had given relatively little attention to subsector analysis and Droject promotion. However, in 1q82, NDFC established a Project Development and Consultancy Department to (i) conduct subsector studies aimed at identifying opportunities for investment, (ii) Promote suitable projects and entrepreneurs and (iii) carry out market potential studies. The TIC Project would provide technical assistance funding to assist NDFC strengthen these areas of its operations. During negotiations, a program of sectoral studies, to be carried out during FY84 - FYR6, was agreed. V. FINANCIAL ASPECTS Portfolio 21. As of December 31, 1982, NDFC's loan portfolio totalled Rs 3.3 billion (US$260 million). Of the 143 prolects in receipt of direct loans, only three were in arrears with overdue principal and interest payments of Rs 177 million (US$14 million) or 5.4% of the portfolio (Attachment 5). To cover these arrears, NDFC has a provision of Rs 44 million (USS3.5 million) for bad and doubtful debts. NDFC's arrears position is satisfactory. However, the quality of the portfolio needs to be monitored closely to avoid -90- ANNEX 5 Page 7 any significant increase in the level of arrears and more importantly, in the percentage of the nortfolio infected by arrears (i.e. principal not yet due). Financial Position 22. NDFC is in a sound financial position. Its financial statements for FY78-FY82 (Attachment 6) show that as of December 31, 1982 NDFC's assets totalled PRs 4.3 billion consisting of loans (76%), investments (14%) and other assets (10%). These were financed by deposits (487), borrowings (33%) and networth (13%). During FY78-FY82, NDFC's assets increased at an average annual rate of 23%; loans at 30% p.a. The growth was financed mainly by deposits which grew From Rs. 1.1 billion in FY78 to Rs 2.1 billion in FY82, or at 33% p.a. (Table 2). UDFC's long term debt/equity ratio ranged fromn 3.4-4.0 during the period and was 3.6 at the end of FY82. This was well below NDFC's limit of 5:1 leaving it ample room to finance its future expansion. Table 2: Key Growth Indicators FY78-FY82 (Rs Billion) Annual Compound FY78 FY79 FY80 VY81 FY82 Growth Rate % Deposits 1.1 1.2 1.3 1.6 2.1 17 Loans 1.1 1.5 2.0 2.3 3.2 30 Investments 0.3 0.2 0.3 0.6 0.6 18 Networth 0.2 0.3 0.4 0.4 0.- 25 Total Assets = Liabilities + Networth 1.9 2.2 2.6 3.1 4.3 23 Profits (mil.) 47 71 83 87 119 26 Source: NDFC. 23. NDFC's key financial ratios are presented in Table 3 below. NDFC's return on equity averaged 25% during the period, making it one of the most nrofitable DFIs associated with the Bank Group. NDFC has been able to operate profitably and maintain its sound financial position by (i) careful management of assets and liability; (ii) maintaining a average spread of 3.7%; and (iii) controlling administrative expenses at a ratio of 0.7% of total assets. Although NDFC's dividend payout ratio has increased significantly, its tax exempt status has enabled it to nlow back profits and build up a strong equity base. -91- ANNFX 5 Page 8 Table 3: Key Financial Ratios FY78-FY82 FY78 FY79 FY80 FY81 FY82 Average Nlet profit/average eqtiitv (%) 25 28 26 23 25 25 Net Drofit/assets () .5 3.2 3.2 2.8 2.8 2.9 Interest snread (%) 4.6 4.5 3.3 3.0 3.3 3.7 Administrative cost/ loan portfollo (%) 0.8 0.6 0.6 0.7 0.7 0.7 Term debt/equitv 4.0 3.5 3.4 3.6 3.6 3.6 Total debt/equity 7.6 6.8 6.3 6.6 7.1 6.9 nTisk asset/capital 6.6 5.9 6.4 7.o 6.3 6.4 Collection rate (%) 94 95 91 94 86 92 Source: NDFC. VI. PROSPECTS Operations 24. Lending. By FY87, total loan approvals are expected to increase from Rs 2.9 billion in FY82 to Rs 6.5 billion in FY87, reflecting an annual compotind growth of 18.0% in current prices or 12% in real term. This growth rate is quite conservative considering growth of 30% p.a. from FY78 to FY82. However, NDFC's main market, the public industrial sector, has been contracting from Rs 6.6 billion in FY78 to Rs 4.1 billion in FY82. NDFC's market share accordingly increased from 2% to 16% and any further increase in NDFC's share in public sector lending appears less attainable as GOP's current policy of restricting investment to the completion of on-going projects will further contract public industrial investment. On the other hand, private industrial investment has been increasing at an average annual rate of 20%. Clearly, rTFC's decision to move more aggressively into the private sector market is timely. If NDFC can maintain a 30% growth for its private sector portfolio (which is presently 22%), it would need to increase its public sector lending by only 6% p.a. in order to achieve the target of 12% p.a. This is considered an attainable and realistic target. -92- ANNEX 5 Page 9 25. NDFC's loan maturity mix is expected to tilt further in favor of term loans, from 37% in FY82 to 54% in FY87. Foreign currency loan approvals which will reach Rs 1.0 billion (tUS$79 million) in FY87 will constitute about 20% of total lending and MDFC`s foreign currency comaitment requirement in FY84 is about IJS$50 million. Total foreign currency disbursement requirements for the five-year period is US$240 million. As of June 30, 1983, NDFC½s project pipeline consisted of 44 projects estimated to have a total project cost of Rs 5o2 billion of which foreign currency requirement would be Rs 203 billion or USS181 million. 26. Resource Forecast, To meet its lending targets NDFC exnects to raise resources by increasing local currency deposits, using S3P refinance lines, fresh equitv infusions of about Rs 100 million in 1935, floating another debenture issue of Rs 100 in 1983 and borrowing foreign currency fund froom ADB, bilateral sources andc from IDA/IBRD. Deposits are orojected to grcw at 15% p.a.,, a rate which appears attainable considering NDFC's past growth of 17% n.a- and the 16% p.a. growth of overall deposits in the banking system in the past five years. SBP refinance lines will be used to match disbursement for sub-loans under these credits, i.e. supnilier's credit and export credit scheme. These will grow at 15% p.a. and will be within the credit ceilings provided by SBP to NDFC. 27~ Based on the foreign currency lending projections, NDFC would require about US$275 million for comrmiltment purposes during FY83 - FY87. Presently, NDFC has a French credit line of TUS$24 million, a BeLgian line of credit of USI1.6 million, and two ATM lines of credit of US$30 million and US$50 million respectively. Except for US$43 million from the second APB loan, 1/ all these credit lines have been fully commAttedi. The projected gap of l'S$232 million is expected to be met partly by an ADB line of US$50 million, the IIC allocation of US$20 million, with the balance of US$162 million to be funded partly by the pool available in the first IIC, allocations under subsequent ITCs, ADB and by commercial banlc borrowing. "DFC's foreign currency resource shortage will be felt inL the second half of FY85 and NDFC plans to borrow from the international mnarket toward the end of CY 1985. Assuming thal: NDFC can borrow US$50 million each under the second IIC and a fourth ADE loan, NDFC should plan borrowing about US$60 million from commercial sources. The Government's New Industrial Polizy is expected to be announced shortly and this may change overall investment plans for the count:ry, with consequent changes in TMFC's financing needs. 1/ The ADB loan is expected to be fully comtmitted by June, 1983. -93- ANNEX 5 Page 10 Financial Projections 28. Based on its lending operations forecast and funding strategy, NDFC's projected financial statements are presented in Attachment 7. Key indicators are summarized below: Table 4: Projected Financial Position FY83-FY87 (Rs billion) FY83 FY84 FY89 FY86 17Y87 Loan Portfolio 4.2 5.3 7.1 9.I 11.4 Deposits 2.6 2.9 3.3 3.8 4.3 Borrowings 2.0 2.9 4.0 5.2 6.5 (Including Debentures) Networth 0.6 0.7 0.9 1.2 1.5 Total Assets = 5.4 6.8 8.6 10.5 12.7 Liabilities + Networth Net profits (Million) 140 199 247 310 382 29. Total assets are projected to increase to Rs 12.7 billion in FY87 reflecting a compound growth of 25%. Deposits are expected to grow¢ at 15% p.a with term deposits (more than one year) growing faster and increasing share from 25% in FY82 to about 35% in FY87. As a percentage of total assets, NDFC's loan portfolio is expected to decline from 75%, to 65% improving its liquidity position and keening its liquidity reserve well within the requirement of 25% of deposits. Assuming continued income tax exemption and infusion of fresh equity-funds of Rs 100 million in FY85, NDFC's networth will grow to Rs 1.5 billion by FY87 maintaining a satisfactory canital base of 13% of assets desnite the projected exDansion in lending operations. With an average gross interest spread of about 4.5%, operating profits are expected to reach Rs 0.4 billion in FY87. 30. For FY83 - FY87, NDFC's profitability and financial structure are projected to be as follows: -94- ANNEX 5 Page 11 Table 5: Projected Key Financial Ratios FY83-FY87 FY83 FY84 FY85 FY86 FY87 Average Net profit/average equity (/%) 30 26 97 28 30 28 Net profits/assets (%) 3.3 2.8 2.9 3.2 3.4 3.1 Interest spread (%) 2.9 3.2 3.2 3.1 3.4 3.2 Administrative Expenses/ loan portfolio (%) 0.8 0.8 0.8 0.6 0.6 0.7 Term debt/equity 3.9 4.2 4.3 4.2 4.2 4.2 Total debt/equity 7.2 7.6 7.2 7.1 6.8 7.2 Debt service coverage ratio 6.3 6.2 4.5 4.7 4.3 5.2 Risk asset/capital 5.9 5.8 5.4 5.3 5.0 5.5 Source: NDFC. NATIONAL DEVELOPMENT FINANCE CORPORATION Organization Chart (As of June 15, 1983) CHIAIRMAN F_~r EVELOPMENT 8, ~~~~~~~~~INESMENT MIONLANSADMINISTRATION POOO PROJECTS DEVELOPMENT FINACE DEVELOPMENT RANK - &NE MONITORIGT OSLA1sAMNSRTO OOO & CONSULTANCY INTONSTTNG Aftab 6Qjreohl D No-, Alkhto, M.I Abbos, Moi,ammad Aslam TMRohsm d MuzafTfr Y_-usf Al, M Sald E P EVP E,P iWPEV EVP EP (1) (o) (1) (2) (1) (1) (2) PROJECT PROCT T MARKET RESCAHCH BRANCHES BRANCHES ICiEF FINANCING IMPLEMENTATION DEPARTMENT NORTH SOUM& IM&M A EHM&M SOETRI ACCOUNTS LAW ECONOMIST N Ahmoed l H MssJeeb Vocant RnshidAhmed SC Abbos | | R Amed | Voccn SR. Ahrmed NosT ARmed | G AbbaS N Mursheo SW sW _ SVP SVP SW l l SP TSP TSP SP vSP SWP (12) (2) (3) (43) (24) (3) (9) (10) (8) (4) (1) HQ arEnches HQ BranEhes FOP; REX R MANAGEMENT l CAR LOAN ADMIN | |COvPTROLLER| | S HqssioR R. R EI A Namorn J RaI A r eOR (6) (2) (2) (9) (TO) Note Fhu-s in porenthesIs aRm the anmber of ocers in th. crncemed dviso, seCTiR &/oT branch World Bank-25458 * Office located away iram head office RET ,lZ iD 0< EtLJr ,t -96- ANNEX 5 Attachment 2 PAKISTAN NATIONAL EEVELOPMENT FINANCE CORPORAT:ION STAFFING TREND FY78 - FY83 December 31 FY78 FY79 FY80 FY81 FY82 FY83 As of January 1 65 66 76 86 96 123 Recruited 13 20 18 13 35 46 Deceased - - 1 - - 2 Resigned 12 10 7 3 8 5 66 76 86 96 123 162 Support Staff 99 100 110 _116 135 137 Total 165 176 196 212 208 299 Professional Staff Turnover Ratio (%) 18.2 13.2 8.1 3.1 6.5 3.1 9/20/83 ASPID -101- ANNEX 5 Attachment 5 Page 3 NATIONAL DEVELOPMENT FINANCE CORPORATION COLLECTION PERFORMANCE ON LOAN PORTFOLIO 1/ FY78 - FY82 (Rs. Million) Year Ending December 31 FY78 FY79 FY80 FY81 FY82 Arrears January 1 Principal 11.0 11.3 16.5 46.1 34.8 Interest 2/ 21.1 15.2 11.3 25.6 57.9 32.1 26.5 27.8 71.7 92.7 Current Dues during the Year Principal 287.6 388.0 661.6 849.7 1,109.4* Interest 2/ 97.2 121.7 157.3 223.3 251.2 384.8 509.7 818.9 1,073.8 1,360.6 Total due for Collection Principal 298.6 399.3 678.1 895.8 1,144.2* Interest 118.3 137.3 168.6 248.9 309.1 416.9 536.6 846.7 1,144.7 1,453.3 Cash Collection Principal 287.3 382.8 632.0 861.0 1,030.0 Interest 103.1 126.0 143.0 191.0 246.0 390.4 508.8 775.0 1,052.0 1,276.0 Arrears December 31 Principal 11.3 16.5 46.1 34.8 114.2* Interest 15.2 11.3 25.6 57.9 63.1 26.5 27.8 71.7 92.7 177.3 Percentage Comparisons Cash Collection/ Total due for Collection Principal 96 96 93 96 90 Interest 87 92 85 77 80 Principal and Interest 94 95 92 92 88 1/ Net of reschedulings and rolled-over working capital loans. 2/ Includes penal interest. * Subject to Long Form Audit. Source: NDFC 9/22/83 ASPID -102- ANNEX 5 Attachment 6 Page 1 NATIONAL DEVELOPMENT FINANCE CORPORATION COMPARATIVE BALANCE SHEETS FY78 - FY82 (Rs. Million) As of December 31 FY78 FY79 FY80 FY81 FY82 Assets Current Assets Liquid Assets 394 464 305 252 211 Accrued Interest on Investment:s 16 1L2 9 12 17 Accrued Interest and Charges on Loans 26 39 68 66 116 Deposits and Prepayments 1 2 4 6 _ 25 437 517 386 336 369 Investments (at cost) Equities 2 2 53 56 56 Government Bonds and Loans, Treasury Deposits 298 214 215 512 524 300 216 268 568 580 Loan Portfolio Principal 1,114 1,461 1,904 2,203 3,276 Interest in Arrears* 16 11 26 58 63 Less Provision for Doubtful Lcans 13 11 16 21 44 1,117 1,4 61 1,914 2,240 3,295 Fixed Assets 1 2 3 4 6 Total Assets 1,855 2,196 2,571 3,148 4,250 Liabilities and Equities Current Liabilities Accrued Interest and Expenses 80 93 111 120 L70 Sundry Creditors 3 8 8 9 10 Provision for Dividend 6 6 13 13 26 Others 7 7 6 10 40 96 114 138 152 2.46 Time Deposits Less than 12 months' maturity 770 897 992 1,134 1,690 More than 12 months' maturity 332 340 335 434 317 1,102 1,237 1,327 1,568 2,007 Borrowings Foreign Currency 250 268 347 394 624 Local Currency 191 294 409 522 785 441 562 756 916 l ,209 Bonds - - - 100 1.00 _T4_1 -562 756 1,016 1,509 Equity Paid-in Capital 126 132 132 132 132 Statutory Reserve 75 111 126 169 229 Contingency Reserve 15 40 92 96 98 Bonds Redemption Reserve - _ - 15 29 216 283 350 412 488 Total Liabilities and Equities 1,855 2,196 2,571 3,148 4,250 Guarantees 81 81 70 100 1.36 Debt/Equity Ratio 4.0 3.5 3.3 3.8 4.0 * Includes dues of 0 - 3 months. 7 3 3 30 19 9/21/83 ASPID -103- ANNEX 5 Attachment 6 Page 2 NATIONAL DEVELOPMENT FINANCE CORPORATION COMPARATIVE INCOME STATEMENTS FY78 - FY82 (Rs. Million) Year Ending December 31 FY78 FY79 FY80 FY81 FY82 Income Interest on Loans 103 134 187 221 302 Other Loan Charges 6 6 9 15 20 109 140 196 236 322 Investment Income and Interest on Bank Deposits 72 59 47 46 88 Profit on Sale of Investments 3 13 10 6 6 Dividend Income _ - 2 3 4 Total Income 184 212 255 291 420 Expenses Interest 127 131 157 188 270 Commitment Fees and Other Charges 2 2 2 1 5 Salaries 4 4 5 7 10 Other Administrative Expenses 4 4 5 8 13 Total Expenses 137 141 169 204 298 Net Profit 47 71 86 87 122 Appropriation Statutory Reserve 24 36 15 43 60 Provision for Doubtful Loans/Others 13 (2) (6) (10) (24) Contingency Reserve (2) 25 64 25 50 Bonds Redemption Reserve - - - 15 14 Provision for Dividend Cash Dividend 6 6 13 13 20 Bonus Share Issue 6 6 - - - 47 71 74 86 120 Financial Ratios (x) Interest Spread 4.6 4.5 3.8 3.4 2.8 Administrative Expenses/Average Loan Portfolio 0.8 0.8 0.6 0.7 0.8 Net Profit/Total Income 25.5 33.5 32.9 29.9 29.0 Net Profit/Average Equity 24.5 28.4 26.4 22.8 27.1 Earnings Spread 5.9 6.5 5.7 4.3 4.3 9-22-83 ASPID -104- ANNEX 5 Attachment 6 Page 3 NA'IONAL DEVELOPMENT FINANCE CORPORATION COMPARATIVE CASH FLOW STATEMENTS FY79 - FY82 (Rs. Million) Year Ending December 31 FY79 FY80 FY81 FY82* Sources Net Profit 71 86 85 122 Additional Non-Cash Charges 1 1 2 3 72 87 87 125 Interest and Other Charges on Portfolio Loans Credited (134) (187) (221) (302) Collected 126 143 191 246 64 43 57 69 Loan Collections 440 632 866 1,030 Increase in Current Liab:lities (Excluding Dividends) 18 17 13 81 Internal Generation 522 692 936 1,180 add Interest on borrowings 32 45 60 87 AVAILABLE FOR DEBT SERVICING 554 737 996 1,267 Drawdown of Borrowings Foreign Currency 43 123 85 340 Local Currency 1/ 120 137 136 328 Debentures - - 98 - Time Deposits (Net Chanige) 135 90 241 440 Total Sources 852 1,087 1,556 2,375 Applications Repayment of Borrowings Principal Foreign Currency 25 44 38 110 Local Currency 1/ 17 21 24 65 Debentures - - - 42 65 62 175 Interest on Borrowings 32 45 60 87 REQUIRED FOR DEBT SERVIC::NG 74 110 122 262 Disbursement of Loans Foreign Currency 43 123 85 340 Local Currency 2/ 744 956 1,082 1,763 Investments (Net Change) (84) 51 300 12 Fixed Assets 3/ 1 1 1 2 Dividend 6 6 13 13 Increase in Current Assecs (excluding accrued interest and charges on loans). 68 (160) (47) (17) Total Applications 852 1,087 1,556 2,375 Liquid Assets Opening Balance 394 464 305 252 Change in Year 70 (159) (53) (41) Closing Balance 464 305 252 211 Debt-Service Coverage 4/ 7.5 6.7 8.1 5.8 * Unaudited 1/ SBP refinance for suppliers' Credit Scheme. 2/ Includes working capital loans, suppliers credit loans and regular term loans. 3/ Expenditure less disposal. 4/ Available for Debt Servicing/Required for Debt Servicing. Source: NDFC 9/22/83 ASPID ANNEX 5 -105- Attachment 7 Page 1 NATIONAL DEVELOPMENT FINANCE CORPORATION PROJECTED INCOME STATEMENTS FY83 - FY87 (Rs. Million) Income FY82 FY83 FY84 FY85 FY86 FY87 Interest on Loans 302 413 505 638 824 1,046 Other Loan Charges 20 22 25 28 31 35 322 435 530 666 855 1,081 Investment Income and Interest on Bank Deposits 88 114 161 175 167 152 Profit on Sale of Investment 6 7 7 7 7 7 Dividend Income 7.6% in FY83 12.5% in FY84 4 5 11 13 17 20 Total Income 420 554 709 861 1,046 1,260 Expenses Interest 270 377 465 559 669 797 Commitment Fees and Other Charges 5 7 7 7 7 7 Salaries (1.5%) 10 12 14 17 20 24 Other Administrative Expenses 13 18 24 31 40 50 Total Expenses 298 414 510 614 736 878 Net Profit 122 140 199 247 310 382 Appropriation of Net Profit Statutory Reserve (50%) 60 70 100 123 155 191 Provision for Doubtful Loans 24 26 33 51 68 76 Contingencies Reserve 26 (5) 17 17 23 37 Bonds Redemption Reserve 14 29 29 29 29 43 Cash Dividend 20 20 20 27 35 35 120 140 199 247 :310 382 Financial Ratios: Interest Spread 2.8 2.9 3.2 3.2 3.1 3.4 Administrative Expenses/ Average Loan Portfolio 0.8 0.8 0.8 0.8 0.6 0.6 Net Profit/Total Income 29.0 25.3 28.0 28.6 29.6 30.3 Net Profit/Average Equity 27.1 26.2 30.3 29.5 28.8 28.5 Earning Spread 4.3 3.2 3.9 3.8 3.7 3.7 9/23/83 ASPID ANNEX 5 -106- Attachment 7 Page 2 NATIDNAL DEVELOPMENT FINANCE CORPORATION P]lOJECTED BALANCE SHEETS FY82 - FY87 (Rs. Million) Audited Assets FY82 FY83 FY84 FY85 FY86 FY87 Current Assets Liquid Assets 1/ 211 139 105 115 104 123 Accrued Interest on Investments 17 18 19 20 21 22 Accrued Interest and Charges on Loans 116 116 116 1'6 116 116 Deposits and Prepayments 25 30 32 34 36 38 369 303 272 28F5 277 299 Investments (at Cost) Equities 56 75 95 120 150 170 Government Bonds and Loans, GTDRS 524 975 1,250 1,250 1,150 1,050 580 1,050 1,345 1,3370 1,300 1,220 Loan Portfolio Principal 3,271 4,118 5,225 6,963 8,966 11,237 Interest in Arrears 63 72 87 109 140 178 3,334 4,190 5,312 7,0;'2 9,106 11,415 Less Provision for Doubtful Loarns 44 70 103 154 222 298 Staff Loan 5 5 5 5 5 5 Fixed Assets (Net) 6 9 12 14 16 18 Total Assets 4,250 5,487 6,843 8,583 10,482 12,659 Liabilities and Equities Current Liabilities 2/ Accrued Interest and Expenses 170 180 190 200 210 220 Sundry Creditors 10 11 12 13 14 15 Provision for Dividend 26 26 26 26 26 26 Others 40 42 46 48 50 52 246 259 274 287 300 313 Time Deposits Less than 12 months' Maturity 1,690 2,080 2,330 2,608 3,000 3,450 More than 12 months' Maturity 317 520 582 652 749 861 2,007 2,600 2,912 3,260- 3,749 4,311 Borrowings 3/ Foreign Currency 624 709 1,096 1,595 2,086 2,688 Local Currency 785 1,137 1,633 2,303 2,943 3,572 1,409 1,846 29 898 5,029 6,260 Debentures 100 200 200 200 200 300 Equity Paid-up Capital 132 132 132 18.2 232 232 Statutory Reserve 229 299 399 522 677 868 Contingency Reserve 98 93 110 127 150 187 Bond Redemption Reserve 29 58 87 116 145 188 488 582 728 947 ,204 1,47i Total Liabilities and Equity 4,250 5,487 6,843 8,592 10,482 12,659 Debt Equity Ratio 4:1 3.9:1 4.2:1 4.3::L 4.2:1 4.2:1 1/ Liquid Assets comprise cash on hand and in bank. 2/ Excluding current maturity oE deposits and borrowings. 3/ Including current maturity. 9/23/83 ASPID ANNEX 5 -107- Attachment 7 Page 3 NATIONAL DEVELOPMENT FINANCE CORPORATION PROJECTED CASH FLOW STATEMENTS FY83 - FY87 (Rs. Million) FY83 FY84 FY85 FY86 FY87 SOURCES Net Profit 140 199 247 310 382 Interest and Other Charges on Portfolio: Credited (413) (505) (638) (824) (1,046) Collected 404 490 616 793 1,008 131 184 225 279 344 Loan Collections 1,433 1,945 2,262 2,877 3,756 Increase in Current Liabilities 13 15 13 13 13 (excluding Dividends) Internal Generation 1,577 2,144 2,500 3,169 4,113 ODD Interesc on Borrowing 128 165 223 288 359 Available for Debt Servicing 1,705 2,309 2,723 3,457 4,472 Draw Down of Borrowings Foreign Currency 187 494 635 715 829 Local Currency 410 616 871 959 1,079 Debentures 100 - - - 100 Time Deposits (Net Charges) 593 312 348 489 562 Paid-up Capital - - 50 50 - Total Sources 2,995 3,731 4,627 5,670 7,042 APPLICATIONS Repayment of Borrowings Principal Foreign Currency 102 107 136 224 227 Local Currency 58 120 201 319 450 Debentures - - _ - - 160 227 337 543 677 Interest on Borrowings 128 165 223 288 359 Required for Debt Servicing 288 392 560 831 1,036 Disbursement of Loans Foreign Currency 187 494 635 715 829 Local Currency 2,093 2,558 3,365 4,165 5,198 Investments (Net Charge) 470 295 25 (70) (80) Fixed Assets 3 3 2 2 2 Dividends 20 20 27 35 35 Increase in Current Assets (excluding accrued interest and charges on loans) (66) (31) 13 (8) 22 Total Applications 2,995 3,731 4,627 5,670 7,042 LIQUID ASSETS Opening Balance 211 139 105 115 83 Change in the Year (172) (34) 10 (11) 15 Closing Balance 139 105 115 104 98 Debt Service Coverage 6.3 6.2 4.5 4.7 4.3 ASPI3 -108- ANNEX 6 Page 1 PAKISTAN INDUSTRIAL INVESTMENT CREDIT (ITC) PROJECT PAKIST&N INDUSTRIAL CREDIT AND INVESTMENT CORPORATION (PICIC) I. INTRODUCTION Background 1. The Pakistan Industrial Credit and Investment Corroration (PICIC) was established with Bank Group and I7C technical and financial assistance in 1957 as a privately-owned corporation to provide long and medium-term loans, in local and foreign currencies, to private industry. It was also intended to play a key role in capital market develonments through the direct purchase and urnderwriting of shares and debentures. During the 196O's PICIC developed into a well managed and experienced DFC and its position as the premier supplier of long term funds for industrial investment in Pakistan became firmly established. PICIC, in effect, pioneered in suoporting new industries in the cement, sugar, and textile sectors in Pakistan which todav are fun- damental to the country's economy. 2. However, the 197O's proved to be an exceptionally difficult neriod for Pakistan and its institutions. The separation of Banpgladesh, the 1972 devaluation of the Rupee by 130", and the nationalization of major private industries in the first half of the decade, contributed tco a drastic reduc- tion in private industrial investment and a general disruption of the economy. Tbis internal situation was further aggravated by the renercussions of the 1973 and 1980 increases in world oil prices. PICIC was directly affected by all these events. A substantial portion cf its assets were lost to Bangladesh. The devaluation of the rupee increased! the domestic currency value of its foreign liabilities while its clients found it difficult to meet corresponding increased rupee payments. The worldwide recessions Dar- ticularly affected Pakistan's textile export industry which accounted for 40% of PICIC's portfolio. 3. Since 1978, GOP's policies have been directed to promoting private investment and to rescue private industry affecterd by the dislocations of the decade. As a result the industrial sector has recovered significantly and industrial demand for financial assistance is growing. Since 1980, GOP has enacted a number of measures 1/ to address the portfolio recovery 1/ Committee for Sick Units, 19RO, Collection Review Meeting, 1980, Presidential Ordinance, 1982. -109- ANNEX 6 Page 2 problems of PICIC and IDBP on a national scale and to revive these insLitu- tions. The World Rank Group and ADB have worked closely with COP and PICIC (also IDBP) to bring these efforts to fruition. Starting in the last quarter of lgl under the direction of new management and a practical approach to overdue accounts, PICIC has been able to reduce its nortfolio in arrears, improve its liquiditv position, and achieve a satisfactory financial condl- tion. PICIC's management has also taken a number of additional measures to enable PICIC to compete in a more competitive financial environment. PICIC is now allowed to borrow in interbank markets and has been making working capital loans. It has modified its lending policy to be more competitiva with other term lending institutions. Bank Group Assistance 4. Since 1957 the Bank Group has extended eleven loans/credits to PICIC for a total of ITS$273 million with important industrial development effects. The latest credit from IDA to PICIC (Credit 101-PAK) for UIS$40.0 million was made in 1990, and has been utilized according to schedutle in assisting industrial projects. As oF April 15, 1983 US$30.0 million had been disbursed of the USS37.0 million assigned to project financing. Disbursements of the balance of US$3.0 million which was intended for a national textile training program, were delayed. Rowever, the textile component was restructured in November 183 and disbursements are expected to be completed by March 31, 19R5. All agreements and understandings reached in connection with Credit 101Q-PAK relating to improvements in the legal framework for collec- tions, the settlement of PICIC's public sector overdues, the rescheduling of SRP cash credits, the establishment and achievement of a collection pIan for 1980-1952, and staff appointments and general compensation adjustments by PICIC have been complied with by GOP/PICIC. PICTC and Industrial Investment 5. From its inceDtion PICIC engaged primarily in financing the foreign currency component of required fixed investment in the private industrial sector. This activity focus was the result of the emphasis of development thinking at the time of its establishment. In the 1950's long term foreign capital for import-substitution industries was perceived as one of the cru- cial elements in economic development. PICIC's charter however intended it to carry broader functions in the canital markets as well as in non-financial assistance to industry. These functions have not been adequately fulfilled because of the adverse developments of the seventies and PICIC's management orientation to the traditional foreign exchange financing function. 6. Within the traditional concept, PICIC's contributions to the develop- ment of the private industrial sector in Pakistan is creditable. In the 25 years of its existence PICIC has provided total assistance for Rs 6.6 billion for 757 industrial projects. Of this amount about 10% reflects PICIC's ANNEX . Page I catalytic function in channelling direct foreign loans and/or foreign invest- ment to Pakistani projects exclu.Usive of its own loans. PT17TC's total assis- tance to industry (Table 1), broken down by sector, shows the importance ct the textile sector in PICIC's portfolio. Table lo PICIC Sectoral Distribution of Cumula-tive Assistance Sector 7 Textiles 38.6 Food Products and Processing 17.6 Eneineering 10e2 Cement, Clay, and Class 9.q Paper, Paper Products antd Printing 5.6 Chemicals 5.6 Miscellaneous (. Total 100.0 Source: PICIC. 7. However, PICIC's role irL industrial finance has been diminished lately. This is partly due to P'ICIC's portfolio and instiltutional problems resulting from the economic dislocations of the 1q70'sz but: it is mostly the result of changing financial and industrial environments. In recent years the Treeminent importance of foreign exchange financing has been reduced as a result of increased availability of suppliers credit and of Pakistan's own inflows of foreign remittances from workers in the Middle Tast and other regions. Some machinery and equipment are manufactured locally. Export industries have developed which primarily require export financing. Within the financial sector on a wcrld wide basis there is greater demand for a broader range of financial services that include working capital, term financing, export finance, leasing, and cash management services. This trend. has rapidly been adopted by Pakistan. New institutions are active in the financial scene with broader mardates, 1/ and the coTnuercial hanking system has been called upon to act in other areas -- particularly in term financing of industry and in the development of Islamic financial instruments. PICIC's share of industrial financing has consequentlv been reduced from about 20% in 1970 to about 3% in 19R2. PICIC's new management is now making a con- centrated effort to regain its market shares. A new corporate elan has been prepared.. Given PICIC's institutional shortcomings, the management would like to maintain market shares and graduallv regaini markets shares without taking on uindue risks. The aTnroach is sound and should enhance PICIC's profitability. 1/ NDFC, PEL, Pak-Lybia, Pak-Saudi, Pak-Kuiwait. -1ANEN1 6 Page 4 IT. INSTITUTIONAL ASPECTS Ownershin and Eoard 8. Ownershin. PICIC's initial paid-tip capital of Rs 20 million was increased progressivelv to Rs 66.4 million by 1974, but during the second half of the seventies the depressed stock market and PICIC's portfolio problems did not allow increases in share capital. In 1974 through the nationalization of commercial banks and life insurance companies, 49% of PTCIC's shares became Government owned as State Life Insurance (American Life) was one of the largest stockholders in addition to the NIT. The remaining 91% of its capital shares are held by private individuals and orRanizations, many of them foreign banks. As of December 31, 1q82 paid-up capital stood at Rs 109.9 million as a result of share dividends distributed in 1977, 197R, and 1981. The concentration of public shares, PICIC's port- folio difficulties, SW' financial suDport and the character of the domestic financial environment have however all contributed to enhance Government control of PICIC. In fact, GOP appoints the Chairman and the Managing Director. Until recentlv, partly by its own choice, PICIC was subjected to the determinations of the National Pay Commission on salary structures and levels. 9. Roard of Directors. TICIC's board of directors is formed by twentv two members, including the Chairman and Managing Director. It consists of fifteen Pakistani and seven foreign directors. Of the Pakistani directors, one represents the Federal Government, one the nrovincial governments on a rotational basis, two the Government institutional shareholders (SLIC and NIT), and the rest are prominent industrialists in addition to the Chairman and the M,anaging Director. The Board meets about four times a year, once to apnrove the Chairman's report and whenever it is necessary to approve large loan nroposals. The unwieldy structure and composition of the Board has in the past, resulted in an unworkable situtation at the Management level. TIowever, in 1982, the Board empowered the Executive Committee, which has seven members and is chaired by the Managing Director, to approve loans u-p to Rs 15 million. At the same time, the Roard reassumed other administrative powers Dreviously entrusted to the 5hairman and assigned the Chief Executive role to the Managing Director. The present arrangement is working reasonably well and has increased management effectiveness. Organization, MTanagement and Staff 10. nrganization. Attachment I shows PICIC's organization chart as of September 1, 1983, reflecting the changes made by management. The idea behind these changes was to integrate functions related to the pro ect cycle. TTowever, a number of operating deficiencies still arise under the present structure. Among them there is the need for a resources and financial management unit to improve the resource planning and funding capability of PICIC. A similar need exists for a senarate personnel administration unit to AiNNFX C -112- Page 5 build up staff strength and sten tip training. The economic department, must be realigned in terms of management information needs and/or operations promiotion functions. Some of the ftunctions of the engineering department need to be revised. The necessity of exnanding PICIC's operations and wi:1en- ing the range of services offered to its clients is apparent. In this con- text it will be necessary to adoDt the organizational structure best suited to develop these activities. An institutional review will focus on organiza- tional changes and review of functions and procedures as required hy the strategy apnears timely. Tlowever, the new management of F'ICIC feels that it presently needs to focus on problems of recoveries andl business development. Ilhen the consideration is completed, PICIC will he carrying out the review and wjill request funding From the tecehnical assistance' furnds under the project. llo fManagement. Since October 1981, PICIC has had a new MTanaging Director, MIr. I.4. Tlianfi, wvho assumed the position on deputation from the SRP where he was the Txecutive Director in charge of Panking r'ontrol. He is a verv capable and experienced banker and well, respected in Financial circles. He has begun to address some of PICIC's organizational. deficiencies with i.nitial actions Oirected at integrating the functions of units working on projects, reviewing procedures, and improving staff compensation levels. IL/ Stens taken so far bv PICIT's rew MIanaging Director haven been beneficial and are in the right direction. 12. Staffing. In 1992 PICIC employed 121 professional staff, ?./ of which most have been with PICIC for more than ten years, many for fifteen years or more. While this fact could point to a satisfactory staffing situation in terms of Drofessional experience it mostly reflects the routine application of work patterns adopted many years back. This is Darticularly true becauise of the no-growth situation of t:he recent past and because of the specialized character of some operating der 11.2 11.1 10.6 19.2 7.3 Administrative expenses/average total assets (0) 0.71 0.71 0.83 0.77 0.73 Long-term debt/equity ratio 6.0 5.6 5.0 4.7 5.1 /1 Net of cancellations. Source: PICIC. -114- ANNEX 6 Page 7 15. PICIC's performance during FY78-FYR2 is characterized by two impor- tant developments. The first is the reduction in the level of its opera- tions. The FYR2 portfolio figure expressed in rupees reflects a reduced portfolio with resnect to FY81 in terms of foreign exchange value which represents 99% of its nortfolio. Earlier vears also show a* downward trend. WIhile in the 1970s, industrial sector demand for investment funds was some- what reduced by the slowdown of the period, this is not the case for the past three years in which industrial investment has grown substantially. Rather the reasons behind the relatively low level of PICIC's operations are the chronic loan recoverv problem and the unavailability to PICIC of greater foreign exchange resources. Since 19Q0, PICIC has receivecl TTSt83 million of foreign exchange assistance from. IDA, ADR, and KfJ of which UTS$C40 million from ADB was declared effective only in March 1982. Its commitments for FY82 were IJS$27 million and disbursements US$23 million. Mfinor bilateral credits and specialized lines from China and the Tslamic Development Rank were also utilLzed, and included in the commitment and disbursement figures quoted. 16. The second important feature of PTCIC's operations in recent vears is the initial turn-around in the portfolio arrears problem which had its origins in the loss of East Pakistan and the devaluation of: the rupee in 1972 and was compounded by adverse economic developments in later years. 'With the passing of time, the problem was magnified beyond manageable proportions as new installments fell into arrears and interest charges were compounded. During 1980 and the first half of 1981, collections of current dues fell to 35%, with the large uncollected amounts increasing the portfolio in arrears. By September 1981, the situation had deteriorated to the noint where the level of arrears had reached Rs 1.5 billion or 62% of the total portfolio. T'he percentage of portfolio infected by arrears, which included future installments for loans already in arrears on past installments, was 67%. 17. However, hy the end of 1982 the trend had been reversed. Through improved collections on current maturities as well as on past due accounts btut more importantly through the rescheduling of princinal and interest owed by projects which had run into serious financial or operational difficulties portfolio in arrears had been reduced to Rs 1.2 billion or 55% of the tota"L portfolio. The most importanat rescheduling agreements have been carried out in the context of the Government Committee on Sick Units with the participa- tion of other creditor institutir)ns and the cooperation of the vakistan Banking Cotuncil. During 1982 PICIC rescheduled debts totalling Rs 500 mil-- lion, against which it received cash pavments of Rs 50 million. The trend is improving. As of June 30, 1933, PICIC had collected Rs 249 million and for 1983, expects to collect Rs 450 million compared with the agreed target of Rs 400 million. Also, PI'IC's portfolio affected by arrears has been reduced to Rs 1.0 billion, or 40N of the portfolio. PICIC's Debt Service Coverage Ratio was 1.15 in June 1983. -115- ANNEX 6 Page 8 IV. FIMANCIAL ASPECTS 18. PICTC's financial statements for the last five years (1978-R2) are given in the Attachment 2. In spite of the limited growth in its operations and the oroblems in nortfolio recovery, PICIC has been able to maintain a modest level of profitabilitv. Tight control on expenditures and a wider spread on its lending operations have made this possible, even though a good percentage of its assets are recognized as non-performing for interest accrual purposes. Reserves for doubtful accounts of Rs 104 million as of December 31, l9q2, are small but can be iustified in terms of the secured nature of the princiDal on loans and PICIC's accounting policy of not accru- ing interest on non-performing assets. 19. PICIC's capital structure remains adequate, due to the retention of profits as reserves and the policy of issuing bonus share issues in lieu of cash dividends until 1982. PICIC's debt/equity ratio at the end of 1982 wzas 5-3:1, well belowq its limit of 7:1. Given PICIC's improved liquidity posi- tion, a cash dividend of 10% was declared in 1993. This first payment to shareholders since 1976 was essential to improve PICIC's Dublic image and restore the confidence of private shareholders. PICIC's shares, which have traded around Rs 7.50 in the market until recentlv have rebounded to Rs 9.5. As PTCTC will need to expand its operations in the future, the matter of future share issues must be kept in mind and investor confidence built up gradually over time. 20. All other financial indicators, as Dresented in Table 2, point to an improved nosition as of December 31, 19R2. PIrIC's financial conditions improved further during the first half of 1983 due to an increase in PICIC's profit from Rs 19 million in 1982 to Rs 48.6 million. The improvement was due mainly to better liabilitv management and monev market operations. During the first half of 1983, PICIC also made a substantial amount of work- ing capital loans with a higher spread. In brief, PICIC is now liquid, SBP cash credits are being amortized, the debt/equity ratio has been reduced, and the debt service coverage ratio has improved substantially. V. PROSPECTS 21, Because of the improvement in the investment climate and GOP's clearly stated policy of promoting private industrial investment, the busi- ness prosDects for term-lending institutions in Dakistan are good. PICIC is likelv to benefit from this trend. PICIC's projected level of operations and financial statements for 1983-87 are provided in the attachments. Table 3 Drovides key figures. -116- AN,NEX 6 Page 9 Table 3: Projected Operations and Key Financial Results ('s million) Year ending "December 31 19R3 1984 185 1986 1987 Operations Loan sanctions - Foreign Currencv 450 530 613 724 853 - Local Currency q5 182 198 216 236 Total 545 712 811 940 ORQ Cormi tnents 535 701 727 789 855 Disbursements 504 684 6q2 742 807 Financial Conditions & Results Cash and short-term deroosits 150 153 180 155 201 Loans (net) 2,58R8 2,992 3,352 3,736 4,132 Equity investments 104 104 104 104 104 State Bank cash credits 696 677 657 607 557 Other borrowings 2,050 2,449 2,806 3,153 3,567 Net worth 516 597 609 676 755 motal assets /1 3,483 3,900 4,293 4,657 5,1003 Net profit (after taxes) 50 58 60 84 96 Ratios Net profit/average total assets (X) 1.50 1.56 1.70 1.87 1.97 Net profit/average net worth (%) 10.00 10.60 11.90) 12.90 13.31 Administrative expenses/average average total assets (0) 0.75 0.78 O.Rl 0.85 0.90 Long term debt/equity ratio 5.10 5.30 5.201 4.9O 4.70 Debt service coverage ratio 1.14 1.14 1.14 1.16 1.16 /1 excl]udes assets in Bangladesh. Source: PICIC. 22. ?TCIC's lending operations are Trojected to increase from Rs 351 million in 1982 to Rs 1,089 million in 1987, an annual growth rate of 257% in current prices. Since PICIC is starting from the smal-L base, the urojected growth rate is rather modest. I]n real terms, the annual growth rate will be around 18o. Given that the private industrial investment in the medium- and -large scale indulstries is expected to grow at a rate of 28% p.a., PICIC's share in industrial finance will continue to decline. PICIC's management is fully aware of this but has deliberately opted for a strategy of slower growth to ensure the high quality of its portfolio, avoird marginal proposi- tions, and earn an adequate return on its capital. Also, PICIC needts time to rehuild the organization and its cadre of professional staff. Therefore, the ANTNEX 6 -117- Page 1l strategy of slow growth for PICIC over the next few years is reasonable and pragmatic. 23. In addition, to continue making foreign exchange loans, P1r:!C is planning to increase the pronortion of local currency financing to improve the mix of its business and profitability. This will he achqieved by an increase in utilization of SBP's suppliers credit facilities and working capital financing funded by loan recoveries and interbank markets. It will continue to reduce its exposure in the textile sector by financing projects in other sectors especially agro-industries, chemical and engineering. 24. Project Pipeline. As of June 3n, lq83, PICIC hacl abrout 20 loan applications under active consideration involving a total of US$47 million (Annex 7). In addition, PICIC had a backlog of 11 approved proiects awaiting funding of UJ$20 million. PICIC's pipeline of projects is presently thin in comparison to other D)FIs. However, this is Aue to the Droblems in recent years. Because of portfolio recovery efforts, lack of both local and foreign resources, and organizational problems, PICIC has not been active in project promotion. In the future, PICIC intends to step up its Dromotional activities particularly in the engineering and chemical sectors. It has modified its lending policies and loan agreements to enable it to compete more efficiently with other DFIs. These measures should have positive impacts on PICIC's nipeline and business prospects. In anv case, the exist- ing pipeline of projects should allow PICIC to meet its lending targets with little difficulty. Resource Requirements 25. ks of June 30, 19R3, PICIC's untied foreign exchange resources con- sisted of USS20 million from the AD11, wbich is adeouate to meet the commit- ment requirements of approved projects. Based on the projected level of commitments for 1983-1985, PICIC would need Rs 1.6 billion (US$125 million) in new foreign exchange resources. Under the proposed ADB loan, PTCTC is expected to receive about TUS$40 million. The gap of TSTW5 million is expected to be financed by the Bank Group (US$20-30 million) bilateral sour- ces, and direct access to the central pool of foreign exchange. PICIC is also exploring possibilities of raising commercial sources. However, the prospects for raising funds from this sources in the immediate future are not very good. Projected Financial Results and Conditions 26. Attachments 3 provide PICI 's projected financial statements for FYR3-FYR7. Barring any major downturn in the economy and in the nerformance of the textile sector, PICIC's financial position should continue to improve. Nlet profit after tax is proiected to increase from Rs 50 million in 1983 to Rs 96 million in 1987. Return on equitv is projected to improve graduallv from 10.0% in 1983 to 13.37 by 1987. This is low, but reasonable, in light of PICIC's past performance. Administrative expenses as a percentage of average total assets are projected to increase from 0.75% in 19R3 to 0.90,% in 1987, reflecting higher staffing levels and more realistic compensation ANNEX 6 -118- Page 11 packages. The level of administrative expenses of less than 1% of assets is reasonable and comnares well with established DFIs. 27. Because of the expected improvements in profitability and loan recoveries, PICIC's financial position is likely to improve. Its DSCR is prolected to remain marginallv above 1.1, which is the minimum requirement for narticipation in the pool under the proposed project; long-term debt/equity ratio is projected to remain well below the limit of 7:1. 28. As of June 30, 1983, PICIC's portfolio affected by arrears amounted to Rs 1 billion, or 40% of its outstanding loan portfolio. PICIC's official reserve for losses were Rs 104 million, or 10% of the portfolio affected by arrears. However, PICIC had Rs 6on million in suspense accounts for unac- crued interest. Together these reserves amounted to about 70% of the port- folio affected by arrears, which is more than adequate to cover the necessary write-offs. PICIC is therefore creditworthv and it is reccmmended as a PFP under the proposed project. ANNEX 6 -119- Attachment 1 PAKISTAN INDUSTRIAL CREDIT AND INVESTMENT CORPORATION Organization Chart (As of August 15, 1983) Chairman NM Uquaili Managing Director IA Honfi INSPECTION & SYSTEMS DEPARTMENT Chief S.Z Kozi Deputy Managing Director Deputy Managing Director Deputy Manoging Director Waaudi Sh.HGY Dayala Mutiur Rohmcin LA_ ORE REGI QUETTA OFFICE r PROJECTS DEPARTMENT OFFICE~ I _ _ I _ _ _ Manager Manager 1 Senior Chief Silkandar Rashid Iqbalur Rahim Ashfaq A Berdi PESrlAWAR OFFICE LOAN DEPARTMENT ENGINEERING ____________________ _ ___________________ _ DEPARTMENT . Manager Chief Chief Engineer Tahir Abbas Syed Ibrahim Fazal Band ISLAMABAD OPFRCE LEGAL DEPARTMENT SPECIAL PROJECT DEPARTMENT Manager Chief t_1 Incyatullah S Mohib Hussain (Vacant) MIRPUR (AK.) SECRETARIAT [ DEPAPTMENTV P Secretary Chief 1 (Vacant) Au dus Sami [ AG Mir ACCOUNTS DEPARTMENT Chief Mahmud Al Khan ECONOMIC & RESEARCH DEPARTMENT Ch,ef S M. Abbosi PERSONNEL SECTION Personnel Officer NA KaWmi Wcrld Earnk-25499 ANNEX 6 Attachment 2 -120- Page PAKISTAN PAKISTAN INDUSTRIAL CREIDIT AND INVESTMENT CORPORATION (PICIC) Basic Data 1. Year established 1957 2. Ownership Private Sector 51% (as of December 1982) GOP-owned institutions 49% 3. Bank Group Assistance Eleven loans/credits for US$273 million with s,atisfactory implementation experience. Last credit: 1019-PAK, signed on May 30, 1980 and effective on October 29, 1980 for US$40 million equivalent of which US$3n.0 million equivalent dlisbu-rsed through April 15, 1983. 4. PICIC Operations (R!3 million) FY78 FY79 FY80 FY81 FY82 Gross sanctions 281 377 376 378 366 Commitments 187 177 47 408 328 Disbursements 260 229 91 199 295 5. Financial Ratios Profitability Net profit/averages net worth 11.2 11.2 9.0 10.2 11.6 Net profit/averag,s total assets 1.2 1.3 1.1 1.3 1.8 Administrative expenses/ average total assets 0.6 0.6 0.7 0.7 0.9 Capital Structure Debt/equity ratio 6.0 5.6 5.0 4.7 4.7 6. Foreign Currency Resource Position (12/31/82) US$ Million Available at beginning of the period 12.4 less new commitments 23.3 plus new resource IDA/ADB 37.2 KfW 5.6 Other 10.9 Available at end of the period 42.8 -121- ANNEX 6 Attachment 2 Page 2 PAKISTAN PAKISTAN INDUSTRIAL CREDIT ANT) INVESTMENT CORPORATION (PICIC) Income Statements (1978-82) (Rs million) For the Year ended December 31 1978 1979 1980 1981 1982 INCOME Interest income 172 188 190 174 205 Commitment fees 10 9 9 25 25 Total income from loans 182 197 199 196 230 Income from short-term deposits 13 10 12 1? 10 Dividend income and capital gains 13 13 9 15 20 Total Income 208 220 220 226 26n EXPENSES Interest on borrowings 143 151 151 155 1R3 Provisions for bad debts - - 4 2 9 Administrative expenses 16 17 21 19 21 Total Expenses 159 168 176 176 213 Profit before taxes 49 52 44 50 47 Taxes 16 16 6 12 15 NET PROFIT 33 36 35 38 32 RATIOS Net profit/average total asset 2.2 2.2 1.8 2.0 1.6 Administrative expenses/average total assets 0.7 0.7 0.8 0.8 0.7 Net profit/average networth 11.2 11.1 11.0 10.2 7.3 Source: PICIC. -122- ANNEX 6 Attachment 2 Page 3 PAKISTAN PAKISTAN INDUSTRIAL CREDIT AND INVESTMENT CORPORATION (PICIC) Balance Shesets (1978-82) (Rs million) 1978 1979 1980 1981 1982 As of December 31 ASSETS Cash and short term deposits 89 81 97 80 115 Government and other securities 17 11 19 14 7 Accrued interest and charges 362 439 507 535 570 Sundry current assets 18 22 24 21 70 Total Current Assets 486 552 647 650 762 Local currency loans 96 85 78 158 465 Foreign currency loans 1,727 1,755 1,715 1,653 1,960 Less: Provision for doubtful advances (85) (90) (94) (99) (104) Total Loans 1,737 1,750 1,699 1,712 2,321 Equity investment (at cost) 86 89 7 97 104 Fixed assets (net) 1 1 1 1 1 Receivables from Government of Pakistan 1 2 1 2 0 Assets blocked in E. Pakistan 410 416 421 425 424 Total Assets 2,722 2,810 2,866 2,888 3,612 LIABILITIES AND NETWTORTH Accounts payable 93 78 73 87 120 Provision for income tax 5 7 - - 90 Dividends payable - - - 11 Total Current Liabilities 99 85 ___73 87 221 Foreign currency long-term borrowings 1,341 1,300 1,203 1,176 1,697 U.S. Aid rupee loan 23 20 17 14 0 State Bank cash credits 427 569 720 726 717 State Bank suppliers credits 47 42 38 45 50 Subordinated government advances 23 23 23 23 20 Rupee debentures 45 18 - - - Total Debts 2,005 2,057 2,074 2,072 2,705 Paid-up capital 80 92 92 92 110 Capital reserves 219 237 271 279 279 Exchange fluctuation reserves 8 8 8 19 94 Networth 306 337 371 390 _ 483 Liabilities in respect of E. Pakistan 410 416 421 425 424 Total Liabilities and Networth 2,722 2,810 2,866 2,888 3,612 Ratios Equity to total debt 5.3 5.6 5.7 5.5 5.5 Equity and subordinated loans to long term debt 5.1 5.2 5.2 4.9 4.7 Source: PICIC. -123- ANNEX 6 Attachment 3 Page 1 PAKISTAN PAKISTAN INDUSTRIAL CREDIT AND INVESTMENT CORPORATION (PICIC) Projected Income Statements (1983-87) (Rs million) 1983 1984 1985 1986 1987 INCOME Interest income 274 312 357 403 451 Commitment fees 6 7 7 8 9 Income from short-term investment 12 14 15 15 16 Equity investments 8 8 8 8 8 Others 1/ 35 40 45 50 55 Total Income 336 380 433 484 539 EXPENSES Interest on short-term borrowings 4 13 21 32 46 Interest on long-term borrowings 211 226 243 254 265 Commitment fees 2 5 6 5 4 Administrative expenses 25 29 33 38 44 Provision for doubtful debts 10 12 14 16 20 Total Expenses 252 284 317 345 378 Gross income 84 96 116 139 160 Less: income tax 33 38 46 56 64 Net Income 50 58 69 84 96 Dividend 17 17 17 17 17 Add to retained earning 33 41 52 67 79 1/ Income received in the period from unaccrued interests is included in this item. -124- ANNEX 6 Attac'hment3 Page 2 PAKISTAN PAKISTAN INDUSTRIAL CREDIT AND INVESTMENT CORPORATION (PICIC) Projected Balance Sheets (1983-87) (Rs million) 1982 1983 1984 1935 1986 1987 (AcLual) ASSETS 1/ Cash 50 78 81 108 83 99 Securities 72 72 72 72 72 102 Accrued interest 6i40 640 640 640 640 640 Loans-gross 2,425 2,702 3,118 3,492 3,892 4,308 Less: loss reserve (104) (114) (126) (140) (156) (176) Loans-net 2,321 2,588 2,992 3,352 3,736 4,132 Other investments 1L04 14 104 104 104 104 Fixed assets 1 1 11 17 22 22 TOTAL ASSETS 3,118 3,483 3,900 4,923 4,657 5,100 LIABILITIES AND NETWORTH 1/ Current liabilities 221 221 221 221 221 221 Short-term borrowings 0 100 200 300 444 571 Long-term borrowing 2,484 2,646 2,922 3,163 3,316 3,553 Total Liabilities 2,705 2,967 3,343 3,684 3,981 4,345 Paid-up capital 1.10 110 110 110 110 110 Reserve & Retained earnings 373 406 447 499 566 645 Networth 483 516 557 609 676 755 TOTAL LIABILITIES & NETWORTH 3,188 3,483 3,900 4,293 4,657 5,100 _/ Assets and liabilities in East Pakistan are excluded. Source: PICIC and mission estimates. -125- ANNEX 6 Attachment 3 Page 3 PAKISTAN PAKISTAN INDUSTRIAL CREDIT AND INVESTMENT CORPORATION (PICIC) Projected Cash Flows (1983-87) (Rs Million) 1983 1984 1985 1986 1Q87 Previous Period Cash 50 78 81 108 83 Securities 72 72 72 72 722 Beginning balance 122 150 153 180 155 Additions in Period Cash income-operations 60 70 83 100 116 Net income (50) (58) (69) (84) (96) Loss reserves (10) (12) (14) (16) (20) Loan collections 227 269 307 342 391 New short-term borrowings 100 200 300 444 571 New long-term borrowings 345 485 500 450 560 Sub Total 732 1,024 1,190 1,335 1,638 Subtractions in Period Loan disbursements 504 684 682 742 807 Increased fixed asset 0 10 6 5 0 Mature short-term borrowings 0 100 200 300 444 Mature long-term borrowings 183 209 259 297 323 Dividend 17 17 17 17 17 Sub Total 704 1,020 1,164 1,361 1,591 Balance - End of Period 150 153 150 155 201 Source: PICIC and mission's estimate. -126- ANNEX 7 PAKISTAN INDUSTRAL INESTMENT CREDIT (IIC) PROJECT PIPELINE OF PROJECTS (As of June 30, 1983) (USS Million) NDFC IDBP PICIC TOTAL Agrobased 73.1 8.4 10.0 91.5 Steel & Engineering 39.3 16.9 8.3 64.5 Cement 41.2 - - 41.2 Cotton Textiles 9.8 17.6 1.0 28.4 Other Textiles - 15.5 4.5 20.0 Chemicals 2.5 9.8 8.3 20.6 Packaging - - 7.0 7.0 Automobiles 6.0 - - 6.0 Electronics - - 5.9 5.9 Mineral & Mining - 3.5 0.3 3.8 Construction - - 0.4 0.4 Others 13.5 6.1 7.6 27.2 Total 185.4 77.8 47.4 316.5 Source: NDFC, PICIC, and IDBP. ANNEX 8 -127- PAKISTAN INDUSTRIAL INVESTMENT CREDIT (IIC) PROJECT 1/ Estimated Commitments and Disbursements Schedule (Rs. million) Commitments Disbursements 2/ Credit T.A. Total Credit T.A. Total _ FY85 July-September 1984 15.0 0.2 15.2 0.0 0.0 0.0 0.0 October-December 1984 27.0 0.2 27.2 9.5 0.2 9.7 9.7 January-March 1985 28.0 0.3 28.3 18.5 0.2 18.7 28.4 April-June 1985 25.0 0.3 25.8 17.0 0.3 17.3 45.7 Sub-total Q5.0 1.0 96.0 45.0 0.7 45.7 45.7 FY86 July-September 1Q85 3.n 0.3 3.3 13.0 0.3 13.3 59.0 October-December 1985 - 0.3 0.3 13.0 0.3 13.3 72.3 .January-March 1986 - 0.3 0.3 12.0 0.3 12.3 84.6 April-June 1986 - 0.1 0.1 10.0 0.3 10.3 94.9 Sub-total 3.0 1.0 4.0 48.0 1.2 49.2 94.9 7Y87 July-September 1Q86 - - - 5.0 0.1 5.1 100.0 October-December 1986 - - - - - - - June-March 1987 - - - - - - - April-June 1987 - - - - - - Sub-total - - - 5.0 0.1 5.1 100.0 Total 98.0 - - 98.0 2.0 100.0 100.0 1/ Assuming that the loan and credit will become effective on July 1, 1984. 2/ Percentages are cumulative. ANNEX 9 -128- PAKISTAN INDUSTRIAL INVESTMENT CREDIT (IIC) PROJECT Documents Available in Project File A. The Manufacturing and Financial Sector 1. Pakistan - Industrial, Sector Strategy Paper (November 1, 1983) 2. Review of Pakistan's Financial System and Impact: on Inudstrial Investment, IBRD Working Paper, July 1982 3. A Comparative Analysis of the Nationalized Commercia.l Banks and Foreign Banks Operating in Pakistan, August 1983 4. State Bank of Pakistan, Annual Report (1982) 5. Sixth Five Year Plan (FY83-FY87) B. Project Related Reports and Documents 1. IDRP's Annual Report (1982) 2. IDBP's Policy and Strategy Statements 3. PICIC's Annual Report (1982) 4. PICIC's Policy and Strategy Statements 5. NDFC's Annual Report (1982) 6. NDFC's Policy and Strategy Statement 7. HRL's Annual Report (1982) 8. HBL's Policy and Strategy Statement 9. TJBL's Annual Report (1982) 10. 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