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FOR omcIL USE ONLY

COLOBI

T a 1YMAM9 W N miam PROMLoan and Project PSUmmar

sorrowr*nd szctnAo6nowl Banco de la Republica (BR)

Quarantors Republic of Colombia

hagLrLniaiest(a) Enterprises in the manufacturing and mining sectors, andinstitutions providing services to help prepare and implementinvestments by such sector businesses; (b) industrial workersdisplaced by the restructuring process; and (c) Governrentagencies managing the environmental pollution control and Projectmonitoring programs.

aanN" U8S 200 million equivalent.

11151: Repayment in 17 years, including 5 years of grace, at the standardvariable interest rate.

ga-nds_ s t For the Project's private sector credit program component, BR

would relend US$ 192 million of the proceeds of the loan in localcurrency to participating financial intermediaries (PFIs) andcharge at least the fully variable average deposit rate of theColombian banking system (DTIF) plus a margin to coveradministrative costs and foreign exchange risk if denominated inPesos or, if denominated in US$ equivalent, a rate reflecting atleast the Bank's interest rate plus a fee to cover the cross-currency risk and BR's administrative costs. Relending rates toenterprises would be determined by the PFI1 according to thematurity, credit risk, operational cost and competition of eachinvestment loan up to a maximum of six percentage points aboveBR's rate to the PFI. The ceiling on the spread has been set toequal or exceed the current average free market spreads. For Pesoloans, BR would bear explicitly the full foreign exchange risk,and would bear only the cross-currency risk for USS equivalentloans. For the public sector support component, US$ 8 million ofthe loan proceeds would be made available by BR to the Governmenton terms identical to BR's repayment obligations to the Bank.

This document has a restricted distribution and may be used by recipients onl- in the .1rformanceof their official duties. Its contents may not otherwise be disclosod without Wo,td Batik *thorization.

J

- LL-

FJXnuciwaioP1SEsznterpri.see S 148PartLcipatLng Financlal Interm dleries 103Prlvate Investment & EnterprLse Equlty Funds 49World Bank 2

TOTAL $ 500

Sate of Returs Investment loan approval. would reqplre normally at least a 12percent flnancial rate of return in real terms.

staff aouraisal Denoit:

8633-CO

SE: mDIBM 1837oR

MEMORAND AND UCCMMATION 0F TUE MIDEITOF TIE NOAL I 01 =RCONSTRUCTION AND DEVELOPAET

TO THE EXECUTIE DIRICTORSON A PROPOOSD LOAN TO COLOMBIA

M11 I STRAL RISTCTRING ANDEVElOPNT PROJECT

1 The following memorandum and recommendation on a proposed loan toColombia for US$200 millton is submitted for approval. The proposed loan wouldbe on standard terms, including 17 years maturity and 5 year. grace.

2. B&SkLrgSU4. The structure of Colombia's industrial production whichis almost entirely in the private sector, has remained relatively static sincethe mid-1970s and of modest importance to the economy, contrasting sharply withthe dramatic changes that have taken place in many newly industrialized countries(NICs). Production facilities have a preponderance of older equipment andindustrial output has been concentrated increasingly in a limited number ofplants. Output has been focused consistently on the domestic market and basfailed to generate a level of exports wbich would reduce Colombia's heavydependence on commodity exports. The competitive position in internationalmarkets of a number of important ColombianAindustries (agroindustry, textile. andclothing, leather and shoes, steel, vehicle assembly and parts) is quite weak.Average product costs are in most cases above their NIC comparators, while factorproductivity is generally low. Product designs suffer basically from inadequatecommunication with external markets and local institutional support. Productquality is hampered by defective raw materials and the aging technologyfrequently in use. Market response time is uniformly high, partly a aconsequence of organizational problems of producers.

3. Basic comparative advantages of Colombia, such as low unit laborcosts, abundant raw materials and good geographical position, are offset furtherby a pletiort of public policy and institutional factors. These have includedhigh duties and surcharges on imported capital goods and technology, scarce long-term credit and high real Interest rates, regulatory constraints on the nobility)f- labor, administrative barriers to the acquisition of technology, dutydr*vbacks and directed credit, and a time-consuming and costly transportationnetwork.

4. The recently elected Colombian Government is implementing vigorouslyan Economic Modernization Program (SUP) set in motion early in 1990 to liberalizethe external trade reginm, accelerate the reform of public services and devolopan internationally competitive private sector. The program marks the recognitianby many policy makers and private entrepreneurs that Colombia's socio-economicobjectives for the 1990s---to accelerate the country's rate of economic growthand employment creation, lower prices to consumers, and further diversify thenation9' export structure---cannot be met by continued high trade protection,import substitution, and capital-driven growth.

5. Rationle for Bank Involvement. Preparation of the IndustrialRestructuring and Development Project (IRDP) has facilitated the definition ofpolicy issues and the competitive strengths and weaknesses of local industry.It has mobilized interest in the restructuring process and helped to build adialogue between private industrialists and the public sector on how to achieveinternational competitiveness. Bank support of the Project has also helped tobring about the public policy and institutional changes required by enterprises

2

to compete and to mobilize the resources and oervices needed by them to implementthe restructuring process.

6. The Project is part of a package of Bank-supported policy andinstitutional adjustments to facilitate the realization of the ENW. A Bank loanof US$80 million equivalent was approved in 1989 for a Fifth Small and MediumScale Enterprise (SHE) Project, and a loan of US$300 million has recently beenapproved to support broad-based public sector regulatory and enterprise reforms.Two additional projects are under preparation which aim inter alia to facilitatethe reorganization of Colombia's industrial development bank for large scaleenterprises, the Instituto de Fomento Industrial (IFI), and to accelerate exportdevelopment. The experience gained in past lending through financilintermediaries to Colombian industry has demonstrated in particular theimportance of addressing directly policy and institutional constraints tointernational competitiveness. Therefore, the proposed Project embodiessubstantial adjustments mainly in the trade, financial sector and labor regimae.

7. Pro1ect Objectives and Descrintion. The Government seeks the Bank'ssupport through the proposed Project in order to facilitate a supply response tothe trade reform. The Project would provide capital and other support to assistthe private sector in renovating existing industrial production capacity so asto reduce product costs, increasing product quality and services, building newcapacity for goods in which Colombia has a dynamic comparative advantage, orphasing out capacity which is unlikely to produce acceptable long run returns tnan internationally competitive business environment. The Project incorporatesthose public policy and regulatory adjustments in the areas of external trade,domestic competition, the financial sector, labor and technology needed toachieve IRDP objectives. Most of these adjustments have already been achievedduring Project processing. The Project, with an estimated total cost of US$500million equivalent, would also include: (a) a private sector credit program tofinance investments and technical assistance to industrial enterprises andsupporting services (US$492 million)I and (b) programs to facilitate laboradjustment, environmental pollution control, and Project implementationmonitoring (US$8 million).

8. The credit program would support investments by enterprises qualifyingas (a) manufacturing and mining sector businesses, Jand (b) services to helpprepare and implement investments by such sector businesses, Including thoseoriented to the subsector level (eg., product design, technology and exportpromotion centers). Eligible expenditures to be financed by the loan would bebroadly defined to include goods and services associated with the acquisition oftraditional fixed assets, working capital, and a broad range of other incrementalexpenditures commonly required in restructuring exercises, such as productresearch and development, development of new marketing and distributing networks,and employee retraining and relocation.

9. Oversight of' Project implementation would be exercised by the Ministryof Econumic Development, (NED) while management of the Project's financialresources would be performed by BR as "second-tier" institution. All developmentand commercial banks in Colombia could, in principlg, become participatingfinancial intermediaries (PPIs). Qualifications as a PFI would depend upon (a)certification that they observe the financial and operating requirements of the

3

Superintendency of Banks, which are satisfactory to the Bank for the proposedProject, and (b) the ezistence of a valid participation agreement. BR wouldreview semi-annually a PI'e organization, stafflng, credit portfolioperformance, loan appraisal and supervision procedures for lending and equitycontributions under the Project, thereafter maintaining or adjusting accordinglyfree limits applicable to subloans.

10. BR would denominate the proceeds of the Bank's loan for the creditprogram in Pesos or US$ equivalent, according to the preferences of theenterprise. If denominated In Pesos, SR would rediscount 701 of a subloan orequity investment made available by a M11 to finance an enterprise investment andcharge an interest rate, to the m equivalent to at least DTF plus a margin tocover administrative cost and foreign exchange risk. If the proceeds aredenominated in US$ quivalent, BR would rediscount OO1 of the US$ senomatedsubloans up to a maximum of 50 of total subproject cost and charge a ratereflecting the Bank's interest rate plus a fee to cover the cross-currency risksand BR's administrative costs. BR would bear explicitly the full foreignexchange rate risk on Peso-denominated financing and only the cross-currency riskon a US$ denominated loan. Maturities of funds relent to PMs wuld match thoseset for beneficiaries. PuIs would set interest rates to clients according to theinvestment characteristics, maturity, credit risk, processing cost andcompetition for each enterprise loan up to a maximm rate of six percentagepoints above the rate from BR to the PFI. This ceiling on the spread has beenset to equal or exceed the current average free market spreads. Loan maturitiesand grace periods would be set by the P1I according to the cash flow and othercharacteristics of the Investment. PMs would mobilize the remaining 301 fromtheir own sources on tems identical to the rediscounted portion. Enterpriseloan approvals would normally require at least a 122 financial rate of return inreal terms supported by a sensitivity analysis. Given that the current tradereform program should substantially reduce the distortions in the econey, aneconomic rate of return would not be required. BR would undertake with Banksupport a regular specific supervision program of the Project portfolio of eachP11.

11. A breakdown of costs and the financing plan are shown in Schedule A.The loan allocation and the Misbursement schedule are shown In Schedule S. Atimetable of key project processing events and the status of Bank Groupoperations in Colombia are given in Schedules C and D, respectively. A map hasbeen included, and the Staff Appraisal leport No. 8633-CO, dated March 20, 1991is attached.

129 Ayreed Actions The main actions agreed upon under the Project areas followas (a) Trade PoUcy: under the Government' trade reform programinitiated in February 1990, quantitative restrictions on imports have beeneliminated (excluding those associated with health and safety and nationalsecurity). It has further announced publicly final targets for the reform: byend-1993 the maximum tariff level will not exceed 231# the average import-weighted tariff will not exceed 161 and the number of tariff categories will bereduced to no more that four (the current maximum is 501 for all productsexcluding vehicles and the weighted average tariff lIs .11). Ongoing commitmentof the Bank's loan under the IRDP credit program would be conditiatupom-i4 =maintenance of these three final targetst and (ii) coverage of industrial

4

domestic production by quantitative restrictions not exceeding 51 of value(excluding health and safety and national security related permits). This secondcondition would not apply If, in the opinion of the Bank, any such incarese abovethe 5S lImit Is required exclusively as a temporary measw to prevent a fall Inthe Government's ainternational reserves causei by an extreme and unexpecteddisequilibrium in its balance of payments, and, further, that the Governmentprepares within 120 days of the QR imposition, an action plan satisfactory to theBank for the substantial elimination of the QRo exempted from the limitation andputs it into effect within 180 days of the imposition. Amendments needed tosimplify and accelerate proceosing of the duty drawback scheme have already beenmade. (b) Domestic Competitions prior agreement with the Bank co a pricestabilization mechanism for domestic cotton production purchased for the textilesand clothing industries and on a deregulation program for the vehicle assemblyindustry would be conditions of first disbursement -to enterprisos in therespective subsectors. (c) Finanscal Sector: (i) interest rate subsidies onindustrial directed credit from BR to PFIs have been eliminated by setting theminimum rates between these entities at the DTF and setting maximum rates tousers to-equal or exceed the current average free market spreads (6 percentagepoints above the rate from BR to PPle; and (iU) industrial directed creditregulations have been harmonised with the Bank loan by raising free limits andshifting the focus of second-tier management to ex post monitoring of mperformanc and auditing of the use of fundsj- (d) Lahor- Congress-has approvedlegislation modifying the Labor Co4e to inter al& permit incresaed mobility oflabor as required by the restructuring process, specifically aimed to: (i)introduce competitiveness as grounds for transfer and dismissal of employees, theadoption of new technology, and reduction of plant capacity, (ii) increaseflexibility in labor contracts, and (iii) reduce the time needed for publicsector approval when required; (e) Technology: agreed measures bave been takento effectively elimminate the selection criteria for technology contracts andconvert contract review procedures into a registration and verification ofcontract data by the Superintendency of Industry; (f) Public Sector SupportProgras: a Pollution Control Program in the National Planning Department (DIP),a Project Monitoring Program in HED, and a Labor Adjustment Assistance ProgramAgreement (LAAP) have bean established. The detailed design of the LAAP wouldbe a condition of first loan disbursement for this component.

13. Benefits and Risks. The Project is expected to help Colombia to shiftits industrial production capacity to areas of comparative advantage in theinternational marketpla¢e. It should. lead to significant increases Inproductivity, sustainable growth, and export market orientation of a number ofindustries, as well as to. Improved environmental control. The main risks toProject implementation are the occurrence of reversals in the Government's tradereform program, that PFis are reluctant to lend for restructuring investmentsbecause of their greater credit. risks, and that investments are Inadequatelyprepared. To mitigate these risks, (a) the trade program has been publiclyannounced, is well underway and the commitment of the Bank's loan is tied to themaintenance of the progress made in its implementation; (b) the Project providesthat interest rates and terms on loans to enterprises can be set by Ms toreflect perceived credit risk up to levels which would equal or exceed current

-- ave*age free -market -spreads-,- tc) substantal pretnvestment vorkb-has been dtonduring Project preparation which many enterprises are using to formulate

S

tveostmnts, and (d) the Project includes a variety of supporting measures andresources to encourage sound design of investments.

14. RecomendaIM. I am satisfied that the proposed loan would eomplywith the IBRD's Articles of Agreement and recammand that the Executive Directorsapprove the proposed loan.

Barber B. ConablePresident

By Ernest Stern

AttachmentsWashbngton, DXC.March 20, 1991

4~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~,

SCHEDULE A

INDUSTRIAL RRSThUCIME AND DEVELOPMENT PRWE¢CT

Estimted Costs and Finanaim P1

Estimted: Cosis:Local Foreign Total

------ US$ millions ------- zPrivate Sector Credit Program 295 197 492 98Public Sector Support Program

Labor-AdjustmentAite 5 1-5 Assistane0Enviromental Pollution Control 1.0 1.0 2.0Project ganagement .uppport O...05 _ O.0

Subtotal 5.0 -3.0 8.0 2

Total 300 200 500 100

Enterprises 148 148 23Participating Finacial ntermdiatri" 103 103 17Private Investmet & EnterpriseEquity Funds 49 49 20World lank 200 200 40

Total .300 200 500 100

SCHEDULE B

COLOMBIA

JIDU8TRIAL ESTRUCTURINO AND DEVELOPMENT PROJECTLoan Allocation and Disbursements

(US$ Millions)

Cateaorv Amount Pereentaae

Loan. and equity investmentsfor enterprises 192 If donominated in Pesos: 701

If denominated in US$ upto a maxitum of 501 ofsubproject costs 1001

Labor Adjustment AssistanceProgram S -- -- 100

Environmental pollutioncontrol 2 1001

ProJect managemnt support 1- 1001

Estimatld Dis semengts: --- S$--l-------------US$ mtllions-----------Bank PY 92 93 94 .95 96 97 98

(avg profile for Bank loan.to industry in Colombia)

Annual 6 44 70 38 22 12 aCumulative 6 50 120 158 180 192 200

Rate of Returns Investment loan approvals would normally require at least a12 percent financial rate of-return.,

-~~~~~~~~~~~~~~~~~~-

SCHEDULE C

COLOMBIA

INDUSTRIAL RESTRUCTURING AND DEVELOPMENT PROJECTTimetable of ReI Proiect Processing Events

(a) Time Taken to Prepare: 18 months

(b) Prepared By: Central Bank vith the assistance ofthe Government, consultants and theWorld Bank.

(c) First Bank Mission: November 1987.

(d) Appraisal Mission Departure: May 1990.

(e) Negotiations. January 1991.

(f) Board Presentations April 1991.

(g) Planned Date of Effectiveness: June 1991.

(h) Relevant PCRs and PPARss Seventh and Eighth DevelopmentFinance Company Loans (Ln. 1598-COand Lii. 1857-CO); PCR of November1989.

First through Third Small ScalIndustry Projects (Lii. 1071-CO; Ln.1451-CO; Ln. 1834-CO); PPAR 2645,PCI of April 1983, PCR of April1986.

SCHEDULE DPage 1 of 2

STATEUENT OF BANK LOANS ANO IDA CREDITS IN COLOMBIA (as of December 31, 1990)

Amount (lossLoan or cancellations)Credit Fiscal ------------------ Undis-Number Year Borrower Purpose Sank IDA bursed

104 Loans and one IDA Credlt fully disbursed a/ 4,238.04 23.48

* .1963 1981 EPM - Plays* Power 69.00 6.432174 1982 Colombla Int Rural Devt II 63.00 12.802303 1983 ICA Agrlc Res & Ext 63.40 4.812349 1984 Carbocol Coal Exploration 7.80 1.452449 1984 EPM Rio Crande ultiputp 164.50 80.6224S3 1984 Fedecafo Ag Diversification 60.0W 5.502470 1986 EMC Cucuta Water/Sew 18.50 9.842477 1986 S. de la Rep. DFC IX 90.00 S.322512 1986 EAAB Bgota Water IV 129.W0 47.872811 1986 Colombia PUblie Health 24.04 11.302834 1988 EEEB Bogota Dist II 189.31 103.272835 1986 Colpuertos Port Rehab 42.80 23.682637 1986 EPh/8'quilla Barranq'la Water 24.W0 8.262887 1988 HIMAT Irrigation 1I 114.00 73.642W88 1986 Cavecinales Rural Transport 62.00 3.782829 1987 Fondo Vial 2nd Ntl Hwy Sector 180.30 37.802889 (S) 1988 Colombia Power Sector AdJ 306.00 75.062909 1988 Caja Agrarle Caja Agraria 15.00 11.76

2981 198 BCH WS a Waste Sector 150.60 134.98

3010 1989 Colombia Ed Sector 100.00 90.023025 1989 8. do Ia Rep. Sth Sm Med Entp 80.06 80.06

3113 19S Colombia Sm-Scate .rrig 78.20 78.20

3157 1990 Fond* Vial Rural Rd Sector 556.00 62.01

8201 1990 Colombia Comm Child Care & Nu 24.06 22.8t3289 1991 Colombiat Rural Dev IneMMt 76.0 75.003278 (S) 1991 Colombia Public Spotor Reform 304.00 304.00

* 2,442.85 9.00 1,637.36

TOTAL 6,678.89 23.48Of which repaid 2,394.20 9.06

Total held by Bank £ IDA 4,284.69 14.48

Amount sold 5.99of which repaid 60.99

Total uadlebursed 1,357.36-

SCHEDULE DPage 2 ol 2

S1sitV O IFC 1MTHS1 Saso cem eerl, 19

tin millions S0J

held Hele by lnisburswofiscal ta Fiscal tear - IFC t15- ov Pesuci- llnclutoingirved Citceo Obliqor Iype oi usgns LOANI E@ITI tOTL IFC pants Participants

195 19 ao LanfinS del aribe, Ltda. Fibreourd 0.50 0.51960165 196065 al Inc nitmnt Noel SR Fwod & Fod Proceng 1.98 v.08 2.Oo1961 1961 Al Envas Colodias LA. Metal CAns 0.70 0.J019n1,68 19a1,&8 ait harie4roauctos Hos Furniture 0. 0.0 0.17191 1961 a Electromnufacturas, LA. Electrical Equipm 0.50 0.5019065 1962 at Ecrn Financ Colombina Evelopmnt Fimance .u 2.02 8.021962/63i85 1962163iS5 Corp Financ Nacional Developet Finance 6.00 2.04 .04 0.0519n3671 1963tn7 at Compania Colodoana Textiles & Firs 24.48 0.15 24.63 22.50&80a9/9 68169/91 de Tejidos Li. 22.50

19n4i70 19W170 a Crp Fmanc do cadas Deopment Fina 0.81 0.8119*4,68 194/18 at Fori de CWodia Iron & Stael 1.27 1.2719sb 19b at Aleaviva karere lwarenousing l.bu 1.ou19 19667 av Ina 6anta LA Livestock 1.00 0.5 1.5819/7074 197170,74 Eaua Do ColotDa iL textiles & Fibvs 58.31 2.61 W.9 32.31 11.59 17.@

199&w7i/s 19M/6/71919*9 199 au Co. Desr Hotles t Turs Touris 0.01 0.01 bt19N673 1969173 ai Corp Financ dei Norte evelP ent Fiance 0.45 0.45196985 19*9i/s at Care Financ del Valle Dvelopent Fiance 6.00 0.43 o.431WO 197i au from Hot lur Nellin Sm bouris 0.24 0.1 0.34197077 19O/77 uF Pr HottlIs SA Tourism 0.80 0.24 1.041973t75 I73/ at Corp s Norrot Vivienda Money & Capital Market v.b4 4.4.19A4 1974 au Centos Kovaca &A Cement & Coast Matenals 1.50 1.50.1974 1975 au Cmmnts del cErie Cont & ECast Materials 3.o0. 3.d01f/ 197* at flnwra Las iTiss Maninq tAbsts" neu 6.00 6.001977A89 1977,89 Pomotora de la lnterconem on utilities .23.Ou 2.00 25.v 12. 7.24

no los Sasouct do la tis transissioaiLosta tlantica. LA. ,

tg77/ if rSt8) uColclihker Cment 0.49 - 2.24 2.73 19li95847 19810 5,7i v Leasng oUivar Equpment Lsming 14.02 0.24 14.22 I.-S 0.311o 1903 frigoriicos Colombian LA. CWd Storage 1.00 0.58 1.58 0.721981/82 1981/82 Petrdo Peohemicals 12.15 3.9b 16.01 5.23 5.9*19828 14i167 Carbons del Caribe nwey 14.78 14.78 11.051983 1984 Ctntos Rio Claro Cemet 22.47 5.0 27.47 2L49 0.371to5 19B sawra Sa Fdo.Expl. EntAy -5.00 5.00 4.1 .4.18187 1987 fuctos Dbrivo e l Sel Chemicals L.0 1.18 7.18 5.90 o.o198f 187 a P ra del 6asto Cantral On Petrcheuicals 0.04 0.041998 1989 Crporacam Fin dd VlleCII Dewlopmnt Finan 5.00 4.78 978 9.78 2.51190 1991 Oleoucto de CEeta, Ll. m Pebtroc cals 10.00 70.00 35.00 3.00 23.00

Total gross mtmnts 287.60 36.22 323.1i3 142.60 v.24 76.52

Ls Canellatuons, -termations,yments NW sales d168 IL.25 181.22

Total Comtmts no ld by IFC 124.43 17.98 142.60- .-

loW Zisbursed tincuding Participants 6.83 6.69 7.52

au Intmnts uch have ben fully canelled. t#sinated, wntten off, sold, redee wr pai

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