t/AA/ 3 g 7 J -•///Document of

The World Bank

FOR OFFICIAL USE ONLY

iit,5.st Ni :1 2'f;3 - CIA 'I; T 2AI Report No. 11253-CIA't~~I A 11hN . N 1 NI;U1 ?h I.L. TEIT lPN IJ i ., i iN :t l'

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STAFF A.PPRAISAL REPORT

CHINA

TIANJIN INDUSTRIAL DEVELOPMENT PROJECT

FEBRuARY 11, 1993

Industry and Energy Operations DivisionChina and Mongolia DepartmentEast Asia and Pacific Regional Office

llis document has a restridted distibution and may be used by redcpients only In the performance oftheir offlcial duties. Its contents may not otherwise be diselosed without Worid Bank authrizaon

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CURRENCY EOUIVALENTS(as of December 31, 1992)

Currency name = Renminbi (EME)Currency unit - Yuan (Y) - 100 fenY 1.00 - $0.174$1.00 a Y 5.75

WEIGHTS AND MEASURES

Metric System

ACRONYMS AND ABBREVIATIONS

ADB - Asian Development BankBOCOM - Bank of CommunicationsCIB - China Investment BankCRS - Contract Responsibility SystemDEMC - Daming Electric Motor CompanyERR - Economic Rate of ReturnFEAC - Foreign Exchange Adjustment CenterPIs - Financial IntermediariesFRR - Financial Rate of ReturnFTC - Foreign Trading CompanyGOC - Government of ChinaGVIO - Gross Value of Industrial OutputICE - International Competitive BiddingICBC - Industrial and Commercial Bank of ChinaLIB - Limited International BiddingMOF - Ministry of FinancePBC - People's Bank of ChinaPCBC - People's Construction Bank of ChinaPFIs - Participating Financial IntermediariesPRC - P3ople's Republic of ChinaSMT - Surface-Mounted TechnologySPC - State Planning CommissionTAIC - Tianjin Auto Industry CorporationTCC - Technical Cooperation CreditTEPB - Tianjin Environmental Protection BureauTIDP - Tianjin Industrial Development ProjectTLIP - Tianjin Light Industry ProjectTMB - Tianjin Municipal BranchTMG - Tianjin Municipal GovernmentTHIB - Tianjin Machinery Industry BureauTPC - Tianjin Planning CommissionTVEs - Town and Village EnterprisesTWBLO - Tianjin World Bank Loan Office

FISCAL YEAR

January 1 - December 31

FOR OMCAL USE ONLY

CHII

TINJIN INDUSTRIAL DEVELOPMENT PROJECT

Loan and Proiect Summarv

Bgrrwe_s: People's Republic of China

Deneficiaries: Municipality of Tianjin (Tianjin)

Amount: $150.0 million equivalent

Terms: Twenty years, including five years of grace, at thestandard variable interest rate

Onlendina Terams: Tianjin would onlend the proceeds of the loan as fol-lows: (i) onlend the industrial credit componeat of$134.5 million to participating financial intermediaries(PPis), and (ii) out of the technical assistance compo-nent of $15.5 million, $200,000 to PFIs and $9.7 millionto eligible enterprises, on the same terms and interestrate as that of the Bank loan. PFIs would onlend theloan proceeds of the indust..ial credit component toeligible enterprises for a maximum period of 15 yearsincluding up to 3 years of grace and at a variableinterest rate equal to the Bank rate plus a minimumspread of 1.2 percent. Subborrowers would carry theforeign exchange risk under the industrial credit compo-nent, and, under the technical assistance component,PFis and enterprises would bear the foreign exchangerisk on the respective amounts indicated above, whileTianiin would carry the foreign exchange risk on thebalance of $5.6 million.

Prolect Descrintion: The project would support the restructuring of five keyindustrial subsectors (machine tools, constructionmachinery, automotive parts, electronic components andelectric motors). It would provide financial assistanceof $134.5 million for the modernization of enterprisesand technical assistance of $15.5 million for strength-ening of institutional infrastructure, studies andexpert services for the five project subsectors. Theproject would aim to: (a) expedite policy and enter-prise reforms at the regional level, leading to greaterautonomy for and accountability of enterprise manage-ment, and encourage the municipal authorities to focustheir activities on supporting and guiding enterprisesrather than directly controlling them; (b) assist insti-tutional development for strategic planning, systemsdevelopment and implementation, engineering and techni-cal support services and human resource development and

This document has a restticteddistribution and may be used by recipients only In the performanceof their oMcial duties. Its contents may not otherwise be disclsed without World Bank authorization.

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redeployment; (c) improve subsectoral organization andinternal enterprise management and syetomss (d) modern-ize and restructure enterprises, including the supportof high priority investments5 and (e) further strengthenfinancial intermediaries.

Prolect Benefitsand Risks: The acceleration under the project of policy and system

reforms, improved services of support institutions andrestructuring of enterprises would result in improvementof subsectoral efficiency and performance. In addition,the subprojects to be supported would meet economicviability criteria and would contribute to higherexports and efficient import substitution. There aretwo main project riskss (a) unanticipated and adversefuture macroeconomic developments and the cumbersomeprocess of coordination between the central and provin-cial authorities could affect the pace of Implementationof the agreed policy and enterprise reforms; and(b) various activities envisaged under the project maynot be completed on time. However, given the Govern-ment' s strong commitment to the reform process, institu-tional arrangements made in Tianjin for project imple-mentation and experience gained under an earlier Bank-assisted industrial project in Tianjin, these risks areunlikely to pose a serious threat to the success of theproject.

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Total Project Costs Local E.elsn TotatI---- ($ million) ----

Industrial investment 65.5 134.5 200.0

Technical assistance& training 6.5 15.5 22.0

Total Costs 22 72.0 150.0 222.0

Financint Plant

IBRD - 150.0 150.0PPIs, enterprises and TMG 72.0 - 72.0

Total 72.0 150.0 222.0

Estimated Dibursement.:

BankF 1994 1995 1996 1997 1998 1999 2000-3------------------- ($ million) --------------------

Annual 5.0 9.5 28.5 52.5 35.5 11.0 8.0Cumulative 5.0 14.5 43.0 95.5 131.0 142.0 150.0

Economic Rateof Returns Not applicable

la Tentative estimates inclusive of taxes, duties, and contingencies. Finalestimates would d pend on individual subproject cost estimates which PPIewould prepare at ihe time of subproject appraisal.

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STAFF APPRAISAL REPORT

CHINA

TIANJIN INDUSTRIAL DEVELOPMENT PROJECT

Table of ContentsPate No.

I. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . 1

II. TH INDUSTRIAL SECTOR IN CHINA . . . . . . . . . . .. . .. 3

A. Background . . . . . . . . . . ... * . .. . . . . . . . . 3B. Industrial Development Strategy . . . . . . . . . . . . 3C. Bark Support to Industry . ..... .. . ..... . .. . . .. 6

IIl. THE-INDUS'LR1AL SECTOR IN TiANJIN . . . . . . . . . . . . . . 10

A. Tianjin and its Industrial Sector . . . . . . . . . . . 10Background . . . . . . . . . . . . . . * . * * * * . 10Structure and Performance of Industry . . . . . . . 10

B. Development Strategies and Policies . . . . . . . . . . 12C. The Five Subsectors .................. 14

Enterprise and Subsector Policy Reforms . . . . . . 14Physical Restructuring of Subsectors--Issues and

Strategies . ... . .. . .. . . . . . . .. .. . 17Development of Technological Infrastructure . . . . 21

D. Bank Role, Lessons Learned and Strategy . . . . . . . . 21

IV* THE RJ;aCT . *ao * * 0 ** 0 3

A. Project Objectives . . . . . ...... 23B. Project Components .t.. * ........ ***. 23

Financial Assistance Component . . . . . . . . . . . 23Technical Assistance ..... * ***..... 24

C. Project Cost and Financing . . . . . . . . . .. . . . . 26D. Project Implementation Arrangements . . . . . . . . . . 26

Role of the Tianjin Municipal Government (TIG) . . . 26Role of Participating Financial Intermediaries (Plls) 27

E. Environmental Impact ..*. .... ........... ......... ... 30

This report is based on the findings of an appraisal mission that visitedChina in June/July 1992. The mission comprised Z. Rhan (Task Manager),N. Hughes (Senior Operations Officer), N. Lichtenstein (Senior Counsel),N. Mathieu (Senior Economist), M. Pharwani (Senior Engineer) and C. Punsalan(Senior Financial Officer). H. Sethi who was a member of the identificationand preappraisal missions also contributed to the preparation of this report.The peer reviewers are Messrs. J. Gamba and R. Heath. The Acting DivisionChief is Mr. Z. Khan and the Director is Mr. S. J. Burki.

V. TIM ................................ 32

A. Main Featires of the Loan . . . . ..... .... 32B. Procuremeni .ad Disbursements . . . . ..... . . 33C. Reporting and Auditing . . . . . . . . . . . . . . . . . 35D. Benefits and Risks . . . . . . ............. 35

VI. AGRE TAND RECOMNENDATION .9.... . ...... *. 37

ASUR

1. The Statement of the Tianjin Municipal Government on theDevelopment Program and Strategy for Machine Tools, ConstructionEquipment, Electronics Components, Automotive Parts andElectric Motors Subsectors ............ a...................... 39

2. Economic and Enterprise Reforms in the Pive SubsectorsIf in Tianjin .... . ...... ...... ...... ... ....... ....... ........ 493. Institutional Strengthening for Workers' Retraining and

RedeploymentinTianjin .. ..*..........** 00 564. Machine Tools Subsector *0 o .... .... 595 Construction Machinery Subsector . .............. 666. Automotive Parts Subsector . .. .. . ... . . . . ..... . . 727. Electronics Components Subsector . . . *. . . . . . . . . . . 798. Electric Motors Subsector *.000 0...00 ... v 849. Institutional Infrastructure and its Development Program . . . 88

10. Terms of Reference of Studies/Project Implementation Workof Consultants . .. . . .. . . . . . .. . .. * * 0 o . 0 ... 4 107

11. Project Implementation Schedule . .. . ....... . . .' 11212. Key Monitoring Indicators ..................... 11313. Project Implementation and Supervision Plan . . . . . . . . . 11414. China Investment Bank (CIB) . ............................... 11615. Industrial and Commercial Bank of China (ICBC) . . . . . . . . 12416. The Bank of Comunications s(BCBO).............. 13317. Estimated Disbursements . . . .. ....... . .. . . . . . 14018. Documents Available in the Project Pile . . . . . . . . . . . 141

TABLES IN TEXT

3.1 Tianjin: Industrial Output Trend . . . . . . . . . . . 115.1 TIDP - Procurement Arrangements . . ...... . ... . 34

TIANJIN INDUSTRIAL DEELOPNMENT PROJECT

1. INTRODUCTION

1.1 Tianjin is one of China's three largest cities which have the statusof province. It has a relatively large and diversified industrial base.Although its industrial output accounts for only 3 percent of the nationalindustrial output it is quite sizable in absolute amount--Y 72 billion($15.2 billion) in 1990. In line vith the national policy, the Tianjin Muni-cipal Government (TMG) is implementing a series of reforms to restructure theindustrial sector. The Bank has already started supporting this programthrough Loan 3022-CHA (February 1989) for the Tianjin Light Industry Project(TLIP). TLIP is assisting T¶G in restructuring three priority subsectors ofthe light industry sector through acceleration of economic and enterprisereforms, improvement of internal enterprise organization and management Sys-tems, physical restructuring of plants and strengthening of support institu-tions. The overall progress on implementation of the project is satisfactory.TMG has now prepared a second industrial restructuring project, viz., TianjinIndustrial Development Project (TIDP) for Bank assistance. The proposed proj-ect would help to accelerate and broaden the reforms initiated with TLIP andextend Bank support for the restructuring of additional priority subsectors.

1.2 As part of project preparation, an in-depth study of the five sub-sectors has been carried out by international consultants (financed under anexisting IDA credit--Credit No. 1664-CHA) in two phases. Phase I has estab-lished Tinijin's comparative advantage in these subsectors based on selectedproduct groups and has proposed strategies and development programs. Phase IIprovides implementation plans at the municipal, subsectoral and enterpriselevel for these strategies and programs. Based on the findings and recommen-dations of the studies, a development program and strategy have been preparedby 11G for the five subsectors (Annex 1) and were discussed and agreed uponwith the government during project appraisal. Economic and enterprise reformsare the focal point of the strategy and the proposed project would assist intheir implementation on two fronts. On the one side, the project would helpthe government in carrying out subsector policy reforms (such as liberaliza-tion of investment, production and pricing; improvements in the foreign traderegime; increased labor mobility; social security and housing reforms; andpromotion of industries where Tianjin has a comparative advantage), which areneeded irrespective of the type of ownership of enterprises. On the otherside, a set of enterprise reforms would be pursued (such as corporatization,improvements in the contract responsibility system, reorganization of subsec-tors, introduction of modern management systems and procedures, and promotionof joint ventures), vhich will make enterprises more efficient and profit-making entities.

1.3 Some of the important elements in the above-mentioned economic andenterprise reforms are: (a) OwnershiRs All beneficiary corporations underTIDP will be shareholding companies and those meeting financial criteria andconditions of the central government will also be allowed to issue shares to

the general public and employees; (b) Prices: About 95 percent of the prod-ucts of the five subsectors are already outside mandatory planning, all theremaining price controls--both mandatory and indicative--will be removed by1995! and (c) Foreifn Trade: The goverment has recently liberalized theeligibility requirements for export rights for products with high-technologycontent; enterprises with exports of $1 million can now be given such rightscompared to the previous $3 million limit. Accordingly, most of the enter-prises in the five subsectors will be able to export directly; (d) SurDlusLabor: Almost 10,000 workers are expected to become surplus in the five sub-sectors as a result of restructuring. These workers will be removed from theenterprises (20 percent in 1993 and 40 percent in 1994 and 1995, respec-tively); and (e) Subsector Reorganizations The present 81 enterprises in thefive subsectors will be reorganized into 21 corporations which will alloweconomies of scale and specialization. Each corporation will be a separatelegal entity with its own profit and cost centers. Ten nonviable enterpriseswill be closed and 22 product groups in which Tianjin does not have a compara-tive advantage, will be discontinued.

1.4 The proposed Bank loan of $150 million would support the foreignexchange needs of the project; $134.5 million as an industrial credit to beonlent through three participating financial intermediaries (PFFs); viz., theChina Investment Bank (CIB), Industrial and Commercial Bank of China (ICBC)and Bank of Communications (BOCOM), for technological restructuring of enter-prises in the five subsectors and $15.5 million for technical assistance forstrengthening of support institutions, studies, expert services, and training.The subprojects to be financed by the PFIs will be consistent with the Tianjingovernment's strategies for the five subsectors and will also meet the invest-ment criteria of the PF1s.

11. THE INDUSTRIAL SECTOR IN CHINA

A. Background

2.1 Industry is China's largest productive sector, accounting for nearlyhalr of its gross domestic product (GDP) in 1990 and employing 17 percent ofthe country's total labor force. About 104,000 state-owned enterprises gener-ate 55 percent of total industrial output; most of the remainder (36 percent)is produced by 1.7 million nonstate enterprises--primarily urban and ruralcollectives, and township and village enterprises (TVEs). The state enter-prises concentrate mainly on important raw materials, capital goods, and stra-tegic commodities, while nonstate enterprises mainly produce downstream con-sumer products. Gross industrial output, which amounted to Y 2,392.4 billion($500.2 billion) in 1990, is shared almost equally by light and heavy indus-tries. The gross value of industrial production increased rapidly between1978 and 1990, at about 12 percent a year in real terms. During this period,light industry registered a much faster average annual growth rate (13.9 per-cent) than did heavy industry (10.3 percent). Chinese manufactured exportshave also grown rapidly from around $9 billion in 1980 to about $46.2 billionin 1990.

2.2 China's industrial development has been constrained by severalstructural deficiencies that stemmed mainly from rigid economic planning andpast industrial strategies oriented towards self-sufficiency at the nationaland regional levels. The most obvious deficiencies pertain to outdated tech-nologies, institutional rigidities deriving in part from quota and price con-trols, a distorted structure of prices, inadequate infrastructure and anunderdeveloped financial sector. These problems are reflected in the low pro-ductivity of labor and low efficiency of resource use in Chinese plants. Thestructure of industry also is skewed toward basic heavy industry. The empha-sis on self-sufficiency at the regional level has led to a fragmented nationalmarket, reduced domestic competition, and the suboptimal use of scarce skillsand resou.ces. As a result, potential gains from economies of scale are oftenmissed. Institutional inflexibility, compounded by inadequate market integra-tion, has provided little incentive for industrial enterprises to improvemanagerial efficiency and product quality. The low prices of energy and basicintermediates for industrial production also contribute to the inefficient useof inputs. Investments in infrastructure, particularly for transportation andtelecommunications, have lagged behind those in industry. This disparity hasin turn been a major constraint on industrial development. The financialmarkets are still in their infancy and until recently only provided limitedintermediation services for enterprises.

B. Industrial Development Stratetv

2.3 Since 1979, the Chinese Government has initiated changes in theindustrial structure and, as part of the ongoing economic reforms, has intro-duced incentives and market mechanisms to improve economic efficiency. Thedevelopment strategy has emphasized modernizing existing equipment, developingmanufactured exports and more efficient light industry, and conserving mate-rial and energy resources in industry. The reforms have focused mainly onfour areas: (i) prices--expansion of the role of market forces in price

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determinations (ii) enterprises--strengthening of enterprise autonomy andmanagement accountability; (iii) trade--promotion of exports to earn foreignexchange to finance the importation of modern technology and equipment; and(iv) financial sector--enhancement of the scope and efficiency of financialintermediation. However, given little international precedent or experiencein successful transition from centralized planning to an effective integrationof plan and market, these reforms continue to be a difficult process, requir-ing caution, experimentation and repeated fine-tuning. Furthermore, the pro-gress of reforms has varied from region to region and subsector to subsector;the status of reforms in Tianjin is elaborated in Chapter III.

2.4 The price reforms are designed to reduce gradually the distortionsthat cause allocative economic inefficiency, particularly by reducing thescope for allocation of resources under mandatory planning and by allowingmarket forces to play a greater role in price determinstion. At present, atwo-tier pricing system exists as a result of differences between the con-trolled prices for quota production under the state all}cation plan and mar-ket-related prices for output above plan targets. Since the start of theeconomic reforms, the Government has allowed a growing portion of industrialproducts to be sold at market prices outside the plan, and it has considerablyraised the price of major industrial inputs, including energy. While thecurrent transitory system is a significant improvement over the strict pricecontrol of the past, distortions in relative prices and gaps between con-trcolled market prices have a number of shortcomings: reduced allocative effi-ciency, discrimination across producers and consumers, administrative complex-ity, and creation of opportunities for corrupt practices and other distor-tions. The Government's strategy is to continue reducing its administrativecontrol over pricing in parallel with gradual dismantling of annual productionplanning and allocation.

2.5 Rapid increases in free market prices and costs of urban living in1989 slowed the pace of price reforms in recent years. After the announcementof major price reforms in May 1988, urban consumer prices, having risen by15 percent in the first two quarters of that year, soared at an annual rate ofover 60 percent in the third quarter. These developments forced the COC torescind the proposed price reforms and initiate a major stabilization (auster-ity) program. During the three-year audterity program, vhich could haveimplied a significant retreat to strong price controls over some strategiccommodities, price reform remained a firm part of the Government's reformagenda. Major adjustments of controlled prices for agricultural commodities(soybeans, grain$ cotton, edible oils, energy inputs, coal, crude oil andpower) and transport (freight and passenger transport) were made during1990-92. These adjustments are expected to create a more favorable environ-ment for further price reform, including a gradual decontrol of prices andcontinued enlargement of the share of total output allocated by markets.

2.6 Reforms have been introduced in the management arrangements andownership structure of enterprises with a view to improving the efficiency ofenterprises. The central theme of these reforms has been the decentralizationof economic decision-making, from the government to enterprises and fromhigher government tiers to lower ones. Enterprises, whose main function hadbeen to carry out production mandates from the government before the reforms,have thus been provided various incentives to operate with greater autonomy in

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a more competitive business environment. As a consequence of these reforms,Chinese enterprises have now become diverse in terms of ownership, size andorganizational and management arrangements. Many small state enterprises havebeen converted to collective enterprises, and new rural collective enter-prises, operated by TVEs, have proliferated in areas close to major cities.The scope for privately-owned enterprises was expanded greatly by new regula-tions in 1988, which eliminated ceilings on the number of employees, andexpanded the lines of business they can enter. New hybrid forms of enter-prises based on domestic joint ventures among different bureaucratic jurisdic-tions have also emerged, as a means of dealing with interregional trade andinvestment barriers. As for the management arrangements of state enterprises,significant changes have also been made in the degree of enterprise controlover their assets and profits. The state enterprise reforms introduced, amongother things, a system of contract management responsibility, a uniform taxrate (55 percent) for many large enterprises, wage incentives for workers, andhigher profit retention by enterprises.

2.7 The economic environment over the next several years is expected tobe conducive to continued and rather accelerated experiments with enterprisereforms. Such reforms, however, will continue to be graduall the step-by-stepprocess which has characterized China's successful reform efforts to date islikely to continue. Main topics on the agenda include modification (in somecases, phasing out) of the management contracting system for state enter-prises, introduction of a system of uniform ta-ation, alternative forms ofenterprise ownership, separation of social (security) functions from commer-cial enterprises, and the introduction and application of company and bank-ruptcy legislation. In particular, the Chinese government has in recent yearsbeen actively investigating theoretical and practical issues related to adapt-ing a shareholding system to Chinese state enterprises, and is launching con-trolled "joint stock" experiments at selected locations. In this connection,an important change in the state investment system was initiated in early 1989through the creation of state and local investment companies, which can pro-vide equity-type funding for state enterprises. Until the recent past, allstate-sponsored investments for state enterprises had been wholly debt-financed.1/ In 1992, the shareholding experiment was broadened beyondShanghai and Shenzhen and regulations were enacted extending the rights ofstate enterprises into new areas such as price setting, planning, labor andforeign exchange rights.

2.8 In this context, TMG has authorized, on an experimental basis, thecreation of shareholding companies in the five manufacturing subsectors underthe TIDP project. The majority of shares will be publicly owned, i.e., heldby the State Assets Administration Bureau of Tianjin. A board of directorsrepresenting the shareholders will be established in each of the selectedenterprises and will be responsible for major corporate decisions. The aboveexperiments will be of two types: (i) enterprises with shareholders beinglegal entities (limited liability companies) and (ii) enterprises with some of

1/ This practice Was an improvement over the preceding one of total grantfinancing. However, total debt financing of newly formed companies fur-ther complicated the ambiguity of enterprise ownership, and was also inconflict with a norm of prudent financial management.

the shareholders being individuals including enterprise staff who may hold upto 20 percent of capital stock (limited share companies).

2.9 In foreign trade, the main changes so far have involved a break-upof the export and import monopolies. This has been done mainly throughlimited decentralization of the export trade and the granting of direct trad-ing rights to production enterprises whose exports are above $3 million ayear. A new round of foreign trade reforms has been put in place in 1991,involving the abolition of export and import subsidies, and equalization ofretention ratios of foreign exchange earnings by enterprises. Transactions inlocal foreign exchange adjustment centers (FEACe) have grown rapidly. Peri-odic adjustments in the official exchange rate hav- been made to the pointthat 1991 saw the introduction of a managed floating rate system.

2.10 The major financial sector refcrms includet (i) formal establish-ment of the People's Bank of China (PBC) as the country's central bank;(ii) divestiture of PBC's commercial banking functions to independent special-ized banks; (iii) creation of a few new banks and nonbank financial institu-tions for various financial services; (iv) introduction of new financialinstruments and establishment of related financial markets; and (v) a gradualrise in interest rates to stimulate economic use of capital and to promotedomestic resource mobilization. These reforms have led to considerable finan-cial deepening despite some setbacks in the recent period of high inflation:the ratio of the size of monetary assets (M2) to gross national productionincreased from 37 percent in 1979 to 75 percent in 1987, and the figure for1990 was 88 percent. Notwithstanding these advances, weaknesses remain. Thesystem remains overwhelmingly dominated by banks, in particular, the four spe-cialized banks. Financial institutions have still to undergo substantialinstitutional upgrading to function as effective intermediaries. There hasbeen a trend in the banking system of increasing portfolio arrears which needsto be arrested. Regulation and supervision of the financial system needsconsiderable strengthening as do the accounting and legal frameworks.Interest rates also need to be unified. While recent reliance on administra-tive mechanisms has enabled the government to regain control of inflation, inthe longer term, PBC needs to develop its indirect monetary policy tools.

C. Bank Support to Industry

2.11 The Bank's objectives in supporting China's industrial developmentare to assist the Government in: (i) improving the policy framework for theindustrial sector as a whole; (ii) building sound institutions and practicesfor subsector planning, project approval and implementation, and financialintermediation; (iii) promoting and implementing technology upgrading, plantrestructuring and rehabilitation, and energy and material resource conserva-tion in selected sectors at the national and provincial levels; and (iv) car-rying out various reforms, particularly in the enterprise and financial sys-tems. As the Bank's relationship with China has deepened, lending and sectorwork have increasingly concentrated on the articulation and design of the spe-cific policies, institutions and procedures, which are integral parts of thereform effort.

2.12 The Bank Group's lending to the industrial sector in China, whichbegan in December 1982, comprises the following: (i) five loans/credits

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totaling $945.6 million to CIB /I to develop it as a premier financialintermediary providing term financing for small- and medium-sized enterprisesin a wide range of industrial subsectors; (ii) four loans/credits totaling$394.3 million to the fertilizer industry 3I to support the building of newfortilixer plant8, development of new phosphate mines, revamping of plants,and strengthening of the institutional infrastructurel (iii) a loan of$100 million for the Shanghai Machine Tool Project (Loan 2784-CHA) in FY87,involving rehabilitation and modernization of the machine tool subsector inShanghai; (iv) a loan of $128 million for the Pharmaceuticals Project (Loan2934-CHA) in FY88 to support the expansion of pharmaceutical production usingmodern technologies and proper manufacturing practices; (v) a loan of$154 million for the TLIP (Loan 3022-CHA) in FY89 to support the restructuringof textile dyeing and finishing, pulp and paper manufacturing, and packagingsubsectors; (vi) a $20 million industry component of the Gansu ProvincialProject (Loan/Credit 2812/1793-CHA) in FY87 for modernization of the ruralindustry bass; (vii) a loan of $50.0 million and a credit of SDR 45.1 million($64.3 million equivalent) for the Rural Industrial Technology (SPARK) Project(Loan/Credit 327412186-CHA) in FY90 to support the upgrading of standards andtechnology for the dynamic TVEs, China's rapidly growing nonstate enterprises;(viii) a loan of $150 million for the Shanghai Industrial Development Project(Loan 3288-CHA) in FY91 to support restructuring and development programs infour industrial subsectors--electrical apparatus, printing machinery, scien-tific precision instruments, and electronic components; and (ix) a loan of$82.7 million for the Regional Cement Industry Project (Loan 3443-CHA) in FY92for the development of the cement industry. In addition, the Planning, Sup-port and Special Studies Project (Credit 1835-CHA), approved in FY87, includescomponents for long-term planning and strategic studies in several industrialsubsectors.

2.13 Physical implementation of most of the investment projects had pro-ceeded generally on schedule until the initiation of the economic austerityprogram in late 1989, when related local funding shortages began resulting indelays in the implementation of several Bank-financed projects. Since late1991, however, the implementing agencies have been taking steps to expediteproject implementation to catch up with the original schedule. GOC has givenassurances that the necessary funds would be made available for Bank-financedprojects. Disbursements of the above loans/credits, after some delays during1990/91, have returned to a satisfactory level. Project Completion Reports(PCRs) have been prepared for the first three CIB loan/credits and the Fertil-izer Rehabilitation and Energy Saving Project.

2.14 The Bank's proposed future lending program in industry and financeincludes: (i) support for selected major industrial subsectors--chemicals,

21 The five CIB loans/credits ares Loan/Credit 2226/1313-CHA in FY83; Loan/Credit 2434/1491-CHA in FY84; Loan/Credit 2659/1663-CHA in PY86; Loan/Credit 2783/1763-CiA in PY87; and Loan 3075-CHA in FY89.

I/ The four fertilizer loans are: Fertilizer Rehabilitation and EnergySaving Project (Loan 2541-CHA) in FY85; Fertilizer Rationalization Proj-ect (Loan 2838-CHA) in FY87; Phosphate Development Project (Loan 2958-CHA) in PY88; AND Hubei Phosphate Project (Loan 3066-CHA) in PY89.

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fertilizers, electronic¢, building materials, etc.--at the national and pro-vincial level., within the framework of defined sector strategies includingbroad-based restructuring; (ii) assistance to enterprises in undertaking keyinvestment projects in important industrial subsectors; and (iii) support fordeveloping the infrastructure for sound financial sector development, and forconsolidating the central banking function of PBC, and further support for CIBand other financial intermediaries in the context of the overall financialsector reform. The increasing devolution of responsibility for planning andimplementation from the center to the provinces has expanded the role of pro-vincial authorities in industrial development. While the central governmentrightly recentralized control of monetary policy as part of the austerityprogram, there is little practical evidence of a reversal in the overalltrend. These developments in turn call for formulating a coherent nationalstrategy for key industrial subsectors and a consistent set of investmentpriorities to be used as guides for provincial policies. The anticipatedseries of provincial and subsector operations is designed to help the centralauthorities and selected provinces articulate and Implement their new respon-sibilities.

2.15 As a result of ongoing reforms, significant developments have takenplace in China in the financial and real sectors. However, many policy dis-tortions and Institutional weaknesses still persist and will take time toresolve. Consequently, the resource allocation efficiency of the financialsector remains inadequate. While the efforts to further improve the policyframework and to strengthen the institutional structure are continuing and theBank is playing an active role therein, assistance to priority sectors andsubsectors of the economy through credit operations is necessary and justifieduntil the financial sector gains the necessary capability for efficientresource allocation.

2.16 The reform measures introduced in recent years have created newopportunities for the Bank to help China in identifying and discussing reform-related issues and experimenting with new systems. For example, the Bank hasproduced several economic and sector studies on key reform issues; workshopsand symposiums on enterprise and related reform issues have been jointly spon-sored by the Bank and the Government.

2.17 The International Finance Corporation's (IFC's) support for theindustrial sector has been limited mainly because, with only a few exceptions,joint ventures have to earn their own foreign exchange to service foreignexchange obligations. This provision has made it difficult for IFC to supportimport-substituting joint ventures even though most potential partners inChina are interested in the domestic market. Since its first operation in1985, IFC has provided a total of $43.0 million to China, all of it to theindustrial sector (equity participation of $3.0 million and loans of$40.0 million). Its five investments include; (i) Guangzhou and PeugeotAutomobile Co., Ltd. (Investment No. 813, FY85); (ii) China Investment Co.,Ltd. (Investment No. 974, FY87); (iii) Shenshen China Bicycles Co., Ltd.(Investment No. 1020, FY87); (iv) Shenzhen Crown Electronics Co., Ltd.(Investment No. 1066, FY88); and (v) Shenzhen Chronar Solar Energy Co.,, Ltd.(Investment No. 1119, FY89).

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2.18 Related to the above, the Bank Group has engaged in a dialogue withthe Government on the need to change the foreign exchange allocation and man-agement system. The current system distorts investments and discouragesimportant import-substitution projects. The foreign exchange adjustment cen-ters, established in recent years in select trade cities and provinces andplaying an increasingly important role (see para. 2.9), have the potential foralleviating this constraint to a large extent.

2.19 In addition to Bank lending and IFC operations, the Bank's programsfor economic and sector work in industry and finance have provided the basisfor an active policy dialogue with the Government. Major topics for whichstudies have been completed include state enterprise management and ownershipreforms, finance and investment, tax reform, industrial policies and struc-tural changes, external trade and capital, tax reform, phosphate subsectorplanning, and electronics. Ongoing and future studies will continue toaddress such areas as enterprise and financial sector reforms, industrialpolicies and restructuring for several subsectors (including electronics,machine building and process equipment manufacturing). This work is increas-ingly being carried out jointly with Chinese agencies.

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II. THE INDUSTRIAL SECTOR IN TIANJIN

A. Tianlin and its Industrial Sector

Background

3.1 Tianjin, an industrial city at the confluence of the ancient GrandCanal and the Hai River, which flows to the Gulf of Bohai, is China's thirdlargest city after Shanghai and Beijing. These three cities have the statusof province and are directly under the jurisdiction of the central government.The city covers an area of 11,305 kI 2, including the city itself, seven subur-ban and maritime districts and five rural counties. The population of themunicipality as a whole was 8.7 million in 1990, with 4.5 million people liv-ing in the city proper.

3.2 Tianjin holds a key place in the Chinese economy. Because of itslocation, Tianjin is a major land and water communication pivot in China. Thetwo trunk lines of the Beijing-Shanghai Railway pass through Tianjin. Theport of Tianjin is the third largest in China. It has thus become a largeeconomic center serving Northern China.

3.3 Tianjin has a relatively large and diversified industrial base. In1990, its industrial output reached Y 71.7 billion (current price) or $15.2billion (1990 price), which was nearly 3 percent of the national industrialoutput. The share of light industry is above the national average: 55.8 per-cent compared vith 49.5 percent for China (at 1980 price). State-owned enter-prises still dominate Tianjin's industry, but their share in the city's grossindustrial output has declined from about 80 percent in the early 1980s toabout 68 percent in 1990. The total labor force employed in Tianjin's indus-try in 1990 was nearly 1.5 million, of which about 0.9 million were in state-ovned units and 0.4 million in collective units, the remainder in either jointventure or private enterprises.

Structure and Performance of Industry

3.4 Tianjin's heavy industry covers a wide range of subsectors and, in1990, it registered an output value of Y 23.3 billion (1980 price), accountingfor 44.2 percent of Tianjin's total GVIO. The main subsectors are: (i) themachine building subsector (electric and nonelectric) which recorded an outputvalue of Y 6.6 billion in 1990 (28.3 percent of total heavy industry outputvalue); (ii) the chemical subsector, with Y 3.5 billion in 1990; (iii) metal-lurgical subsector, Y 3.0 billion; and (iv) the transportation equipment sub-sector, Y 1.8 billion.

3.5 In 1990, Tianjin's light industry achieved an output value of Y 28.5billion (1980 price), accounting for 50.8 percent of the city's total indus-trial output. Light industry in Tianjin produces a large variety of consumergoods. The main subsectors are textiles and clothing (with an output value ofY 6.6 billion in 1990, which was 23 percent of total output value of lightindustry) and food processing. Other products include beverages and ciga-rettes, paper and paper products, pharmaceuticals, bicycles, watches, TV sets,etc.

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3.6 Tianjin's industrial output grew at the rate of 10.2 percent perannum at constant 1980 prices between 1980-90. Also both heavy and lightindustries grew at about 10 percent per annum (Table 3.1). Tianjin manufac-tures 17 percent of China's medium- and big-sized tractors, 5.3 percent ofautomobiles, 2.5 percent of steel, 2 percent of electric motors, 17 percent ofbicycles and 5.4 percent of television sets. Its machine building industryaccounts for 4 percent of the total subsector output value of China. Itselectronic industry accounts for 5 percent of the nation's total output value.

Table 3.1: TIANJIN: INDUSTRIAL OUTPUT TREND(Y million, 1980 prices)

Avg. annualOutnut value strowth ()

1980 1988 1990 1980-90

Gross output in industry 19,700 44,080 51,800 10.2of which:

Heavy industry 8,830 19,590 23,300 10.2of which:Machine building La 4,672 6,647 7,163 4.4Transport equipment 431 1,633 1,800 15.4Construction equipment /L 25 116 116 16.6Electronic equipment la_ 438 2,072 2,927 20.9

Light industry 10,870 24,490 28,500 10.1of which:Consumer electronics 40 811 854 35.8

La Estimates for 1990.

Sources: Forty Years of Tianiin. 1949-1989, pp. 424-438; China StatisticsYearbook. 1990, pp. 405-418; and Tian_in Plannina Commission (for1990 data).

3.7 Exports of goods from Tianjin amounted to $1.8 billion in 1990 andgrow at an average of 1.6 percent per annum in US dollar terms, during1980-90. While the leading export earners are textiles, garments, foodstuffsand other light industry products, the export of machinery grew at 8.2 percentper annum during the same period.

3.8 Despite its Impressive growth, Tianjin's industrial sector is con-fronted with many problems. It is often characterized by lack of specializa-tion, uneconomic size of operations, and inadequate management systems. Gen-erally, the factory buildings are old, technology and equipment is outdated,plant layouts are cumbersome, and the consumption of electrical and thermalenergy and raw materials is high.

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B. Development Strategies and Policies

3.9 During the 1970s, especially during the Fifth Five-Year Plan(1975-80), Tianjin developed the intermediate material subsectors necessaryfor the expansion and diversification of its industry. In particular, prior-ity was given to chemical and steel subsectors. Since the early 1980s, someof the inefficient and obsolete production capacity in heavy industry wasconverted to manufacture of light industrial goods. Considerable new capacitywas also added in the light industry sector, especially after the mid-1980. tomeet a fast-growing domeotic demand for durable consumer goods.

3.10 The development of the transportation, water and electricity sectorswas given priority in the mid-1980s. Substantial investments were made duringthe Seventh Five-Year Plan to increase the supply of electricity and freshwater. Also, incentives were provided to economize the use of these scarceresources. Tariff rates for water were increased, and penalty rates estab-lished for use of electricity above the industrial norms.

3.11 In the future, emphasis will still be given to low energy consumingand technology-intensive industrial activities. During the Eighth Five-YearPlan (1991-95), TMG Intends to make the best use of its local specificresources--salt and petroleum--to undertake large chemical investment proj-ects, and to make automotive and electronics leading sectors for the develop-ment of its industry. Priority will be given to subsectors where Tianjin hasa comparative advantage, including textiles, consumer durable goods, machineryand equipment, food processing, packaging, chemical processing, plastics andgarments. In each subsector, specific groups of products have been identifiedwith good development potential. Machine tools, construction equipment, auto-motive parts, electric motors, and electronic components are listed amongthem. Export of small electric motors and automotive parts will be also pro-moted.

3.12 Tianjin considers industry to be its main engine of growth andexpects to gain a more important place in the economy of the country throughindustrial development. It has already embarked on a selective program ofindustrial restructuring which includes gradual enterprise reforms within thenational framework, strengthening of support institutions (i.e., R&D centers,training institutes, etc.), technological modernization of enterprises andinprovements in their organization and management systems. While progress isbeing made on the restructuring of the industrial sector, TMG is consciousthat, for a balanced and efficient growth, it needs a comprehensive long-termindustrial development strategy and the preparatory work for this purpose isalready in progress, assisted by the Second Technical Cooperation Credit (TCCII, Cr. 1664-CHA).

3.13 Tianjin has actively pursued enterprise and policy reforms in indus-try, including the five subsectors of the proposed project (details in A2). TMG has established economic corporations for most of the industrialsubsectors; these corporations provide a layer between industrial bureaus andenterprises and thus some degree of autonomy and accountability to enter-prises. There is little mandatory production planning; enterprises are gener-ally subject to indicative planning. The Tianjin Planning Commission (TPC)has the authority to approve projects costing less than Y 30 million for light

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industry and Y 50 million for heavy industry; projects with costs of more thanthese amounts are sent to the State Plamning Commission (SPC) or the StateCouncil for approval.

3.14 At present, controlled prices apply to 35 products and, indicativeprice. to 18 productst all other products have market prices. In actual prac-tice, products under indicative pricing are generally in surplus supply andtheir prices are also market-determined. As regards the five subsectors ofthe project, about 95 percent of the production is outside the national planand therefore the prices are set by market conditions.

3.15 Until mid-1992, direct export rights were given to enterpriseswhich, inter alia, could export or had potential to export at least $3 millionvalue per annum. This limit has now been reduced to $1 million for machinerysad electronic products with high technology content, and $2 million for prod-ucts of the same category with low technology content. Most products of TIDPwill have a $1 million limit. This would promote direct contact between themanufacturers and foreign buyers and thus result in technology transfer,prompt market response and efficient production planning by the Chinese enter-prises. The government is also encouraging the use of foreign trading compa-nies (FTCs) as export agencies whereby enterprises which do not have directexport rights pay a commission to FTCs for their marketing services. Thisarrangement allows enterprises to have direct contact with buyers and alsoentitles them to retain most of the foreign exchange earned through exports.Already, several products of the project's five subsectors, e.g., graders andautomotive parts, are directly exported by enterprises.

3.16 Foreign exchange retention schemes have been abolished for enter-prises which export through FTC. (nonagency basis). They must now purchasetheir foreign exchange at foreign exchange adjustment centers (FEACs). If theenterprises were benefiting from direct export rights, they can keep 80 per-cent of their foreign exchange earnings.

3.17 Almost all enterprises in Tianjin are subject to the contractresponsibility system. The Tianjin Bureau of Finance signs a contract for twoor three years. Tax payments are included in all contracts. During theEighth Five-Year Plan period, the enterprises are being submitted to moreperformance targets than just the profit level. Yearly loan repayments arespecified sad new contracts have a duration of three to five years. New work-ers in enterprises are governed by labor contracts.

3.18 The growth of financial institutions, including the arrival of BOCOMin Tianjin, and the expansion of bank branches and subbranches has provided alittle more freedom to enterprises in the choice of banks for deposit andcredit operations. Some competition exists among financial intermediarieswhich results in better service to enterprises.

3.19 In order to address the issue of surplus labor and the lack of labormobility, TMG has prepared a citywide housing reform plan which would beimplemented from the beginning of 1992. The plan provides for a compulsoryhousing savings program for two thirds of city workers, housing bond acquisi-tion for new rental housing, gradual increase of rent to "full cost" level bythe year 2000, and the sale of about 20 percent of housing over 10 years at

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high discount. In addition, TMG has proposed to establish and support housingrental compantes; cooperative societies to build housing which enterprise andgovernment support; and municipal, enterprise and individual level "housingfunds."

3.20 The city has pooled pension and unemployment insurance schemes atthe municipal level separately for the government, SOE, and collective sec-tors. For health insurance, the municipality is preparing new measures topool major medical care insurance schemes in several districts. These mea-sures are to be ready for implementation in 1993.

3.21 Despite significant progress, enterprise reforms need to be furtheraccelerated in Tianjin as in the rest of China. The regulatory, ownership andmanagement rc'vs of the government have to be separated in more distinctterms. Enterprise management should be given full autonomy and madeaccountable for corporate results. The relationship between economic corpora-tions and constituent enterprises needs to be streamlined. The entry and exitof enterprises has to be facilitated. The price structure has to be madefully market-oriented. Enterprises must now use the more liberal rights toexport directly. The contract responsibility system needs to be overhauled,preferably to be replaced by a transparent and uniform taxation system. Thefinancial system needs to be liberalized to provide more efficient service tothe industrial sector. Labor mobility has to be enhanced by acceleratingsocial security and housing reforms.

C. The Five Subsectors

3.22 The five subsectors included in the project are machine tools, con-struction equipment, electronic components, automotive parts, and electricmotors. These subsectors are among the priority subsectors in 7MG's develop-ment strategy (para. 3.11), and many of their products play a significant rolein the domestic market. During the preparation of the project, internationalconsultants have carried out an extensive analysis of strengths and weaknessesof individual subsectors including market potential and comparative advantageof their main products, and have made recommendations for their future devel-opment strategy. The consultants' reports are available in project files.Based on this work and inputs of Bank staff, subsector restructuring plansfocusing on (a) enterprise and subsector policy reforms and (b) subsector-specific products and market strategies and organizational changes that wouldbe supported under the project have been agreed between the Bank staff andTMG. The reforms and strategies are briefly described below.

BnterDrise and Subsector Policy Reforms

3.23 As mentioned earlier (para. 2.7), while the industrial sectorreforms introduced in China, including Tianjin, represent major policy initia-tives, the process consists of a step-by-step approach supported by selectiveexperimentation. In order to provide further autonomy and accountability toenterprises and to make them more responsive to market signals, additionalreforms are contemplated. In Tianjin, new measures are anticipated in all thefive subsectors and the pace of implementation of certain reforms is to beaccelerated. These reforms dealing with corporate governance, prices, domes-tic competition, foreign trade, production and investment policies, taxation

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and CRS, and labor mobility, including housing and social security, areincluded in Tianjin government's development program and strategy (Annex 1)for the five subsectors of this project, which were discussed in detail withBank staff during project preparation and appraisal, and which has been for-mally adopted by Tianjin. During negotiations, assurances were obtained fromTMG that it would take all steps necessary to implement the agreed developmentprogram and strategy and exchange views with the Bank at least every sixmonths on its implementation. Details of the reforms are outlined below.

3.24 Shareholding Slatem. In order to promote experiments in sharehold-Ing type companies, all beneficiary corporations under TIDP would have shareownership. The beneficiary corporations which, on the basis of their past twoyeara' consolidated accounts, would have a minimum of 15 percent return onequity (net income before taxes as percentage of equity), and a percentage ofnet income (after taxes) to capital not less than a one-year bank depositrate, will become "limited share companies." Furthermore, whenever they canmeet necessary criteria and conditions, these corporations will also beallowed to issue shares to employees and individual investors, according tothe new central government regulations. The shares of the corporations wouldbe listed at Shanghai, Shenzhen, or Tianjin (should it have its own stockexchange) and the Tianjin government will seek central government approval forthis purpose. Other beneficiary corporations will also be shareholding compa-nies but would be classified as "limited liability companies," which do notissue publicly traded shares. Their shareholders would be typically the StateAsset Management Bureau, some other corporationslenterprises, and nonbankingfinancial institutions. During project implementation, consultants will helpto reorganize the subsector structure into new corporations (paras. 3.41,3.44, 3.48, 3.52 and 3.53). Tianjin has already prepared model charters forthese corporations which provide for a shareholder-type structure, based onthe new central government directives issued in 1992. The model charters andrelated explanations and clarifications have been made available to the Bank,and these have been discussed and agreed upon during appraisal.

3.25 Cross-regional ownership can be an appropriate solution whenever anenterprise in Tianjin needs another enterprise to share the production ofparts and assembly, in order to achieve a high level of production, reducecosts and improve competitive position. However, there are still difficultiesin persuading enterprises in other regions to invest in such an enterprise.Nevertheless, TMG will try to establish initially at least one corporation(most likely in the construction machinery subsector) with cross-regionalshareholding ownership on an experimental basis.

3.26 Prices and Competition. Measures have been taken in recent yearstoward freeing prices and production from mandatory and indicative planning inthe five subsectors (para. 3.14). However, further measures will be taken toremove by 1995 indicative pricing and what remains of mandatory planning inthe five subsectors. In fact, indicative prices have already lost their sig-nificance and actual prices are generally determined by market conditions inthe five subsectors.

3.27 Investment and Technoloav. In the automotive sector, the Tianjingovernment has now been given the authority to approve investments below Y 30million, as in other subsectors. In the area of technology transfer, the five

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subsectors will use effectively the services of the Tianjin InternationalScience and Technology Consulting Company, the Tianjin Foreign InvestmentAdvisory Center and other similar specialized agencies, to obtain informationand seek suitable foreign partners.

3.28 Poreljn Trade. With the new lower limit for direct export rights(para. 3.15), most of the enterprises in the five subsectors would be able toundertake direct exports. All other enterprises would be alloved to use FTCson an agency basis which would make possible direct contacts with foreignbuyers and retention of 80 percent of earned foreign exchange by these enter-prises.

3.29 Taxes and Contract Responsibilit System ICRS). CRS has too manyperformance indicators (which may include production, productivity, sales,employment, profits, taxes, etc.) and it, thus, becomes difficult for theenterprise management to maximize efficiency and profitability. In order toobtain greater benefits from the system, TMG will streamline the contractobligations by reducing the number of targets in new contracts to a few essen-tial ones (viz., profits and debt servicing), and the contracts will not berevised during implementation. In the longer term, tax remittances would becompletely separated from the CRS.

3.30 LaboL Mobilit=. Enterprises already have excess labor and its sizewill increase after restructuring. About 10,000 workers are expected tobecome surplus in the five subsectors as a result of restructuring. The sur-plus labor needs to be redeployed, so that enterprises can operate with costefficiency and compete successfully in the international market. This is avery complex issue and has many dimensions: need for information on subsectorlabor surpluses and deficits, matching overall labor supply and demand at themunicipal level through the support of an employment center, and provision ofunemployment insurance. Some reforms in the area of labor mobility have beenalready initiated in Tianjin for specific categories of labor (Ane 2) TMGwill address the labor surplus issue in the five subsectors by developing theexisting employment center, improving unemployment insurance facilities, andcreating employment opportunities. It will also take the following steps:(i) surplus workers would be identified and released from the subsectors(20 percent in 1993, and 40 percent each in 1994 and 1995); (ii) employmentcenters (including Tianjin Labor Service Company) would actively support thereleased workers in identifying job opportunities in other enterprises/subsec-torsi and (iii) financial support and training would be assured for the work-ers to be redeployed. The Bank will provide technical assistance under theproject to strengthen the institutional framework for labor redeployment(para. 4.10 and Annex 3).

3.31 Housint. ?MG is making the maximum use of the facilities providedby the recent reforms undertaken in this area to promote individual housingtransactions and to separate the supply of housing services from the enter-prise activities. With these objectives, and within the framework of themunicipal housing reforms, TMG will introduce experiments first in the fivesubsectors under :he project. The reforms would include transferring housingassets of enterprises, or their housing mangement rights, to the TianjinHousing and Trust Company in charge of housing, and offering to workers in thefive subsectors real opportunities to purchase dwellings. Tianjin would sub-

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stantially complete by 1995 the implementation of housing reforms in the fivesubsectors.

Physical Restructurin_ of Subsectors--Isoues and Strategis

3.32 The background information on the five subsectors of the project isgiven in Annexes 4-8. The subsectors have a solid technical foundation forfurther development and through support of specific restructuring measureswould be able to achieve increased efficiency and competitiveness and make ademonstrative impact on other subsectors in industry. The main issues andsubsector specific strategies for restructuring are as follows:

3.33 Structure of Subsectors. Most enterprises In the subsectors aresmall in size in comparison to international standards and have fragmentedproduction which inhibits efficiency, quality and competitiveness. The orga-nizational structure of the subsectors needs to be revamped to allow the con-solidation of enterprises into viable commercial organizations. This wouldhelp to achieve effective management control of the constituent enterprises,and create a large critical mass to efficiently mobilize and allocate avail-able financial resources.

3.34 Product and Market Concentration. For historical reasons, capitaland resource allocation decisions have been made by the government as a partof the planning process and without adequate consideration of commercialpotential. This has led to manufacture of a wide range of products with lowvolumes and inadequate coverage of markets both domestic and export. Tianjinneeds to concentrate capital and other resources on those industrial activi-ties where it has potential comparative advantage and the market viability ofproducts is clearly established. Success in building a strong domestic marketplatform is a critical step toward developing comparative advantage in exportmarkets. In addition, the subsectors need to strengthen marketing, sales,distribution and service capabilities.

3.35 Develoument and AbsorDtion of Technoloat. Most enterprises haverelied heavily on centralized R&D institutes and, recently, on licensingagreements for more sophisticated products. However, the enterprises have notbeen able to develop capabilities for internal product development or fullutilization of imported technologies. The subsectors should be more selectivein acquiring modern technologies and should seek greater commitment from for-eign partners to share new technology in the future. Internal organizationsad expertise needs to be developed to adapt, absorb and commercialize tech-nologies in Tianjin.

3.36 Plant Facilities and Layout. Most of the plant equipment is obso-lete or outdated. Furthermore, plant facilities are, to a large extent,poorly organized with inappropriate production layout and flow. These prob-lems have to be resolved to bring operational efficiency and improve qualityand, thus, to enlarge market share.

3.37 Manasement Development. Management skills are underdeveloped.Enterprises lack an understanding of strategic planning and the need to adoptflexible and innovative approaches to respond to market sinals and to makeprompt adjustments in operations. There is a need to establish appropriate

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manaSement functions at all levels and to train managers in areas of productand market development, cost control, production planning, quality control,etc. Also, enterprise management information systems should be strengthenedto enable improved enterprise management.

3.38 While the above-mentioned issues are common to all five subsectors,their magnitude varies. Also, each subsector has a different structure. Thefollowing paragraphs provide summary information on each subsector and mainelements of Tianjin government's restructuring strategies (Annex 1).

3.39 Machine Tools. The machine tools subsector represents one ofTianjin's key industrial subsectors under the Tianjin Machinery IndustryBureau (THIB). It is organized into five major product groups and, in 1991,consisted of 16 enterprises with approximately 15,300 employees and totalsales of Y 245 million. Tianjin's share of the domestic machine tools markethas been stable at about 6 percent, but its share is much higher for certainproducts such as hydraulic presses for which Tiarnjin is a domestic marketleader. The total value of exports in 1991 was Y 3.6 million ($0.69 million).

3.40 The restructuring strategy for Tianjin's machine tool subsectorfocuses on further development of hydraulic presses in which Tianjin has astrong position and good future prospects. Development of other products suchas gear-cutting equipment and machining centers would be undertaken in jointcollaboration and technology relationships with foreign manufacturers toupgrade technologies, to provide Tianjin access to export markets and toensure achievement of economies of scale. The producers of selected tools andaccessories would continue to solidify their position. Uneconomical productssuch as vertical spindle grinders, large lathes, and boring and radialmachines will be phased out by December 1994. Nonrelated products (e.g.,valves, pumps, and micro motors) have already been moved to other subsectors.The restructuring of the subsector would also include consolidation andupgrading of manufacturing operations to reduce cost, improve quality, phaseout nonessential facilities and reduce inventories.

3.41 The present subsector organization, which includes 16 state-ownedenterprises managed by THIB, would be restructured, into two independent andspecialized corporations, one each for machine tools and accessories. As apart of this organizational restructuring, the weaker pla:.s and inefficientworkshops would be divested or phased out by December 1994.

3.42 Construction Equigment. In 1991, the construction equipment sub-sector consisted of 11 enterprises with about 11,000 employees and Y 290 mil-lion in sales. The subsector is organized under TMIB. Tianjin is among theleading maufacturers of graders in China, with a market share of over 80 per-cent. Overall, the subsector in Tianjin is more productive than the rest ofthe country as measured by output value per employee. Nevertheless, the sub-sector still faces strong challenges to its domestic position.

3.43 Tianjin's construction equipment subsector has a strong base forimproving its position. Tianjin's leadership position in motor graders can bemaintained and production of crawler dozers can be further developed throughrapid diffusion of imported technology to a full line product program and theexpansion of capacity to reach economy of scale. As regards forklifts and

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related diesel engines, Tianjin would plan their development in joint collabo-ration or technology-transfer agreements with foreign reputed manufacturers.The manufacture of other products such as freight elevators, heat exchangers,hoists, lifts and gearbox repairs would be discontinued by December 1994.Tianjin would also develop mutually complementary marketing arrangements withother national manufacturers so as to be in a position to offer a wider prod-uct range.

3.44 In order to focus subsector efforts on viable investment productc, anew corporation would be formed from the enterprises engaged in earthmovingequipment, forklift trucks and diesel engines. The new corporation would beresponsible for development, engineering, manufacturing, marketing and manage-ment functions related to the products of the former enterprises. It wouldallow greater productivity, lower manufacturing costs, improved product qual-ity and better foreign market prospects.

3.45 Electronic Components. The subsector is under the Tianjin Electron-ics and Instruments Administration Bureau which has 198 enterprises and about100,000 employees. The enterprises are organized into 40 group companies orcorporations. The 12 enterprises producing passive components employ about20*000 persons. In 1991, the total sales value of the passive componentssubsector was Y 145 million. Despite its relatively modest market share,Tianjiln's passive component subsector ranks fourth among Chinese centers thatproduce passive components. Nevertheless, Tianjin still has low output volumeby international standards. The market pattern varies widely from one productto the other. For mature products such as fixed resistors and aluminum capa-citors, 20-30 percent of sales is made within Tianjin's electronic industryitself, another 40-50 percent is sold to the domestic market outside Tianjinund the remaining 25-40 percent is exported.

3.46 The future development of passive components will be determined bythe growth in the electronic industry in China and the ability of producers tocompete in domestic market as the national industry restructures and consoli-dates over the coming decade. It is, however, obvious that Tianjin has toincrease its share of the domestic market through restructuring the subsectorand, thus, to achieve economy of scale and a competitive position among themajor manufacturers.

3.47 Within the passive components, Tianjin would focus on componentssuch as capacitors and resistors where it is a significant domestic producer.Tianjin also proposes to establish the technological foundation for surfacemounted chip-type capacitors and resistors. These products would be upgradedin terms of product and process technology and their capacity raised to eco-nomic scale. Efforts would be made to raise domestic market share to at least10 percent.

3.48 The enterprises in the subsector are loose administrative coalitionsand lack full financial or management control of their constituent enter-prises. In order to achieve greater competitive advantage and economy ofscale, an organizational restructuring of the subsector would be carried outin which all enterprises producing capacitors and resistors would be mergedinto two separate corporations, one for each of the product groups. Enter-

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prises that are nonviable and cannot be restructured have been identified, andwill be closed by December 1994.

3.49 Automotive Parts. The Tianjin automotive parts subsector consistsof 56 enterprises producing a range of automotive parts and components [39enterprises under the Tianjin Auto Industry Corporation (TAIC) and 17 smallenterprises under TMG1. TAIC has been designated by the national governmentas a center for manufacturing and assembling mini-vehicles. The Tianjin auto-motive industry has experienced steady growth during the 1980s. The totalproduction value of the industry increased at 16 percent per year between 1984and 1990. Employment, production and exports of the automotive industry inTianjin were about 7 percent, 8 percent and 3 percent, respectively, of thenational total.

3.50 Like the national industry, Tianjin's automotive sector is frag-mented and includes enterprises with small production volumes, high cost ofmanufacture, and low productivity. Less emphasis has been placed on develop-ing components which would meet world standards and quality. Most of theTianjin components do not have a strong position in the China market. Abouttwo thirds of the components manufactured in Tianjin are sold internally toTAIC. There is a strong need to build foreign technical relationships for newproduct and process technologies, as it would help to enhance the quality,raise output volumes, and increase efficiency.

3.51 In order to improve the performance of the subsector, an innovativerestructuring approach and strategy have been developed to restructure thesubsector along the lines of automotive parts subsystems rather than the indi-vidual products pursued at present. Tianjin would concentrate on potentialsubsystems such as drive train and auto-electric parts. These subsystemswould be developed to provide Tianjin with capability to supply automotiveparts at the national level and to leverage the expanded domestic position inforeign markets. Auto parts in which Tianjin does not have comparative advan-tage have been identified; their production would be discontinued and theconcerned enterprises would be closed by December 31, 1994.

3.52 As regards the subsector organization, the enterprises under TAICare constrained by their major role of satisfying TAIC needs and therebyremaining small and locally oriented. This structure would be changed to onethat would focus on closely interrelated product and process technologies andinterrelated domestic and export markets. Under the new system, 13 indepen-dent corporations would be created which will focus on manufacture of subsys-tems. The new organization structure would induce economy of scale in allfunctions. Each subsystem corporation would oecome the center of productexcellence within the subsector and, thereby, develop recognition in marketsprovided by auto manufacturers and parts dealers.

3.53 Electric Motors. Tianjin's electric motor subsector is relativelysmall, consisting of four enterprises, but dominated by one large enterprise.It employs about 3,000 persons and has a sales revenue of about Y 70 million.The subsector has exported 20-30 percent of the production value to SoutheastAsian markets. The subsector is, however, characterized by low economies ofscale, outdated equipment, low productivity, obsolete product design and lackof a full line program. The situation also holds true for the country as a

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whole. Tianjin, therefore, plans to orient its products to the full range ofsmall motors, consolidate and upgrade its production, extend its domestic mar-ket, and solidify its exports. The development program has been establishedby consultants to meet these objectives. As a part of this program, the pres-ent lead company in the subsector will form a joint venture with a leadinginternational manufacturer and would cease to exist in its present form.

Development of Technological Infrastructure

3.54 All the subsectors have their own research and design institutes andvocational trainin8 schools (Annex 9). They function under the concernedindustrial bureaus or the sectoral corporations. These institutes cannotprovide the desired service because of lack of modern equipment includingcomputer hardware and software, testing equipment and teaching aids and facil-ities. They have limited contacts with similar institutions in developedcountries and it is, therefore, difficult for them to keep up with the latesttechnological developments abroad. Subsector enterprises themselves have notgiven sufficient attention to the importance of R&D. The auto parts industry,in particular, has lagged behind and it needs to substantially strengthen itsR&D center. The electronics subsector would need to establish a technicalcenter in which the technological foundation for surface-mounted technology(SET) products can be laid and the development of other electronics productscan be undertaken. Machine tools and construction machinery subsectors alsoneed to strengthen R&D to develop and assimilate new technologies. The devel-opment program and strategy aim at establishing technical centers within eachcorporation and strengthening training schools through the import of necessaryequipment and software. The techbical centers would provide demand-drivenproduct development, systems engineering and other related services aimed atimproving product design and operational efficiency of the subsector corpora-tions.

D. Bank Role. Lessons Learned and Strateav

3.55 In line with the Bank strategy for the industrial sector in China,the proposed project has been designed to deepen enterprise reforms and torestructure industry in Tianjin with the objective of improving its efficiencyand competitiveness both in domestic and international markets. A develo;imentstrategy and progrsm for specific subsectors have been prepared to achieve theabove objective, and reflect extensive preparatory work in which the Bank hasplayed a major role.

3.56 International consultants have carried out comprehensive studies ofthe selected subsectors. The studies have helped to determine the comparativeadvantage of key products in each subsector and recommended restructuringmeasures that would lead to economies of scale, product specialization, newmarketing strategies, phasing out of nonviable products, reorganization of thesubsectors, improvements in enterprise organization and management systems,and strengthening of institutional infrastructure. The Bank has considerableexperience in industrial restructuring based on its earlier work in China andother countries and has, thus, been able to provide close guidance to consul-tants in developing appropriate programs and strategies. Furthermore, a veryconstructive dialogue initiated with TMG on this subject under TLIP has pro-vided a good foundation for advancing reforms by adopting new measures and

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undertaking new experiments in the industrial sector in Ti.njin. These mea-sures and experiments go far beyond those initiated under TLIP.

3.57 The overall implementation of TLIP is satisfactory: most of thepolicy and enterprise reforms included in the project have been carried out bythe Tianjin government. The credit line component of the project has beenfully committed. Institutional strengthening and consultants' studies underthe technical assistance component have been substantially completed. Theproject has, however, faced certain difficulties during implementation. Sub-projects requiring ICB have been slow to implement because of lack of experi-ence of CIB (Tianjin Branch) and enterprises in these procedures. A similarproblem was faced in the selection of consultants. However, the experiencegained under TLIP would be beneficial in alleviating such problems in thefuture, particularly for TIDP. Two large subprojects are facing cost overrunsbecause of prolonged time taken in preparation and an unusually high increasein the cost of imported equipment. In the future, PFIs will need to preparecost estimates more carefully and, during the subproject review process, Bankstaff will ensure that the cost estimates are realistic and that adequatecontingency provisions have been made. Foreign training of staff under TLIPhas been slow, mainly because of their lack of proficiency in English or otherforeign languages. TIDP would therefore put greater emphasis on trainingwithin China with the help of foreign experts.

3.58 During the implementation of TIDP, the Bank will maintain closedialogue with TMG to ensure continuous progress in economic and enterprisereforms. It will also ensure that the Bank loan proceeds will be used formodernization and technical restructuring of enterprises and strengthening ofinstitutional infrastructure in accordance with the development program andstrategy for the five subsectors. This would be pursued through regularsupervision missions, review of subprojects to be financed by PFIs under theBank loan, and detailed periodic reporting by the Tianjin government and PPIs(para. 5.9). In addition, international consultants will be engaged under thetechnical assistance component to assist in project implementation, with par-ticular focus on physical restructuring of subsectors and introduction ofmodern management systems and practices (para. 4.8). (The project implementa-tion and supervision plans are given in Annex 13.)

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IV. THE PROJECT

A. Proiect Obiectives

4.1 The proposed project forms part of the Bank's overall effort tosupport the implementation of the GOC's program of industrial restructuring.The project will focus on five important industrial subsectors in Tianjin,viz. machine tools, construction equipment, auto parts, electronic components,and electric motors, that have been given high priority for development by themunicipal government in the 1990s. It would assist the implementation of theTianjin government's development program and strategy for the above subsectorsand would have the following specific objectives:

(a) acceleration of policy and enterprise reforms in the selected sub-sectors;

(b) modernization and restructuring of subsectoral enterprises based oneconomic criteria and commercial viability;

(c) strengthening of institutional infrastructure for strategic plan-ning, systems development and implementation, engineering and tech-nical support services, and human resource development and redeploy-ment;

(d) organizational restructuring and improvement of internal enterprisemanagement and systems; and

(e) diversification and strengthening of the financial intermediationprocess.

B. Proiect Components

4.2 The project will have two main components:

(a) financial assistance for the technological restructuring of enter-prises in the five subsectors; and

(b) technical assistance for the overall subsector restructuring pro-grams including the strengthening of institutional infrastructure inTianj in.

The description of two components is as follows.

Financial Assistance Component

4.3 The project will provide financial assistance of $134.5 million outof the proposed IBRD loan to meet the foreign currency requirements of thetechnological restructuring of enterprises in five subsectors. The fundswould be onlent through financial intermediaries, which would be responsiblefor the appraisal and assessment of overall viability of individual subproj-ects. At present, there are 16 subprojects in the pipeline that are proposedto be financed under TIDP. In the machine tools subsector, subprojects will

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include further development of hydraulic presses, gear-cutting machines, andmachining centers; the latter two to be considered for assistance provided thesponsoring enterprises obtains foreign technical collaboration. As regardsthe construction equiRment subsector, crawler dozers and motor graders havebeen identified for financial assistance so as to improve the product-mix andachieve economies of scale. A few other products would also be eligible forassistance if Tianjin enterprises develop joint ventures and/or technicalcollaborations with leading international manufacturers. In the electronicssubsector, subprojects will aim at improvements in product and process tech-nology and economy of scale in production of capacitors and resistors. Finan-cial assistance will also be provided to the auto garts subsector for subproj-ects belonging to two priority subsystems, viz. drive train (including clutch,gearbox, propeller, shaft, differential, rear axle, wheel break drums, andsuspension components) and auto-electrical subsystem. Only those products inthe above subsystems will be included in the subprojects where economies ofscale and potential domestic and international markets will give comparativeadvantage to Tianjin enterprises. In the electric motors subsector, there isonly one subproject for improving quality and producing a full range of smallmotors.

4.4 The line of credit will be used by borrowing enterprises to importmachinery and equipment and to finance incremental working capital (i.e.,imported inputs) and interest during construction on loans in foreignexchange. PFIs would ensure that (a) all subprojects to be financed underTIDP are consistent with the development program and strategy of the Tianjingovernment and its own investment criteria which include a minimum ERR and PRRof 12 percent, (b) the subproject snd sponsoring enterprise/factory are incompliance with environmental control guidelines (para. 4.29), (c) sub-borrowers shall be corporations established pursuant to the organizationalrestructuring of subsectors as agreed between the Bank and the Tianjin munici-pality and with charters acceptable to the Bank (para. 3.24) and (d) suchenterprises would have a satisfactory projected financial position, in partic-ular a debt-service coverage of at least 1.5 times, a current ratio of atleast 1.5:1 and a long-term debt/equity ratio of no more than 70:30. Thesubprojects in the pipeline are subject to change if PFIs' detailed analysisshows them not to be viable or, as a result of changes in the plans of speci-fic enterprises, they are no longer suitable for financing.

4.5 Although the project is primarily intended to assist the five iden-tified subsectors, PPIs will be allowed the flexibility to finance subprojectsin other subsectors to be agreed between the Bank and the Tianjin governmenton the basis of studies and development strategies to be prepared by themunicipality. During negotiations, assurances were obtained from PPls on theabove eligibility and investment criteria for assisting enterprises under theindustrial credit component of the project.

Technical Assistance

4.6 Technical assistance of $15.5 million will be provided out of theproposed IBRD loan to finance equipment, computer hardware and software,advisory and consultancy services, staff training, studies, etc., for overallsubsector restructuring and strengthening of PPIs, as described in the follow-ing paragraphs. During negotiations, assurances were obtained from IMG that

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it will carry out the technical assistance component in accordance with theprogram to be agreed with the Bank.

4.7 Develoument of Technolozical Infrastructure. The project will helpto strengthen the design and research activities and vocational training inthe five subsectors to implement the Tianjin government's strategy for thedevelopment of technological infrastructure (pars. 3.54). Detailed informa-tion on the current status of all the support institutions and the program fortheir development to be supported by project technical assistance is given inAnnex 9. The equipment, consulting services and training to be provided underthis component will help the beneficiaries to upgrade their research and test-ing facilities and teaching sids, and enable them to increase their contactswith counterpart institutions in developed countries, thereby increasing theirexposure to latest technological developments. A sum of $11.8 million hasbeen provided for this technical assistance component. During negotiations,understandings were reached with TMG on the necessary details.

4.8 Proiect Imnlementation Support. Consultant services will berequired to assist in the implementation of the project, with particular focuson organizational restructuring, production consolidation, management informa-tion systems, financial and cost accounting, and industrial engineering andoperational effectiveness in the five subsectors. A sum of $2.5 million outof the technical assistance funds will be used to finance consultant services.Detailed terms of reference (TOR) for the work which would be carried out byinternationally recruited consultants are given in Annex 10. The TOR werediscussed and agreed to with TtG during project appraisal and were confirmedduring negotiations [see para. 6.3(b)]. In view of the importance of theconsultants' role in the successful implementation of subsectoral restructur-ing program, the appointment of consultants will be a condition of loan effec-tiveness.

4.9 Trainint of Enterprise Manaaement and Staff. The training of seniormanagers and staff of enterprises in modern policies, strategies and methodol-ogies relating to investment production, marketing and personnel matters isessential. Broad outlines for such training have been established with theassistance of consultants engaged to carry out subsector studies. Detailedtraining programs to be organized within China and abroad will be developed byconsultants who will assist in project implementation. A sum of $700,000 outof the project's techneical assistance funds has been allocated for training ofenterprise managers and staff; $500,000 to be used to engage foreign expertsto organize seminars in China in the areas of production planning and control,human resource management, finance, marketing and sales, operations and inven-tory management, quality control, and foreign technical relations and trade;and another $200,000 for foreign training. About 250 trainees will partici-pate in 3-4-week seminars within China (seven seminars with 30-40 participantseach) and about 15 trainees will go abroad for about two months each. Duringnegotiations, assurances were obtained that TMG will furnish to the Bank forapproval, by October 31 each year, a 12-month program for local and overseastraining to be financed under the project.

4.10 Strenathenint of Institutional Framework for Labor Develonment.There are several organizations in Tianjin that assist in the redeployment ofsurplus workers. These include employment centers (including Tianjin Labor

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Service Company), an unemployment insurance scheme and several training cen-ters. The role of these organizations needs to be widened and made moreeffective to cope with surplus labor in the industrial sector in Tianjin,including the five subsectors of TIDP. In order to strengthen the aboveinstitutional framework, technical assistance of $300,000 will be provided asoutlined in Annex 3. The main focus of technical assistance will be on theTianjin Labor Bureau and the Labor Service Company. Consultants will help toimprove their organization, systems and procedures; their managers and seniorstaff will make study tours of a few employment centers abroad; and computerequipment will be procured to strengthen the database for unemployed workers,their retraining needs, and employment opportunities.

4.11 Strenathening of PFIs. For staff of the PPIs, $125,000 would beallocated for training in project identification, appraisal and supervision.PFIs' project staff would attend a four-week course to be offered by foreignconsultants in Tianjin at the beginning of project implementation and onceagain 18 months later. It is expected that about 25 staff would attend eachcourse. In addition, $75,000 would be allocated for specialized trainingabroad for PFIs' staff. During negotiations, an assurance was obtained fromPPIs that staff training would be carried out in accordance with a trainingprogram agreed with the Bank.

C. Proiect Cost and Financing

4.12 The main component of the project is the restructuring of enter-prises which will be financed through a credit line of $134.5 million to PPIs.The cost of this component will be the sum total of individual subprojectcosts that will be estimated by PFIs at the time of subproject appraisal.Consequently, the cost of this main component cannot be estimated accuratelyat this stage. However, on the basis of past ratios of foreign and localcurrency cost components in such subprojects, the total cost of the projectincluding incremental working capital is estimated at about $222 million equi-valent. The total cost of the technical assistance component is estimated atabout $22 million of which $15.5 million would be in foreign exchange.

4.13 The proposed Bank loan will meet the foreign currency requirementsof $150 million. Local currency requirements for technological restructuringwould be financed by PPIs, other Chinese banks and enterprises' own resources.The Tianjin government will provide the necessary local currency funds for thetechnical assistance component of the project.

D. Proiect Implementation Arrangements

Role of the Tianiin Municival Government (T1G)

4.14 TMG, CIB, ICBC and BOCOM (Tianjin) will be responsible for overallproject implementation. TMG, besides carrying out economic and system reformsas outlined in the development program and strategy, will coordinate and moni-tor all project-related activities. Tianjin has established a high-level taskforce headed by a Vice Mayor for industrial restructuring. It comprisessenior officials from the Tianjin Finance Bureau, Tianjin Economic Commission,Tianjin Machinery Industry Bureau, Tianjin Electronics Bureau, Tianjin AutoIndustry Corporation, Industry Department of TPC, PCBC, CIB, ICBC and BOCOM.

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This task force vill be maintained and will be supported by the Tianjin WorldBank Loan Office, a project implementation unit originally established forTLIP. This office, which has a full-time staff of 15, vill be responsible,inter alia, for follow-up on (a) implementation of the development program andstrategy for the five subsectors; (b) implementation of the technical assis-tance for support institutions; and (c) consultants' work for the implementa-tion of the project. The office will also liaise on a regular basis with theconcerned municipal government departments, central government institutions,CIB, ICBC, BOCOM and the Bank. It will prepare six-monthly reports on projectimplementation together with PFFI (para. 5.9). During negotiations, assur-ances were obtained from the Tianjin government on the maintenance of theexisting task force and the above office with competent staff in adequatenumbers, and with functions and responsibilities acceptable to the Bank. Theexpertise required for supervision would involve mechanical and electricalengineers for the review of subloans and ICB procurement, as well as financialanalysts/operation officers for subproject review and general supervision. Itis expected that this would involve 8 staff-weeks (SW) in FY94, 12 SW in FY95,16 SW in FY96 and 11 SW in FY97. A project implementation and supervisionplan is given in Annex 13.

Role of Participating Filnancial Intermediaries (PFls)

4.15 Three financial intermediaries, viz., CIB, ICBC and BOCOM, willonlend the Bank loan proceeds to subprojects in the five subsectors. Theywill also be responsible for the appraisal and supervision of subprojects. Abrief write-up on these intermediaries is given in the following paragraphs(details in Annexes 14-16).

4.16 China Investment Bank (CIB) commenced operations in 1981 as a devel-opment bank financing mainly investment projects in the industrial sector.While CIB is under the supervision of MOF, it retains close links to thePeople's Construction Bank of China (PCBC) and many of its senior staff areex-PCBC staff. CIB has 31 branches and 28 subbranches. Although some degreeof lending authority is delegated to branches, decisions on large projects aretaken at the Read Office in Beijing. CIB's investment priorities and policiesare defined in its Statement of Operating Policies and Procedures and itsDevelopment Strategy Statement. During negotiations, assurances were obtainedfrom CIB that it will exchange views with the Bank on any proposal to modifyits charter or these statements.

4.17 Since 1982, CIB has received five loans from the Bank, has been thesole financial intermediary (FI) under the TLIP, and was one of the severalFIs for the SPARK Project and Shanghai Industrial Development Project. At theend of 1991, CIB had total assets of Y 14.7 billion and a total long-term loanportfolio of Y 8.2 billion. CIB's lending activities have declined since1989, reflecting the efforts of the government's austerity program that con-tinued from late 1988 to 1991. CIB also had difficulties in mobilizing for-eign currency resources after Tiananmen events of June 1989. Its loanarrears, though still relatively small, increased from 2.5 percent of thetotal portfolio in 1990 to 3.2 percent in 1991, which is partly the result ofa conservative policy of CIB's management on loan rescheduling. CIB's overallloan collection rate was also low at 75 percent in 1991. CIB needs to makemore concerted efforts to improve its collection performance. During negotia-

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tions, understandings were reached with CID that before submission of itsfirst subproject to the Bank, CIB wills (a) revise its policy statement toinclude a loan recovery target of 90 percent of loan repayments due; and (b)submit a plan satisfactory to the Bank for reaching the above target, includ-ing projected loan recovery percentages for 1993-95. Furthermore, in thecontext of supervision of CIB I-V and new operations, including the proposedassistance for flnancial institutions' development in China, the Bank isengaged in an active dialogue with the government and CIB on the latter'sfuture role, operational strategy, and resources.

4.18 CIS has stayed within agreed prudential limits on debtsequity anddebt and interest service coverage. During negotiations, assurances wereobtained that it would maintain a maximum long-term debttequity ratio of 5:1as provided In CID V. As required under CIB V, CIB is increasing provisionsfor doubtful loans so as to reach 2 percent of the total portfolio at the endof 1992. Although increased provisions for bad debts have reduced CIB's prof-itability in recent years, profits are expected to increase in 1993 and there-after, with the return on equity reaching 6 percent by 1995.

4.19 CIB's Tianjin branch was one of its earliest branches and its staffhave gained significant experience and expertise in project appraisal andsupervision. As of December 31, 1991, the Tianjin branch had approved 71Bank-financed subproject. under the five CIB loans for a total amount of $72million in foreign currency and Y 154 million in local currency. Of the 71subprojects, 29 have been completed with the subloan fully repaid, 38 areoperating and repayments are satisfactory, and four are still under construc-tion. Under TLIP, 15 subprojects are being financed for a total of $141 mil-lion in foreign currency and Y 280 million in local currency. The performanceof the Tianjin branch and of its subprojects has been satisfactory.

4.20 Industrial and Commercial Bank of China (ICBC) was founded as aspinoff of two departments of PBC. Its top echelon includes a President andfour Executive Vice-Presidents with 20 major departments at the head office.At the end of 1991, it was the largest state-owned commercial bank with totalassets of Y 1,117.5 bllnion ($203.2 billion) and net worth of Y 48.0 billion($8.7 billion). It accounts for nearly half of the loans and deposits inChina's financial sector. It has the largest number of branches (over 30,000)and employs over 500,000 people. Its Shanghai branch is a participant in theBank's Shanghai Industrial Development Project. ICBC's Tianjin MunicipalBranch (TMB) would be implementing its participation under TIDP.

4.21 The head office of ICBC is involved mainly in policy formulation andoverall supervision of branch operations. Lending operations are fairlydecentralized in its provincial and regional branches, down to the districtsubbranch level with varying delegated authorities. It has prudent financialpolicies which should promote a diversified portfolio, e.g., exposure limitson Industrial sectors (30 percent of loan portfolio) and single borrower(10 percent of equity), and maximum project size of up to Y 2 billion, maximumdebt/equity ratio (4:1) for project financing, minimum financial rate ofreturn (15 percent) and positive current ratio and debt service coverage ofeligible projects. It "matches" its uses and sources of funds in terms ofinterest rates, maturities, and currencies.

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4.22 ICBC has received a credit line of $100 million from ADS. To helpimplement ICBC's program to modify, upgrade, and modernize its accounting,auditing and MIS, ADB has also provided technical assistance funds to financeconsultancy/advisory services and training. It is committed under the ADBproject to maintain a maximum total d-ebt/equity of 20 times and net long-termdebt/equity of 10 times which are reasonable. During negotiations, assurancesvere obtained from ICBC that it would maintain the above limits. Under TIDP,TMB has adopted, for the first tine, a formal statement outlining moredetailed and specific operations and financial policies which are appropriate(Annex 14). During negotiations, assurances were obtained from ICBC that itwill exchange views with the Bank on any proposals to modify the above state-ment.

4.23 At the end of 1991, ICBC's gross revenues increased at an average of22 percent per year and reached Y 75,755 million and its net income increasedat about 11 percent per year, reaching Y 6,339 million. Its administrativeexpenses averaged about 0.7 percent of total assets, which is reasonable. Itsliquidity position has remained satisfactory. Its Searing ratios have beenmaintained at acceptable levels with long-term debt/equity at 8.29 times andtotal debt/equity ratio of within 20:1 in 1991. ICBC's arrears amount toY 27,105 million or 3.4 percent of total outstanding portfolio, which is rela-tively low. IC8C expects to maintain a collection ratio of about 95 percent,which should be achievable given the short-term nature of most of its portfo-lio and consequent close monitoring of the accounts. Accumulated provisionsfor doubtful debts were equivalent to 0.32 percent of total loan portfolio, alevel currently allowed by the Ministry of Finance (MOP). ICBC has recom-mended an increase in the provisions to 3 percent by 1997, which is appropri-ate and approaches international norms.

4.24 1MB would implement ICBC's participation under TIDP. At the end of1991, TMB had total assets of Y 28,048 million ($5,100 million), deposits ofY 15,124 million ($2,750 million), total loans of Y 23,180 million ($4,215million) and net income of Y 169 million ($31 million). The Technical Innova-tion Credit Department of TMB (TIC/TUB) will be directly involved under TIDP.It has a total staff of 222, of which 88 are in the main branch. TIC/TMB isheaded by a general manager and three vice-managers. Seven people areinvolved in appraisal on a full-time basis, including three engineers and twoeconomists. It is guided by ICBC's manual of operations for TIC and a project

anagement and appraisal manual issued in 1986 and patterned after CIB'sappraisal manual. Subbranches normally perform the regular follow-up withquarterly reporting and TIC/TmB does full supervision up to project completionfor all foreign exchange loans (e.g., subloans under TTDP). While TIC has hadsubstantial experience in term financing, its staff need to participate intraining to be provided under TIDP.

4.25 Bank of Communications (BOCOM) was established in 1908 in Beijing,nationalized in 1949, and had its operations suspended until it was reestab-lished in 1986 and relocated in Shanghai. For all practical purposes, BOCOMis a new bank. It has been very innovative in seeking clients and setting upbranches at locations with large demand. It is also the first bank to adopt apublic shareholding system involving diversified ownership at the branchlevel. Each branch has a separate legal personality, operational autonomy andfinancial accountability. The Head Office exercises "unified leadership" in

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the appointment and removal of principal staff, establishing operating poli-cies, plans, rules and regulations and foreign business.

4.26 BOCOM has 70 branches and subbranches in 69 cities, of which 27 areengaged in foreign transactions, 29 handle insurance and 38 deal with securi-ties. BOCOM had total assets of Y 78.5 billion at the end of 1990 and a netprofit of Y 1.6 billion during the year, which gave a return of 2.1 percent onassets and 24 percent on capital employed. The above rates of return werequite high by international standards.

4.27 BOCOM's Tianjin branch was established on February 28, 1992 with apaid-in capital of Y 205 million, of which the Head Office holds Y 50 million,the Tianjin Municipal Government Y 100 million and 26 entities Y 55 million.At present, BOCOM-Tianjin's portfolio is mostly short-term commercial loansfinanced by deposits and share capital. It will establish a long-term lendingunit, which would consist of mainly ex-CIB staff who are already working withBOCOM-Tianjin. Furthermore, it is coordinating closely with CIB, which hassubstantial experience in long-term investment financing and will also adoptthe latter's appraisal and supervision manuals. BOCOM-Tianjin is preparing apriority training plan in appraisal and supervision techniques, which would beimplemented by end-1992. It has also adopted a formal Statement of OperatingPolicies and Procedures governing its long-term investment financing activ-ities. The latter contains prudential limits relating to exposure in a singleenterprise (maximum 20 percent), capital adequacy (minimum 10 percent), debtand interest service coverage (minimum 1.5 times), debt:equity (maximum 5S1)and collections targets (90 percent). During negotiations, assurances wereobtained from BOCOM that it will exchange views with the Bank on any proposalsto modify the above statement. BOCOM-Tianjin's projected financial perfor-mance is expected to be quite satisfactory; a net profit of Y 25 million(10.9 percent return on equity and 2.1 percent on assets) is expected in 1992.This would increase to Y 50 million by 1995 (19.5 percent return on equity and1.8 percent on assets). During negotiations, assurances were obtained fromBOCOM-Tianjin that it would maintain a maximum long-term debt:equity ratio of5:1.

E. Environmental Impact

4.28 The project subsectors are not major pollutants, but their manufac-turing process will still have environmental impact. The manufacture ofmachine tools and construction equipment entails founding and casting, metalleaf treatment, assembly and painting. The manufacture of auto parts involvesmetal cutting, heat treatment, stamping, plastic molding, welding, coating andpainting. These processes may lead to air and water pollution if not con-trolled. Solid wastes are generally recycled and pose less of a problem. Theproject envisages the manufacture of passive electronic components whichinvolve the use of electroplating, ceramics processing, ammonia, caustics,cyanides, heavy metals, chelates, and other bonding materials and treatingfurnaces. The use of these materials and processes can cause air and waterpollution and solid waste problems if not controlled. However, the volumes ofwaste materials involved are relatively small and can be contained, recycledand disposed at a relatively low cost. Metal industries also cause noisepollution. In addition, workers' safety and hygiene problems can be a seriousissue in the industries involved. The environmental issues of the project

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would be addressed through the following arrangements which will ensure thatall subprojects to be financed under the project comply with local as well as8ank guidelines for pollution control.

4.29 The Tianjin Environmental Protection Bureau (TEPB) has confirmedthat all enterprises of the subsectors involved in the project must complywith its guidelines. TEPB must approve their renovation and expansion plansand would periodically monitor their compliance. Moreover, as part of theinvestment approval process in Tianjin, TEPB would routinely be involved inapproving all feasibility reports for subprojects under the loan, i.e., clear-ance by TEPB is required before any subproject can be financed by PFIs. Inparticular, TEPB would require that all subprojects in the subsectors to befinanced under the Bank operation include adequate expenditure for controllingenvironmental pollution and providing for workers' safety and hygiene. Foreach feasibillty report, TEPB would review the environmental provisions toensure that they meet China's environmental standards which are adequate forthe subprojects. It would also ensure that the subproject's sponsoring fac-tory is in compliance with those standards.

4.30 During negotiations, assurances were obtained from PPI. that theywill ensure that all subprojects will be approved by TEPB and be consistentwith environmental standards satisfactory to the Bank. Furthermore, under-standings were reached that appraisal reports and summary information on indi-vidual subprojects to be sent by PPIs to the Bank, will indicate specificallythe equipment to be procured for pollution control. During project implemen-tation and before the Bank's approval of individual subprojects, or the autho-rization for withdrawals, Bank staff will check and ensure that the necessaryequipment is included in the list of machinery to be procured for eachsubproject.

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V. ZD.L=QA

A. Main Features of the Loan

5.1 Lendin* and Onlendina Arrangements. The People's Republic of China(PRC) will be the borrower of the proposed Bank loan of $150 million equiva-lent. Assurances were obtained during negotiations that the loan amount willbe onlent by PRC to the Municipality of Tianjin (Tianjin) for 20 years with 5years of grace and at an interest rate equivalent to the Bank's standard vari-able rate. Tian;jin would relend (a) the financial assistance component of theloan ($134.5 million) to PIle for relending to eligible enterprises on afirst-come, first-served basis, and (b) $200,000 out of the technical assis-tance component for staff training on the same terms and interest rate as thatof the Bank loan. Tianjin would also relend to enterprises in the five sub-sectors, out of the technical assistance component, $6.5 million to developtechnical centers, $2.5 million to engage consultants for project implementa-tion and $0.7 million to train staff, on the same terms and interest rate asthose of the Bank loan. In order to regulate the flow of resources from thePRC to beneficiaries and to set out the respective obligations of variousentities, the following agreements will be signed: (a) Loan Agreement betweenthe PRC and the Bank; (b) Subsidiary Loan Agreement between Tianjin and PPIs;(c) Project Agreement between the Bank and Tianjint (d) Project Agreementbetween the Bank and PFIs; and (e) Subloan Agreements between PFIs and enter-prises. State Council approval of the Loan Agreement, signing of the Subsid-iary Loan Agreement under (b) above, satisfactory to the Bank, and Tianjin'ssigning of an agreement with consultants for project implementation will beconditions of effectiveness of the Bank loan (para. 4.8).

5.2 All subborrowers of PFIs will carry the variable interest rate riskand foreign exchange risk between the currency pool index and the Chinese yuanand will pay an interest rate equal to the Bank rate plus a minimum spread of1.2 percent. The onlending rate is consistent with the recently approved IDACredit for the Tianjin Urban Development and Environment Project (Credit 2387-CHA) and is considered adequate to cover the associated administrative costsand the credit risk in view of a limited number of relatively large-sizedsubloans expected to be financed under the loan. The relending rate to enter-prises and PFIs under the technical assistance component is also justifiedconsidering that these funds will be used for strengthening mainly R&D-typework and management and staff capability. The maximum repayment period forindividual subloans would be 15 years including a grace period of up to 3years. The last date for submission of subloan applications will be June 30,1996. Assurances on the above terms and conditions were obtained during nego-tiations. The project completiot. -te will be June 30, 1999. The closingdate of the loan will be June 30, 2000.

5.3 The onlending rate to enterprises would, over the life of the sub-loans, be positive in real terms, given projected inflation rates. China'sinflation rate (based on retail index) was 6 percent in 1986, 7.5 percent in1987, 18.5 percent in 1988, 17.8 percent in 1989, 2.1 percent in 1990, and3.0 percent in 1991 and is estimated to be 6 percent in 1992 and 5 percent inlater years. During negotiations, assurances were obtained that, from time totime at the request of any party, the Government and PPIs would exchange views

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with the Bank on the interest rates to be charged by PFIs in their lendingoperations in light of their cost of funds and profitability and of movementsin interest and inflation rates in China and internationally.

5.4 !r-Je Limit. It is recommended that the free limit under the pro-posed loan should be set at $4.0 million with the exception that the firstsubproject under each subsector, irrespective of the subloan amount, would betreated as above the free limit, which would require the Bank's priorapproval. Also, the first three subprojects from each PPI will be treated asabove the free limit, irrespective of subsector. It is estimated that 13 per-cent of the subloans by number and about 10 percent by amout will be belowthe free limit.

B. Procurement and Disbursements

5.5 Procurement. The Bank's experience with procurement under earlierindustrial credits to CIB and TLIP has been satisfactory. Consequently, pro-curement conditions will be same as for TLIP. The ICB limit for the indus-trial credit component of TIDP would be $5 million, which is considered appro-priate. Local bidders would be granted the standard preference, equivalent tocustom/import duties or 15 percent of CII cost, whichever is lower, in thecase of ICB. Contracts below $5 million would be awarded after evaluation andcomparison of quotations solicited from at least three qualified suppliers,except proprietary equipment which can be procured by direct contracting. TheBank's standard review and approval procedures (from bidding documents to thecontract awards) would be applied to all ICB packages above $5 million. Allother procurement contracts would be subject to post-review by the Bank, andPIs would maintain all relevant documents in their records for this purpose.Mise would also be responsible for the overall supervision of procurement bysubborrowers. Only about a dozen contracts are expected to exceed $5 million.(In TLIP, nine contracts have been/would be awarded on the basis of ICB.) Theprocurement arrangements are summarized in Table 5.1.

5.6 The items of equipment to be procured by the beneficiary institu-tions under the technical assistance component would be generally of lesservalue (i.e., procurement packages less than $1 million) and specializednature, including testing and measuring devices, prototypes, computers, teach-ing aids, etc. As the number of suppliers for such equipment is generallylimited, procurement will be through international shopping (i.e., at leastthree bids from qualified suppliers in different countries). However, forthose items of special equipment, which would have contracts of more than$1 million, procurement will be through limited international bidding (LIB),with bids invited from a short list of specialized suppliers to be agreed withthe Bank. Furthermore, each contract estimated to cost $500,000 or more willbe subject to the Bank's prior review. Consultant services required for theproject will be engaged in accordance with the "Guidelines for the Use ofConsultants by the World Bank Borrowers and by the World Bank as ImplementingAgency." The above arrangements were discussed and agreed during negotia-tions.

S.7 Disbursements. Disbursements would be made against: (a) 100 per-cent of amounts disbursed by PMs under subloans except for interest duringconstruction which would be 90 percent of total; (b) 100 percent of foreign

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Table 5.1: TIDP - PROCUREMENT ARRANGEMENTS($ million)

Project element Procurement method TotalICB LCB Other cost

Industrial credit component la 95.0 - 105.0 200.0(95.0) (39.5) (134.5)

Technical Assistance ComponentGoods and Technical Assistance forProject Implementation - 4.5 12.3 16.8

(4.5) (7.3) (11.8)

Other Technical Assistance andTraining - - 5.2 5.2

(3.7) (3.7)

Total Financint 95.0 4.5 122.5 222.0(95.0) (4.5) (50.5) (150.0)

la Includes initial raw materials and spare parts covered under incrementalworking capital.

Note: Figures in parentheses are the amounts to be financed by the Bank.

expenditures, 100 percent of local expenditures (ex-factory), and 75 percentof local expenditures for other items procured locally, for goods under the TAcomponent; and (c) 100 percent of expenditures for consultant services for theimplementation of technical assistance program and training. Disbursementsfor contracts of or above $200,000 and all consultant services will be madeagainst full documentation. Disbursements for contracts of less than$200,000, interest during construction, and training will be made againstStatements of Expenditure (SOE), with the full documentation held by the TMGor PFIs, as appropriate, for review by the Bank supervision missions. Expen-ditures for staff training would be paid from the Special Account against theactual costs of travel, subsistence and training fees. PFIs will submitmonthly summary sheets giving information on amounts of individual subloans,contracts, amount of payments, purpose of loans, name and address of machinerysuppliers, and the country of origin of machinery. Similar monthly summarysheets will be submitted by the TMG on expenditures under the technical assis-tance program. Disbursements are expected to be completed by June 30, 2000.The disbursement projections (given in Annex 17) are based on the disbursementprofile of industrial development and finance operations in China with adjust-ment for time needed in the first two years to reorganize subsectors and cre-ate new enterprises which would receive subloans. In order to facilitateproject disbursements, a Special Account to be maintained in US dollars and tobe operated by TMG would be established under the loan in a bank on terms andconditions satisfactory to the Bank. The Special Account would have an autho-

- 35 -

rized allocation of $8.0 million which is equal to four monthe estimated aver-age disbursements. Applications for repleniskment will be submitted monthlyor when the amounts withdrawn are equal to 50 percent of the initial deposit,whichever comes sooner.

5.8 Retroactive Financing. Eligible expenditure under the technicalassistance component of the project up to a total of $5.0 million (3.5 percentof the loan amount) incurred subsequent to July 31, 1992 will be allowed forfinancing under the loan on a retroactive basis. It will enable the procure-ment of some of the urgently needed items of machinery and equipment of rela-tively small value by support institutions and engagement of consultants toassist in project implementation.

C. Reiogtina and Auditing

5.9 The progress of the reform actions will be reported by the Tianjingovernment at six-month intervals and discussed periodically with the Bank.In addition, the Tianjin government will provide: (a) semiannual progressreports on implementation of various items included in the technical assis-tance component of TIDP; and (b) annual audit reports on (i) the SpecialAccount and (ii) Statements of Expenditure with respect to the technicalassistance component, prepared by independent auditors acceptable to the Bank.PFIs will submit: (a) semiannual reports on progress of all subprojects underimplementation; (b) annual reports on all completed subprojects during thefirst three years of subprojects' operations, providing information on perfor-mance of individual subprojects against anticipated construction and opera-tional targets (project cost, time schedule, production, sales, exports, andprofitability); reasons for any cost and time overruns, and shortfalls inmeeting original targets and actions being taken or proposed to be taken by'Pus and/or the project sponsor to improve performance; and (c) an annualaudit report on (i) PFIs' accounts and (ii) Statements of Expenditures withrespect to the financial assistance component of TIDP audited by independentauditors acceptable to the Bank. All audited accounts and statements will besubmitted within six months after the end of each fiscal year. During negoti-ations, understandings were reached on the above reporting requirements andassurances were obtained on the auditing requirements.

D. Benefits and Risks

5.10 The acceleration of policy and enterprise reforms in Tianjin willresult in greater autonomy and accountability for enterprise management,higher efficiency, and increased competition in the five subsectors in Tianjinand more rational resource allocation decisions which increasingly reflectunderlying factor costs. The modernization and restructuring of enterprisesin the context of a suitable overall restructuring strategy for the individualsubsectors is expected to result in significant gains in enterprise productiv-ity, more efficient use of energy and raw materials and an increase in produc-tion quality and exports. The strengthening of the technological infrastruc-ture will assist the five subsectors in designing and implementing new proj-ects, product development, quality control, and product testing and willincrease their exposure to the latest technological advances in foreign coun-tries.

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5.11 The main project risks relate to (a) the itplementation of policyand enterprise reforms by the Tianjin government, and (b) the timely comple-tion ot various activities envisaged under the project. Although the govern-ment is fully commltted to the economic reform program, the need to ensuremacroeconomic stability and the inevitable sensitivities associated with pro-grams of this magnitude will affect the pace of its implementation. However,the direction of the reform process is not in doubt, and its pace is now beingaccelerated. Furthermore, the increasing delegation of greater authority tothe provinces should allow the Tianjin government to move easily ahead withmany of the reforms to which it is committed.

5.12 The complexity of the project, which deals with five subsectors,three fiuancial intermediaries and several support institutions, could resultin implementation delays. While specific subcomponents are to some extentindependent, in that they are not dependent on the involvement of all projectinstitutions for their implementation, overall project activities will requireclose coordination and supervision to ensure timely and satisfactory comple-tion of the project. The experience gained in the implementation of TLIP andthe efficient functioning of special project implementation unit in Tianjin(para. 4.14) will be of great help in this regard.

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VI. AGREEMENTS AID RECOMMENDATION

6.1 During negotiations, assurances were obtained on the following con-ditions of loan effectiveness:

(a) State Council to approve the Loan Agreement (para. 5.1);

(b) The Municipality of Tianjln and PFITs to sign Subsidiary Loan Agree-ments satisfactory to the Bank (para. 5.1); and

(c) Tianjin to engage consultants to assist in the implementation ofsubsectoral restructuring programs (para. 5.1).

6.2 Assurances were obtained from the PRC, THG, and PPIs on the follow-ing conditions:

(a) PRC to:

(i) make loan proceeds available to Tianjin for 20 years with 5years of grace at the Bank's standard variable interest rate(para. 5.1); and

(ii) exchange views on PPIs' interest rates (para. 5.3).

(b) TMG tg:

(i) carry out and exchange views with the Bank at least every sixmonths on implementation of the development program and stra-tegy for the five subsectors (Annsx 1) including economic andsystem reforms and strategies for subsector restructuring(para. 3.23);

(ii) carry out the technical assistance program as agreed with theBank (para. 4.6) and furnish to the Bank for approval, byOctober 31 of each year, a 12-month training program (para.4.9);

(iii) maintain the project task force and the office with functionsand responsibilities acceptable to the Bank and with competentstaff in adequate numbers to coordinate and monitor the overallimplementation of the project (para. 4.14);

(iv) onlend $134.5 million out of the industrial credit componentand $0.2 million out of the technical assistance component toPPIs for 20 years with 5 years of grace at a variable interestrate equal to the Bank's rate (paras. 5.1-5.2);

(v) onlend to enterprises in the five subsectors, out of the tech-nical assistance component, $6.5 million to develop technicalcenters, $2.5 million to engage consultants for project imple-mentation, and $0.7 million to train staff, on the same termsand interest rate as those of the Bank loan (para. 5.1); and

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(vi) meet auditing requirements (para. 5.9).

(c) PFIs tot

(i) ensure that eligible subprojects were consistent with the TMG'sdevelopment program and strategy for the subsector concerned,met PFIs' lending criteria including a minimum ERR and FRR of12 percent, were sponsored by enterprises established pursuantto the organizational restructuring of subsectors and withsatisfactory projected financial position, vere approved byTEPB, and were consistent with environmental standards satis-factory to the Bank (paras. 4.5 and 4.30):

(ii) carry out staff training in accordance with a program agreedwith the Bank (para. 4.11);

(iii) exchange views with the Bank before making any proposal tomodify their policy statements (paras. 4.16, 4.22 and 4.27);

(iv) maintain satisfactory debt/equity ratios (paras. 4.18, 4.22 and4.27);

(v) onlend to subborrowers at a variable interest rate equal to theBank rate plus a minimum spread of 1.2 percent (para. 5.2);

(vi) exchange views with the Bank on interest rates (para. 5.3); and

(vii) meet auditing requirements (para. 5.9).

6.3 Understandings were reached with the TMG and PPIs on the followings

(a) Details of the technical assistance for support institutions to beimplemented by the TMG (para. 4.7);

(b) Detailed terms of reference and timetable of work to be performed byinternational consultants for the implementation of subsectoralrestructuring programs (para. 4.8);

(c) CIB to submit a satisfactory plan for improving loan recovery (para.4.17); and

(d) Information to be provided by PPIs in each subproject appraisalreport on the equipment to be procured for pollution control (para.4.30).

6.4 With the above conditions and assurances, the proposed project issuitable for a Bank loan of $150.0 million repayable over 20 years (including5 years of grace) on standard terms to be made to the People's Republic ofChina.

39 - ANEX I

CHINA

TIANJIN INDUSTRIAL DEVELOPMENT PROJECT

The Statement of the Tianlin Municipal Government on the Development Programand Stratert for Machine Tools. Construction Eguipment. Electronics

Comnonents. Automotive Parts and Electric Motors Subsectors

A. Background

1. Tianjin, the third largest city in China with a status of province,has a relatively large and diversified industrial base. In 1990, its indus-trial output reached Y 71.7 billion (current price) or $15.2 billion. Theoutput grew at a rate of about 10 percent per annum at constant 1980 pricesbetween 1980-90. In 1990, Tianjin manufactured 17 percent of China's mediumsize tractors, 5.3 percent of automobiles, 2.5 percent of steel, 2 percent ofelectric motors, 17 percent of bicycles and 5.4 percent of television sets.Its machine building industry accounts for 4 percent of the total subsectoroutput value of China. Its electronic industry accounts for 5 percent of thenation's total output value.

2. Exports of goods from Tianjin amounted to $1.8 billion in 1990 andgrew at an average of 1.6 percent per annum in US dollar terms, during 1980-90. While the leading export earners are textile, garments, foodstuff andother light industry products, the export of machinery grew at 8.2 percent perannum during the same period.

3. Despite its impressive growth, Tianjin's industrial sector is con-fronted with many problems. It is often characterized by lack of specializa-tion, uneconomic size of operations, and inadequate management systems. Gen-erally, the factory buildings are old, technology and equipment is outdated,plant layouts are cumbersome, and the consumption of electrical and thermalenergy and raw materials is high.

4. Since early 1980s, the Tianjin Municipal Government (government) isemphasizing the development of low energy consuming and technology-intensiveindustries. During the Eighth Plan (1991-95), the government plans to makethe best use of its local resources--salt and petroleum to undertake largechemical projects, and to make automotive, machinery equipment and electronicsas leading sectors for the development of its industry on a priority basis.Subsectors where Tianjin has a comparative advantage, including textiles,consumer durable goods, machinery and equipment, food processing, packaging,chemical processing, plastics and garments, will be restructured and devel-oped. Some of the above subsectors are being assisted under the Tianjin LightIndustry Project financed by the World Bank. Other priority subsectors, viz.,machine tools, construction equipment, automotive parts, electronic compo-nents, and electric motors are to be restructured with the assistance of theWorld Bank for the proposed Tianjin Industrial Development Project (TIDP).

5. The government considers the industry to be the main engine ofgrowth and expects to gain a more important place in the economy of the coun-

- 40 - ANNEX 1

try through industrial development. The government has already embarked on aselective program of industrial restructuring which includes gradual enter-prise reforms within the national framework, strengthening of support institu-tions (i.e., R&D centers, training institutes, etc.), technological moderniza-tion of enterprises and improvements in their organization and managementsystems.

B. Rntervrise and Subsector Policy Reforms

6. The Tianjin government has actively pursued enterprise and policyreforms in industry including the five subsectors of the proposed project.There is now little mandatory production planning; enterprises are generallysubject to indicative planning and market adjustment. At present, among majorproduct groups, controlled prices apply to only 35 products, and indicativeprices to 18 products; all other products are subject to market prices. Asregards the five subsectors to be assisted under TIDP, about 95 percent of theproduction is now outside the national plan and therefore the prices are setby market conditions. Economic corporations have been established for most ofthe industrial subsectorsa these corporations are responsible for the profitsand losses of enterprises in their jurisdiction.

7. Until mid-1992, direct export rights were given to enterpriseswhich, inter alia, could export or had potential to export at least $3 millionvalue per annum. This limit has now been reduced to $1 million for machineryand electronic products with high technology content, and $2 million for prod-ucts of the same category with low technology content. Most products of TIDPwill have a $1 million limit. This would promote direct contact between themanufacturers and foreign buyers and thus result in technology transfer,prompt market response and efficient production planning by the Chinese enter-prises. The government is also encouraging the use of FTCs as export agencieswhereby enterprises have direct contact with buyers and pay a commission to'TCs for their marketing services. This arrangement also entitles the enter-prises to retain most of the foreign exchange earned through exports. Manyproducts of the project's five subsectors, e.g., graders, automotive parts,and coil springs are already exported by enterprises using FTCs as an agency.

8. Foreign exchange retention schemes have been abolished for enter-prises which export through FTCs (nonagency basis). They must now purchasetheir foreign exchange at foreign exchange adjustment centers (PEACs), If theenterprises were benefiting from direct export rights, they can keep 80 per-cent of their foreign exchange earnings.

9. Almost all enterprises in Tianjin are now subject to the contractresponsibility system. Tax payments are included in all contracts. Duringthe Eighth Five-Year Plan period, the enterprises are being submitted to moreperformance targets than just the profit level. Yearly loan repayments arealso specified and new contracts have a duration of three to five years,instead of two or three years in the past. New workers in enterprises aregoverned by labor contracts.

10. The growth of financial institutions, including the arrival of theBank of Communications in Tianjin, and the expansion of bank branches andsubbranches has provided flexibility to enterprises in the choice of banks for

- 41 - ANNEX 1

deposit and credit operations. Some competition now exists among financialintermediaries which results in better service to enterprises. A few foreignbanks have been approved to set up branches and they would soon become opera-tional.

11. As one of the key measures to address the issue of surplus labor andlack of labor mobility, arising from the enterprises' social obligation ofproviding houses to employees, the government has prepared a city-wide housingreform plan which is beginning to be implemented in 1992. The plan providesfor a compulsory housing savings program for 80 percent of city workers, hous-ing bonds acquisition for allocation of new rental housing, gradual increaseof rent to "full cost" level to year 2000, and the sale of about 20 percent ofhousing over 10 years at a high discount. In addition, the government hasdecided to establish and support housing rental companies) cooperative socie-ties to build housing with enterprise and government support; and municipal,enterprise and individual level "housing funds."

12. The city has also pooled pension and unemployment insurance schemesat the municipal level separately for the government, SOEs, and collectivesectors. For health insurance, the municipality is preparing new measures topool major medical insurance schemes in several districts. These measuresvill be ready for implementation in 1993.

13. The Tianjin government recognizes that despite significant progressas mentioned above, reforms need to be furtiier accelerated, and it plans tofollow a continued step-by-step approach supported by selective experimenta-tion. The main objective of these reforms is to provide further autonomy toenterprises and to make them more responsive to market signals. New measuresare planned in all five subsectors and pace of implementation of certain re-forms is to be accelerated as described below.

14. Corporatization and Shareholdins System. In order to promote exper-iments in shareholding type companies, all beneficiary corporations under TIDPwould have share ownership. The beneficiary corporations which, on the basisof their past two years' consolidated accounts, would have a minimum of 15percent return on equity (net income before taxes as percentage of equity),and a percentage of net income (after taxes) to capital not less than a one-year bank deposit rate, will become "limited share companies." Whenever theycan meet necessary criteria and condztions for this purpose, these corpora-tions will also be allowed to issue shares to employees and individual inves-tors, according to the new central government regulations. The shares of thecorporations would be listed at Shanghai, Shenzhen, or Tianjin (should it haveits own stock exchange), and Tianjin government will seek central governmentapproval for this purpose. Other beneficiary corporations will also beshareholding companies but would be classified as "limited liabilitycompanies." Their shareholders would be typically the State Asset ManagementBureau, some other corporationslenterprises, and nonbanking financial institu-tions.

15. Cross-regional ownership can be an appropriate solution whenever anenterprise in Tianjin needs another enterprise to share the production ofparts and assembly, in order to achieve economies of scale through high levelof production, reduce coats and improve competitive position. However, there

- 42 - AME I

are difficulties in persuading enterprises in other regions to invest in suchenterprise. The government will make its beat efforts to establish initiallyat least one corporation (most likely in the construction machinery subsector)with cross-regional shareholding ownership on an experimental basis.

16. Prices and Competition. Measures have been taken in recent yearstowards freeing enterprises and production from mandatory and indicative plan-ning in the five subsectors. However, further measures will be taken toremove by 1995 indicative pricing and what remains of mandatory planning inthe five subsectors.

17. Investment and Technolony. The Tianjin government has now theauthority to approve investments below Y 30 million in all subsectors. In thearea of technology transfer, the five subsectors will use effectively theservices of the Tianjin International Science and Technology Consulting Com-pany, Tianjin Foreign Investment Advisory Center and other similar specializedagencies, to obtain information and seek suitable foreign partners. Further-more, the enterprises will be encouraged to establish long-term technologysharing experiments with leading foreign manufacturers and the government willsimplify its procedures to facilitate such collaboration.

18. Forcion Trade. With the new lower limit for direct export rights,most of the enterprises in the five subsectors would be able to undertakedirect exports. All other enterprises would be allowed to use FTCs on anagency basis which would make possible direct contacts with foreign buyers andretention of 80 percent of earned foreign exchange by these enterprises.

19. Taxes and Contract Responsibilitv System. The contract responsibil-ity system (CRS) has several performance indicators (which may include produc-tion, productivity, sales, employment, profits, taxes, etc.) and it, thus,becomes difficult for the enterprise management to maximize efficiency andprofitability. In orcir to obtain greater benefits from CRS, the governmentwill streamline the contract obligations by reducing the number of targets innew contracts to a few essential ones (viz., profits and debt-servicing), andthe contracts will not be revised during implementation.

20. Labor Mobility. About 10,000 workers are expected to become surplusas a result of restructuring of the five subsectors. The government willaddress this issue by developing the existing employment centers, improvingunemployment insurance facilities in Tianjin, and creating employment opportu-nities. It will also take the following steps in 1993-95: (i) surplus work-ers will be identified and released (at least 20 percent in 1993 and 40 per-cent each in 1994 and 1995) from the five subsectors; (ii) the employmentcenters (including Tianjin Labor Service Company) would actively support thereleased workers in identifying job opportunities in other enterprises/subsec-tors; and (iii) financial support and training would be assured for the work-ers to be redeployed. The government will also take necessary steps tostrengthen the role of the employment centers and to improve the trainingfacilities for labor redeployment and will use the TA component of TIDP forthis purpose.

21. Housina. The Tianjin government is making the maximum use of thefacilities provided by the recent reforms undertaken in this area to promote

- 43 - AUXI

individual housing transactions and to separate the supply of housing servicesfrom the enterprise activities. With these objectives, and withlvn the frame-work of the municipal housing reforms, the government will introduce experi-ments first in the five subsectors under the project. The reforms wouldinclude transferring housing assets of enterprises, or their housing manage-ment rights, to the Tianjin Housing and Trust Company in charge of housing,and offering to workers in the five subsectors real opportunities to purchasedwellings. Substantial progress in this regard will be accomplished by 1995.

C. Physical Restructurinx of Fiye Subsectors

Main Issues and Anproaches

22. Structure of Subsectors. Most enterprises in the five subsectorsare small in size in comparison to international standards and have fragmentedproduction which inhibits efficiency, quality and competitiveness. The orga-nizational structure of the subsectors will therefore be revamped to allow theconsolidation of physical assets and manpower, and closure of nonviable activ-ities. This would help to achieve effective management control of the con-stituent enterprises, and create a large critical mass for investment andoperational efficiency.

23. Product and Market Concentration. For historical reasons, capitaland resource allocation decisions have been made by the government as a partof planning process with focus on higher production. This has led to manufac-ture of a wide range of products with low volumes and inadequate coverage ofmarkets both domestic and export. In future, Tianjin would concentrate capi-tal and other resources on those industrial activities where it has potentialcomparative advantage and the market viability of products is clearly estab-lished. In addition, it will build a strong position in domestic market as acritical first step toward success in export markets. Furthermore, the fivesubsectors will strengthen marketing, sales, distribution and service capabil-ities.

24. Develonment and Absorption of Technoloat. Most enterprises haverelied heavily on centralized R&D institutes and, recently, on licensingagreements for more sophisticated products. However, the enterprises have notbeen able to develop capabilities for internal product development or fullutilization of imported technologies. In future, the subsectors will be moreselective in acquiring modern technologies and will seek greater commitmentfrom foreign partners to share new technology over the long term. The inter-nal organization and expertise vill also be developed to adapt, absorb andcommercialize technologies in Tianjin.

25. Plant Facilities and Layout. Most of the plant equipment is obso-lete or outdated. Furthermore, plant facilities are, to a large extent, notwell-organized with inappropriate production layout and flow. These problemswill be resolved to bring operational efficiency and improve quality and,thus, to enlarge market share.

26. Management Develorment. Modern management skills are underdevel-oped. The enterprises have lack of understanding of strategic planning andneed to adopt more flexible and innovative approaches to respond to market

- 44 - AMU I

signals and to make prompt adjustments in operations. In future, appropriatemanagement functions will be established at all levels aud managers will needmore intensive training in are"s of product and market development, cost con-trol, production planning, quality control, etc. Also, enterprise managementinformation systems will be strengthened to enable improved enterprise manage-ment.

Restructurine Strategies

27. Machine Tools. The restructuring strategy for this subsectorfocuses on further development of hydraulic proeses in which Tianjin has astrong position. Development of gear cutting equipment and machining centerswould be undertaken only in technology collaboration relationships with for-eign manufacturers to upgrade technologies, to provide Tianjin access toexport markets and to ensure economies of scale. Uneconomical products suchas vertical spindle and floor type surface grinders, boring and radial drill-ing machines and large lathes would be discontinued no later than December1994. Nonrelated products such as valves, pumps, and micromotors have beenalready moved outside the subsector as recomaended by the consultants. Themanufacture of related accessories such as work tables, lead screws, etc.,would be maintained under a separate corporation, the Tianjin Machine ToolAccessories Corporation.

28. With respect to the manufacture of horizontal spindle surface grind-ers with creep control and CNC, and two spindle vertical grinders for theautomobile industry, the production of these products would be maintained andreviewed for continuation or further expansion by December 1994.

29* The present subsector organization which now includes nine state-owned enterprises managed by TMIB would be restructured into two independentshareholding corporations--the Tianjin Machine Tool Corporation and theTianjin Machine Tool Accessories Corporation (to which reference has alreadybeen made under para. 27). The Machine Tool Corporation would comprise ofseparate product divisions, viz., the hydraulic press division, the machinecenter division, the surface grinder division and the gear cutter division.The corporation would have certain common manufacturing facilities for fabri-cation, precision machining, assembly and testing equipment for use by theproposed product divisions. Hydraulic Press General Works Number 1 and Number2 would be merged and form the new Hydraulic Press Product Division; Number 4Machine Tool Works and the Grinder General Works would cease to operate nolater than December 1994 and the facilities in Nhmber 1 Machine Tool Worksexpanded for the manufacture of gear cutting machines, machining centers andsurface grinder products specifically listed in para. 28.

30. The enterprises within the proposed subsector corporations would nothave separate legal status. The respective product divisions would be the newprofit centers for management accounting and the manufacturing facilitieswould constitute cost centers.

31. Construction Equipment. TianJin is well-positioned geographicallyand industrially to expand its construction equipment subsector. Tianjinwould concentrate on those products in which it already has a comparativeadvantage and strengthen its marketing position through cooperative arrange-

-45 - ANNEX 1

ments and mutually complementary relationships with other national manufactur-ore. To achieve economies of scale, it is proposed to adopt a manufacturingstrategy wherein common production facilities are provided in specializedworkshops for plate preparation, fabrication of components and machining forthe proposed range of construction equipment products. The product lineswould be broadened and strengthened through foreign technology transfer agree-ments. Under the construction equipment division the manufacture of crawlerdozers and motor graders would be expanded wvhreas the manufacture of wheelloaders would be maintained and further investment would be made only ifdomestic and foreign partners can be found. The manufacture of concrete mix-ers would be discontinued latest by December 1994.

32. The expansion of forklift truck production will take place only withthe participation of a leading international manufacturer preferably as ajoint venture shareholder or alternatively under a long-term technology trans-fer agreement. The manufacture of forklift truck axles would continue; how-ever, the manufacture of other products such as freight elevators, heatexchangers, hoists, lifts and gear box repairs would be discontinued latest byDecember 1994.

33. The manufacture of existing models of diesel engines for off-highwayapplications would be maintained and new models would be introduced, provideda suitable joint venture partner under a shareholding or long-term technologytransfer agreement can be located. The manufacture of hydraulic torque con-verters would be maintained.

34. The grey iron foundry which provides castings for diesel engines andother construction equipment would be upgraded, whereas the foundry for steelcastings would be phased out by December 1994.

35. A new corporation would be formed to replace the present 11 enter-prises in the subsector. This corporation would have four product divisions--construction equipment; industrial equipment (forklifts); components (dieselengines and hydraulic torque converters); and foundry. The corporation wouldenter into marketing collaboration arrangements with selected domestic manu-facturers of complementary products so as to be in a position to offer to itspotential customers a full range of construction equipment. The separatelegal status of all enterprises Included under the various product divisionsof this corporation would coase with its formation. This structure wouldallow greater productivity, lower manufacturing costs, greater flexibility inproduction planning and scheduling, improved product quality and better for-eign market prospects. Its integrated structure would attract suitable for-eign partners who could strengthen Tianjin's position in the constructionequipment subsector.

36. Electronic Components. The future development program and strategyof this subsector focuses on passive components. Within the passive compo-nents, Tianjin would concentrate on aluminum electrolytic (AS) capacitors andthin film resistors. At the same time, it is proposed to initiate develop-ment work on the manufacture of surface mounted technology (SHT) chip compo-nents.

- 46 - ANNE

37. To realize economies of scale in manufacturing high quality passivecomponents, the expansion of AE capacitors and thin film resistors would becarried out only under joint venture shareholding arrangements with interna-tionally reputed foreign manufacturers. Two separate corporations--a capaci-tor corporation and a resistor corporation would be formed for this purpose.These arrangements would enable Tianjin to increase its market share in thegrowing domestic market and exports through the marketing organization of theforeign partner.

38. The two enterprises manufacturing AE capacitors--Tianjin Radio Com-ponent Factory No. 1 and No. 14 would be merged into the proposed joint ven-ture capacitor corporation. Carbon film resistors manufactured by TianjinRadio Component Factory No. 9 would be produced by the proposed joint ventureresistor corporation, and thereafter the Factory No. 9 would be closed. TheTianjin Xin Tong Resistor Corporation would, however, continue to operateindependently.

39. Tianjin Radio Component Factory No. 2 which manufactures variablecapacitors, No. 3 which manufacturers transformers for TV sets, No. 6 whichmanufacturers delay lines, and No. 10 which manufactures potentiometers wouldoperate directly under TECIC, and would maintain the manufacture of theseproducts. Tianjin Radio Component factories Nos. 12 and 20 which manufactureAS capacitors and ceramic disc capacitors, respectively, would be closed downlatest by December 1994. Tianjin Radio Component Factory No. 16 which manu-factures capacitors for power factor correction would be moved outside thesubsector. The monolithic capacitor production in Radio Component Works No.15 would be transferred to the proposed SMT laboratory.

40. In order to promote the development of SMT for chip-type capacitorsand resistors, it is proposed to initiate steps for technology absorption andprocess development in a technical center to be set up for this purpose.Commercial production of SMT products would be considered only under a share-holding joint venture with a leading international company and subject toeconomies of scale, market justification and techno-economic viability ofmanufacturing these SMT products being clearly established.

41. Automotive Parts. In order to improve the performance of this sub-sector, an innovative restructuring approach and strategy has been developed.The subsector would be restructured into 13 automotive parts subsystems ratherthan along individual product lines as at present. The restructuring of twoof these subsystems where Tianjin has a high potential comparative advantage--the drive train and the auto--electrical products would be taken up on a pri-ority basis. The subsystems would be developed to provide Tianjin with thecapability to supply automotive parts at the national level and to leveragethe expanded domestic position in foreign markets. Emphasis would be placedon developing components which would meet world standards of quality forpotential exports and gain a strong position in the China market. Foreigntechnical relationships will be developed for new product and process technol-ogies, to enhance quality, to raise output volumes, and to increase effi-ciency.

- 47 - ANNEX 1

42. Within the subsystems, products which do not have potential forcomparative advantage would not be manufactured in Tianjin and OEMs wouldprocure them from other national/international suppliers.

43. The manufacture of propeller shafts would be phased out. Also, themanufacture of CV joints would not be pursued, except under a joint sharehold-ing and technology transfer arrangement. The manufacture of regulators anddistributors would be phased out. In the engine parts subsystem, the manufac-ture of rings, piston pins, valves and connecting rods would be phased out.The manufacture of radiators in the enterprise under the Civil Affairs Bureauis of doubtful viability, but it is proposed to be maintained on the consider-ation that over 40 percent of its employees are handicapped persons. Themanufacture of hand-brake line would also be phased out. All phase out activ-ities would be completed and the concerned enterprises closed latest byDecember 1994.

44. The manufacture of automotive parts subsystems would be delinkedfrom the direct administrative control and supervision of TAIC. Under the newstructure, independent corporations would be created for each subsystem andwill include only those enterprises which are viable. These enterprises willlose their legal status and function as product divisions of the subsystemcorporations. The drive train subsystem corporation will have two productdivisions--the Auto Gear Division and the Axle Division. The Tianjin AutoAxle Works and the Bus and Van Axle Works would be merged into the proposedAxle Division. Likewise, some of the independent enterprises manufacturingelectric motors within the auto electric parts subsystem would be merged.These new organization structures would induce econmAies of scale in all func-tions. Each subsystem would develop through its product and excellence, rec-ognition in the OEM and after-market parts.

45. Electric Motors. Although the subsector includes four enterprises,it consists basically of one large enterprises, Daming Electric Motor Corpora-tion (DEMC). The other three enterprises are very small production facilitiesand are operating as collectives. DEMC has realized growth in sales andexports of electric motors in the past five years (though its exports havedeclined in the last two years), but its present manufacturing facilities andproduct designs are not suitable for efficient product expansion and need tobe upgraded and modernized. Consequently, DEMC's restructuring would beundertaken only with the participation of a foreign joint venture shareholdingpartner who should be a leading electric motor manufacturer. A strong jointventure partner would provide leadership to DEMC to improve its financial,technical and market performance in both domestic and foreign markets. Theproposed joint venture would need to build new plant facilities at the presentsite and would make use of the existing foundries within and outside the sub-sector. With the establishment of such a joint venture, DEMC in its presentform would cease to operate.

46. General. In all the above subsectors, factory office and buildings,plant, equipment and other fixed assets which are rendered surplus as a conse-quence of rationalization, merger and closure of enterprises would be sold,scraped or otherwise disposed of.

D. Development of Technological Infrastructure

- 48- ANNE 1

47. The design and research institutes and the vocational traininginstitutes within the five subsectors cannot provide adequate technical sup-port services. They lack computer hardware and software, testing equipmentand teaching aid facilities. They have limited contacts with similar institu-tions in developed countries and therefore cannot keep up vith the latesttechnological developments abroad. Subsector enterprises have also not givensufficient attention to the importance of R&D. The linkages between nationaland regional R&D institutes and enterprises are wesk.

48. In order to strengthen the technological support system, it is pro-posed to establish one technical center within each subsector under TIDP.However, in case of subsectors/subsector corporations, such as electricmotors, resistor and capacitor corporations, which are proposed to b. devel-oped only in conjunction with foreign joint venture partners on a shareholdingbasis, the functions of technical center would be provided by the foreaignjoint venture partner. In such cases, it is not necessary to create such atechnical center using World Bank loan proceeds for TIDP.

49. Tianjin has a number of vocational training Institutions which areassociated with the subsector enterprises. These institutions would bestrengthened on a selective basis through the provision of modern teachingaids, training materials and equipment, books, etc., to enable them to bettermeet the needs of restructured subsector corporations.

- 49 - AM 2

TIAMJIl IUDUSTRIAL DVKLOPMRT PRJC

Economic and EnterDrise Reforms ln the Five Subsectors in Tianjlin

1. An extensive range of economic and enterprise reforms have beenimplemented in Tianjin in the five subsectors. These reforms relate to domes-tic competition, foreign trade, production and investment policies, enterprisereforms, financial sector and labor mobility, including housing and socialsecurity. Many of these reforms have been initiated at the national level andapplied to Tianjin, as well as other major cities selected for experimenta-tion.

Price and Market Reforms

2. Most of the production in the five subsectors is now outside thenational Plan. Prices are therefore set by enterprises according to marketconditions. Only prices of some products, and that too for small quantities,are controlled by the central or the municipal government.11 Prices inmachine tools and the construction equipment subsectors are determined bynegotiation between enterprise and clients, particularly at the time of annualnational conventions.

3. Since the early 1980s, the national market of the electric motorssubsector has been completely liberalized. The market, however, reains quiteregionalized. The majority of the sales of Tianjin electric motor subsectoris in Tianjin, and the same applies to other provinces. The regional protec-tive policies to prevent the entry of products from other parts of the countryhave been removed, but the segmented market structure still exists because ofpast relationship between buyers and sellers.

J1 For a very few types of construction equipment, machine tools, ceramiccapacitors, aluminum capacitors, potentiometer, fixed resistors andmedium-sized electric motors (about 20 hp) prices are set by the centralgovernment (Central Price Commission and respective supervisory minis-tries). The state reference prices are set in relation to the unit costof the product, a mark-up of 8 percent and the demand. However, theseprices can vary slightly from one region to another for the same product.Higher unit costs will tend to generate higher prices, but the mark-upwill be in general lower. Also, the enterprise can change these refer-ence prices within a range of 10-30 percents 10 percent for auto parts,and 15 percent for machine tools. In general, prices of new products arenot brought under administrative control during the first three yearsfollowing the creation of the product. Prices of raw materials used inthe five subsectors, such as steel, copper, pig iron and coke are set bythe central government for only the small proportion of production whichis still under the plan target.

- 50- ANNEX 2

4. Enterprises in the electronic components subsector (capacitors andresistors) are also free to produce and sell according to market requirements.Annual production plans are still sent to the bureau, but only for informa-tion. The selling price are determined through negotiations between the buyerand the enterprise. The Ministry of Machinery and Electronic Industries(MMII) issues price guidelines for key products. However, the contractingparties are not compelled any more to follow them. The guidelines are used asan overall market information background.

S. In the automotive parts subsector, the prices are not controlled andthe Tianjin Automobile Industry Corporation (TAIC) is left relatively free torespond to changing local and national market conditions. For cars, pricesare nationally fixed by the central government. An enterprise can propose andobtain local modifications of the national reference price if it can show thatthe changes are needed to provide a better response to its own market andimprove its sales performance. The prices of trucks and other vehicles havebeen fully liberalized.

Investment Reforms

6. Presently, for capital construction and technical renovation invest-ments in the five subsectors, the State Planning Commission (SPC) must approvemedium- and large-size projects. Scale is measured by production capacitycriteria. Total cost criteria are also applied. Technical renovation proj-ects costing less than Y 30 million (total cost) for light industry andY 50 million for heavy industry are approved by Tianjin Planning Commission.Larger projects are sent to SPC or the State Council for approval. Untilrecently the automotive subsector was submitted to a more stringent investmentauthorization rule. Now, the subsector is subject to the general regulation.

Foreian Trade Reforms

7. A large proportion of exporting enterprises in the five subsector inTianjin have been selling their products in local currency to FTCs whichresell them in foreign currency to foreign buyers. Under this purchasing andreselling regime, enterprises are closely associated with each major step ofthe operation: identification of the product and specifications, marketing,negotiations, and after sales service. Now, in a few cases, FTCs are actingon an agency basis. This new trading arrangement is developing slowly sinceenterprises often cannot collect the foreign exchange proceeds in a relativelyshort period.

8. Direct exporting has expanded since 1987 from a very small base.Direct export rights have now been granted to more than 10 percent of export-ing enterprises. FEACs have substantially expanded their activity in recentyears. The volume of transactions in Tianjin reached $100 million in 1989.However, compared with Tianjin exports of $452 million for the same year, thistransactions volume appears still relatively low.

9. An FTC is specifically assigned to each of the five subsectors forimport and export transactions. FTC8 are mostly under the Foreign Tradeiureau, but in some cases under the Industry Bureau of the subsector (elec-

- 51 - AM= 2

tronics). The transformation of PITCs into export sale agencies is beingstrongly encouraged by the Foreign Trade Bureau of Tianjin Municipality.

10. Export subsidies to FTCe have been abolished. They are not any moresheltering enterprises from exporting at a loss. It then becomes progres-sively in the interest of the exporting enterprises to use FTCs as a serviceagency. Moreover, foreign exchange retention schemes have been abolished forenterprises which do not export directly but sell to FTCs. They must nowpurchase their foreign exchange in FEACs.

11. Several enterprises in the five subsectors export directly. Untilmid-1992, direct export rights were given to enterprises which, inter alia,could export or had potential to export at least $3 million value per annum.This limit has now been reduced to $1 million for machinery and electronicsproducts with high technology content, and $2 million for products of the samecategory with low technology. Except electric motors which will have a $2million limit, all other products of TIDP will have a $1 million limit.Already, products like graders and auto parts are directly exported by enter-prises. In this case, they can retain at least 80 percent of their exportearnings.

12. Until recently, enterprise exports in the machine tools and con-struction subsectors have been below $1 million. Therefore, no export rightshave been granted. Exporting enterprises are selling their products to FTCswhich in turn sell them abroad. However, exports of the gear-cutting companyhave now reached the new $1 million bencbmark, and the company would becomeeligible for direct exports. The same applies to the forklift factory in theconstruction equipment subsector.

13. As regards the external trade in the electric motor subsector, thetotal export was $1.7 million in 1991, and, therefore, the Daming ElectricMotor Company (DEVC) does not yet benefit from the direct export status.Presently, only one enterprise (Tianjin Middle Circle Capacitor Corporation)in the electronic components subsector benefits from direct export rights.

14. Since early 1991, in the automotive subsector, TAIC has directexport rights. The Tianjin branch of the China National Auto Import ExportCorporation (CNAIEC), which was also under the supervision of TAIC, has lostits status of a branch,2I and is now exclusively under the supervision ofTAIC. The corporation can retain almost 100 percent of its foreign exchangeearnings. However, more institution-building is needed to develop exports.Up to now, TAIC's knowledge of foreign markets has been relatively limited,its after sales support abroad minimal, and its access to export channelssomewhat inadequate.

21 This means it has lost its authority to mandate exports production andpricing on behalf of the national FTC and its ability to receive exportssubsidies.

-52 - ANN% 2

Tax. Credit and Profit Distribution Policies

15. The 1984 income tax law has been fully implemented in Tianjin.Before 1984, enterprises used to remit profits to the State. Now state enter-prises remit taxes on the basis of 55 percent of their profits. The indus-trial and commercial tax has been replaced since 1984 by a product tax and avalue added tax, and finally by a value added tax alone. The value added taxis fully implemented in the five subsectors and the average rate in thesesectors is about 14 percent.

16. Tianjin was selected in 1984 as one of the first cities to implementthe CRS reform. Now practically all enterprises in the city are under theCRS. One main aspect of the system is the link between the growth of product-ion and the growth of total wage payments. As a result, about Y 1 of bonushas been paid to workers yearly for Y 7 of profits and taxes. The enterpriseshave been also provided with more autonomy in the management of their employ-ees, through the introduction of possible wage-earning penalties and theemployee contract systems.

17. In the machine tools subsector, the Tianjin Finance Bureau signs acontract for two or three years with subsector corporations, which in turnsign the contract with the enterprises. During the Eighth Plan period, enter-prises are being subjected to more performance targets than just the profitlevel. Yearly loan repayments and tax payments targets have been specifiedand new contracts have a duration of three to five years.

18. For the time being, the CRS and taxes in the electronic componentssubsector are still handled at the enterprise level rather than by the newcorporation, mainly because the enterprises have kept their legal entity sta-tus. The CRS includes a profit target, a tax payment obligation as a fixedpercentage of the profit, and tax rebates to allow loan repayments.

19. Profits after taxes are usually allocated among five items: produc-tion development fund, welfare fund, bonus, reserve fund, and new productdevelopment fund. The rule is that the development fund and the reserve fundshould not take more than 60 percent in profit allocation. Bonus to the work-ers in the machine tools subsector can be fixed every year in the traditionalway, i.e., as a fixed percentage of profit after taxes. More and more, how-ever, it is being merged with wage increases as a reward for better perfor-mance.

Enterprise Ownership

20. Enterprises in the five subsector have in many cases been estab-lished to produce only specific categories of output and the related produc-tion system is often too vertically integrated. To gsain economies of scale,the subsectors must be reorganized towards more horizontal integration.Diversified shareholding could be utilized to ensure a good coordinationbetween activities of various categories of enterprises, especially foundries,enterprises producing parts and components, and finished product lines.Diversified shareholding would be a major improvement towards more enterpriseautonomy, flexibility, and efficiency. The central government has issued inMay and June 1992 regulations which outline a preliminary legal framework for

- 53 - ANNEX 2

shareholding. These regulations include standards for setting up: (i) 3lim-lted liability companies" whose shareholders could be the State Asset Mbnage-ment Bureau, other enterprises, and nonbanking financial institutions, and(ii) "limited share companies" which can also include employees and foreigninvestors as shareholders.

Labor Mobilitv

21. Current T,abor SuRplv Policies. In order to provide employment to agrowing number of persons entering the labor force and to adjust to sectoralchanges in labor demand, three categories of policies are being implemented.First, new job opportunities are offered through the development of small-scale service industries: for example, the establishment of food services andsmall-scale hospitals is encouraged. Second, concerned industrial bureaus andthe labor bureau work out a solution to reallocate the workers across subsec-tors. Third, employees are left free to find a new job by themselves eitherin the ssame subsector or outside. To help implement these policies industrialbureaus submit every year to the Labor Bureau a list of new employment vacan-cies. If the required qualifications differ from the available skills, theworkers are given additional training in one of the 19 training centers underthe labor bureau.

22. Current Vocational Training Policies. A number of institutions areresponsible for providing and upgrading skills of workers.

(a) The Tianjin Labor Bureau and the Bureaus in the industrial subsec-tors have their own training facilities, mostly for new workersentering in the subsectors.

(b) The enterprises in each subsector have their own training capabili-ties to impart skills to new workers as well as upgrade the skillsof existing workers.

(c) Technology schools have been established in the five subsectors.

(d) Special programs are geared to send workers for training in otherprovinces and even abroad.

When a worker needs to acquire new skills as a result of a restructuringarrangement, one of the following arrangements are made: (i) the worker issent to the Tianjin Branch of the China/Germany higher-level training center;(ii) the worker is oriented to the high technology training center of a voca-tional school; (iii) the worker is sent to the training center of the bureauof the subsector activity requiring new skills snd knowledge.

23. Restructurint Issues. The workers identified as surplus in anenterprise must apply to the supervising bureau who will transfer them toemployment-deficit areas in the same subsector. If the subsector cannotabsorb more workers, employment search beyond the subsector will be handled incollaboration with the municipal labor bureau. When a bureau transfers anemployee from one factory to snother, it verifies that the employee has therequired skills for the new job. If not, the employing company will have totrain the new workers. In spite of these measures, the process of workers'

- 54 - ANNX 2

reallocation remains uncertain and rather limited. First, reallocation isgenerally within and not across subsectors. Second, the training to redeploythe existing workers is to be provided by the hiring enterprise. This enter-prise may find more costly to upgrade the skills of an existing worker than tohire a newly qualified worker.

24. Manpower redeployment is a very complex issue and has many dimen-sions: information on labor surpluses and deficits, matching overall laborsupply and demand at the municipal level through the support of an employmentcenter and unemployment insurance. Some reforms in the area of labor mobilityhave been already initiated in Tianjin for specific categories of labor. Amunicipal employment center (Tianjin Labor Service Company) and an unemploy-ment insurance scheme have been operating for several years in Tianjin. How-ever, their role is still quite limited.

25. Emillovment Contract. The employm-nt contract system has beenapplied to newly hired workers since 1983. As a consequence, the number ofemployees under the contract system amounts to 7 percent of the labor force inTianjin, and to about 11 percent of the labor force in the five subsectors.The principles guiding the contract are the following: (i) the workers areselected according to the adequacy of their professional and technical quali-fications; (ii) the enterprise director can dismiss the worker at the end ofthe contract; (iii) during the interim period between two employmento, thevorker receives unemployment insurance benefits. By contrast, the permanentworker La "permanently" employed and does not receive unemployment insurance.

Housing Reforms

26. Most of housing and welfare benefits are enterprise related. Theydo not represent in principle an obstacle to labor mobility, because allenterprises grant the same benefits. In practice, however, differences in thequality of the benefits are to be expected. The enterprise buys housingfacilities for its workers and rents these facilities at a low fixed rate.Moreover, enterprises contribute to building up the retirement fund of aworker and the State provides the remainder. Health and social welfare bene-fits are directly provided by the hiring enterprise and are the same acrossenterprises.

27. Considerable efforts have been made by TMG to reform the housingdelivery system. Recent developments include the creation of a special publicfund for housing construction, a plan for a step-by-step increase of rents,the individual housing acquisition scheme, housing bonds acquisition for newrenters, and the creation of cooperatives for housing construction.

Financial Sector

28. Financial sector reform experiments were introduced first in Tianjinand in a few other cities. Implementation of the reform program began inApril 1987 and has been successful up to now. Segmentation of the financialmarket is being progressively removed by allowing sector specialized financialinstitutions to develop their business with clients from all sectors. Recip-rocally an enterprise can chose a specialized bank from a different sector.For example, an agricultural bank can make a loan to an urban enterprise.

-55- ANNEX 2

However, construction activities still have to be financed by constructionbanks. Second, more banks can now accept deposits. Third, interest rates ondeposits and long term loans are fixed, but interest rates on working capitalcan fluctuate in the proportion of 20 percent of the level established.Fourth, state enterprises can issue negotiable bonds with the authorization ofthe relevant bureau.

29. More than 30 new financial institutions have been set up. They aredivided into three categoriess (i) subsidiaries of state banks; (ii) collec-tive banks which are owned by city districts; (iii) leasing companies whichcan lease imported equipment; they can be either collectives or state-owned.

30. The growth of financial intermediaries, including the arrival ofBank of Communications in Tianjin, and the expansion of bank branches andsubbranches has provided a little more freedom to enterprises in the choice ofbanks for deposit and credit operations. As a result, some competition doesexists among financial intermediaries.

- 56- ANNEX-3

CHINA

TIANJIN INDUSTRIAL DEveLoPMERT PROJECT

Instiltutional Strengthenina forWorkers' Retrainina and Redeulomuent in Tianiin

Background

1. Employment of workers by enterprises in China has been mainly on"permanent" (i.e., lifetime) basis. The most important step towards changingthis practice has been the introduction of a fixed-term contract system in1983. It facilitates the hiring of new workers for a fixed term at the end ofwhich their services can be terminated. However, only a small proportion ofthe labor force is covered by this system (7 percent in Tianjin, 10-12 percentfor TIDP's five subsectors). In addition, T1G is pursuing a number of dif-ferent approaches to promote the creation of new jobst (a) promotion of ser-vice industries (e.g., restaurants) as Subsidiaries of state-owned enterprises(SOEs) to absorb some of their own surplus labor, (b) assisting in retrainingand the redeployment of surplus labor across the industrial sector with thesupport of Tianjin Labor Service Corporation (TLSC) and Training Centers and(c) encouraging the rapid development of the service sector as a whole as oneof the main outlets for employment growth in the medium to long term.

2. The above efforts need to be further streamlined and improved toreduce the burden of surplus labor on SOEs. The main objective of therestructuring of five industrial subsecturs under TIDP is to improve theirefficiency and competitiveness. This would require, inter alia, olosure ofinefficient and uncompetitive enterprises resulting in displacement of largenumber of workers and reduction of surplus labor in other enterprises. Simi-lar restructuring programs in other industrial subsectors would also necessi-tate redeployment of labor. It is recognized that this will create a majorsocial challenge to the Tianjin Government.

3. TLSC is in operation as a division of the Tianjin Labor Bureau (TLB)and it is recognized as the Employment Division of TLB. It has five predomi-nant functions: (a) to establish employment procedures for the "Da Yie"youngsters (those who have never been employed); (b) provide employment intro-duction services and employment opportunity marketing services for "Da Yie";(c) collect employment insurance from joint ventures, private enterprises andcollectively owned enterprises for contract workers and deposit it with theTianjin Finance Bureau; (d) manage labor resources and coordinate trainingprograms; and (e) investigate employment opportunities for unemployed workers(those who are in between jobs). Although the current focus of the LaborService Company is "Da Yie," it is planning to pay greater attention to theneeds of unemployed workers.

4. Tianjin has traiuing facilities for preemployment and on-the-jobtraining. The Labor Bureau, Personnel Bureau and other administrative bureaus

- 57 - ANNE

provide vocational and technical training to workers and cadres (vhite collarworkers). The Economic Codission coordinates management training in Tianjin.

Obscetive of the Technical Assistance (TA)

5. The purpose of this TA component is to help strengthen the existinginstitutional framework for the redeployment of labor in the industrial sectorin Tianjin and to enhance its capability to meet the increasing demand. Thereare several successful models in the US, Canada, Europe and other developingcountries that can be followed. As a result, Tianjin institutions willimprove their capability to, inter alia, centrally compile a list of laid-offworkers, forecast future worker displacement, and counsel, retrain and rede-ploy them in gainful employment. The consultants to be engaged under TA, willsuggest how the present institutions for job placement need to be reorganized,rationalized and strengthened. In addition, TA will provide for procurementof computer equipment to develop and maintain a data base and foreign trainingof selected staff in TLB and TLSC.

8coPe of the Consultants' Work

Task I: The consultants will outline the detailed procedures to prepare andmaintain a comprehensive list of displaced workers who require retraining andredeployment in coordination with the Labor Bureau and administrative bureausresponsible for the industrial subsectors.

Task 2: The consultants will determine how a strategic planning approach canbe employed to forecast the possibility and probability of future worker dis-placement as a result of enterprise closing or structural adjustment ofTianjin's industrial base, especially SOEs.

Task 3: Based on the above information, the consultants will design a systemto forecast the educational, technical and skills categories that will becomeredundant and will require retraining and redeployment.

Task 4: The consultants will also suggest as to how a list of existing andfuture job openings suitable for the displaced workers will be compiled andregularly updated. This will require continual collection and analysis ofeconomic, planning, technological and market data and its translation intojob opportunities for the displaced workers. This information will be morereadily available once the recommended data base and information system isestablished. It will also require close coordination with the central andmunicipal bureaus and commissions responsible for planning, approval of capi-tal projects and job creation. Based on this information, a system will bedesigned by which future job openings broken down by education, technical andskills level categories will be regularly compiled and used for placement oflaid-off workers. It will also be used to plan training courses to focus onpresent and forecast needs of skills and expertise.

Task 5s The success of creating new job opportunities in tertiary and ser-vices industries in Tianjin will also be evaluated and recommendations made asto how these should be completely delinked from enterprises that no longerrequire these workers.

- 58 - AM 3

Task 6s Based on a review of the present training and redeployment programsunder the different bureaus, commissions, corporations and enterprises; thestudy will determine their effectiveness and success in redeploying laid-offworkers. A scheme for rationalizing them will be prepared.

Task 7: The consultants will recommend measures for the institutionalstrengthening of TLSC to undertake all the above tasks, including organiza-tional arrangements under the TMG. The consultants will recommend as to howthis institution can be kept lean, flexible and unbureaucratic.

Task 8: This task will cover the organization structure, personnel, budgetfor the first five years and mandate of TLSC. It will also review and recom-mend whether this institution should be under one bureau or commission ormanaged by representatives of a small number of concerned bureaus and commis-sions who will manage it as a Board of Directors. The consultants will alsoreview and recommend whether the enterprises laying off workers and thoseemploying them should pay a fee to TSLC for its services and how this feeshould be determined.

6. It is envisaged that a consulting team of two expatriate consultantsfor a total period of eight months, supported by three local consultants willbe required for this assignment. The expatriates will include a specialist inlabor redeployment/job creation specialist, and one training specialist (eachfor four months). Local specialist with experience in training, worker rede-ployment and computer usage will be required for a total period of eightmonths.

7. The TA component of $300,000 would be utilized as follows: consul-tants--$240,000, computer equipment--$15,000 and foreign training--$45,000.

-59 - ANNEX 4

CHINA

TIANJIN INDUSTRIAL DEVELOPMENT PROJECT

Machine Tools Subsector

Background and Organization

1. China has over 800 factories producing 2,200 different types ofmetal cutting, metal forming and other machine tools with a total output valueof $1.4 billion in 1990 accounting for about 3 percent of world market share.From 1977 to 1988 annual consumption of machine tools in China increased by10.4 percent in nominal terms and 4.4 percent in constant terms. China'spresent machine tool population of over 3.2 million machines is one of thelargest in the world. However, 90 percent of the machines were built with thetechnology of the 1950s or 1960s. Only 10 percent reflect the latest technol-ogy. It is estimated that 55 percent of the machines installed are of morethan 15 years of vintage reflecting technological obsolescence. The propor-tion of modern machines integrating numerical control systems in the productspectrum of manufacturing lines in China is less than 1 percent in comparisonwith 50 percent in the United States which indicates the extent of technologylag in this industry. Around 90 percent of the machine tools manufactured inChina are sold in the domestic market. Twenty percent of total sales are atindicative prices and the rest via commercial channels, indicating largelymarket-oriented approach in this subsector.

2. Tianjin's machine tool industry consists of 16 enterprises and about15,300 employees with total sales of Y 245 million ($45 million) in 1990 orabout 4 percent of China's total market. It has six main product segmentswith the share of metal cutting machines at 34.3 percent and metal formingmachines at 22.9 percent, the balance being accessories and tools for machinetools and miscellaneous working machines plus a marginal share of automaticcontrol machines. In terms of value, five metal cutting machine tools (gearcutting machines, surface grinders, large lathes, radial drilling and machin-ing centers) represented 29.1 percent of the total machine tools production,two metal forming machines (large and small hydraulic presses) comprised22.9 percent and four equipment and parts (electric control panels, pumps,high pressure pump valves and miscellaneous machine tool components) equalled22.1 percent of the subsector production value. Tianjin has a virtual mono-poly in China in gear cutting machines and key position in the manufacture ofsurface grinders, hydraulic presses and large lathes. These are alsoTianjin's main areas of exports. Tianjin was not a major producer of machin-ing centers up to 1988 but came into prominence by exporting 90 machiningcenters without CNC that year. It is also in the early stages of technologytransfer discussions for CRC controllers. Among components and accessories,electromagnetic chucks, optical accessories and grinding wheel dressers arepromising products for expansion. Details of Tianjin's major machine toolmanufacturing enterprises in each major product segment and their relativesizes are given in Attachment 1.

- 60 - AMNE4

3. Within the Tiajin Municipal Government (IMG), the Tianjin MachineBuilding Bureau 1t responsible for overall development of this subsector.Apart from machine tools, the Bureau also oversees the working of ConstructionEquipment, power generating and transmission equipment, and other mechanicallybased Industries. In 1991, the Bureau represented 320 individual enterprises,approximately lSI,000 employees and total sales of Y 3.4 billion of which theshare of machine tool. subsector was 7.6 percent, 12.3 percent and 10.9 per-cent respectively. The Machine Tools subsector enterprises are organized intofive major product groups.J/ The enterprises in these groups, however,directly report to the Bureau. The Bureau also has a horizontal level offunctional deprtments monitoring the individual major business function ofthe enterprises *.g., quality, production planning, finance, operations, sci-ence and technology, e¢t. Since the mid-1980., a program of industrial andmanagement refoms hae been implemented which has decentralized the decisionmaking process and shifted the focus of management to the enterprise level.However, the decision making responsibility still overlaps between differentlevels of subsector organization. For Instance, the absence of free pricesfor some inputs creates a need for an allocation system for these Inputs. Forinputs sourced from abroad, the enterprise without independent foreign traderights is compelled to use a local or national importlexport corporation as anagent In the selection of and payments for the purchases. The autonomy forfacility rationalization at the enterprise level is nonexistent as it involvesallocation and disposition of productive assets with impact on workers' earn-ings. The enterprises are characterized by vertical integration, low capitalequipment utilizatlon, duplication of facilities, inefficient products anduneconomic level of operations. Engineering and product development talent isnot pooled to develop the base of skills necessary to quickly absorb new prod-uct and process technologies. Current plans for renovation and reorganizationof foundry workshops are quite Inadequate. Without world class foundry facil-itios, Tianjin cannot compete within China or 'n the international market.Low volume purchases by individual enterprises afford them very little lever-age with suppliers. As regards marketing, international operations requiregood technical knowledge of products, active marketing support and extensiveafter-sales service and parts package which are currently lacking or nonexis-tent. Given these constraints the machine tools subsector in Tianjin needsrestructuring to attain competitive strength.

Performance of the Subsector

4. Between 1987 and 1991, while the production of the machine tools inTianjin increased by 34 percent, its national share marginally declined from5.7 percent to 5.2 percent. Tables below show (a) trends in overall produc-tion and consumption of machine tools for China and Tianjing and (b) trend forspecific machine tool segments and major products in Tianjin.

1/ The five major product groups ares First Machine Tool Group, Metal Form-ing Machine Group, Crinding Machinery Group, CNC Machinery AccessoriesGroup and Coc Sezvo Group.

- 61 -

Cum MACNI TOOL MART(Y million)

1987 1988 1989 1990 1991Est.

Domestic Production 3,368 4,181 4,429 3,919 4,498Imports 1,839 2,123 2,295 2,568 3,029Exports 346 488 882 1,181 1,155Consumption 4,861 5,816 5,842 5,306 6,372Tianjin Production Valus 192 212 238 199 232Production share (2) 5.7 5.1 5.4 5.1 5.2

Notes In 1990, the number of Ti1ajin's enterprises decreased from 22 to 16.

Source:t TECC estimates.

TIANJIN--PRODUCTION OF MACHINE TOOLS

_Sales C million) CADR laSegment Products 1987 1988 1989 1990 1991 (2)

Metal Gear cutting machines 34.35 42.84 36.64 33.37 44.10 6.4cutting Surface grinders 15.83 18.37 19.17 16.00 19.10 5.1machines Machining centers 0.00 0.40 4.95 9.00 23.50 177.0

Rotary arm drills 6.70 4.75 4.05 4.06 3.18 -15.4Boring machines 0.64 1.90 n.a. 0.25 n.a. -Large lathes 10.75 13.76 8.44 10.34 12.8 4.5

Metal Hydraulic presses 43.79 49.43 54.02 62.89 67.42 14.0formingmachines

Equipment Magnetic chucks 1.88 1.84 1.85 1.83 1.40 -7.2and parts Optical accessories 1.99 2.10 1.33 1.82 4.28 21.1

Grinding whel dressers 6.07 7.01 7.72 7.45 8.86 9.9

l Cumulative annual growth rate.

While Tianjin was somewhat lagging in keeping pace vith China's overallmachine tool produesrs In sustaining its market share, its own production ofmaehine tools for gear cutting machines, surface grinders, hydraulic presses,large lathes and machining centers shoed significant growth rates. On the

-62- AN_EX 4

other hand, Tianjin's production of radial drilling and boring machines showednegative rate of growth.

Market Develoament

5. During 1987-91, the Chinese machine tool market grew from Y 4,861million to Y 6,372 million, i.e., an average annual growth of 7 percent peryear. During the same period, China's production of machine tools grew at7.5 percent and exports at 35.2 percent per annum. The Chinese machine toolmarket is projected to grow phenomenally from Y 6.4 billion in 1991 to Y 27billion in the year 2000. Domestic production is projected to grow at muchfaster pace than in the past, but the net deficit of about Y 1.9 billion ($344million) in 1991 is estimated to increase to over Y 8 billion ($1.5 billion)by the turn of the century.

6. The world machine tool market has grown from $15 billion in 1977 to$38 billion in 1988. The leading producers are Japan, Germany, USA, USSR,Italy and Switzerland. The major consumers are Japan, USA, Germany, Italy,UK, France, China and South Korea. Machine tool markets in these countrieshave high import propensity though USA, Germany and Japan are export leaderstoo with over $3 billion in net exports each. China's imports equaled$227 million in 1988 mainly from Japan, Germany, USA, Switzerland and Italy.Of China's total exports of $71 million in 1987, 30 percent were to Hongkongand Asia, 33 percent to Eastern Europe, 10 percent to Western Europe, 8 per-cent to USA and 18 percent to other countries. Tianjin's exports totalling$9.2 million in 1988 and $14 million in 1989 were mainly to Hongkong andSoutheast Asia followed by Eastern Europe. The export model for Tianjin dif-fers from the rest of China. China's exports are mainly lathes, grinding andmilling machines as against hydraulic presses, gear cutting machines and sur-face grinders from Tianjin. The most significant importer of Tianjin'smachine tools is Eastern Europe. Many of these exports are part of bartertrade agreements which are under great pressure as a result of changes occur-ring in that region. Tianjin will therefore have to depend upon its own com-petitive strength in terms of higher qualitylprice ratio, technical salesnetwork and expertise including joint ventures or tie-ups with leading worldmachine tool producers/exporters, product specialization, upgraded productionand brand recognition.

Subsector Capabilities and Competitiveness

7. The changing trends of Tianjin's market share in some of its strongareas and not-so-strong but potential areas during 1987-91 are summarized inthe table below.

- 63 - ANNX 4

Item 1987 1988 1989 1990 1991_----------- - (Y million) ---------------

Surface GrindersChina market 67.1 60.6 76.7 75.8 75.7Tianjin sales 15.4 16.67 14.2 13.9 16.2Market share (2) 23.0 27.0 18.5 18.4 21.4

fIdraulic PressesChina market 227.7 264.6 276.3 257.6 315.0Tianjin sales 45.2 49.8 57.4 60.5 66.3Market share (M) 19.8 18.8 20.8 23.5 21.1

Gear CuttinA MachinesChina market 49.4 39.1 58.0 53.3 53.4Tianjin sales 27.4 28.0 35.0 28.9 32.1Market share (Z) 55.6 71.7 60.3 54.3 60.4

Machining CentersChina market 42.38 56.84 64.5 117.2 198.9Tianjin sales 0 0.40 4.9 4.5 18.1Market share (Z) 0 0.7 7.8 3.8 9.1

CNC ControllersChina market 16.0 27.4 n.a. n.a. n.a.Tianjin sales 0 0 0 0 0Market share (S) 0 0 0 0 0

Servo MotorsChina market 17.7 17.3 n.a. n.a. n.a.Tianjin sales 0 0 0 0 0Market share(X) 0 0 0 0 0

8. Tianjin's domestic market share during 1987-91 in machining centers,CNC controllers and servo motors vas negligible. As regards surface grinders,hydraulic presses and gear cutting machines, Tianjin is a market leader butits share has remained t*nstable. While Tianjin had some export success inrecent years, the prospects of sizeable exports in the near future to the freeinternational market are poor because of strong competition from large well-established multinational companies with extensive dealer networks. Toachieve significant export capability in the long term, the basic thrust ofachievement of competitive strength and subsector development in the 19908should be the domestic market place. One of Tianjin's greatest obstacles inachieving competitiveness in the machine tool subsector is below minimum eco-nomic scale of production particularly in surface grinders and medium sizehydraulic presses which are potential areas for Tianjin'as market share. Thepresent scale of production of Tianjin in both these areas is nearly 50 per-cent of the minimum economic scale. The financial performance of the subsec-

- 64 - AfhM 4

tor also Indicates underlying weaknesses. Domestic price. of metal cuttingand metal-forming machine tools are below world prices. At the came time,machine tools like spiral level gear rougher and hydraulie press earn a nega-tive gross margin at domestic prices. The majority of the products do notseen to be viable in economic terms.

Restructurina Needs

9. The machine tools subsector suffers from shortfalls in productionstructure, product and manufacturing technologies, production organization andmanagement systems. Manufacturing constraints include technological obsoles-cence, subscale operations, high vertical integration, poor equipment utiliza-tion and maintenance, excessive overheads, antiquated facilities and layoutand lack of market driven product development. The manufacturing system is animportant area of concern due to inefficient production scheduling levels,long production cycles and large buffer inventories. Purchases of relativelysmall quantities of components by individual enterprises (as against largepurchases by strong commercial corporate groups) afford them very littleleverage with suppliers. The poor quality of control systems in theae enter-prises also weakens their competitive position. The management informationsystems are inadequate and do not permit decision-making based on accurate andup-to-date data and analysis. The staff training and incentive system alsoneeds to be improved to promote better operating skills and performance.Tianjiin's constraints also include lack of international pricing strategy andinsufficient marketing, technical sales and distribution capabilities formachine tools An intensive restructuring of the subsector is needed tointroduce modern structure and systems, higher technology products, contem-porary manufacturing techniques, and product specialization. These changeswill allow the subsector to increase its domestic market share, build up sus-tainable exports and achieve high levels of profitability for future invest-ments. The restructuring program for the subsector proposed with the assis-tance of international consultants provides for considerable change in theorganizational structure, product and market strategies and operational strat-egy and is reflected in Tianjin government's development program and strate-gies for the five subsectors.

Investment Plan

10. Consultants have estimated that total investment for the subsectorrestructuring would be about $40 million ($32 million In foreign currency andY 42 million in local currency).

- 65 - 4Attachbent 1

TW_JI IUSTRAL DEVR LOPI T PROJICT

Machine Tool Subsector

Factory Product line 1991 sales Percentcr million)

Natal Cuttina Ratesrise

No. I Machin Tool Works Gear cutter 33.8 13.8Vertical & horizontal uaehine cener 15.7 6.4Custom gear 10.5 4.3

No. 2 Mahne Tool Works Large lathe 12.8 5.2

1o. 4 Mschine Tool Works Radl*l dill. 2.2 0.9Vertical machie cutter 7.6 3.1ENM, etc. 3.0 1.2

no. 9 Machlne Tool Worku Sawing & quenching machine 4.6 1.9Isatrument Machine Tool Works Electric discharge wire cutter 8.6 3.5

Natal Fond= nrteDrise

Bydraulic Press No. 1 General Works Hydraulic press 300-1,000 tOes 77.5 31.7Hydrauic Press No. 2 General Works Small Press 7.2 2.9Foundry Works CastingGrinder Factory Foundry Casting

GrI*dina Entererise

Grinder Machine ain Workshop Surface grinder 20.8 8.5

Accessory Interurise

Machine Tools Optical Instrumeat Works Optical measuring tools 4.3 1.8Electromagnetic Plateu Work. Electromagnetic table 1.4 0.6Machine Tool Accessory Works Machine cutting tools a clapso 4.2 1.7Component Jig Works Clamp set 8.9 3.6Grinding Wheel Work Grindia g wheel 18.2 7.5Transmissin Works Ball screw 3.5 1.4

Total 244.8 _00.0

- 66 - ANNE S

CHINRA

TIANJIN INDUSTRIAL DEVELOPMENT PROJECT

Construction Machinery Subsector

Backzround and Organization

1. Since the beginning of China's open door policy in the early 1980sthe construction industry has undergone a period of substantial change in sizeand scope. Large-scale infrastructure projects are no longer constructed bymobilizing legions of workers. China is now building high speed roadways,containerized port facilities and international airports that require advancedconstruction techniques and equipment. China's construction equipment indus-try now has an opportunity to build a manufacturing capacity to meet itsdomestic requirements and further consolidate the production base to developcomparative advantage in export markets.

2. Tianjin is one of the ten major regions of China producing construc-tion equipment, and it has a strong base for improving its domestic and inter-national competitiveness. Tianjin's construction equipment subsector is moreproductive than the national average as measured by sales per employeeIY 17,000 per worker versus Y 13,500 per worker). Also, the average sales perenterprise in Tianjin is much higher (Y 21 million) compared to the nationalaverage (Y 6.6 million). The subsector is represented by 11 enterprises,10,900 employees, Y 72 million in net fixed assets and Y 290 million in sales(1991 figures) (Attachment 1). The enterprises include four major manufactur-ers, two for earth moving equipment, one for material handling equipment andone for key parts/components, i.e., diesel engines; which are responsible for79.2 percent of net fixed assets and 86.7 percent of sales of the subsec-tor.l/ A few small producers of components/parts, lifting equipment, build-ing material equipment and service/repair support are also included in thesubsector.

Performance of the Subsector

3. During 1987-91, total sales of Tianjin's construction equipmentindustry increased at an average annual rate of 9.2 percent. In terms ofindividual major equipments, the growth rates were higher for motor graders(11.0 percent) and forklifts (8.5 percent) and lower for diesel engines(4.4 percent), crawler dozers (-8.3 percent), and wheel loaders (-4.0 per-cent). (The figures are based on sale by numbers.) A comparison of Tisnjin'snational market share of major products during 1987 and 1991 shows an increasefor motor graders, forklifts and diesel engines, and decline for crawler doz-ers and wheel loaders. The following table shows the relative shift over theperiod.

1/ The four major enterprises of the subsector are: Tianjin EngineeringMachine Factory (TEMP); Tianjin Construction Machine Factory (TCMF);Tianjin Forklift Factory (T?m); and Tianjin Engine Works (TEW).

-67 -

TIANJIN CONSTRUCTION EQUIPMENT SUBSECTOR--TRENDS IN MARKET SHAREOF MAJOR EQUIPMENT

Item Total Tianjin sales Tianjin's market share(no. of units) (1

1987 1991 1987 1991

Motor graders 102 155 56.0 82.0Diesel engines 2,644 3,145 7.6 9.0Forklift trucks 758 1,050 6.0 8.0Crawler dozers 382 270 13.0 9.0Wheel loaders 47 40 0.7 0.4

The share of Tianjin in China's exports in 1991 was 100 percent for motorgrader., 8 percent for diesel engines and 5.5 percent for forklifts. Therewere no exports of crawler dozers and wheel loaders. Tianjin has a virtualmonopoly in China in the manufacture of motor graders. The only other poten-tial producer is Changehun where one company has begun to import SKD kits fromGerman manufacturer (Boukema). Tianjin ranks third in the Chinese market fordiesel engines.

4. Tianjin's construction equipment subsector has a strong productionbase. However, its competitiveness and growth of market share is constrainedby the lack of economies of scale, vertical integration of product lines, lowcapital equipment utilization with resultant high production costs, inadequatediffusion of imported technology, lack of leverage in supply relationships toobtain cost and delivery advantage in procurement of raw materials and compo-nents, inadequate allocation of resources where Tianjin has comparative advan-tage and the lack of market-driven product development. The improvement ofsubsector's competitiveness would require reorientation of production andmarketing strategies, transformation of subsector organization to respond tomarket signals efficiently, upgrading technology and equipment and strengthen-ing of organization and management capabilities. Because of the nationalcharacter of the subsector, Tianjin's restructuring and development programsshould consider joint relationship with other national manufacturers who havealready developed technology linkages with reputed foreign manufacturers.

Market Develooment

5. The Chinese construction equipment industry 21 has grown at 16 per-cent per year since 1984. The overall growth in the manufacture of five prin-cipal end product markets, has averaged about 20 percent per annum over

21 This includes excavating equipment, shovel equipment, hoisting/compact-ing/foundation/building renovation/municipal/military construction equip-ment, railroad equipment, road surfacing equipment, industrial vehiclesand pneumatic tools.

- 68- ANNEX

1986-91. Exports have also increased from insignificant levels while importshave remained stable during the past three years. The following table showsthe product-wise position.

CHINESE MAE=T FOR MANN CONSTRUCTION EQUIPMENT

Equipmeat Production ExDorts Imports Aunarent market1991 CAGR (2) 1991 CAGR (2) 1991 CAGR (t) 1991 CAGR (X)(Y M) (1986-91) (Y M) (1986-91) (1 K) (1986-91) (T M) (1986-91)

Bulldozers 1,003 23.2 93 56.8 78 23.8 988 21.3Diesel engines 770 11.2 35 42.6 8S 18.6 770 10.6Forklifts 874 11.1 69 48.6 125 27.0 940 11.3Motor graders 66 32.6 2 26.0 17 12.9 71 26.6Wheel loaders 1,377 19.2 23 78.1 52 t-)3.0 1,406 17.6

6. The future market size for construction equipment will be influencedby infrastructure development, capital investment at the enterprise level andthe overall growth in economy. One of the main users of construction equip-ment is the roads and highway sector. In the Eighth Five Year Plan, thenational road system is projected to increase by 100,000 km of which 1,000 kmwill be high speed roadways. The existing roadways to the tune of 30,000 kmwill also be renovated and upgraded. Special attention will be given to thedevelopment of mining industry which is a large user of construction equip-ment. The increase in freight transport should generate greater demand formaterial handling equipment. With this background, the projected Chinesemarket growth rates through the year 2000 are 19 percent for motor graders,9-10 percent for diesel engines, 8-10 percent for forklifts, 7 percent forcrawler dozers and 6-7 percent for wheel loaders.

7. The global market size for the major construction equipment exceeds$38 billion, comprising of approximately $8.8 billion for crawler dozers,$7.4 billion for motor graders, $6.5 billion for wheel loaders, $6.6 billionfor forklifts and $4.7 billion for diesel engines. The market is dominated bytwo major companies, Caterpillar and Komatsu, with a combined share of nearly70 percent which is expected to increase to about 80 percent by 1995. Duringthe decade of the 1980s, a wave of bankruptcies, consolidation and joint ven-tures swept the world construction equipment industry In which only six majorcompetitors remained in competitive position which apart from Caterpillar andKomatsu include John Deere, Case, Champion and Fiat Allis. Strategic alli-ances among industry participants have contributed to the globalization pro-cess. These alliances provide for horizontal integration of products, fullscale merger or sharing of resources, more effective market coverage, greatervalue added for end users and reinforced financial strength for manufacturingenterprises. With global overcapacity and fierce competition, only companieswith versatile product range, high quality product lines and economic produc-tion scales supported by extensive dealer network and after sales support areable to compete in the international market. The two major manufacturers,viz. Caterpillar and Komatsu, have comprehensive marketing plans to pose achallenge to Chinese manufacturers in their own market. Both corporationshave developed local sales and service networks and extensive technologytransfer relationships with key Chinese manufacturers. A strategy similar to

- 69 - ANNEX 5

the foregoing would have to be adopted by Tianjin to face competition andimprove its position in the construction equipment subsector.

Subsector Catabilities and Comuetitiveness

8. The world leading producers of construction equipment have productdevelopment, manufacturing, marketing and distribution at a very large scale.Consequently, the development of this industry in China has to achieve econo-mic level of operation through product specialization and Tianjin's efforts inthis area should be directed at interregional collaboration.

9. An analysis of Tianjin's subsector capabilities and competitivenessindicates lack of product focus; satiquated product and process technologiesfor the majority of products; suboptimal domestic and export pricing; inade-quate professional marketing, distribution and after sales support; limitedproduct development capabilities; low production scales (well below economiclevels); inefficient subsector organization; excessive costs particularlyrelated to inventories and material scraps; narrow technical relationships andinefficient absorption, adaptation and commercialization of technologies. Forinstance in motor grader production where Tianjin holds virtual monopoly inChina, the technology imported from Orenstein and Koppel of Germany about sixyears back has not yet been properly absorbed and commercialized. The presentmanufacturing scale is also not economical. Development of other productlines such as crawler dozers, wheel loadetrs, diesel engines and forkliftswould necessitate additional technology transfer/joint collaboration c-upledwith sharing of production with local partners. Special emphasis needs to begiven to decreasing scrap rates in production shops, lowering inventories andincreasing overall resource utilization. Tianjin should also seek less expen-sive supplies of materials and better leverage with suppliers of compo-uentslparts such as heavy duty castings, hydraulic sub-assemblies, etc. Pric-ing policies must take into account the true cost of resources to the economy.

Restructuring peeds

10. Despite the constraints under which Tianjin's construction equipmentsubsector has been operating, it has a strong base for improving its position.Tianjin currently enjoys a leading position in motor graders; a significantposition in diesel engines; foreign technical relationships for motor graders,crawler dozers and forklifts; proximity to research institutes and infrastruc-ture for manufacturing. The subsector, however, faces many constraints(paras. 4 and 9) which have resulted in: (a) declining market share for threeof the five major products of the subsector; (b) insufficient funds for futureinvestments; (c) poor product development 31; and (d) low export capabil-ity. An intensive restructuring of the subsector is needed to introduce anintegrated national subsector encompassing strategic alliances at regionallevelo, modern corporate structure and systems, upgraded technology, produc-tivity and product quality, lower manufacturing costs and better market pros-pects. These changes will allow the subsector to regain and enhance its

I/ Majority of the new products PY 250 and F series motor graders, 245engine, D60 and D65 crawler dozer., etc., have not progressed beyondtrial production stage).

- 70 - MM E

domeostic market share, build up sustainable exports and achieve high levels ofprofitability. A comprehensive restructuring plan therefore has been devel-oped for the subsector by the Tianjin Machinery Industry Bureau and theTianjin Planning Commission with the assistance of international consultants.The plan consists of changes in the organizational structure, product andmarket strategies and operational strategy and is reflected in Tianjin govern-ment's development program and strategies for the five subsectors.

Investment Plan

11. Consultants have estimated that total Investment for the subsectorrestructuring would be about $135 million ($71 million in foreign currency andY 350 million in local currency).

-71 -AE 5Attacbment 1

IANJIN LI IL DIEVELOPMET PROJECT

Constructon Badplunnt Subsector

S of 1991Groups Products sales EZterprises

Construction equipsent Crawler dozer 22.51 TJ Construction Machineryfactory (TCMF)

Motor graderWheel loader 16.00 TJ Engineering Machinery

Factory (TEOF)

Concrete omxer 1.84 TJ Mixer Works

Subtotal 40 35

Industrial equIpment Forklift 15.90 TJ Forklift Factory (TFP)

Freight elevator 3.59 Jlnxiang Machinery Works

Hoist and lift 1.76 TJ Hoist Works

Subtotal 21.25

components Diesel engines & generators 32.80 TJ En8ine Works (TlW)

Forklift axle 0.79 Nanjiao Universal MachineryWorks

Hydraulic torque converter 1.47 TJ Hydraulic MacbineryWorks

Subtotal 35.06

Others Foundries _

Gearbox repair 0.47 No. 2 Gear Repair Works

Radiator 2.87 Heat Exchange EquipmentWorks

Subtotal 3.34

Subsector total 100.00

- 72 - ANNEX 6

IIANJI INDUSTRIAL DEm LOPMENT PROJECT

Automotive Parts Subsector

Subooctor and its Performance

1. The Tianjin automotive parts subsector is comprised of two groups ofenterprises. The first group consists of 39 enterprises producing a widerange of automotive parts and components under the Tianjin Automotive IndustryCorporation (TAIC). Outside the supervision of TAIC there is another group of17 small and cottage enterprises which also produce automotive parts. TAIC isa bureau-level corporation administered directly by the Tianjin MunicipalGovernment and acts as an independent economic entity. In addition to automo-tive parts production, TAIC has five OEM vehicle assembly operations. Theparts and components of TAIC enterprises include electricals, instruments,axles, transmissions, mechanical assemblies, etc. The second group of 17automotive enterprises is controlled individually by the Tianjin MunicipalGovernment through its different bureaus. These enterprises are engaged inmachinery, seving/stitching of seats, reworking rejects, and manufacturingancillary products for automotive part enterprises under TIAC. The subsectorcontributes 48 percent of the total sales of the Tianjin automotive industryand employs 35,000 persons and accounts for 12 percent of total employment inthe automotive parts subsector of China. Thus, Tianjin accounts for a signif-icant portion of the national automotive parts and components subsector.Attachment I provides the basic data of TAIC plants in the subsector.

2. The Tianjin automotive industry has experienced steady growth ofabout 16 percent during the 1980s. This high growth is due to large expansionof vehicle output. In 1989, TAIC total vehicle output exceeded 46,000 units.Vehicle output drives automotive parts output. Thus, the total productionvalue of automotive parts components has increased sharply. In 1991, TAICproduced Y 964 million ($175 million) in automotive parts, more than twofoldincrease in production compared to 1987. The following table demonstrates theperformance of the Tianjin automotive parts subsector since 1987:

- 73 - ANNEX 6

TSANJIN - AUTOMOTIVE PARTS SUBSECTOR PERPORMANCE

Averageannual

1987 1988 1989 1990 1991 growth_______--_--- (Y million) -------------- (Z)

Automotive Parts

Output 430 705 767 512 964 22.4

Sales 542 988 1,040 536 956 15.2

Export 6 5 4 6 9 10.7

Automotive Industry

Output 950 1,442 1,522 1,703 3,205 35.5

Sales 1,159 2,073 2,127 1,784 3,177 28.7

Export 6 66 10 21 29 48.3

In 1990, Tianjin's automotive industry output value was equivalent to6.5 percent of the total for China, but the automotive parts subsector's sharein total output value of China was 8.7 percent.

3. About two thirds of components manufactured by TAIC are sold inter-nally. The market distribution for two major categories of automotive partsis very distinct. Ninety percent of the sales of engines in 1989 took placewithin the automotive industry whereas remaining automotive parts accountedfor only 35 percent; an additional sale of 1.5 percent for engines and 10 per-cent for remaining automotive parts. Sales within China other than Tianjinmade up for 8.5 percent for engines and 50 percent for remaining auto parts.Exports contributed only 5 percent of sales of automotive parts excludingengines. Export values for automotive parts fluctuated between Y 4 million in1986 to Y 6 million in 1987, a year when the value of Tianjin automotiveindustry exports, especially of vehicles, reached its peak. Export of automo-tive parts in 1989, was directed to Japan (40 percent), US (15 percent) andEastern Asian countries (45 percent).

Harket Develoiment

4. China's automotive industry experienced rapid growth in the SixthFive-Year Plan (1981-85), but growth flattened out during the Seventh Five-Year Plan (1986-90). The gross output value of the automotive industry grewat an average annual rate of 30 percent (in constant terms) between 1981 and1985. However, since 1985 the output value of the industry has remained thesame in constant terms. The production value for automotive parts and compo-

- 74 - ANNEX 6

nents reached Y 7.7 billion ($2.1 billion) in 1988. This production has beenabout 20-30 percent of the total output value of the automotive industry since1985, indicating vertical integration within the industry, despite its deepfragmentation. Fluctuation in vehicle production impacts directly on theautomotive components subsector. The market development is demonstrated inthe following table.

CHINA - AUTOMOTIVE PARTS MARKET(Y million in constant 1984 terms)

Averageannual

1987 1988 1989 1990 1991 growth----- (Y million) - - ----------- (X)

Domestic output value 4,727 5,366 11,094 11,306 15,322 34.2

Tmports 1,254 1,079 1,291 2,283 3,152 25.9

Exports 49 88 264 438 636 89.8

Domestic consumption 5,922 6,257 12,121 13,151 16,808 29.8

Tianjin market share 266 487 461 432 819 32.5

Between 1984 and 1988, the total national demand for automotive partsincreased by an average of only 2 percent per year. Growth in automotiveparts trade was, nevertheless, vigorous, with imports expanding at 26 percentper year and exports at 47 percent per year. However, the high volume ofimported automotive parts and volattlity in the vehicle market combined toyield a 1 percent per year decline in the output value of domestic automotivepasts subsector. Imports jumped from 6 percent of the automotive parts mar-kets in 1984 to 17 percent in 1988.

5. There is a tremendous need to strengthen the domestic market posi-tion of the Tianjin automotive parts subsector. The subsector is severelyundercapitalized. Although the production of automotive parts has made possi-ble a high growth rate (20 percent) between 1984-88, its market share in termsof production value has increased from 4 percent in 1984 to only 8 percent in1988. The price structure of Tianjin automotive parts subsector is very com-plex. There are many price tiers for automotive components. Prices for auto-motive parts vary widely depending upon specific products. In general, domes-tic market prices are often higher than export prices (for example, coilsprings, radiators and horns) due to low production volumes and high per unitproduction costs. However, for some components such as gears, ignition coilsand automotive bolts, the export prices are higher than local market prices,indicating good export potential. As indicated earlier, about two thirds ofcomponents manufactured in TAIC enterprises are sold internally, the remainingportion is sold directly in local market. Therefore, TAIC did not see the

- 75 - AIMEX 6

need to develop a national sales, distribution and service network. In orderto specialize its production and develop economies of scale in automotiveparts, Tianjin automotive parts industry must develop new market channels.Development of sales and service centers is still at an early stage and needsto be accelerated.

6. The expansion of the domestic market for automotive parts during the1990. wl be driven primarily by growth in OEM vehicle manufacture. In 1988,the China National Automotive Industry Corporation developed an overall planfor development of domestic automotive production which calls for expansion ofcurrent capacity from 650,000 vehicles in 1988 to 1.2 million vehicles in 1995and 1.7 million in the year 2000. The plan also calls for a shift in theprogram from medium and heavy trucks to light trucks and passenger cars. Thisstrategy, if implemented, implies growth in OEM automotive parts demand of 9percent per year between 1990 and 2000, significantly higher than the 1.6percent growth of component demand between 1984 and 1988. It has been esti-mated that the national components market in constant 1988 prices would be inthe range of Y 13-16 billion ($2.8-3.4 billion) in 1995. The key successfactor for Tianjin in the national automotive components market during the1990s will be the ability to sell to the large and growing OEM vehicle assem-blies outside Tianjin through economies of scalo, international quality andcompetitive price levels.

Spbsector CaRabilities and Competitiveness

7. As the automotive parts subsector in Tianjin competes in fragmentedmarkets, its products form only 10 percent of national total and do not have astrong competitive position in China market. Only limited automotive partssuch as rear axle gears, brake tubing and coil springs play a somewhat compet-itive role in terms of output volume. In order to compete efficiently,Tianjin must expand its production of high potential products for the domesticmarket place. The main Chinese competitors surpass Tianjin's production by afactor of more than two. Without increased production capacity, the subsectorvill be unable to decrease costs sufficiently to penetrate the major OEMs inthe domestic market. On the technology front, inadequate efforts have beenmade to develop local components meeting world standards. As no sigaificantinvestment in research and development or in acquisition of technology hasbeen made so far, Tianjin must rely on foreign technical relationships for newproduct and process technologies. Although Tianjin has a license for zompletevehicle technology through its relationship with Daihatsu, none of the automo-tive parts enterprises reported a direct licensing arrangement with Daihatsuor any other of its suppliers. Tianjin relationships are just starting. Ithas recently established a joint venture to manufacture filters and few otherproducts, but these investments comprise only a fraction of the subsector.Attracting new foreign investment from foreign component manufactures will bedifficult as many domestic components manufactures in China are competing forforeign collaborations.

8. Quality of inputs directly affects the cost and quality of manufac-tured products. In this regard, the high proportion of costs allocated tomaterial and energy, greater shortages of inputs, and low scale of productionadd to a low degree of competitiveness. At present, there are only a fewindividual products, where Tianjin can reach a minimum efficient scale, given

- 76 - AM L 6

the projected domestic demand of such products in 1995. In order to broadenits product range with economic scale, Tianjin would have to export a substan-tial share of its production. Although Tianjin has three automotive tech-nology research institutes, none of them specializes in automotive parts, buton the whole the existing lnfrsstructure support can be well developed in thecontext of Tianjin automotive parts development. These weaknesses need to beaddressed in a successful restructuring progrsm.

Restructurina Need

9. Broad measures are necessary to overcome the subsector's weaknesses.These includes competitive product systems; increased capacities to reachminimum economic scale; improved efficiency and productivity; imported tech-nologiest strengthened marketing and commercial relationship; and efficientsubsector organization. 7TG In consultation with foreign consultants hasdeveloped a restructuring plan which foresees improved subsector competitive-ness in domestic and export markets, and high comparative advantage of poten-tial products and is reflected in Tianjin Government's development program andstrategies for the five subsectors.

Investment Plan

10. Consultants have estimated that the total investment for the subsec-tor restructuring would be about $71 million ($55 million in foreign currencyand Y 85 million in local currency).

- 77 - hUANNEXL 6Attacbment I

IAIL DDUSIRI4 DEVELOPT PROJECT

Automotive Parts Subsector

.~~~C t

S of1991 1991

Subeyti prduct Enterprise sales sales(Y 1,000)

1. Drive Train 24.57Axle S differential bhmaing Auto Axle Works 65,500 10.80for Daita van & truckGearbox S bevl g"rs Auto Gear Works 46,000 7.59Axle G ifferetlal housing Du and Van Axle Works 23,600 3.89for 8afeg m cha.rdo he suportPropeller *haft Auto Transmission Shaft 13,900 2.29

Works

2. Auto glse- 13.72trical

Ignition coil Ignltion Coil Works 19,490 3.21tvitch a hor, Transportation Equipment 18,707 3.08

WorksWiper & washer Auto Wiper Work. 13,320 2.20Regulator & distributor Auto Electric Equipment 11,200 1.85

WorksMagneto, fan motor S magnet Magnetic Motor Works 11,190 1.85clutchStartet & generator Englne Electric Machine 9,280 1.53

Works

3. ngine Parts 13.47Water pump Water Pump Works 30,450 5.02Radiator Radiator Works 17,161 2.83Piaton Piston Work. 10,250 1.69Rimg & thermostat Piston RIng Works 7,938 1.31Oil p_p, bolt & nut Internal Combustion Engine 6,800 31.12

Nut WorksPiston pln, valves Internal Combustion Enlgne 6,280 1.00

Attachbent WorksConnecting rod Connecting Rod Works 2,860 0.47

4. Interior 11.72Trim

Seating & iterior trm Auto Trim Work. 68,000 11.21Sunshade board Bo. 4 Auto Accessory Works 3,100 0.51

S. rake 8.38Band brake No. 2 Auto Accessory Works 24,700 4.07Urake cylinders, clutch No. 5 Auto Accessory Works 13,600 2.24Bra"e line Auto Brake loes Works 6,900 1.14lond brtke line Auto Flexible shaft Works 5,600 0.93

6. Suspeonson 7.03Leaf spring Leaf Spring Works 19,734 3.25Sbocks Auto Shock Absorber Works 17,600 2.90Coil sprig Auto Spring Works 5,308 0.88

7. Wheel Auto vbel Auto Wheel Factory 41,250 6.80

- 78 - ANN 6Attachment 1

Z of1991 1991

subsystem Product Enterprise sales sales(Y 1,000)

8. Others 3.36Auto lock Auto Look Works 11,930 1.97Iron casting piece Auto Foundry Works 4,700 0.78Precise casting plece Auto Precision Foundry 3,720 0.61

Works

9. Steering 3.13Steering gear Steeraing Gear Works 10,800 1.78Steering vheel Auto Plastic Part Works 8,200 1.35

10. LightIngAuto lamp Auto Lamp Works 15,264 2.52

11. Fuel 2.46uel pump Fuel Pmp Works 5,800 0.96Carburetor Auto Carburetor Works 5,400 0.89Oil & fuel filter Oil Filter Works 2,400 0.40Air filter Auto Air Filter Works 1,300 0.21

12. Instrument Auto Instrument Auto Instrument Works 10,400 1.72

13. Clutch Clutch assembly No. 1 Auto Accessory Works 6,780 1.12

14. Body OEM 0 0

15. Chassis OEM 0 0

16. Exhaust OE 0 0

17. Air con- Outsourced 0 0ditioning

18. Battery Outsourced 0 0ChargingSystem

19. Audio Sys- Outsourced 0 0tem

Total 606.412 100.00

- 79 - AMEL 7

TNAMEIN INDUSTRIAL DEVIELOPHENT PROJECT

Electronics Components Subsector

Organizat ion and Performance

1. The electronics components subsector is a part of the electronicsindustry. It includes passive electronics components J/ but excludes activeelectronics components such as transistors and integrated circuits, etc., aswell as electricals components. The electronics industry is managed by theTianjin Electronics and Instruments Administration Bureau which includes 198enterprises and employs about 100,000 persons. These enterprises are orga-nized in 40 group companies which report directly to the Bureau. The groupcompanies have overall financial and planning control of their enterprises,but the individual enterprises maintain separate management functions and someautonomy in decision making relating to product development, process techno-logy, personnel, sales and marketing, etc. These group companies have astrong administrative relationship with the Bureau which has recently madeplans to merge them into one corporation with each of the 40 companiesreporting to product-specific business units.

2. The passive components subsector has 12 enterprises which employed20,000 persons in 1991. The subsector had a total sale of Y 145 million in1991. Attachment 1 shows the main products and sales of individual enter-prises.

3. Tianjin's passive components subsector is only 3.2 percent of thenational passive components industry, measured in terms of output value.Although the industry has relatively small output share, it ranks fourth whencompared to other cities in China and ninth, when compared to other provinces.

4. The following table shows the development of the subsector and itemajor product groups:

XI These includes: capacitors, resistors, potentiometers, connectors andswitches, control devices, transformers and magnetic devices, speaker andacoustic devices, and crystal devices.

-80 - AMIh 7

TIAWJIN: ELECTRONIC PASSIVE COMPONENTS SUSSECTOR

1987 1988 1989 1990 1991

Volume o'. Production (million pieces)

Capacitors 200.2 226.3 189.7 265.6 250.9Resistors/potentiometers 498.3 602.3 487.4 461.0 603.6Connectors/switches 40.2 51.4 41.3 42.1 39.4Control devices 3.0 4.4 n.ea. UO& na e*Transformers/magnetic devices 29.6 43.8 39.5 43.8 59.3Speakers/acoustic devices 6.6 7.5 4.4 4.1 4.4Crystal devices 8.2 10.5 11.7 10.2 12.7

Tianjin's passive components subsector has experienced a marginal erosion indomestic market share (from 4 percent in 1988 to about 3.2 percent In 1991)owing to a faster pace of expansion of the electronics Industry in some otherprovinces. Tianjin's passive components subsector, although low In outputvalue by world standards, has fairly large-sized capacity eompared to thenational level.

Market Development

5. The electronics subsector in China consists of over 3,000 enter-prises employing approximately 1.5 million people. The production of passivecomponents in 1991 was valued at about Y 5 billion. Capacitors, acousticassemblies, and resistors are the three largest segments of the Industry con-tributing 33 percent, 23 percent and 10 percent respectively of the totalpassive components market. China has a strong domestic market capability forthe passive components. It has developed rapidly and resulted in substantialimport substitution and enhanced potential for exports. The national marketsituation 1988 was as follows:

CHINA - MARKET FOR SELECTIVE PASSIVE COMPONENTS, 1991($ million)

Production Imports Exports

Aluminum electrolytic capacitors 167.8 no&* 48.2Fixed resistors ) 324.0 nuas 31.1Potentiometers resistors )

China has been able to develop electronics industry to substantially meetdomestic demand for passive components. However, the Industry suffers frommany problems, Including fragmented production, lack of specialization, exces-

-8- A 7

sive vertical Integration, low labor productivity, uneven product quality, andlow technological capability.

6. While there Is severe fragmentation at the enterprise level, theChinese market is consolidated in geographical terms. Enterprises in Jiangsu,Guangdong, Shanghai, Beijing and Tianjin produce about 70 percent of the majorpas8ive components. Regions such as Jiangsu and Guangdong have grown morerapidly and produe- a selected variety of products at higher production vol-umes with new equipment and facilities, and have taken the leadership role inproduction of major passive components.

7. Globally, the passive component industry has been experiencing astable, if not declining, market. The largest segments are connectors, wireand cables, capacitors, transformers and resistors. In the US market, thesefive components represent 80 percent of total passive component sales. Overthe last ten years, new technologies in resistors and capacitors have startedpenetrating the global market. These technologies have altered the economicsof electronic assembly manufacturing. Industrialized countries have taken thelead in the production of these technological products and the global marketconditions have become highly competitive. In order to penetrate the exportmarket, China has to make tremendous efforts to develop economies of scale,bring product quality to International standard, and introduce modern andreliable technologies.

Tianlin's Subsector Canabilities and Constraints

8. As mentioned above, Tianjin's passive components subsector has arelatively small market share, which has declined slightly in recent years.The diversified product range of Tianjin's passive component industry does notallow Tianjin to play a major role in any of the major products except leadedresistors where Tianjin occupies about 7 percent of national market and is themarket leader, thus providing a production volume advantage over other Chineseprovinces. Tianjin ranks fourth in capacitors, however, it has the potentialto build strong consolidated production. While restructuring, consolidation,and upgrading of leaded component production is an important priority forTianjin, it should start the development of surface mounted technology (SMT)components which are going to rapidly replace leaded components in world mar-kets. In the global market, Tianjin is poorly positioned to compete effec-tively. It has achieved some export success in leaded resistors but it hasbeen at relatively low-volume levels. The relatively large size of the domes-tic market would be an important factor for Tianjin in determining long-termexport potential. It can gain competitive advantage from the large size ofdomestic leaded components markets, provided it restructures its industry andincreases its domestic market share significantly. Also, the relationshipwith foreign companies for equipment purchases and technology acquisitionneeds to be strengthened for products in which Tianjin has strong potential toincrease its competitive position, both in domestic and export markets.

9. Tianjin enterprises do not meet world standards in productionscale. For example, Tianjin Radio Components Factory No. 9 produces 500 mil-lion resistors annually whereas a typical resistor plant outside China pro-duces 1.5-2 billion pieces annually and large plants produce as many as 8billion pieces annually. In addition to technologically backward operation

- 82 - ANNEX 7

processes, manufacturing is hampered by poorly maintained and outdated processequipment. Besides, the subsector suffers from inadequate management systemsand marketing networks. As a result of the above weaknesses, subsector prod-ucts are not cost effecient and competitive.

Restructuring Needs

10. Despite the above-mentioned weakness, Tianjin offers strong develop-ment potential for electronics because of an established industrial base,significant capital investment in electronics over the past 10 years, growinginterest of foreign investors, support from the central and municipal govern-ments, and its coastal location. An efficient restructuring of the subsectorvould introduce modern structures, upgraded and high technological productsand modern manufacturing techniques. These changes will allow the subsectorto regain and expand its domestic market share, build up exports, and achieveprofitability for future investments. Consultants have prepared comprehensiverestructuring plans to accelerate Tianjin's development of passive componentsand these are reflected in Tianjin government's development program and strat-egies for the five subsectors.

Investment Plan

II. Consultants have estimated that the total investment for the subsec-tor restructuring would be about $44 million ($36 million in foreign currencyand Y 45 million in local currency).

- 83 - AM 7Attacbment

TUIJIN IDUSTRIAL DEVELOPMENT PROJEC

Passive Comnonep_ts Subsector

1991 sales 2 of 1991Product Enterprise (Y'000) sales

1. Capacitor 58,177 40.071.1 Alwmnm electrolytic capacitor 32,103 22.11

Ti Radlo Component Works No. 14 22,839 15.76Ti Radio Component Works No. 1 8,356 5.75Ti Radio Component Works No. 12 928 0.60

1.2 Variable capacitor Ti Radio Component Works No. 2 18,664 12.88

1.3 Monolithic/ceramic disc capacitor 6.018 4.13Ti Radio Component Works No. 15 4,803 3.30XEsTong Resistor Company 1,000 0.69Ti Radio Component Works No. 20 215 0.14

1.4 Thin film capacitor Ti Radio Component Works No. 16 1,392 0.95

2. Delay llne TJ Radio Component Works No. 6 28,862 19.90

3. Film resistor 19,119 13.18TJ Radio Component Works No. 9 14,317 9.87XinTong Resistor Company 4,802 3.31

4. Potentiomerer TJ Radio Component Works No. 10 14,749 10.17

S. Inductor, transformer TJ Radio Component Works No. 3 12,040 8.31

6. Others Electronic Component Set SalesCompany 11,924 8.22

Total 145.035 .00.00

- 84 - ANNEX 8

TIANJIN INDUSTRIAL DEVELOPMENT PROJECT

Electric Motors Subsector

Background and Organization

1. China's electrical machinery industry has a history of over 70years. There are more than 900 enterprises manufacturing electrical machineryin China. Of these, 397 enterprises including 286 electric motor manufactur-ing works are under MMEI. These 270 enterprises had over 200,000 employeesand fixed assets of Y 2,578 million ($507 million) in 1991. The national out-put of AC motors in 1988 was 34,000 MW and increased at the rate of 9 percentper year from 1985 to 1988. Small- and medium-sized AC motors contributed to62 percent of this output.

2. The geographical distribution of electric motors production in Chinais as follows:

Percent ofnational output

East S0South-center 29southwest 12Northwest 9

3. The Tianjin electrical machinery industry is over 40 years old. Itbegan with a number of small repair shops engaged in the rewinding of electricmotors, and gradually developed into an electric motor manufacturing industry.In 1991, the industry employed 3,000 workers and had sales revenues ofY 75 million ($19 million), with fixed assets of Y 50 million ($8 million).Its total output was 540 MW.

4. Within the electric motor subsector, there are four enterprises, ofwhich the largest is Daming Electrical Machinery Corporation (DEMC). Theother three enterprises are operating as collectives. DEEC has over80 percent of the subsector's output and 68 percent of its employees. Furtherdiscussion on this subsector would be limited to DEMC.

Performance

S. DEMC was established in 1952 and produces electric motors from0.5 kW to 18.5 kW. DEEC's sales revenues grew at an average annual rate ofover 13 percent from 1987 to 1991. In 1991, DEMC's sales were Y 52 million($9 million) and fixed assets Y 23 million ($5 million), with 1,768 employees.DEMC's exports grew rapidly from 1985 and reached a level of $2.7 million in1989, representing 40 percent of its output in physical terms (152 MW out of atotal production of 382 MW). In the past two years, however, exports have

-85 - ANM a

declined. In 1986, DEMC was recognized as an exporting enterprise and permit-ted to retain a obare of its foreign exchange earnings.

6. The domestic market for electric motors in the 0.5-18.5 kW range isserved by a large number of manufacturers. Although the primary focus ofthese manufacturers is to meet the requirements of their regional markets,they are increasingly serving markets beyond their own region. Due to thevery large number of enterprises engaged in this field, and the resultingfragmented market structure, none of the electric motor manufacturers has adominant market share. It is evident from Table 1, which represents the over-all market shares in the domestic market of China's leading electric motormanufacturers.

Table It DOMESTIC MARRET SHARES 01 ELECTRICMOTOR MANUFACTURERS

Name of enterprise Percent market share

Dalian Motor Factory 5.60Beijing Motor Factory 4.72Xian Motor Factory 3.20Shanghai Yuejin Motor Factory 2.20Bachan Motor Factory 2.10Hebei Motor Factory 1.80Daming Electric Motor Factory (DEMC) 1.65

DBMC is not in a position to meet the total requirements of motors in Tianjindue to its limited production capacity.

7. DEMC's manufacturing equipment and product technology lag consider-ably behind current international standards. Some domestic manufacturers suchas Shanghai Yuejin Motor Factory have entered into technology-transfer agree-ments with foreign manufacturers (Yuejin with ABB), and have better designsand production facilities. DEMC's capacity of around 400 motors per dayplaces it at the lower end of the economic scale for manufacturing motors of0.5-18.5 kW size.

Market Develoiment

8. The global market for electric motors increased at an annual rate .-f3 percent during the 1980s. The growth rate in China was much higher with anannual growth of over 8 percent. In lin with the projected growth in indus-trial development in China, a similar growth rate is projected for the nextdecade. China leads Japan In total output of electric motors.

9. Global imports of electric motors of all sizes is over $7 billion,with the European Community accounting for over 30 percent of the total. ForChinese manufacturers, Hong Kong, which accounts for 2 percent of the worldtrade in electric motors ($140 million), currently provides the largest poten-tial market. Hong Kong's imports of motors from China represented nearly

-86 - ANNEX 8

40 percent of all its imports ($59 million). Of this, import of electricmotors of smaller sizes from China to Hong Kong was $9 million. DENC exported$2.7 million of these small motors to Hong Kong in 1989.

10. Besides Hong Kong, the four Southeast Asian countries--Singapore,Malaysia, Thailand and Philippines--are large importers of electric motorswith imports averaging over $200 million annually. Thus, the electric motorindustry in China has a good potential for continued growth to meet therequirements of the rapidly growing domestic market and for exports, particu-larly to Southeast Asian countries.

DEMC's Cavabilities and Compoetitiveness

11. DEMC manufactures the Y-series AC motors. The Chinese Y-seriesmotor is a unified design developed by the Shanghai Electric Science ResearchInstitute. The motor conforms to IEC standards and its performance in termsof efficiency and power factors compares favorably vith European designs.However, its design is nearly 30 to 40 percent heavier than the comparabledesigns of world leaders in this industry. It is also slightly more noisy inoperation.

12. To increase its potential for exports in markets other than South-east Asia, DEMC needs to manufacture not only motors of updated designs, butalso to NEMA standards and suitable for 60 Hertz applications (for NorthAmerican markets). The present insulation in the motors restricts their useto applications in which the temperature rise is less than 45°C and needs tobe upgraded.

13. DEMC's manufacturing technology dates to the early 1960.. It ischaracterized by the use of strip stock to make laminations in single-strokepresses; general-purpose machine tools; labor-intensive operations; simplisticproduction and inventory controls; and inadequate quality control. Its cur-rent scale of operations is on the low side. Plant management is weak in somekey areas.

14. DEMC has been able to export its products by accepting 20 to 30 per-cent lower prices than the better-quality motors of similar specifications.DEMC's prices in the domestic market are competitive.

15. Due to its outdated manufacturing facilities, DEMC has a 5 percenthigher ratio of manufacturing cost to sales revenue compared with competitorssuch as Shanghai Yuejin. The low sales realization and higher manufacturingcosts have had an adverse impact on DEMC's financial performance.

RestructurinA Needs

16. Almost all the input resources required for the manufacture of elec-tric motors are available from domestic sources. With the right designs, pro-duction facilities and manpower, the manufacture of motors of small size, dueto their relatively low international price, should provide a potential forcomparative advantage to China. This arises from the very low costs incurredin personnel expenses in China.

- 87 - ANNEX 8

17. The projected growth rates ln the domestic and export markets pro-vide an opportunity for DEMC for profitable expansion of its operations. How-ever, this would be possible only throudh an intensive restructuring of theenterprise. A complete revamping of production facilities, product designsand managerial structure is considered essential for successful restructuring.These factors point to the need for associating a strong joint-venture partnerwho would not only bring in the investment, but would provide the management,product designs and manufacturing technology and equipments, as well as accessto global markets. The latter is necessary if DEMC is to operate at an eco-nomic level. The proposed restructuring plan for DEMC prepared by consultantstakes the above factors into account and is reflected in Tianjin government'sdevelopment program and strategy for the five subsectors.

lnvestment Plan

18. Consultants have estimated the total investment for restructuring atabout $19 million ($16 million in foreign currency and Y 16 million local cur-rency).

-88 - ANNEXM 4

TIANJIN INDUSTRIAL DKVELOPNENT PROJECT

Institutlonal Infrastuguture and its Develooment Program

A. Backaround

l. In addition to the assistance to be provided by TIDP for the overallrestructuring of the five subsectors, the project will assist in the develop-ment of support institutions through the establishment of Technical Centers innew corporations and the strengthening of Vocational Training Institutions inselected subsectors.

2. The establishment of Technical Centers will strengthen the abilityof the subsectors to absorb foreign technology and would lay the foundationfor self-sustaining technological growth. In addition, these centers wouldassist the top management of the subsectors' corporations in the developmentand implementation of related engineering and management systems, which wouldenhance their operational performance and international competitiveness. Thegoal is to create "centers of excellence' which act as catalytic agents tofacilitate the management of many changes associated with restructuring opera-tions. In order to give due recognition to the importance of the role of theTechnical Center, the Read of the Technical Center would be responsible to thePresident of the Corporation.

3. Tianjin is well-endowed in terms of vocational training at the pre-employment stage and on-the-job training. There is, however, need for ratio-nalization and strengthening of these institutions rather than the setting upof new training facilities.

4. The recommendations relating to the design of Technical Centers andthe strengthening of Vocational Training Institutions have been developedjointly by the subsectors and the consultants, and revieved by Bank staff.

B. Concent of Technical Centers

5. The principal function of Technical Centers is to provide supportservices in the following areas:

* technology absorption, product engineering and development

e process and systems development

* information and planning systems

6. Technologv Absorption. Product Eniineerins and Development_. Theprimary objective is to accelerate the absorption and application of technolo-gies acquired under technology transfer and joint-venture agreements and tokeep abreast of new technical developments in subsectoral products. Researchstaff and technical specialists at the centers vould provide services in areas

- 89 - ANX 9

such as stress analysis, modeling, dynamices and vibration, tribology and wear,hydraulics, fatigue systems, materials and metallurgy, etc., as may be rele-vant to the design of the subsector's products.

7. The Head of the Technical Center would establish strong linkages andrapport with national and regional research institutes, especially those inthe Tianjin-Beijing area. He/she would ensure that the services and facili-ties available at these institutes are appropriately utilized, thus avoidingduplication and achieving cost-effectiveness.

8. The existing design institutes within the subsector enterpriseswould continue to operate at their present locations. At present, thesedesign institutes are mainly engaged in product performance and test work.Some of the laboratory equipment proposed to be acquired by a Tochnical Centermay be physically located within the enterprise design institutes if suchlocation would lead to more effective utilization of this equipment. Toensure coordination of product development activities, the Head of the enter-prise design institute would report on a functional basis to the Head of theTechnical Center.

9. Process and Systems Develonment. The Technical Center would assumeresponsibility for the development of following systems:

* developing CAD/CAE capability including computer software for designapplications

- develop capability for adaptation of CNC systems for machine toolsmaufactured by the subsector

* establish product standards

* establish quality assurance systems

* set up computer-aided machining and manufacturing process laboratoryto improve productivity of CNC machining, metal cutting, welding,etc.

* establish data banks and data bases for keeping track of technologydevelopments

10. Manatement Information and Planning Systems. The Technical Centerwill assist top management in the development of corporate strategies andoperational plans. It will institute management and cost-accounting systems,keep track of competition and long-term trends and forecasts of domestic andglobal demands for the subsector's products and collect market intelligence.

11. The precise range of services and activities of the respective Tech-nical Centers would be established during project implementation and would betailor-made to the needs of each subsector corporation.

12. Technical Centers would be supported under TIDP for the machinetool, construction equipment, and auto-parts subsector corporations. In thecase of electric motors and passive resistor and capacitor components, techni-

-90 - AML 9

cal centers are not being included because the concerned corporations would beestablished as joint ventures with leading international foreign companies.Foreign partners normally provide the requisite institutional framework fortechnology absorption and management information systems.

13. Technical Center Staff. The staff for the Technical Center would becarefully selected from among the best talent available within the subsectorenterprises, regional and national institutes, and from enterprises outsidethe fivo subsectors. Rey staff members would be provided with suitable train-ing to enable them to perform their functions efficiently.

14. Investment. The projected investment in Technical Centers is $11.50million in foreign currency and Y 25.07 million in local currency. Details ofthese investments are provided in Attachment 1 to this annex.

C. Vocational Training Institutions

15. Based on the analysis of the t.aining facilities existing in Tianjinand within the enterprises, it has been concluded that there is no need forestablishing new training institutions. However, there is need for strength-ening the existing training institutions.

16. It is proposed to provide equipment, teaching aids, video, slide andoverhead projectors; computer hardware and software, etc.; and books and peri-odicals to the following training institutes:

* Tianjin Mechanical and Electric Institute

* Machine Tools - Technical Workers School

- Construction Equipment - Technical Workers School

* Electric Motors - Technical Workers School and Second TechnicalSchool

17. The projected investment in vocational training is estimated at$300,000 In foreign currency and Y 2.1 million in local currency. Details ofthis estimate are provided in Attachment 2 of this annex.

18. Charge-Back System for Services Rendered by Technical Centers andVocational Trainint Institutes. Services provided by the above institutionswould be on the basis of charging the beneficiaries for the services rendered.The system of appropriate charges for respective services would be establishedduring the project implementation stage.

- 91 - ANLAAttachment 1

TIANJIN INDUSTRIAL DEVELOFNENT PROJECT

Develonment of SuiDport Institutions

A. Machine Tools Subsector

1. Baketround. The national and regional research institutions sup-porting the machine tools subsector are the following:

* Tianjin Gear Cutting Machine Tools Research Institutec Tianjin Hydraulic Press Research Institute* Tianjin Precision Grinder Research Institute* Beijing Machine Tool Research Institute* Jinan Casting and Forging Machinery Research Institute* xian Microelectric Motor Research Institute

2. Entergrise-Based Desisn Institutes. There are four enterprise-baseddesign institutes with the following structure:

2zisting institutes Location Space (M2) Staff Capability

Gear Cutting Machine Tool NO. I MT 2,700 125 * Testins and designResearch Institute * Computer for cal.

culation only

Branch Laboratory Beijing No. 4 MT 120 18 * Testing and designMachinery Tool ResearchInstitute

Hydraulic Press Research Hydraulic Press 2,100 53 * Testing and designInstitute * Computer for cal-

culation only

Precision Griuder Research Grinder Works 550 33 * Testing and designlastitute

These institutes are mostly engaged in design and some prototype and modelingactivities. Considering the limited tools and facilities these institutespossess, they have made some useful contributions in terms of new designs anddevelopments. The Gear Cutting Institute is designing CNC bevel-gear genera-tors and new high-speed gear shapers. In the case of hydraulic press, theInstitute has designed larger-size, new PC and CNC presses for special appli-cations for powder metal and grinding wheel applications. The Branch Labora-tory of the Beijing Machine Tool Research Institute undertakes the core designof the machining centers produced by the No. 4 Machine Tool Works, in closecoordination with its headquarters in Beijing. In the case of grinders, theInstitute will be phased out in line with the product strategy for this prod-uct.

- 92 - ANNEX 9Attachment 1

3. tachie Tool Technical Genter. A new technical support center wouldbe set up for the machine tools subsector and will be part of the TianjinMachine Tools Corporation. One of the primary tasks of this center will benew product development, while the design functions will remain with divisional research institutes (such as Sear cutting, machine centers, hydraulicpress and surface grinders).

4. The center will have several functions including performance test-ing, technical library maintenance, design optimizatiou, material testtng,engineering and manufacturing software application and development, precisionmeasurement, certification sensing and metrology, CICIDNC and Servo applica-tion, meetings and seminar, etc. This will be a center for technology absorp-tion, digestion and dissemination of machine tool research, design and devel-opment andlor metal processing advancement. It would have a staff of 60-70pet'sons.

5. Provosed Investment. Details of the laboratory equipment and otherfacilities are as followsz

$ mln Y min $ min(equiv.)

Land. Enaineering Buildlna. Plant and LayoutLand: this will be erected in the site belonging to

the vacated No. 4 Machine Tool site which will beeventually the site for the Machine Center Division - - -

Buildings (1,000 m2) - 0.70 0.13

Laboratory Ecmuiment (Hardware)Machine tools pesformance laboratoryLab interferometer for position error 0.08High-precision (0.001-0.0001 mm) electrical andmechanical dial gauge 0.02

Electronic level 0.01Vibration, acoustic tester 0.04Generating path tester 0.03Gear train accuracy tester 0.08Frequency analyzer and various kinds of sensor, etc. 0.10Thermal deformation testing system 0.15

Technical libraryComputer information retrieval system 0.05Video system 0*05

Design analysis and design optimization labWorkstation 0.02

Computer for computer software development6 sets of 80386/80486 0.12Workstations (CAD FM,, etc.) 0.02

93 - AM111 9Attachment 1

$ mln Y mln $ miln(equiv.)

Metallurgical and material labMetagraphic 0.10Spectrometer (share with university)

Precision measurement, metrology and standardLaser equipment 0.08Conventional 0.103D CME 0.50

CECDNCI, servo and autoemtion component applicationlab (this lab will only do benchmark testing. Thecomplete machine tool application testing will beperformed in the main Maehine Tool Performance Lab)

conventional 0 10Test rig 0.10

Subtotal 0.45 1.30 0.69

Computer Utilization. Technical Assistance. PorelmnTechnoloer. Trainina Needs

Computer software (hardware Included in the equipmentlist 0.15 0.50

Technical publicatioas, trainuig software, books,subscriptions, etc. 0.20

International manufacturing society, long-term member-ship, etc* 0 20

Subtotal 0.55 0.50 0.64

Total 1.00 2.50 0.46

Contingencies 0.15 0.38 0.07

Total Investmnt 1_15 0853

S. Construction Eaui_ment Subsector

6. Background. The national and regional research Institutions sup-porting the construction oquipment subsector are the following:

* Tianjin Engineering Mechinery Research Institute* Changsha Construction Equipment Research Institute* Transport Equipment Research Institute - Forklift Branch* Shanghai Internal Construction Engine Research Institute* Tianjin Forklift Research Institute* Tianjin Machine Technology Information Institute

- 94 - MM 9Attachment 1

* Tianjin Research Institute of Construction Machinery (TRICM)

7. Enterprise-Based Desian Institute. At present, crawlers, gradersand forklifts in Tianjin have their own design and development facilities,with the following structures

ResearchEntineerint institutem Staff m! Staff Capability

Graderiloader 900 97 Design, prototype, hydrau-lics

Crawler 900 85 Power train tests, design,hydraulics

Forklift 600 46 400 58 Power train tests, testground

Diesel engine 3,700 135 Design, test lab, design (2)386

The engineering capability of each of these equipment divisions is limited todesign and testing functions, based on imported product technology. They havesome "re-engineering" capability in applying the imported technology to theextended product line. The product technology comes from Komatsu, Balkancar,Faun, etc. Their new diesel design 115 series is influenced by John Deere andRicardo. The Tianjin Forklift Research Institute is a regional institutelocated at the Forklift factory. It is functioning as a design office for theBalksncar.

8. Construction EcuiDment Technical Center. The Technical Center willbe set up in the Construction Equipment Corporation and will serve all itsdivisions in the areas of engineering, manufacturing, management, marketing,cost accounting, productivity and quality technologies. A common databasewill be shared by all units within the corporation. It will form a strong(contractual) linkage with the National Research Institute of ConstructionMachinery, and share its engineering and laboratory resources to the maximumextent possible. It would have a staff of 80-90 persons.

9. The main functions of the center would include:

(a) Setting up a Technical Information Center including market statis-tics and disseminating current information to the divisions in asystematic and timely manner.

(b) Developing CADICAE capability including computer drawing, computerbill of materials, with common database throughout the corporation.

- 95 - ANN 9Attachment 1

Also, developing design optimization and design analysis softwarefor all divisions.

(i) Setting up a material database and a metallurgical lab.

(ii) Setting up a corporate-wide management resource planning systemand implement it step by step for every division.

(iii) Setting up a computer-aided machining and processing (metalcutting, welding, etc.) lab to improve machine productivity andproduct quality, especially for the new CNC machines. Thissoftware module will be eventually added to the HRP II softwarefor machine loading and scheduling.

(iv) Setting up a job ".counting/product line accounting system; itwill be added to the Management Information System to be estab-lished in all divisions step by step.

(v) Setting up a corporate-wide technology forecasting and market-ing analysis function to assist divisions' marketing and salesfunction.

(t) Working, on a contract basis, with TianJin's National ResearchInstitute of Construction Machinery (TRICH) on new equipment andcomponents (hydraulic transmission, torque converter, electroniccontrols, etc.).

(d) Working with Tianjin University's National Combustion EngineResearch Institute in the area of fuel economy, combustion develop-ment and exhaust emission reduction.

(e) Providing seminar, training facilities and conference rooms suitablefor meeting with international guests and advisors.

- 96 - ARM 9Attachment 1

10. Prooosed Investment.

$ ml U ln $ Uln(equiv.)

Building (1,000 in) - 0.70 0.13

Laboratory EquipmentTest facility for the Technical Center 0.70 0.60 0.11

Computer and software development laboratoryTechnical Information Center, Workstation SoftwareDevelopment, testing and measuring, etc. 0.87 2.30 0.42

Technology transfer and training 0.30 0.30 0.06

Subtotal 1.87 3.9 0.72

contingency 0.28 0.60 0.11

Total 241 4.S 0.83

C. Auto Parts Subsector

11. Backeround. The auto parts subsector is supported by the followingnational and regional institutions:

* TAIC Aut motive Research Intitute. It is the R&D center for theTAIC OEM companies. It is being consolidated and expanded.

* China Automobile Technolonr Research Center. It deals with plan-ning, tecbnology development aud manufacturing facility. TALC hasused this organization for some of its production planning. Thecenter does not conduct any product research nor any auto partsdevelopment. It reports to local sectoral bureaus.

* Tian1in Combustion Enaine Research Institute. It is a nationalcombustion research laboratory located at Tiiijin University. Thelab conducts diesel combustion research, not related to TAlC or itsauto parts business.

* TAIC Automotive Research Institute. The present TAIC ResearchInstitute has not been active in the development of auto parts. Ithas a total staff of 350 amployees with an engineering staff of 175-180. A major expansion is being planned with an investment of Y 45million. The Institute serves primrily the 03K. under TAIC and isunlikely to be of much support to the auto parts subsector.

- 97 - AMNEAttachment 1

12. Teehnical Centers. The subsystem corporations, in particular thetwo drive train and the auto electric subsystem corporations, would establishTechnical Centers to facilitate product design and process and system develop-ment.

Drive Tral- Technical Center

13. The technical capability of the present enterprises in the drivetrain subsystem is limited to producing parts based on drawings received fromDaihatsu or from TAIC design office. R&D capability is limited to reengineer-ing and manufacturing based on sample parts. It is supported by TAIC's "Auto-o'bile R&D Center." aowever, there is little evidence that this "center" is

serving the auto parts subsector.

14. The proposed Technical Center will provide advanced technology andInformation support needed for product R&D, manufacturing productivity, prod-uct quality, cost reduction, market forecasting, cost accounting, manufactur-ing input planning, integrated management information systems, etc. It willbe the center for technology absorption, digestion and dissemination. It willprovide multifunctional services including new product development, perfor-mnce (including noise) testing, life-cycle testing, process optimization,gear design software development, process improvements, in-process qualitycontrol and diagnostics, etc. The major requirement of the drive train sub-system is the capability of developing quality gear box and differentials witha low sound level (86 dB), and coming close to the international standard.

15. The main functions of the center would include:

(a) Providing a solid link with the National Qeav Research Institute,National Mechanical Research Institute (located in Zhenzhou) and theGear Research Laboratory of Chongqing and Xian Jiao-Tung Universi-ties.

(b) NEtablishing a technical information center on gear design, gearprocessing and testing and a library on current domestic and inter-national documents on engineering advancement and on marketing sta-tistics.

(c) Conducting product R&D functions based on technical forecasts andmarket demand.

(d) Applying CAD, structured bill of material, common engineering andmanufacturing database to all divisions of the Drive Train Corpora-tion.

(e) Applying computer-aided parts processing and machine loading, prod-uct costing techniques, mmaufacturing resource planning, and manage-ment information systems uniformly and step by step to all the divi-sions.

(f) Setting up a small material, metallurgical lab and a precision mea-surement, aetrology, standard lab.

- 98 - AMDL9Attacbaent 1

(g) Setting up a gear box and axle test lab including endurance, soundlevel and paver losses.

16. Prooosed Investment

$ mln Y mln $ mln(equiv.)

Building and location (1,000 m2) 0.70 0.13

EquipmentDrive train dyno (test stand) 0.60Torque meter, etc. 0.10Sound level and vibrator measurement 0.02Material testing 0.11Alignment equipment 0.08

Subtotal 0.23 0.68 0.12

Computer and software6 sets of 80386180486 and CAD software 0.08 0.12MRP II, MIS software, etc. and a workstation 0.30

Subtotal 0.08 0.42 0.08

Technical support and trainin8 needs 0.20 - 0.20

Total 0.49 1.80 0.33

Contingencies 0.06 0.25 0.05

Total 0.55 2.05 0,38

Auto-Electric Technical Center

17. Backfround. The present subsystem engineering and R&D capabilityconsists mainly of making parts according to TAIC drawings or samples. Someenterprises have re-engineering capability. TAIC's R&D Center provides verylittle assistance to the auto parts enterprises.

18. Technical Center. The overall functions of the Auto-Electric Tech-nical Center are similar to those described under the Drive Train TechnicalCenter with special emphasis on the development needs of auto-electric prod-ucts. Its focus will be on the following activities:

* product R&D to meet market demand

- 99 -M 9Att&achment 1

* absorbing and disseminating up-to-date management, marketing, engi-neering, manufacturing technologies

* applying NRP, MIS, cost accounting systems uniformly and step bystep in the divisions of the corporation

* conducting performance test, life cycle test, etc.

* developing design analysis optimization software

o upgrading production process for productivity and quality

19. Proposed Investment.

$ mln Y mln $ mln(equiv.)

Now building (1,000 m2) 0.70 0.13Equipment 1.50 1.00 0.18Computer hardware and software (6 sets of

80386180486) 0.20Technology transfer and training 0.60

Subtotal 2.30 1.70 0.31

Contingencies 0.35 0.'5 0.05

Total 2.65 1.95 0.36

D. Electronic Component Subsector

20. Backaround. The electronic components subsector has the followingsupport institutions:

* Copy Technology Research Institute (Tianjin)* Capacitor Research Institute (Beijing)* Chip-Type Component Research Institute (Guangzhou)* Component Production Equipment Research Institute (Chengdu)

21. The present structure of subsector enterprise-based R&D institutionsis as follows:

_ 100 -

AttachlMen I

Existing institutes Location Space (o) Staff Capability

No. 6 Research Institute No. 6 200 35 * Delay line sensor* Ceramie Material

Development

Ceramic Material Ltd. No. 15 50 10 * Ceramic Research* Chip Material

Tech4ical Departmeat All other * Product and Pro-euterprises cess Developnent

22. StrStegy for Future Develogment. The restructuring of this subsec-tor is built around two subsector corporations, one for capacitors and t}:eother for resistors. These corporations would be established as shareholdingjoint ventures with reputed international manufacturers. It is expected thatthe foreign partners would assume responsibility for providing and updatingknow-how and systems products and manufacturing processes, organization sys-tems, etc., and therefore the provision of a new Technical Center under TIDPfor the above purpose would not be necessary.

23. Technical Center for Surface-Mounted Technologa (SMT). The proposedTechnical Center for SMT would enable the electronics stibsector to continuelimited development work and technology assimilation in SMT components, i.e.,chip capacitors and resistors. It would help to develop technologies that canbe used? throughout the subsector. It would also reduce duplication and mini-mize investment through centralized chemical properties measurement and ana-lytical and testing facilities.

24. The monolithic capacitor production in Radio Components PactoryNo. 15 would be transferred to the Teecnical Center for SlT and also newequipment will be added. The pilot operation would require a complete processline with one piece of equipment for each process. The initial equipment forthe technical center to be financed under the proposed TA can be classifiedinto laboratories (general and special service group) and pilot operations(chip capacitors and resistors) as detailed below:

(a) Laboratories. Surface-mounted assembly equipment (laboratory size),particle size measuring equipment, surface-mounted measurementequipment, and powder characterization equipment.

(b) Chip Ca2acitor. Cutter, binder burnout oven, controlleriprogrammer/furnace (kiln), termination equipment, termination firing belt fur-nace, plating equipment, electrical sorting and characterizationequipment (capacitance, loss tangent, insulation resistance, break-down voltage), temperature chamber, tape on reel equipment for chipcapacitors, screen-making equipment for screen printing, and clean-ing equipment.

(c) Chip Resistors. Automatic screen printer, drying furnace, sinteringfurnace (kiln), laser tuner for resistance, chip breaking equipment,laser cutter, printer for markers, termination equipment, termina-

' 101 - AINEI LAttaehmant I

tion firing belt furnace, plating equipment, tape on reel equipmentfor chip resistors, and electrical testing equipment.

25. The total new lvestment In this Technical Center is estimated asfollowst

$ ln Y mln $ mln(equiv.)

Buildings 4.00 0.73Equipment 3.25 5.40 0.99Purniture & office equipment - 2.50 0.46Organization & technology management 0.15Data bass system for technical and market research 0.15Training 0.20Technology acquisition 0.50

Total 4.25 11.90 2.18

Contingency 0.75 2.10 0.39

Total 5.00 14.00 2.57

E. lectric Motors Subsector

26. Bagktround. On an organisational basis, the Daming Research andDevelopment Institute (Darnig R&D) is part of the Tianjin Daming ElectricMachine Corporation (Daning). While Daning R&D derives come financial supportfrom Daminag, it operates largely independently of Daning. Daming R&D islocated in Tianjin in a multilevel building of about 1,600 m' in an area whichis physically remote from the Dadnig plant.

27. Daming R&D engages prinarily in applications type research throughfive primary research areas which includes

(a) Electric Motor Division, which is working in the area of onargy-saving motors and variable-speed motors.

(b) Computer Numeric Control Application and Research Division, which isworking in the area of numeric control technology and applications.

(c) Industrial Drive System Division, which is working in the area ofmotor control systems and servo motor development.

(d) Motor Test Division, which Is a government-eertified testing facil-ity performing motor testing for Daming and others.

- 102 - AMNE9Attachment I

(a) Computer Division, which is working on computer-based testing andequipment control applications.

28. Daming R&D has the capability to make mall electrical and mechani-cal prototypes and samples. It also writes software to support ongoing worvDasnig R&D employs 180 persons, of which 10 are senior engineers, 20 are engi-neers and 70 are technicians. The remaining personnel are employed In otherenterprises, which are either owned or supported by Daming R&D.

29. The ongoing work at Daming R&D is original and creative and hasapplicability to Daming's operations. Closer goal-setting, focus, and cooper-ation between Daming and Daming R&D would be mutually .ieneficial to both orga-nizations. Specifically, work on some of the metallurgical problems confront-ing Daming would be most beneficial. Daming R&D should also be utilized byelectromechanical parts producers in the automotive subsector.

30. Future Strateav. As it is proposed to establish a shareholdingjoint venture with a reputed international manufacturer of electric motors, itis expected that the foreign partner would provide the necessary product,manufacturing and systems know-how. A new Technical Center is therefore notbeing proposed for this subsector under TIDP.

TECHNICAL CENTERS - SUMN1ARY OF INVESTMENT($ million)

Subsector Foreign cost Local cost Total cost

Machine tools 1.15 0.46 1.61Construetion equipment 2.15 0.83 2.98Auto partsDrive train subsystem 0.55 0.38 0.93Auto-electrical subsystem 2.65 0.36 3.01

Technical Center for SMT 5.00 2.57 7.57

Total 1l.S0 4.60 16.10

- 03 - ANX9

JIN I23pUSMR&L DESELOPM NT PROJECT

Support Institutions - Trainina

Present S$atug

1. Tianjin is well-endowed in terms of training facilities. The LaborBureau is the government agency responsible for Tianjin's training policy,guidance and support for training of blue-collar workers. Training coursesare conducted by three bureaus: labor, personnel and economic commission.Training is also carried out by the administrative bureau responsible fordifferent subsectors, e.g., Machine Building Bureau, TAIC and Electronics andInstrumentation Bureau.

2. Based on analysis of the training irstitutes, it has been concludedthats

(a) There is an adequate number of training institutions in Tianjin.

(b) There is a need for rationalization rather than setting up of newinstitutions.

(c) There are no training institutions dedicated to the auto parts andelectronics subsectors.

sd) The existing training institutions for the three subsectors underthe Machinery Building Bureau need to be strengthened in lire withthe product and market strategies for the restructured subsectors.

(e) Instead of setting up new institutions for the auto parts and elec-tronics components subsectors, they should utilize the services ofthe existing institutions in the bureau. TAIC and Electronics andInstrumentation Bureaus should realign the focus of one of theexisting institutions toward the needs of restructured auto partsand electronics components subsectors.

(f) The investment in training facilities would be restricted to thetraining institutions directly related to the three subsectors; viz.Machine Tools, Construction Equipment and Electric Motors.

3. In line with the above, and based on consultants' recomendations,it has been agreed to strengthen the following training institutions by pro-viding equipment to undertake training; teaching aids (video, slide and over-head projectors, computer hardware and software, blackboards, flip charts,etc.); and books and periodicals:

104 - a= 9Attachment 2

* Machine Toole - TechAScal Workers School* Construction Equipment - Toehnical Worker# School* Electric Motors - Technical Worker. School and Second Technical

School* Tianjin Mechanical and Electric Institute.

Details of the recommended investments in these lnstitutions are given in thefollovsng paragraphs.

4. Machine Sools. Tianjin Technical Worker School

* LEtablished in July 1961* 60 teachers* Current enrollmonet 496 students* Purposet train techanical workers in lathes and machine centers* Present equipment includess 33 lathes and 10 other auxiliary equip-

ment

Prconsed Devalonmewt Plan. .Y S equiv.

Building (500 i!) 150,000 27,522Numeral controlled teaching equipments11 sets 55,600 76,800 14,091

Contingency 8,400 29,600 5,431

Iotal 64.000 256.400 47.044

S. Construction Ecuilment. Tianjin Technical Worker School

* Established in September 1964- 82 teachers, I professor and 17 lecturers* Current enrollment: 262 students* Purposes training of internediate-level technical workers* Degrees offered: electrician, welding, milling, lathe* Present equipment: 23 lathes, 4 milling machines and 4 grinding

machines

Progosed Dovelopment Plans - Y S eau.iv.

Electrician laboratory - 50,000 9,170Testing instruments - 20,000 3,670Milling machine - 450,000 82,570Grinding machine - 210,000 .8,530Contingency - 134,000 24,590

Totgl ^ 864.000 158.530

- 105 - ANWUX Attacbment 2

6. Electric Motors.

Electric Motor Technical Workers School

* Established in July 1975* 92 teachers, 2 professors and 16 lecturers* Current enrollment: 350 students* Purposes training of intermediate-level technical workers for manu-

facture of electric motors* Present equipment includes 19 lathes

Proposed Development Plans S Y S eauiv.

Workshop building (500 ma) - 150,000 27,520Lathes: 10 sets 260,000 47,710Computers 15,000Language laboratory 15,440Teachers' training (5 persons) 44,800 8,220Contingency 4,560 65,200 11,960

Total 35.000 520.000 95.410

Tianjin Second Technical School for Electric Motor Factory

* Established in May 1979* 56 teachers* Current enrollment: 200 students3 Present equipment includes: 12 lathes, 2 milling machines, 2 drills

and 2 vertical drills

Proposed Development Plans S Y S equiv.

5 lathest model 6140, 36,000/set 180,000 33,270Display lathe: I set 17,500Drills: 5 sets 50,000 9,170Physics laboratory 40,000 7,340Electrician laboratory 40,000 7,340Language laboratory 17,300Contingency 5,200 44,000 8,070

Total 40.000 354.000 64.950

7. Common Pacilities. Tianjin Mechanical and Electrical Institute

* Established in 1981* 64 teachers, 8 professors, 26 lecturers* Current enrollment: 2,700 students* Degrees offered: machine making, industry automation, motor cable

and vire, computer, industry statistics, CNC equipment, economics* Present laboratories/equipment includes: material laboratory, elec-

tronic laboratory, hydraulic press laboratory, material strengthlaboratory, electric laboratory, computer laboratory

106 - lE= 9Attachment 2

Pronosed Develogment Plans Y S euiv

Computer CPU486s 5 sets, 30,/OOOset 25,000 30,000 5,510Drawing instruments: 2 sets, 15,000/set 30,000 5,510Language laboratory 10,000 14,000 2,570Control equipment 28,000 5,140CNC lathe 16,000 2,940Computert 286, 5 sets 10,000 12,000 2,200Contingency 10,000 24,000 4,400

Total 55.000 154.000 28.260

8. In addition to the above, the following imported training equipmentwill be provided for common use by the Bureaus and enterprises:

Computer facilities 42,000Teaching aids (including VCRs, slide 42,000projectors, overhead projectors)

Books, periodicals and technicalliterature 6,000

Contingency 16,000

Total 106.000

TRAINING CENTERS - SUMMARY OF INVESTHENT($'000)

Subsector Foreign cost Local cost Total cost

Machine Tools 64 47 111Construction Equipment - 158 158Electric MotorsTecEnical Workers School 35 95 130Second Technical School 40 65 105

Common FacilitiesTianjin Mechanical and ElectricalInstitute 55 29 84

Training Aids 106 - 106

Total 300 394 694

- 107 - ANNX10

CHIE

TIAIJIN INDUSTRIA DEVELOM NT PROJECT

Terms of Reforence of Studies/ProiectI_mvlementation Work of Consultants

A. In_roduction

1. The Tianjin Municipal Govermoent (?MG) has used the services ofinternational consulting firms to prepare subsector specific restructuringprograms for the following five industrial subsectors.

(a) Machine Tools Subsector

(b) Construction Equipment Subsector

(c) Auto Parts Subsector

(d) Electronics Components Subsector

(e) Electric Motors Subsector

2. The consultants, working together with concerned municipal bureaus,corporations and enterprises in the respective subsectors, have submittedtheir recommendations. The proposed subsector strategies are aimed at improv-ing the overalU operational efficiency and effectiveness of the subsectors toincrease both domestic and international competitiveness and develop direct/indirect exports. These strategic changes need to be carried out across thesubsector corporations and factories and support institutions and encompassorganizational development and structure, product/market strategies includingdevelopment of marketing and distribution channels, appropriate managementplanning, control and information systems, operational effectiveness programsin the manufacturing and technology functions, strategic planning, etc., sup-ported by appropriate policy and institutional reforms. The consultants'recommendations have been accepted in broad outline by concerned governmentauthorities in China and the program is now ready for implementation. Theauthorities recognize that the management of this implementation project is anextremely complex task requiring coordination and control of several activi-ties and the active participation and cooperation of numerous individualswithin many government departments and the concerned corporationsIfactories.TMG propose to implement this complex restructuring project with the assis-tance of international consultants. As electronic components and electricmotors subsectors would have joint-venture partners who will bring their ownknow-how for individual enterprises, consultants' role will be limited inthese two subsectors.

B. Objectives

3. The objective of the proposed consultancy services is to assist thevarious authorities involved in the implementation of the restructuring pro-grms through systematic design end successful implementation of the entire

- 108 - AUEX 10

process so as to ensure timely completion of the project activities with mini-mal disruption of current operations. The ultimato objective to the successof the business enterprises in these subsectors in achievitg the goal andobjectives of the industrial restructuring. As organization structures andsystems are closely related and interdependent, they should be compatible andmutually reinforcing. To avoid any organizational dysfunctioning, these twotasks are, therefore, being integrated and form a part of this consultingassignment.

4. The primary responsibility for the implemeutation of the subsectorrestructuring projects will be that of the TMG, including Tianjin PlanningCommission (TPC), Tianjin Economic Comission (TEC), and respective industrialbureaus, assisted by an interagency Tianjin World Bank Loan Office (TWBLO),which will monitor the tasks relating to the subsector restructuring programs,prepare details of policy measures for approval by the authorities and monitorthe technical assistance component of the project. The role of the consul-tants in these matters is to support the concerned officials through TWBLO inthe detailed design of project implementation tasks, define the human andfinancial resources that are necessary, assist in the development of workplans and activity schedules, implementation of these detailed plans andfinally, in effective project monitoring and control systems. An importantobjective is to transfer this expertise in project design and implementationto the management of the subsector corporations/factories to enable them toindependently continue such functions in the future. Additionally, the designof factory organization structures and management systems requires extensivework and foreign consultants should utilize to the maximum extent possible,consistent with the availability of suitable local consulting skills, theservices of Chinese consulting firms. It may also be desirable to use Chineseconsultants where possible to facilitate communication and effect economies inconsulting expenses.

C. Scope of Services

Assistance in Pro1ect Manatement Desitn and Imnlementatlon

5. The restructuring proposals focus on a number of managerial and"software" issues (subsector organization, management systems, operationaleffectiveness, production technology, product development and technologytransfer, etc.) as well as hardware aspects. Plans for implementation of allthese multiple interdependent activities will need to be established, detailedtasks identified and scheduled as a part of the Master Project Design.Detailed near-term implementation plans (1-12 months) will need to be drawn upto incorporate some of the implementation steps which can be initiated immedi-ately to ensure the success of the entire subsector restructuring program andthose which have long lead times but involve relatively low levels of fundingand, therefore, can also be initiated promptly. Next, long-term comprehensiveImplementation plans will have to be established. The consultants will assistin the project implementation and monitoring process as frequently as is con-sidered necessary for timely and successful completion of project activities.

6. Beside advice and active assistance in project management, there arecritical tasks forming an essential part of the restructuring program whichconstitute the core of this consulting assignment. The consultants will fur-

- 109 NAM 10

thor be expected to supplemnt the t-sks with any other activities that maybe crucial to the success and effectiveness of these restructuring programs.These critical desgn and Implementation tasks relate to: (i) organizationstructure and developmnmt; (11) marketing and sales distribution; (iii) opera-tional effectivenes program (iv) production technology upgrading; (v) man-agement planning control and informtion systems; (vi) product development andtechnology trsnsfert and (vil) consolidation of production. The scope of workunder each of these h8e ts briefly described in the following paragraphs.

(a) Or&nixza,toal Structure and Ortanixation Development

7. The consultants will need to assist the subsectors in developingdetailed organization structures at the corporate, divisional and factorylevels . This work vill Include defining roles and responsibilities, job spec-ifications, optimum manniag, and en assessment of current management personnelto fulfill the new roles.

8. It is apparent that the Implementation of the recommended organiza-tion structure cannot bc done without extensive training at all levels ofmanagement and operations staff. This aspect of organization development iscrucial to the success of the project. The consultants will identify the gapsin managerial and supervisory skils,, prioritize the training needs and assistin conducting short training seminars (up to one week) particularly for seniormanagement. They will also advis, on the type, venue and cost of in-depthtraining progras of longer duration which would be necessary for developmentof the requisite smagerial skills at different levels. The actual conduct ofthe long duration training courses is, however, outside the scope of thisassignment.

(b) MarketUng and Sales Distrlbution

9. The strengthening of the marketing organization and distributionarrangements has been Identified as a priority task. Consultants will assistin developing the organization structure and in establishing marketing poli-cies which are in consonance with the recommended product/market strategies.They will also assist in locating and establishing adequate distribution chan-nels, and sales and services networks for the domestic and target interna-tional markets, including likely joint venture partners to facilitate exports.

(c) Onerational Iffectiv_nees Protrams

10. Several short-term projects for improving operational effectivenessand aimed at improving productivity, reducing costs, enhancing quality,increasitg capacity utilization, etc., have been recommended. Consultantswill design and then a"ssit In implementation of such operational effective-ness measures in the subsector factories. This will include the design andimplementation of operational system upgrades including production planningand control, lventory managementp preventive maintenance, quality assurance,etc. Consultauts will also review current plans for capacity expansionthrough acquisition of fixed assets in light of likely improvements which maybe realized through these operational effectiveness measures.

- 110 - ANNIX 10

(d) Uporadina Production Technology/Manufacturing Processes

II. Consultants will assist in identifying gaps in production processesas currently practiced and recommend/implement suitable improvements consis-tent with realization of optimum manufacturing costs as related to the volumeof production.

(e) Product Develo2,ment and Technoloay Management

12. Consultants vill assist in identifying acquisition of technicalexpertise from appropriate sources for improving products. This also includesassistance in implementation of measures aimed at improving technology absorp-tion, in-house product development, efficient utilization of institutionalinfrastructure for R&D, and in ensuring that enterprises initiate steps forredesign of key products and acquisition of new technology.

(f) Development and Design of Strateaic Planning. Manaxement and ControlSystems

13. Based on the organization structures which are to be implemented,consultants will develop and design management information systems for all keymansgement functions including corporate, divisional and factory level opera-tions control, financial accounting, planning and control, cost accounting,materials management (corporate and divisional level), business planning,uarket and sales system, manpower planning, performance evaluation and incen-tive systems, etc. Some of the other subsystems such as production planningand control, preventive maintenance, quality assurance, stock control, etc. asalready referred to in para. 10 as a part of operational effectiveness mea-sures are also to be included. The consultants will determine the adequacyand readiness of the factories to implement these systems manually or with thehelp of computers. This will also depend on the availability of the requiredhardware and software in China. However, the design of the systems should besuch as to facilitate electronic data processing and integration at a laterdate.

14. The product/market strategies recommended for the respective subsec-tors are based on the macroeconomic environment in China as foreseen today.It is necessary to institutionalize within enterprises the capability torespond to macroeconomic and business environment changes which will inevita-bly take place in China and the overseas markets even during the implementa-tion of the present project. Consultants will assist in establishing theorganization needed for long term business and strategic planning in eachsubsector to build full-fledged strategic planning capability. The organiza-tion of a practical strategic planning unit at the corporate and divisionallevel should be implemented in the near term.

(g) Consolidation of Production

15. Consultants will assist the respective corporations in the drawingup and implementation of plans for rationalization of products and consolida-tion of production facilities so as to optimize utilization of resourcesthrough elimination, wherever feasible, of the manufacture of overlappingproducts or components at more than one production facility. Such rational-

- 11l - X 10

ization proposals would involve relocation of physical assets and manpowerfrom a less efficient to a tore efficient site.

16. Proposals for investments in projects for expansion/diversificationwill be considered only after the impact of implementation of the above con-solidation measures have been taken into account.

D. Schedule of the Study and Renortin2

17. The proposed assignment will be carried out by a consultant teamconsisting of experts in organization and systems design, management informa-tion system, accounting and financial management, marketing, market training,and technological aspects of the five subsectors. The assignment will bephased over a period of three years from the date of contract award.

18. The consultant(s) shall submit the following documents and reports,to be written in English:

(a) An Inception Report within two weeks from the date of contract awardsummarizing the detailed work program, arrangemints needed for thefield work of the study, major issues to be investigated in-depth,and more importantly, a detailed list of information (where neces-sary, data formats will be provided) to be prepared by Tianjin gov-ernment and enterprises in the five subsectors before the start offield work.

(b) Appropriate periodic progress reports on a monthly, quarterly orsix-monthly basis clearly defining the progress made under variousactivities and including design details of the organization struc-tures/management systems/operational effectiveness measures proposedand implemented.

(c) Interim report at the end of the first and second year of assignmentoutlining the progress made so far at subsector, enterprise andfactory level in carrying out the assignment and the specificdetails of the work to be performed in the remaining period.

(d) Draft Final Report, detailing the work performed in accordance withthe Terms of Reference, including detailed findings and recommenda-tions, actions initiated to carry out the recommendations, and fur-ther actions to be taken along with a timetable.

(e) Final Report within one month after receiving the comments on theDraft Final Report from Tianjin Government and the World Bank; and

(f) Implementation Manuals (as part of the Final Report) for facilitat-ing the introduction and implementation of the recommendations andnew systems, which should includet (i) organization manual forenterprises; (ii) manual for marketing and sales promotion; (iii)manual for installation and maintenance of HIS for enterprises;(iv) cost accounting manuals for enterprises, including applicationsto cost control; and (v) other manuals to help improve operationalefficiency, e.g., staff training, inventory management, preventivemaintennUce, etc.

- 112 - I I

TINJIrN IUDUMUTIAL bRVK9kU ZO=J

Proiect ImlRMntstinm Sceludule

1993 1994 1995 1996 1997 1998 1999

,Physical !e.*,ucturina of Interstices____

Establisbmeat of corporations I

Appointmeut of consultants X

Preparatlon of restructurlg plans forenterpriaes/plants

Approval of subloans by PPs_

Procurement - -

Production start-up

gMaaemeLt. -Organization and Systems

Systems organizational plans of corporatio,divisions and plants

Implementatioa of marketing strategies

Development and impl.mntation of MSg

Training of enterprise management and staff

Dovelovment of $tchnololical Infrastructure

Procurement of equipment | =

Training

Strenathenina of P"s

Staff training -

- 113 - mmiII I&

Caft

TIANJIN IDUSTRIL DEVELOPENT] PROJECT

KeU Monitorina Indicatgr.

Indicatore Target Dates

A. bWer&Ii

Loan effectiveness July 1993

S. Enteririse Reforms

Establishment of corporations July 1993Closure of nonviable plants December 1994

C. Policy Reforms

Removal of all price controls December 1995Removal of all surplus labor December 1995

D. Utilization of Industrial Credit Component by PMIs

Last date for subproject submission June 1996Last date for loan withdrawal December 1999

E. Impl1Mentation of Tehnical Aesistance Comoonent

Development of Inastitutional Infrastructure

Selection of suppliers March 1994Completion of civil vorks June 1994Start of use of new equipment January 1995Commencement of staff training January 1994Completion of staff training December 1995

P. M a' Staff Training

Commencement January 1993Completion December 1995

- 114 -AN 13

'IAN IUlDUSTRIAL D--LOPflKNT PROJECT

Pro1ect Umolementation Task and SunerviLSIo PlA

1993 1994 1995 1996

1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4

1. Imple=entation Task (AJencv)

A. Subsector Reform Stratni_es

Establish Corporations (tlG) __ ----Close Noaviable Plants tTMG) ------Removal of Price Controls (2MG)Redeploy Redundant Labor (TMG-) ______ ------------Reviwe Progress on Reforms (WB) x x x x x

B. Credit Comnonent

selection of Consultants (I -)-----------Preparing Restructuring Plans (Cons) __ ------------Complete Subproject Appraisals

Approve Subloans (WB) -- ------------ _-_________ ------

C. Tecbnical Assistance Comnonent

1. Workers Retralnina & Redeuloyment

Select Consultants ______Submit Consultants Report ----- -------

2. Pro lect ImLlementation SurnortOrganization Restructuring _ ------------Production Consolidation __ __ ------------NlS/Accounting Systems_ ------------ ------------ ._ ___ >Industrial Engintering _--_-__-___ ______-___ ------------ ________ >

3. Establish Research Institutions &Techic_al Centers (1TMG &EnterDrIseJ)Procure Facilities & Equipment ------------ ------------Staff Training ------- ------------ ---

4. Train EnterDris. Manatement andStaff (11(0)Prepare Annual Training Plan x x xSelect Consultants ------------ ------------ -----------Coamence Seminars ------- ------------ -----------Commence Overseas Trainitg ------- ------------ ___________>

5. Train PFI Staff (Pyle)Select Consultants ---- ----Commence First Course ----Comuence Second Course -----Conmence Overseas Training ______ ----------- >

- 115 - AN1EL11

1993 1994 1995 1996

12 3 4 1 2 3 4 1 2 3 4 1 2 3 4

I. Prolect Sunervision Missions

1. EGIP Implant eubsectoralstrategies, review enterprisereform strategies x

2. Fous on Implementationorganization and subsectoralstrate8r

3. Review progre4s on enterpriserestructuring, tech. assistance& training

4. ocus on empeditlag subprojectreview and procurement x

5. Focus on effectiveness ofproject Implementation arrange-ments x

6. In-depth overall Implementationreviw x

- 116 - A

CRIN

TIANJIN INDUSTRA DEVELO_PMET RCT

China Investment Bank ICIB)

1 CIB, through its Tianjin Branch, will be responsible for theappraisal and supervision of subprojects to be financed under the proposedBank loan. Although staff from the Read Office will be involved in theappraisal process, the Tianjin Branch will prepare the appraisal reportsrequired for each subproject and forward them directly to the World Bank forreview. CIB has already gained substantial experience in project appraisaland is the only financial institution in the industrial sector in China whoseinvestment finance decisions are based on generally accepted project appraisaltechniques and procedures. It has received, so far, five credit lines fromthe Bank Group: CIB I (Loan/Credit 2226/1313-CIA) for $70.6 million approvedon December 21, 1982; CIB II (Loan/Credit 2434/1491-CHA) for $175.0 millionapproved on June 5, 1984; CIB III (Loan/Credit 2659/1663-CHA) for $100.0 mil-lion approved on March 3, 1986; CIB IV (Loan/Credit 2783/1763-CHA) for$300.0 million approved on Match 3, 1987; and CIS V (Loan 3075-CHA) for $300.0million approved on May 30, 1989. CIB is also the finanetal intermediary forTrLIP and one of the Fls for the SPARK. project and the Shanghai IndustrialDevelopment Project. The Bank has alsc provided considerable support to CIB'sinstitutional development. It has developed sufficient capability to satis-factorily appraise and supervise subprojects that will be financed under TIDPand to take objective investment financing decisions. The institutional,operational, and financial aspects of CIB are described below.

2. The Institution. CIB commenced its operations in 1983 as a govern-ment-owned development finance institution. As of December 31, 1991, it hadpaid-in capital of Y 1,845 million ($344 million equivalent). CIB is adminis-tratively under the supervisory responsibility of MOP. It t1so retains stronglinks with PCBC, from which most of its staff, both at central and provinciallevels, has been drawn. Its oraanization consists of (a) a head office inBeijing which performs an administrative and supervisory role for its entireoperation; and (b) provincial branch offices, which have the direct responsi-bility for screening, appraisal and supervision of projects. The branchoffices have expanded from three in 1982 to 31 provincial-level branches and28 subbranches at the municipal level. CIB has delegated limited loanapproval authority to selected branches; decisions on larger loans are takenat the bead office.

3. CIB's 33-member Board of Directors has remained structurally thesame since 1983; it is chaired by the President of PCBC and includes represen-tatives of the Government departments and banks concerned. The Board meetsonce a year and has delegated most of its operational decision--making author-ity to a Managing Committee consisting of the Board Chairman, the three DeputyChairmen (all from PBC) and eight Managing Directors (of vhich four compriseCIB 's senior management, and one representative each from SPC, MOF, PBC andthe State Administration of Exchange control).

- 117 - AME 14

4. Cul's management at the bead office consists of a President andthree Vice-Presidents who have the responsibility of supervising specificdepartments. Each branch office is also headed by a President. The totalnumber of staff at the head office has incressed from 33 in 1984 to 173 as ofApril 30, 1992. The staff includes 32 engineers and 83 economists/financialanalysts, who are directly involved in project appraisal and supervision work.The staff at the branches has also increased from 84 to 1,640 during the sameperiod. CIB plans to recruit more staff before the end of 1992 to strengthenits project supervision capability to cope with the growing loan portfolio.However, many managers and professional staff still lack advanced financialskills and experience, and there is thus a continued need for training, whichis reflected in the three-year rolling training plan of CID.

5. CIB's major operational and financial yolicies are outlined in itsPolicy Statement, which was last amended in April 1989. It permits CIB toprovide local and foreign currency investment as well as working capitalloans, to develop consulting services and to undertake other financial opera-tions (i.e., equity investments, lease financing, guarantees, loan syndica-tions, etc.). CIB's total foreign currency lending to any one project wouldnot normally exceed $20 million and total local currency lending would notexceed Y 40 million ($8.5 million equivalent); any exception to this rulewould depend upon agreement between CIS and the Bank.

6. Until now, CIB has mainly provided foreign currency loans for capi-tal investment in light industry projects. It has relied largely on the BankGroup for foreign currency funds and on the Government for local currencyfunds. To ensure its long-term viability in a more competitive environment,CIB had adopted in April 1989 a revised Development Strategy Statement whicharticulates CIB's plan to: (a) diversify its portfolio by industrial subsec-tor and type of client by seeking out an increasing share of nonstate enter-prises: (b) diversify its sources of funding particularly by enhanced commer-cial borrowings abroad but also by increased domestic resource mobilization;and (c) expand and develop new product lines and services such as free-standing working capital loans, leasing operations, equity investments andloan syndications. The progress in this regsrd has, however, been limited.

7. CIB8s project annraisal is undertaken in accordance with its Indus-trial Projects Appraisal Manual, which was prepared with Bank Group assis-tance. The need to improve the manual, especially in the areas of financialand economic rate-of-return analysis, has been recognized for some time. CIBhas prepared a substantially enlarged revised version in Chinese, which wasreviewed by an ApriL 1992 Bank supervision mission and found to be satisfac-tory. Since 1991, greater emphasis has been placed on strengthening projectsupervision of projects, In particular for projects facing operational andfinancial problems. CIB is currently revising its Project Supervision Manual,and the new version is expected to be completed before the end of 1992. TheBank is also encouraging CIB to get involved at an earlier stage of subprojectpreparation so that potential problems can be identified and avoided.

8. Since its establishment in 1982, CIB has made considerable progressin its institutional development. It has adopted effective lending proce-dures, recruited a large number of well-educated junior- and middle-levelstaff, carried out extensive training in China and abroad, started to diver-sify its funding resources, sad developed an important branch network compris-

- 118 - AMEX 14

iog key provinces and municipalities. CIB has implemented various institu-tional strengthening measures agreed under CIB IV and V and has established aseparate unit for economic research and reporting and appointed a full-timeinternal auditor. Nevertheless, much remains to be done. CIB's current orga-nizational structure results in fragmentation of responsibility in the manage-ment of financial resources and financial reporting. This dilutes financialaccountability, hinders the capability of the Head Office to monitor the per-formance of the branches and limits access of individual departments to finan-cial data generated by other departments. It is expected that with the recentintroduction of a new financial management information system, CIB's internalfinancial management and reporting will improve considerably.

9. Operations. A summary of CIB's actual and projected lending opera-tions is given in Attachment 1. The size of CLB's lending increased signifi-cantly since its establishment until 1983. Its foreign currency loan approv-als in 1988 were $402.0 million, an eightfold increase from $49.8 million in1983. Local currency approvals increased from Y 165.2 million in 1983 toY 495.5 million in 1988. The sharp increase was made possible by the contin-ued financial support from the Bank Group and the availability of funds fromother sources including ADB, KfW, and foreign commercial banks.

10. Since the beginning of 1989 when the Government initiated the eco-nomic austerity program, CIB's lending operations have shown a sharp decrease.During 1989, foreign currency term-loan approvals were $154.7 million, only38 percent of the level of the previous year. Local currency term-loanapprovals were also very low at Y 46.0 million. Term-loan approvals in 1990increased to $183 million in foreign exchange and Y 513 million in local cur-rency. CIB's working capital loans increased significantly during 1989/90because of general liquidity constraints faced by industrial enterprises. Italso reflected a change in CIB's business strategy and plan, as agreed withthe Bank under CIB V. At the end of 1990, the total working capital loanapprovals reached Y 1.9 billion, consisting of $130 million in foreign cur-rency, and Y 1.3 billion in local currency. CIB's foreign currency term-loanapprovals totaled only $130 million in 1991, reflecting the tight resourcesituation facing ClB, due mainly to difficulties in mobilizing additionalforeign-exchange resources. However, local currency loan approvals increasedto Y 824 million during the same period.

11. CIB's financial forecast for 1992-95 is supply-driven due toresource constraints since 1989. CIB's forecast ervisages an increase inforeign currency loan approvals from $311 million in 1992 to $505 million in1995, and in local currency loans from Y 1,590 million to Y 2,536 million.

12. Financial Performance. The actual and projected income statementsand balance sheets of CIB for 1983-94 are provided in Attachments 2 and 3,respectively. CIB's net pr_,t (after business and income taxes) was Y 89.0million (6.2 percent of equity) in 1987 but declined to Y 46.5 million(2.6 percent of equity) in 1990 and Y 45.4 million (2.6 percent of equity) in1991 due to the expiry of the tax holiday in 1988 and higher bad debt provi-sions in 1990 and 1991. CIB's administrative expenses in 1991 continued to belower in relation to assets, representing 0.08 percent of its average totalassets (down from <0.2 percent in 1990). CIB's average interest spread on allforeign and local currency loans decreased gradually from 4.1 percent in 1985to 1.4 percent in 1991, mainly because of the higher share of foreign currency

- 119 - ANNEX 1A

loans in CIB's total resources, which have relatively low spread. However,the overall average spread is still satisfactory. CIB's long-term debt toequity ratio was 3.3:1 at the end of 1991, well within the 5:1 limit providedunder CIB V. CIB's debt service coverage ratio in 1989 was 2 times, and wouldremain around 2 times between 1992-94.

13. In 1991, loans in arrears (i.e., overdue over 90 days) amounted to3.2 percent of total outstanding portfolio, an increase of 28 percent over1990 when arrears were 2.5 percent of total loan portfolio. This increase isnot only due to increasing arrears (up 20.7 percent), but also to a decline inoutstanding portfolio (down 7.3 percent). On the other hand, the increase inarrears also reflects a conservative loan rescheduling policy based on theprinciple that no individual loan can be rescheduled more than once, andestablishing strict rescheduling criteria. Although the amount rescheduled in1990 and 1991 was almost the same (about Y 300 million), the number of loansrescheduled declined sharply from 34 in 1990 to 20 in 1991. No reschedulingswere approved up to June 30, 1992, although a number of requests were pending.CIB's overall collection rate for 1991 was low at 75 percent, (collection dataare not available for 1990). There was no significant difference in collec-tion rates between arrears and current repayments, indicative of the existenceof a "hard-core" one fourth of the portfolio of difficult collectibility, andCIB will need to make significant efforts to improve its performance in thisarea. During negotiations, understandings were reached with CIS that beforesubmission of its first subproject to the Bank, CIB will: (a) revise itspolicy statement to include a loan recovery target of 90 percent of loanrepayments due; and (b) submit a plan satisfactory to the Bank for reachingthe above target, including projected loan recovery percentages for 1993-95.

14. In China, levels of provisions for bad and doubtful loans are estab-lished by MOP for all banks and are not based on asset classification. How-ever, the government and CIB agreed to make an exception under CIB V and,accordingly, CIB increased its provision for bad debt from 0.2 percent in 1988to 1.9 percent at the end of 1991, and would further increase it to 2.0 per-cent by December 31, 1992.

15. According to CIB's financial forecast, its financial performance isexpected to remain satisfactory under 1992-95. Net income after taxes woulddecline somewhat in 1992 to Y 40.2 million after allowing for provisions forbad debt of Y 280.1 million, the smount required to raise total provisions to2 percent of loan portfolio. Subsequently, however, net income would rise toY 212.8 million in 1993, and to Y 268.5 million in 1994. The average interestspread on CIB loans would remain at between 1.5 and 2.0 percent, and the lowspread, coupled with CIB's low leverage, would result in an average return onequity of about 3 percent in 1992. However, CIB expects to rapidly expandborrowed funds during the period, and its long-term debt to equity ratio isexpected to increase from 3.3:1 at the end of 1991 to about 4.4:1 at year-end1995. Consequently, the return on equity would double to 6 percent in 1995.During negotiations, agreement was reached with CIB that its maximumdebt/equity ratio will remain at 5:1. The State Audit Administration performsan external audit of CIB's accounts and it has been satisfactory.

16. An overall review of CIB indicates that, despite significant prog-ress in institution-building and an increase in level of operations, it hasmany weaknesses. Its management and staff need further strengthening; the

- 120 - AM 14

appraisal quality has to be maintained more uniformly; loan collections haveto be improveds resources have to be diversified; and last but not leastimportant, its long-torm role has to be defined clearly. At the eame time, ithas to minimize and ultimately cease its dependence on the government and PCBCfor institutional and funding support. The above measures vill help CID tobetter prepare for the emerging competition in the financial sector and, moreimportantly, to find its rightful place in the financial sector in China. Inthe context of supervision of CIB I-V, and new operations, including the pro-posed assistance for the development of financial institutions in China, theBank is engaged in an active dialogue with the government and CIB on the lat-ter's future role, operational strategy and resources. The government and CIBmanagement are also keenly interested in CIB's further institutionalstrengthening and its finding a market niche in China.

17. Utilization of Bank Loans/IDA Credits. CIB 1-111 have been com-pleted satisfactorily and a Project Completion Report has been issued. BothCIB IV and V are presently under disbursement, and, as of December 31, 1991,their status was as follows: (a) CIS IV--207 subprojects approved for a totalamount of $301.5 million, the credit line Was 98 percent committed and77 percent disbursed, and 176 subprojects were operational; (b) CIB V--176subprojects approved for a total amount of $231.3 million, the credit compo-nent was 77 percent committed and 23 percent disbursed, and 50 subprojectswere operational. CIB IV was originally expected to be complete by June 30,1992, but the closing date has been extended by one year due to slower-than-expected disbursements resulting from the effects of the 1988 austerity pro-gram.

18. CIB Tianiin Branh. The CIB Tianjin branch was one of the first tobe established and is among the most developed branches of CIB. It is headedby a full-time President, assisted by two Vice-Presidents, and has a totalstaff of 75, of which 80 percent are professionals. One-third of the staff(25) is directly involved in project appraisal and supervision, including 21economistslfinancial analysts and 3 engineers. Almost all the staff hasreceived training after joining CIB. Most of them have attended short train-ing programs organized by the head office. Seven staff have participated inEDI training programs in China and another eleven have received training inforeign countries. A sum of $50,000 was included in the technical assistancecomponent of TLIP for further training. Eight staff have received training sofar under this component, in Singapore and the Philippines. The branch staffhas also gained valuable knowledge and experience by participation in theimplementation of TLIP and preparation of TIDP.

19. As of December 31, 1991, the Tianjin branch had approved 71 subproj-ects under CIB I-IV for a total loan amount of $72.0 million in foreign cur-rency and Y 154.0 million in local currency. Among the 71 subprojectsapproved, 29 are completed (loan repaid), 38 are operating and are repayingsatisfactorily, and 4 are under construction. Under the TLIP, 15 subprojectshave been approved for $141.2 million in foreign currency and Y 280 million inlocal currency, of which 5 have been completed and are repaying satisfactorilyand 10 are under construction. Overall, the operational and financial perfor-mance of completed subprojects has been satisfactory.

- 121 - AIN 14Attgchment 1

OUA

T JI,II IIIDUSTRIAL DVELOPMET PROJECT

ChIn Investment Bank

Annl terat ions PerformanceCY million)

Actual Projected1991 1992 1993 1994 1995 1996

AI2YElILocal currency 627 1,646 1,707 1,729 1,876 2,050FolreSf currency 577 1,699 1,800 2,321 2,760 3,232(US dollar) (108) (311) (329) (424) (505) (591)

Total 3104 3.345 3.S07 4.050 4.635 5.282

COmaltmentoal currency 671 1,609 1,684 1,764 1,917 1,848

loreln currency 868 1,848 1,811 2,162 2,832 3,319(US dollar) (162) (338) (331) (395) (518) (607)

To_tal M1.S 3.457 3.496 3.926 4.748 5.167

Zlsburementocal currency 690 1,546 1,607 1,729 1,875 2,050

Worelgn currney 1,079 2,000 1,807 2,321 2,760 3,232(US dollar) (201) (366) (330) (424) (505) (591)

DU&al 1.770 3.546 3.414 4.050 4.635 5.282

Loan lenaent.Local urrency 101 80 100 120 144 173Joreiga currency 641 586 857 1,125 1,445 1,781(US dollar) (119) (107) (157) (206) (264) (326)

Total 742 666 957 1.245 1.589 1.954

Loan OUtetandiJtLoal currency 5,353 6,403 7,841 11,584 13,642 17,693lorel4a currency 5,950 7,274 9,321 10,547 12,332 14,074(US dollar) (1,110) (1,330) (1,704) (1,924) (2,254) (2,994)

11.303 13.677 17.162 22.131 25.974 31.767

- 122 - AMUhX 14Attachren 2

TIhJIN INDUSTRIAL DEVULOPHENT PROJECT

China IMestmen_t Bank

Income Statement(Y million)

Actual Prolected1991 1992 1993 1994 1995 1996

Income

Interest Income frm LoansLocal currency 249.56 672.50 945.39 1,165.81 1,379.18 1,606.68Poreign currency 444.94 656.77 1,001.41 1,219.70 1,466.95 1,739.05

Jtrest Income on Deposittcal cu-rrency 79.98 129.42 148.76 175.54 204.99 237.39Foreign currency 80.35 88.76 109.05 129.16 149.28 169.42

Income on aouitv InvestmentsLocal currency 0.29 0.37 2.17 2.53 2.96 3.48Foreign currency 0.00 2.26 7.18 12.11 19.49 30.57

9thez !MomeLocal currency 17.36 19.09 21.00 23.10 25.42 27.96Foreign currency 9.64 10.82 11.90 13.09 14.40 15.84

Total income 882.12 1.579.99 2.246.88 2.741.04 3.262.67 3.830.39

Ireenses

Pfaanial exaenses-Loc currency interest 220.85 526.94 771.44 922.12 1,075.47 1,231.77Foreign currency interest 476.03 624.82 796.58 975.52 1,116.01 1,325.73Foreign curreney fees 22.09 28.76 37.39 48.60 63.19 82.14

Subtotal 718.96 1180.52 1605.41 1946.25 2254.66 2639.65

AdministratIve and otherexpenses 12.11 15.34 19.44 24.60 31.32 39.83

Provisions for doubtfulaccounts 5.59 280.13 94.19 104.66 104.49 123.88

Depreciation and amortization 4.59 5.93 7.75 10.08 13.10 17.03

Total xDenses 741.24 1.481.96 1.726.79 2.085.58 24403.57 2.820.39

Profit before taxes 140.88 98.03 520.07 655.46 859.10 1,010.00(less) Busiu ess Tax 24.36 8.82 46.83 58.97 77.30 90.88

Net profit before Income tax 116.52 89.21 473.24 596.49 781.80 919.12(lese) Income tax 71.08 49.07 260.44 327.96 429.89 505.40

Net income after tax 45.45 40.15 212.80 268.53 351.91 413.72

- 123 - Attrscent 3

CIA

IMANJIN INDUSlRIAL DEVELW PNENT }ROJECT

China Investment Bank

Balance Sheet(Y million)

1991 1992 1993 1994 1995 1996

AssetsCash and bank deposit 2,310 2,436 3,127 4,416 4,723 4,288Accounts receivable 1,055 1,002 1,543 1,466 1,486 1,605Working capital loans 3,128 3,714 4,912 8,256 10,307 12,986Others 3 4 4 4 5 6

Total current assets 6.495 7.156 9.586 13,142 16.521 18.885

Long-term assetsLoan.s Local currency 2,334 3,079 3,413 3,916 4,028 5,524

Poreign currency 5,950 7,274 9,321 10,547 12,332 14,094(less) Provisions for doubtful

debts (109) (390) (484) (588) (693) (817)Net long-tern loan portfolio 8,175 9,963 12,250 13,875 13,667 18,801Equity lvestments 27 92 149 233 359 547Revolving funds 9 9 9 5 5 5Net fixed assets 28 67 89 116 151 196Other assets 6 6 6 3 3 3

Total lonr-term "ssets 8.245 10.137 12.503 14.232 16.185 19.552

Total assets 14.740 17.293 22.089 27.374 32.706 38.43J

Liabilltles and EuitvCurrent liablitiesAccounts payable 665 605 566 1,051 1,0S59 1,593Total deposits 4,862 5,978 7,617 9,313 11,001 12,489Current portion of long-term

liabilities 726 693 1,201 1,644 1,920 2,051

Total current liabilities 6.253 7.276 9.384 12.008 13.980 16.133

Lont-term debtsDomestic borrowings 668 890 1,090 1,290 1,490 1,690World Bank 3,485 4,293 5,035 6,110 7,010 8,196ADB 338 448 958 941 1,730 1,913Bonds 0 0 400 1,244 2,248 3,521Bank loans 2,148 2,165 2,313 2,277 2,066 2,034Foreign government loans 3 81 184 340 549 811

Total lons-term debt 6.642 .797 9.980 12.202 15.093 18.165

Total liabilities 12.895 15.073 19.364 24.210 29.073 34.29t

Paid-in capital 1,426 1,763 1,891 2,019 2,069 2,119Retained earnings 420 457 833 1,144 1,564 2,020Total equity 1,845 2,220 2,725 3,164 3,633 4,139

Total llabilities and eaulty 14.740 17.293 22.089 27.374 32.706 38.437

Managed funds 6,515 16,614 21,299 25,961 31,029 36,322

Long-term debtsequity ratio 3.6 4.5 4.5 3.9 4.2 4.4

- 124 - ANNEX 1S

TIANJIN INDUSTRIAL DEVELOPMENT PROJECT

Industrial snd Commercial Bank of China (ICBC)

1. Bskgrgou. By virtue of State Council Decree 146 dated Septem-ber 17, 1983, ICBC was founded as a spin-off of the former Savings Departmentand the Industrial and Comercial Administration Department of the People'sBank of China (PBC). ICBC does not have a Board of Directors but is headed byits President who is appointed by the PBC with the approval of the State Coun-cil. It remains the largest state-owned commercial bank with total assets ofY 1,117.47 billion ($203.18 billion, which is estimated to be eighth largestin the world) and net worth of Y 48.0 billion ($8.73 billion). Outstandingloans and deposits amounted to Y 797.12 billion and Y 640.50 billion, respec-tively, estimated at nearly half of the total loans and deposits of China'sfinancial sector. It is a banker to about 90 percent of the medium and largestate-owned enterprises (SOEs) and has the largest number of branch network,with over 30,000 domestic branches/subbranches including 20,280 savingsoffices and one representative office in Singapore, 208 foreign correspondentbanks, two subsidiaries and employing over 500,000 people. It is governedmainly by its Articles of Association approved on November 15, 1989 and aStatement of Policy approved in July 1990.

2. ICBC's Shanghai branch is one of four participating financial insti-tutions under the Bank's Shanghai Industrial Development Project. In 1991,ICBC obtained a loan of $100 million from the Asian Development Bank forrelending to industrial projects including a technical assistance/trainingcomponent for ICBC's accounting, staff training, audit and management informs-tion system. ICBC also raises long-term local currency resources through bondissues (up to five years in maturity) which cumulatively amounted to Y 6.357billion at the end of 1991.

3. Organization. Manaaement and Staffing. ICBC is headed by its Presi-dent (Ms. Zhang Xiao) and four Executive Vice-Presidents (EVPs) at its headoffice in Beijing. The head office has 20 departments divided among the EVPsand the main groupings are: creditiloan and accounting; planning/research,audit and international business; general administration and subsidiaries; andsavings and personnel. The head office is involved mainly in policy formula-tion and overall supervision of branch operations. Lending operations arefairly decontralized in its provincial and regional branches (29), citybranches (180) down to the prefectural, county, and district subbranch levelwith varying delegated authorities. The head office performs some bankingactivities mainly relating to foreign exchange and term loans under its Tech-nical Innovation Credit (TIC) department.

4. In December 1991, ICBC had a total staff of slightly over 500,000,of which about 19 percent and 65 percent are university and high school gradu-ates respectively and about 16 percent have had some vocationalltecenicaltraining. The head office has a small complement of about 800 people of whichtwo thirds are professional. While on-the-job training is emphasized, ICBC

- 125 - ANNE2_ 1

has five colleges, 43 adult middle schools, and 46 training centers. Itstraining included the project appraisal program sponsored by the Bsank's EDIwhere some 52 staff of its TIC department attended. The ADB technical assis-tance component is providing funds for further training, particularly in loanappraisal, project management and market analysis as well as in the managementof foreign exchange business.

5. policies ond Strategies. ICBC intends to expand its operations andto work towards providing the full range of banking and financial products andservices focussing on medium and large industrial enterprises and export-oriented enterprises. One of ICBC's priorities is to expand its internationalbusiness by increasing the number of its branches handling foreign transac-tions and its network of correspondent banks and representative offices, byonlending of credit lines from foreign/international institutions (e.g., WorldBank, ADB, etc.) and raising resources in the international financial marketthrough bond issues. Another major objective is to facilitate specializationand/or mergers (enterprise groupings) in support of enterprise reforms inChina to improve efficiency. It also has prudent financial policies whichshould promote a diversified portfolio, e.g., exposure limits on industrialsectors (30 percent of portfolio) and single borrower (10 percent of its networth or Y 4.8 billion at 1991 year-end); and maximum project size of up toY 2 billions maximm debtlequity ratio (4tl) for project, minimum financialrate of return (15 percent) and positive current ratio and debt service coverof eligible projects. It ensures the "matching" of its uses and sources offunds both in terms of interest rates, maturities, and currencies. Further-more, ICBC has taken steps to better manage its liquidity by targeting a rea-sonable "loan/deposit" ratio of 75 percent in several of its branches. One ofits medium-term objectives is to fully computerize and interconnect all itsbranches and offices for which some technical assistance would be availableunder the ADB loan. While ICBC does not formally have policies on its "gear-ing" ratios, it is committed (under the ADB project) to maintain a maximumtotal debt/equity of 20 times and net long-term debts/equity of 10 times whichare reasonable.

6. Result of Ooerations and Finances. ICBC's actual and projectedincome and balance sheet statements for 1987 to 1996 are provided in Attach-ment 1. ICBC's gross revenues doubled from 1987 to 1991 to Y 75,755 millionwith an average growth rate of about 22 percent per year. Despite the inter-est changes in 1989/90, ICBC has kept its margin over 2 percent. Its netincome grew at about 11 percent per year reaching Y 6,339 million for 1991;this is equivalent to 13.35 percent return on equity (or 7.35 percent afterinflation). Its administrative expenses averaged about 0.7 percent of totalassets which is reasonable. Its current ratio remained positive and averagedslightly over 1.5 times. However, its capital/loan ratio has been decliningslightly from a high of 6.98 percent in 1987 to 5.75 percent at the end of1991. Its gearing ratios have been maintained at reasonable levels with long-term debt/equity at 8.29 times and total debt/equity ratio of within 20 * 1 in1991. Although long-term loans more than doubled from 1987 to 1991 toY 105,508 million, ICBC's long-term resources more than tripled maintaining anappropriate matching of maturities.

7. Arrears and Loan Provisions. At the end of 1991, ICBC's arrearsincreased by 43 percent to Y 27,105 million up from Y 18,900 million in 1990.

- 126 - ANNEX 15

However, as a percent of total outstanding portfolio, arrears remained at arelatively low level of 3.4 percent. Arrears from short-termi working capitalloans accounted for 98 percent of total arrears and were 3.8 percent of totaloutstanding working capital loans; arrears from long-term loans amounted toY 562 million or 0.53 percent of outstanding long-term loans. ICBC expects tomaintain a collection ratio of about 95 percent which should be achievablegiven the short-term nature of most of its portfolio and consequent closemonitoring of the accounts.

8. Accumulated provisions for doubtful debts would amount to aboutY 2,590 million (9.6 percent of total arrears) which is equal to 0.32 percentof total loan portfolio, a level currently allowed by the Ministry of Finance(MOP). MOF regulations would allow this percentage to increase to 1.0 percentof loan portfolio by 1997. However, ICBC is recommending an increase to3 percent by 1997 which is appropriate and approaches international norms.

9. ICBC's accounts are externally audited by the State Audit Adminis-tration (SAA) which also audits other World Bank projects and is supported bythe Bank's TA projects to improve its capacity and standards. Under TIDP,ICBC would provide the Bank with its audited financial statements including along-form audit and statement from SM on the adequacy of its loan provisions(similar provision is contained in the ADB agreement). To help implementICBC's program to modify, upgrade, and modernize its accounting, auditing andMIS, ADB is providing TA funds to finance consultancy/advisory services andtraining.

Tianlin Municilal Branch

10. Backaround. While ICBC head office will be the signatory of theProject Agreement with the World Bank under the TIDP, its Tianjin MunicipalBranch (THB) would be approved and authorized to implement ICBC's participa-tion under the TIDP. THB is one of four municipal/autonomous regional branchof ICBC (Tianjin, Shanghai, Guangxi, and Xinjiang branches). At the end of1991, TMB had total assets of Y 28,048 million ($5,100 million), deposits ofY 15,124 million ($2,750 million), total loans of Y 23,180 million ($4,215million) and net income of Y 169 million ($31 million). Compared to otherbranches, it is estimated that TMB ranks 12th in total assets and total loans,16th in total deposits, 10th in net income and about 14th in total TechnicalInnovation Credits (TIC) or long-term loans. It has a total staff of nearly11,000 of which about 80 percent are considered professional (high school andabove education and with substantial experience in banking). TMB has 4 dis-trict subbranches, 9 district business offices, 263 savings offices, and 5county subbranches.

11. Oraanization and Manasement. TMB's organization almost mirrors thatof the head office with equivalent 20 departments. One major difference isthat four departments (internal audit, supervisory, personnel, and trust/investment agency) appropriately report directly to the president (equivalentto the rank of EVP of head office) while the other departments report to threeVice-Presidents divided basically into administration, lending operations,banking/savings and international operations. Of note are separate departmentfor credit card and a training center. The main branch accounts for about10 percent of the staff or 1,072 of which 872 are considered professional.

- 127 - AM la

12. Policies and StrateRies. TMB's operations are implemented inaccordance with the policies and regulations adopted by its head office.Under the TIDP, TMB has agreed to adopt some policies specific to its opera-tions as contained in its Statement of Operating and Financial Policies. ICBCand THS have agreed on these policies. ICBC head office would also consideradopting similar policies for its other branches. It is significant that, forthe first time, TMB will adopt and formalize its policies in many importantaspects. For example, THM has a defined a timetable to achieve ICBC's plan toattain a more reasonable loan/deposit ratio of 75 percent and a capital/loanratio of 10 percent by 1996. TMB also defines some important operationalexposure limits as followss (a) long-term loans not to exceed 30 percent oftotal loan portfolio; (b) maximum of 35 percent of savings deposits to beutilized for long-term loans; (c) exposure to single sector not to exceed30 percent of TMB's total loan portfolio and 10 percent of TMB$s equity to asingle enterprise or maximum of 70 percent of client enterprise's total assetswhichever is lower. TNB targets a minimum collection ratio of 90 percent ofamounts due which is acceptable and will enforce agreed fixed loan repaymentschedules from clients which heretofore, have been flexible with emphasis onforeign exchange loans. Furthermore, TMB will closely monitor and superviseits loans ensuring that full leverage on the client is utilized to improverepayment performance, e.g., working capital loans to be renewed only forenterprises not in arrears on long-term loans. TMB will also require andensure full collateral coverage on loans and appropriate external audit of itsclients' financial accounts and statements. Such operating and financial pol-icies would provide TMB appropriate and prudent guidelines for its operations.

13. Technical -Inovation Credit DeDartment. This department (TICITMB)will be directly involved for ICBC's participation under the TIDP and giventhe expected size of subprojects and subloans, would be undertaking theappraisal of subprojects. It has a total staff of 222 of which 88 are in themain branch. TIC in the main branch is headed by a general manager and threevice-managers. One vice-manager is in charge of 4 divisions involved in proj-ect appraisal/supervision: light industry and textile, heavy industry,machinery and electronics, and research and development. This group has fourengineers, two economists, one lawyer, and two management engineer background.Seven people are involved in appraisal on full-time basis including threeengineers and two economists. Since 1979, this group has been appraising andapproved 132 projects out of a total 214 TIC projects requiring mostly long-term local currency loans. It is guided by ICBC's manual of operations forTIC (full project cycle) and a project management and appraisal manual issuedin 1986 and patterned after the CIB appraisal manual. For TIC loans, itrequires a feasibility study, audited financial statements, and documents fromrelevant approving agencies such as the finance and planning bureaus. TIC inthe main branch would, as a standard procedure, require a "credit check" onthe applicant's creditworthiness and inputs from a sector specialist fromrelevant subbranches. Subbranches normally perform the regular follow-up withquarterly reporting and coordination with TIC in the main branch which doesthe full supervision up to project completion for all foreign exchange loans(e.g., loans under the TIDP). While TIC has had substantial experience interm financing, its staff needs to participate in the training to be providedunder TIDP particularly in the appraisal of enterprises restructuring andmarket-oriented operations, analysis of environmental aspects, and TIDP'sprocurement procedures.

- 128 - AM 15

14. Financial Perfogmne, and Condition. A sumaOry of TIMIs income andbalance sheet statements for 1987 to 1996 are shown in Attachment 2. ThE'sperformance approximates that of ICEC as whole in terms of overall growth.Gross revenues more than doubled from 1987 to 1991 to Y 6,426 million with anaverage growth rate of about 24 percent per year. In 1989190, TMh has alsokept its interest margin over 2 percent. However, net income growth showed alower average growth of about 6 percent year (11 percent for ICBC) reachingY 135 million in 1991; TMB's return on equity are almost identical to ICBC aswhole, i.e., 13.18 percent nominal and 7.13 percent real. Its administrativeexpenses averaged about 0.45 percent of total assets which low and 50 percentthat of ICBC as a vhole (0.7 percent). Its current ratio remained positiveand averaged slightly over 1.7 times. TME's capital/loan ratio was alsodeclining from a high of 7.15 percent in 1987 to 5.84 percent at the end of1991 which are slightly lower than ICBC as whole due mainly to the low reten-tion of profits by the branch. However, 1MB's projection show that by 1996its capital/loan ratio would be 9.5 percent compared to a target of 10 per-cent. Its gearing ratios have been maintained at reasonable levels with long-term debt/equity at 6.85 times in 1991 and total debt/equity ratio was within20sl for 1991. TMB like ICBC as whole maintains more than adequate long-termresources to funds its term loans, i.e. ratio of term sources to term loansremained at almost 3:1 by the end of 1991. Total loan/deposit ratio was highin 1991 at 153 percent. To ensure its liquidity and lower costs of short-termborrowings, TMB plans to exert efforts to mobilize its own deposits so thatsuch ratio would be within 100 percent by 1996; however, working capital loan/deposit ratio would be at 75 percent by 1995.

15. Arrears and Provislons. At the end of 1991, TMB's arrears Werereasonably low and amounted to Y 519 million or 2.3 percent of outstandingloans. Arrears from short-term working capital loans accounted for 91 percentof total arrears and were 2.39 percent of total outstanding working capitalloans; arrears from long-term loans amounted to Y 47 million or 0.2 percent ofoutstanding long-term loans. ICBC expects to maintain a minimum collectionratio of about 90 percent which should be achievable given the short-termnature of most of its portfolio and consequent close monitoring of theaccount. Accumulated provisions for doubtful debts would amount to aboutY 23.3 million (4.S percent of total arrears) or 0.1 percent of total loanportfolio, a level currently allowed by the Ministry of Finance (MOF). TMB isstill projecting to maintain this level of provisions although it would followhead office policies once these are approved by MOP, i.e. to increase accumu-lated provisions to 3 percent of outstanding loans.

16. The Tianjin Audit Bureau (TAB) conducts regular audits of TMB'soperations but are currently limited to accounts relating to the credit plan,i.e., all accounts except profit and loss and agency business. Under theTIDP, SAA would authorize TAB to prepare audited financial statements of TMBincluding audits of the project accounts, statement of expenditures, and spe-cial accounts. These audit reports would be submitted to the Bank within sixmonths after end of each fiscal year, i.e., by June 30.

IaA.twll san DCm %Ifft _ bw Statame

for "ar .uiAd Zeomber 31 IV" iwo, D ogo sv, z lon iTo AMw iooa AM IV9 l 010Ozjdammud 6 =outh.

bIL.t an Loats 23,433 29.431 37.9I" 60.132 62,974 64,101 36.201 6,S868 7S,89 790893 84,899 91.217ruto"t o por .(l 19 1.802 2.925 3,371 6,868 7,641 8,630 4.828 696 9,336 9,731 10.lit 10.3*4A640071CO116 lotbar337 1,042 904 2.102 1,301 3,004 1.1 If ,244 S,A0 3.784 8.067 4.414memaL _ 235792 3.419 41.565 69.102 72.916 75.755 36.540 sO.o28 66.249 s24es 8.O013 106.109

mUUL ow depots 9037 11.348 17.260 31.384 34.319 36 147 1s,09 36 S.53 39491 42.649 46.061 4749.4Intuteet ow borrosltu S.21S IO.17U 6,775 14,69 152 14.439 7,6 s 1.2 153941 16,738 17,373 S1.454OLp n d t Bpes". 1S94 1,943 987 32 4407 3,638 4.182 2372 4S°.0 6,273 7.403 6,733 10.308143 294 362 438 S19 610 418 792 9S1 11 41 13569 1.541. for O bts * 4se9 s 58641 $ 8224S 61 2321 7S80 0 330 390 667 603 39 3,12 2.231 6PS39 937 assprov. or o el 0 0 0 2 0 0 05 0 0 0 0 0helm... tax * 1,263 14,390 2,061 3,373 378 S 5.33 1,599 S3.8 4,136 44.48 1.147 3233Total snbtte" IL174 22.334 30-9'6 53.888 _j-j_ 319.614 3.35° 6.7917 569.03 83_758 790524 6J.041

obomma imam ~~8.418 I0.863 10.359 13.214 13.230 15.941 5.503 Lull3 17.0 1865-0 19.4961 Pg-j SLees. Staff some M Vand lfsr* I"& SO2 1,087 1,380 2,239 2,394 2,331 1,214 2,606 3.007 3.393 3.73 4,108tonst katp TM 400 400 400 400 400 400 200 400 400 400 400 400

2i_o Wf two" Tea 7.175 9.378 8.790 12°373 1049e 12S990 4.091 125823 1S°6S7179 86.77 1°B376 17960Ues tnome tfx 4,249 3.662 58424 2 632 7.397 S.034 2,226 7,92 83 9,2 ,321 92247Add$ DOW*/W*.Mlos.1t. 505 543 462 1,1231 1,365 1403 543 1,343 1,698 3,87 2,034 2,239

W_3 4.059 4.193 6.974 4.2 6.330 2.50 6.417 61 7.512 I&" 9.7

tome taxi. totals ese*taf _1.80 1.26 1.02 1.22 03 0.63 0.23 0.70 0.8 0.6 0.60 0.33Ret £coo.ulw.. total oeset. 0.81 0.84 0.7 1.03 0.34 0.63 0.22 0.53 0.51 0.31 0.47 0.44fkt Inw me.quitp 13.0 14.27 12.64 18.3 10.03 13.33 4.91 11.63 12.02 11.60 11.14 10.34

cataIo et 7.00 7.50 16.00 13.00 10.00 5.00 3.00 6.00 3.00 3.00 3.00 3.40so"l tax". 4.08 6.77 -3.1 3e .37 0.03 7.33 1.91 3.63 7.02 6.00 6.14 3.34aesets ~~~~~ ~~~~~0.61 0.62 0.60 0.65 0.74 0.57 0.31 0.65 .71 0.73 0.73 0.77Income from ... u/Av.. lean portfolio 6.94 7.21 7.9 11.15 O."9 8.39 3.68 7.86 7.7 7.39 7.09 6.81depoet:. ~~~~~ ~~~~4.06 4.32 3.12 8.06 7.69 6.11 2.76 3.20 3.23 4.99 4.77 4.54Interest Marfn ~~~~~~2.88 2.89 2.64 3.09 2.20 2.39 0.91 2.55 2.48 2.39 2.32 2.24

votes Op*r*tlqiadninstratles oxempoms Includes staff boomelwelfare for ratio sanaysts.

Industrial and Cainrasl Bnk %*CIns - Bl&nce Sheet.

Pert jee aede )eoeur 31 L,UO spot Zvi" a WYS LsVJ IWIS Ld'6 L1

qW= Asooto 2.627 2,854 4,014 4,710 5,244 5,696 5,964 6,400 7,10006,00 ,00o1000_tjt<I X630.006 46.195 53,953 69,S99 101.912 S3,059 94,109 152,"00 1700 191.00 214,500 240.2

0 3 o87,58 439,9 2 sl5125 61*2*OJ 691.612 727.966 774,0 867,700 9tl1W0 1.0688400 1,19.000ewrrencj 3,3~~~~~~ ~~~04 714 5,7 8.210e. n.. . U.S. U.S. .. U&

0 0 754 141 86,322 92,763 36,904 41,300 46,300 51.90 so,106Total COrret eAstt 362.902 444.050 505.320 411.426 742.628 866,609 924.841 970.700 1.087.100 1.217.700 L363.800 1.327.300

am*s L.ola otfolio 378,441 437.77 499,079 578,7 694,013 797.120 644.304 868,172 1,007,403 1,128.742 1,243.9791,513e Capital ns 3736,745 387,587 441,5222 514,371;' 6181,3>72, 6791,6121 7237.4 7897458,7020 0473,7800 927981,38001 6960.40190 1,219,000h pres 0 50 o 53 207 3 1,120j7 1.7587 2,o5903s 3.187987 3,7724 t247 8 ,00 9,342 10,279 10,935

tore Losom 41,876 s30,1 t ,S637 64,404 76,543 105,508 116,338 117.700 131,700 147,400 165.300 165,200,IVI"h nd sa 41,67 so:I 57 530 71667 7411010.;4j 111,400 124,700 16o9.80 156,eo 7 e80

0 58 4366 1,545 325 57.7 93 29 0H n 67 n. nonot taft-terl LO&e 41.87 6 s0o188 57.327 63.016 75,674 105.500 116.330 117.700 131.700 147.L00 1.300 13.2009

Isnj utess 4,254 7,042 7,6512 14,46 14,410 46.541 46,84 74,300 6550 9So60 107,300 120.100Mr& edIwauet 0 0 7,3 32,0 i3,400 42,243 49.027 417,400 53,300 1559.17000 66:600 70.800

1.5551580. sciatien 68a~~~~~~~Go 973 '1,32 '1,743 '2.282 l.. .e,:e e n.e: lae. U.n.

lkt Pimd asvta3.686 4J.601 5."I &4.45 7.912 10.170 11.279 11.300 12.600 14.100 15.800 17.700Oter Asse"t. 12,360 .7,331 13,653 8,092 20,536 24,276 18,654 26,000 S3,600 35,100 39,400 44,300

Total Aseets 447.07S 523.212 596,672 736.460 S95.157 1.117.449 1.184.943 1.251,600 1.401.800 1.570.000 1,75.400 1.969.400

UIITW & 1

w1Xt@t 155,143 183,77 206,609 20W,617 245,206 277n366 341,51S 310,700 348,200 390,500 4 o90,00Foreig raq01,9 ,2 94 .. ne n.e.G nk.e. nV I 139,r783 1513.8 1 164,5795 174,216 20,4 217,025 20s,7s5 244,500 274,000 307,300 344.400 386,300Cuent atats of.

ldS.tCgS ~~~~~~~O528 0 ~~~~ 0 0 0 1:0 U.S. U.&. U.e. U.. IL.*. U.*. M.e.

.2I~~~enois1 bands 1,65~~~~~~~9 1612 110 1,33 U.1 us. u .e. U.S. n.e. U.*. lu.eAl t;ot 11 95w79 & :457§ I'm137 53,10 u,90 nU.& n.e. n.e. nU.. u.s. n.e. n.e.Tol Currnmt Lbilities 310.564 344.6U 394.581 3S5.20 4572 49211 547.2Q 555.200 622,200 697.00 782.000 877.100

98,572 130,482 149,350 20, 492 272,143 363,117 401,677 406,300 435,400 51, $72,30 642,0000 0 1,195 3.021 4,9~~~~~~~f.169 26,9107 32,6831 31,900 35,400 40,100 44,900 50,400 1,167 2.3~~~~:175 109 ,458 6,77 6,19 7,100 7,900 8900 t 10,000 120

0 0 .. US. US .. US0 0 8 ° U 299. U": n. n.e. ne U.

Total -t Lbilitie 98,572 S11,849 1SS.241 210.921 280,.69 396.384 441.227 445.300 498.700 559.700 627.200 73600

Agency Business 6,301 7,152 7,849 6,24 8,220 71,524 66,422 60,300 90,00 101,000 113,100 126,900Tenet and 0 0 0 27.490 29.2~~~~~ ~~~~~~0 3494 42,904 41,30 44,3 S:9:00 52 5,300

r 1 hts 3,93200 9,042 °6225 6396 f791,056 561,1376 27,441 59 200 64,700 $ 4 2 580s 9O,S400Total LSabilities 420,757 492.659 561.896 495.324 048.219 1,053.481 1,125.264 1.18l.300 1.323.900 1.484.700 L.6g3.800 2,866.300

WtAi ite 18,449 16.449 16,449 16,449 18,449 18,449 16,.449 18,:400 16400 18400 16,400 16,400at ecin rofits 187,48472 12,41404 16,328 282,680 26,4490 29'5964 37 15.000 42,300 48,200 56,700 64,600

LS,941 5: 6000 17,200 16,70 19,5oo 20 tooTotal E4uStv 24,321 30.553 34.777 41.137 46.939 48,047 54.176 54.300 60,700 66,600 75n.00 81.000 t

Total Liabilities, and Butv 447,078 523.212 596.673 736.461 89S.158 1.117,469 L.184.945 1.31.4,00 1.401.800 I.570.000 1.78.400 1.969.400

m1Wsnt Ratio (times 1.2 1.3 1.3 1.4 . 1.6 1. 7 1.7 1.7I 1.7 1.7 1.7 ICalLiAabizi Rat.eqio (ZineG)6.9 6.90 4.864.4 60 6.0 5.9 5.94 5.8T 15.99 14.12 16.1t 6t 18.0m 21 2077 21.76 21.81 22.29 22.15 22.4

Long-tern 8e~~~tlsquity (tines) S~. 74 4.32 4.4 8.29 0.1 8.0 622 6.4 035 846Tern z iTen Loan. (tinee) 32.984 324 3.28 3.95 4 32 4.23 4264 4.24 .252 4.24 84 25, 4. 25

Notet CupSlfW ac ratio does not reflect e4hted loan amounts by risk categories. TSre finea includs epity plus long tarn debtel tern l1am memo long-to

- 131 - hWSL 1

ItLutAWte an& CMe Wnel SA g1 Chia - Income Statem

for yg sded Deceuber i t°ie. t Mr 'M 4 A Pr 2t.t d

v,nc 2,S72 4,170 6,930 7,294 6,426 6,940 7,496 8,095 6,743 9,442later so 3w Oeskt vliB S 5 91 124 132 142 153 166 17 193

UC .S. tU.O. U.-S. aU.S. U.S. n.e. n.S. *.*. a.e. n.S.

Tetel I=9" Ll .4A_228 I.021 Zj_ 6.4 5 S Zs 7.649 S.26 8.922 9.638

m on deolt 87 37 692 809 723 781 843 911 984 1.063Inerest oa dttorr e 2,289 3,321 5,799 5.96 5,000 5,400 5,832 6,299 6,803 70347

as et 45 59 69 8S 9 10 119 131 144£delntoratte. buena.. ~~4 4 to 9 1 11 12 13Or.fer DOubtful Debts 0 15 2 3 4 4 4 4 4 4

ftoa. forhzer nLoee 0 0 0 0 0 0 0 0cIbe 49 60 94 106 102 107 113 119 126 133

rew i2663 1L 6.W52 6.9U 5.926 6j99 6 7911 7.463 8.059 8.703

0peratim LOAM3P46 387 368 J 632 L6_3 23S 2l 84S 932Leos Staff oi. nd Wolfer. Fund 16 18 26 31 51 61 46 71 77 83Los,s bDe lpm.ntfund 6 7 11 12 20 24 26 2S 31 33

cMe Before Incoug Tax 324 l MLj 427 561 38a 64 99 _ I S1J

to*$ Ifom tea 23 240 228 29* 392 423 438 495 335 578

let Income 109 JU In 135 169 In7 IL 220 12 S

Uccme toawe. ttSot

aertto 0.00 2.11 1.46 1.16 1.25 1.40 1.32 1.29 1.25 1.23 1.20not 3.melwe. total seete 0.00 0.71 O.75 0.35 0.61 0.65 o.9 0.57 0.56 0.35 0.54Not incomslsve. .9*Ays 0.00 11.91 12.82 9.93 11.73 13.18 11.22 11.65 10.08 8.72 7.96

1fUt. rte 7.00 7.50 I1.00 15.00 10.00 6.00 6.00 5.00 5.00 $.00 5.00Ree1 tax" .7.00 4.41 -5.1S .5.07 1.73 7.18 6.22 6.45 5.0S 3.72 2.96

Op t. & g_a. mp."n 0. tolcest 0.00 0.33 O." 0.46 0.4 0.54 0.54 0.53 0.52 0.51 0.51ntcome from LoenclIAw. loan portfolio 0.00 21.1S 18.35 26.63 2.53i 17.80 17.17 16.61 16.54 16.41 16.22Vinancal ExpeneoolAve. borrowIng. &de:tse 0.00 18.27 16.29 24.2 21.26 15.33 14.71 14.31 14.02 13.83 13.61

Interest MgTSU 0.00 2.91 2.08 2.10 3.27 2.47 2.45 2.50 2.52 2.56 2.61

Notes OperatIftlodInnIstetivs, expansees Icludes oteff bowsalvelts"e for ratio osnelylo.

- 132 - MNEX 15Attachment 2

tutrl end CNA rmcatl -k of ofin .

for year eaW beeembot 31 ssllc IV Ivs. Iw6esi 4yg pgY& jjA £131 1111 " eId IIU3 £1w0

MET!4 es 94 104 94 114 120 10 130 18 2S0

.ewedt etote 1,308 1,348 1,59 2,092 2,440 5,031 3,48 4,480 ,338 4,145

e's l°%sta/ 11,434 1,47. 4.0 t,9 1,801 19,775 321253 2.4S0 23.$90 24.360 25.520

Total Currt Aeet 12 14.014 16.6 19.987 IL 4I 24.4 26.218 2S220 P.87e lI.685

arog. Loan Portfolio 12.811 14.3SS 16.734 20,307 23.180 5.50o 27.75 s0.015 51,899 54,013Lten Workuin Capital loane 11,434 12,67 14,889 17,801 19,775 21,253 22,430 23,590 24.360 23,320

L e ..t.rn Loans 1.377 1.48I 1,865 2.306 3.405 4,247 5,525 ,423 7,539 8,493vbihe yuan 1,343 1,480 1,568 1,896 24604 3,330 4.270 3,210 *,140 7,080

Le-IP *W-0-7 p 34 205 297 410 797 917 1.035 1.213 1,599 1.613Laos* . vsai 0 13 16 19 23 27 31 35 39 43

Vat Loon-teno tLo 1.377 1.670 1.849 LML &M32 4t-#° LII4 JA90 7.500 8.650

4gc B sUN" 941 900 1,037 1,189 1,327 1,300 1,670 1,800 2,040 2,230Tr.aatd lusestmouto 0 0 0 0 0 0 0 0 0 0

Fled LAssts toast) a.e n., n.e n.e 1.e n., .S. .0. U.e U.eLas " *c. eprdcSation n.e U.S n.S U.* n.e n.4 n.e U.S U.a U.&

ftPzd A-to 59 94 99 113 146S in J 220 260 28

Other Astate 277 444 400 437 660 878 1,270 1,830 2,560 3,78

Total Asgte 13_61 17.144 20.039 jj.21W 28.048 31.162 h4.6# A 42 SAM 46.628

LThB!LI?I28 I ZUIST

Locaem P 4,021 4,293 483U 53,02 6,936 8,100 9.300 11,000 12,600 13,700Torefg currecy U.S. U.S. n.&. U.e. n.e. n.e. n.e. U.S. U.S. U.e.

Borrowial: (PlC) 3.532 4,083 4,894 5,639 5,919 *,200 6,500 5,394 3,417 1,826

Ln Star n.e. U.S. Q.&. n.S. n.S. n.S. n.S. U.S. U.e. n.S.iac l d U..S. U.S. U.S. n.S. n.e. U.S. n.S. U.S. ns.

aund In transt Ue. .e. U.S. U.e. U.S. U.&. n.e. U.S. U.S. .&.

Total Current Labilites 33 1 78 9.277 11.141 12J87L j4J%M A E0 1639" 16-017 1AIB6-ter M "1101MSw

oal T oa 3,323 3,713 5,091 4.684 8,188 9,600 11,400 14,400 17,900 21800?oren currency n.'e. n.S. U.'. nk.e. n.S. n.S. n.S. U.S. n.S. U.S.

Fi nanil Bonds 101 156 i6i 2536 315 330 580 420 430 $00L,4-terounRS gYC) 34 1S8 273 58 757 870 1,002 1,136 1,333 1340

auuqp Lss Proisions0 0 0 0 0 0 0 0 0 0

Total Loo-tern uSbltiaa 3.660 4.057 5.526 WM52 E 105S 00 12-982 16.176 19.683 25.840

A4ecy Busesn 855 906 991 1,149 1,409 1,60 1,700 18S0 1,120 2,350Tguot and luva.tment 0 0 0 0 0 0Otber LiblItiles 2,011 2,431 2,788 2,698 2,522 2,517 1,676 890 810 740

Total LiablSitie 14.099 ISMSl 18.383 22331 56.064 2977 12.15e X352 8.630 42.456

-w mcapital 771 771 771 771 771 771 771 871 971 1,171Retained lamingp 145 314 317 441 381 731 945 1,439 1,774 2,049

Nat operating Profit. 346 387 348 470 $32 468 736 798 843 932

Total tvu S914 985 1.088 1"S2 2M 1.302 1?736 2.310 2.743 3.240

Total Liabilities and Soultv 15.361 17144 20,039 24.2U13 2.048 31.162 51h 38.460 42.238 46-628

Wflante Ratio (time) 1.7 1.7 1.8 1.8 1.7 1.7 1.7 1.7 1.9 2.0Capital Adagucs Ratio (3) 7.15s 4.87 6.30 5.97 3.84 5.90 4.26 7.71 8.62 9.34Total Lib tleeloquit (time) 1S.39 16.01 17.00 18.59 19.20 19.29 18.52 15.30 14.07 13.10Long-tern dahtlequity (tbin.) 4.00 4.12 5.00 6,21 6.85 7.19 7.48 7.00 7.17 7.56ter finsncelTer Loas (time) 2.66 2.43 2.99 3.02 2.74 2.36 2.45 2.33 2.62 2.76

La Uaudited.notet Cpital aequc ratSo does not reflct wetigtd blen amounts by risk catarle. TeS fince mean. net long-tern lSbil-

itisa tar lo.t insn long-tarn l a balance shet.

Sourcet IIJC.

-133 - ANEX 16

TIAJIN IN TIh DEVELOEN PROJECT

The Bank of Communications (BOCOO)

1. The InstitutIon. BOCOM was first established in 1908 in Beijing toprovide long-term finan¢e to the transportation and telecommunications sec-tors. The bank was nationalized upon the founding of the PRC in 1949, but itsoperations were subsequently suspended until 1986, when it was reestablishedby the State Council and relocated in Shanghai. On March 10, 1987, PBCapproved BOCOM's charter to operate as a nationwide comprehensive bank underits supervision. It may raise funds and provide a full range of commercialbanking services in both local and foreign currencies, as well as establishingsubsidiaries, making equity investment, issuing guarantees, syndicating loansand issuing and trading securities domestically and internationally. It mayalso invest in or form joint ventures with overseas banks, finance companiesor enterprises, subject to the approval of PBC.

2. BOCOM's business develonm2ent strateay is described as a "three com-binations" strategy, combining domestic and international banking business,wholesale and retail banking and traditional and nontraditional operations.It has been one of the most innovative financial institutions in China, sincefrom its reinception it was allowed to select its own clients, to set upbranches where credit demand was greatest and to accommodate diversified own-ership at the branch level (branches are separate legal entities). Thisstrategy has enabled BOCOM to gain the full support of provincial and localgovernments.

3. BOCOM was the first bank to adopt a nublic shareholding system andto extend this to its branch network. PBC, as representative of the state,holds 100 percent of the head office shares, while the head office holds aminimum of 50 percent of the shares of each branch, with local governments,enterprises and individuals holding the balance. Each branch therefore is aseparate legal entity with operational autonomy and financial accountability.However, the head office exercises "unified leadership" over the branches inthe appointment and removal of principal staff, establishing operating poli-cies and plans, operating rules and regulations and foreign-related business.

4. BOCOM has 70 branches and subbranches In 69 cities, of which 27 areengaged in foreign exchange transactions, 29 handle insurance and 38 deal insecurities. BOCOM's recent financial performance has been very satisfactory.At the end of 1990, BOCOW had total assets of Y 78.5 billion, an increase of48 percent over 1989. Total loan portfolio increased at a lower rate (42percent), reflective of a lending slowdown, as the loan-to-deposit ratiodeclined from 106 percent at the end of 1989 to 88 percent a year later.Consequently, net profit increased 41 percent, to Y 1.6 billion, and return onassets showed a small decline from 2.2 percent to 2.1 percent. Nevertheless,BOCOC' a return on assets is quite high by international standards, and returnon capital employed (24 percent) is also very satisfactory.

- 134 - ANNEX 16

5. BOCOM's Tianiin branch was established on February 28, 1992 with apaid-in share capital of Y 205 million, of which BOCOM's head office holdsY 50 million, Tianjin Municipal Government, Y 100 million and 26 entities(factories, corporations and financial institutions) hold the balance ofY 55 million. Other than its share capital, BOCOI-Tianjin's major source offunds is deposits (Y 500 million). It will prepare its first annual financialstatement at the end of 1992, and it will be audited by the Tianjin AuditBureau. BOCOM-Tianjin has received the required authorizations to carry outforeign transactions and to become a participating financial intermediary(PFI) under the proposed TIDP.

6. BOCOM-Tianjin's manaRement consists of a general manager and twodeputy general managers. Together with three other senior staff and tworepresentatives of the Tianjin Municipal Government, they form a seven-membermanaging committee which is responsible for taking operational decisions.BOCOM-Tianjin has a total staff of 145, of which 50 are professionals. It isorganized into 12 departments, with one third of staff in the Credit andInternational Banking Departments. BOCOM-Tianjin will be responsible forappraisal and supervision of subprojects as a PFI for TIDP and will forwardeach subproject it finances to the Bank for review. Four professional and twosupport staff from the Credit and International Banking Departments have beenselected to form a long-term lending unit under the direction of the DeputyManager of the Credit Department, who would report to the Deputy General Man-ager for International Operations. Several staff are from CIB and have long-term laending experience. BOCOM has already begun working with CIB and willadopt the same project appraisal and supervision manuals developed by CIB forits own staff. Also, BOCOM is placing a great deal of emphasis on rapid ini-tiation of staff training in subproject appraisal and supervision and trainingcarried out before loan signing could be financed retroactively under theproposed project. However, BOCOM's participation in the TIDP will be limitedby the small size of its own equity and the corresponding limitation on itscam exposure to any single borrower.

7. BOCOM-Tianjin's main operating and financial policies have beenreviewed by Bank staff. These are now consolidating in a formal Statement ofOperating Policies and Procedures which establishes the basis for investmentfinancing activities, and provides prudential limits to safeguard its finan-cial condition, such as: (i) exposure in a single enterprise or group ofenterprises should not exceed 20 percent of its equity; (ii) the ratio ofcapital to different categories of assets weighed by their respective riskshould not be less than 10 percent; (iii) debt service and interest servicecoverage ratios should be not less than 1.5 times; (iv) the ratio of long-termdebt-to-equity would be limited to a maximum of 5:1; and (v) collectionsshould be not less than 90 percent of total repayments due.

8. BOCOM-Tianjin's financial forecast is supply driven, that is, it isgoverned by its capital structure and leverage limit rather than potentialcredit demand. Loan approvals in foreign exchange are estimated to be quitehigh ($256 million) in 1992, reflecting sizeable foreign exchange deposits itreceived following its inception, and would decline to $148 million in 1993and increase thereafter to $274 million in 1995. Local currency approvals(i.e., expected outstanding amounts under approved credit lines) wouldincrease from Y 2,298 million in 1992 to Y 5,000 million in 1995. This pat-

- 135 - ANNEX 16

tern of lending growth is consistent with BOCOM-Tianjin's commercial bankingorientation and the low leverage base from which it stsrted in 1992.

9. Financial Performance. Projected balance sheets and incame state-ments for NOCON-Tianjin for 1992-95 are provided in attachments two and threeof this annex. A net profit (after business tax) of Y 25 million is projectedin 1992 (10.9 percent return on equity and 2.1 percent on assets), rising toY 50 million in 1995 (19.7 percent return on equity and 1.8 percent onassets). The high return on equity is reflective of low initial leverage, andthe overall high returns are also due to the fact that BOCON-Tianjin is notsubject to income tax, since under the public shareholding system shareholderspay income tax on their sehare of net profits (66 percent of which is distrib-uted as dividends). BOCOM-Tianjin's expected reliance on borrowing to financegrowth is reflected in its debt-to-equity ratio, which would increase from4.2:l at year-end 1992 to 10.4:1 at the end of 1995. Long-term debt-to-equity, which would be limited under the TIDP to a 5:l maximum, would increasefrom 2.1:1 to 4.5sl. Overall, BOCOM-Tianjin's financial performance isexpected to be quite satisfactory.

- 136 - AML 16Attachment 1

CHI

TIANJIN INDUSTRIAL DEmELOPMENT PROJECT

Bank of Communication--Tianlin Branch

ODerations(Y million)

1992 1993 1994 1995 1996

AprrovalsLocal currency 2,298 3,223 3,600 1,200 5,000Foreign currency 256 148 246 252 274(* million equiv.) (16.8) (27) (45) (16) (50)

Total 2.551 3.371 3.846 4.452 5.271

CommitmentsLocal currency 2,039 2,901 3,559 3,821 4,879Foreign currency 230 153 230 241 252($ million equiv.) (12) (28) (42) (44) (46)

Total 2.269 3.057 3.789 4.062 5.131

Disbursement.Local currency 1,835 2,617 3,490 3,508 4,701Foreign currency 208 137 164 246 274($ million equiv.) (38) (25) (30) (45) (50)

Total 2.013 2.751 3.654 3 Z54 4.978

RenavmentsLocal currency 1,035 2,242 3,170 3,305 4,452Foreign currency 16 98 82 131 198($ million equiv.) (3) (18) (15) (24) (36)

Total 1.051 2.340 3.252 3.436 4.650

Net Loan PortfolioLocal currency 790 1,135 1,451 1,634 1,862Foreign currency 191 230 312 427 503($ million equiv.) (35) (42) (57) (78) (92)

Total 981 1.395 1.763 2.061 2.365

- 137 - AMW.N 16Attacbment 2

TLANJIN INDUSTRIAL DEVELOPMENT PROJECT

Bank of Communications--Tianjin Branch

IScome Statement(Y million)

1992 1993 1994 1995 1996

Income

Interest Income from LendinaLocal currency 57.9 91.6 119.0 142.0 162.0Foreign currency 8.4 11.6 14.3 20.3 23.3

Subtotal 66.3 103.2 133.3 162.3 185.3

Interest Income from DeliositsLocal currency 5.0 7.0 11.0 13.0 15.0Foreign currency - - - - -

Subtotal 5.0 7.0 11.0 13.0 15.0

Other Incame 3.0 3.2 5.0 5.0 5.0

Total Income 74.3 113.4 149.3 180.3 205.3

Exoenditureg

Interest (local) 40.8 66.0 88.0 104.0 115.0Interest (foreign) - - - - -

Fees (foreign) - - - -

Subtotal A0.8 66.0 88.0 104.0 115.0

Management and other fees 5.1 11.0 13.6 20.0 27.0Provisions - 1.0 1.0 2.0 2.0Depreciation 0.4 0.4 1.0 1.0 1.0

Total E,wenditureg 46.3 78.4 103.6 127.0 145.0

Profit before tax 28.0 35.0 45.7 53.3 60.3(les8) Business tax 3.0 5.0 7.0 8.8 10.0

Net Profit 25.0 30.0 38. 44.5 50.3

- 138 - NNEX 16AttahmteL_t3

TiAlAN UNMUSTRIAL DEVELOPNENT PROJECT

Bank of Communications--Tianjin Branch

Bslance Sheet(Y million)

1992 1993 1994 1995 1996

Assets

Current Asset.Cash and bank deposits 90 156 202 233 271Short-term loansLocal currency 690 1,035 1,345 1,548 1,780Foreign currency 191 219 247 269 284

Subtotal 881 1.254 1.592 1.817 2.064

Long-term loans (current)Local currency - 30 30 33 32Foreign currency - - 4 20 46

Subtotal - 30 34 53 78

Accounts receivable 75 75 75 75 75

Total current assets 1.046 1.515 1.903 2.178 2,488

Lona-term AssetsLoanst Local currency 100 100 106 86 82

Foreign currency - 11 65 158 219(less) Provision - (1) (1) (2) (2)

Net long-term loans 100 110 170 243 299Equity investment 10 10 10 10 10Net fixed assets 1 1 2 2 2Other assets 43 56 55 60 60

Total of lonA-term assets 154 177 237 315 371

Total assets 1.200 1.692 2.140 2,493 2.859

- 139 - ANNEX 16Attachment 3

1992 1993 1994 1995 1996

Liabilities & Shareholders equity

Current LiabilitiesAccounts payable 46 107 166 261 265Long-term liabilities (current) - 158 227 286 322Deposits 283 360 467 538 629Short-term liabilities 48 70 87 100 150

Total current liabilities 377 695 947 1.185 1.366

Long-term liabilitiesDomestic borrowing 525 671 795 810 919World Bank - 11 65 158 219ADB - -Borrowing in other countries - - - - -

Total lon1 -term liabilities 525 682 860 968 1.138

Other liabilities 68 80 90 90 100

total liabilities 970 1.457 1.897 2,243 2.604

Shareholders' EauitvPaid-in capital 205 205 205 205 205Retained earnings 25 30 43 45 50

total shareholders' equity 230 235 243 250 255

Total liabilities andshareholders' eauitv 1.200 1.692 2.140 2.423 2.859

- 140 - AW4EX 17

CRINA

TIANJIN INDUSTRIAL DEVRElOPI4ENT PROJC

Estimat,ed Dlsbursements La($ million)

Poft*le ESYear Period Amount Cumulative Sector Project

FY94 July-December 1.50 1.50 - -January-June 3.50 5.00 3 1

FY95 July-December 4.00 9.00 6 3January-June 5.50 14.50 18 6

FY96 July-December 10.50 25.00 34 13January-June 18.00 43.00 54 25

FY97 July-December 22.50 65.50 66 40January-June 30.00 95.50 74 60

PY98 July-December 25.50 121.00 78 78January-June 10.00 131.00 82 82

FY99 July-Decer-er 8.00 139.00 90 90January-Ju..e 3.00 142.00 94 94

FY2000 July-December 3.00 145.00 96 96January-June 5.00 150.00 98 100

FY2001 July-December - - 100 -

la Based on a disbursement profile of industrial development and financeoperations in China with adjustment for time needed in the first two yearsto create new corporations and reorganize the subsectors.

- 141 - ANNEX 18

CH

TIANJIN INDUSTRIA1 DEVELOPMENT PROJECT

Documents Available in the Prolect File

A-1 Report of Phase I study by AT Kearny on machine tools, constructionequipment, auto parts and electrwinics components subsectors

A-2 Report of Phase I study by Electric Design and Research Institute ofMMEI on electric motors subsector

A-3 Report of Phase IT study by International Business and TechnicalConsultants, Inc., International Development Ireland and TianjinInternational Engineering Consultants Corporation on machine tools,construction equipment, auto parts, electronics components and electricmotors subsectors

B-1 Charters for corporations prepared by Tianjin Municipality

B-2 Official Tianjin Municipal Government Statement on development programand strategies for the five subsectors of TIDP

B-3 Detailed working papers for TIDP