RESTRICTED

Report No. P-301

FILE Cut,

This report was prepared for use within the Bank and its affiliated organizations.They do. not accept responsibility for its accuracy or completeness. The report maynot be published nor may it be quoted as representing their views.

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

INTERNATIONAL FINANCE CORPORATION

REPORT AND RECOMMENDATIONS

OF THE

PRESIDENT

TO THE

BOARDS OF THE BANK AND THE CORPORATION

ON A

.PROPOSED BANK LOAN TO

THE PHILIPPINE NATIONAL BANK

FOR THE

DEVELOPMENT CORPORATION PROJECT

AND ON A

PROPOSED IFC INVESTMENT

IN THE SAME PROJECT

October 25, 1962

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INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELDYTINT

INTERNATIONAL FINANCE CORPORATION

REPORT AND RECOif,4ENDATIONS OF THE PRESIDENTTO THE BOARDS OF THE BANK AND THE CORPORATION

ON A PROPOSED BANK LOAN TO THE PHILIPPINE NATIONAL BANKFOR THE DEVELOP,ENT CORPORATION PROJECT

AND OM A PROPOSED IFC INVEST.ENT IN THE SAIE PROJECT

1. I submit herewith the following report and recommendations withrespect to the proposed loan, in various currencies amounting to the equivalentof US$15 million, to the Philippine National Bank (P1\NB) for relending tothe Private Development Corporation of the Philippines and a proposed IFCinvestment (including standby commitments) in the Private DevelopmentCorporation of the Fhilippines.

PART I - HISTORICAL

2. At the beginning of 1961, the suggestion of organizing a privately-owned development financing corporation was discussed in Mlanila betweenMr. Knapp and the then President of the Republic (President Garcia) andother prominent officials and private contacts, and received encouragingsupport. I then invited Mr. George D. Woods, Chairman of the First BostonCorporation, to serve as a special consultant to the Bank and IFC to investi-gate the need and desirability of setting up such a corporation in thePhilippines, and to assist, if the facts warranted, in the creation ofsuch an institution.

3. Hr. Woods visited the Plhilippines in July 1961 and reached theconclusion that the creation of a private development corporation wouldbe of important assistance to the Philippines and would comnand widespreadlocal support in the country. This conclusion was supported by the 1961Bank Economic Mission to the Philippines wlhich recommended that the highestpriority should be accorded to this project.

4. However, no further action was taken in 1961 because electionswere to be held in November and all important decisions were being deferred.President I;Iacapagal of the Liberal Party was then elected in the place ofPresident Garcia, and after taking office in January 1962, his Administrationconfirmed its support for the proposal to establish a private developmentcorporation. Accordingly, Hr. Woods returned to the Philippines in HIay.His report, dated June 4, 1962, wras circulated to the members of the Boardas an annex to R 62-59 dated July 20, 1962.

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5. In brief, Mr. Woods reaffirmed his previous conclusion that theestablishment of a private development corporation was well justified.After discussions in Manila, and in Washington with the Bank and IFC andwith the U.S. Agency for International Development (AID), he made thefollowing specific recommendations:

(a) the corporation should start with y id-up equity ofP25 million (about US$6.4 million)_7, 60 to 70% of thisstock to be subscribed by Philippine investors, and thebalance by foreign investors. He also considered thatan investment by IFC in the equity of the new corporationwould be desirable.

(b) P37.5 million (about p9. 6 million), should be providedby the U.S. Government as a long-term loan with a termof 30 years, repayments to be made in equal amounts fromthe 16th to the 30th years; free of interest or at anominal rate of interest; and in the event of theliquidation of the corporation, any part of the loannot then due for repayment to rank subordinate to theequity.

(c) the Bank should make a loan to the corporation in theamount of US$15 million.

The Government of the Philippines submitted a request to the U.S. Governmentto make available the long-term loan on the terms required, and in due coursethe U.S. Government agreed to do so subject to negotiation on the final terms.

6. During Mr. Woods' last visit in ilanila, a Steering Committee ofprominent Filipino businessmen was formed to take over the primary responsi-bility of working up this project. The members of the Steering Committeeare: Messrs. Francisco Ortigas, Jr., Chairman, a well knowm lawyeridentified with a number of important charitable and community projectsin the Philippines; Jesus Cabarrus, a prominent mining industrialist,President of the Mining Association of the Philippines; Manuel J. Marquez,President of the Bankers Association of the Philippines; Aurelio Montinola,a former Secretary of Finance and Chairman of several corporations in theconstruction industry. Mr. Washington SyCip, of SyCip, Gorres, Velayo andCompany, Certified Public Accountants, is acting as Secretary of the Steer-ing Committee, and Mr. Sixto Roxas, at that time Executive Vice Presidentof Filoil, agreed to serve as Consultant to the Committee.

7. Early in September, the Bank and IFC invited for negotiations theSteering Committee and representatives of the Government. Representativesof the PNB were also invited since the proposed loan is to be made throughthe PNB (see paragraph 27). The Steering Committee simultaneously startednegotiations with AID. The suggestions made by l4r. Woods were accepted byall parties concerned as a basis for negotiations. The negotiationswere concluded on October 11, 1962.

1/ At P3.9:351 which is the prevailing market rate.

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8. The proposed loan would be the Bank's fourth loan in thePhilippines. It would increase the total amount lent by the Bank tothat country to about $76.0 million, net of cancellations. Loanspreviously made are:

Amount of LoanYear Borrower Purpose Net of Cancellations

1957 National Power Corpcraticn Electric power (Binga) 4j18,500,000!/1961 Govermment Dredging 8,500,0001961 National Power Corporation Electric power (Angat) 34,000,000

2/Total net of cancellations 61,000,000-

of which has been repaid 987,000Total now outstanding 60,013,000

Amount sold 1`3,533,300of which has been repaid 987,000 2 ,56 300

Net amount held by Bank $57 466,700

1/ Original principal amount $21 million.2/ Undisbursed balance as of September 30, 1962, !38,040,h33.

PART II - THE PRIVATE DEVELOPi1q,1T CORPORATION OF THE PHILIPPINES

9. Purposes. The proposed Private Development Corporation of thePhilippines (hereinafter called the Corporation) will be incorpDrated inthe Philippines for the purpose of assisting privately-controlled industrialand other productive enterprises in the Philippines. The objectives of theproposed Corporation are stated in its Articles of Incorporation, a draftof which is attached hereto (No., 8). It will make medium and long-termloans, provide underwriting fahulities and invest in the equity of privateindustrial enterprises.

10. Resources. The share capital and loans proposed for theCorporation are as follows:

Equity P 25 million

U.S. AID loan 37.5 "

Bank loan US$15 million equivalent-/to 58.5 "

Total resources P121.0 million

1/ At P3.9:Z1 which is the prevailing market rate.

11. The equity of P25 million will be divided into 2,500,000 sharesof P10 each. In order to assure that the control of the Corporation willremain in Filipino hands, the capital stock is divided into two classes,namely, Class A shares, which shall comprise not less than 70% of theauthorized capital stock, to be subscribed and owned exclusively by citizensof the Philippines and IFC, and Class B shares, which shall comprise thebalance of the authorized capital stock, to be subscribed and owned byanyone, but initially intended to be subscribed and held mainly by a numberof foreign banking and investment institutions. Subscribers to the sharecapital wfill be required to pay 40% of the nominal value of the shares uponsubscription, and, thereafter, 15% every sixty days until the stock isfully paid up.

12. IFC is proposing to help raise the equity of the Corporation by(a) subscribing up to 80,000 Class A shares, (b) giving a standby commitmentin respect of 500,000 Class A shares less the amount alloted to it pursuantto the foregoing subscription and (c) giving a further standby commitmentwith respect to shares not fully paid up. The details of the proposed IFCinvestment and standby commitments are described in Part III. That partalso describes the situation with regard to the expected purchase of Class Bshares by overseas investors.

13. Reserve policy. The Articles of Incorporation of the Corporationprovide that the Board of Directors shall set aside annually a minimum of20% of the net profits after taxes in a reserve account until the same shallequal the amount of outstanding loans subordinated to equity. Monies in thereserve account would not be available for cash, bond or stock dividends.In addition, the Corporation is to agree with the Bank that at the outsetthe minimum to be set aside in the reserve accotnt shall be 50% of netprofits after taxes until the account shall have reached the amount ofP3 million (see Project Agreement, Section 2.15 and Attachment No. 5). Underthe proposed loan agreement with AID, the Corporation will make a similaragreement with respect to reserves and is also to agree that if the netprofits after taxes of the Corporation exceed an amount equal to 20% of thesum of paid in unimpaired capital and surplus of the Corp6ration (not includ-ing the amount in the reserve account) as of the beginning of the year in whichthe profits were earned, the Corporation shall set aside additional reservesamounting to 50% of such excess until the amount in the reserve accountequals the amount of the AID loan which at the time is outstanding but notdue and payable.

14. Foreign exchange risk. The Steering Committee of the Corporationagrees with the usually accepted practice that the exchange risk on allforeign exchange loans should be passed on to the borrowers from theCorporation. However, under Republic Act No. 529 of the Philippines, thereis a prohibition against the use of a gold, dollar or other currency equiva-lent clause in agreements contracted in the Philippines. Therefore, it.has been agreed that PNB, to which the proposed Bank- loan would be made forrelending to the Corporation, will assume that risk as long as Republic ActNo. 529 remains in force. PNB will make a single charge to the Corporation,for carrying the foreign exchange risk, of 2.96% on the cumulative amnountswhich shall have been disbursed under the Loan.

15. The Government has advised us that it proposes to seek an amend-ment to or repeal of Republic Act No. 529 early next year, when the Philip-pine Congress comes back into session, so as to permit PNB and theCorporation to enter into an obligation measured by a currency other thanPhilippine currency. After this amendment or repeal has become effective,the exchange risk will be passed on to the Corporation which in turn intendsto pass it on to the ultimate beneficiaries.

16. Directors and management. The Articles of Incorporation providethat the Directors of the Corporation shall be five until the first annualmeeting of stockholders, (to be held not later than sixty days after fullsubscription and allotment of the capital stock) and thereafter shall beeleven. Of the eleven Directors elected at the first annual meeting, eightmust be citizens of the Philippines and holders of Class A shares and shallbe elected solely by holders of Class A shares; the remaining three Directors,who must be holders of Class B shares, shall be elected only by the holdersof Class B shares. It is expected that one of the eight Directors electedby the Class A shares will be a representative of PuJB. The Steering Committeehas agreed to propose to the Board of Directors the appointment as ExecutiveVice President of the Corporation of a highly qualified and experiencedperson who has had more than thirty years experience in international andinvestment banking and industrial development in the United States, Europeand Latin America.

17. Business policies. The Steering Committee has informed the Bankthat they will recommend to the Board of Directors of the Corporation theadoption of the Statement of General Business Policies hereto attached(No. 10). Under the policies, the Corporation would undertake, inter alia:

(a) to assist in the economic development of the Philippines byencouraging the growth of productive enterprises in theprivate sector.

(b) to define the "privately-controlled industrial and otherproductive enterprises" as enterprises which are privatelyoperated and managed and in which private ownership is ofcontrolling interest (at least 2/3 of the voting stock).

(c) not to seek to control any of the enterprises that theCorporation finances.

(d) to diversify its investments.

(e) to set up a maximum amount of investment in any one enter-prise being financed as a percentage both of the Corporation'stotal assets (10%) and of the total assets of the investmententerprise (50%).

(f) to dispose of its equity investment in any one enterprisebeing financed as soon as this becomes feasible.

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(g) to distribute the ownership of the Corporation as widelyas possible.

(h) to base the decision to assist in any project or enterprisesolely on economic and business merits.

18. U.S. AID loan. The U.S. Agency for International Development isto lend to the Corporation the sum of P37.5 million with a term of 30 years,repayments beginning in the 16th year. The interest on the outstandingbalance of the loan will be 1/2 of 1% per annum. The main provisions ofthe draft AID agreement are the following:

(a) Separate fund: the proceeds of the loan shall be maintainedby the Corporation as a separate fund and commitments andinvestments made from this fund, with certain exceptions,shall not be made if disapproved by AID after consultationwith the Corporation. In this connection, AID has informedthe Corporation that it would not propose to review invest-ments already reviewed and approved by the Bank.

(b) Reserves: special provisions are included, as described in

paragraph 13 above.

(c) Required prepayment: in any year after the amount in thereserve account described above (see paragraph 13) equals theamount of the loan which at the time is outstanding but not dueand payable, 50% of the amount by which the net profits aftertaxes exceed 25% of the paid-in unimpaired capital and surplusof the Corporation (not including the amount in the reserveaccount) shall be applied to prepayment of the loan.

(d) Subordination: in the event of liquidation, the amount of theloan not then due and payable shall have a position subordinateto equity, provided, however, that any amount payable becausethe loan shall have been accelerated for breach of a covenant(other than covenant of payment) shall rank before any paymentto shareholders but after payment of all other outstandingdebts and liabilities of the Corporation.

(e) Impairment of capital: if at any time the assets of theCorporation exceed the liabilities (not including the paid-inunimpaired capital, surplus and reserves of the Corporationand the amount of the loan which at the time is outstandingbut not due and payable) by an amount equal to or less thanthe sum of (1) P25,000,000 and (2) one-half of the amount ofthe loan which at the time is outstanding but not due andpayable, AID may declare all or any part of such outstandingbalance and interest thereon to be due and payable immediately.

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PART III - PRCPOSKD IFC IIMVSTIENT

19. The Steering Conmittee has expressed a strong desire for IFCto take a moderate stake in the equity of the Corporation as evidence of its

confidence in the project. The Steering Committee considers that such IFCinvestment will assist in ensuring a good response to the proposed publicoffering of shares.

20. Overseas investors are impressed with the prospects for thecontinued industrial development of the Philippines and the role that aprivate financing corporation, such as the Private Development Corporationof the Philippines, can play in assisting the continued expansion of theprivate industrial sector. The high quality of the local sponsors of theCorporation, as reflected in the composition of the Steering Co)mmittee, hasdrawn a great deal of overseas support to this project. The shares availableto be held by overseas investors (investors who are not citizens of thePhilippines) are the Class B shares iThich comprise 750,000 shares of 10 each(approximately US;l.9 million). Prominent overseas investors wlho haveindicated their intention to make application for these shares include13 United States financing institutions, primarily Edge Act subsidiaries ofleading United States banks, a German bank, two British banks and possiblyothers. It is expected, accordingly,, that the Class B share issue will befully subscribed and, in fact, certain overseas investors will not be ableto obtain the full nunber of shares desired. In view of this position, itwould be undesirable for IFC to seek an allocation out of the Class B shareissue and it is proposed that IFC -jill subscribe to the Class A shares.

21. The Class A shares, which comprise 1,75O,000 shares of P10 each(approximately US6h.5 million), will be offered to, and can be held by,citizens of the Philippines and also by IFC; an IFC investment in theseshares wTould not have the wider market available to the Class B shares.It is the intention of the sponsors, fully supported by the PhilippineGovernment, the Bank and IFC, to attempt to spread shareholdings among thelargest possible number of shareholders in the Philippines, and this willrequire an extensive selling campaign to inform the smaller investorsregarding this opportunity. As there may be some lag in these shareholderscoming forward, the Steering Committee feels it desirable to arrange somestandby commitment for a part of the local share issue. The SteeringCommittee has asked IFC to enter into this conmitment.

22. It is proposed that, subject to certain conditions,:

(a) IFC will subscribe firm to 80,000 Class A share of P 10each (approximately USL:`2050O0), on the terms of theProspectus, on the understanding that IFCts applicationwill be scaled down as appropriate in accordance iwiththe allotment procedure adopted by the Corporation. IFChas informed the Steering Commnittee that it would expectIFC1s application to be scaled down so that the IFCallotment would be no greater than the largest allotment

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given to a Class B subscriber and, preferably, nogreater than the largest allotment given to a Class Asubscriber.

(b) IFC will also give a standby commitment for 500,000Class A shares of P 10 each (approximately US'Pl.28 million),less the amount of shares allotted to IFC under (a) above.For this standby commitment IFC would receive a commissionof - 105,000. If IFC has to take up any shares under thisstandby commitment, it would be IFCts intention to sellthese shares to investors in the Philippines at an earlydate.

23. In order to simplify the complex legal arrangements armong theparties, it has been felt essential to obtain some assurance that, ifsubscribers default in paying in the remaining 60% of the value of theseshares, after payment of the initial 40% on subscription (see paragraph 11),there are satisfactory arrangements to ensure that the shares on wJhichthere are such defaults are taken over and paid for in full. To meet thisrequirement, it is proposed that IFC enter into a standby commitment withthe Corporation to the effect that IFC pay in the amount unpaid on suchshares (after the initial 40% on subscription has been paid), with interestand expenses relative thereto, in exchange for transfer to IFC of all suchunpaid shares, provided that no other person is prepared to make an equallyfavorable or more favorable bid for such shares. For this standby commit-ment, IFC would receive a commission of P 60,000.

24. In my opinion, the risk involved in this latter standby commitmentis very small. Before IFC would be obliged to take over any shares underthis comnitment, subscribers would have to have forfeited the hLO%o or moreof the price of the shares already paid by them; even in such cases, it islikely that other buyers would be prepared to buy these defaulted sharesunder the procedure set out in the Philippine law at a lesser discountthan is represented by IFC's offer under this proposed commitment. However,the sponsors of the Corporation are arnxious to have this ultimate safeguardand a commitment by IFC of this nature will greatly simplifyr the legalarrangements by insuring full eventual subscription of the shares to be issued.

25. Full details of the above arrangements are contained in the draftLetter Agreement between IFC and the Corporation attached (No. 7).

PART IV - THE PROPOSED BANK LOAN

26. The main features of the proposed Bank loan are:

Borrower: Philippine National Bank (PNI3).

Guarantor: Reoublic of the Philippines.

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Amount: In various currencies equivalent to$15 million.

Purpose: Proceeds of the loan to be relent bythe Philippine National Bank to theproposed privately-owned and managedPrivate Development Corporation of thePhilippines, which would (a) make mediumand long-term loans, (b) provide under-writing facilities, and (c) invest inthe equity of private industrialenterprises.

Amortization: At the time each part of the loan iscredited to the Loan Account, the Bankand the Corporation will agree on anamortization schedule for repayment ofthat part. These amortization scheduleswill provide for semi-annual repaymentson January 1 and July 1 in each year andfor final repayment not later thanJanuary 1, 1978.

Interest Rate: Wfhen a part of the loan is credited tothe Loan Account, the rate of interestcharged on that part will be the Bank'srate current at the time the credit ismade.

Commitment Charge: 3/4 of 1% per annum from the time theLoan Account is credited, on the amountso credited.

27. Under existing legislation the Philippine Government is notauthorized to guarantee a Bank loan to a private corporation, although itis expected that new legislation to authorize such a guarantee will beenacted at a later date. Therefore, in order to avoid delaying the projectand since the Philippine Government may guarantee loans to corporations ownedor controlled by the Government, it is proposed to make the loan to PNB, acorporation the shares of which are almost wholly (99.7%) owned by thePhilippine Government (see Note on the Philippine National Bank,attached(No. 11)); PNB in turn would relend the funds to the Corporation.

28. Since the loan is for the benefit of the Corporation, a directworking relationship between the Bank and the Corporation has been es-tablished by means of the Project Agreement. Insofar as the carrying outof the Project and the operation of the Corporation are concerned, this

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Agreement gives the Bank substantially the same rights it normally obtainsin its agreements with similar financing corporations. Among other things,it provides that:

(a) investment projects (requiring finance from the Bank)whose foreign exchange costs shall equal or exceed a limitto be agreed from time to time between the Bank and theCorporation are subject to the Bank's approval (LoanAgreement, Section 2.02(b) and (c), and Project Agreement,Section 2.03(b) and (c).) For the time being, it isproposed to set that limit at $100,000.

(b) the Corporation shall not incur, assume or guarantee anydebt in excess of three times the aggregate of (a) theequity and (b) the outstanding portion of the AID loannot due for payment (Project Agreement, Section 2.09).

29. PNB will, under the terms of the Subsidiary Loan Agreement, givethe Corporation the greatest freedom possible in the use and administrationof the proceeds of the loan; as a consequence, PNB is to delegate to theCorporation most of its rights under the Loan Agreement (Subsidiary LoanAgreement, Section 3), including the right to withdraw moneys under theBank loan.

30. Other important conditions under which PNB would relend theproceeds of the Bank loan to the Corporation are the following:

(a) Until Republic Act No. 529 is appropriately amended orrepealed (see paragraphs 14 and 15 above), the amountswithdrawn under the Bank loan will be reloaned in pesosequivalent to such amounts.

(b) If and when Republic Act No. 529 is appropriately amendedor repealed PNB will relend to the Corporation the amountswithdrawn from the Loan Account in the various currenciesso withdrawn.

(c) Arrangements for repayment by the Corporation to PNB willbe such that the foreign exchange risk will be borne byPNB until Republic Act No. 529 is so amended or repealed;thereafter the foreign exchange risk will be passed on tothe Corporation. (As noted above (paragraph 15) theCorporation would pass it on to the ultimate beneficiaries.)

(d) To cover its expenses, PNB will charge the Corporation0.443% per annum over and above the rate of interest whichPNB has to pay to the Bank. As already mentioned (seeparagraph 14 above), PNB will further charge the Corporationfor carrying the foreign exchange risk. These charges willbe subject to review when appropriate.

PART V - LEGAL INSTRUMENTS AMD LEGAL AUTHORITY

31. The following draft documents are attached:

1. Loan Agreement between the Bank and PNB (No. 1).

2. Guarantee Agreement between the Republic of the Philippinesand the Bank (No. 2).

3. Project Agreement between the Bank and the Corporation(No. 3).

4. Subsidiary Loan Agreement between PNB and the Corporation(No. 4).

5. Letter from the Corporation to the Bank regarding thereserves policy (Section 2.15 of the Project Agreement),(No. 5).

6. Letter from the Corporation to the Bank regarding the limitapplicable for approval of investment projects by the Bank(Section 2.02(b)(ii) and (c) of the Loan Agreement), (No. 6).

7. Letter agreement between IFC and the Corporation (No. 7).

In addition, drafts of the following documents concerning the Corporationare attached: Articles of Incorporation (No. 8), By-Laws (No. 9), Statementof General Business Policies (No. 10). Also attached are a Note on thePhilippine National Bank (No. 11), and the report of the Committee providedfor in Article III, Section (iii) of the Articles of Agreement of theBank (No. 12).

32. Conditions of effectiveness of the Bank Loan Agreement include,among other things, (i) that the Corporation shall have been incorporated,(ii) that the share capital shall have been fully subscribed and at least40% paid in cash at par, and (iii) that the AID agreement shall besatisfactory to the Bank and that conditions precedent to disbursementthereunder shall have been fulfilled. Disbursements under the AID loanin turn are conditional among other things upon the effectiveness of theBank Loan Agreement.

33. Subscriptions to the share capital of the Corporation, includilgsubscriptions by IFC, will be accepted only if certain conditions are ful-filled, namely, the Bank and AID loan agreements shall have become effectiveand the share capital shall have been subscribed in full. It is expectedthat the offering of the shares of the Corporation will be made during thelatter part of this year and that upon successful completion of the offeringthe Bank Loan Agreement and the AID agreement will become effective.

34. The Guarantee Agreement follows the normal pattern of the Bank'sguarantee agreements.

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PART VI - APPRAISAL OF ThE PROJECT

Economic Situation

35. The economic background against which the proposed loan should beconsidered is described in the attached "Memorandum on the Economic Situation"dated October 25, 1962 (No. 13). As indicated there, the past year haswitnessed several major changes in the Philippine economic policy. The newGovernment which was elected last November took action in January to dis-mantle fully the system of foreign exchange controls which had been in forcefor over ten years. Simultaneously, credit restrictions were introduced andsteps taken to eliminate the Government's budget deficit. The peso wasallowed to float and has now stabilized at a realistic rate for the firsttime since the war. These measures reversed the decline in exchange reserveswhich started in 1961, and they promise to lead to a further strengtheningof the external position in the coming year.

36. The Government has also adopted a new Five-Year Economic Programand, for the first time, has taken vigorous administrative action to ensureeffective implementation of such a program. This Program incorporates recom-mendations made by the Bank Economic Mission which visited the Philippinesin the summer of 1961 at the request of the previous Administration. TheMission's preliminary reportl/ was submitted to the Government last Januaryand was published as an annex to the President's State of the Nation Message.The Bank has also been providing technical assistance in implementing theProgram.

37. These initiatives are directed at meeting the Philippines' basiceconomic development problem, which is essentially one of maintainingadequate growth rates of per capita income and employment in the face ofa rapidly expanding population and a stagnation in the traditional sourcesof external earnings. Its solution will require a substantial increase ininvestment to help diversify production and increase productivity. Themanufacturing sector will have to play a key role in this process.

Justification of the Project

38. The past decade has witnessed a remarkable growth in Philippinemanufacturing. Output tripled in the ten year period 1950-60, and nowaccounts for around 17% of the national product - a comparatively high pro-portion for a country whose per capita income is about P150 Private foreigninvestors have played a significant role in this development, but the greatpart has taken place under private Filipino initiative and ownership. Inthe early 1950's, the Government set up a number of manufacturing establish-ments, but started selling them in 1957, and now is practically out of thefield altogether.

39. The great part of manufacturing investment since the war has beenfinanced with short and medium-term loans. The equity base has been smalland long-term loan capital has been quite limited. About the only domestic

1/ Report No. FE-23, dated January 19, 1962, "ECONONIIC GROWTH OF THiE PHILIP-PJIES - A Preliminary Report Prepared by the Bank Staff" which was distributedto the Executive Directors of the Bank on January 19, 1962 (Secm62-20).

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sources of long-term loan capital have been the Government-ouned DevelopmentBank of the Philippines (DBP) and the U&S. sponsored Tndustrial DevelopnentCenter. In 1956-60, it is estimated that these sources financed 15-20%of industrial investments, which were around - 1.2 billion for the fiveyear period, Financing through short and medium-term loans was madepossible by high profit rates resulting from the very favorable treatmentgiven domestic producers by the Government tax and import licensing policies.In the past three years, however, these privileges have been progressivelyreduced, and by 1960 many firms started to experience serious problemsas the result of their financing arrangements. In 1961, as the squeezebecame more general, the DBP extended industrial loans of over P 00 million,an amount which approximately equalled total investment in manufacturingfor the year. A large part of this consisted of refinancing commercialbank loans and foreign suppliers' credits. In 1962, the DBP has been ableto provide very little further help because it has reached the limit ofits authorized capital.

40. WJith profits now at more normal rates, an increase in the supplyof long-term risk capital for industry would be necessary just to mqaintaininvestment at its past rate. But the requirements will be very much higherif manufacturing investment is increased on the scale envisaged both bythe Governmient's Five-Year Program and by the Bank Economic .Mission. 1/The Itission estimated that to maintain an adequate growth rate for theeconomy as a whole, manufacturing investment of more than P3 billion wouldbe necessary in the next five years, or about twice the 1956-60 level inreal terms. A major consideration underlying this projection is thatindustrial development has now reached a point where it has become economicto substantially increase the proportion of investment going into capital-intensive types of production based on domestic raw materials, such asmineral processing, fertilizer, industrial chemicals, wood products, etc.The likelihood that such a shift will talce place has been greatly increasedby the recent change in the exchange rate, which will make such investmentmore profitable than in the past, and at the same time reduces the profita-bility of light manufacturing based on imported raw materials.

41. The Droposed Private Development Corporation can play a Ikey rolein meeting these expanded financial requirements. First of all, it woulddirectly increase the supply of long-term loan capital and equity funds forindustry. Second, and perhaps more important, it would help to widen thecapital market in the country and thereby to stimulate the inflotr ofequity and long-term funds from other sources - both domestic and foreign.Finally, as its management gains experience, it will be in a better positionthan almost any other institution in the country to provide guidance onboth the opportunities and pitfalls associated with the shift away from thesimpler manufacturing technoloQr of the past to the more complex andcapital-intensive activity likely to dominate future development.

1/ See "ECONOMIC GROWiTH OF THE PHILIPPINE,S" especially pp. 19-30.

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Prospect of Fulfillment of Obligations

42. I believe that the proposed resources, the management and thepolicies of the Corporation are such as to ensure a significant andvaluable contribution by the Corporation to the development of privateindustry in the Philippines and at the same time to ensure a profitableemployment of its resources. I also believe that P\B is an acceptableborrower as an intermediary for the proposed Bank loan.

43. Present external debt of the Philippines amounts to I.h30 millionmost of which consists of medium term credits to the private sector. Thebulk of these will be repaid in the next several years, and total serviceon present debt will drop from an estimated peak of 10% of export earningsin 1964 to 5% by 1968. Thus, there remains considerable scope foradditional debt on conventional terms, provided it is of a reasonablylong-term nature. The repayment of the proposed 3l5 million Bank loanshould be within the capacity of the Philippine economy.

PART VI - COMPLIANCE WIJITH THE ARTICLES OF AGREENELET

44. I am satisfied that the proposed Bank loan complies with therequirements of the Articles of Agreement of the Bank and that the proposedinvestment by IFC complies with the requirements of the Articles of Agreementof IFC. The Philippine Government has advised IFC that it has no objectionto the proposed investment by IFC.

PART VII - RECOISHvMDATIONS

45. There is still a number of legal and procedural matters whichhave to be taken care of before the Corporation can be organized and theProspectus issued. In addition, while we have agreed in substance withthe terms of the AID loan agreement, there are still several draftingpoints remaining to be agreed. For these reasons it is not intended tosign the Bank's Loan and Guarantee Agreements until arrangements regard-ing these matters have substantially been completed. Furthermore, it maybe necessary, because of changes in certain documents relating to thesetransactions, to make consequential changes in the Bank's draft agreementspresented herewith; accordingly under the draft Bank Resolution proposedhere for adoption (No. 1h) we would have the power to make changes inthese documents which would not be substantial.

46. I recommend

(a) that the Bank make a loan to the Philippine NationalBank, with the guarantee of the Republic of thePhilippines, for relending to the Private DevelopmentCorporation of the Philippines upon its incorporation,in an amount in various currencies equivalent to 15million for a term of 15 years at such rates ofinterest and substantially on such other terms andsubject to such other conditions as are specif.ed inthe draft Loan, Guarantee, Project and Subsid..-½ryLoan Agreements attached, and that the Bac-k's Execu[;JveDirectors adopt a resolution to that effect in the i.-rmattached (No. 14); and

(b) that the proposed subscription and standby conmitmentsby IFC be approved on substantially the terms outlinedabove, conditional upon the Prospectus offering theshares of the Corporation and any other legal documentsbeing satisfactory in form and substance to IFCtsmanagement; and that the Board of Directors of IFCadopt a resolution in the form attached (No. 15).

Eugene R. Black

Washington, D.C.October 25, 1962