Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. P-4558-BD

REPORT AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL DEVELOPMENT ASSOCIATION

TO THE

EXECUTIVE DIRECTORS

ON A

PROPOSED CREDIT

IN AN AMOUNT OF SDR 147.8 M'LLION

TO THE PEOPLE'S REPUBLIC OF BANGLADESH

FOR AN

INDUSTRIAL SECTOR CREDIT

May 18, 1987

This document has a restricted distribution and may be used by recipients only In the performance oftheir official duties. Its montents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

The external value of the Bangladesh Taka (Tk) is fixed in relation to abasket of reference currencies, with the US Dollar serving as interventioncurrency. The official exchange rate on March 7, 1987 was Tk. 30.77 buyingand Tk. 30.83 selling per US Dollar.

ABBREVIATIONS AND ACRONYMS

ABW - Autonomous Bodies Wing (Ministry of Finance)BSB - Bangladesh Shilpa BankBSRS - Bangladesh Shilpa Rin SangsthaCCPE - Council Committee on Public EnterprisesDEDO - Duty Exemption/Drawback OfficeDFI - Development Finance InstitutionEPZ - Export Processing ZoneCDP - Gross Domestic ProductNBR - National Board of RevenueNCB - Nationalized Commercial BankNGO - Non-Governmental OrganizationNIP - New Industrial PolicyPFP - Policy Framework PaperPSE - Public Sector EnterpriseQR - Quantitative RestrictionSAF - Structural Adjustment FacilitySFYP - Second Five-Year PlanTFYP - Third Five-Year Plan

FISCAL YEAR

July 1 - June 30

FOR OFFICIAL USE ONLYBANGLADESH

INDUSTRIAL SECTOR CREDIT

Table of Contents

Page No.

CREDIT SUMMARY

Io THE ECONOMY .................................................. 1

Background I................................. Recent Economic Developments ............................... 2Development Strategy .... ............................... 3Financing Needs and Prospects .............................. 5

II. BANK GROUP OPERATIONS IN BANGLADESH * ......................... 6

III. INDUSTRIAL SECTOR *........................ 8

Sector Context ... ....................... ..... .......... 8The New Industrial Policy (NIP) ............................ 10

IV. INDUSTRIAL POLICY FRAMEWORK AND REFORkS UNDER THEPROPOSED SECTOR CREDIT .....e....o............ ee.ee.. o.., 12

A. Export Policies and Administration ..................... 12B. Tariff and Import Regime ......... ..................... 16C. Investment Sanctioning .......... ...........o.... 22D. Public Sector Industrial Enterprises ................... 24E. Financial Sector Issues .. **.....**.......**....... 26

Origins of Recovery Problem ............................ 27DFI Action Program ....*0O* ....... ...................... 28Establishment of Credit Discipline ..................... 28Institutional and Financial Rehabilitation of the DFIs . 30DFI Autonomy .......................... *... ...... . 30Financial Restructuring ................................ 30Institutional Strengthening of DFIs ..... ............... 31

V* THE CREDIT ........................... .............. **.* .... 31

Procurement and Disbursement ............................... 31Tranching ...... . 32

VI. COLLABORATION WITH THE IMF. .. . ..... *.*.*. 33

VII. RECOMMENDATION ............*...................*....... 34

Annex I: Economic IndicatorsAnnex II: The Status of Bank Group Operations in BangladeshAnnex III: Summary of Actions and Implementation Schedule

This documont ha a festicted distbuon and may be used bg -V in the pformanceof tei offica dues Its contents may not otherwbe be disb 44 Bank authofuztion.

BANGLADESH

Industrial Sector Credit

Credit Summary

Borrower: People's Republic of Bangladesh

Amount : SDR 147.8 million (US$190 million equivalent)

Terms s Standard

Purpose s The Credit will provide foreign exchange to finance generalimports. In order to attain the objective of achieving highrates of industrial growth to meet domestic demand, expandexports and create employment outside agriculture, theGovernment has agreed to undertake a major industrial policyreform program. The reform program covers (a) developingand improving administrative and financial arrangements forimplementation of export policies; (b) rationalizing thestructure of protection; (c) liberalizing the investmentapproval system; (d) improving the central monitoring of theperformance of public enterprises, while granting them moreautonomy and strengthening their management; and(e) improving the efficiency of the industrial creditsystem.

EstimatedDisbursements: The proposed Credit would be available for disbursement in

two tranches: SDR 77.8 million (US$100 million equivalent)upon credit effectiveness and the remaining SDR 70.0 million(US$90 milli,'n equivalent) subject to Government meeting thespecific conditions listed in Annex III and following areview, no later than January 31, 1988, that sound industrialsector policies are being followed. It is expected thatcredit disbursements of about US$15 million equivalent willtake place in FY87 and US$175 million equivalent in FY88.

INTERNATIONAL DEVELOPMENT ASSOCIATION

REPORT AND RECOMMENDATION OF THE PRESIDENTTO THE EXECUTIVE DIRECTORS ON A PROPOSED

INDUSTRIAL SECTOR CREDITTO THE PEOPLE'S REPUBLIC OF BANGLADESH

1. I submit the following report and recommendation for a proposedIndustrial Sector Credit to the People's Republic of Bangladesh in an amountof SDR 147.8 million (the equivalent of US$190 million), on standard IDAterms, to provide foreign exchange for financing general imports. The creditwould support the Government in implementing policy ard institutional reformsin tne industrial sector.

PART I - THE ECONOMY

2. A Country Economic Report, "Bangladesh: Promoting Higher Growth andHuman Development" (Report No. 6616-BD, dated-March 10, 1987) was distributedto the Executive Directors on March 16, 1987.

Background

3. Bangladesh has a very high population density, limited naturalresources and widespread poverty. Annual per capita income is currently onlyabout $150; its continued high rate of population growth remains a majorconstraint on development.

4. Agriculture is the mainstay of the economy, accounting for about halfof the Gross Domestic Product (GDP) and three quarters of employment andexports. Despite good progress in agriculture, food production remainsvulnerable to natural disasters, and the country continues to require annualfoodgrain imports of about one tenth of total consumption. In addition,agriculture has not been able to fully absorb the rapidly growing laborforce, nor to generate adequate foreign exchange earnings. Therefore, growthin industry, which accounts for about 10 percent of GDP, and expansion inlabor-intensive exports have become important development objectives.However, Bangladesh's labor force is largely unskilled and lacks theeducation, health and nutrition necessary for this transition. The adultliteracy rate is only about 262, and per capita public expenditure on educa-tion is among the lowest in the world. Other constraints on industrialdevelopment include weak infrastructure (power, transportation), inefficientpublic enterprises, restrictive trade and payments policies and a weak domes-tic financial system.

5. The economy is also characterized by a very low savings rate, whichin part reflects the low level of incomes, and by a large structural paymentsgap. Remittances account for half of national savings, which in turn financeless than half of total investment in the economy. Export earnings cover

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only one third of the import bill, with raw jute and jute goods stillaccounting for over half of total merchandise exports. The capacity tofinance imports can be severely affected by external factors (e.g., fallingjute prices, declining remittances) largely beyond the Government's control.Inadequate growth in domestic resources also seriously constrains the financ-ing of key public investments as well as the operation and maintenance ofexisting assets.

6. Despite these constraints and repeated disruptions caused by naturaldisasters, Bangladesh has made significant progress in the 1980s. Notably,policies designed to strengthen the agricultural, industrial, and exportsectors have been adopted, permitting the economy to grow by about 4X peryear during the Second Five-Year Plan (SFYP) (FY81-85). 1/ Foodgrain produc-tion growth averaged 3.52 per year during the same period despite adverseweather conditions; this was faster than in the 1970s and significantly abovethe rate of population growth. Industrial output, which stagnated in theearly 1980s, has rebounded, led by efficient import substitution and exportoriented, labor-intensive activities. Von-traditional exports have grown onaverage by over 20% per year in the 1980s, and development of domestic com-mercial energy supplies, especially natural gas, has increased rapidly,enabling relatively high growth in the power and fertilizer sectors andsignificant import substitution of petroleum products.

Recent Economic Developments

7. The Government has continued to make progress during FY86 and FY87towards creating a stable and undistorted economic environment. Monetaryexpansion has been brought under control, and in response to prudent demandmanagement, the balance of payments and budget deficits have been broughtdown to manageable levels and the rate of inflation has fallen to about 10.The official exchange rate has been adjusted frequently in small steps toimprove and maintain competitiveness. The real effective exchange ratedepreciated by 12% in FY86; although a small appreciation of 4% occurred inthe first six months of FY87, this has recently been reversed. In addition,the authorities have expanded the share of the transactions conducted at the(free) -icondary market rate, and the gap between the official and secondaryexchange rate has narrowed from 151 in PY85 to an expected 7% in FY87.

8. Interest rates continue to be maintained at positive real levels,and while there is a need to increase the flexibility of the interest ratestructure, their general levels are for the most part sufficient to encouragesavings. Agricultural pricing policies are also more efficient than in manyother countries. Domestic farmgate prices generally reflect internationalprices, providing appropriate signals to farmers. Finally, trade and

1/ Almost all data in Bangladesh refer to the financial year (FY) whichruns from July 1 to June 30.

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industrial policies (tariffs, quotas, restrictions and licenses) have beenimproved markedly since 1982, but especially in FY86 and FY87. However,these improvements are only the first step in a phased program, and there arestill excessive distortions in the trade system, especially due to high andvariable tariffs.

9. The last two years have also witnessed some disappointments. Overallreal GCP growth in FY86 was 3.9%, lower than the previous two years and wellbelow the Third Five-Year Plan (TFYP) (FY86-90) goal of 5.4X. Industrialexpansion of only 1% in FY86 was well below the 9Z annual rate of the pre-vious two years, and the agricultural sector appears to be losing its growthmomentum; foodgrain productior. fertilizer consumption, agriculture creditand investment in irrigation equipment all fell in FY86 for the first time inmany years. In addition, the deterioration in credit recovery rates for bothagricultural and industrial loans led to serious resource misallocation andharsh inequities. The Government has recently taken strong steps to restorefinancial discipline, and data for the July 1986-March 1987 period show anencouraging improvement.

Development Strategy

10. The alleviation of poverty remains the cornerstone of theGovernment's development strategy. In the first ten years of Independence(1912-1981), the proportion of the population in extreme poverty (thoseunable to afford enough food to live a reasonably active life) rose from 43%to 50%. Real wages fell, and the quality of the diet worsened. Since 1982,this deterioration appears to have been arrested. More food has been madeavailable to lower income groups, partly through the rapid expansion ofFood-for-Work and Vulnerable Group Feeding programs, and real agriculturalwages have risen, recovering to their pre-Independence levels in 1986 for thefirst time. The incidence of poverty appears to have declined slightly,although the absolute number of poor has continued to increase and the mag-nitude of poverty remains overwhelming.

11. The Government has recognized that sustaining and extending thesemodest gains in poverty alleviation will require progress on two fronts.First, overall economic growth must be raised, and second, increased emphasismust be given to human development programs and to special interventions toaid those who tend to be by-passed by overall economic growth.

12. The TFYP seeks to raise the GDP growth rate to over 5Z per year.This will require raising both investment and savings as a proportion of GDPby about 2 percentage points each year over the five-year period and increas-ing the efficiency of investment. The Government's policy priorities weredescribed in its Policy Framework Paper, discussed by the Committee of the

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Whole on January 29, 1987. 1/ Six areas of particular emphasis weredescribed:

- restoring the momentum of growth to the agricultural sectorthrough improved service delivery;

- extending the process of industrial reform initiated underthe New Industrial Policy through deregulation, tradelih-'ralization, privatization and promotion of non-traditionalexports;

- ensuring international competitiveness and balance ofpayments stability through flexible exchange rate managementand prudent borrowing policies;

- strengthening the domestic fiuancial system throughrehabilitation of the Development Finance Institutions, sternaction against defaulters and the gradual establishment ofa more autonomous, accountable banking system;

- mobilizing additional public revenue through an enhancedtax effort, subsidy reductions and public pricing policies; and

- improving the efficiency of public expenditure through expandedoperation and maintenance allocations, stricter evaluation ofinvestment projects and improved project implementationcapacity to use available external assistance more effectively.

13. Overall economic growth, even if over 5X per year, will be insuffi-cient to ensure adequate alleviation of poverty. Special interventions toprovide economic opportunities to the most vulnerable, including the landlessand women, are a necessary complement to sound economic management. A numberof innovative approaches involving the provision of credit, functional train-ing and market information to groups of poor men and women have recentlyyielded encouraging results. Non-Governmental Organizations (NGOs) areplaying an especially important role in this regard, and the Government iscurrently exploring the scope for improved partnership with the NGOs in theexpansion of these programs.

14. The Third Five-Year Plan also gives a higher priority to humandevelopment programs than in the past. Health and education indicatorsremain unacceptably low, and performance in Bangladesh continues to compareunfavorably with other countries at a similar stage of development. Childand infant mortality rates, for example, are twice the average rates for

1/ See "Bangladesh: Policy Framework Paper for the Period July 1986 - June1989", dated January 15, 1987 (IDA/SecM87-12).

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low-income countries, literacy rates are among the lowest in the world, thepopulation per nurse is still over three times the average for low-incomecountries in Asia and the Pacific, and easily avoidable diseases stillaccount for a substantial proportion of deaths.

15. Assisted by IDA and other donors, the Government is giving a highpriority to both expanding the coverage and improving the quality of humandevelopment programs. In health and family planning, emphasis needs to begiven to improving internal efficiency and program management, strengtheningmother and child health care, improving coverage in urban areas and harness-ing the unique strengths of the NG0s. In education, further efforts must bemade to reduce wastage and expand non-formal education opportunities.

Financing Needs and Prospects

16. Achieving the goals of higher growth and enhanced human resourcedevelopment will require increase4 foreign aid flows. Total disbursements of$5.5 billion are likely to be required over the remaining three years of theTFYP period (FY88-90). This compares with disbursements of US$3.9 billion inthe most recent three years (FY84-86), representing a real increase of 201for the period as a whole. Over half of the increased flows can come fromimproved implementation performance of the large existing undisbursed projectaid pipeline (currently standing at over US$4.6 billion). No real increasesin project aid commitment levels (currently about US$1.1 billion per year)will be required. Food aid will also continue to be required at about itspresent level of US$250 million per year to help bridge the gap betweendomestic production and effective demand, and to provide for vulac-able groupprograms. Finally, commitments of quick disbursing program aid will need torise by about 5% per year in real terms. About US$1.7 billion of disburse-ments of this form of aid will be required over the three-year period.

17. With good progress in implementing the policy reform package, andwith careful aid coordination, almost two-thirds of the need for quick dis-bursing aid is expected to be available from bilateral and other multilateraldonors. IDA would need to finance the remaining one-third, or about US$600million during the three year period. In addition to the proposed IndustrialSector Credit, IDA's program tentatively includes quick disbursing credits tosupport policy adjustments and institutional strengthening in the financial,energy, education and agriculture sectors, and a Structural AdjustmentCredit.

18. This level of borrowing is not expected to place excessive strainon Bangladesh's debt servicing capacity. While the debt service ratio(including obligations to the IMF) has risen over the last three years, from16% in FY84 to 30% in FY87, this has been due primarily to repurchase obliga-tions to the Ih' and to repayments of commercial food loans necessitated bythe 1984 floods. The ratio will fall to 21% in FY88 and is projected tolevel out below 20% in the l990s.

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PART II - BANK GROUP OPERATIONS

19. Cumulative Bank Group commitments to Bangladesh total US$3,709.9million equivalent. This figure includes reactivation of eleven credits(US$154.4 million) made to Pakistan before 1971 as well as a consolidationloan (US$54.9 million) and a consolidation credit (US$37.5 million) approvedin 1975 to cover liabilities arising from projects complet-d prior toIndependence. IDA has approved 96 new credits since Bangladesh became amember in 1972. Of the total IDA comnitments, approximately 20% have beenfor agriculture, irrigation and rural development, 17% for power and energy,9% for industry, 8% for education and technical assistance, 6% for transpor-tation and telecommunications, 3% for population control, 3% for urbaninfrastructure, and 34% for imports program support. Since Bangladesh becamea member of IFC in 1976, five investments have been approved.

20. IDA chairs the annual BangLadesh Aid Group meeting which provides aforum for donor consultation, and IDA's Resident Representative chairsregularly scheduled donor meetings in Dhaka to exchange views on policyissues, project implementation and aid coordination. In November 1986, IDAchaired a special meeting of donors and Government repreeentatives, hostedby the Federal Republic of Germany, to review programs to assist the ruralpoor in Bangladesh.

21. IDA's country assistance strategy is designed to support the ThirdPlan's priority development objectives (para. 12). IDA lending hasemphasized agriculture, with particular importance attached to increasingfood production by augmenting the supply of essential inputs such as irriga-tion equipment, fertilizer and improved seeds, the development of extensionservlcPs, research programs and rural cooperatives, -he provision of agricul-tural credit and the promotion of input and output pricing policies thatallow adequate incentives to farmers to increase production. IDA has alsosupported the Government's efforts to encourage greater private sector par-ticipation in the supply and distribution of agricultural inputs. Finally,IDA's lending program has promoted agricultural diversification throughincreased production of fish and forestry products.

22. IDA assistance to Bangladesh's industrial sector is intended toenhance the sector's capacity to contribute to a higher, sustained level ofeconomic growth, provide productive employment for a rapidly growing workforce and improve the country's external trade and payments position on asustained basis. IDA has assisted Banglades''s industrial sector throughprogram credits as well as specific projects to increase fertilizerproduction, rehabilitate the jute and textile industries, strengthen develop-ment finance institutions and promote small-scale industries. The proposedIndustrial Sector Credit is the first of a series of policy-based creditsintended to support industrial and trade policy refcrms, export promotionefforts, enhancement of public enterprise efficiency and financial sector

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reforms. This credit provides a policy framework for future industrialcredits and specific industrial investment projects.

23. IDA's lending in the energy sector has been designed to expand theuse of natural gas as a substitute for imported oil, rationalize the supplyof petroleum products, promote conservation and more efficient energy use andencourage further gas and oil exploration. IDA is also financing projects toexpand the country's power generation and transmission capabilities and ruralelectrification system. Recognizing the critical shortage of traditionalfuels, IDA is financing investments in forestry to increase the supply offuelwood.

24. In the transportation sector, IDA has supported projects to improvethe inland water transport system, expand the country's sea port facilitiesand upgrade key sections of the road network, as well as a multi-modalproject to enhance fertilizer handling and distribution operations.Bangladesh's road network is extensive, but the roads are in poor conditionand inadequately maintained. IDA's future transport lending will concentrateprimarily on supporting the Government's programs to rehabilitatedeteriorated roads, improve maintenance standards, techniques and expenditurelevels and strengthen overall investment planning.

25. In the educatior sector, IDA's lending strategy focuses on primaryeducation and skills development. Lending for primary education supports thenational goals of achieving universal primary education, reducing illiteracy,expanding access to education and upgrading quality. Projects for vocationaland technical education promote the training of craftsmen, technicians andengineers.

26. To help alleviate the severe economic and social pressures created bythe extremely high population density and the continuing population increase,IDA and other donors are assisting the Government in implementing acceleratedfamily planning and maternal and child health care programs. Bangladesh'surban population is expected to increase from about 16-18 million in 1985 tobetween 35-40 million by the year 2000. IDA is already financing water andsanitation improvements in Chittagong and Dhaka, and future projects areplanned to provide IDA support to help the Government address the problem ofproviding low-cost shelter and infrastructure services to the urban poor.

27. Bangladesh has needed, and will continue to need, substantial fastdisbursing foreign exchange resources, on highly concessional terms, becauseof the large structural imbalances between the country's export earnings andimport requirements, and its domestic savings rate and investment needs. Toassist Bangladesh in addressing these structural problems, a significantproportion of IDA's annual lending to Bangladesh has been and will be, in theform of fast disbursing program credits. In addition to providing much-needed foreign e-change and local counterpart financial support, annualprogram credits provide a useful vehicle for addressing a wide range ofsectoral and macro-economic policy issues. IDA plans to focus its future

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policy dialogue on measures designed to improve the efficiency of theindustrial sector, strengthen the financial system, encourage the efficientdevelopment of the energy sector, address policy and institutional issues ineducation, and strengthen agricultural sector institutions. IDA's support inthese areas would likely be through fast disbursing sector adjustmentcredits. IDA will also continue to provide support for adjustment policiesdesigned to mobilize more domestic financial resources in the public andprivate sectors and more efficient resource utilization through measures toincrease public sector revenues, enhance the efficiency of public sectorenterprises and improve the planning of public expenditures and investment.

28. Project implementation is hampered not only by a shortage of domesticfinancial resources, but also by weak institutions, limited managerialcapacity and cumbersome bureaucratic procedures. IDA, in consultation withother donors, is engaged in a continuing dialogue with the Government on waysto improve project implementation. In support of broader institutionalreform, IDA is: (a) providing technical assistance for project preparationand implementation, (b) financing projects to train civil servants and othermanagerial and technical personnel, and (c) encouraging the Government tointroduce administrative reforms and improve the structure and management ofthe civil service.

PART III - INDUSTRIAL. SECTOR

Sector Context

29. Bangladesh's manufacturing sector accounts for about 12% of GDP and8Z of total employment. The modern manufacturing sector, consisting ofpublic sector and large-scale private units, generates 58% of value added butemploys only 18% of the manufacturing labor force. Small and cottageindustries account for most of the employment (82%) in the sector and theremaining 42% of total value added. The public sector's share has declinedcontinuously since mid-1975 and currently constitutes about 40% of totalfixed assets in the modern manufacturing sector, compared to about 90% in1972.

30. Despite the manufacturing sector's relatively small size, it plays aprominent role in the country's external trade. Mostly due to jute products,it currently accounts for almost three-fourths of total merchandise exports.About 30% of value added in modern manufacturing now originates in exportactivities. Bangladesh has very iimited natural resources and depends onimports for most of its raw materials. Given the import-intensive nature ofindustry, manufactured exports, especially non-traditional exports, will haveto continue to expand rapidly to meet growing import requirements, if thesector is to grow rapidly without creating undue pressure on the balance ofpayments.

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31. At the time of independence in 1971, Bangladesh's nascent industrialsector was in disarray. Bangladeshi entrepreneurs owned only 18% of totalfixed assets in the modern industrial sector, the rest being owned by non-locals and the East Pakistan Industrial Development Corporation (EPIDC).Under Presidential Order (P.O.) 27 of March 1972, the Government ofBangladesh took over all enterprises considered abandoned by their non-Bangladeshi owners as well as EPIDC's units. The Government also national-ized all units owned by Bangladeshis in cotton textiles, jute and sugarmanufacturing. As a result, public ownership of fixed assets in modernmanufacturing increased from about one third to almost 90%. The privatesector was also excluded from jute export trade, insurance and banking; itsrole was limited to business activities with fixed assets below Tk 1.5million.

32. The loss of entrepreneurs and managers, physical damage to assets andinfrastructure, loss of export markets and the transition to public ownershipall disrupted the sector. By FY75 industrial output had declined to 75% ofits FY69 level. Government emphasis on rehabilitation of existing units andhigher capacity utilization helped industry rebound, and industrial outputincreased at an annual average rate of 7Z during FY75-FY81. Nevertheless,the FY69 level of industrial output was regained only in FY79. After thisinitial spurt in industrial production due to higher utilization of existingcapacity, the sector stagnated during FY81-FY83 because of a sharp decline inBangladesh's terms of trade, reductions 'in Government investments due toresource constraints and demand management policies introduced in the FY83Budget.

33. Following the early nationalization measures and concentration onpublic sector industrial units (1972-75), there was subsequently a shift inthe Government's policies to encourage a more active role by the privatesector in industrial development. The number of industries reserved for thepublic sector was reduced to 18 in 1975. Investment ceilings for privateindustries were raised in steps to Tk 100 million and finally abolished in1978. The rights of foreign equity shareholders were restituted. In 1975,the Government decided to denationalize selected enterprises previously ownedby Bangladeshis and to disinvest "abandoned" enterprises by auctioning them.Under this policy 116 units were turned over to the private sector between1976 and 1982. The stock exchange, closed between 1972-75, was reopened, andin 1976 the Investment Corporation of Bangladesh was established to providebridge financing and underwriting facilities to the private sector.Industrial term credit to the private sector was increased from Tk 200 mil-lion in FY76 to Tk 1,481 million in FY80. Despite these positivedevelopments, the relative inefficiency of public sector enterprises (PSEs),the elaborate system of administrative controls and a complex structure ofincentives inhibited industry from responding quickly and effectively to thechanged environment. Furthermore, achievement of the increases in theefficiency of resource allocation expected from privatization were con-strained by major iftefficiencies in credit allocation by the financialsystem. In most cases, the industries financed by the Development Finance

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Institutions (DFIs) were determined by the Government in an ad hoc manner.As a result, the growth of manufacturing output, which averaged about 4.2% ayear during FY74-83, fell significantly short of its potential.

The New Industrial Policy (NIP)

34. To respond to these problems and promote more rapidindustrialization, the Government introduced a New Industrial Policy in June1982. NIP's objectives are to liberalize industrial policies, denationalizeselected PSEs, improve the efficiency of the remaining PSEs and promote theprivate sector. Following NIP's introduction, the Government hasaccomplished an extensive denationalization program, import and investmentregimes have been liberalized and export and exchange regimes rationalized.

35. The pace of divestment/denationalization was accelerated after theNIP's announcement. The Government denationalized 27 textile mills, con-stituting 45% of the country's spinning and 57% of its weaving capacity, and33 jute mills accounting for 38% of total production capacity. More recentlyfour more textile mills were sold through tenders. In addition, 474 otherindustrial enterprises and two nationalized commercial banks have beendivested to the private sector, and 92 additional industrial units are in theprocess of divestiture. Furthermore, the private sector has been allowed toenter the banking sector, and there are now ten private banks, five of themforeign. The denationalization policies have facilitated a reorganizationand consolidation of PSEs, including capital restructuring andrehabilitation. The number of public industrial corporations was reducedfrom 11 to 6, and large amounts of debt were converted into equity. However,the denationalization program's magnitude and speed led to the transfer ofmany firms without adequate agreements on responsibility for past debts andon asset values, which has contributed to the financial institutions' loanrecovery problems (para. 84).

36. A major incentive designed to stimulate exports has been the sig-nificant real devaluation of the exchange rate starting in FY76 andaccelerating after FY80. As a result non-traditional exports have grown veryrapidly, with their annual growth rate accelerating over the last five yearsto 28% in FY84 and 38% in FY85 in real terms. The share of non-traditionalexports in total merchandise exports has consequently increased from 51 inFY74 to 18% in FY80 and 33X in FY85.

37. Despite serious foreign exchange shortages since FY79, the Governmenthas gradually simplified and liberalized its import regime. Major reformsinclude the adoption of a new commodity classification system, rationaliza-tion of the import regime and tariffs, simplification and standardization ofimport procedures and lifting of quantitative restrictions on most industrialraw materials. Furthermore, imports have been progressively shifted from thecontrolled official (cash) market to the secondary market where the exchangerate better reflects the opportunity cost of foreign exchange. In FY87 thesecondary market's share of total imports will increase to 42% from 28Z in

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FY86, and currently only foreign aided and petroleum imports are channeledthrough the official market.

38. Recognizing the need to reduce the rigid controls and cumbersomnesanctioning procedures on private industrial investment in Bangladesh, theGovernment has taken several steps to liberalize the investment approvalprocess and increase incentives to private investors. Since the NIP wasintroduced in 1982, only six industries (arms and ammunition, atomic energy,telecommunications, air transport&tion, power generation and distribution,and mechanized forestry) have been reserved for public investment, while bothpublic and private investment are allowed in thirteen others. The mostimportant initiative was the introduction in FY80 of a free list ofindustries not requiring investment approval (subject to certain requirementsabout their financing) and its subsequent expansion to 50 categories (out of144).

39. As a result of the improved policy environment and favorable macteconomic developments, the industrial sector grew 9X p.a. during FY84 andFY85. The demand for industrial products was stimulated by the combinationof increased purchasing power due to sustained growth in agriculture,monetary expansion during FY84-FY85 and the greater availability of rawmaterial imports for industry as a result of successful import substitutionin energy and fertilizers. The gro,4th of workers' remittances during the1980s also created additional domestic demand and supplied a major source offoreign exchange. Von-traditional exports performed well during this period.Ready-made garment exports led the way, increasing in value from $10.8 mil-lion in FY83 to US$116 million in FY85. The garment sector alone has createdabout 140,000 jobs, mostly for poor women, in the last three years.Industrial growth fell to 1% p.a. in FY86, mostly as a result of unfavorablemacroeconomic developments. The collapse of jute prices in the internationalmarket coupled with monetary restraints and the credit recovery drive led todecreases in demand for textiles and agricultural implements. Output reduc-tion in these two sectors and jute manufacturing lowered the overall growthrate. In addition, export growth in garments decreased due to internationalquota restrictions. While there was a large decrease in real public sectorinvestment, private manufacturing investment almost doubled between FY81 andFY85, with most investments flowing into export and other labor intensiveindustries. Although real private investment declined in FY86, it was still75% higher than in FY81. The sector's structure has also changed radically.Most of the growth has come from labor intensive industries like garments andlight engineering. The chemicals subsector has also grown at a faster pacedue to increased production of fertilizers and pharmaceuticals. The increasein the share of labor intensive industries has been at the expense of olderindustries such as cotton textiles, jute, paper and tobacco, the combinedshare of which is now below 42%, compared to 62% in FY74.

40. Achieving rapid growth and diversification in the industrial sectorwith heavy emphasis on labor intensive activities is an important element inthe Government's policy to meet domestic demand, expand export markets and

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create employment outside agriculture. To achieve these objectives, theGovernment must simultaneously continue its program of reform and adjustmentin industry and strengthen the financial sector. The proposed credit wouldsupport that process.

PART IV - INDUSTRIAL POLICY FRAMEWORK AND REFORMS UNDER THEPROPOSED INDUSTRIAL SECTOR CREDIT

41. The policy reforms supported by the proposed credit are based onjoint reviews by the Government and IDA of the experience under the NIP aswell as on the preliminary reports of studies financed under the FourthTechnical Assistance Credit (Cr. 1124-BD) on trade and industrial policies,on the UNDP financed Public Sector Enterprise monitoring and managementproject and on the Institutional Review and Portfolio Audit of the DFIs. InJune 1985, the Government set up an interministerial task force to interactwith IDA on industrial sector issues, and IDA and the Government subsequentlyreached agreement on the broad outlines of a comprehensive medium-termindustrial reform program. The Government has made significant progress inimplementing the agreed policy reforms and will continue to implement them ina phased manner. The proposed Industrial Sector Credit would support theGovernment's industrial policy reforms as well as strengthen the administra-tive arrangements necessary to implement them. The reform program covers(a) developing and improving the administrative and financial arrangementsfor implementation of export policies, (b) rationalizing the structure ofprotection, (c) liberalizing the investment approval system, (d) improvingcentral monitoring of the performance of public enterprises, while grantingthem more autonomy and strengthening their management and (e) improving theefficiency of the industrial credit system.

A. Export Policies and Administration

42. After independence, Bangladesh's export structure was dominated byjute and to a smaller extent, tea, while non-traditional exports were only 5Zof total exports. International demand and prices for jute have declinedconsistently since the 1970s due to competition from synthetic fibers. Inorder to reduce dependence on jute, the Government of Bangladesh has triedto diversify its exports by encouraging other domestic resource-basedindustries such as shrimp and leather as well as new activities which processimported raw materials for export. The first breakthrough in the latter typeof activity was in readymade garment exports (para. 39). The framework of

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reform outlined below is intended to generalize the processes and institu-tional mechanisms which were successful in garments to other exportactivities. 1/

43. Although the Government has already made significant progress in manyareas of export policy and administration, further actions are necessary ifthe export growth momentum is to be maintained. Several general principlesshould guide these actions. First, priority should be given to designingmore efficient administrative systems and to creating or strengthening theinstitutions necessary to implement specific policies which have already beer.announced but not yet implemented effectively. Second, product or firm-specific policies and guidelines should be generalized to all industries andfirms that generate direct and indirect exports, without bureaucraticimpediments. Finally, institutional mechanisms are needed that would reactwith speed and flexibility to external challenges such as protectionismthrough close collaboration between the Government and the export sector.

44. Exchange Rates for Exporters. Since FY80 the Government ofBangladesh has devalued the currency in real terms by 17Z to increase exportcompetitiveness. In addition, adjustments to the Export Performance Benefitssystem, which allows exporters to obtain part of their export receipts at thehigher secondary market rate, have also contributdd to the pace of effectivedevaluation for exporters. Under the IMF Stand-By Arrangement effectiveuntil June 1987, the Government of Bangladesh will continue to pursue aflexible exchange rate policy designed to avoid a renewed appreciation of theofficial real effective exchange rate. Under the proposed credit, theGovernment would continue to-manage its exchange rate policy in line withthis objective.

45. Free Trade Status for Exports. A major objective of the proposedcredit is to establish a policy framework that gives direct and indirectexporters the equivalent of free-trade status for their export activities.Under free trade status for exports, firms should be able to import requiredinputs without restrictions and be exempt from duty and other taxes on theseinputs.

46. Restriction-Free Imports. Under the 1985-86 Import Policy Order a"negative list" system-was introduced for general imports, but a "positivelist" is still retained for banned and restricted items that can be importedonly by designated export industries. Even though the current practice does

1/ rhe reform program which would be supported under this credit isdesigned to stimulate non-traditional exports. Jute exports, the largtsttraditional export product, face different problems and require addi-tional measures. IDA has recently completed a study of the jute sectorwhich is being reviewed with the Government.

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not restrict access to imported inputs for most existing export industries,the Government has agreed to change the system from a case-by-case orproduct-by-product approach to a general system under which no importrestriction would be applied to inputs used for direct and indirect exports,other than the general procedures laid down by the proposed Duty ExemptionDrawback System (para. 47). Since the proposed system is in the process ofbeing established, as an interim measure the Government's FY87 Import PolicyOrder decrees that exporting units can import banned raw materials with arecommendation from the Export Promotion Board and permission from the ChiefComptroller of Imports and Exports.

47. D Ft Free Imports. Currently there are five administrativeexemption/drawback schemes to exempt exporters' imports from duties as wellas direct and indirect taxes. These schemes are applied to differentproducts, and because of administrative problems, they have been largelyineffective. Currently, bonded warehouses (without custom officer), whichare allowed only for garment and specialized textile manufacturers thatexport lOOX of their output, are the most efficient of these schemes 1/ andhave contributed significantly to the success of garment exports. TheGovernment plans to generalize the bonded warehouse system and make it thecornerstone of the duty-free import administration for all firms that gener-ate exports directly or indirectly. Even if the bonded warehouse system canbe made effective, expcrters should still be offered the choice of alterna-tive drawback systems. To establish and manage a generalized bondedwarehouse system and to develop the other alternative duty drawback systems,the Government has decided to set up a Duty Exemption/Drawback Office (DEDO)within the National Bureau of Revenue (NBR). DEDO will consolidate allpolicy-related and other technical tasks on imports for exports which arecurrently being carried out by various agencies. In June 1986, theGovernment established a cell to form the nucleus of DEDO. DEDO will beconverted into a permanent department by July 1, 1987, and initiation of itsactivities would be a condition for release of the credit's second tranche.

48. In addition to the duty exemption/drawback schemes, Bangladesh hasopened an Export Processing Zone (EPZ) in Chittagong where both foreign andlocal enterprises can set up factories exempt from customs duties and importrestrictions. This initiative has so far met with only limited success.Currently fourteen firms are operating in the EPZ; five more are expected tobegin operation in the near future. EPZ's development has been hampered by(a) the Zone Autho-ity's limited autonomy to approve investments and in otheradministrative matters, (b) lack of infrastructural facilities in the Zoneand (c) lower incentives compared to zones in other countries. A sub-committee set up to evaluate the EPZ's performance emphasized these con-

1/ The notional payment system used successfully in some developingcountries is similar to the bonded warehouse system (without customofficer).

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straints in a report submitted to the National Committee on IndustrialDevelopment. The sub-committee's recommendations were accepted, and amend-ments to the Zone Authority's Orders were issued in June 1986. The amendedOrder concentrates all decision-making powers in the Zone Authority so thatpotential investors can deal with only one agency. This should significantlyfacilitate both new investments and the operations of the existing units.Furthermore, the Zone Authority's increased powe, .snable it to act independ-ently to change both the incentive structure and to decide on infrastructuralinvestments in the zone.

49. Export Financing. Pre- and post-shipment working capital exportfinancing is available only to direct exporters in local currency from thecommercial banks up to 90% of an export L/C or order. To ensure equal, easyaccess to working capital financing for direct and indirect exporters, fur-ther improvem~ents will be made in three major areas. First, small and infantexporters' access to preshipment working capital cannot be assured unless thepreshipment export finance guarantee system is strengthened. The ExportCredit Guarantee Scheme of Sadharan Bima Corporation, a Government-ownedinsurance company, is Bangladesh's only export guarantt' institution. Untilrecently, the coverage of this scheme was very limited. In FY87 theGovernment restructured the Export Credit Guarantee Wing by converting itinto a department with a separate budget and increased its capital and staff.However, duje to rapid expansion of its coverage in FY87 the guarantee systemrequires further restructuring to increase its effectiveness. Second,indirect exporters currently do not have access to the Government's exportfinancing system. Third, preshipment credit in foreign exchange for purchaseof imported inputs is not available to all exporters. Some exporters canimport inputs only on suppliers' credit, while others are not allowed toimport on such credit. Such product-based export credit leads tobottlenecks, especially for new exporters and products.

50. The following actions will be taken under this credit to addressthese problems in export financing:

(a) The Government will prepare. a plan to strengthen the arrangements forexport credit guarantees and following review of it with IDA, imple-ment agreed measures as a condition for release of the secondtranche. This plan would include, as necessary, provisions forincreased autonomy and expansion of capital, staff and management ofthe scheme; it would also review the need for technical assistance.

(b) Bangladesh Bank established a task force in May 1986 to rationalizethe structure of export financing through modernization ofadministrative arrangements for pre-shipment financing, the creationof a foreign exchange revolving fund to finance exporters' importsand the establishment of rediscounting mechanisms for export loans.Implementation of this task force's agreed recommendations will be acondition for release of the second tranche.

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51. Promotion of Backward Linkages. The Government's objective ofincreasing the value added of exports by providing equal export incentives toinput-supplying indirect exporters has not been achieved, primarily becauseBangladesh lacks administrative mechanisms to give incentives to indirectexporters. The Inland Back-to-Back L/C system, which is already used inBangladesh for a few products, is an administrative system that can enableindirect exporters to enjoy duty exemption/drawback as well as the creditbenefits of direct exporters. This system should be generalized to allindirect products and all types of indirect expor.ers. The Government shouldalso introduce export finance guarantees to pool the risks of infant andsmall exporters to complement the effects of the Inland Back-to-Back L/Csystem in facilitating backward linkages. To achieve these objectives,circulars and manuals are being prepared on the administrative mechanisms forthe expansion of the Inland Back-to-Back L/C system to all indirect exportsand export incentives. The issuance of these circulars and manuals will be acondition for release of the second tranche.

52. Responding to Import Quotas. The sudden imposition of garment quotasby several OECD countries in 1985 created an atmosphere of uncertainty andcaused losses, factory closures and large-scale layoffs. The internal quotaallocation system was delayed and when announced, it created serious problemsfor established exporters. The Government has significantly revised theinternal quota allocation policy for 1987 and 1988 and has issued it threemonths prior to the start of the quota year, so that problems encountered in1986 will not be repeated. While every effort should be made to enlargeBangladesh's quotas, the Government should also develop the capacity torespond quickly, if quotas appear likely to be imposed on other products, byalerting exporters and facilitating orderly adjustments. For this purpose,the Export Promotion Bureau has established an export monitoring unit. Thisunit will be operational for monitoring garment exports as a condition of thesecond tranche.

B. Tariff and Import Regime

53. The structure of protection in Bangladesh is characterized by tariffanomalies and extensive administrative mechanisms to allocate foreignexchange as well by various types of quantitative restrictions (QRs). Mostproducts at the final stages of production are protected by outright bans,restrictions or high tariffs. Tariffs for intermediate products aregenerally quite high but lower than the rates for final products. However,there are serious anomalies within this general structure because some inter-mediate inputs are banned or have much higher tariffs than final products.Special exemptions and the existence of many transactions that bypass offi-cial channels create additional anomalies in the levels of effective protec-tion for different industries. The structure is further complicated by thevery large number of tariff rates and the way different products are assignedto them. Import duties are itiportant because, in addition to protectingdomestic industries, they provide more than 55X of government tax revenues.Since the Government faces a serious domestic resource shortage, any program

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to reduce tariffs must also give close attention to alternative measures toprovide offsetting revenue sources.

54. The medium-term strategy for tariff and import regime reform inBangladesh has three major components:

(a) The tariff structure needs to be rationalized to reduce the widevariation of tariffs and ensure that similar products have similartariff rates. This requires reduction of a number of tariff rates,consistency in product allocation to different rates and reduction ofthe range of effective protection among different products.

(b) The role of QRs and other administrative controls on imports shouldbe reduced; QRs should gradually be phased out so that industries areonly protected by tariffs.

(c) Given the predominance of import duties in Government revenues,tariff reforms will have to be accompanied by tax reform to generatealternative revenue sources. Further work therefore needs to be doneto evaluate the existing tax system and identify new revenue sources.

55. Rationalization of the Tariff Structure. Until FY86 the tariff codehad twenty-four different statutory rates (including zero). There is also asales tax levied at different rates only on imports, further increasing thenumber of effective duty rates. These rates are not based on easilydiscernible, consistent principles. As a result, for many products, basicraw materials receive higher protection than intermediate outputs, which arein turn protected more heavily than final products. In many cases, basicallysimilar raw materials are treated differently when used in different inter-mediate and final processes. The most important problem is that productsassumed to be highly protected either by bans or very high tariffs have notbeen able to enjoy this protection consistently because tariff concessionsand exceptions have been accorded indiscriminately to many related products,thereby eroding the protection, and because large quantities of goods areimported by smuggling.l/ Since concessions and extra-legal imports have veryuneven impacts, industries in which products are subject to smuggling and/orconcessions have had very low or even negative rates of protection, whileother industries not affected by smuggling and/or concessions have had highlevels of protection.

1/ In many subsector studies, a large gap seems to exist between thedomestic supply plus official imports and any reasonable demandestimates. They are prominent in textiles (yarn and cloth), bicycletires, cigarettes, electronics, cutlery and chinaware, batteries andtoiletries.

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56. To eliminate the problems associated with 24 tariff rates, theGovernment recategorized about 7,000 items in 11 tariff rates in FY86. Ofthese 11 rates, five are for the majority of raw materials (rates of 0-20X),one for intermediate products (50% rate) and one for final products (100%rate). In addition, there are four higher rates for some final products,mainly what are called luxury consumption goods: 150% for items such asmusic centers and washing machines, 200% for made-up textiles, perfumes andprecious stones, 300% for cars and ready-made garments and 400% forcigarettes. The new system constitutes a major reform in reducing the varia-tion in tariffs and ratiodalizing the structure.

57. In addition to the reforms already undertaken, the following furtheractions are needed:

(a) Although the number of tariff rates has been reduced, the addition ofsales taxes to these tariffs still results in a large number ofeffective duty rates. Therefore, further reduction in the number ofeffective duty rates is desirable. To achieve this objectivep inearly FY87 the Government recategorized sales taxes into three ratesof 0, 10% and 20% and started to eliminate sales tax on manyproducts by assigning zero percent sales tax to them. In FY88 andFY89 the Government will introduce a revised tariff schedule byreducing the number of tariff rates to eight (0, 2.5Z, 5%, 10%, 20X,50%, 75% and 100%) and limiting the sales tax to two rates (OS and20%); this will reduce the number of effective duty rates from 33 to16.

(b) The tariffs above 100Z on many goods give unduly high rates ofprotection to domestic producers and encourage smuggling. TheGovernment will reduce tariffs on luxury goods with tariffs of 100%or more to a maximum of 100% over a two-year period.l/ Maximum tariffrates will be reduced to 150% by FY88 and to 100% by FY89. The firstreduction in FY88 will be a condition of the second tranche release.

(c) Although the rationalization of tariff rates eliminated manyanomalies, some sectors still face very uneven rates of effectiveprotection and other anomalies which impede their development. Theseproblems are particularly acute in the two largest subsectors, thetextiles and the steel and engineering subsectors. These two subsec-tors account for about 40% of value added in manufacturing and morethan 50% of all imports. Based on technical assistance studies andthe recommendations of IDA missions, a three-year program (FY88-FY90)has been developed to reduce the total protection in these two sec-

1/ On seven items with very high domestic excise taxes, special higherrates will apply i.e. 300Z for whisky and luxury cars and 200% forbeverage concentrates, precious stones, cigarettes, perfumes and furs.

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tors (including sales tax, customs duty, development surcharge andimport license fee) in phases to a range of 0-85% from ranges ofapproximately 25-200Z in textiles and 2.5-200% in steel andengineering. The revenue losses expected from these changes would beapproximately 2-3% of all tax revenues if the volume of imports didnot change. The Government has agreed in principle to liberalize thetariffs in these two subsectors and started adjusting tariffs in FY86and FY87. This restructuring will be implemented over a three yearperiod beginning FY88. In the first year of this program (FY88) theGovernment will reduce the maximum total protective tariff for finalgoods in these sectors from over 200% to 125% and make consequentialdownward adjustment to rates for raw materials and intermediateproducts. The tariff reductions in FY88 will be a condition of thesecond tranche release.

(d) A longer term program of further tariff rationalization should becarried out in other subsectors, based on ongoing effective protec-tion studies financed by the Fourth Technical Assistance Credit (Cr.1124-BD). The Government is committed to further tariffrationalization, and subsequent phases of the reform could be sup-ported under future sector credits.

58. The two subsectors for which protection will be restructured underthe credit face special problems. In textiles, the major problem has beenthe high cost of imported cotton and cotton yarn caused by high tariffs andbans, while weaving (including handlooms) has been squeezed by cheaper legaland illegal cloth imports. Domestic textile production has grown very slowlysince independence, with very little improvement in quality. However, thereis a large domestic market for cloth if prices can be lowered and qualityimproved. Furthermore, the rapid growth of garment exports, which currentlyuse only imported fabric, has created a large market which could be filled bymore efficient, higher quality domestic cloth production. The objective inthis sector is to lower tariffs and eliminate anomalies while relaxing QRs.l/

59. In steel and engineering, the main problem is the high cost of domes-tically produced steel, due to a very inefficient public sector steel milland high tariffs on imports to ensure the mill's profitability. At the sametime, the products of the metal-working industry receive almost noprotection. The recommended strategy is to reduce the price of basic steelby lowering tariffs, eliminating ad hoc duty concessions given to differentfirms and increasing tariffs on engineering products to eliminate the nega-tive protection they currently face. This might require direct productionsubsidies if the Government maintains the steel mill's present outrut mix.The revenue implications for the central budget of alternative action pack-

1/ In addition, there are two ongoing IDA textile projects (Cr. 1215-BDand Cr. 1477-BD) for restructuring public as well as private units.

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ages (e.g., physically restructuring the mill, closing it down or changingits output mix) have been presented to the Government.

60. Reducing Quantitative Restrictions. The main thrust of IDA'sdialogue with the Government on the import regime has been to encourage itto: (a) move imports from the official market where the rates are administra-tively determined to the secondary market where the exchange rate betterreflects the opportunity cost of foreign exchange; (b) replace the positivelist which specifies importable products with a negative list in which onlyprohibited products are specified so that the magnitude of QRs are tran-sparent and can be monitored; and (c) reduce QRs over time and move towardsprotection by tariffs.

61. The Government has made significant progress in transferring foreigntrade transactions from the official to the secondary market, paving the wayfor eventual unification of these markets. The share of exports goingthrough the secondary market increased from 27X in FY85 to 53Z in FY86 and isplanned to reach 71% in FY87. As a result, raw jute, tea, and wet blueleather will be the only exports transacted at the official exchange rate.The share of imports coming through the secondary market increased from 20%in FY85'to 28% in FY86 and is expected to reach 421 in FY87. As a result ofchanges announced this fiscal year, all non-Government imports, except thosefinanced by foreign aid or through barter arrangements, will come through thesecondary market. The major items imported through the official market willbe foodgrains, fertilizer and certain capital equipment for officially spon-sored projects.

62. As a result of understandings reached during preparation of theproposed credit, in FY86 the Government moved from a positive to a negativelist, supplemented by a restricted list containing items importable underconditions specified in the Annual Import Policy Order. Under the newprovisions, all imports have been freed except those subject to the negativeor restricted lists. This constitutes a major liberalization of the importregime. The restricted list consists of three components. The first com-ponent lists the banned items that are importable by established exportersand foreign exchange-earning hotels. This part duplicates a part of thenegative list that applies to export activities. The second component listsitems that require prior permission for import. These include seeds,insecticides, chemicals for explosives, drugs and chemicals for drugs andsimilar items. The third component lists items that are only importable byregistered industrial enterprises, up to the values specified in theirpassbooks. The negative list was introduced only in FY86, and there havebeen problems associated with both its coverage and the administrative arran-gements for import procedures. A special commission was appointed to resolvethe problems of transition and facilitate orderly import procedures. TheFY87 Import Policy Order liberalizes imports further by shortening the nega-tive and restricted lists. Restrictions on 140 items have been lifted,including diesel engines, trucks, buses and inputs for the electric goodsindustry. The number of restricted spare parts items for the jute and tex-

tile industries has beer. reduced by 537. In terms of four-digit ITCcategories, the negative tist has been reduced from 389 categories to 321categories (out of a total ot 1192), an 18% reduction. Finally, part ofthe restricted list pertaining to commerciaL importers has been eliminated.However, the restricted list, which limits the import of certain rawmaterials to industrial users only, still pena.izes thousands of small andcottage industries which have to import their raw materials indirectlythrough commercial importers. The Government intends to continue reducingthe negative and restricted lists in the following phased manner: (a) therestricted list for industrial imports will be eliminated by reducing thenumber of items on the list in three approximately equal annual steps begin-ning in FY88 so that by FY90 all industrial inputs will also be importable bycommercial importers; and (b) the import liberalization will continue byreducing the number of categories in the negative list by about 20% per year,which would be comparable to the reductions in FY86, and in this process,priority will be given to the items in textile and steel and engineeringsectors such that all such items will be eliminated from the negative listwithin three years. The implementation of these reductions in FY88 will be acondition for release of the credit's second tranche.

63. Bangladesh's import and customs clearance procedures are extremelylengthy and complex. Under an ongoing UNDP-financed study, preliminaryrecommendations have been made to simplify customs valuation and clearanceprocedures, and the National Board of Reve.nue (NBR) has done additional work.The Government has prepared a summary of the reform measures identified inthese reports and will reach an agreement with IDA on an action program toadopt these proposals by September 1987.

64. Identification of Alternative Revenue Sources. Although the primarypurpose of import duties is to protect domestic industries, another majorobjective has been to earn revenues for the Government. Currently more than55% of total Government revenues in Bangladesh come from tariffs and salestaxes levied solely on imports. At the same time, the scope for increasingGovernment revenues from other taxes is limited, at least in the short run.Despite efforts to increase public revenue through cost recovery measures andincreased user charges, the Government continues to face severe constraintson public revenues. There is thus little ready alternative to the revenuesfrom import duties, placing a major constraint on more cc.aprehensive tariffreform.

65. Some revenue losses due to across-the-board tariff reductions can beoffset by eliminating QRs on imports, enabling a higher volume of dutiableimports. There are, however, major short-term constraints to increasing thevolume of imports because of the pressures of Bangladesh's already tightexternal position during the next few years (para. 18); net foreign exchangeavailability is projected, at best, to stay constant in real terms.

66. To address this problem, IDA has started a series of joint studieswith the Government on the prospects for expanding the tax base. A prelimi-

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nary study on taxation of agriculture has already been completed. A jointIDA-IMF tax mission visited Bangladesh in December 1986 to develop alterna-tive tax sources to reduce the dependence on trade taxes. The Government hasalso commissioned a series of studies on different aspects of domesticresource mobilization. On the basis of this work, the Government and IDAexpect to develop a comprehensive program to reduce the reliance on customsduties as the main revenue source which would be supported by a structuraladjustment credit in FY89. Implementation of the tax reform program willstart in FY88, enabling the Government to offset revenue losses of the firstyear of tariff reductions supported under this credit, which are expected tobe about 1% of tax revenues or around US$12 million. The maximum totalrevenue loss due to tariff reductions in the textiles and the steel andengineering subsectors is projected to be 2.5X of tax revenues or aroundUS$30 million at the end of three years without taking into account increasedimports as a result of removal of bans. Over the next three yer-s, reformsunder the comprehensive tax program are expected to offset further tariffcuts under this credit as well as permit further tariff rationalization inother sectors under a possible Second Industrial Sector Credit (FY90).

C. Invest ment Sanctioning

67. Private investment in Bangladesh is subject to approval by variousagencies depending on the sector, investment size and what the investor seeksfrom the Government. The investment sanctioning process has gradually beendecentralized, and many agencies, including banks and other financialinstitutions, have been given the right to sanction projects. Despitedecentralizaticn, investment sanctioning continues to create delays.Furthermore, the approval process for long-term loans from the banking systemadds further delays. To minimize the problems encountered in undertakinginvestments, "free sectors" were introduced in July 1980. Firms within thefree sectors can, without sanctioning, begin construction and use their ownlocal currency to buy foreign exchange from the secondary market to importmachinery. Free sector investments financed through the secondary markethave been primarily in ready-made garments, fish processing, printing andpublishing, synthetic textiles and pharmaceuticals, while investments inheavy industries (chemicals, ceramics, paper) have been financed solely bylong-term credits through the official market. Furthermore, since 1980private investment in manufacturing has more than doubled, and all growthhas come from investments undertaken in the free sectors.

68. The main objective of discussions during preparation of this credithas been to liberalize the investment sanctioning system further by extendingthe scope of the free sectors. In accord with understAmrd4ngs reached duringpreparation of the proposed credit, the Government issued a RevisedIndustrial Policy in June 1986 which included the folil;.ing provisions toliberalize the investment sanctioning system substantially:

(a) The Investment Schedule issued periodically by the Governmentspecifies priority sectors, the quantity of investments that should

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be undertaken in each of these sectors and sanctioning rules.Because these investment targets have been unrealistic and not bind-ing on private investors, they have not served their intendedpurpose. However, financial institutions have tended to follow theInvestment Schedule in making lending decisions rather than conduct-ing meaningful pvoject appraisals. Under the revised policy theInvestment Schedule wiLl be indicative and contain only a set ofgeneral guidelines for assisting investment decisions without quan-titative specifications on additional capacity.

(b) Unless there is a specific reason for not allowing investment incertain industries, all industries should be treated as free sectorsnot requiring approval. Decisions on credit to finance these invest-ments should be based on financial institutions' and investors' ownappraisals. The Revised Industrial Policy reserves only sevenindustries for the public sector. These are power generation andtransmission, arms and ammunition, atomic energy, telecommunications,air transportation, mechanized forestry, currency printing andminting. In addition, the Government has issued a short list ofdiscouraged industries, in which there are either environmentalconstraints (i.e., deep sea trawling) or very serious over-capacity(i.e., jute carpets), where prior nermission is required. All otherindustries (125 out of a total of 144) are now treated as free sec-tors which do not require prior approval if the investments arefunded from investors' own resources (including short term bankfunding).

(c) The requirement that all investments in industries using more than20% imported inputs must be approved by the Investment Board has beenrelaxed by increasing the imported input limit to 50%.

(d) Currently, when financial institutions give term loans for industrialprojects, the projects are considered "sanctioned." However, thereare size limits on the financial institutions' sanctioning authority.These size limits have been increased significantly to US$1 millionfor comrnercial banks and to US$2 million for DFIs and will continueto be increased over trime. Approximately 90% of investments shouldnow come under these Limits. This gradual approach has been adoptedprimarily because of financial institutions' weaknesses in appraisingindustrial term loans.

69. However, liberalization or investment sanctioning before lendinginstitutions' appraisal capacit;es are improved and distortions in the incen-tive framework are eliminated mighr Lead to investments with high financialbut low economic returns. Liberalization of investment sanctioning is there-fore being closely coordinated With elimination of the distortions in thesystem of protecLion (paras. 55-63) as well as improvements in the capacitiesof the two development finance institutions (paras. 81-99). The Governmentalso intends to develop a longer-term program of financial sector reformswith TDA's assistance during FY88.

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D. Public Sector Industrial Enterprises

70. Bangladesh now has about 160 public sector industrial enterprisesunder six main industrial sector corporations controlled administratively bythree different ministries. Each industrial PSE is controlled by a publiccorporation, wh.ch in turn is supervised by its ministrv. The functionalministries (Finance, Planning, Labor, etc.) exercise control by orders anddirectives issued through the administrative ministries, and thus cheGovernment retains all major decision-making powers.

71. Although it nationalized almost all large-scale industrialenterprises in 1972, the Government subsequently, especially after 1975, hastried to encourage the private sector to play the lead role in industrialdevelopment while reducing the public sector's role and improving itsperformance. Under the NIP, the Government aimed to improve PSEs' perfor-mance by: (i) reducing the role of public sector through denationalization ofpreviously Bangladeshi-owned jute and textile mills and disinvestment ofabandoned units; (ii) restructuring the capital of and physicallyrehabilitating retained units; (iii) giving PSEs autonomy in setting prices;(iv) awarding management contracts to run large, poorly performing units;(v) selling up to 49% of the shares in PSEs to the general public; and(vi) giving enterprise boards more autonomy in PSE operations. The RevisedIndustrial Policy announced in July 1986 reiterated the Government's commit-ment to these objectives.

Reducing the Role of Public Sector

72. New Investments. The Government has reduced the number ofindustries reserved for the public sector to seven and decided that futuregrowth in industry will come through expansion of the private sector. Thispolicy has been followed since late 1970s; only about 15-20% of the AnnualDevelopment Programs have been allocated to PSEs, mainly for completion,rehabilitation and modernization of existing units. Large new investmentshave been made only in fertilizer production, where the availability ofnatural gas gives Bangladesh a comparative advantage.

73. Denationalization. Bangladesh has carried out one of the largestdenationalization/disinvestment programs in the world by transferring about650 industrial enterprises to the private sector. The Government has alsoannounced that it will continue the process of divestiture as well as sellingshares of remaining firms.

74. Restructuring Divestment/denationalization policies havefacilitated a major reorganization and consolidation of PSEs, which has beenaccompanied by a process of capital restructuring and rehabilitation ofindustrial sector corporations. During FY81-85 reviews of capital and debtstructure of six industrial corporations by the Finance Division led toconversion of about Tk. 4.5 billion from debt to equity and Tk 480 milliionfrom debt to grants. In addition, during this period there was a cash infu-

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sion of about Tk 3.8 billion as additional equity. In the same vein, Ziaand Chittagong Fertilizer Companies have been brought under the management ofthe Bangladesh Chemical Industries Corporation which now operates all fer-tilizer factories in Bangladesh. The proposed reorganization of jute andtextile industries is being supported under IDA technical and financialassistance. Mills under these two corporations are being physically restruc-tured under the seme IDA projects. The Government has also signed a manage-ment contract with a multinational company to run Bangladesh Machine ToolFactory, a large ailing unit.

75. As a result of these measures, the public sector's share of fixedassets in the modern manufacturing sector has declined to about 40% fromabout 90% in 1972. During FY80-FY85 the sector corporations generated asurplus in three of the five years. The big losses suffered by the JuteMills Corporation in FY82 and FY85 completely offset the surpluses of othercorporations as well as surpluses in other years, leaving these corporationswith an average loss of Tk 19 million on average annual sales ofTk 20 billion. Despite these losses the net profit to sales ratio improvedto -0.1% during FY80-85, compared to -7.4% during the previous five years.However, primarily due to the collapse of jute prices, net profit to salesratio has declined to -4.2% in FY85 and -9.8Z in FY86.

76. Increasing the Efficiency of PSEs. Despite significant preparatorywork, very little has been accomplished on the important issue of enterpriseautonomy, which is the key to improving the performance of PSEs. Under theproposed credit, the basic objective would be to improve PSEs' operationalefficiency through enhancing enterprise autonomy while establishing cleareraccountability and performance criteria and improving central monitoring oftheir activities. To achieve this objective the Ministries of Finance andIndustries initiated a UNDP-financed project entitled Development ofPerforman.ce Evaluation and Financial MIS Systems for Autonomous Bodies in1984. A Monitoring Cell attached to the Finance Ministry's Autonomous BodiesWing (ABW) is responsible for project execution, which is coordinated by acommittee chaired by the Secretary, Finance Division. The project isdeveloping comprehensive indicators of public enterprise performance toanalyze their macro-economic impact for policy decisions. It will alsodevelop a system of performance evaluation for PSEs, taking into account bothcommercial and social objectives to ensure meaningful control by the corpora-tions and administrative ministries while maintaining essential enterpriseautonomy. In addition to this project, institutional and legal changes areneeded to operationalize the new system being developed.

77. Institutional and Legal Mechanisms. In November 1985 the Governmentconstituted a Council Committee on Public Enterprises (CCPE) chaired by thePresident to consider issues pertaining to PSE operations. The CCPE decidedthat a Public Corporations (Management Coordination) Ordinance was needed toprovide more autonomy to the PSEs in their operations and to facilitateeffective monitoring of their performance. The Ordinance, promulgated in

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June 1986, limits Government intervention in the enterprises' operations bygiving their Boards the right to decide on personnel, production and pricingmatters and adopts the principle that firms will be compensated for financiallosses incurred because of Government intervention.

78. The Monitoring Cell temporarily attached to the ABW is currentlyimplementing the UNDP-assisted project to develop performance evaluation andfinancial MIS systems for PSEs. The Monitoring Cell was built up duringPhase I of the project (July 1984-June 1986) and now includes 13 full-timeprofessional and 15 support staff. Both local and overseas training has beeneither given or is planned for all cell members and appropriate ABW staff toprepare them for their future role. By September 30, 1987, the MonitoringCell within the ABW will be strengthened further, both in terms of personneland skills, so that by the end of Phase II a system of performance evaluationmay be recommended for general adoption. The Monitoring Cell would initiallyassist the ABW in setting targets as well as monitoring and evaluating theperformance.

79. The ABW is also to be strengthened and will take over the functionsof the Monitoring Cell currently implementing the project and assist thetarget-setting process among ministries, corporations and enterprises as wellas supply technical support for monitoring and evaluation.

80. Implementation.' The Covernment selected two enterprises--NorthBengal paper Mills Ltd. and General Electric Manufacturing Company Ltd.--fora pilot exercise for the implementation of the new performance evaluationsystem. Performance goals were developed by a task force comprising repre-sentatives of the PSEs, the Monitoring Cell and representatives from relevantcorporations and ministries. Enterprise revenue budgets for FY87 consistentwith the performance goals were also prepared. Only North Bengal Paper Millshas actually implemented the new system. The Monitoring Cell conducted amid-year evaluation of actual results and established performance targets forthe period July 1986-June 1988. By July 31, 1987, the enterprise will submitreports to the Monitoring Cell describing its actual achievements in thespecified performance areas. By September 1987, the enterprise will alsosubmit copies of its audited accounts, and the Monitoring Cell will prepareevaluation reports, which would rate performance on individual goals as wellas prepare a consolidated overall performance measure using pre-specifiedweights. This system will be extended to at least three additional PSEs inFY88. This program would be used, together with the ongoing UNDP-financedproject, to extend the performance evaluation system to all industrial PSEsunder a possible Second Industrial Sector Credit (FY90).

E. Financial Sector Issues

81. Continued rapid industrial expansion will require support from anefficiently functioning financial system as well as policy and institutional

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reforms along the lines discussed in the preceding section. Unfortunately,Bangladesh's banking system, especially the DFIs, is experiencing seriousproblems which, if not corrected, could undermine the Government's industrialreform program. The system faces a short-term crisis because recovery ratesfor both industrial and agricultural term loans have fallen to unacceptablylow levels. This lack of credit discipline impedes efficient allocation ofinvestment resources, vitiates the effectiveness of interest rate management,restricts the volume of new loans that can be made consistent with monetarypolicy objectives, and undermines the DFIs' financial viability. There arealso longer term issues concerning the banking system's structure, legalframework, management and supervision which need to be addressed if it is toperform efficiently.

82. In Bangladesh the two DFIs--the Bangladesh Shilpa Bank (BSB) andBangladesh Shilpa Rin Sangstha (BSRS)-have been the main source of termloans for industry, while the nationalized commercial banks (NCBs) have onlyengaged in a limited amount of term lending to small and medium industries,mainly through their participation in IDA and ADB-financed projects. Becauseof their small size and recent establishment, the private banks' industriallending has been quite limited.

83. The proposed credit would, therefore, include measures to increaserecovery rates for industrial term loans by the DFIs and the three NCBsparticipating in IDA-financed small industries projects as well as measuresto strengthen the DFIs institutionally and financially. These measurescomplement actions implemented under the Thirteenth Imports Program Credit(Cr. 1655-BD) to improve the recovery of agricultural loans. The Governmentintends to develop a broader and longer term program of financial sectorreforms with IDA's assistance during PY87 and FY88.

84. Origins of the Recovery Problem. The DFIs' loan recovery ratesdeteriorated sharply during the early 1980s. For example, the DFIs' cashcollection rates as percentages of payments due (including overdues) declinedfrom 35-40% in late 1970s to 9% in FY86. Similarly, the repayment rates forNCB loans under the two ongoing IDA-financed small industries projects havealso been unsatisfactory, declining from 23% in FY84 to 19% in FY86. Thispoor recovery performance is due to a variety of factors. The banks haveweak appraisal capacities, limited managerial autonomy and generally followedgovernment directives to channel credit into targeted sectors without dueregard to projects' viability. Moreover, many projects experienced start-upproblems, delaying repayment capacities, and the banks exercised noflexibility in restructuring such loans. Large real devaluations have sub-stantially increased the debt burden of loans denominated in foreignexchange. The Government's denationalization program (para. 35) has beenanother source of difficulty; because of the program's speed and scale, therewas inadequate attention to clarifying the obligations to be assumed by thenew private owners. Consequently, DFI loans to many denationalizedenterprises have been disputed on both the accuracy of DFIs' calculations ofborrowers' obligations and their liability for debts incurred when the

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enterprises were publicly owned. Finally, the genuine problems encounteredby many enterprises have been used as an excuse by a group of willful defaul-ters not to repay their loans.

85. DFI Action Program. The Government has committed itself to addressthese problems. UNDP-financed consultants conducted an Institutional Reviewand Portfolio Audit on the two DFIs during 1984-85. IDA and other donors,which have provided most of the funds for DFI lending in Bangladesh, withheldcommitments to finance new industrial credit projects, pending this study'soutcome. In March 1985, the Government signed a Memorandum of Understandingwith the principal donors (IDA, ADB, KFW and UNDP) and announced an ActionProgram in June 1985, to strengthen the DFIs and improve loan recovery. Thekey elements of the Action Program involve enhancing the DFIs' managerialautonomy and legal powers, restructuring their finances, strengthening theirinternal organization and procedures, restructuring problem projects andapplying a variety of pressures on defaulters.

86. Implementation of the Action Program has been uneven, and only slowprogress has been made in improving loan collections. In April 1986 thedonors formally reviewed implementation of the Action Program with theGovernment, and a second portfolio audit to reassess the provisions for badand doubtful debts was completed in May 1986. In July 1986 a joint IDA andADB mission reviewed the audit reports and reached broad agreement with theGovernment on bad debt provisions, restructuring plans and collectiontargets. The measures implemented under the Action Program to increasecollections were also evaluated. As a result of these discussions, theAction Program was essentially revised and up-dated. The following sectionshighlight the program's key measures.

87. Establishment of Credit Discipline. The DFIs require several kindsof support from the Government if their own recovery efforts are to succeed.Many defaulters have refused to repay the DPIs because of disputes abouttheir liabilities (para. 84). The Government has taken two steps to resolvethese disputes. First, a committee was established in late 1985 to reviewdisputes raised by borrowers, especially regarding the calculation of adjust-ments under the Government's Exchange Fluctuation Absorption Scheme (EFAS).The committee's report, issued in May 1986, endorsed the DFIs' contentions inalmost all cases and recommended approaches to reach accommodations withcategories of borrowers such as jute mill owners. Second, after severaladjustments of the scheme, June 30, 1986 was established as the closing datefor borrowers to accept proposed EFAS adjustments, and the Governmentannounced that no further concessions would be granted. These actions havesubstantially reduced the ambiguities regarding many defaulters' obligations.

88. An important element of the Government's recovery strategy has beento deny DFI defaulters access to privileges and facilities such as approvalof new investment projects and sponsorships of'companies. The most effectivesanction has been an instruction to banks not to extend new term credits to

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defaulters identified by the DFIs (jute mills were exempted because of thefinancial problems experienced by this sector, which is economically veryimportant because it generates about 40% exports, and there have been otherselective exceptions in individual cases). In August 1986 Bangladesh Bankinstructed the banks to stop all credits to defaulters unless they obtaincertificates of no objection from the DFIs.

89. The DFIs' Charters empower them to take over defaulters' projectswithout recourse to the courts. In practice Government clearance has beenrequired before they can take action in specific cases. During late 1985 andearly 1986 the Government took several months to review requests to proceedagainst several defaulters but approved only two cases. However, in mid-1986requests to take over ninety defaulters' projects were approvedexpeditiously, and action has already been taken against most of them.

90. The DFIs have also initiated legal cases against numerous defaulters.However, in addition to delays due to defaulters' legal maneuvers, theprocessing of these cases is often slow because of administrative bottlenecksin the legal system., The Ministry of Law, in consultation with the Ministryof Finance, will review the status of all legal cases initiated by the DFIsand identify measures to expedite their processing. In addition, a new LoanRecovery Act has been prepared and is expected to be submitted to Parliament.

91. PSEs accounted for 18% of BSRS's arrears at the end of FY86, incontrast to only 2% of BSB's arrears. Three PSEs were responsible for 75% ofBSRS's public sector arrears; all three companies dispute their liabilities.The Government has reviewed the status of arrears and is working with thePSEs to establish repayment schedules. The arrears of these PSEs to BSRSwill be eliminated over the next two years, i.e. by July 1968.

92. Although various processes have been initiated under the ActionProgram to improve the recovery of industrial term loans, it is also neces-sary to establish target recovery levels for the DFIs and for NCB loans underthe two ongoing IDA-financed small industries projects (Cr. 825-BD and1065-BD) and to provide tangible measures of progress. The DFI targets arebased on detailed analyses of the collection prospects and seasonality inactual collections for all loans in their portfolios, assuming that theGovernment provides the kinds of support discussed above. The targets havebeen set as absolute amounts of cash collections; collection ratios aremisleading because of the accumulation of interest and penalties and thelarge amounts of doubtful debt in their portfolios. Separate targets havebeen established for private borrowers and PSEs. Total collections for thetwo DFIs are targeted to increase from Tk 761 million in FY86 to Tk 1,270million in FY87, baped on a 75% increase in collections from private bor-rowers and a 35% increase in payments from PSEs. If these targets were met,the DFIs' combined collection ratio would increase from 9% in FY86 to 13% inFY87 and 18% in FY88. However, in terms of collections of current dues only,the collection ratio would increase from 25% in FY86 to 40% in FY87 and 50%in FY88.

J

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93. Similar analyses were made of the project loans of the three NCBsparticipating in the ongoing IDA-financed small industries projects. Theircombined targets imply an increase in their cash collections of about 300%to Tk 99 million in FY87. If this target is met, their annual aggregatecollection ratio will increase from 19% in FY86 to 33% in FY81 and 46% inFY88.

94. The targets have been set on a monthly basis starting in July 1,1986. The DFIs and NCBs met the targets established for the period fromJuly 1, 1986 until March 31, 1987. Achievement of the two DFIs' combinedcash collection target and of the three NCBs' combined cash collection targetfor the period from January 1 through December 31, 1987, will be a conditionfor release of the second tranche. During the period of January 1-December 31, 1987, the DFIs will need to collect a minimum ofTk. 1,370 million and the NCBs, a minimum of Tk. 136 million.

95. Institutional and Financial Rehabilitation of the DFIs. In additionto short-term measures to improve credit discipline, the Action Programprovides for the medium-term institutional and financial rehabilitation ofthe DFIs. These measures will be monitored under the proposed credit, andsatisfactory implementation of specific provisions will be conditions forrelease of the second tranche.

96. DPI Autonomy. The DFIs' charters provided them with insufficientautonomy, and the Government had become excessively involved in operationalmatters, lowering their efficiency and inhibiting their ability to makeindependent decisions about loans. In consultation with IDA and ADB theGovernment has enacted revised charters for both DPIs. The revised chartersenable 49X private shareholding, including by foreign parties, and providegreater autonomy to the DPI Boards and managements.

97. Financial Restructuring. As a result of the problems experienced bya number of projects, the extension of many loans on the basis of inadequateappraisals and the cumulative burden of interest on arrears, penalties, anddevaluations, the DFIs' portfolios include substantial levels of doubtfuldebt. However, at the beginning of FY86 provisions for bad and doubtful debtrepresented only 12X of BSB's portfolio and 15X of BSRS's portfolio. Theconsultant study included an audit of their portfolios, and the Governmentcommissioned a second audit to reassess the provisions recommended by theconsultants. On the basis of these audits and discussions with IDA and ADB,the Government has decided to increase BSB's level of provisions to theequivalent of 34% of its portfolio as of June 30, 1985, and BSRS's provisionsto the equivalent of 55% of its portfolio on that date. About half of theprovisions were included in FY86 financial statements, and the remainingprovisions will be included in the financial statements for FY87. As aresult of these provisions the DFIs' financial positions will deterioratesharply. The Government intends to recapitalize the DFIs, primarily by

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converting Government loans into equity, in order to maintain theirdebt/equity ratios at no more than 3:1.

98. In addition to the aggregate adjustments, the auditors recommendedthat provisions be made for most loans. Over the next 12 to 18 months theDFIs will review their portfolios to assess the future income-generatingability of each loan and as appropriate, reschedule individual loans andselectively write off loan amounts which do not have realistic prospects ofbeing serviced. These developments will be monitored continuously andevaluated in January 1988.

99. Institutional Strengthening of the DFIs. The DFIs require additionaltechnical assistance to enable them to strengthen their portfoliorehabilitation, loan collection and supervision, appraisal functions andaccounting and personnel systems. Terms of reference for this assistancehave been agreed in principle, and UNDP funding is being arranged.Initiation of the technical assistance program will be a condition of secondtranche release.

PART V - THE CREDIT

100. The proposed credit would be the first IDA credit supporting theGovernment's program of policy and institutional adjustments in theindustrial sector. The development of this program and the reforms whichwould be supported under the proposed credit are described in Part IV of thisreport. A timetable of key events relating to the credit and special condi-tions of the credit are listed in Annex III. The proposed credit wasappraised during March 1986. Negotiations were held in Washington duringApril 6-14, 1987. The Government of Bangladesh was represented by a delega-tion led by Dr. A. H. Sahadat Ullah, Member, Planning Commission.

Procurement and Disbursement

101. The proposed credit of US$190 million equivalent would finance about4.8% of Bangladesh's total merchandise imports and about 7.9% of the grosscapital inflows over the disbursement period (third quarter of 1987 untilfourth quarter of 1988). In view of Bangladesh's severe balance of paymentsand budgetary resource constraints, the funds to be provided under theproposed credit would be used to finance imports of any goods other thanthose specified in a shortlist of ineligible items. Imports directlyfinanced from other scurces would not be eligible for IDA financing. Notmore than 25% of the proceeds of the credit would be used to finance theimport of any commodity or group of commodities falling within a singletwo-digit Division of the Standard International Trade Classification (SITC),Revision 2. Disbursements would be fully documented except in respect ofsmall contracts for less than $50,000 equivalent, which would be on certifiedStatements of Expenditures with the relevant support documentation retained

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by Bangladesh Bank fnd made available for review by IDA representativesduring Supervision Missions. Credit withdrawals based Statements ofExpenditure would be audited annually by independent auditors acceptable tothe Association.

102. Procurement would be limited to goods from countries eligible underthe Bank's Guidelines for Procurement. Both public and private sectorimports would be eligible for financing. Except for proprietary items, allimports costing the equivalent of US$2,000,000 or more would be procuredunder contracts awarded after International Competitive Bidding (ICB). IDAwould review procurement decisions after such contracts have been signed andprior to the first payment in respect of such contracts from the specialaccount to be established by Bangladesh Bank for the credit. Non-proprietaryitems costing less than US$2,000,000 equivalent could be procured throughnormal procurement procedures for such purchases, which generally include theinvitation of quotations from no fewer than three suppliers. Contracts forcommonly traded commodities could be awarded on the basis of price quotationsavailable from organized international commodity markets. Contracts forproprietary items or equipment, subject to domestic standardization regula-tions endorsed by IDA, could be let on a negotiated basis, but the award ofsuch contracts would be subject to prior approval by IDA, if individualcontract value exceeds US$200,000 equivalent, up to an overall ceiling ofUS$20,000,000 equivalent. IDA would conduct a post disbursement review ofall contracts signed with values exceeding US$500,000 equivalent and wouldconduct similar reviews of all other contracts on a random basis.

103. Disbursements would be made against 100% of the foreign exchangecosts of eligible imports against iithdrawal applications prepared byBangladesh Bank. Expenditures made prior to credit signing, but afterMarch 1, 1987, in respect of eligible imports, would be eligible for retroac-t,ve financing, up to an aggregate amount equivalent to US$19 million. It isexpected that the proposed credit would be fully disbursed within about18 months. A special account of US$30 million equivalent would be estab-lished in Bangladesh Bank for the proposed credit for the purpose ofprefinancing all eligible items. In order to support the Government ofBangladesh's policy of liberalizing its foreign exchange market system, theproceeds of the credit would be used to finance expenditures through thesecondary foreign exchange market (para. 37).

Tranching

104. The proceeds of the proposed credit would be made eligible forwithdrawal in two tranches. The first tranche equivalent to US$100 millionwould be released when the proposed credit becomes effective. The secondtranche, equivalent to US$90 million, would be releaRed subject to IDA beingsatisfied, following a review by January 31, 1988, that the Government isfollowing sound industrial sector policies, including meeting the specificconditions listed in Annex III.

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PART VI - COLLABORATION WITH THE IMF

105. In the last year, IDA and the IMF have jointly prepared and nego-tiated with the Government a Policy Framework Paper (PFP) (discussed by theCommittee of the Whole on January 29, 1987) which sets out the Government'spolicy objectives for the medium-term (para. 12). Following this, a three-year Structural Adjustment Facility (SAF) was approved by the IMF Board onFebruary 6, 1987, and SDR 58 million was disbursed pursuant to the firstannual arrangement under this facility. The SAF covers the period FY87-89and total access is now projected at SDR 154 million; benchmarks for theimplementation of the Government's medium-term program, outlined in the PFP,are to be agreed annually by the Government, IMP and IDA, and those for FY88are currently being prepared. In February 1987, Bangladesh also received SDR89 million under the Compensatory Financing Facility in respect of an exportshortfall primarily of jute and jute products in the year ended September1986. These funds were in addition to the SDR 180 million made availableunder the current Stand-by Arrangement, approved by the IMF Board in December1985, for the period of December 1985 to June 1987.

106. These IMF resources have been made available to support the com-prehensive adjustment policies initiated by the Government in 1985, whichwere subsequently developed into the medium-term structural adjustmentprogram in the PFP. Macro-economic management improved substantially in PY86and FY87 and is broadly in line with that envisaged under the program. As aresult, the deficits on the crrrent account of the balance of payments andthe budget have been reduced to manageable lev,els. In addition, in late FY87the Government initiated serious efforts to restore discipline in the domes-tic financial markets. Under the medium-term program supported by the SAF,the Government will endeavor to raise the annual GDP growth rate to at least5%, reduce inflation to 7% by the end of the three-year period, limit theexternal current account deficit to about 7% of GDP, and maintain the levelof gross international reserves at above two and a half months of imports.To achieve these objectives, the Government will pursue restrained demandmanagement, raise domestic savings and improve resource allocation. Thelatter measures will include reforms in tax policy and administration and thefinancial management of public enterprises, as well as further strengtheningof loan recovery efforts in the agricultural and industrial sectors

107. Bank-Fund collaboration in the policy dialogue with Government hasbeen close. IDA's objective under its policy based lending, such as theThirteenth Import Program Credit (Credit 1655-BD), have been coordinated withIMF programs under the Stand-by Arrangement and are also reflected in thePolicy Framework Paper. In the past year, IMF staff have also participatedin IDA missions on tax policy and financial policy, and are assisting in thepreparation of reports on these subjects.

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PART VII -'rECOIIhINDhflON

108. I am satisfied that the proposed credit would comply with theArticles of Agreement of the Association and recoimend that the ExecutiveDirectors approve the proposed credit.

D. B. ConablePresident

Washington, D.C.May 13, 1987

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- ~~~zc WICA?~~~~~S ~Pes. I of 3

Mid-1985 PopuLatLco WUll.) 1011985 Pot Capita mW te 118$: 10

A. Sharm of Oross Domestic PVoduct D. Growth Rates (2 p ar aiui)

(fzee murrnt pxico data) (frmee ostant pric data)

19o5 1973 198 1984 9p 198 6. m 1965-73 1973-80 1980-84 1985p 1986.

Gross Domestic Product c.p. 100 1o0 z00 100 100 100 0 57 3.5 4.1 3.9Not Indirect Tam*s 3.1 2.4 5.2 5.4 5.2 5.1.. .

Agriculture 52.8 57.9 50.3 48.4 50.1 45.1 O.; 3.4 3 1'.8 2.9Industry 10.7 10.1 14.9 14.6 14.2 13.6 -6.1 11.9 4.2 6.1 2.7(of which Manufacturing) 5.4 6.4 9.9 8.8 8.3 ..- 1.9 13.3 1.8 3.2Services 36.5 32 34.8 37 35.7 41.3 1.5 7.4 3.9 6.3 5.8

Resource Balance -3.7 1 -0.7 -11.l -10.2 48.7 . .

Esports of 08FS ~~~~ ~~9.7 6 5.6 6.1 6.1 6.4 -13 17 6. 21 34inportsof WRS 13.4 5% 14.3 17.2 16.3 15.1 -3.9 9.3 5.2 7.6 -20

Total Expenditures 103.7 99 108.7 111.1 110.2 108.7 -0.3 6.3 3.6 4.9 0.4

Total Cautuoption 92.2 90.1 97.5 98.8 96.9 95.6 0.3 6.8 4.1 4.1 0.2Private Cansmntica 83.2 86 91. 3 91.9 89.2 87.5 . .

Cenaral Govoeuut 9.1 4 6.2 6.9 7.7 8.2 . .

rowss Domestic Investment 11.5 8.9 11.3 12.3 13.3 13.1 -5.4 3 -0.1 12.1 2.3FLxed Inwsntm 11.5 . . . . . . .

CAngsO In StoCk.. . . . .. ... .

Gross Domatic Saving 7.8 9.9 2.5 1.2 3.1 4.4 .. -1.5 -30.9 128.5 179.2Net Factor om0.1 0.3 0.1 -0.5 -0.4 -0.5 . .

ntie Currelat Transfers . .. 1.6 3.9 2.5 3.8 . .

Gross National Saving * . . .S 4.7 5.1 7.7 .. 27.4 .0.3' -9.5' 117

In millwon f L4U's 1965 1973 198 1984 1985p 1986.(at Constant 1980 prices) ---- ---- -

Gross Dmomstic Pro"uc 135 135 19 230 239 249 0 5.7 3.5 4.1 3.9Capaity to lapot 14 13 11 13 15 13 -4.7 1.4 3.7 14.7 -9.9Ten, of TradeAdjustmeant 6 2 0 -2 1 -1 . .

Gross DOstio locales 141 135 198 228 240 247 -0.4 5:.7 3. 3 5.1 3.1 Cros National Product 135 134 198 229 258 248 0 S.? 3.3 4.1 3.9Gross National Inom 141 136 19 227 239 246 -0.4 5.6 3.1 5.1 3

- 100)--------- -- -------- Iflatiom Rates (2 a.)----C. Price Indices* 1Iwo 1 19 1983 194 l9sSp 1906. 1965-73 1973-80 1980-84 I98 1986.

Ccansrer Prices (IFS 64) 100 130.8 143.8 157.8 175 .. 8.1 14.5 12.3 10.9ilbolesale Prices (VFS 63) 100 121.4 128.2 148.9 .. . . 12.9 10.2Implicit OM Daflator 100 124.4 130.6 152.1 174.9 187.6, 7.3' 13.4 10.6 1s 7.3Implicit. Napeditures Deflator 100 129.3 135.1 154.4 174.5 191.2 7.7 13.7 11.1 13.1 9.5

0. Other Indicators 196573 1973-80 1980-8SP----- -----.. ~~~~~~~~~~~~~~~Notes:

Growth Rates (X p.a.):Population 2.6 2.4 2.6 Patu on the DcomicA indicators tablesLabor Force ... .should foll., the definitins andGross National Income p.c. -2. 9 3.1I 1 caonpts of the fteadard Tables andPrivate Consuiption P.C. ... tiandard Attachmets. Mme ivdicators

should imlwo- iata. thra18h the mostImport Elasticity: recetaly car .t0d Calaudar Fewt (or

Import (Om$) I -W Cap) .145.9 1.6 1.3 fiscal year in the case of fiscal yearcountries).- Staff estimetes aWbe used

Marginal Saving Ratess if final or prelibmiar actuals; we notGross, Natioael Savin . . 9.7 Yet available. TMe use of astinmtes andGross Domestic $aving -114.2 -14.6 6 prelminary fipArs shoul be Indicated

by.IOM (period awera4s):

a - estimated datauShre of Total 1t65 1973 31980 19& P p prelimnar d"at

lAbor Force in:--- -Agtuau t.

Total . .

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hoe 1Page 2 of 3

BWCL*DEW - IC I3 8TC

Volds ImIej (1980 - 100): Value at Corent Prices (milieon US$):

E. tarcbm4ise Exports 1980 1982 1983 1984 1985p 1966 1980 1982 1983 1984 198'vp 1986e

Rev Jute 100.0 97.S 114.3 96.5 71.6 116.9 144 102 110 117 151 124Tea 100.0 130.6 128.2 128.2 108.8 124.8 33 38 46 69 61 33J.eatbmr lOD.0 104.7 112.7 123.5 98.0 87.6 66 63 58 85 70 61

9wiap. etc. 100.0 174.6 231.9 262.7 322.4 392.2 87 53 72 77 87 113Maufactures ) 100.0 115.2 114.6 121.9 123.7 122.1 442 370 401 463 565 488Other Exports )Total brcbandise Exports FOB 100.0 114.4 121.0 124.5 120.5 131.9 7'22 626 687 811 934 819

F. Nar dtl lapors

Food 100.0 49.7 74.2 74.8 100.1 70.6 716 361 473 487 607 367PM sd Other Ees 100.0 102.9 85.7 85.4 91.9 109.6 1S3 5U4 411 355 359 355Other Xqpots

Other CIswllrt Goods ) 100.0 129.3 95.2 125.6 147.3 123.5 728 980 707 e12 1065 951Othor 14teradlate Goods )Capital Good 100.0 108.4 117.8 110.1 113.9 120.0 545 615 655 S99 616 691

Total Merchandise Ixpors CIF 100.0 96.2 92.5 100.2 116.5 104.5 2372 2504 2246 2353 2647 2364

0. Ten of Trade (1980 - 100) 1980 1982 1983 1984 1985P Ee -------------------------_-otes:

Meah. Exports Price indix 100 95.6 95.7 102.5 99.4 98.6March. 1port Pr I e 100 94 93.7 93.4 88.4 86.3 Data an the Zoaic Inditcators tablesMarchbadise Tans of Trade 100 101.7 102.1 109.7 112.5 114.3 should ollow the definitions and

aconepts of tbo Standard Tables adUS$ mllons (at current prices): Standad Attamts. M Indicators

ohm"- - -- l 4 dat throush the ostB. Balance of Paymnts 1980 1982 1983 1984 1985 1986 recently oahleted calndar Year (or

-________________ -_--- --- -- _-- --- fiscal yer in he aeof fiscal yearExorts of Goods and NFS 906 940 987 1043 1195 1040 countries). Staff eatlmtesa sy be used

M ;rchandise (FP) 744 726 783 821 966 819 if final or prelSinary actuals are notNon-Factor Services 163 214 204 222 229 221 yet avalable. The use of estiats and

PrliminaW fieums abould be indicatediAports of Goods and N8S 2560 2883 2529 2540 2848 2587 by:

Merchandise (FOB) 2107 2417 2096 2111 2360 2364Nor-Factor Service 454 466 433 430 488 223 a stJated data

p *preliminary dataResource Balance -1654 -1943 -1542 -1497 -1653 -1547

Net Factor Thorn 14 -96 -110 -65 -123(Intert per MRS) 46 61 68 75 89 106

Not Current Transfers 210 387 593 552 9 s56(Workers ranittance) 197 368 576 527 364 0

Curran Account Balance -1430 -1652 -1059 -1010 -1321 -1084

Loos-Taro Capital Infla. 365 529 598 495 531 1169Direct lnstment 0 0 0 0 0 0Officlal Capital Grants 908 669 782 737 700 546Net LT LoOs (DRS data) 659 620 478 445 455 640Other LT inflo (Not) -1202 -761 -662 -687 -623 -17

Total Other Itrn (net) 875 901 668 739 677 -4Net Short-toon CapLtal 920 819 687 747 660 -4Capltal Fiacu N.E.I. 0 0 0 0 0 0Erors and CUlsios -45 82 -19 -8 17 0

CiuWs In NVt Reserves 190 222 -207 -224 112 -81Net Credt fron IM 4 49 49 20 -6 -3Other Raserve charges( - incates incrse) 186 173 -255 -244 119 -78

As sbars of GD:Resourc Balae -12.9 -14.7 -12.7 -10.7 -10.9 -9.9Interest Payts 0.4 0.5 0.6 0.5 0.5 0.7Curret Accont Balane -11.2 -12.5 -8.7 -7.2 -8.2 -6.9

) rau. It :tinte atl Reserves (il. US8) 300 183 524 390 337 475R 1serve la. 0.1d (il. US$) 331 207 546 406 354 475Offia X-Rate (LC sUS$) 15.48 20.04 23.76 24.95 26 29.89Index Ral Bff. XV- Base 1980 100 95.07 94.18 104.47 107.05 .. ----------------------- --OF nillOs of awrt us$) 12792 13231 12140 14026 16106 1569

-37-

Psi 3 of 33ANADEM - EzUWDc InDIA1m

Share of (QP (1) Gragrkitares (bea.a.)

I. bAdut (specify imil) 198 1982 1983 1984 19 85

p 1986. 1980 - 83 1984 1983 1986.

Current Receipta 8.7 8.8 8.8 8.2 8.6 9.1 14.0 12.6 25.6 17.7Current Es1P.d-AtUre" 6.4 3.6 6.7 6.6 6.6 7.4 16.9 20.0 20.3 11.3Current Budget Balance 2.3 3.1 2.1 1.6 2.0 1.7 3.1 -10.2 147.6 -7.0

C.Vit,l Receipts . . . . . ..

Capital Espenditurvs 14.1 11.8 1S3.3 10.7 9.6, 9.0, a.a 1.0 3. 7 16.5'Overall Deficit -11.8 40.7 -11.2 -9.2 -7.6 -7.3s 9.7 -1.1 -1.1 -7.6

Official capital Granr )9.6 7.6 9.8 8.0 6.9 6.7 26.3 -1.3 2.9 9.9External Borrowing (net) )0.1 1.2 -0.03 0.9 0.8 ) .. 0.7 -27.7 -14.0Domestic Non-Beat Finui9L 2.2 9.9 0.2 1.2 -0.2 -0.2 Domestic Bank Ftianong

Not Disbursemets (US$ millices) Debt Outstainilng 4 Disbursed (US$ .1l.)J7. External Capital Plows,Debt ----------------------

and Debt Bntd anRtina 1980 1982 1983 1984 IM8P 1986. 1980 1982 198 1984 I965p 1986.

Public & Publicly Guarantead LT 659 620 478 443 ASS 640 3549 4449 4885 5155 5968 6672

Official Creditors 660 609 466 449 463 .. 3476 4360 4792 5074 5884)Ilt$l.teral 305 276 255 336 417 .. 1383 1878 2114 24'13 2886

of Which IIIR 0 0 0 0 -2 .. 55 55 55 55 53of %hich IDA 156 188 200 246 275 .. 926 1270 1459 1677 199

Bilateral 354 333 210 113 46 .. 2092 2482 2678 2661 299

PrIv*te Creditors -1 II 13 -4 -8 .. 73 89 93 81 asStppLiera -7 -4 -1 -2 -4 .. 43 43 40 37 33Plmsmial Markects 6 14 114 -2 -4 .. 30 46 53 44 48

Private Non-Guaranteed I.?. . . . . 0 .. . . . .0

TOWa LT 659 620 478 445 453 640 3549 4449 488 .5153 3968 6672

IN Net Credit 94 107 51 -60 23 .. 269 413 441 SS6 424Net short-Tem Capital 920 819 687 747 660 -4 212 209 170 133 135 135

eTel Inaludics 1W 1 Not ST 1671 1547 121 1133 1138 .. 403 5070 5496 5644 6526

Bank and MID Ratios 1980 198 1983 1984 1985p 1986----- ---- -- - --- -- notes:

Share of Total Long-Ten DM01. IEN as I of Total 1.53 1.23 1.12 1.07 0.869 .. Data en the Economic Indicators tablesr2. IMA as I of Total 26.09 10.33 29.8 32.34 33.36 .. bsould follow the definitions AS. IB804IDA as I of Total 27.64 29.78 30.99 33.61 34.26 .. concepts of the Standard Tables andShare of Total LT Debt Services I Standard Attacbments. Ihe indicators1. IBM0 as I of Total 4.03 2.75 3.63 1.8 1. 77 .. should include data through the mast2. MDA as X of Total 7.15 7.11 7.33 9.15 10.27 .. w*eotly capleted calendar year (or3. rBR4~DMA, as Z of Total 11.18 9.86 10.95 10.95 11.99 . fiscal yar ii the Case Of fiscal YOar

conre). Staff estimates may be usedD00-to-Enports Ratios Lf final or preliminary actual. arm not

yet available. The use of estimates end1. Lons-Term DabtlElmspo 355.74 457.08 481.86 468.68 476.98 618.34 preliminary figures should be Indicated2. 1W Creatitlapats 26.96 42.39 43.31 32.38 33.815 .. by:S. Short-Term Debt/Exports 21.25 21.47 16.77 12.09 10.79 12.314. LT+M*+Sr DODlEsporta 403.96 520.95 542.14 513.15 521.1 eAe estimatad data

p =preliminary dataDa-t*-GP Ratios

1. Long-Tens, DebtI00p 27.74 33.6-2 40.24 36.73 37.05 42.722. DIf CredtilWP 2.1 3.12 3.63 2.54 2.633. Short-Term DIbtICDP 1.66 1.58 1.4 0.95 0.84 0.864. LT,.M4'ST DOD1009 31.5 38.32 45.27 40.24 40.52

Debt serviceIvota

1. Publi & Ogxaataed LT 7.71 12.71 13.33 15.69 17.13 25.572. Private Non-Ouzanatee LT .. . . . .

3. Totail LI Debt servIe7.7 12.7 13.33 15.69 17.13 25.5714. DIV Papurcohas 4. so" Chas.5. Interes Galy en ST Debt

March 1987

-38-

ANNMX IIPage 1 of 3

TEE STATU8 OF BANK GROUP OPERATIONS IN BRGL&DBSN IL

A. STATZEMET OF BANK LOANS AND IDA CREDITS (as of March 31. 1987)

AmountsLoan or (less cancellations)Credit U8$ Nillion /bNumb,er YXes Borrover lPurpoe Ink IDA Undisbursed

One loan and 65 credits fully disbursed 54.90 1,804.50 -

912 1979 Bangladesh Vocational Training - 25.00 8.96955 1979 Bangladesh Small-Scale Drainage &

Flood Control - 25.00 4.43964 1979 Bangladesh Highways II - 10.00 0.741001 1980 Bangladesh Chittagong Water Supply II - 20.00 2.991054 1980 Bangladesh Education IV (Primary Education) - 40.00 9.121096L&. 1981 Bangladesh Fertilizer Transport - 25.00 9.651140kL 1981 Bangladesh Rand Tubevells - 14.96 2.291147k 1981 Bangladesh Agricultural Credit - 40.00 7.141184kL 1982 Bangladesh Drainage & Flood Control II - 27.00 13.501204/ 1982 Bangladesh Chittagong Urea Fertilizer - 15.00 1.381205/c 1982 Bangladesh Textile Industry Rehabilitation - 30.00 25.921215 1982 Bangladesh Extension & Research II - 27.00 16.701247ki 1982 Bangladesh Chittagong Port - 60.00 62.141254lc 1982 Bangladesh Ashuganj Thermal Power - 92.00 52.781262k 1982 Bangladesh Rural Electrification - 40.00 14.491287lk 1982 Bangladesh Deep Tubewells II - 44.17 29.611301/c 1983 Bang-ladesh First Righway Project

(Supplemental) - 6.00 0.391318kc 1983 Bangladesh Business Management

Education & Training - 7.80 5.361321k 1983 Bangladesh Telecommunications III - 35.00 23.681349kc 1983 Bangladesh Public Administration

(Training and PersonnelManagement) - 12.00 8.35

1357k 1983 Bangladesh Energy Efficiency andRefinery Rehabilitation - 28.50 24.30

1384kL 1983 Bangladesh Rural Development II - 100.00 95.631396k.L 1983 Bangladesh Agricultural Training II - 8.10 6.791399Lk 1983 Bangladesh Sugar Rehabilitation and

Intensification - 20.00 16.781402kc 1983 Bangladesh Petroleum Exploration Promotion - 23.00 11.321440/c 1984 Bangladesh Fifth Teehaical Assistance - 25.00 28.201455kc 1984 Bangladesh Second Agricultural Research - 24.50 27.921467k 1984 Bangladesh Water Development Board - 41.50 45.871477k 1984 Bangladesh Textile Industry Rehab. II - 23.00 27.77F0221c 1984 Bangladesh Textile Industry Rehab. II - 22.00 26.61149O0I 1984 Bangladesh Technical Education - 36.00 29.48

-39-

AUNXK IIPage 2 of 3

A. Bank Loans and IDA Credits to Usa*ladesb (continued)

AmountsLoan or (less cancellations)Credit 1U8$ Million /bNumber Year BrxmNr PuIr"o Usk IDA D_disbursed

1574/c 1985 Bangladesh Second Primary Education - 78.00 88.201586Lc 1985 Bangladesh Second Gas Deveopment - 110.00 138.461587/c 1985 Bangladesfi Flood Rehabilitation - 30.00 11.701591/c 1985 Bangladeshl Third Flood Control & Drainage - 48.00 59.861633k£ 1986 Bangladesh Rural Blectrification II - 79.00 94.371634/c 1986 Bangladesh Second Forestry Project - 28.00 30.671648Lc /d 1986 Bangladesh Power Trans & Distribution - 56.00 63.151649k. 1986 Bangladesh Population & Family Health III - 78.00 91.291651/c 1986 Bangladesh Shrimp Culture - 22.00 24.561655ic 1986 Bangladesbh Iports Program XIII - 200.00 95.781734c /e 1987 Bangladesh Dhaks WASA III - 30.00 33.941749/c Lt 1987 Bangladesh Refinery Modificatiirn & LPG

Recovery & Distribution - 47.00 51.43Total 54.90 3,558.03 1,423.70

of which has been repaid 3.81 17.88 -Total now outatandina S1.09 3.540.1S

Amount sold 0.00 0.00Total now held by Bank ad IjDA 5109 32540.15Total undisbursed L/ 1.423.70

La The status of the projects listed in Part A is described in a separate report onall Bank/IDA financed projects in execution, which is updated twice yearly andcirculated to the Executive Directors on April 30 and October 31.

lb The original principal of credits under replenishments 1 to 3 has been increasedby the amount of the translation adjustment as a result of the devaluation ofthe United States dollar in 1972 and 1973.

/c IDA Sixth and Seventh Replenisbmnets Credits denominated in SDRs. The principalamounts are shown in U.S. dollars equivalent at negotiations as shown in thePresident's Reports. The undisbursed amounts are calculated at the rate of exchangeon March 31, 1987.

Li Effective October 14, 1986./e Not yet effective.Lf Difference of $1.3 million between the undisbursed amount of $1,423.70 shown above

and the undisbursed amount shown in Statement of Development Credits at 2/28/87represents $1.3 million cancelled under Credit 864-JD in February 1987.

-40-

Annex IIPage 3 of 3

D. STATIH-IT OF IFC INBSTU7S (&a gf lurch 31. 1987)

UndisbureedBalace inc.

Fiscal Total Held Participants' UndisbursedYear TyDe of Business Emits Loan mtIn byvz .IPCtio.ao IFC Portion

1969 aranaphuli Paper Hills Ltd. Pulp 6 Paper 0.63 5.60 6.23

1979 Highapeed 8bipbuilding 6Heavy Engineering Co., Ltd. Shipbuilding 0.36 1.20 1.56 0.91

1980 industrial Prootion andDevelopment Company of DFCBangladesh, Ltd. 1.05 - 1.05 1.05

1985 Industrial Development oney leasing Co. of Bsngladesh Capital(IDLC) Market 0.17 2.62 2.79 2.79 I.44 2.44

1985/86 gata Shoe Co.(Batsladesh) Ltd. Shoes L.S1 4.45 _4AK IA6 3A. 1.12

TO-AL 2.T2 I8 1

-41-Annex IIIPage 1

BANGLADESH

Industrial Sector Credit

Supplementary Data Sheet

Section I: Timetable of Key Events

Preparation mission May 1985Pre-appraisal mission October 1985Appraisal mission March 1986Negotiations April 6-14, 1$187Date of Effectiveness (planned) July 30, 1937

Section II: Special IDA Implementation Actions

None

Section III: Special Condition

It is proposed that the proceeds of the credit be eligiblefor withdrawal in two tranches. The first tranche of SDR 77.8 million(US$ 100 million equivalent) would be released when the proposed creditbecomes effective. SDR 14.9 million (US$ 19 million equivalent) of thisfirst tranche would be made available on a retroactive basis. The secondtranche of SDR 70.0 million (US$ 90 million equivalent) would be released,subject to IDA being satisfied, following a review by January 31, 1988, thatthe Government is following sound industrial sector policies as well asmeeting the specific conditions listed in Section IV of this Annex.

-42-

page 2

IIIDUSTRI*L SICTOI CR8DIT

Objectives Actions AlrUedy Undertaken Actions to be Taken Prior to_Secnd Tranch Re1leas

A. Ex gort Policy Indication in Fns7 import 4 Rxport Polity OrdersAdEaiZzaLutioa that "negative list" does not vply to imports

for export production (pars. U .Ensure free trade sta-tus for all indirect Promulgation of revised Orders for xportas well as direct Processiag Zone Authority to enhance itsexporters, improve autonomy and streamline procedures forfinancing & guarantees securing approval. & utility connection.available to all required for new industries in theexporters, maintain zone (para. 48).appropriate exchangerate & strengtheninstitutions whicbsupport exports

Creation of Duty Exemption/ Drawback Cell as Conversion of Duty Xxemption/Drawbackfirst step in creation of permanent office to Cell into a permanent office &design & implemat improved duty exemption 6 initiation of its activities (pars. 47).drawback systems; assignment of core staffto cell (para. 47).

Preparation by an inter-agency task force of initiation of implementation of pro-proposal to provide incentives to indirect posals made by task force on incentivesexporters by applying inland back-to-back for indirect exporters (para. S1).LIC system to all direct and indirectexports (para. 51).

Formtion of task force within Initiation of implemntation of pro-Ranglndesh lank an to preparation of po"ls by export fineing task forceproposls to improve export (pare. 50).finening to moderise administrativearragemeats for preshipment financing, createa foreign excbhge revolving fund to financeexporters' iports & establisb an automticrediscountlng necmbnien for export loas(para. 50).

-43-

Page 3

Objectives Action Already Undertaken Actions to be Taken Prior toS_ BoMA trenh le se

Revision of internal quota allocationpolicy for 1987-88 (pars. 52)

Establishment of 8sport Monitoring Unit in satisfactory operation of the Etport8zport Promotion Dureeu (paro. 52). Monitoring Unit for garenat exporte inclo-

din *asigment of staff, dewlto _etspecifications for periodic publi-cation of information & distributionto concerned eprtets (pare. 52).

Strengthening the Export Guarantee schXe by Preparation of plan to further strengthenconverting it into a depertuent and increasing Export Guarntee Schm bicb wouldits capital and staff (para. 49). include. as necessary, proposls for

the schee nd initiation of thispla (pars. 50).

Naintenance of flexible exchnnge rate policy Naintenance of flexible exchbge rete policyto avoid appreciation of official real effective to avoid appreciation of official real effectiveexchange rate (par. 44). exchange rate (pars. 44)

B. ta3iff and loort. Cbange from positive list of unrestricted imports92AIMP to negative list of prohibited products (para. 62).

Liberalising the significant shift frou official foreign exchangetrade regime by market to secondary msrket so that in FM86 531rationalising tariff of export 6 282 of import transactions were madestructures, reducing through secondary market, compared to 27Z ofeffective rates of exports 6 201 of imports during ms (pare. 61).protection in keysectors and reducing Reduction of tariff rates to 11 & reclassification ofquantitative item within nem rates (pars. 56).restrictions.

Agreement to introduce a revised tariff schedule in FM8and FY89 by reducing the number of tariff rates to 8and limiting the "les tax rates to 2 which will reducethe nmber of effective duty rates from 33 to 16 (para. 57).

-44-

Page 4

Objectives Actions Already Undertaken Actions to be Taken Prior to-secod Sranch Release

Liberalization of imports through furtherreductions in number of items in negative &restricted lists, lifting restrictions on 140items (such as trucks, diesel engines and buses),reducing by 537 number of spare parts items forjute and textile industries included in restrictedlist & eliminating part of restricted list per-taining to commercial importers (para. 62)

Agreement to reduce the negative list by 20X Implementation of reductions in neg-eacb year giviug priority to textile and steel ative & restricted lists agreed atand engineering products and remove restrictions negotiations by incorporating thenon commercial importers of industrial raw in the FY88 Import Policy Ordermaterials in equal installments over three (pars. 62)years (para. 62).

Commitment to lover tariffs in phases during Reduction of tariffs on luxury goodsFY88-89 on luxury goods vith tariffs of 150l above IS02 to a maximum of 1502or more to a maximum of 1002 by FY89 (para. 57). (para. 57)

Tariff changes in FY86 and FY87 budgets intextile and engineering (para. 57).

Agreement on a phased program during PY88-PY90 Restructuring of tariffs on importsto restructure tariffs & reduce quantitative for textiles & steellengineeringrestrictions in textiles & steel/engineering subsectors such that the maximumsubsectors. to 0-852 for both subsectors total protective tariff for final(para. 57). goods in these sectors are reduced

to 1252 and corresponding reductionswill be wade in tariffs for rawmaterials and intermediate products(para. 57).

Simplification of import pro-cedures, elimination of importlicences and implementation ofpass books for industrialimports (para. 37).

Review of existing studies on import &customs procedures & agreement to developa program to implement these recoumendatiomsby October 1987 (para. 63).

-45-

Pagt 5

Objectives Actions Already Undertaken Actions to be Taken Prior toSecond Trench Release

C. Investment Modification of investment sanctioning system bySanctionina replacing specific quantitative targets investment

schedule with general guidelines and making itLiberalize investment indicative (para. 68).apptoval system byreducing government Except for industries reserved for public sector.control on new designation of all industries as free sectors notindustrial investment. requiring approval (pars. 68).

Increase in the limits on finance institutions' termlending wbich require government approval (para. 68).

Increase from 202 to at least 502 in the minimum per-centage of imported inputs which require projectsto be reviewed by the Investment Board (para. 68).

D. Public Sector Indus-trial Entercrises

Significantly reduce Major public sector enterprise denationalization programthe scope and size of under which about 650 enterprises were transferred frompublic sector in public to private sector (para. 73).manufacturing by

* denationalization, tnactment of Public Enterprise Management Ordinancelimiting the areas in limiting government intervention in public sectorwhich public sector can enterprises' operations by giving their Boards greateroperate and introducing operational authority (para. 77)a new performancetargeting and evaluation Issues of revised industrial policy statement limitingsystem to increase the areas in which public sector can enter and definingautonomy and efficiency the future denationalization policy (para. 71)of remaining publicenterprises. Award of management contracts to foreign firms to run

large PSI. (para. 74)

-46-

Page 6

Objectives Actions Already Undertaken Actions to be Taken Prior toSecond trench Relg __..

Sevelopment of new system to increse enterpriseautono3y while establishing clearer accountabilityand performance criteria (para. 76).

Submission to IDA final proposl forstrengthening finance Ministry' AutonoaousBndies Ving & organisational arrangements fordeveloping 6 monitoring performace targets forpublic sector industrial enterprises (para. 78).

Initiation during FY87 of pilot program involvingone public sector industrial enterprises to intro-dsce a new public enterprise perfornce targeting,Initoring & evaluation system and agreemnt toinclude 3 additional public sector enterprisesin pilot program during FY88 (para. 80).

S. inancil- Sector WI technical assistanceprgram (parc. 85).

Increase recovery Agreement on TOR for additional DYI technical Satisfactory implemetation ofof industrial assistance to strengthen appraisal, loan WI technical assistance programloan & strengthen supervision/collection & portfolio rehabilitation (para. 99).Davelopuent Finance capabilities & accounting 6 persomnel systemsInstitutions (Ils). (para. 99).

Agreement with donors on an Action Program tostrengthen the DFIs 6 improve loan recoveries(pars. 85).

Implemsntation of key elents of Action Poram.including closure of concessions under ExchangeFluctuation Absorption Schem (ISAS), easures

ainst willful defaulters, take-over actionsagainst large defaulters, appointmet of lawyers

without prior Government approval, & satisfactoryproposed amendmnts to WI Orders (pares. 87-90).

Encetment of revised WFI charters (para. 96)

-47-

AiUIPage 7

Objectiv e Actions Already Undertaken Actions to be Taken Prior toSecond Tranch Releak_ _

Sbission to IDA of WI ad IDA financed aCelo an portfolio nalyses, strategies to increascollections & reacbedule b write- off loans. Arevised projection of future collections (parse.92-93).

Cash collection targete et for July l-Dec 31 Collection of Tk. 1,370 million by1986 of Tb. 330 million by Wi*s nd of Tn. 39 DFls and Tb. 136 million by WCEsmillion by three MtU participating in during Jan I-Dec 31, 1987IDA-financed c_l industries projects (parse. 92-94)(pares. 92-94).

Agreemat to eliminate public sector enterprises'arrears to sasglsdech Shilps Rin Sngatba, theDWI for vwich this is a significant problem byJuly 1988 (pars. 91).

Initiation of increased provisions for bad & Satisfactory progress in imple-doubtful debts. recapitelisation to schie A menting DWI programs for provisionsmaintain WI debt/equity ratios at no more than for bad and doubtful debt. recapi-3:1, 6 selective rescbeduling & writing-off of talisation ad & loan rschedulingaloans (paras. 97-98). & write-offs (parse. 97-98).