Document of

The World Bank

FOR OFFMCIAL USE ONLY

Repwot No. 8613

PROJECT COMPLETION REPORT

EGYPT

MISR IRAN DEVELOPMENT BANK PROJECT(LOAN 1842-EGT)

MAY 4, 1990

Industry and Energy Operations DivisionCountry Department IIIEurope, Middle East and North Africa Regi^nal Office

Thi document has a resricted distribution and may be used by reipients only in the performance ofther offiec dudes. Its contnts may not otherise be disclked without World Bank authorization.

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ACRONYMS

BOA - Bank of AlexandriaCBE - Central Bank of EgyptDIB - Development Industrial BankIMDBI - Industrial and Mining Development Bank of IranMIC - Misr Insurance CompanyMIDB - Misr Iran Development BankPCR - Project Completion ReportPR - President's ReportSAR - Staff Appraisal ReportTA - Technical Assistance

J yISCAL DEAR

January 1 to December 31

FOR OFFICIAL US ONyTHM WORLD BANK

Washington. D.C. 2033USA.

oa OCtoGmiwulopw atm_ IvMaituim

May 4, 1990

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE SIDENT

SUBJECT: Project Completion Report on EgyptMisr Iran Development Bank Project

(Loan 1842-EGT)

Attached, for information, is a copy of a report entitled "ProjectCompletion Report on Egypt - Misr Iran Development Bank Project (Loan1842-ROT)" prepared by the Europe, Middle East and North Africa RegionalOffice. No audit of this project has been made by the Operations EvaluationDepartment at this time.

Yves Rovaniby RLm K. Chopra

Attachment

This document has a estricted distribution and may be used by recipients only in thc perfonnanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorz*tion.

FOR OMCIAL USE ONLY

PROJECT COt4PLETION REPORT

Rani

MISR IRAN DEVELOPMENT BANR PROJECT(LOAN 1842-EGT)

TABLE OF CONTENTS

PREFACE .... ....... .***...... ............ *....... ***...*...... .*... l

BASIC DATA SHEET ............................ .................. iiiEVALUATION SMOARY ........ ... ... . .. .. .... .*.* ............. v

PART I: PROJECT REVIEW PRCM THE BANKS PERSPECTIVE .... ... .... 1

I. Proiect Identity . ............................ 1

2. Economic and Policy Settint ............................. 1Financial Institutions and Policy .... ...................... 2Banking Regulation . ................................... 2Industrial Sector Policy Issues ......................... 3Conclusions 3............................................ 3

3. Proiect Objectives and Descrigtion ..... ................. 3Background .... ..... 3Loan Objectives .................................. 3

4. Proiect Design and Execution ............................ 3The Project .... ..................... * ** * ** * ** *** 3Design and Execution Problems ........................... 4A. Currency of Lending and Onlending Rates for

Bank Funds . 4B. Exchange Risk ..................................... 4C. Exchange Rate ............ 5

Contract Amendment ..................................... 5Conclusions Regarding Project Design and Preparation .... 5A. Repricing Bank Funds .............................. 5R. Other Project Design Considerations ............... 6

Conclusions Regarding Policy Znvironment ..... ....... .... 6The Technical Assistance Program ...... .................. 7

5. Loan O Prtf; ..olPgrfema .aee I.......................e 7

8ub-Project Profiles. .eeee....... ..Sestoral and nvestment its ................... 8Sub2oau Portfolio status .Conclusions .... ........... *.......... ........ 11

This dument ha a resrctd disibution and may be usd by recpients only In the perfomance oftheir official duties. Its contents may not otherwis be disclsed without IFC authorization.

TABLE OF CONTENTS (cont'd.)

Page No.

6. Sub-Proiect Appraisal and Creditworthiness Review ....... 11Appraisal Capability ... ........ ............... t.o..* 11Conclusions ......... **.*..to* *....*.. *a****e*... ....... 12

7. Financial Operations ... ***** .... *.................**... 13Financial Structure ....... *...... .. ..... ...... .. 13Equity Investment *...................t. 14Conclusion ........................*.to .........#.*a*... 14Profit and Loss from Operations ......................... 14Financial Margins Under Loan 1842-EGT ................... 15Accounting .......... ,* ...... 04 ... 15Conclusions ............. * ......... **. ............ 16

8. Summary of Results .......... ....* .......... .... ....... . 16

9. General Conclusions and Recommendations ................. 17

PART II: PROJECT REVIEW FROM THE BORROWER'S PERSPECTIVE ...... 19

PART III: STATISTICAL INFORMATION ... ......................... 28

Table 1: Characteristics of Sub-Projects Financed ............ 28Table 2: Status of Projects Financed by the Bank ...... ...... 30Table 3: Balance Sheet as of December 31, 1988 ............... 33

Statement of Profit and Loss as of December 31,1988 ............ ***............ ................. to......... 35

Attachment

Comments Received from MIDB ..... ............... ........... .. .. 37 .

PROJECT COMPLETION REPORT

MISR IRAN DEVELOPMENT BANK PROJECT(LOAN 1842-ECT)

PREFACE

This is the Project Completion Report (PCR) for the First Misr IranDevelopment Bank (MIDB) Project, for which Loan 1842-EGT in the amount ofUS$30.0 million was approved on May 13, 1980. The loan was closed onJune 30, 1987, two years behind schedule. Only about 792 of the total loanamount (US$23.6 million) was disbursed prior to loan closing; the last dis-bursement was on September 23, 1987.

The PCR was prepared jointly by the Bank's Europe, Middle East andNorth Africa Regional Office, Country Department III (Preface, EvaluationSummary, Parts I and III) and the Borrower (Part II).

The preparation of the PCR began with a Bank mission to MIDB inJanuary 1989. The PCR is based upon data obtained from MIDB and upon theStaff Appraisal Report (No. 2573-EGT), dated April 9, 1980; the President'sReport (No. 2780-EGT), dated April 18, 1980; the Loan and Project Agreements;correspondence with the Borrower; internal Bank memoranda; and supervisionreports.

The draft PCR was sent by the Region to the Borrower for review.The comments received from the Borrower are reproduced as an Attachment tothe PCR.

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PROJECT COMPLETION REPORT

MISR IRAN DEVELOPMENT gAmK PROJECT(LOAN 1842-EGT)

BASIC DATA SHEET

LOAN POSITION(Amounts in US$ Million)

As of Mar. 31. 1990Original Disbursed Cancelled Repaid Outts.ding

Loan 1842-EGT 30.0 23.56 6.44 21.21 2.35

CUMULATIVE ESTIMATED AND ACTUAL DISBERSXEMEU

"SflO FY f HUl UL fil mis fL fIB

Appraisal Estimate (USS N) 0.0 2.3 13.3 25.5 29.5 30.0 30.0 30.0 30.0Actual (US$ O) 0.0 0.0 0.3 6.5 9.0 16.0 18.0 22.3 23.6Actual as 2 of Appraisal (M) 0.0X 0.0X 2.3X 25.5 30.52 53.3X 60.0X 74.3K 78.7XDate of Last Disbursement: Septeamer 23, 1987

PROJECT DATES

Orilinal Reuised/Acyal

Board Approval n.a. 05113/80Loan Signing n.a. 06/04/80 LaLoan Effectiveness 10106180 12131180Loan Closing 06/30185 06/30/87

STM INPUTS(staff weeks)

fr fu7 E f 1n1 flu f u FY8 flX F11 ur frn 12ai

Preappraisal 34.1 1.3 - - . 35.4Appraisal - 44.9 12.6 - 7 - - - . . - 57.Negotiations - 9.8 - - - - - - - 9.8SLpervfsion - - 0.2 5j UL iu 2L 1Z _ j 1-9 23-7

Total 34.1 46.2 23.8 5.3 8.8 2.8 2.0 1.? . 1.0 1.9 127.6

_a Loan Agreement was amended on November 14, 1983.

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MISSION DATA

No. of No. of Staff Date ofMonth/Year Weeks Pgrsons Weeks Resort

Supervision I 05181 2.0 1 2.0 06/15/81Supervision II 05/82 1.0 2 2.0 06/07/82Supervision III 11/82 0.8 1 0.8 12/08/82Supervision IV 09/86 0.2 6 1.2 09/30/86Supervision V 10/87 1.0 3 3.0 11/24t87

OTHER PROJECT DATA

Borrower: Arab Republic of EgyptExecuting Agency: Misr Iran Development Bank (MIDB)

Follow-on Proiects

None

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PROJECT COMPLETION REPORT

MISR IRAN DEVELOPMENT BANK PROKECT(LOAN 1842-E6T)

EVALUAMTON SUMMARY

Introduction

1. This is a project completion report (PCR) on the Bank's firstindustrial development project through the Misr Iran Development Bank (MIDB),an Egyptian/Iranian joint stock company, established under Law 43 (on foreigninvestment) in May 1975. MIDB was designed to serve as a form of merchantbank to promote and finance larger projects. MIDB had at the outset a sharecapital of US$20 million, fully paid in. The shareholders, each contributing252 of the capital, were: Bank Melli, Iran; Industrial and Mining DevelopmentBank of Iran (IMDBI); Bank of Alexandria (BOA), Egypt; and Misr InsuranceCompany (MIC), Egypt. As a joint venture bank with only 502 Egyptianownership, MIDB could not deal in local currency. MIDB had been successful inmobilizing local resources for its clients' projects, when required, primarilyfrom its two local shareholders: BOA and MIC. Ultimately it had to deal inlocal currency as the interest and exchange rate policies made it difficult toon-lend in foreign exchange. It initiated such dealing in 1983 when theGovernment purchased Iranian shares and increased Egyptian ownership of MIDBto 75%.

Objectives of the Loan

2. The objectives of the proposed Bank loan to MIDB were: (i) tocontinue and expand the Bank's support to the building in Egypt of aninstitutional capacity to provide financial and other support to the privateindustrial sector that was started with Bank's assistance to the DevelopmentIndustrial Bank (DIB); (ii) to help MIDB fulfil its role of promoting/financing medium and larger scale private sector industrial projects withspecial emphasis upon the construction and capital goods manufacturingindustries, as well as export-oriented industries; and (iii) to contribute toMIDB's institution building and training efforts.

Implementation Experience

3. Disbursement of the loan started slowly as Loan 1842-EGT wasconsidered by potential borrowers to be excessively priced and risky comparedwith other available term credit. The loan was amended in late 1983 to giveborrowers access to the central bank's preferred exchange rate and relief fromthe cross currency exchange risk. On that basis, the loan began to move andUS$23.4 million was used for 13 sub-projects within 24 months. In 1985, theEgyptian pound was devalued and the preferential rate moved from LE 0.84 tothe US dollars to LE 1.34, at which point most solvent borrowers negotiatedlocal currency loans to repay their dollar obligations. Overall, about 202 of

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the loan was cancelled and 252 repaid ahead of schedule. Regardinginstitution building, during loan preparation the Bank was very active inhelping MIDB to organize and establish itself. The Bank had planned tocontinue these efforts during the course of its loan supervision activity.Clearly, opportunities for institution building were substantiallyunderestimated. Ultimately very little was done as Borrower-Bank contact wasminimal.

Results

4. The Bank loan financed 232 of 13 sub-projects whose total costamounted to US$103.4 million. About 70Z of MIDB's sub-projects were for newand mainly raw material import dependent, import substitution projects. Thusthe impact of the subsequent devaluations on the subborrowers' capacities tosustain operations and repay dollar debt service charges was negative. Onlyone-third of the sub-projects are currently operating normally and theexpected overall financial and economic results of the other eight projectsmay not be achieved. MIDB's total exposure to doubtful or failingsub-projects could be equal to or exceed US$23 million and the effects of theproject upon MIDB's financial structure will be substantially negative.MIDB's concentration on high risk type of loans, e.g., capital intensive newventures, with new technology and untried management, was in line with theloan's concentration objectives. This strategy ran counter to sound creditrisk management policy which was not established within MIDB. Whilesub-project appraisals were well organized, and often well done, risk analysisunderestimated the negative impact of inflation and devaluation on debtservice capacity and the market analysis for new projects was not sufficientlyrigorous. Bank sub-project reviews failed to identify what proved to be themain flaws in sub-project appraisal.

Sustainability

5. MIDB was correctly viewed as a well structured and financeddevelopment finance institution that possessed many of the basic requiremdentsfor it to continue to grow and to operate on a profitable and sustainable longrange basis. Egypt's underlying monetary and financial policies, however, didnot provide the necessary foundation of interest and exchange rate policies tosupport term lending operations in foreign exchange, which was the basis forMIDB lending. MIDB's accounting and financial policies were negativelyaffected by tax regulations affecting income recognition and provisiontaking. MIDB accepted lending risks that could not be sustained in thecontext of the surrounding policy environment. The low financial spreads of2.252 and 3.302 permitted MIDB under the project were not adequate to covercosts, provisions and provide MIDB with a real return on capital. The BankLoan did not contribute to the financial strengthening of the institution.

Lessons

6. The major lessons that emerge are:

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- Term lending in foreign exchange cannot be sustained on a soundbasis where there exists substantial distortions in interest and exchange ratepolicies.

- Sound financial operations can be hampered by tax laws andregulations that do not foster sound accounting and provisions policies.

- For Bank lending to contribute to the long-term development ofdevelopment finance institutions, underlying policy conditions must beappropriate.

- The actions required to achieve the stated institutional objectivesof a project should be made explicit and put into a schedule of action.

- The Bank's capability to identify errors in sub-project appraisalreports in the areas of marketing, appraisal of management skills or riskanalysis must be strongly qualified, if necessary, so as not to mislead DFIsabout what Bank approval of a sub-loan really means.

PELJECT COMPLETION REPORT

MISR IRAN DEVELOPMENT BANK PROJECT(LOAN l842-EGT)

PART II PROJECT REVIEW PROM THE BANR'S PERSPECTIVE

1. Project Identity

1.01 This is a project completion report (PCR) on the Bank's firstindustrial development project through the Misr Iran Development Bank (MIDB),an Egyptian/Iranian joint stock company, established under Law 43 (on foreigninvestment) in May 1975. MIDB was designed to serve as a form of merchantbank to promote and finance larger projects. MIDB had at the outset a sharecapital of US$20 million, fully paid in. The shareholders, each contributing25% of the capital, were: Bank Melli, Iran; Industrial and Mining DevelopmentBank of Iran (IMDBI); Bank of Alexaiidria (BOA), Egypt; and Misr InsuranceCompany (MIC), Egypt. As a joint venture bank with only 50% Egyptianownership, MIDB could not deal in local currency. MIDB had been successful inmobilizing local resources for its clients' projects, when required, primarilyfrom its two local shareholders: BOA and MIC. Ultimately it had to deal inlocal currency as the interest and exchange rate policies made it difficult toon-lend in foreign exchange. In 1983 the Government purchased Iranian sharesand increased Egyptian ownership of MIDB to 75%.

1.02 The loan was the first to MIDB, and the fourth DFC operation inEgypt. The previous operations in Egypt included two IDA credits to theformer term lending department of BOA, which was later converted into theDevelopment Industrial Bank (DIB -- Cr. 412-UAR of FY73 and Cr. 576-EGT ofFY76) and a loan given to DIB in FY78 (1533-EGT). The primary function ofDIB, a public sector bank, is to promote and finance small and mediumenterprises, mainly in the private sector.

1.03 This project completion report was prepared by the Bank's Europe,Middle East and North Africa Regional Office, Country Department III, on thebasis of data obtained during a Bank mission to MIDB in January 1989, upon theStaff Appraisal Report No. 2753-EGT, dated April 9, 1980; the President'sReport No. 2780-EGT, dated April 18, 1980, correspondence with the Borrower;internal Bank memoranda; and supervision reports.

2. Economic and Policy Settmn

2.01 During the 1950's dnd 1960's Egypt developed as a virtual commandeconomy with a dominant public sector, fixed, administered prices - includingexchange and interest rates - and a pattern of trade oriented heavily towardeastern bloc economies. Beginning in 1974, the Government began to graduallyliberalize selected aspects of the economy with the aim of acceleratingdevelopment and stimulating foreign and domestic investment.

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2.02 Fueled by a rapid rise in exports of petroleum at favorable prices,as well as swelling remittances of workers abroad, Suez Canal revenues andtourist receipts, the period from 1974-1980 saw inflows from these sourcesgrow by 402 per annum (from US$700 million to US$8,800 million). The economygrew at 9S per annum during this period but with substantial distortions basedupon Egypt's controlled and/or fixed prices for consumer goods, energy,transport and rent. Exchange rates were also fixed and were overvalued. Theresulting bias was to move productive investment and human resources away fromagriculture and toward the urban sector. Comparative advantage in industryshifted toward energy and import and capital intensive activity. In mid-1981,about six months after Loan 1842-EGT became effective, Egypt's foreignexchange driven economy faltered as oil prices fell and the foreign exchangeand interest rate distortions reduced remittances and incentives to exportwhile expanding domestic consumption. The domestic consumption, capitalintensive nature of loans financed under Loan 1842-EGT reflect in some measurethe outcome of these policies (para 5.02).

2.03 Financial Institutions and Policy. The financial system consisted ofthe Central Bank cf Egypt (CBE) which regulates the banking sector and plays amajor role in the formulation and implementation of monetary and creditpolicy. The banking sector expanded since 1974 in line with increasedbusiness activity and the greater role played by the increasinglysophisticated banking system. Credit to business continued to expand at anannual rate oi almost 25S in the 1981-85 period and the banking sector grew toabout 80 banks of various types. Stock exchanges were established in Cairoand Alexandria; they maintain thin secondary markets for the shares of a smallnumber of enterprises. The Capital Markets Authority, established in 1979 asa regulatory body, is trying to promote the development of capital markets andbroaden the equity ownership of enterprises, for which the market is very thin.

2.04 The Misr Iran Development Bank (MIDB) was created in 1975 as amerchant bank to specialize in equity and term financing for mainly larger andsome medium-scale industrial projects. Initially a joint venture with severalIranian banks, it is now owned 75S by Egyptian government banking andinsurance institutions and 25S by Iranian, government-owned, bankinginterests. Small and medium-scale projects were and are mainly financed bythe Development Industrial Bank (DIB). Term financing for agroindustry andagriculture is mainly supported by the Principal Bank for Development andAgricultural Credit. A number of commercial banks engage in moderate volumesof term financing of medium and larger scale projects. About 15% of loanportfolios of commercial banks are credits that exceed one year. The majorbanks, including MIDB, have in the past been subject to pressures to financefavored development initiatives, whatever their merits. Recently banks havebeen subject to pressures to reduce their aggressive efforts to collect ondelinquent loans and to advance rescheduling of destitute loans.

2.05 Banking Regulation. The banking system was and is regulated by theCBE. The CBE sets both passive interest rates and nominal lending rates forlocal currency operations. They establish a highly detailed schedule thatspecifies interest rates for 15 categories of deposit taking and lendingoperations. These administratively set rates proved to be negative between1977 and 1982 and may have been positive in 1983. Rates for commercialforeign currency loans are set by the market as points over LIBOR. Interestrates for official aid loans are determined ad hoc by the CBE who also setsfinancial spreads for banks under such loans, generally at 2.5% which isinadequate to provide for profitable operations.

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2.06 Industrial Sector Policy Issues. Egypt's transition from a largelycentrally planned system to a mixed market economy initiated in 1974 wasadvancing slowly and with some difficulty. It was considered that the largenumber of problems confronting the policy makers (including the need foremployment generation, higher exports, efficient utilization of capital andthe development of a coherent industrial sector strategy) could not beresolved in the short run.

2.07 Conclusions. Loan 1842-EGT was undertaken in a substantiallydistorted macro-economic environment and with a banking system whosecapability to mobilize resources and make profitable loans was restricted inline with CBE interest rate policy. Regarding these issues, Loan 1842-EGTremained policy neutral, which was not unusual for DFI loans, during thatperiod.

3. Project Objectives and Description

3.01 Background. The initial request for a Bank loan in support of MIDBwas sent to the Bank by the Government in September 1977. To prepare andappraise the project, Bank missions visited Egypt in January, March and July1978 and to update the appraisal in October 1979. As approved by the Bank onMay 13, 1980, the project provided for a US$30 million loan to the Government,the proceeds of which were to be used to finance mainly large and medium-scaleprivate enterprises, through MIDB.

3.02 Loan Obiectives. The MIDB Project sought to:

(i) build up in MIDB an adequate capacity for the promotion,financing and other assistance to the private industrial sector;

(ii) support MIDB in its role of promoting and financing of mediumand larger private sector industries with priority to:

(a) building materials and construction contracting (25X)(b) capital goods manufacturing (252)(c) export-oriented industry (25S)(d) other viable industrial projects (25%)

(iii) contribute to MIDB's institution building and training efforts;and

(iv) continue efforts to help MIDB's policy, operational and lendingstrategies and plans.

3.03 It was expected that the institution building efforts (iii) and (iv)would be provided by the Bank during the course of its supervision missions.

4. Project Design and Execution

4.01 The Proiect. Consistent with its objective of resource transfer tohelp finance medium and large-scale priority industrial enterprise and itslimited institutional development goals (para 3.02), Loan 1842-EGT was simplein its design (para 4.08). The loan did establish specific sub-sectorallending objectives and priorities, including an objective to use 25% of loanfunds to finance the development of a capital intens've, technology-rich

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capital goods industry (para 3.03). The loan did not provide for acorresponding mechanism for monitoring the achievement of sub-sectoral lendingtargets or for promotional mechanisms. These lending goals were not reached.

4.02 The technical assistance component of the project was very limited inscope and content (para 4.09). During project preparation the Bank played aproductive and valuable institutional development role as the missions helpedMIDB's senior management to prepare key policy and procedures documents and todeal with organizational issues. On the basis of experience gained duringpreparation, it was expected that continued technical assistance to MIDB couldbe provided by the Bank as a part of an ongoing loan supervision process. Theobjectives and scope of these technical assistance (TA) activities were notdefined in operational detail, thus, neither work programs nor manpowerrequirements were presented. Ample evidence exists to conclude that(i) MIDB's TA requirements were greater than expected, and (ii) even themodest TA expectations of the SAR remained unfulfilled (para 4.07).

4.03 Design and Execution Problems

A. Currency of Lending and Onlending Rates for Bank Funds. The SAR did notadequately address the difficulties inherent in attempting to successfullyprice and market Bank funds in the distorted financial monetary environmentthat Egypt was experiencing at the time of the loan. Because MIDB was foundedas a joint venture company, with 501 foreign ownership, it was prohibited fromlending in Egyptian Pounds (LE), thus, the proceeds of Loan 1842-EGT were tobe used for foreign exchange lending. Egypt's monetary authorities maintaineda multiple exchange rate regime and fixed interest rates for both deposittaking and lending operations. Lending rates were initially set at 11.0%which provided a marginally positive rate in real terms.

B. Exchange Risk. The Government was not prepared to accept thecross-currency exchange risk (i.e. the exchange risk between the Bank's poolof currencies in which Bank funds are denominated and disbursed and thedollar) for MIDB, as it had for the Development Industrial Bank under theBank's Medium and Small Industry Project (Loan 2074-EGT). Thus, Loan 1842-EGTwas to be repassed by the Borrower to MIDB on Bank terms and conditions and tobe onlent to Egyptian industry as foreign exchange subloans with sub-borrowersassuming the full foreign exchange (the exchange risk between the Egyptianpound and the dollar) and cross-currency risks of the loan. MIDB wouldultimately assume the exchange risks for failed projects. Loan funds underthe MIDB project were considered by potential borrowers to be excessivelypriced and risky and the loan was not committed until the exchange risk issuewas resolved in November 1983 (para 4.05). The prospect of facing anopen-ended cross-currency exchange risk premium was not acceptable to Egyptianindustrial borrowers, who in the end proved to have sound judgment"'. Thecross-currency risk premium, as of December 31, 1988, was US$2.93 millionbased on the outstanding historic loan balance of US$8.42 million.

1/ This issue was resolved when an amended Loan Agreement became effective inNovember 1983 (para 4.05). Under the amendment the Government agreed toassume the cross-currency exchange risk for which MIDB provided them witha commission of 3.722. The total cost of Bank funds to MIDB was 11.972plus commitment fee. MIDB onlent at about 15% in US$.

C. Exchange Rate. The Government would not agree to make available toborrowers under Loan 1842-EGT the CBE's preferred exchange rate, which hadbeen made available to DIB's borrowers. The preferred CBE exchange rate wasin 1983 LE 0.84 to US$1.00. MIDB borrowers would, at that time, have beenrequired to exchange their local currency at the CBE's free rate of LE 1.16for US$1.00 when they sought to repay their foreign exchange denominateddebt. Under the CBE's multiple exchange rate policies there were noassurances that the differences between the preferred and free rates would notspread, to the further disadvantage of the MIDB borrowers.

4.04 Investors appear to have found it difficult to analyze the real costsof Bank funds, compared with the costs of alternative sources, in view of theuncertainties that faced investors when using Bank funds in Egypt's unsettledmonetary and financial policy environment between 1981 and 1983. Theunanticipated slow pace of loan disbursement during 1981-83 resultedin an agreement to amend the Loan Agreement in late 1983 and to give MIDBborrowers access to the CBE's preferential exchange rate plus relief from thecross-currency exchange risks (para 4.05). Finally, the flight of a number ofsub-borrowers from Bank funds, by their prepayment of a high percentage ofsubloans in 1985, all attest to the difficulties experienced in DFIprojects in setting the right onlending conditions in: (i) a tightlycontrolled financial market that operated with multiple, fixed exchange ratesand administered interest rates, or (ii) attempts to use the Bank's pool offunds as the DFI's media of exchange when (a) other foreign exchangeoperations were being conducted using a single currency, or (b) otheroperations are being conducted in local currency.

4.05 Contract Amendment. Onlending conditions were renegotiated in late1983 as an alternative to cancelling the still unutilized loan. As MIDB wasby then 75% owned by the Bank of Alexandria and other agencies of theGovernment, the Borrower agreed to accept the cross-currency exchange risk fora fee and to provide MIDB's sub-borrowers with access to the preferential CBEexchange rate. On that basis, US$23.4 million was disbursed for 13sub-projects within 24 months. In 1985, in the midst of a general devaluation'the CBE raised its preferential exchange rate from LE 0.84 to LE 1.34 toUS$1. At that moment almost all solvent sub-borrowers under the loannegotiated local currency credit lines and used their own funds to pre-paytheir outstanding MIDB foreign exchange loan balances (para 5.03). Two majorinsolvent borrowers were refinanced, in local currency, by MIDB itself torepay Bank loans (para 5.03). Taking into account the US$6.4 million in loanbalance cancelled at the time of loan closing at the end of 1987, and US$8.5million of subloan prepayment, only about US$15.1 million of the US$30 millionproject was actually used, as intended, for term financing.

4.06 Conclusions Regarding Project Design and Preparation

A. Repricing Bank Funds: Setting a competitive price for Bank fundsfor the MIDB project proved to be more difficult than expected as a resultof: (i) the multiple currency make-up of the Bank's pool of foreign funds,(ii) the volatility of the foreign exchange markets, and (iii) the CBE'sadministered multiple exchange rate and fixed interest rate regimes and theresulting complex problems that needed to be resolved when converting loanfunds to or from local currency.

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B. Other Project Design Considerations: The experience of the MIDBproject indicates that for the Bank and Government to successfully advancethis first MIDB project and for MIDB to have been able to make competitivelypriced loans to industrial enterprises, without undue risk to itself and toits client and excessive cost to the Government, the following conditionswould have usually needed to prevail:

(i) the Government's interest and exchange rate regimes would besubstantially liberalized and in equilibrium and prices forloans, deposits and major money market instruments would reflectmarket conditions;

(ii) the foreign exchange resources being provided by the Bank wouldhave needed to be de-coupled from the funds used by MIDB forproject lending. The Government would have used the proceeds ofthe Bank loan for its own purposes and would have onlent thelocal currency equivalent to MIDB at the current, financialmarket determined rates that approximate the market rate forterm deposits or the treasury note rates, etc. Thus, Bankforeign currency funds and their terms and conditions would havebeen de-coupled from the terms and conditions prevailing in thelocal financial markets;

(iii) sub-borrowers could have used the proceeds of the local currencyloans to acquire the foreign exchange needed for projectimplementation at prevailing foreign exchange market rates whichwould have placed them on a parity with other borrowers; and

(iv) the Government could have used the foreign exchange proceeds ofthe Bank's loan for its current productive purposes while takingappropriate measures to hedge its foreign exchange risks.

C. An SAR prepared for a project in which Bank funds would beintermediated through a DFI, such as this MIDB project, should identify in'moredetail how all of the major issues affecting the use of Bank funds have beenresolved, including:

(i) competitive pricing of Bank funds and how the issue ofcross-currency exchange risk costs have been resolved;

(ii) the capacity of the DFI to bear the foreign exchange risks offailed projects; and

(iii) the ability of the Government to use the foreign exchangeproceeds from the Bank loan and the measures taken to assist theGovernment to hedge these risks.

4.07 Conclusions Retardint Policy Environment. The slow pace ofdisbursement and use of loan funds encountered by Loan 1842-EGT highlights thedifficulties faced in project design and pricing when the borrowing country'sexchange and interest rate policies are distorted (at the time of the loan,Egypt maintained a multiple exchange rate regime and interest rates ondeposits were fixed below the rate of inflation). Bank funds can be used mostefficiently by real sector sub-borrowers when they are available in localcurrency. Such onlending conditions can best prevail when interest and

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exchange rates reasonably reflect market conditions and expectations. On thatbasis, the Government using available hedging techniques could accept toreceive and repay Bank loans (as it would any other foreign exchange loan usedto finance public or real sector requirements for growth) at minimum futurebudgetary costs. Where exchange and interest rate policies are distorted, theBank's multi-currency pool of funds would generally need to be onlent inforeign exchange, with the attendant problems of interest rate and currencyrisks that can sometimes make Bank funds too complicated and expensive to usecompetitively. Loans would face the class of problem initially encountered inthe MIDB loan, e.g. slow commitment and disbursement, high failure rates. Inthe case of Loan 1842-EGT, there was also the high cost to MIDB for theultimate assumption of the foreign exchange risks of failed sub-projects thatwere imported raw material and capital goods intensive, as a result of thethen prevailing overvalued exchange rate (para 5.03).

4.08 The Technical Assistance Program. A major objective of the loan wasto help improve MIDB's overall institutional capability as adevelopment/merchant bank. This task was to be accomplished during the courseof the Bank's routine loan supervision activity as MIDB was rightly consideredto be one of the better state-owned banking institutions in Egypt. It remainsa serious, professional organization with a management that desires to improveall possible aspects of its operation, enhance its profitability and financialstrength. Its presents limitations as an institution result in substantialmeasure from external macro-policy variables (paras 2.03, 2.04, 2.05) as wellas from a need to improve professional skills and procedures. During theearly stages of project preparation the Bank's staff was very influential inassisting MIDB to develop and adopt an initial policy statement that helpedMIDB to define its financial structure and its procedures for loan appraisaland approval.

4.09 As a result of the Bank's initial high level of professionalinvolvement, many of the policy elements required to advance MIDB'sperformance were in place at the time of the loan. MIDB's management wasreceptive to Bank assistance and there was ample scope for further assistanceto MIDB to help it improve its credit and risk management operations andprocedures, establish more appropriate accounting policies (making andaccounting for provisions and taking and suspending income) and to install animproved financial information and management system. Based on the status ofMIDB's loan portfolio, there appears to have been scope to improve aspects ofMIDB's loan appraisal and credit management process and the administration ofdebt collection and supervision.

4.10 Conclusions. The proposed design for technical assistance was modestgiven MIDB's status of a new financial institution, its prospects forLmprovement and management's stated desire to improve Its efficiency andproductivity. It is highly unlikely that MIDB's potential for improvementcould have been realised with a technical assistance program limited tosupervision misslons undertaken on a twice a year, four weeks per year,basis. In the end, the Bank did not fulfill its limited supervisionobjectives. In the 45-month period from December 1982 to September 1986 only4 man-weeks of Bank staff time was spent on relevant field supervision.It is likely that more tim ha been spent on KIDS than is reportedbecause missions that visited ggypt to supervise DIB, or on other businesmay bave visited KIDD but may not have reported on the time spent or onthe issues through the Form 590. Most of the limited supervision effort

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was devoted to problem solving. Field supervision activity declined to zeroduring 1983-85 as a result of a major impasse in macro policy dialogue and abreakdown in project preparation activity. Thus, the fulfillment of theinstitutional development objectives of Loan 1842-EGT became the victim ofother concerns.

4.11 In preparing a first Bank operation with a new financial institution,the role of institutional development should be presented in adequate detail.The institution building objectives of Loan 1842-EGT were inadequatelydetailed in the SAR. The opportunities for creating technical improvementsand meeting MIDB's needs for improved methods and procedures and for manpowertraining in credit and project analysis may not have been fully appreciated;had they been, then MIDB's long-term technical assistance and systems buildingrequirements might not have been scheduled in the context of normal projectsupervisory activity. It would be productive if, during the preparation of aninitial loan operation, a program of assistance is detailed and oriented toachieve the agreed upon objectives. The program would identify the resourcesneeded to finance this program and the possible sources of its funding. Thisinitial technical assistance plan/program would be periodically updated as newneeds and opportunities emerge. Thus, the SAR would provide adequateattention to detailing the need for assistance and how and along what timeframe the assistance could be provided.

5. Loan Portfolio Performance

5.01 Sub-Project Profiles. Total investment under Loan 1842-EGT amountedto an estimated US$103.4 million, with one major paper mill project accountingfor 25% of the total. Bank financing amounted to US$23.6 million or 23% oftotal investment costs for the 13 sub-projects financed under the loan. Theaverage subloan was US$1.8 million, close to project expectations. Loan1842-EGT turned out to be an exceptionally high risk project as almost 70% ofthe sub-projects financed, and more in amount, were newly created enterprises,which is reflected in the high percentage of non-performing Bank-financed loanportfolio (para 5.03). MIDB does not have an explicit credit risk managementpolicy nor has it developed a network of limits against which to measure itslending activity.

5.02 Sectoral and Investment Mix. The original requirement under the LoanAgreement E(para 2.02(a)(i)(ii)(iii)] was that investments for theconstruction, capital goods and export industries each account for 25b oftotal loan disbursement. Disbursements for the construction industryaccounted for 7.42 of total. One failing export-oriented sub-project amountedto 112 of total disbursements while no capital goods industry projects werefinanced. Disbursements failed to meet the sectoral objectives embodied inthe Loan Agreement as the project financed mainly large import substitutionventures. Four of the five largest projects accounting for half the fundsdisbursed were designed for import substitution purposes. These importsubstitution projects appeared to be highly profitable when Egypt's exchangerate was fixed and overvalued and price and trade policies favored rawmaterial imports. Capital goods industry sub-projects were not presented forfinancing. The sectoral lending objectives of the Project were neitherenforced nor formally altered.

5.03 Subloan Portfolio Status. The following indicates the status of theindividual subloans financed under Loan 1842-EGT.

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Portfolio Status

Loan 1842-EGT Financed Sub-Projects(Millions of US$)

Amount of Loan BalanceName of Proiect Disbursement Status of Proiect Outstanding

(US$) (US$)

A. Normal Projects

1. Misr Air Conditioner 2.8 Operating normally 0.5

2. National Drilling 3.0 Operating normally 1.7

3. Arab Porcelain Co. 0.9 Operating normally 0 (Prepaid)

4. A. Maharem Textiles 0.5 Operating normally 0 (Prepaid)

5. Nile Clothing 0.8 Operating normally 0 (Prepaid)

B. Special

6. Misr InvestmentFinance 0.9 Reorganizing 0

Total Normal Projects US$ 8.9 US$ 2.2

C. Problem Proiects

7. Ready Made Garments 2.6 Attempting to rehabi- 2.3litate a failing ope-ration working at verylow capacity. Lowprospect for positivefinancial result.

8. Pyramides Paper Mill 5.1 Attempting to revive a ---------0----------failed operation. Low MIDB provided fundsprospects for positive to repay Bank loan.financial return. Total MIDB exposure

is US$5.5 equiva-lent.

9. International Blankets 2.7 Reviving a failed ope- 2.1& Textiles ration. Rescheduled,

etc. Low prospectsfor positive financialreturn.

10. Arab Ceramic Co. 1.8 Attempting to solve pro- 1.6duction problems andincrease sales. Pros-pect for positive finan-cial return is low tomoderate.

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Amount of Loan BalanceName of Proiect Disbursement Status of Project Outstandin8

(US$) (US$)

11. Misr Iran Building 1.7 Attempting to solveMaterials problem of competition MIDB provided funds

from low cost produ- to repay Bank loan.cers running illegal Total MIDB exposureoperations. Low to is USS8.6 equiva-moderate prospects lent.over longer term.

12. Roma Macaroni Factory 0.4 Attempting to solve ma- 0.3nagerial problems. Fairprospect for success.

13. Misr International 0.4 Liquidator attempting ---- -O-- -Furniture to salvage a company MIDB provided funds

whose product line is to repay Bank loannot selling by use of Total MIDB exposureplant for other wood to project is US$2.6products and possible equivalent.export.

Total Problem Loans US$ 14.7 US$ 8.5

Estimated Additional Financial Exposure US$ 17.2Gross Total Current Exposure to (1842-EGT) ProblemSub-projects US$ 25.7

Loan BalancesTotal Normal andProblem Loans US$ 23.5 US$10.7

5.04 Of the 13 subloans financed under Loan 1842-EGT (shown above) fivesub-projects, accounting for 34% of total disbursement, are operating innormal condition. These projects are expected to fulfill or exceed theirprojected financial and economic rates of return targets. Three of thesesub-projects have prepaid their Bank loans to escape from the foreign exchangerisks of the loan.

5.05 Eight other sub-projects accounting for 66% of the US$23.6 milliondisbursed are shown above as problem loans. MIDB prepaid almost US$8.5million to the World Bank to relieve these problem loans from the additionalforeign exchange risks and costs and to restructure the pre-paid projects.MIDB's exposure under the original larger scale Misr/Iran joint ventureoperations (building materials, furniture, clay brick) exceeds US$16.7million. For three of these eight sub-projects no financial or economicinternal rates of return were provided by MIDB, mainly because the sub-loanswere below the free limit. For the remaining five sub-projects, the estimatedfinancial internal rate of return for one sub-project was 12%, for another 18%and for the other three 25% or larger; while the estimated economic internal

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rate of return ranged from 16% to 58%. These sub-projects will likely notrealize their expected financial and economic rates of return because of theprolonged period over which they have faced problems.

5.06 Conclusions. (a) MIDB's lending under Loan 1842-EGT wassubstantially and probably excessively directed toward the highest risk typeof loan, e.g. new ventures, new technology, capital intensive, with new anduntried management teams. (The summary of reasons why each sub-project failedto achieve its objectives is shown in Part III, Table 2, pages 1-3). Theobjective of allocating 75S of the Bank's loan to three sectors, which wouldhave accounted for about 301 to 502 of MIDB's term portfolio at the time, mayrun counter to sound risk management practices. The basis for that decisionand for the loan covenant is provided in the SAR, but the impact upon MTDB incase it turned adverse was not included. A credit risk policy that isflexible but limits investment in new/pioneering projects to a realisticpercentage of loan/equity portfolios may be worth establishing for eachmedium/large-scale industry lending operation. Over the longer term, a majorobjective of Bank-financed DFI projects would be to help the financial inter-mediaries to develop appropriate credit risk management policy and procedure.

(b) Egypt's policy in the early years of the loan favored importsubstitution industry by making low cost foreign exchange and financingavailable. The biases induced by this policy may be traced in the sub-projectselection list (Part III, Table 1, page 2) which included (i) a largepercentage of capital intensive projects oriented towards domestic con-sumption, and (ii) a high percentage of sub-projects that failed to meetfinancial and economic goals because their costs of raw materials imports andfinancing surged as exchange rates were adjusted.

(c) MIDB's total exposure (including loans and equity investments,capitalized interest and equity conversions) to doubtful or failingsub-projects financed under Loan 1842-EGT amounts to an estimated US$23million. While some projects may be salvaged in whole or in part and theliquidation of some other projects will cover investment, nevertheless, it isexpected that MIDB could suffer losses that could weaken its capital structure(Part III, Table 3, page 2).

6. Sub-Project Appraisal and Creditworthiness Review

6.01 Appraisal Capability. MIDB's professional staff generally presenteda well organized sub-project appraisal to the Bank. Production cost estimateswere adequately detailed as were financial forecasts and multi-year productionand financial forecasts, along with a risk analysis (all calculated bycomputer). Overall, MIDB's project appraisal capabilities are of a relativelyhigh level compared with those of other DFIs in similar environments. MIDB'ssub-project submissions to the Bank meet most of the Bank's criteria foradequacy and most projects were approved for financing as presented. The Bankmade few if any written comments on the above free-limit sub-projectappraisals that were presented to the Bank. The Bank's sub-project review wasmade against a highly detailed checklist that contained every appropriatevariable involved in an investment decision. The review process, however,failed to detect weaknesses in the appraisals for the sub-projects that failed.

6.02 The following conclusions may be drawn from the data available fromsub-project files and discussions with MIDB.

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(a) The Bank's checklist and MIDB's appraisal reports were wellorganized and inclusive of all the key appraisal variables. Their standardsfor what constitutes an acceptable proof of a sub-project's creditworthinesswere for some cases not sufficiently rigorous, especially for new projects.

(b) MIDB's appraisal reports focussed on detailing productionprocesses and costs and financial forecasts under various risk, cost anddemand assumptions. Bank appraisal review appeared to be centered around theforecasting and economic modeling aspects of the project. Where IFC technicalcomments are available, they were well focussed and highly relevant to theengineering processes selected and to input pricing assumptions.

(c) The maior real causes of sub-project failure proved to be:

(1) Inadequate management,(2) Inadequate marketing,(3) Inadequate pilot production testing;(4) Projects were large and ambitious and start-up for these

complex projects was costly and delayed. Investmentsshould have been staged for slower and more organic growth; and

(5) The extent of the LE devaluation possibilities wasunderestimated.

Five large projects failed substantially because their managements wereinadequate to organize, plan for and execute their projects. Two majorprojects failed because there proved to be small market prospects for theirproducts given the reality of style, price or quality presented.

(d) The major problem in forecasting was the assumption that foreignexchange costs would only increase by 40% over the life of the project. Infact costs of foreign exchange increased from LE 0.84 to LE 1.80 to US$1 andprojects that were heavily dependent upon raw material imports (especially forwood pulp, timber and fibers) have suffered, some have died "-

6.03 Conclusions. As indicated above, MIDB's sub-project appraisals underLoan 1842-EGT were of relatively high standards in terms of organization,presentation and the methodology applied. But clients should have provided asa condition for sub-loans more positive proof of (i) the marketability of newproducts, or (ii) the capability of a project management team to plan for andadvance a complex project. These areas could have been the subject ofproductive discussions between the Bank and MIDB and should have been areasfor which technical assistance was provided.

l/ To assist DFIs to establish appropriate forecasting assumptions with respect todevaluation impacts, it would be useful to review general experiences withdevaluation in other relevant countries. There exists ample experience in Bankloans around the world, during 1988-89 to indicate that devaluations of theorder of lOOS to 2002 could be expected in countries similar to Egypt'seconomic and policy circumstances.

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6.04 To some extent MIDB accepted the Bank's sub-project approval as afinal signal of sub-project creditworthiness. The Bank's sub-project approvalprocess is not designed to second guess sub-project creditworthiness because,among other things, the Bank is rarely in a position to make sound judgmentson the adequacy of the underlying guarantees or the quality of the LoanAgreement. The Bank's sub-project review is designed to appraise thecompleteness of the DFI's appraisal. Because the Bank is not on the localscene, the questions and the issues raised are normally focused on sub-projectoperations, and rarely on marketing, distribution or other more subjectiveareas. In that context, it might be useful to explicitly state to DFIs thatthe Bank's approval of a sub-project does not mean that a judgment has beenmade as to sub-project's creditworthiness and prospects for success.Alternatives might be for the Bank to (i) stop looking at projects foranything except consistency with the JLoan Agreement, or (ii) adopt an approachakin to the direct appraisal of a project by devoting more time to individualsub-project reviews using staff or consultants that have the experience andskills to judge the adequacy or inadequacy of the information provided onmanagement and administration and the proofs offered that the marketing anddistribution assumptions are well founded and have been adequately tested andresearched. It is not clear that the Bank has been able to apply thenecessary time and skills to sub-project review to identify weaknesses inprocess, especially in the more subjective areas of management, distributionand marketing, which is what the free-limit review system may be thought toprovide. There is a need to carefully examine the extent to which the Bank isorganized to make a contribution to all aspects of the sub-project reviewprocess. If it is not, it should consider qualifying the meaning of itsapproval.

7. Financhd Operations

7.01 Financial Structure. MIDB had US$401.8 million in total resources asof December 31, 1988. Capital and reserves represented 132 of this amountwhich should be adequate capitalization to support a DFI that has a highpercentage of short-term operations (para 7.02). 69.4S of MIDB's resourceswere short-term deposits and placements by commercial banks andcorrespondents, 5% medium-term CDs and 2% World Bank term resourcesl'.MIDB's term resources are currently a decreasing percentage of the total(Part II', Table 3, page 2). In 1985 term resources vere 2.82 of total lia-bilities of US$367.5 million, currently they are 2.2Z of a reduced liabilitybase of US$350.3 million. In 1980 M1DB was still a large pool of fundsseeking market opportunities as 801 of its total resources were uncommitted.Currently, MIDB faces a tight cash flow position arising from its low returnson loans and investments and a deteriorating term loan portfolio.

7.02 Short-term placement of funds with banks and correspondents accountsfor 52% of MIDB's assets. Short-term loans and other short-term operationsaccount for an additional 10.5S (Part III, Table 3, page 1). MIDB's mainsources of income arise from its large-scale placement of short-term depositsor purchase of CDs using the deposits placed by commercial banks (Part III,

I/ MIDB carries its provisions and other receivables accounts as resourcesamounting to 10.5% of its total liabilities, in line with Egypt'saccounting standards.

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Table 3, page 3). Margins on such operations are a low 0.751 on averageassets but risks and costs are small and the cash flow is used to sustain theinstitutional overhead. MIDB's medium and long-term lending operationsaccount for 12.41 of total. These operations result in a negative cash flowas the cost of such funds exceeds the effective yield.l/ Consirx-ent with itsmandate as a merchant bank, equity investments account for 7S of total assetsand yield a return of 2.042 p.a., well below MIDI's average cost of funds of7.062 and average yield of 7.701.

7.03 Equity Investment. MIDB's mandate to invest in equity positions hasproven to be more difficult to manage than expected. A key problem is theabsence of a satisfactory domestic equity market. Thus, MIDB is locked intoalmost US$30 million in shares from which it cannot rapidly extract itself, atreasonable market prices. Loan 1842-EGT provided that MIDB could borrow topurchase equity in a sub-project that it would partially finance. MIDB hasmade equity investments equal to about US$5.5 million in the companiesfinanced under the Bank loan, a small percentage of which was financed underLoan 1842-EGT. Equity investments financed under the Bank loan have beenparticularly burdensome, as MIDB is required to repay the Bank on the samebasis as the composite amortization schedule of the project, while MIDB'sequity investments are essentially frozen and are earning only small returns(para 7.02) that are not adequate to cover MIDB's cash flow requirements forrepayments of principal and interest under the loan.

7.04 Conclusion. A DFI's equity investments, made on borrowed funds, to anew enterprise will generally result in a negative cash flow to the DFI, withrespect to its repayment of interest and principal. First, dividends oninvestments are not likely to equal the interest cost of the borrowed funds,at least in the short and medium term. Second, the DFI has low prospects forearly sale of shares to repay the Bank, on the basis of an average compositeamortization schedule, even with a substantial period of grace. Finally,without an active capital market the DFI has to rely upon private placement orresale of shares to the new company - prospectively without compensationadequate to cover the risks and costs incurred. Under Loan 1842-EGT, MIDBwould carry the full foreign exchange risks of funds that it would borrow topurchase equity, in addition to interest and commitment fees. It can beargued that the Bank's foreign currency funds are too costly for equityspeculation. The cost and risks of equity investment when using Bank loanfunds were not fully examined during project development. Considerationshould be given to requiring that SARs, which provide for loans to support aDFI's equity investment, undertake an analysis of: (i) the cash flow impactsupon the DFI under the repayment schedule, (ii) the condition of the capitalmarket and its capacity to absorb secondary placements of equity and (iii) thefinancial strength and maturity of the DFI and its capacity to make adequateprovisions for the more risky forms of investments.

7.05 Profit and Loss from Operations. MIDB's gross operating profits frombanking activity has deteriorated substantially since 1980, when MIDB earned1.5% on average assets from financial operations. In 1987 MIDB lost 0.3% on

1/ World Bank funds cost on average 11.38% and yield an estimated 9.95%,taking into account suspended interest on legally failed projects. On atrue cash flow basis, MIDB's yield could be as low as 6% to 7%.

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financial operations and in 1988 it is expected to earn a slim 0.12 (Table 3,page 4). Overall, MIDB's total earnings as a percentage of average assetsdeteriorated from an excellent 2.5% in 1980 to 0.692 in 1988. This hasresulted mainly from the shrinkage of net interest margins from 2.41 to 1.3%of average assets in the period. The reductions in margins are due to lowerinterest collections ratios and to higher volumes of low margin, short-termcommercial bank placements (para 7.02).

7.06 Financial Margins Under Loan 1842-EGT. As a result of its highvolume of commercial bank placements, MIDB's costs of operations are in linewith those experienced by the more efficient DFI. Loan 1842-EGT, however, didnot provide MIDB with the possibility of covering its costs of operations ormaking provisions for loan losses while earning a return on capital equal tothe current average rate of inflation (15%). Given MIDB's 131 capital tototal asset leverage ratio (equal to a Debt/Equity ratio of 6.7 to l) toachieve such a return MIDB would have to earn 2 percentage points of financialspread (on average assets) just to provide for a 15% profit. MIDB requires anadditional 1.5 percentage points of financial spread to cover theadministrative and supervisory costs of lending operations and 1.0 percentagepoint for provisions. MIDB's total minimum margin requirement of about 4.5percentage points are very reasonable for a DFI operating on a low leverageratio. Loan 1842-EGT was initially designed to provide MIDB with 2.25percentage points of spread, adequate to cover costs and provisions but not toprovide for a reasonable return on capital. Under the amended agreement aspread of 3.03 percentage points was provided. After payments of costs ofoperations and provisions, this spread provided MIDB with an inadequate returnof 4.071 on capital.

7.07 Accounting. MIDB's accounts are maintained in accordance withaccounting standards prevailing in Egypt and in line with the reportingrequirements of the Central Bank. These standards and requirements may not beoptimum for the production of relevant financial statements and informationrequired for the analysis of a financial institution. Nevertheless, MIDB'saccounting/financial department does produce a substantial number of highquality budgetary and cash position reports and evaluations that assist seniormanagers to control financial operations in line with cash flow realities.

7.08 MIDB's financial reports are audited and approved annually by aqualified external auditor, based upon local accounting policies and codes ofaccounts acceptable to the CBE regulatory authorities. ITe auditors do notcomment on the adequacy or inadequacy of provisions for loan losses or policyon income recognition. MIDB's accounts are an historic record of change usingconsistently applied standards. The data are accurate but the accounts aresubstantially less relevant than should be the case. Loan portfolio valuesare the subject of substantial overstatement as there exists no objective loanportfolio classification system and loan loss provisions are taken only on avery small percentage of non-performing loans. Loan loss provisions aredetermined by the Board of Directors following a review of the totallydestitute portions of the portfolio. MIDB's capital account is also inflatedby the profits that have been recorded in years when cash income was equal toonly 33% of income accruals. Income accruals could continue to be taken oftenfor years after payments have gone into arrears. Income accruals aresuspended only after loans move into legal action, which may be years aftertotal delinquency has been established. Thus, MIDB's income statements andbalance sheet values are overstated by some undetermined amount representingincome taken on delinquent and defaulted loans.

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7.09 MIDB's provisions for loan losses are understated for two mainreasons. First, tax regulations do not recognize provisions as an expenseitem unless provisions are applied against a specific measurable loss sufferedas a result of court determined liquidation action. From a tax point of viewprovision taking is on a cash basis. This prohibits bankers from writing offportions of loan portfolios over time against objective measures of loanportfolio deterioration. Second, bank regulators do not require that:(i) loan portfolios be classified; (ii) consistent measures be taken toobjectively establish annual provision levels; and (iii) income accruals besuspended automatically after some uniform, reasonable period of non-paymenthas been exceeded.

7.10 Conclusions. Existing regulatory supervision of FiIDB does notrequire that it maintain prudential standards with regard to establishingbalance sheet values for portfolio or taking of interest income. Thus,current accounting practices and portfolio valtuation and provision makingpolicies as they reflect the requirements of regulators and tax authoritiesare not adequate for the efficient financial management of banks. Taxregulations penalize the banks that attempt .o follow conservative andccnventional policy for establishing loan loss reserves. The existingenvironment of tax policy, regulation and accounting convention are notconducive to MIDB operating on a sound basis, although M.DB on its own hasattempted to operate on a sound system basis, to the extent possible. Thesecould be productive areas of World Bank concern in the future given itssuccessful involvement with the financial systems and regulatory practices inother areas. Under Loan 1842-EGT these areas of policy and practice were notpursued.

8. SummarY of Results

8.01 As a direct result of the loan, MIDB gained recognition and hasemerged as one of the more respected and better managed financial institutionsin Egypt. The Bank contributed substantially to the early development ofMIDB, especially in the key area of policy formulation, by its technicalassistance efforts that were integrated with the loan preparation process(para 4.09).

8.02 The technical assistance objectives of the project, i.e., to continueto help MIDB advance as a development/merchant banking institution, were notachieved. It was expected that continued institution building of MIDB couldbe accomplished during loan supervision which till the end of 1982 hadaveraged about 12 man days per year. The SAR substantially underestimatedMIDB's needs and capacity to absorb assistance in the areas of projectappraisal, accounting and credit risk management, among others. Opportunitiesto assist MIDB were also lost, as the institution viewed very positively Bankassistance to them. Toward the end of the project, almost nothing was done inthe area of technical assistance as the Bank did not field a supervisionmission in the period from May 1982 till November 1986, as macro-issuesdominated Bank/country relations (para 4.10).

8.03 Regarding the direction and pace of loan disbursement, the objectiveto provide financing in three priority sectors (exports, constructionindustry, materials and capital goods) using 75% of loan resources was notachieved as financing of these sectors was less than 20% of total.Commitments and disbursement were slow, until the loan was amended in November

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1983 to provide (i) that beneficiaries of the loan would not bear thecross-currency exchange risk and (ii) that MIDB's borrowers would have accessequal to DIB's borrowers to the Central Bank's preferred exchange rate.Commitments slowed again in 1986 as devaluations continued. At the time ofloan closing in 1987, US$6.4 million of the US$30 million loan was cancelled.The loan did not disburse as expected during 1981-1983 because it wasmispriced. The SAR assumption that borrowers would accept the cross-currencyexchange risk for a small 0.05 percentage point proved to be wrong, and shouldhave been considered a project risk (para 4.04).

8.04 About two-thirds of the 13 sub-projects financed under the loan mayfail to yield positive financial rates of return. A significant, yetundetermined number, may fail outright despite MIDB's best efforts torestructure them. The expected economic benefits of the project may not beachieved, given the status of major sub-borrowers (para 5.03).

8.05 The financial impact of the Bank loan upon MIDB has todate beensubstantially negative. Ultimate losses are as yet not measurable, but MIDB'scurrent total exposure in overdues, equity, capitalized interest andguarantees signed on behalf of its distressed and restructured projects couldbe equal to US$25 million or possibly more. MIDB has a substantial negativecash drain as a result of the Project as it has financed about US$8.5 millionin sub-borrower pre-payments of the Bank's loan, with its own shorter termlocal currency resources. It undertook this action when a major devaluationthreatened to submerge a number of the weaker projects (para 5.03).

8.06 The narrow financial spreads allowed MIDB under the projectcontributed to its financial distress. Based on its low leverage (132capital/asset ratio), MIDB required a break-even spread of about 4.5S to covercosts of operations, make provisions and earn a return on capital equal to therate of inflation (about 15%). The Bank loan initially provided 2.252 andlater a 3.032 spread which could cover MIDB's low operating costs, provide 12for needed provisions and yield only 42 on capital (para 7.07).

8.07 MIDB has, since the loan ended, continued to improve itsorganizational structure and has set up new internal capabilities to deal withthe difficult task of restructuring projects and liquidating closedenterprises. To handle the impact of loan losses, it has substantiallyincreased its share capital and plans to make annual provisions for loanlosses of 1.52 of loan and equity portfolio for at least the next five years.

9. General Conclusions and Recommendations

The outcome of Loan 1842-EGT has demonstrated that:

9.01 Distortions in the exchange and interest rates created conditions forinvestment that could not be sustained after the inevitable devaluations andincreases in interest rates. A number of major sub-projects made under Loan1842-EGT failed, as terms of trade and costs of funds for import dependentsub-projects became highly unfavorable. In the absence of appropriateexchange rate and interest rate policies, the risks of term lending to MIDB'sclients became excessive.

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9.02 The Bank's multi-currency pool of funds proved to be too special anddifficult to correctly price for re-lending by MIDB. This loan would have hada better chance to succeed if the Bank's pooled foreign currency funds wereused by the government for its own general requirements, and in return thegovernment would have released counterpart local funds for use by MIDB forproject lending, priced in line with local market conditions with foreignexchange for imports purchased by sub-borrowers at the prevailing free marketprice.

9.03 In the absence of well founded, prudential banking regulation,appropriate accounting practices and tax regulations (that encourage soundbanking practices), prospects are high that the financial institutions willfollow less than optimum accounting policy and practices with respect toincome recognition and making of loan loss reserves. Under such conditions,prospects are less than optimum that the Bank-sponsored institution buildingefforts that are directed at a DFI would achieve their objectives. In thecase of Loan 1842-EGT, inappropriate tax law regarding provisions, out-of-dateaccounting and the absence of useful banking regulation all operated toinhibit MIDB's financial management. This suggests that Bank loans directedat financial institution building should rarely be considered in the absenceof complementary long-term programs to address the legal and institutionalrestraints tc the financial efficiency of the DFI.

9.04 The slackening of institutional development efforts under this loanaltered the original key loan objective of institutional development. Thischange in loan objectives resulted from a change in overall Bank/countryrelations. There was no recorded statement of intention, and the issue of howto amend project objectives in an ongoing project was not addressed. Giventhe difficulty of maintaining full institutional memory and commitment overthe life of a project and to ensure that project objectives do not get droppedinadvertantly or in the budget process without due notice and consideration,specific action needs to be taken. A reasonable approach would be: First,that loans that assert the importance of institutional development would berequired to provide in the SAR a detailed annex on the specific annualmanpower or other contribution that the Bank and other concerned parties wouldmake toward achieving assistance goals (paras 4.10-4.11). Second, duringperiodic loan supervision, the Bank's compliance with its own stated list ofcommitments to program objectives would be determined in the same fashion asBorrowers' compliance with its commitments are measured and a compliance memobe prepared. The PCR does evaluate the Bank's fullfillment of its projectcommitments, but it comes too late in the project cycle to be helpful inensuring that loan objectives would actually be met.

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PART II: PROJECT REVIEW FROM THE BORROWER'S PERSPECTIVE

Introductio:

In 1978, it becam obvious that KIDB'. loan and investant approvals udsurpassed its long-tem resources.

In order to continue 'idin new invotmaents, KIDS approachd 131 in anattempt to acquire additional term resources.

Several IBWD missions visited KIDS and following their exmination of theSaJk's activities, they conluded that IDS was inded a suitable chuane forIBRi assistance to the Egyptian industry. The mission took into consideratioMID;'8s success in boostimg private sector activity in Egypt which was lookedat as one of the main pillars for the success of the open door policy.

After lengthy negotiations between 3IWD, the Egyptian Government adKIDS, a loan agreement was reached on June 4, 1980.

A) Prosect Descri0tion:

According to the Loan Agreement, MM30 agreed to lend KIDS, through theEgyptian Covernment, an amount equivalent to US$ 30 million. This amout mato be used to provide foreign exchange for private industrial projects,concentracting on export-oriented projects as well as those in construction,contracting and capital goods sectors.

5) Documents of the Loan:

The main documnts of the loan are as follows:

1. The Loan sareement:

This was signed on June 4, 1980 between IBiD and the Egyptian Govezt atallocating a long trm loan of US$ 30 million to be used -through KIDB- in thefinancing of industrial development projects.

2. The urolect agreesent:

This was signed on June 4, 1980 between IBRD and KIDS stating theobligations of KIDS towards the execution of the Loan Agrem_t.

3. The Subsidiary Loan hAremrnt:

This was signed betwoen the Egyptian Government and KIDS on November 3,1980 relending the amount of the loan to KIDB and specifying the rulesregulating the relation between KIDS and the Government in this respect. Theloan was then declared effective on December 31, 1980.

- 20 -

4. Aireement modifvinz some of the rules of the Subsidilar Loan Atreemnat:

The loan was originally intended to bs repaid in U.S.Dollars. However,the unfavourable exchange rate regime called for the alteration of thoseconditions to allow sub-borrowers to repay_An Egyptian Pounds. Accordingly, anagreement to that effect was signed between the Egyptian Government and NIDBon November 14, 1983.

C) Utilization of the Loan:

The total amount of the loan (US$ 30 million) was completely comtitted toprojects approved by 11DB. However, only an amount of USS 23,564,088 waswithdramw from the loan. It is worth mentioning that the utilization of theloan, since it became effective in December 31, 1980 and up-till thecancellation of its undisbursed balances on October 18, 1987, varied accordingto the conditions applied concerning currency of repayment as well as thegeneral economic climate in Egypt.

Accordingly the life time of the agreement could be divided into threemain periods:

1. From Dec. 1980 to Nov. 1983

The utilization of the loan was rather slow. The reasons behind this were:

First. the loan was to be repaid in U.S.Dollars. At the same time otherfunds from IBiD and bilateral sources were made available to Egyptian projectswith the stipulations that repayment was to be effected In Egyptian pounds atthe official exchange rate. Such arrangements entailed a large subsidycomponent as the official rate was lower than the market rate at all times.Also many projects preferred to fix their debt liability in local currency byborrowing Egyptian pounds and buying dollars in the open market. Second. thefixed interest rate on the loan became unfavorable as the dollar interestrates began to decline. Third, many of the loan conditions, especially thoserelated to TCQ and to the exclusion of some productive sectors such astourism, turned away many projects.

Under these conditions only 5 comitments totaling U.S.$ 7,556,000 wereapproved during the above period, representing 25.21 of the total commitmentsunder the loan. Sald amounts were to be repaid in US dollars. The total amountdisbursed of those commitments stood at US$ 7,291,055 (about 96.5S of thecommitments). This total amount disbursed represents about 30.9% of the totalamounts disbursed from the whole loan.

- 21 -

2. From -ov. 1983 to Jan. 1985

As the World Bank and the Government came to acknowledge the difficultyin utilizing loan No. 1842 they agreed on November 14, 1983 to reviserepayment conditions to allotfsubborroweri to repay in Egyptian pounds.

As a result of this change, the years 1983 and 1984 witnessed an increasein the number of IBRD approved financing. Ten new commitments were approved(including a second financing to NIZACO) during that period, with a totalvalue of US$ 22,444,000 (about 74.8% of the total commitments). This figureincludes the amount of US$ 779,000 which was reallocated in 1986 to the VileClothing Co.

3. From Jan. 1985 to Oct. 1987:

Although the loan was fully committed in 1984, economic policy changes In1985 necessitated a revision of the approved project list. Some projects werocancelled and others were sought. The economic policy changes of January 1985were responsible for considerable pessimism on the part of investors, and tbeyaccounted for financial hardships to many. Rectifying measures taken later inthe same year could not quickly improve the investment climate or remedy thefinancial difficulties facing new investments.

on the other hand, the changes that took place in the exchange marktscreated expectations of additional deterioration of the Egyptian pound.Accordingly, many investors shied away from taking commitments at futureexchange rates. Also the decline in the U.S.Dollar exchange rate abroadincreased the liability of IBID borrowers as they had to pay a higherXRevaluation factor" which reached 1.40 at times.

As a result of the above adverse changes the loan was no longercompetitive. Moreover, equity participations in some projects were not calledin as quickly as planned, and one project, namely the I.V. Solution Company,was cancelled. K1DB's efforts to attract new projects were not fruitful.Accordingly, only an amount of USS 16,273,033 was disbursed out of the amountscommitted during 1983 and 1984 (US$ 22,444,000) i.e, about 72.5% of thosecommitments, bringing the total amount disbursed from the whole loan to U8$23,564,088 or about 78.5% of the amount of the loan.

D) Cancellation of the undisbursed balsaces of the loan:

Despite the extension of the closing date of the loan several times, itbecame clear in 1987 that no effort could achieve the full utilization of thebalance of the loan. A decision was therefore taken to cancel the undisbursedbalances of the loan which stood atU.S.$ 6,435,912 and IBRD was informed onOct. 18,1987.

- 22 -

3. General Evaluation of the loan:

The utilization tables of the loan reveal the following facts:

The total amount of the loan (US$30 million) was committed to 14projects (15 approvals of which 2 for Kiraco). One Project (IV Solution)was cancelled later bringing the number of projects financed to 13projects.

Out of the total commitments, US$ 22,011,000 (73.4O) were in the form ofloans, and US$ 7,989,000 (26.5%) in the form of equity participation.

The amounts withdrawn from the loan totaled US$ 23,564,088 (78.5% of thetotal amounts committed).

Out of that total, US$ 18,040,879 (76.6S) were in the form of loans, andUS$ 5,523,209 (23.4S) in the form of equity participation.

The Industrial sector's share in the toal committed amount was VS$23,817,000 (79.41), while the financial and services sectors* share wasUS* 6,183,000 (20.6S). The industrial sector's share of the total amountswithdrawn from the loan was US$ 19,671,453 (83.51) while the share of thefinaneial and services sectors was US$ 3,892,635 (16.5).

The private sector's share in the total committed amount was US321,832,000 (72.8%), and the share of the joint venture projects (public/private) was US$ 8,168,000 (27.20). No amounts were committed to thepublic sector.

Meanwile, the share of the private sector of the total withdrawn ammuntof the loan was U* 17,812,605 (75.6S) and the share of the joint venturesector was US$ S,751,483 (24.4S).

Out of the 13 projects financed through the loan, 10 projects (77%) weredometic arket oriented and one project (7.7%) was export - orientedwhile 2 projects (15.3S) were for both domestic and export markets.

Nine of the financed projects (69?). wer new,while four (31?) wwerexpansions of existing projects.

Out of the 13 projects fin nced, five wero in new citis and eight in oldcitis. Two projects wre in free sone area and eleven were in-land.

As for the size of the sub-projects, One project (7.71) wam ls"s than W8*2 million, thre projects (23%) between 2-4 aillion 03 dollars, twoprojects (15.4S) between 4-5 million U8 dollas, nd seven projects(53.9%) exceeded US$ S million.

- 23 -

- Rqpayment periods for projects ranged between 5-7 years.

- The 13 projects financed 8enerated new employment totaling about 2467workers.

-- The present status of each of the 1=projects financed through the loanis stated in the enclosed table No.4.

In part one of the PCR it was mentioned that the Auditor's Report doesnot include information about the adequacy of the provisions.

However, the auditor normally attends the meetiog of the Board ofDirectors in which the audit report is discussed and makes a verbal statmemtabout the adequacy of the provisions.

It is worth mentioning that relations between IBD and KMDS werecharacterized by full co-operation. The periods betwoen KIDS approvals ofprojects and IBND approvals, ranged between one month and eleven months.

NMDB provided IBiD regularly with information required periodically or onthe occasions of visiting IBRD missions. Field visits were also arranged forIBND representatives to projects sites.

TABLE NO, I

n A! o 2= 6816

APInVb OTS"DAI or min UTIl an30 T3 APFLICA?IUU* AJOuTM V UIIMO6CUALS sEpawnEE? ouTsTaUOCiUwpPICNAL OF P3Jg¢ a *o4r mLOA TOTAL OA 0or gm80 CoMUtZMUSS FMoE t1 O*ll305

t1) t9.4.19t1 Mist RuraA Ce. - 350.000 no,ooo 1.10.1401 Sept.31 8*trU112o(ZFtOD) (ml) 350.C00

(2) 33.1.1951 e dy ade ;gsumtas - 3.0000 20.040000 1.10.1931 feb.12 7.570.303.31 2io143.43 3.393.U 1.9(TAU6OSu) (An) I 2.104

(3) 32.5.1S 353*30(b_) - , 1000,000 l.000.00 *4.2.193 Iacmb at 011.914.*2 9t1,914.42 -

£4) 4*4.19SU DrIllieg mIsC-(AO) - 2.000000 3.000.000 4.8.19U2 h"6 3,993.461.6 1.6t21000.00 1.124.401.93

(5) 31.10.2933"* "Tlase PaPe () 1.M,500.00 3.025.000 5.335.00 7.1.1933 Jan.33 S .0"9002.95 5.0S,00.3.9S -5.333.000

(4) 17t.3.193 t tsett Macatroni tt(1) - 500.000 500,00t 22.4.1963. Nareb 33 ,441,tl0.92 100.000.0o 341.010.925041.000 I

t() 11.11.9"3 Arab Pereelo1a Co.t-12) - 900.000 000.000 37.132.29 0 e. 62"DION0 916.290.11 913,310.11

tO) 35.1.1933 atern tleaa S1lailmki 500.0o0 2.023.000 23542.000 15.11.1934 1eo04° 2.694.047.8U 615.888.16 2.016.145.72* ?aatlles Ca.(AOS) 3.*543000

:9) 25.12.193 sltar lavestewt 3.133.090 - 3I.14.0 33.3.1934 Ju" 64 693.152.9 939.152.19 -

;10)10.10.1904 blncares UtAlWe - 5005000 500.00 35.9.134 Ocobe 64 500,00.00' 500.00.00 Iledsstele £304) *500.0o .

:11)7.6.19t*4 Plo ¢t Zn. foe Clan' 1?7.Mie - 1,fo0.0r0 15.11.Cy34 1.140 .00 .40.000. 1.140.000 - Jb

U)t.6.1954 o1323C (24) g 1.043.000 *29,00o 1395.000 15.11.1934 1.65.000 1.639.403.96 1.341.59".6 491.605.32Arab Ce..1. Cerasle

3)3.0l.1964 Pr.S.st (AwC) - 1.3)5.000 1,315o00 15.11.19#4 Dh. 1994 1,19.944.04 184,444.04 1,433.500.001.61$1000

14)3.6.194 I.V.861"tUess(AGO) 3,745.000 3.,45.000 15.11.1964 Uner4 Statwna3.145.000 -

15)13.2.194 Mtile Clothing Ce.lU3) - 119,00 7t9.000 2.6.1954 30.9.93 - -

11m,000 760,093.l 10,039.39 -

TOTAL 1.9t1t000 22,011,000 30.00t.uWo 3o,000,000 3*544.09.00 o 15.59*55.38 11946.4)1.42

C) Stadow$ for 1"ading applcAtloec aboe the ftre 11.1t Oub.lcsn.CS) "&nSs gw PeldIng w&liestloa, ble.lb t. fre lIblt _ub-le(a) St3t fw 541141mg materials aed" s"telsa_tuleto) Staldsfo Lw eap1e 1eed".(a) Studs for eupew edesled prejeet.

a') ll1t of slgatere of t& lfear Ir t Ca. InMeeserd.01.

*"3 Lees esreessat Sined ma WiA U.9.

ALt I

-25-

TABLE NO. 2

Cv4AACT!RtST?CS OF SUB-PWOJECTS FINANCES

size or Sue-PqOJiCt

INTERVYLSCOOO'SS) ESTIHATE ACTUAL ISSt?ATE1 ACTUALS900-2000 1.00 1.00 7.69 7.692000-3000 1*00 2.00 7.*69 15.383000-4000 - 1.00 1.00 7.69 7.6940C0-5C00 3.00 .2.00 23.08 15.385000- 7.00 7.00- 53.85 53.83

SttE OF SUB-L0A4S

INTERVELSCOOOSS) ESTtA?Tt ACTUAL - ESTIMATEZ ACTUAL$- 300-400 2.00 2.00- 15.38 15s.3

'00-500 2.00 2.00 15.38 15.38S00-800600-700700-800

* 800-900 1.00 7.*69900-1000 1.00 2.00 7.69- 15.381000-2000 3.00 3.00 23.08 23.082000-3000 3.00 2.00 23.08 15.383000-4000 1.00 1.00 7.69 7.694000-SOO 1.00 7.69

SIZE OF ENTERPRISES BEFORE THE LOA# -

tNTERVELS(OOOSS) ACTUAL S' -3000-5000 1.00 7.695000-6000 2.00 15.386000- 1.00 7.69

TERMS OF THE SUB-LOAN

SUg-LOANS ARE REPASS SUR*tNG S-7 TEARS

SALES bESStNATtON

ESTINATE ACTUAL tSTtRATES ACTUALZ0ONlSTIC RARKlT 10.00 11.00 76.92 84.62EXPORT 1.00 7.6980TN 2.00 1.00 15.38 7.69

TYPE Or EWTERPRISES

Ngw 9.00 9.00 69.33 69.23-EXPANSION 4.00 4.00 30.77 3017?

FtNANCIAL RATtS OF RETURN

>12 1.00 8.3312-15 2.00 16.*6716-20 1.00 8.3321-25 2.00 16.*?26-30 2.00 16.67Zo< 4.00 33.33

" ." .h qF *t 4 * t W S

i i IiI;III8I.e .?. o " g oo o HUa, ,,IS

S.' S. I

HCig s I'|3w

?ASL Ile. 4

JP r j *e t Statue

1) latmatloe"l Blanketa an the coeny isf tacla finnetal problm do* to _betape In liquidity neded for votb* capitol reqIinnts r1mltiestextile. Coen th lam incees In exohese rats ed peice t1|le. Acerdlaly. this e toe decrease tn the production cteityt.

moreoer, th aepen fed sinextin problem during th trial gw peid. nsequmntly. the co_pay gave"

3) ts" Paper thb capaW encounte fiacial probliw due to ireas, to the prices of cm intecials softly due to the Incrase in(Pyred Papr K11tt1 Coery)* eu_t ee rtee. 1herer, Km pepmrd on ut dated fincial study.

3) tkrm Stetiles Industries the cteW peid the cmining balance of the 233 loan tfrm its t resou ces.

4) 31 Clotbn C e Opattn nowly.

5) Seem aearoni te" co*pn is facin tacheal. uerbtins, magerial. and financial probliw. Consequetly, the ceany reqeted

4) Arab Coqany for Cernc* It coqanw ti facin toekmteel problem leading to a doclin to the produetIen capcity. therefore. 335 preprend anup.dated fineal study.

1) Bier Panitur Coapany te ceany ti facin tfi cel problem de to the icreas in the prices of beasi poductio cot itm. as well asinlketI difl le1ties. tr e eapa requested A ae _dulift.

6) Arab oreoleta Cowan th coapay prepid the 1333 loan to avoid exceane rte risls.

9) st Itran 1or Clay kicks the _mpny enoontered financa bardew al an *atem of taechical and na-etin protles. Rescbodulift atudcamtted.

10) 31ACC operating succesafully.

11) Dilling i ^otin nornely.

12) 3sw inveetmat mince Ocmpany _h capay faces sdministcative problm due to the witbartl of te friweign artne.

13) Dewy 1ade Oaaacnta (tedroskI) I ad Onuwkiltlenal Ase_cta±-- ec of qlified teceiall mnagmat staff.- Lack ot qlty cteetrl proedu.-Lac of prope production potain and maintenace nsten.

Marhtinc Asect: -- InblItty to pntrcate e_prt ekets due to ined_ete narketing policy me abs_nc of efleiet _aeItlg

stratas.- Difficulty In "rating pert of the production In the lecal _erkt du to partiol reetrictim applid by Fr

afmg autbority.

- A in laveetmi cost due to deay in Implettion prosres.

a am _aploe_to i tew state of the _co y Is nawloed.

- 28 - Table 1Page 1

PART III; STATISTICAL INFORMATION

Characteristics of Sub-Projects Financed

Size of Sub-Project Number of Sub-Pro,jects(Thousand of US$) Estimated Actual X

900 - 2,000 na 1 7.72,000 - 3,000 na 2 15.43,000 - 4,000 na 1 7.74,000 - 5,000 na 2 15.4

Over 5,000 na 7 53.8Total 20-25 13 100.0

Size of Sub-Loans Number of Sub-Projects(Thousand of US$) Estimated Actual X

300 - 500 na 4 30.8500 - 800 na 0 0900 - 1,000 na 2 15.4

1,000 - 3,000 na 5 38.43,000 - 5,000 10-12 2 15.4

Total 20-25 13 100.0

Size of Enterprise (Pre-Loan)(Assets in Thousands of US$)

3,000 - 5,000 15,000 - 6,000 2

Over 6,000 1Total 4

Type of Enterprise No.

New Enterprise 9Expansion Enterprise 4

Total 13

- 29- Table 1Page 2

Terms of Subloans(Term) (Number)

5 years 46 years 57 years 4

Total 13

Destination of Sales

Domestic Market 11Export 0Both 2

Total 13

Financial Rates of Return Number

Less than 15% 315% to 202 120X to 252 2252 to 302 2More than 30X 4

Total 12

EstimatedIndustrial Type Number Jobs Created

Food Processing 1 104Textiles & Clothing 4 832Furniture 1 260Ceramics & Glass 2 121Paper & Paper Products 1 105Air Conditioner 1 600Construction Materials 1 160Oil Industry Services 1 192Finance 1 90

Total 13 2,465

1. Average Total Investment Cost per Job Created m US$42,000.

2. Cost per Job (less Paper Nill Project) - US$33,000

Proiect Comletion Report

Misr Iran Development Bank Proiect(Loan 1842-EGT)

Status of Proiects Finane OXy the Bank(Thousand of USIS

Outstanding ProblemSugr.iQs.t NMr Dihbrlemennot BaIhlance Ptspct MarkettoiR_earch Fku"font Investment Plan

1. Ready Made Garments 2,571 2,293 Probable loss to origi- Can't export product as Inadequate technical Too big. too fast and(TACROSKEEN) nal equity holders. NIPS planned. Assumed market management. Inadequate implementation poorly plan-Prtobin may suffer loss given for product & can't pene- production 6 quality ned. Project was overstizedunique size and layout trate. control. and too expensive. Caughtof plant. in devaluation with heavyforeign debt.

. International Blankets 2.694 2.078 Financial returns may Good blanket product, but Inadequate for opera- Poor financial plan. inade& Textiles never be positive. Pro- made original production tion. MIDS has opera- quate working capital toProbklU ject may stabiliOe errors. tion ur.der its over- meet higher costs of foreignadvance after restruc- sight. exchange ad import prices.turing involving D/E Iconversion.

3. Pyramids Paper Mill 5,090 0 a/ Serious financial pro- Paper converter using Adequate. Slower than anticipated.Prob7le blems. Costs of basic imported raw material. Devaluations changed theraw materials have sharp- Product price based upon entire cost/price structure.ly increased as a result undevalued exchange rate.of devaluations. Resche-duling study completed.

4. Nile Clothing 780 0 Successful company ert: Normal. Adequate. Realistic.Normal pi@ to shed Fx issues.Borrowed funds fromHIPS. Some problems onrepayment of cross-currency add on.

S. Abdul Rahman Textiles SOO 0 Successful company pre- Adequate, Adequate. Realistic.Normal paid loan to shed FXissues. Used ownresources to canceldebt.

0504M0

Outstanding ProblemsSubRerAlUt Nm hshaustsin .a1anee tralw±at UarkatnLhsiasearch bauegn&nt tnves.mnt Plan

6. m Macaroni Factory 442 347 Losses during 1984-65 S Has good market penetration. Management Is incompe- Managemnt has not PlannedProbim lack of profits in Should not be problem iwen tent. The production has sell. lacks spare parts.

recent years ensure low product is produced at been poor. quality very cannot recruit or retainfinancial rate of expected quality standards. bad, spoilage rates good lhaers.return. heeds restruc- high. etc. hI0S putturing to stabilize. director on board to

find management solution.

7. Arab Company for 1.624 1,633 Delays in start-up for Harketing not yet fully Management did not Delays and increased invest-Ceramic Products two years has created confronted. fully pilot test the ment have altered investment

Prablm serious cash flow oro- raw material, clays, plan. Company faced withblems. Project may never etc. flaw in techni- need to reschedule flnalexperience projected cal planning and pilot sources of capital. There isfinancial rate of return. scale product testing. no room for further error.

Too big to fast.

S. "tsr Iran Furniture 361 0 t/ Total product & market Poor to no market research Developer is a furni- The plan was too big tooCo. (HIFCO) disaster as furniture to test a new type of fur- ture importer/trader fast. An attempt to esta

Problem enterprise. M11O is niture for Egypt. Product with no prior expe- blish a new industry withattempting to raise dead has inadequate consumer rience in operating too little investment tnproject. HI0D8 putting acceptance. With US$25 industrial enterprise. test marketing of prototypesadditional cash into million in debt it is the The company faces pro- and slow Introduction intoovercapitali2ed venture biggest furniture factory duct, production and market place.with no prospect of in hiddle East. cost problems.return on capital.

9 hisr Finance 0 Not yet fully into operation. The company faces administrative problems eue to withdrawal of foreignPre Start-u partners.

10. 1isr Iran Air Condi- 2,?57 498 Successful company. Pre- Excellent plan, good atten- Very adequate profes- well planned and ekecutedtioning Co. (HICANO) pared a detailed pro- tion to testing of market sional management and project.

Nomal gram and schedule for assuptions. technical skills provi-action when firm was ded by joint ventureorganized. Joint ven- partner.ture with large foreignair conditioner Co.(HI08 has large equityposition).

11. Arab Company for 913 0 Successful company. Pre- Adequate. Adequate and with ample Adequate.Porcelain paid debt to excape fX technical/production

Umul problems. skills.

S0" t4l.0lu0s448 s~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~l-

Outstanding ProbleksSuborotact Name Disbursement Balance Prospects arketino/Research M3n*8men t Investment Plan

12. Misr Iran Co. for 1.740 0 ;/ Serious financial and Too big too fast with poor Original foreign group Plan was adequate on theBuilding Material marketing problems as to no marketing or distri- who built plant and ope- assinption that market would(CLAY BRICK) well as raw material use bution research. Product rated as joint venture support a high priced cons-

problems. Low price clay proves to be very price has pulled out. Need to tructidn material.brick producers reopened sensitive. Very little identify and retainand sell lower quality research in clay soil strong local managementbrick at lower price. mechanism, skills.Has had sharp effect onclay brick sales.

13. National Drilling 2,999 1.125 Successful company. Adequate. Adequate. Adequate.

a/ WIGS provided PPN with local currency loan of LE 9.6 million of which LE 6.6 was disbursed on 12/31/87 to repay World Sank loan and help it escapeforeign exchange prOblem.

b/ IDS has asststed this bankrupt company to reschedule its debt and has invested almost US$700.000 in equity.r, WIGS provided Clay Brick Company with local currency to repay World Sank loan. The Company is destitute and seeks to restructure.

08041t

33 Table 3

Page 1

PROJECT CGOPLETION REPORT

HISR IR DEVELOPHEMT BAN PROJCT(LOAN 1842-EGT)

Balance Sheet as of December 31, 1988(Thousands of US$)

1988 1987 1986 1985 1984 1980

Assets

CurrentCash & due from banks 207,793 216,533 196,220 240,321 227,359 166,581Investments in Securities 3,877 4,677 5,837 9,787 5,787 28,958Bankers' acceptance 3,473 4,093 4,706 4,905 4,953 -Short-term loans 35,023 47,552 60,560 59,610 67,042 30,220Loans to Banks (facilities) 18,500 18,500 18,500 16,000 25,000 7,660

Long-termLong & medium-term loans 31,389 40,293 46,325 66,780 53,367 15,503Equity investments 29,232 32,219 28,292 15,583 13,342 6,627Loan & interest dues V/ 46,520 42,789 31,652 20,873 13,980 -Other debt balances 13,164 12,552 11,262 10,173 12,175 6,947Fixed assets 12,783 13,358 13,863 14,226 10,641 653

Total Assets 401,754 432,566 417,217 458,258 433,646 263,149

1/ Non-suspended portion of overdues.

- 34 -Table 3Page 2

PROJECT COMPLETION REPORT

EGYPT

MISR IRAN DEVELOPMENT BANK PROJECT(LOAN 1842-EGT)

Balance Sheet as of December 31, 1988(Thousands of US$)

1988 1987 1986 1985 1984 1980

Liabilities & Shareholding Equity

CurrentCustomers' deposits 110,055 129,606 123,615 111,010 112,872 85,571MIDB certificate of deposit 20,600 21,750 21,750 21,750 22,850 11,825Banks & Correspondent 168,670 177,117 179,129 233,851 213,122 107,834Other 1/ 42,995 44,141 32,820 35,642 31,966 13,573

Long-termLong-term borrowing 7,968 8,759 10,211 9,055 7,791

Total Liabilities 350,288 381,373 367,533 411,308 389,401 218,808

Capital & ReservesCapital 40,000 40,000 40,000 40,000 40,000 40,000Reserves 11,466 11,193 9,684 _Q1

950 4,245 4,341

Total Capital & Reserves 51,466 51,193 49,684 45,950 44,245 44,341

Total Liabilities & Capital 401,754 432,566 417,217 458,258 433,646 263,149

1/ Including provisions for: investments US$12.6 million, doubtful loans US$2.5million and Credit Balances US$26.9 million.

-35 - Table 3Page 3

PROJECT COMPLETION REPORT

EGYPT

MISR IRAN DEVELOPMENT BANK PROJECT(LOAN 1842-EGT)

Statement of Profit and Loss as of December 31, 1988(Thousands of US$)

1988 1987 1986 1985 1984 1980

Interest Income

Short-term loans 16,163 16,292 18,862 28,642 35,479 24,746Long-term loawis 1/ 7,266 6,692 9,356 9,297 7,150 1,717

Total 23,429 22,984 28,218 37,939 42,629 26,463

Interest Expenses

Short-term borrowing 16,909 16,855 18,856 26,606 32,236 21,069Long-term borrowing 982 1,075 1,079 949 804 _ 94

Total 17,891 17,930 19,935 27,555 33,040 21,163

Net Interest Income 5,538 5,054 8,283 10,384 9,589 5,300

(Less) Provision for bad anddoubtful accounts 1,775 2,799 2,227 2,964 1,852 300

Net Financial Income 3,763 2,255 6,056 7,420 7,737 5,000

(Less) General & AdministrativeExpenses 3,2S0 3,389 4,113 3,818 3,914 1,635

Gross Operating Profit (Loss) 483 (1,134) 1,943 3,602 3,823 3,365Other Income 3,192 4,798 4,027 4,541 4,070 2,750

(Less) Other expenses 784 933 881 803 840 673

Net Profit (pre tax) 2,891 2,731 5,089 7,340 7,053 5,442

1/ Include fees, commitment fees, commission, etc.

OS04M

- 36- Table 3

Page 4

PRJC CONILETION REPORT

iGrPT

MI8R IRAN DEVELOPMEWT BANR PROJECT(LOAN 1842-EGT)

Statement of Profit and Loss as of December 31, 1988(Percentage of Average Assets)

1988 1987 1986(Percentage) (Percentage) (Percentage)

Interest Income

Short-term loans 3.9 3.8 4.3Long-term loans 1.7 1.6 2.1

Total 5.6 5.4 6.4

Interest ExDenses

Short-term loans 4.1 4.0 4.3Long-term loans 0.2 0.2 0.2

Total 4.3 4.2 4.5

Net Interest Income 1.3 1.2 1.9

(Less) Provision for bad anddoubtful accounts 0.4 0.7 0.5

Net Financial Income 0.9 0.5 1.4

(Less) General and AdministrativeExpenses 0.8 0.8 0.9

Gross Operating Project (Loss) 0.1 (0.3) 0.5Other Income 0.8 1.1 0.9

(Less) Other Expenses 0.2 0.2 0.2

Net Profit (pre tax) 0.7 0.6 1.2

Average Assets (Millions of US$) 417.2 424.8 436.3

-37 -

AttachmentMISR IRAN DELOPMB8T BANK

Comments Received from MIDB

14/6/1989Mr. Emile B. SawayaSenior Operations OfficerIndustry and Energy Division U / 93Country Department 3Europe. Middle East and North Africa RegionThe World Bank1818 H Street, N.W.Washington. D.C. 20433U.S.A.

Dear Mr. Sawaya.

I would like to acknowledge -wi-h thanks- the receiptof your letter dated May 24, 1989 and the enclosed copy ofthe draft pro3ect completion report (PCR) for Loan1842-EGT.

We have reviewed parts one and three of the PCR andwe agree -in general- with the conclusions andrecommendations stated therein.

Consequently no changes were necessary in the draftof part two of the report which was prepared by MIDB anddelivered to you during your last visit to Egypt. A finalcopy of that part is attached.

As concerns the recommendations relating to trainingand technical assistance that could be arranged throughthe World Bank. we will study it and will come back to youwith specific request of assistance in areas where wethink assistance is needed.

Once again. I would like to thank you and yourcolleagues for all the efforts you exerted and your kindassistance and cooperation.

With warnmst regards, - -

I remain.

Yours sincerely.

Al-Motaz MansourManaging Director