Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No- 5400-HU

STAFF APPRAISAL REPORT

HUNGARY

FINE CHEMI4CALS PROJECT

February 27, 1985

Industry Department

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

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CURRENCY EQUIVALENTS

Currency Unit = Forint (FT)

US$1 = Ft 50Ft I = US$0.02

WEIGHrS AND MEASURES

Metric System

ABBREVIATIONS AiND ACRONYMS

Biogal - Biogal Pharmaceutical WorksBVK - Borsod Chemical WorksCaola - Factory for Cosmetics and Household ChemicalsCC - Convertible CurrencyCREMOLIMPEX - Foreign Trade Company for the Chemical IndustryChinoin - Chemical and Pharmaceutical Works Ltd., ChinoinCMEA - Council for Mutual Economic Assistance (COMECON)Egis - Egis Pharmaceutical WorksGedeon Richter - Chemical Works of Gedeon RichterGYKI - Institute for Drug ResearchGYOGYERT - Pharmaceuticals Wholesale Trading and Distribution CompanyKDI - Methyl Diphenyl DiisocyanateMEDIMPEX - Hungarian Joint Trading Company for PharmaceuticalsNqBH - National Bank of HungaryNEVIKI - Research Institute for Heavy Chemical IndustriesNitrokemia - Nitrokemia Industrial WorksOMFB - Office of Technological DevelopmentReanal - Reanal Factory of Laboratory ChemicalsSDB - State Development BankVEGYTERV - Hungarian - anmical Industries Engineering Center

FISCAL YEAR

January 1 to December 31

Industry DepartmentJanuary 1985

FOR ICIAL USE ONLYHUNGARY

FIDE CHEMICALS PROJECT

Loan and Project Sumary

Borrower: National Bank of Hungary (NBH).

Guarantor: Hungarian People's Republic.

Beneficiaries: Eight chemical companies, two research institutes and a designand engineering institute.

Amount: US$73 million equivalent.

Terms: Fifteen years, including three years of grace at the standardvariable interest rate.

Relending US$72.6 million of the proposed loan would be onlent toTermS: beneficiary enterprises for periods up to 15 years, including

up to four years of grace, at an interest rate equal to atleast the Bank rate plus a 30% mark-up which includes a fee tocover the foreign exchange risk to be borne by NBH.

Project The proposed project seeks to increase and diversifyDescription: production of fine chemicals, particularly pharmaceuticals,

and in keeping with the Bank's assistance strategy to Hungaryis designed to increase foreign exchange earnings inconvertible currencies through the expansion of exports andimport substitution. The major project components consist of(a) investments by five pharmaceutical enterpri,ses to expandthe production of selected final products and intermediatesand to upgrade production processes to internationallyaccepted Good Manufacturing Practices (GMP) standards; (b) theconstruction of a 25,000 tons per year methyl-diphenyl-diisocyanate (MDI) plant as a basis for initiating productionof certain types of polyurethanes to supply both the domesticand export markets; (c) a plant with 15,000 m3 annualcapacity to produce ion exchange resins; (d) investments bytwo enterprises to expand production oi selected plantprotection chemicals and their intermediates; (e) a 4,000 tpysulfonation plant to supply intermediates, presently imported,for the production of detergents; (f) construction of anorganic waste incinerator with a capacity of about 25,000 tonsper annum; (g) modern equipment required by enterprises andresearch institutes for research and testing of pharmaceuticaland plant protect'on products; (h) assistance to thepharmaceutical industry in conducting clinical trials andregistration abroad of selected final products for sale inOECD markets on a pilot basis; and (i) technical assistanceand training.

Project The project is expected to generate incremental salesBenefits revenues at full development of about US$274 millionand Risks: equivalent and pretax profits of about US$88 million

equivalent per annum. The estimated incremental contribution

This document ha a resuicted diwtibuon and may be used by ecpients only in the perfoa unce of itheki ofra duties. Its cn tsn may not otherwse be dbdosed without Wodd Bank authorizato

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to the Government budget in the form of annual income tax isestimated at US$47 million equivalent. Net foreign exchangeearnings and savings are estimated at US$106 million equivalent peryear. The project is expected to assist the project beneficiariesin significantly upgrading their technical level of production.Other benefits include the strengthening of planning and marketingsystems, particularly in export markets, significant energy savingsin construction from the use of HDI-based polyurethane foams, andthe reduction of environmental pollution through the incineration ofsolid wastes and measures to control to acceptable levels air andliquid pollutants. Furthermore, by upgrading the quality ofproduction processes, the project would strengthen thepharmaceutical industry's ability to continue to compete in sellingactive ingredients and final products in convertible currencymarkets. The main risks of the project concern the MDI andpharmaceutical components. The profitability of investments in thepharmaceutical subprojects will depend on the effectiveness of thecompanies' research and development efforts to develop innovativeproducts or better, cheaper processes for existing drugs.Similarly, the extent of the profits on the MDI project will dependon the company's ability to develop polyurethane systems andappropriate marketing arrangements. The project includes assistancefor strengthening R and D and marketing systems, and, based onconservative assumptions about product development and prices, isjustified economically.

Estimated Costs: Local Foreign TotalUS$ Million

Production Investments

Pharmaceuticals and intermediates 74.7 49.3 124.0Plant protection chemicals 4.7 2.7 7.4MDI and polyurethane systems 28.2 27.1 55.3Ion exchange resins 13.9 4.7 18.6Detergent intermediates 0.9 1.1 2.0Incremental working capital 14.3 3.6 17.9

Research and Development 3.0 4.8 7.8Pilot Marketing Scheme for Pharmaceuticals 0.1 8.3 8.4Studies, Training, Technical Assistance 0.6 0.8 1.4

Base Cost 140.4 102.5 242.9Physical Contingencies 12.5 9.1 21.6Price Contingencies 26.3 20.7 47.0

Total Project Cost 179.2 /1 132.3 311.5

/1 Includes $18.7 million of taxes and duties.

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Financing Plan: Local Foreign Total

- US $ Million -

World Bank 73.0 73.0Beneficiaries 70.1 - 70.1NBH 97.3 56.8 154.1SDB 3.0 2.5 5.5Governmenet 8.8 8.8

Total 179.2 132.3 311.5

Estimated Disbursements;

IBRD FY 1986 1987 1988 1989 1990US$ Million

Annual 6.6 16.8 26.2 15.4 8.0Cumulative 6.6 23.4 49.6 65.0 73.0

Economic Rate of Return; About 36 percent.

Appraisal Report: No.5400-HU, dated February 27, 1985.

HUNGARY

FINE CHEMICALS PROJECT

TABLE OF CONTENTS

Page No.

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

II. THE CHEMICAL SUBSECTOR AND THE FINE CHEMICALS INDUSTRY 1

a. Introduction . .. IB. The Chemic - "'sector .. 2C. The Fine ChL- Is Industry 4D. Pricing . ............ 8E. Marketing and Distribution 10F. Research and Development. . . 11

III. MARKET, MARKETING AND PRICES ................. o ........ .. 12

A. Pharmaceuticals ........ .. .................... 12B. Plant Protection Chemicals: Pyrethroids . .15C. MDI and MDI-based Polyurethanes .. 16D. Ion Exchange Resins. 18E. Intermediates for Plant Protection Chemicals

and Detergents .................... 19

IV. THE BORROWER AND PROJECT ENTITIES . . .19

A. Introduction .. 19B. The National Bank of Hungary. 19C. The Project Entities .20

V. THE PROJECT .23

A. Overall Project Objectives and Scope .. 23B. Bank Role and Rationale for Bank Assistance . .23C. Production Investments ......... .. ................... 24

1. Objectives and Description ...................... 242. Implementation and Schedule .... ................. 273. Environmental Aspects ........................... 27

This report was prepared by Dominiq'ie Babelon, Roger Heath,David Caplin, Roger Batstone, Sannasie Thiyagarajan of the Bank andMichael Peretz, Yaacov Ziv and William Firth (Consultants).Secretarial assistance was provided by Ms. Edna Kelly and wordprocessing assistance by Mesdames Muriel Greaves, Eleanor George andAdrianne Johnson.

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TABLE OF CONTENTS (Continued) Page No.

D. Research and Development ............. 30E. Pharmaceuticals Pre-Marketing Pilot Operation ..... 31F. Studies, Training, Engineering Design ..... 32G. Overall Project Coordination ...................... 33

VI. CAPITAL COSTS, FINANCING PLAN, PROCUREMENT ANDDISBURSEMENTS 34

A. Capital Costs .... 34B. Financing Plan, Borrowing and Onlending Arrangements 36C. Procurement 38D. Disbursements 39

VII. FINANCIAL ANALYSIS ... ....................... 41

A. Revenues, Costs, Profitability and Cash Flowsof Subprojects 0.000..41

B. Financial Rates of Return .......... 41C. Projections of Companies Financial Statements

and Financial Covenants ....................... 41D. Reporting and Auditing Requirements ........ .42

VilI. ECONOMIC ANALYSIS .................... .... ... . .*...... 44

As Assumptions 44B. Economic Rates of Return and Net Present Values ..... 46C. Sensitivity Analysis ..... 47D. Foreign Exchange Savings .... . ............ 47E. Other Benefits and Policy Measures ......... 47

IX. AGREEMENTS 48

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ANNEXES

2-1 The Chemical Subsector (Tables 1 through 5)2-2 The Regulatory System for Appproval of New Pharmaceutical Products

3-1 Past and Projected Pharmaceuticals World Trade and Hungarian CCExports

3-2 Projected world consumption and Incremental Sales ofPharmaceuticals from the Project, by Therapeutic Classes

3-3 Past and Projected Growth of Hungarian Pharmaceuticals Sales andExports - 1983-1990

3-4 Estimated Incremental Pharmaceutical Sales from the Project, byType of Products and Markets - 1990

3-5 Estimated Incremental Pharmaceutical Sales from the Project, bytherapeutic classes - 1990

3-6 MDI-Estimated Markets for Projected Output3-7 Ion Exchange Resins - Actual Production, Projected World Market

Requirements and Supply, and Destination of Project Output4-1 NBH Financial Statements4-2 The Project Entities4-3 Financial Performance of Project Companies - 1981-83

5-1 Summary of Implementation Arrangements5-2 Project Schedule5-3 Design Requirements for Subprojects

6-1 Project Cost Estimates, by subprojects6-2 Detailed Financing Plan6-3 Maturities and Grace Periods6-4 Estimated Disbursement Schedule for Bank Loan

7-1 Summary of Subprojects Financial Results - 19907-2 Subprojects Financial and Economic Rates of Return7-3 Projected Prices of MDI7-4 Structure of MDI Production Costs7-5 MDI Subproject - Financial Analysis - Summary of Major Operating

Cost Assumptions.7-6 Summary of Companies Projected Financial Statements.

8-1 Sensitivity Analysis.8-2 Project Net Impact on Convertible Currency Trade Balance in 1990

Map - IBRD 18757R

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DOCUMENTS AVAILABLE IN THE PROJECT FILE

Reference Title, Date and Authors

A - Hungary - Chemical Sector Review World Bank - November 9, 1984(Report No. 5330-HU).

B - Annotation on the Activity of the Hungarian PharmaceuticalIndustry - Association of Hungarian Pharmaceutical Manufacturers -October 1984.

C - Production Investments Feasibility and Market Studies (includingcapital cost estimates, implementation schedules and cost/benefitanalysis).

D - Arthur D. Little - Review of the Feasibility Study of BVK MDIProject -October 1984.

E - Investments in Research and Development.

F - Companies Financial Statements - Past and Projected.

G - Terms of Reference for the Proposed Studies.

I. INTRODUCTION

1.01 The Government of Hungary has requested Bank financing for a FineChemicals Project to assist in the implementation of its strategy to reori-ent the industry towards fine and speciality chemicals based on intenisiveresearch and development (R&D) activities and which show good potential forincreased convertible currency earnings and savings. The Project consistsof four major complementary components: (a) funding of a package of priori-ty investments to increase or initiate production of pharmaceuticals, poly-urethane systems, plant protection chemicals, specialty resins (ion-exchange resins) and intermediates for fine chemicals; (b) increasing thecapacity and upgrading the facilities of selected key research and develop-ment organizations; (c) fnading pre-marketing expenses (clinical trials andregistration) for a small number of Hungarian products in selected OECDcountries to permit their eventual sales on a pilot basis under Hungarianbrand names; and (d) studies and training to support the above investments,identify further development potentials in the Hungarian chemical industry,prepare a restructuring program for the fertilizer industry, and improvethe strategic planning capabilities of the Hungarian chemical enterprises.

1.02 The financing requirements of the Project, including physicalcontingencies and price escalation, are estimated at US$311 million.Foreign exchange costs are estimated at US$132 million. The proposed Bankloan of US$73 million would cover 23Z of total financing requirements and55% of foreign exchange costs. The balance of US$179 million will be pro-vided by cofinanciers, from internally generated funds of the Projectenterprises and from resources of the National Bank of Hungary (NBH), theState Development Bank (SDB) and the Government budget. The proposed pro-ject fits well into the Bank lending strategy for the industrial sector inHungary of assisting the Government in its pursuit of structural adjust-ments and technology improvements, with a principal aim of increasing con-vertible currency earnings or savings in areas where the country hascomparative advantages.

1.03 The proposed project was appraised in September 1984 by Ms. D.Babelon (Chief), and Messrs. R. Heath, D. Caplin, R. Batstone and S.Thiyagarajan of the Bank, and Messrs. M. Peretz, Y. Ziv and W. Firth(consultants).

II. THE CHEMICAL SECTOR AND THE FINE CHEMICALS INDUSTRY

A. Introduction

2.01 The Country Industrial Sector Strategy Paper, which was preparedby the Bank and discussed with the Hungarian authorities in late 1983(Report No. 4778-HU of January 1984), identified the chemical subsector asa key subsector which had grown rapidly within the industrial sector andwhich exhibited clear growth potential with good prospects for exports andimport substitution.

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2.02 In April/May 1984, a Chemical Sector Review mission of the Bankvisited Hungary to review the status of the industry, identify its develop-ment potential and major constraints and define the rationale for Bankassistance. The mission coincided with the start of preparatory work forthe next five-year plan (1986-90), which is scheduled for approval by theend of 1985. The discussions with the review mission and its conclusionscontributed to the definition of the future strategy in the chemical sub-sector and for establishing priorities for funding during the 1986-1990plan period. A detailed analysis of the subsector is presented in thereport of the mission (Report No. 5330-HU of November 9, 1984 - ProjectFile, Reference A).

2.03 The review confirmed that the chemical industry should now focuson developing higher value downstream chemicals as the main subsector stra-tegy for the next five-year plan. In the course of the review, the Bankanalyzed the investment proposals of the various enterprises and assistedthe authorities in prioritizing them. This process resulted in the selec-tion of key investments which the Bank could assist in financing throughvarious projects and in the deletion of a number of other projects or theirpostponement pending further studies. The review also pointed out the needfor rehabilitation of certain branches of the fertilizer industry and forfurther studies in other branches of the chemical industry.

B. The Chemical Subsector

2.04 Between 1960 and 1980 the chemical subsector was the fastestgrowing subsector of the manufacturing industry and the second largest interms of industrial production value, value added and productive fixedassets. In 1982, it accounted for 13% of Hungarian exports and 20% ofimports. Until 1980, growth was essentially based on the development ofbulk chemicals in the fertilizer, refining, petrochemical and plasticsindustries and generally, on the production of commodity chemicals fordomestic as well as export markets. Since 1979, however, subsector growthhas significantly slowed down as a result of lower refinery throughput,world overcapacity in fertilizer and petrochemicals, the worldwiderecession and the Hungarian government's stabilization policies. Key dataon the past growth and structure of production, value added and trade inthe chemical subsector are presented in Annex 2-1, tables 1 through 5.

2.05 The Chemical Sector Review mission concluded that, beyond plantcapacities required to meet domestic demand, Hungary holds no medium- orlong-term advantage in capital-intensive branches of the chemical indus-try. The main conclusions of the mission with respect to future strategiesare summarized below:

(a) efforts should be intensified tc diversify the industry awayfrom bulk petrochemicals towards higher value-added fine andspeciality chemicals and their intermediates (pharmaceuti-cals, plant protection chemicals, paints, cosmetics, speci-ality rubbers, speciality resins), in which Hungary has acompetitive advantage due to the large availability of qua-lified but inexpensive technical, engineering and researchstaff, and a systematic effort should be undertaken at iden-tifying and promoting such fields;

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(b) in the immediate future, within these branches, priorityshould be given to those activities which can, or have thepotential to improve substantially the convertible currencybalance, either through export generation or through importsubstitution of Intermediate products (particularly in thepharmaceutical and pesticides industries);

(c) Hungary holds no long-term advantage in the production ofbasic petrochemicals and fertilizers for exports. Theseiridustries are highly capital-intensive, yet the count;y isnot a producer of the type of equipment required, nor doesit have access to cheap raw materials. No new capacitiesshould therefore be built if a substantial portion of theoutput is to be exported; efforts should rather be directedat downstream processing of the existing surplus of petro-chemical raw materials into higher value-added intermediatesand fine chemicals and polymers into plastic products forthe domestic market;

(d) in the medium term measures shonld be undertaken torestructure the fertilizer industry. In the ammonia indus-try, there is an obvious need to replace obsolete highlyenergy-intensive capacity for the local market, but thelocation, number and size of the new plant(s) still requirefurther study. The phosphate industry is currently based onlow-analysis Single Super Phosphate (SSP) and onnitrophosphates. AK though there are tentative plans toproduce phosphoric acid in Hungary for Triple SuperPhosphate (TSP) production, this is of uncertain economicviability. The direction that the phosphate industry shouldtake also requires careful prior study; and

(e) all branches of the chemical industry should continueefforts at reducing the use of materials and energy, parti-cularly in the refining and fertilizer industries.

2.06 The Bank should seek to support the proposed strategy through acontinuous dialogue backed by a series of operations in the subsector.These would include: (a) the proposed Fine Chemicals Project,fwhich wouldaccelerate the reorientation of the chemical industry towards higher value-added products; support associated R&D activities; and strengthen chemicalenterprises' strategic planning and marketing orientation; (b) a possibleFertilizer Restructuring Project which would address the questions of opti-mal size, location and technology of the fertilizer industry and distribu-tion aspects; (c) the Industrial Restructuring Program, being developed incollaboration with the Bank, which includes a special sub-program address-ing current bottlenecks to further development of the plastics processingindustry for the domestic market; (d) a possible second industrial energysavings project wh'ch would continue to support energy conservation effortsin the chemical industry. Finally, under the Fine Chemicals Project, pros-pects for further developments in other branches of the fine chemicalsindustry (such as detergents, paints and varnishes and their intermediates)will be studied, to form the basis of the investment program for implemen-tation during the second half of the next five-year plan period(1986-1990).

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C. The Fine Chemicals Industry

2.07 Fine chemicals production in Hungary consists essentially ofpharmaeuticals, plant protection chemicals and other chemicals such aspaints and varnishes, detergents and speciality resins. Together, thevalue of total output of fine chemicals in 1982 amounted to about US$ 0.9billion, or about 45% of total output value of the chemical sector (exclud-ing refineries and town gas production and plastics and rubber process-ing). Pharmaceuticals (US$ 0.4 billion) were by far the most importantbranch, followed by plant protection chemicals (US$ 0.2 billion) and otherfine chemicals (US$ 0.3 billion).

2.08 (a) Pharmaceuticals. The pharmaceutical industry in Hungary isover 100 years old and has a long established innovation and export tradi-tion and a good international reputation for producing quality products.It is the world 's ninth largest exporter of pharmaceuticals. The industryexports about balf of its total output, or Ft 13.1 billion in 1983 (4Z oftotal Hungarian exports), of which 42Z (Ft 5.2 billion, or USS 115 million)we-a directed to Convertible Currency (CC) areas. Pharmaceutical exportsrepresent 20% of convertible currency exports of the chemical industry.Past and future trends in world pharmaceutical consumption, production andtrade are summarized in paras 3.01 through 3.04.

2.09 Between 1970 and 1980, Hungarian output grew by an average of6.2% per year. Exports to CC areas grew at an average rate of 17.4% per-nmum, thus showing increased penetration of these markets. Since 1980,however, CC exports have grown only by 6% to 7Z per year, as a large shareof these exports have gone to institutional markets of developing countrieswhose increasing economic problems have impaired their ability to order andpay for the drugs.

2.10 The reason for Hungary's success lies in several factors besidesits long tradition: (a) expenditures by enterprises in R&D are signifi-cant; and significant state funding for basic and applied research isavailable through the Central Development Program for pharmaceuticals,pesticides and intermediates (para 2.32); (b) the six pharmaceutical compa-nies are organized into a manufacturers' association which effectivelyinfluences the direction of spending of R&D funds allocated for basicresearch by the Government to the companies themselves or to researchinstitutes; (c) companies compete in development of new processes and/ornew products; and (d) the industry has established an export marketingorganization, MEDIMPEX, which si.nce July 1982 has been the marketing arm ofthe companies themselves which share its operating costs in proportion totheir export sales. In summary, the ineustry has been able to reach itspresent position thanks to an organization whLch is effectively rationaliz-ing all stages of R&D while competing on product and process research.

2.11 The current pattern of pharmaceuticals exports is shown in thetable on the following page.

Pharmaceutical Exports-1983(US$ millions)

Convertible Currency ExportsTo CMEA Developed Developing Total CC Exports

Countries Countries Countries Exports Total

ActlveIngredients - 65 27 92 32

FinishedFormulations 175 4 19 198 198

Total 175 69 46 115 290

While the overwhelming proportion of formulations are exported to CMEAcountries, exports to CC areas are essentially of bulk active ingredients.Almost all CC exports of finished formulations are to developing coun-tries. MEDIMPEX maintains agencies in 18 LDCs, including Thailand, Syria,Egypt, Kenya and Ivory Coast. In a few countries (India, Pakistan,Bangladesh and Nigeria), it has established joint manufac_.,ing and market-ing operations with fully fledged marketing forces of detail men. Themajority of CC sales of formulations, however, s main of standard drugsthrough public sector tenders issued by LDCs' central purchasing authori-ties. Over 70% of CC sales of active ingredients are to developed coun-tries, in bulk form. For the exploitation of an innovative Hungarianactive ingredient, the practice, at present. is for Hungarian companies toenter into a royalty agreement with a foreign partner (usually a multina-tional); the foreign partner pays for the clinical trials in its home coun-try and other markets where it is given exclusive marketing rights. Itsubsequently registers the product in its name and markets the formulatedproduct using its own brand name. The Project incremental output will bemarketed using these existing networks and practices (para 3.08).

2.12 Hungary's comparative advantage and future prospects for theindustry have been analyzed in a study (Project File, Reference B) preparedin the framework of the Industrial Export and Restructuring Project (Loan2397-HU). Based on the review of the report, the future strategy for theindustry was extensively discussed during the sectoral and appraisal mis-sions with the Association of Hungarian Pharmaceutical Manufacturers aswell as with the management and staff of each of the six pharmaceuticalcompanies. The major conclusions of that review were that the industry hasa much higher potential to earn convertible currencies. This is to beachieved by: (i) shifting the production pattern substantially towardshigher value products, i.e. less bulk drugs and active ingredients salesand more formulations into dosage forms; (ii) the industry focusing itsresearch efforts more towards the development of original products and lesson process development for already existing drugs (except when processesdeveloped in Hungary have significantly lower costs than standardprocesses); (iii) increasing penetration of developed countries markets,which constitute the major markets, particularly for new drugs; (iv) focus-ing R&D on leading growth areas worldwide, such as anti-infectives, cardio-vasculars, cancer therapy agents and psychotropics (para 3.03); and (iv)developing the local production of intermediates when economic. The

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investment program to be financed under the Project will assist in meetingthese objectives (paras 3.05 through 3.09 and 5.03 through 5.07).

2.13 Another important conclusion of the review is that while there isstill significant scope for increasing exports of standard and bulk drugs(para 3.03), in the long term the risks will increase for the industry forthe following reasons: (a) markets for tenders for standard formulationsand for s_.-andard bulk active ingredients are not secure markets becausethey are governed exclusively by price competition as long as the productsmeet acceptable quality standards; Hungary's position will be increasinglychallenged by new low-cost producers (para 3.03) which are aggressivelyapproaching these same markets; (b) developing countries do not potentiallyrepresent markets capable of sustaining steady growth of Hungarian pharma-ceutical sales as budgetary and foreign exchange restrictions may substan-tially affect their ability to order and pay for drugs, as evidenced byrecent experience; (c) increasingly, t-.e largest LDCs are attempting toestablish their own industry; and (d) finally, OECD countries representtwo-thirds of world pharmaceutical markets and are virtually the onlymarkets for innovative products.

2.14 Reliance on sales of bulk active ingredients to developed coun-tries also has the disadvantage that: (i) while the Hungarian industryavoids the substantial costs of registration and marketing promotion anddevelopment in OECD countries, by so doing it also foregoes high value-added and profits associated with the sales of brand name formulations,particularly for original products; and (ii) they do not benefit frombrand-name protection: formulations sold under brand names not only estab-lish a market position for themselves which outlasts patent protection, butalso strengthen the market position of other brand name products sold bythe same company.

2.15 A balanced strategy for the future development of the Hungarianpharmaceutical industry thus calls for the industry to explore alternativeways to market its innovations in OECD countries under its own or jointlyowned brand name. So far, action has been hampered by the industry's lackof experience in direct marketing in developed countries, by lack of accessto foreign exchange to finance the clinical trials which are necessary toachieve registration (these are briefly described in Annex 2-2), by unsuit-able terms of available credit, and by formulation facilities not meetinginternational Good Manuf-cturing Practices (GMP) standards. GMP standardsare imposed by most foreign regulatory authorities before permitting theentry of foreign formulated pharmaceutical preparations into their domesticmarkets. Under the Project, the Bank will finance the installation offormulation facilities meeting GMP standards, to come on-stream in 1988, inthe four largest pharmaceutical companies (paras 5.03 through 5.07).

2.16 It is clear that such a change in marketing strategy needs to bevery gradual and geared to the companies' ability to assume the associatedfinancial burden and risks. But it is important that the industry startexperimenting on a limited scale with the various avenues open to marketbrand name formulations in OECD markets particularly for originalproducts. Depending on the countries, the type of products and the optionsavailable, the marketing of brand name formulations can be approached in avariety of alternative ways, including: (a) by entering into joint ventureswith companies which are willing to use their own existing marketing net-

works for the sale of Hungarian formulations under Hungarian or jointlyowned brand names; (b) by acquisition of companies with such existing net-works; or (c) by setting up their own marketing forces. This last option,however, should be assessed wit' care, since it entails substantial costsand risks. In all cases, the negotiating power of the Hungarian companieswould be considerably strengthened if they were in a position to pay forthe drugs' pre-marketing expenses (clinical trials and registrationexpenses). Through the Project, the Bank would, on a pilot basis, assistthe Hungarian industry in funding pre-marketing clinical trials andregistration expenses for a limited number of products in selected OECDcountries (paras 5.22 through 5.26).

2.17 (b) Plant Protection Chemicals. In contrast to the pharmaceuti-cal industry, the development of the pesticide industry started only in theearly 1960s, in response to rapid growth in domestic demand. In the early1970s, production for exports to CMEA countries became important, particu-larly under the Agrochemical Agreement with the Soviet Union. Since 1980,production has increased very rapidly; between 1980 and 1983, production inconstant prices increased by 136% and exports to CMEA countries by 260%.The total turnover of the pesticide industry in 1984 is estimated at aboutFt 10 billion (US$220 million). About 602 of total production is consumeddomestically and 40% is exported. Seventy-five percent of exports are toCMEA countries and 25% to CC areas (US$24 million in 1983). Domestic pro-duction satisfies about 75% of domestic demand. The balance, consisting ofspecialities not produced in Hungary, is imported mostly from CC coun-tries. Today, over 400 different products of all types are on sale inHungary, imported as well as domestically produced.

2.18 Production of plant protection chemicals and their intermediatesis spread among ten companies. Production of these chemicals, particularlyherbicides and fungicides, enjoyed increased popularity in the late 1970sin response to increased demand and as an avenue for diversification. Thestructure of production and exports reflects this basic orientation--essen-tially commodity chemicals and chemicals produced under license from largeforeign corporations for marketing in Hungary and in the CMEA markets(80% of exports to CMEA markets are formulated chemicals produced underlicense). Exports to CC areas, however, consist primarily of active ingre-dients produced in excess of domestic requirements, which are formulatedabroad by purchasing corporations and sold under their own brand names. Ofthese active ingredients, 40% are commodity chemicals and 60% are producedunder cooperation agreements and incorporate either intermediates producedin Hungary or Hungarian process developments. Production of plant protec-tion chemicals, however, is still heavily based on imported intermediatesand active substances.

2.19 The Government's policy is to encourage increased exports toCC areas of plant protection chemicals or intermediates incorporatingoriginal Hungarian developments. However, one of the major constraints toincreased CC exports today is that domestic toxicological tests are notaccepted on the major developed markets as the local testing facilities donot meet international Good Laboratory Practices (GLP) standards. Suchtests are generally required on all products, existing as well as innova-tive. Since their foreign cost is high, most companies cannot afford torepeat them abroad. Hungarian companies have thus increasing difficultiesin meeting tender requirements even for standard products.

2.20 The Government strategy for this branch consequently focuses on:(a) upgrading domestic testing facilities to meet GLP standards and to per-form the whole range of tests required, so that the testing organization(NEVIKI) may be put on the list of approved facilities by foreign registra-tion authorities; (b) developing the local production of intermediates toreplace imported ones; and (c) focussing available investment funds on com-panies which have stepped up their R&D efforts on original products withgood market potential on the domestic as well as export markets. Such astrategy would be supported under the project through the funding ofinvestments for the production of selected plant protection chemicals andintermediates (paras 5.08), testing facilities (para 5.20) and studies(para 5.27).

2.21 (c) Other Fine Chemicals. Total sales in 1982 of fine chemicalsocher than pharmaceuticals and plant protection chemicals amounted to aboutFt 9.2 million (US$230 million). This category encompasses a wide varietyof products, including paints and varnishes, detergents, cosmetics andhousehold chemicals, speciality polymers and resins (polyurethane systems,ion exchange resins, etc.) and photochemicals. Their production is widelydistributed among all chemical enterprises, although each product type isnormally produced by one or two companies only. The Project includesinvestments to increase production of MDI and MDI-based polyurethane sys-tems (para 5.09), ion exchange resins (para 5.10), and intermediates fordetergents (para 5.11). Market prospects for these products in the worldand in Hungary are described further in Chapter III. The Project will alsoinclude funding for studies aimed at identifying further prospects fordevelopment of the fine chemicals industry, particularly during the secondhalf of the coming five-year plan period (1986-1990) (para 5.27).

D. Pricing

2.22 (a) Producer Prices. In 1980, Hungary introduced the concept ofcompetitive prices", by which, with few exceptions, producer prices(prices paid to producers and by producers) of raw materials, intermediatesand finished products are linked to world market prices, either directly(actual export and import prices), or indirectly through specific rules andregulations. These prices apply irrespective of whether goods arepurchased/sold on the world market for convertible currency, or from/toCMEA countries for transferable rubles, or purchased/sold on the domesticmarket. This pricing system is aimed at simulating market conditions in anenvironment of still limited competition among domestic producers and fromimports.

2.23 For basic and intermediate chemicals, producer prices are deter-mined by either one of three rules: (1) if a product is imported, domesticprices are set at the level of actual or calculated imported prices (CIF)from convertible currency areas (plus customs duties)l/; (ii) if thatmaterial is produced domestically and if more than 5% of-total productionis exported, the domestic price will be set at the export price and will bevalid for all other enterprises which produce the same product, but sell

1/ Custom duties range from 0% for pharmaceuticals to 0% to 5X forplant protection chemicals, 4Z to 102 for fertilizer, and 6% to 122for other chemicals.

only on the domestic market; and (iii) if a product is normally not tradedbut produced and consumed in the country (e.g. ethylene) the domestic pricewill be based on prices prevailing in the nearest, realistically accessibleforeign market. For finished chemical products, the principles of pricefixing are essentially the same. However, differences in quality, diversi-ty in product mixes and trading conditions make the assessment of equiva-lent world prices difficult. For this reason, an additional regulationrequires that for each product group profitability of domestic sales be nohigher than for export sales. In order to simplify the present, rathercomplex regulations, which in some cases act as a disincentive to export(for that reason numerous exceptions have been granted since 1980),Resolution 1007/1984 of the Council of Ministers approving the new packageof economic reforms now permits enterprises to freely set prices betweenthe equivalent FOB and CIF prices.

2.24 (b) Consumer Prices. In 1980, sales of the chemical industry tofinal consumers represented only 13% of total consumption of chemicals, therest being sold as materials and intermediates to other producers, includ-ing 23% to agricultural producers (essentially fertilizers, pesticides andplastics packaging materials). For products directly sold to final consum-ers, prices fluctuate according to producer prices, plus margins to trad-ers. While farm prices of fertilizers are subsidized, the subsidy onpesticides was eliminated in 1984. Consumer prices for drugs are also sub-sidized, as a matter of social policy. Since 1977, health care has ceasedto be governed by insurance and is now considered by the State to be theright of every Hungarian citizen. Consequently, the Hungarian public paysa nominal fee for the pharmaceuticals purchased (between US$0.5+ and 0.10equivalent per prescription). Producer prices are negotiated between pro-ducing enterprises and GYOGYERT (the Pharmaceutical Wholesale Trading andDistribution Company), acting on behalf of the Ministry of Health, with theBoard of Materials and Prices also involved in the negotiations. Pricespaid to the enterprises by GYOGYERT are based on world prices for the sameor similar products. The difference between producer and consumer pricesis paid to GYOGYERT out of the Government budget. This consumer nominalreimbursement fee system has been functioning for several years. There isno evidence that almost free access to drugs has led to large overconsump-tion. In fact for ethical drugs (requiring a prescription), which accountfor 70% of total drug sales, and in most therapeutic classes, there is someindication that underprescribing occurs. Doctors are under pressure tounderprescribe because a computer check is kept of their prescribing acti-vities and in the event of overprescribing, the Ministry of Health contactsthem to seek an explanation.

2.25 Continued prescription of low-priced obsolescent drugs, however,is affecting the enterprises' profitability of domestic sales. By law,they must continue to supply the local market with these drugs until theyare removed from the register by the appropriate Ministry of Health Commit-tee (which in 1983 removed only 4 drugs from a list exceeding 1,200items). Production of these drugs, however, is uneconomic because it istying up production capacity for a large number of low-price drugs producedon a small scale and is resulting in losses for the companies. Under theProject, assurances were obtained from the Government that: either (a)obsolescent drugs will be promptly removed from the list of drugs which thecompanies have the obligation to produce as soon as substitutes are avail-able from either domestic production or imports; or (b) if their continued

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production is required to ensure stability of drug supplies, the companieswill be compensated for losses incurred.

2.26 In order to permit the application of the above principles,assurances were obtained that: (i) by July 1985 the Government will appointa commission under the chairmanship of the Ministry of Health, with repre-sentatives from the companies, to review the procedures mechanisms andcriteria for deletion of obsolescent drugs and to establish compensationcriteria and mechanisms for those drugs which are maintained on the compul-sory production list; (ii) the commission will present its recommendationsto the Government and to the Bank by the end of December 1985; (iii) theGovernment will afford the Bank a reasonable opportunity to comment on theproposed regulations; and (iv) these regulations will become effective nolater than January 1987.

E. Marketing and Distribution

2.27 Domestic as well as foreign trade remains largely concentrated inthe hands of a number of specialized companies. Foreign trade for thechemical industry is mostly carried out by four organizations - CHEMOLIMPEX(for most chemical products except pharmaceuticals), MEDIMPEX (pharmaceuti-cals), PHARMATRADE (medicinal plants) and MINERATIMPEX (petroleum crude andrefinery products). In addition, CHEMOCOMPLEX deals with the import andexport of chemical plant equipment. MEDIMPEX is the jointly-owned foreigntrade company of the pharmaceutical enteiprises, which cover its operatingcosts in proportion to their share in export sales (para 2.10). The othertrade companies usually operate on a commission basis. The above-mentionedorganizations no longer have exclusive rights to foreign trade. Increas-ingly, profit-sharing arrangements are being worked out with manufacturersand may involve joint offices or joint ventures. All companies have theright to apply for foreign trade rights if they wish to do so. The Govern-ment has also introduced an additional element of competition into foreigntrade operations by setting up four general profile trade companies.These, however, have so far made few inroads into the rather specializedbusiness of trading chemical companies.

2.28 Domestic trade has also been substantially decentralized sincemanufacturers are allowed to sell directly to users. In fact, large con-sumers of inorganic chemicals and petrochemicals usually obtain theirrequirements directly from local manufacturers. Small volume purchases canbe obtained from VEGYTEK, the major wholesale trading company of the chemi-cal industry. Until 1980, the distribution of agrochemicals (fertilizerand plant protection chemicals) was almost exclusively in the hands ofAGROTRUST, a specialized wholesaling and distribution trust. In 1980, the-trust was broken up into 17 county-based wholesale companies (withoutexclusive rights on their territories), which today form the so-calledAGROKER network. Agrochemicals are also traded by 17 Farmers' CooperativeTrade Companies (TSKER's) which are in direct competition with AGROKER.The domestic distribution of locally produced as well as importedpharmaceuticals, however, remains the exclusivity of GYOGYERT, the pharma-ceutical wholesale company. GYOGYERT supplies directly to 19 pharmaceutic-al centers (one for each county, plus Budapest) and 180 health institutes.Local pharmacies obtain their supplies from their respective CountyPharmaceutical Center.

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2.29 Distribution Margins. Margins allowed to wholesalers are fixedby the Government and, with the exception of fertilizer, appear sufficientto cover the trading costs plus some profit. VEGYTEK's markup, forinstance, covers its operating overheads plus a profit of about 5% on turn-over. Margins allowed on plant protection chemicals are sufficient tocover costs and pro-ide an incentive to traders to promote sales. Whole-sale margins for pharmaceuticals are also sufficient to cover distributioncosts and allow GYOGYERT a reasonable profit on its sales. A review of thelevel of trading margins for fertilizers would be carried out in connectionwith the proposed fertilizer study (para 5.27).

F. Research and Development

2.30 Research and development activities in the chemical industry arewell developed in Hungary. In 1981, a total of US$69 million was spent onchemical R&D, representing close to 8% of total value added in the chemicalindustry. Over 85% of this amount was spent on applied research anddevelopment. R&D efforts focus on process and product development in phar-maceuticals (42% of funds spent), plant protection and other fine chemicals(37%) and their intermediates (whenever technology is not available fromoutside) (21%). Total staff employed in chemical R&D was close to 6,900including over 2,300 scientists and engineers.

2.31 Salaries of research workers in Hungary (including social chargespaid by the enterprises) are about one-tenth that of West European sala-ries. Since labor costs normally account for 50% to 70% of RJD expenses,this low-cost R&D is seen as an important element of Hungary's competitive-ness in R&D-intensive industries, particularly pharmaceuticals, plant pro-tection and other fine chemicals. Pharmaceutical companies spend onaverage 5Z to 6% of their turnover on R&D. If salaries of research workerswere adjusted to West European levels, this percentage would be equivalentto 20% of turnover. Though, admittedly, Hungarian pharmaceutical saleshave a lower value-added than sales of the average Transnational Company(TNC) because of the larger proportion of bulk and standard drugs, thelevel of R&D spending compares relatively well with R&D spending by TNCs.TNCs involved in pharmaceuticals spend 10-15% of their pharmaceutical turn-over on R&D. R&D spending on plant protection chemicals varies substan-tially according to companies (from 1% to 4% of turnover). Researchworkers in Hungary are sometimes able to considerably supplement theirincomes when research work is successful as they normally share profits orroyalties from license or patent sales for commercial development. Thequality of R&D work is high as evidenced by the number of patents filedeach year (about 1,000), the new products marketed each year (25-30 newspecialties in the pharmaceutical industry), increasingly original products(one to three per year), worldwide cross-licensing and, generally,sustained sales growth of the fine chemicals industry.

2.32 Enterprises account for 80% of R&D expenses (including workcommissioned from research institutes) and 71% of all research engineersand scientists. Enterprises are being encouraged to be increasingly res-ponsible for their own R&D. They are allowed to treat all their R&Dexpenses as oporating costs and rewards to research workers are not taxableas other salary increases. All chemical enterprises are required to con-stitute a technological development fund in proportion to value added (from1% to 12%, depending on branches). This regulation aims at securing a

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minimum level of R&D expenditure in the industry. A portion of this fundis put 'n a central fund, the allocation of which depends on either theMinistry of Industry, the Office of Technological Development (OMFB), theMinistry of Agriculture or other ministries for funding of specificprograms considered priority. These funds may be allocated to researchinstitutes or to compaL'es for research projects consistent with broadobjectives defined in Central Development Programs. A special feature ofpharmaceutical R&D is that all funds contributed by pharmaceutical compa-nies are al'ocated to the industry itself, either to the companies or toits research institutes.

2.33 Seven applied research institutes are also providing support tochemical enterprises. The two most important are the Research Institutefor Pharmaceuticals (GYKI) (para 4.04 and Annex 4-2), and the ResearchInstitute for Heavy Chemical Industries (NEVIKI) (para 4.04 and Annex 4-2),which increasingly specialize in testing of plant protection chemicals.These two institutes will be supported under the Project (paras 5.19 andthrough 5.20). Since 1980, all these institutes are independent entitiesoperating on a profit basis (except for GYKI, which is jointly owned by thepharmaceutical companies). This decision was motivated by the need toavoid past duplications in basic research work with the budget-financedinstitutes of the Academy of Science (which specialize in fundamentalresearch) and to reinforce the orientation of the industrial appliedresearch institutes towards meeting the needs of the industry. Presently,research institutes are competing in a number of fields for contract workfrom the companies (particularly in plant protection chemicals and theirintermediates). Fees charged to enterprises for contracted work normallyaccount for 60% to 80% cf total funding of the institutes, and the balanceis from royalties or profit sharing in successfully developed processes,products or ventures and from funds allocated by the Government in theframework of Central Development Programs.

III. MARKETS, MARKETING AND PRICES

A. Pharmaceuticals

3.01 World Consumption, Production, Trade and Major Trends. In 1980,world consumption of pharmaceuticals stood at US$81.6 billion, with OECDcountries accounting for 64% of the total, centrally planned economies forabout 20%, and developing countries for about 16%. Production of pharma-ceuticals is similarly concentrated in industrialized countries, with 85%of total production being shared between Western Europe (41%), the USA(26%) and Japan (18%). World trade is dominated by about 200 transnationalcompanies (TNC's), operating mainly out of six major producing and export-ing countries - USA, West Germany, Switzerland, United Kingdom, France andItaly; between them these six countries account for over 70% of worldtrade, which in 1980 amounted to US$13.9 billion (Annex 3-1). While devel-oped markets accounted for over 95% of total exports, they also absorbedtwo-thirds of world imports. The share of developing countries in totalimports increased from US$1.9 billion in 1974 to 4.5 billion in 1980, orabout 32% of total world imports. With total exports of US$290 million in1983, Hungary, though being the ninth largest exporter in the world,accounted for less than 2.3% of world trade. Exports to CMEA countries

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represented 60% of Hungarian exports; Hungarian exports to CC markets(US$115 million in 1983) accounted for only about 1% of total CC worldtrade in pharmaceuticals.

3.02 Pharmaceutical sales worldwide have grown, in constant terms, onaverage at about 10.5% per year between 1970 and 1980 (about 15% in currentterms), but growth has slowed down noticeably since the late 1970's. Thisphenomenon is attributed in part to the general economic slowdown, theresulting difficulties of many developing countries in sustaining pastgrowth in drug imports, and attempts by many governments to keep downrapidly escalating costs of health care. Other contributing factorsinclude: (i) the more stringent and time consuming regulatory environment,which has tended to slow down the introduction of new, generally high-priced drugs; (ii) downward pressures on prices brought about by theincreasing use of generics (particularly encouraged by public healthservices for the reasons mentioned above); and (iii) increased competitionin cost-saving process developments for the manufacturing of existingdrugs. Uncertainties regarding future growth of drug use in LDCs make pro-jections of future sales highly speculative and result in very wide varia-tions in available estimates. A conservative estimate would projectaverage annual growth during the 1980's at between 4% and 6% in real termsfor both world consumption and trade (Annex 3-1).

3.03 Prospects, however, vary substantially among types of drugs(generic or specialities) and therapeutic classes. Continued fast growthis expected in sales of antUinfectives (particularly antf!iotics), psycho-tropics, cardiovasculars, cancer therapy agents and drugs related to thetreatment of old age diseases. An estimate of future drug sales by majortherapeutic classes is presented in Annex 3-2. Another major trend isexpected to be the growing market for generics, for reasons mentioned inpara 3.02. Competition for this market, however, is intensifying inparallel with market growth, with the emergence of new exporters (China,Korea) and the creation by some of the TNCs themselves of genericsdivisions.

3.04 The assessment of market prospects for specific products isespecially difficult in the pharmaceutical industry for a number or rea-sons: (i) demand may shift rapidly from one product to the other as new,better drugs constantly appear on the market; (ii) commercial secrecy inthis very competitive industry prevents outside assessment of competitors'direction of R&D efforts and future production plans, which change quicklyin response to the outcome of R&D efforts and market conditions; (iii) themultipurpose nature of production facilities and the batch technologiespermit quick shifts of production capacity from one product to the otherwithin the same or different therapeutic classes. This flexibility, toge-ther with the generally low capital intensity of pharmaceuticals produc-tion, makes the general industrial issue of production capacity and minimumplant sizes secondary in the assessment of market prospects.

3.05 Markets for Incremental Project Output. As mentioned in para2.12, the Hungarian pharmaceutical industry has analyzed its future strate-gy and the ways it can best maintain, consolidate and, if possible, improveits position in the changing environment of world pharmaceutical markets.On the one hand, the industry needs to modernize and expand its manufactur-ing facilities and bring them, especially the formulation plants, up to GMP

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standards. As discussed below, the subprojects, which constitute most ofthe companies' investment programs for the coming 5 years, will allow thecompanies to maintain and expand their exports of generic drugs and ofactive ingredients in therapeutic classes with the best growth prospects.In parallel, the industry will start approaching the brand-name specialitymarket of developed countries so that in the long run it can spread itsmarket risks more evenly (para 2.16).

3.06 Although the Project facilities are essentially multi-purpose,the companies have provided detailed production plans and market estimatesfor the specific products they intend to market during the first years ofplant operation. The various subprojects included under the Project areexpected to produce a wide variety of drugs in many different therapeuticgroups (17 active ingredients and 47 Formulated products). All these drugsare registered in Hungary and in most other countries of intended sales, orregistration procedures are well underway in these countries and areexpected to be completed by the time the Project facilities come onstream. The patent and license position of the proposed products have beenexamined by the companies, which have given formal declarations that noneof the subprojects under consideration infringe any other company's ororganization's existing patents nor do they conflict with the provisions ofany license agreements in force. These declarations as well as details onproduction plans, markets and market analysis on each product are availablein the Project File, Reference C. The estimated distribution of increment-al sales by categories of products (therapeutic classes), types of product(active ingredients or formulations), intended markets and patent situationis summarized in Annexes 3-2 through 3-5.

3.07 An analysis of the structure of incremental sales derived fromthe Project shows that: (a) the subprojects are essentially export-orient-ed since close to 90% of the output will be exported. About 72% of theexports will go to CC countries, with the remaining 28% going to CMEA coun-tries. Experts of active ingredients will represent 35% of total plannedincremental CC exports. These are essentially to developed countries,while exports of formulated products (accounting for the remaining 65%)will be mostly to developing countries. The high proportion of formulatedproducts in total exports reflect the current strategy of increasing valueadded of Hungarian pharmaceutical exports (para 2.12). Over two-thirds ofprojected sales of formulations will be in the form of injections and 15%in the form of capsules, which are considered to be more difficult tomanufacture than vials, tablets and other dosage forms and thus fetchhigher prices and are less exposed to competition from local industries inthe countries of intended sales. Exported formulated products willbe primarily generics (85%), while exported active ingredients (forformulation abroad) will mainly be original products (53%) and thengenerics (26%). While the proposed products are spread among. a largenumber of therapeutic classes, emphasis is on anti-infectives,cardiovasculars, vitamins and veterinary products. In each one of thesecategories, however, incremental Project sales represent a minute share ofpresent and projected world needs and trade, as shown in Annexes 3-1 and3.2.

3.08 It is expected that all incremental Project production will bemarketed using the strategies and channels developed for present exports(para 2.11). Formulated products for export to developing countries will

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be through public tenders, local distributors, and, in countries whereMEDIMPEX has developed them, joint marketing ventures. Sales of formulatedproducts to developed countries (about 21Z of formulated sales) would bethrough wholesalers or foreign partners. Sales of active ingredients areexpected to be through the type of joint ventures described in para 2.11whereby the foreign partner pays for pre-marketing and registrationexpenses in its own country and markets the product under its own brandname.

3.09 Project Impact on Hungarian Pharmaceutical Sales and Exports.Incremental sales of Hungarian pharmaceutical products from the Project in1984 prices are estimated at IJS$92 million by 1990, which represents anincrease of 22% over 1983 sales (US$425 million) (Annex 3-3). Of theseincremental sales, it is expected that about US$67 million will be exportedto CC countries, a 58% increase over 1983 Hungarian exports to these coun-tries. These projections are- in line with past growth of both Hungarianproduction and exports and -fith the past and projected growth in worldpharmaceutical consumption and trade, which are shown in Annex 3-3. Assum-ing that the companies are able to maintain present exports in constantterms, the Project would allow them to keep pace with projected increasesin world consumption and maintain their total share of world CC exports ofabout 1%. This is considered realistic in spite of increased competitionon the generic and active substances markets, which are the traditionalmarkets for Hungarian production. MEDIMPEX has established a reputationfor consistently high quality at low prices; Hungarian companies areespecially strong in process development and, by focussing on more sophis-ticated formulations and products with complicated multi-step processes,they expect to be able to maintain their competitive position; by providingfunding for their R&D departments, the Project would contribute to rein-force their innovation capability in this respect as well. Finally, theupgrading of their formulation facilities to GMP standards will removepresent constraints to increased formulation sales on international tendersand other standard drug markets.

B. Plant Protection Chemicals: Pyrethroids

3.10 The consumption of synthethic pyrethroids has grown very rapidlyin the world during the past decade. Their share in total insecticide usehas increased from 3% in 1977 to 182 in 1983 and is expected to reach 30%to 35% by 1990. In fact, pyrethroids are the only insecticides which areforecast to show positive growth during the coming years. This is becausetraditional products contain larger and less powerful amounts of active in-gredients and because pyrethroids are relatively harmless to humans and theenvironment and can be tailor-made to combat particular pests. Planned in-cremental output under the Project consists of 230 tons of twointermediates as well as 100 tons of finished products (all for veterinaryuse) and 7.5 million aerosols for household use. The intermediates arePermethrin acid ethyl ester (DV ester), of which Chinoin, the company incharge of the pyrethroids subproject, is one of two producers in the world(and the orly one in Europe) and ethyl chrisantemate, of which Chinoin isone of four producers in the world (and the only exporter in Europe).Incremental production of DV ester would amount to 180 tpy, of which 135tpy would be exported to Western Europe, most of it through the extensionof an existing contract with a British company. Under this contract, DVester is exchanged against the pyrethroid permethrin (for the production of

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which it is a major intermediate). Permethrin is then formulated inHungary for sale on the domestic and CMEA markets. Since pyrethroidsconsumption in CMEA countries is growing very fast, no difficulties areexpected in the marketing of the proposed 100 tons of permethrin-basedproducts (which are mostly for the CMEA market) nor of the aerosols, forwhich there is a large unsatisfied demand in Hungary. Negotiations for theextension of this contract are well underway. Signature of this contractwill be a condition of disbursements under this subproject. The otherintermediate, ethyl chrisantemate is the acid component in the manufactureof other types of pyrethroids (including deltametrin and tetramethrin).Incremental CC exports (50 tons) would represent about a third ofincremental CC countries requirements by 1990. Letters of intention topurchase these additional quantities have been received from several WestEuropean companies.

C. MDI and MDI-based Polyurethane Systems

3.11 Introduction. The market study for the MDI subproject wasprepared by the Hungarian Chemical Industries Engineering Center (VEGYTERV)(para 4.04 and Annex 4-2) based on work done by various market researchgroups in Hungary. These studies were reviewed by Arthur D. Little, whichalso prepared an analysis of world and Western European present and futureMDI market prospects (Project File, Reference D).

3.12 Worldwide MDI Supply/Demand Situation. Polyurethanes (PUs)constitute the largest category of cellular plastics and elastomers. Theyare the most versatile of all polymeric materials and are produced in awide range of forms. The main applications for MDI-based PUs are: (i)from polymeric MDI: rigid foams for insulation purposes in the constructionindustry and insulation foams for refrigeration equipment; and (ii) frompure MDI: microcellular integral skin foams (shoe soling), elastomers(spandex) and PU-based adhesives, sealants and coatings. Pure MDI isobtained by a distillation and refining process from the crude product,leaving polymeric MDI as the residue from distillation. The pure MDI com-mands a premium of around 25% over polymeric grades. Pure and polymericMDI are normally produced in a proportion of 20% and 80%, respectively.MDI is generally sold as a component of a system", which consists of allnecessary ingredients as well as the technology to transform them intofoams or other finished products. Besides MDI, the other major componentof systems are polyols (a polyester or polyether).

3.13 MDI demand has continued to grow strongly over the last decade,even through the worldwide recession of the early 1980s, as new applica-tions were developed, exploiting the versatility of MDI-based PUs, foam ornon-foam. Growth slowed down from the annual 10% of the mid-1970s to onlyaround 5% in the early 1980s. MDI investment decisions in 1978 and 1982were nevertheless based on over-optimistic growth forecasts and the world-wide recession has resulted in surplus capacity. Worldwide capacity utili-zation, however, is now recovering towards respectable levels (85% in1983). Forty-three percent (43%) of total capacity is located in the US,41X in Western Europe, 9% in Japan and 7% in CMEA countries. There are nosignificant differences in price levels between these major markets. SinceMDI is costly to transport (up to US$130 per ton between the US and WesternEurope), shipments between continents only occur occasionally.

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3.14 Under the most conservative assumption, consumption would grow by3% per annum in real terma in Western Europe, based on an assumed 2%average annual growth in economic activity and on the assumption that notake-off will occur in some potentially large outlets (automotive bodypanels, particle board binders). Under a less conservative assumption, the5% past growth during the early 1980s will be maintained. Thus, it islikely that additional capacity will be required as early as 1988 (date atwhich the BVK plant would start operations), or at the latest by 1991. Theprojected supply/demand situation in Western Europe is summarized below:

Present and Projected Supply and Demand Situation in Western Europe(thousand tons per year)

1984 1988 1991 1993

Effective Capacity 356 386a/ 386a/ 3Production at 95% of capacity 338 36J- 36f- 36f-Consumption b/. Assuming 3% growth p.a. 2 9 8 C/ 345 377 396. Assuming 5% growth p.a. 298R/ 380 441 485

Surplus/Deficit, Assuming 3% growth p.a. +58 +22 -10 -29. Assuming 5% growth p.a. +58 -13 -74 -118

BVK P!lnit - Planned output

Total - 15 24 24of which: exports d/ 11 18 17

Source: Arthur D. Little.

a/ Excluding BVK plant; and assuming that all existing capacity remains inoperation, that declared expansion plans are carried out, and thatsome existing plants are debottlenecked.

b/ Including net exports.c/ 1983d/ Including to CMEA countries.

3.15 Destination of Project Output. Hungary imported about 3,000 tonsof MDI in 1983. However, consumption is being constrained by lack offoreign exchange. Demand projections for the various uses and types ofMDI-based products show that domestic consumption should absorb about 5,000tons of MDI by the late 1980's and 8,000 to 10,000 tons by the mid 1990s.In addition, BVK is in the process of negotiating contracts to exchangeabout 4,000 tpy of MDI against aniline feedstock from Czechoslovakia andover 6,000 tpy of MDI against polyols and TDI from Yugoslavia. 2/ Thus,markets for over 60% of the Project output are already reasonably secured.

2/ These exchange contracts, however, are not crucial to the plant'sfinancial and economic feasibility, which has been assessed on thebasis of border prices (para 8.07).

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It is expected that the balance (up to 8,000 tpy) will be exported to CCareas. Estimated sales by destinations are summarized in Annex 3-6.

3.16 Prices. Over the past 3 years, prices of MDI have been depressedin Western Europe and in the US, due to the general economic slowdown. In1983, prices started recovering in the US as demand increased and thistrend continued during 1984. _n Europe, prices also started recovering,but the -price war prevailing in Europe following the entry of Upjohn as alocal producer have prevented faster price recovery in spite of relativelyhigh effective capacity utilization (852). Prices in 1984 were still atunsatisfactory levels. As demand in Europe increases to levels where allcapacity is utilized, prices are expected to increase as shown below, until1987. They would subsequently slightly decrease in real terms until 1990,following the projected price decreases in aniline, its major raw material(para 8.07). Past and projected MDI prices are presented below:

Prices of MDI - In Constant 1984 Terms(USS per ton)

Actual Projected1980 1984 1987 1990 1995

Polymeric MDI 1,750 1,250 1,420 1,380 1,460Pure MDI 2,200 1,650 1,810 1,750 1,870

Source: Arthur D. Little.

3.17 The price of MDI may be considerably higher when it is sold as acomponent of a PU system than when sold in bulk; however greater expendi-tures are required to market PU systems and to provide technical service tocustomers than simply to sell MDI as a commodity. BVK is now developing amarketing strategy which aims at selling as much MDI as possible in theform of systems (using imported polyols for the other systems component).Assurances were obtained from BVK that it will provide to the Bank forreview a comprehensive plan which will include detailed marketingarrangements for MDI systems sales by the end of June 1987 (18 monthsbefore the start of the plant operation).

D. Ion Exchange Resins

3.18 Ion exchange resins are speciality resins used as auxiliarymaterials in water treatment plants. The major market for ion exchangeresins worldwide are power plants (two-thirds of sales). Other applica-tions are expected to increase sharply in the future, particularly In theareas of condensate treatment for large boilers and effluent treatment.Currently, Hungarian production is concentrated at Nitrokemia, whichproduces about 6,000 m3 of ion exchange resins, of which 1,500 m3 areconsumed domestically, 2,300 m3 are exported to CKEA countries and 2,500 m3

are sold in CC countries (mainly USA, Switzerland and Spain). The Projectwill produce an incremental quantity of about 9,500 i 3 of ion exchangeresins by 1990. The products are of high quality and command ready salesin export markets. Enquiries from potential major customers willing to

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sign long-term contracts have already been received for about 6,000 R3 ofresins, although the Project is not scheduled to come on stream for another3 1/2 years.

3.19 The current and expected world demand of ion exchange resins andthe destination of the Project incremental output are presented in Annex3-7. By 1990, incremental sales from the Project will amount to about 3.5Zof world requirements. Incremental CC sales will account for only 4.3% oftotal needs of CC markets and a third of their incremental requirements.The incremental output will be marketed on CC markets through establishedmajor manufacturers (about 42%), extension of existing contracts with localdistributors (about 31%) and the balance directly to users (27%).

E. Intermediates for Plant Protection Chemicals and Detergents

3.20 (a) Monochloroacetic acid, the production of which is plannedplanned under the Project by Nitrokemia, is an intermediate with a widerange of uses in the fine chemicals industry. In Hungary, it is being usedessentially in the production of herbicides (80%) and cellulosic fibers.The whole output from the expansion of the existing plant (4,000 tpy) wouldbe sold domestically, in replacement for imports.

3.21 (b) The proposed Sulfonation Plant of Caola will produce inter-mediates for the production of fine detergents, rinsing compounds and cos-metics, and will permit substitution of imports of the intermediates aswell as of finished products and the extension of Caola's product range.All production will be sold domestically.

IV. THE BORROWER AND PROJECT ENTITIES

A. Introduction

4.01 This chapter summarizes key features of the companies andresearch institutes which are participating in the Project. The financialanalysis of the subprojects and their impact on projected financial state-ments of the major companies are presented in Chapter VII. A more detaileddescription of the project entities is presented in Annex 4-2 and keyfinancial data for each production company are summarized in Annex 4-3.Detailed financial statements for the period 1981-83 are available in theProject File, Reference F.

B. The National Bank of Hungary (NBH)

4.02 The Borrower of the Bank loan will be the National Bank ofHungary (NBH), which will onlend the loan proceeds to the participatingentities. NBH is the central bank and the major commercial and developmentbank of Hungary. As the central bank, NBR handles the foreign exchange andgold reserves, plays a principal role in setting the exchange rate, deter-mines banking policies, and issues bank notes and coins. It is the mainbanker for the State, state enZerprises, banking institutions and coopera-tives. It also has responsibility for establishing and administering thecredit policies of the banking system. As a commercial bank, NBH acceptsdeposits, and extends loans to Hungarian enterprises and cooperatives forworking capital and investment. It carries out payments, credit, and other

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banking operations relating to foreign trade and other external economicrelations, and administers exchange controls. The volume and direction ofcredit to be granted by the banking system and the credit and interest ratepolicies to be followed are described in official credit policy guidelineswhich are reviewed annually by NBH and the National Planning Office toreflect changes in monetary policies and help facilitate the implementationof the five-year plan. The NBH headquarters are in Budapest and itoperates country-wide through 19 regional offices and 71 branches.

4.03 NBE's balance sheet and income statement indicate that the insti-tution is in good financial condition (Annex 4-1, tables I and 2). Grossincome and profit have increased over 1979-83 by 45Z and 26Z respectively.A sharp increase in profit took place between 1982 and 1983 due largely toincreases in interest rates. Holdings of gold, foreign exchange andSpecial Drawing Rights (SDRs) also increased substantially during 1983.The main sources of NRBH funds are the mandatory deposits of banks andenterprises. In 1983 other important sources of funds were IMF deposits,foreign loans and, in part, NBH's own profit. The overall financial posi-tion of NBH is sound largely due to: (a) its role as the central bank;(b) its close review of sub-borrowers' finances by controlling borrowingsand holding their accounts; and (c) its excellent credit recovery record.NEBH would have no difficulty in meeting its obligations under this Projectas well as the ongoing Industrial Energy Diversification and ConservationProject (Loan 2317-HU), the Industrial Export and Restructuring Project(Loan 2397-HU), and the proposed Integrated Livestock Industry Project.

C. The Project Entities

4.04 Brief Description of Participating Entities. Eight companies,tvo research institutes and an engineering institute will participate inthe Project, the activities of which are further described in Annex 4-2.These are five pharmaceutical enterprises (Gedeon Richter, Chinoin, Egis,Biogal and Reanal) which would implement the pharmaceutical and thePyrethroids subprojects; BVK, the second largest petrochemical enterprisein Hungary, would implement the MDI subproject; Nitrokemia, which has avery diversified production of a wile range of fine and specialitychemicals, would implement the Ion Exchange Resins and the MonochloroaceticAcid subprojects; and Caola, the major producer of household chemicals andcosmetics, would construct a sulfonation plant for the manufacturing ofintermediates required for its own operations. All the companies are wellestablished, some of the pharmaceutical companies were founded over 70years ago; the most recent is Caola, which resulted from the merger ofseveral smaller companies in 1963. Gedeon Richter, Chinoin, Egis, Biogal,Reanal and Caola are located in Budapest, while BVK and Biogal are locatedin the northeastern part of Hungary and Nitrokemia is located nearVeszprem, close to Lake Balaton (Map). The two research institutes areGYKI, the jointly-owned institute of the pharmaceutical companies, andNEVIKI, the major screening and testing organization for plant protectionchemicals (para 2.33). VEGYTERV, the major design and engineeringinstitute for the chemical industry would also participate in the Project.While GYKI and VEGYTERV are located in Budapest, NEVIKI is located inVeszprem.

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4.05 Management Structure. All production companies participating inthe Project are state enterprises. They are presently managed by executiveboards headed by the General Manager and composed of the company's deputymanagers, and in some cases, representatives of the labor union and othersocial organizations. The General Manager, who is appointed by theiinister of Industry, is in turn responsible to a Supervisory Councilheaded by the Ministry of Industry. This Supervisory Council, however,only has the role of advisor to the Vice Minister who has power to enforceor reject its recommendations. Experience has shown, however, that whilecompanies have tended to rely on the Ministry for their general orientationand investment plans, the Ministry has not been in a position to to providethem with adequate guidance. This setup also explains the generalweaknesses in strategic planning discussed below in para 4.08.

4.06 The Government is planning to break the hierarchical link whichstill exists between the Ministry and the General Manager by setting up newtypes of Boards of Directors (Enterprise Councils). Half of the Board mem-bers would be representatives of the company's management, and the otherhalf of the employees. This board will exercise the traditional owners'rights, including the appointment of the General Manager (through acompetitive process open to qualified applicants) and the determination ofhis/her salary and performance reward; the approval of the enterprisestructure (including mergers, joint ventures, setting up of subsidiaries);and the review of the company's strategy and investment program. The newboards will be put into operation in the whole state-owned industrialsector over a period of two years (1985 and 1986). A review of experiencein the industrial sector with the new form of Management Boards is plannedby Hungarian authorities for the end of 1985 or early 1986 and adjustmentsto the new regulations will be made at that time if necessary.

4.07 Internal Organization. State enterprises are otherwise indepen-dently managed in all aspects of their internal organization, personnelrecruitment, technological development, investment planning, procurement,sales, business policies, commercial and other functions normally associ-ated with the operations of an enterprise. All companies are organizedfunctionally into divisions (generally technical, financial, commercial,personnel and legal, and planning and investments) headed by deputymanagers. Companies are free to set up their own internal organization,which has evolved overtime in response to changes in scope of activitiesand increased exposure to markets. Except for the MDI subproject, all sub-projects fit well into existing operations and their management does notrequire modifications to the companies' existing organization structures.The MDI subproject, however, is a new activity for BVK and is very differ-ent in nature from its other major activities (fertilizers, PVC and PVC-based plastic processing). Because of the critical need for continuousfeedback between PU systems marketing operations and product development,flexibility in management is essential, which the integration of MDI opera-tions in BVK's functional lines may not allow to the extent required.Consequently, while BVK's investment department would be in charge ofimplementing the MDI subproject, the MDI activity would be subsequentlyorganized into a business area or a subsidiary, with its own managementgathering all the production, R&D, marketing and market follow-up functionsfor the company's polyurethane operations. Assurances were obtained that,by December 1985, BVK would present a proposal, acceptable to the Bank, tothat effect.

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4.08 Strategic Planning. Although all companies prepare medium- andlong-term plans (in addition to annual plans), their comprehensiveness andutility appear to vary significantly. Strategic planning capabilities aregenerally limited, as companies have so far tended to put excessive reli-ance on government authorities for long-range orientations (para 4.05above). Their planning capabilities seem to focus on short- or medium-termgrowth and justification of projects for obtaining the necessary creditapprovals. Long-range strategic planning, however, is particularly impor-tant in an environment of quickly changing technologies and market demandand the upcoming self management of all state enterprises. The need formanagement training and consulting assistance to improve strategic planningin chemical enterprises will be addressed in the context of the Project(para 5.28).

4.09 Cost Accounting and Transfer Pricing. The companies havedeveloped cost accounting and transfer pricing systems which permit a rea-sonable assessment of the profitability of their various plants, factories,product lines and even products. In fact, product level costing is well-developed because price regulations have required that profitability on thedomestic market be no higher than on export sales. Transfer prices formaterials and intermediates produced and used by the companies are usuallybased on market prices, i.e., those which the company does or could obtainby selling them outside. The basis for allocation of overhead and otherfixed costs among product categories is reasonable.

4.10 Auditing. All enterprises are subject to financial auditing bythe General Control Directorate of the Ministry of Finance, which carriesout on-site audits of each enterprise normally once every second year, inaddition to routine review of financial statements, which are receivedthree times a year. These audits, which are satisfactory within theirdefined scope and periodicity, focus on compliance with local accountingprocedures, on whether financial statements reflect the real position ofthe enterprise, on the constitution of proper funds and their use and pro-per calculations and payment of taxes. NBH accounts are audited by inde-pendent certified public accountants, which are acceptable to the Bank.

4.11 Financial Condition. Key financial data for each of the ninecompanies are summarized in Annex 4-3. Detailed financial statements forthe period 1981-83 are available in the Project File, Reference F. Allpharmaceutical companies, Nitrokemia and Caola are in a sound financialcondition. Key financial ratios (profitability indicators, current ratios,long-term debt/equity ratios and debt service coverage ratios) are general-ly consistent with experience in similar industries elsewhere. As detailedin Annex 4-2, BVK has recently faced liquidity problems following signifi-cant world price decreases irn both fertilizers and plastics in the early1980s, but in December 1984 the Government resolved to reschedulerepayments of the large outstanding debt which was contracted to financethe VCM, chlorine and PVC plants (all of which came onstream in 1978). Thecompany is now in a financial condition sound enough to implement the MDIsubproject, which should significantly contribute to restore its profitabi-lity and decrease its vulnerability to world market fluctuations in fertil-izer and PVC prices. All companies are in a position to fund theirrequired contribution to the various subprojects out of internal cashgeneration from their existing operations (para 7.04).

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V. THE PROJECT

A. Overall Project Objectives and Scope

5.01 The Project aims at accelerating the implementation of a strategyfor reorienting the Hungarian chemical industry towards R&D-based fine andspecialty chemicals with good potential for increased convertible currencyearnings and savings. This objective would be achieved through the follow-ing four major complementary components under the Project:

(a) funding of priority investments in the fine chemicals industrywhich were identified during the comprehensive review of theinvestment program of all chemical enterprises which took placeas part of the Chemical Sector Review (para 2.02). These produc-tion investments consist of (i) upgrading manufacturing capaci-ties of the pharmaceutical industry to internationally acceptablestandards, in order to avoid losses of exports which will occurotherwise; and (ii) initiating, expanding and modernizing theproduction of pharmaceuticals, MDI-based polyurethane systems andother selected fine and speciality chemicals and their interme-diates with significant features of export generation and/orimport substitution;

Cb) increasing the capacity and upgrading the facilities of selectedkey research and development organizations so that they can per-form a wider range of the required tests for the companies andaccording to internationally acceptable standards;

(c) funding clinical trials and registration expenses in selectedOECD country(ies) so that the pharmaceutical industry can attempton a pilot basis to penetrate these potentially large and moresecure markets with formulations sold under its own brandname(s);

Cd) providing consultancy services to: (i) assist the pharmaceuticalindustry to prepare a detailed marketing strategy for the abovepilot component; (ii) assist BVK in developing the details of itsmarketing plans for the sale of polyurethane systems; (iii) pro-vide training for selected managers and staff of all chemicalcompanies in strategic planning; (iv) carry out studies to helpidentify further prospects for development in the chemical indus-try after 1988, and prepare a restructuring program for thefertilizer industry.

The Project will be implemented over a period of four-and-a-half years andis expected to be completed by June 1989.

B. Bank Role and Rationale for Bank Assistance

5.02 The Bank's role in Hungary's industrial sector is to assist theGovernment in its pursuit of structural adjustments and technologyimprovements, a principal aim of which is to increase convertible foreignexchange earnings or savings. The Bank assisted the Government with adviceon the investment strategy for the chemical subsector and on the selection

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of priority investments in the subsector, which would be supported by theproposed project. By focusing on the production of high value-added finechemicals, particularly pharmaceuticals, the Project would build onHungary's comparative advantage in fields requiring a high level of R&D,based on the country's pool of low-cost, highly qualified scientists andengineers. The Project would seek to strengthen strategic planningcapabilities of all chemical companies through special training programsfor the management and staff of these companies, and it would initiate achange in long-term marketing strategy for pharmaceutical innovations byassisting the industry to enter, on a trial basis, the potentiallylucrative developed country CC markets with final products sold underHungarian brand names. The Project would also provide funds for a study ofthe necessary restructuring of the fertilizer industry and identify futuredevelopment potentials in a number of branches of the chemical industry.Thus, the Project would be consistent with the Bank's strategy forassistance to Hungary by building on the country's competitive strengths,reorienting the direction of investment in the chemical industry, improvingthe efficiency of resource use, strengthening the balance of payments inconvertible currencies, and offering external technical assistance.

C. Production Investments

1. Objectives and Description

5.03 (a) Pharmaceuticals. The Project would aim at consolidating theposition of the Hungarian pharmaceutical industry on world markets by:(i) replacing or upgrading those formulation facilities not yet meeting GMPstandards and expanding other formulation facilities so that all Hungarianpresent and planned finished products sold in dosage form (formulations)are manufactured in accordance with GMP standards; (ii) modernizing andexpanding a number of the companies' multipurpose fermentation and synthe-sis plants to permit the increased production of a wide range of activesubstances, formulated products, as well as some intermediates and medicalaids.

5.04 At the Gedeon Richter Company, investments would include: (i) anew multi-purpose injection plant at Budapest, of a total capacity of 350million ampoules per year, to replace and expand the existing plant (205million ampoules per year), which does not meet GMP standards: (ii) theexpansion of the fermentation (by 2 x 80 m3 fermenters) and synthesis capa-rcity at the Budapest p'ant for the production of about 27 tpy of varioussteroid intermediates (allowing the conversion of the process frompresently imported, expensive intermediates to earlier, cheaper ones) andthe additional production of about 160 kg per year of steroids; and(iii) the construction in Dorog of a waste incinerator of a totalincineration capacity of 25,000 tons per year to permit disposal ofdangerous wastes of the Budapest and Dorog production plants of GedeonRichter, Chinoin and Egis.

5.05 At the Chinoin Company investments would include: Ci) a newinjection plant at Csanyik Violgy (near Miskolc) with a total capacity of150 million ampoules per year, to expand the company's injection makingcapacity from 105 million to 255 million ampoules per year (the existingplant was recently upgraded to meet GMP standards); (ii) the expansion andmodernization of the fermentation plant at Ujpest, Budapest, by the

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addition of 2 x 150 m3 fermenters and modernization of the downstreamrecovery section, to produce an additional 42 tpy of various activeingredients for antibiotics; and (iii) the modernization and expansion ofthe synthesis plant at Ujest, Budapest, by the addition of twomuilti-purpose batch-type production lines for the production of abou. 141tpy of active ingredients (and their intermediates) in various therapeuticgroups (veterinary anthelmintics, cardiovasculars, anti-parkinsonism, andtreatment of old-age diseases).

5.06 At the Egis Company, investments would include: (i) modernizationof the existing liquid formulation plants at Budapest (Holgy) and Kormendto bring them to GMP standards and expand their capacities from 80 millionto 140 million ampoules per year at Budapest (for iniections) and from 5.5million to 9 million units per year at Kormend (for syrups); (ii) moderni-zation and debottlenecking of the existing synthesis and tabletting plantsfor cardiovasculars at the Budapest (Kereszturi) and Kormend plants, topermit an increase in the production capacity of cardiovascular activeingredients by 65 tpy and of formulations by 60 million tablets per year;and (iii) debottlenecking, modernization and expansion of the veterinaryproducts synthesis and formulation plants at Budapest (Kereszturi) andKormend, to increase the manufacturing capacity of active ingredients andtheir intermediates by 100 tpy and of their formulation facilities by300,000 ampoules for injections and 120,000 powder-filled ampoules peryear. This additional capacity will be used for the production ofantibiotics, anthelmintics and potentiated sulfonamides.

5.07 At the Biogal Company, investments would include: Mi) a newformulation plant at Debrecen of a total capacity of 120 million ampoulesper year for liquid injections, 20 million powder-filled ampoules, 180million capsules as well as tablets and coated tablets (1 billion peryear), syrups and other liquid preparations (3.8 million vials per year),ointments and gels (5 million units per year), and suppositories (12million units per year), to replace and expand the existing plant whichdoes not meet GMP standards; (ii) expansion of the synthesis plant atDebrecen, with the addition of two multipurpose production lines, for theproduction of about 45 tpy of antibiotics and their intermediates; and(iii) expansion of the existing surgical plaster plant at Debrecen to manu-facture 1.15 million meters of surgical plasters per year; and at theReanal Company, expansion of the diagnostic test manufacturing facilitiesat Budapest to produce an additional 180,000 packs of mixed diagnosticagents.

5.08 (b) Plant Protection Chemicals. Investments in plant protectionchemicals will consist of two sub-projects: (i) at the Nitrokemia Company,the exv-sision of the Monochloroacetic acid plant built in 1982 at Fuzfogy-artelep, near Veszprem, to increase its capacity from 6,000 tpy to 10,000tpy. This product is an intermediate used essentially for the productionof herbicides, but is also used in the production of cellulosic fibres andpharmaceuticals; and (ii) at the Chinoin Company, expansion of the pyreth-roids plant at Nagyteteny, Budapest, to increase its capacity by 230 tpy ofpyrethroid intermediates, 100 tpy of active ingredients and 7.5 millionaerosol cans per year for household use.

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5.09 (c) MDI and MDI-based Polyurethane Systems. The Projectconsists of the construction of a 25,000 tpy of Methyl Diphenyl Diisocya-nate (MDI) production unit at the BVK works at Kazingbarcika (nearMiskolc). As explained in para 3.12, MDI, in conjunction with polyols(polyethers and polyesters) and various additives (blowing agents,surfactants, catalysts) forms a polyurethane 'system' which the end userprocesses for a variety of applications. An important part of thesubproject will be the acquisition of 'system' technical know-how and theconstruction of the necessary laboratory and test facilities so that thecompany can sell a wide variety of systems and provide the technicalback-up services to its customers for systems and straight MDI. Themanufacturing process for MDI is (i) the condensation reaction of anilinewith formaldehyde to form diphenylmethanediamine (MDA); (ii) the HDA isdissolved in orthodichlorobenzene (ODCB) and is reacted with phosgene togive crude MDI and by-product hydrochloric acid; (iii) the hydrochloricacid is recovered; and (iv) the crude MDI is purified and separated bystripping and distillation and sent to storage. The major raw materialsand their supply will be as follows: (i) aniline (19,000 tpy) will besupplied through an exchange agreement with a Czechoslovakian produceragainst MDI exports; (ii) formaldehyde (3,730 tpy) will be supplied fromthe existing facilities of North Hungarian Chemical Company located about15 km from BVK; (iii) phosgene (9,870 tpy) will come from an existing BVKplant that will be debottlenecked as part of the subproject; (iv) polyols(for systems) will be supplied from a Yugoslavian producer in exchange forMDI; and (iv) caustic soda (9,400 tpy) will be supplied from BVK's existingfacilities. The major by-product from the project, hydrochloric acid(28,100 tpy at 33% concentration) can be easily sold on the local marketfor use in the metallurgical industry and for water treatment. Allutilities required, with the exception of cooling water that will beexpanded as part of the subproject, will be provided from the existingfacilities. Finally, the Project will also finance foreign consultingassistance to assist BVK in preparing marketing arrangements for MDI-basedsystems (para 3.17). Assurances were obtained that such consultants willbe contracted no later than b7 the end of June 1986.

5.10 (d) Ion Exchange Resins. At the Nitrokemia Company, the Projectwill finance the replacement and expansion of the existing capacity of6,000 m3 per year (dating from 1959) by establishing a new plant of a capa-city to produce 15,000 m3 per year of styrene-based ion exchange resins.These are speciality products used for water purification for industrialuse and power generation plants (para 3.18). The plant will be located atFuzfogyartelep.

5.11 (e) Detergents Intermediates. At the Caola Company, establish-ment of a sulfonation plant of a capacity of 4,000 tpy of active agents fordetergents, to replace equivalent imports. These are mainly used for highquality cosmetics and soaps and will extend the present range of Caola'sproducts. The plant will be located in Budapest. The subproject involvesthe construction of sulphur trioxide production facilities used (in highpurity form) for the sulfonation of a range of natural and synthetic gly-cerides and other reagents.

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2. Implementation and Schedule

5.12 All Project companies have well established investment depart-ments which have implemented their investment programs in the past and willimplement the proposed subprojects. The investment programs for Nitrokemiaand the pharmaceutical companies (which essentially comprise the Bank-financed subprojects) are similar in size and costs to their programs forthe past five years, which have been implemented satisfactorily. BVY'sinvestment department has also successfully implemented investment projectsof a much larger size than the proposed MDI subproject. These departmentswill be responsible for overall project management, including procurement,cost control and construction supervision. The companies' technicaldepartments, except for the BVK's MDI, the Gedeon Richter waste incinera-tor, the Nitrokemia Monochloroacetic acid and the Caola sulfonation subpro-jects, will be responsible for basic and detailed engineering (withassistance from local consultants). For the Nitrokemia Monochloroaceticacid subproject, detailed engineering, some procurement services and someconstruction supervision will be provided by the foreign consultant whodesigned the original installation. For the Gedeon Richter incinerationsubproject and the Caola sulfonation subproject, major package units willbe procured so that process and detailed design work in Hungary will belimited. For the BVK MDI subproject, technology and know-how will besupplied by a foreign consultant who will provide licenses, know-how, basicengineering, supervision of detailed engineering, some construction super-vision, technical evaluation for all major equipment items procured,start-up assistance, training for plant operation (including trainingabroad in an existing plant), systems formulation technology and processand product development information during the period of the license.Assurances were obtained that BVK will contract the foreign consultant nolater than by the end of August 1985. All foreign procurement under theProject will be carried out through one of the specialized foreign tradeorganizations. Details of the implementation arrangements for each of thesubprojects are summarized in Annex 5-1. 7or all projects the engineeringis already well advanced regarding offsites (steam, cooling water, powersupplies, etc.) and layouts. For the inside battery limits, the basicengineering, where provided locally, has been completed; where it is to beprovided by foreign companies, sufficient data has already been obtained togenerate equipment lists and to provide adequate information for sizing allmajor items and utilities requirements. Thus implementation of the varioussubprojects was initiated prior to January 1985 (except for the Biogal sur-gical plasters subproject which, due to site constraints, will commence inJanuary 1986). All subprojects are expected to be completed by mid-1989.Subproject implementation schedules are summarized in Annex 5-2.

3. Environmental Aspects

5.13 The establishment and enforcement of environmental regulationsare the responsibility of three national authorities directly responsibleto the Council of Ministers: The National Water Authority, for water pol-lution; the National Authority for Environment Protection and NatureConservation, for air pollution and waste disposal; and the newly createdNational Safety Inspectorate, for health and safety aspects. Water pollu-tion and health and safety regulations are acceptable and are being ade-quately enforced. Waste disposal regulations are acceptable and are beingadequately enforced except for organic wastes disposal where enforcement is

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constrained by the lack of incinerators (para 5.16 below); air pollutionregulations are less stringent and enforcement is inadequate. However,significant tightening of the regulations and increases in the associatedpenalties are being planned for implementation in 1985. The proposedchanges were reviewed by the mission and were found to be consistent withBank recommendations.

5.14 Regarding the subprojects, assurances were obtained from thecompanies that the Project facilities will be designed and operated inaccordance with the existing Hungarian water pollution, toxic wastedisposal, health and safety regulations, which are satisfactory to theBank, and with air pollution standards satisfactory to the Bank.Assurances were obtained from the Government that it will take all actionon its part (included the enactment of air pollution regulations and theprovision of means necessary for their enforcement). In addition, thecompanies have been notified of a number of specific design features (whichexisting plants lack) which they have agreed to incorporate into thesubprojects in order for the Project facilities to conform with theproposed environmental regulations (Annex 5-3). An assurance was obtainedin that respect.

5.15 (a) Pharmaceutical Subprojects. None of the pharmaceuticalsubprojects pose ervironmental problems that cannot be handled by theexisting effluent treatment plants, except that a number of the organicresidues from such treatment plants and other wastes directly from the pro-duction units have to be disposed of in land fills, which can lead topollution of ground water supplies. To solve this problem for the existingplants and for the Project facilities, two organic waste incinerators willbe constructed. One will be located in the north-eastern part of Hungaryand will handle organic wastes from Biogal as well as from other industriesin the area. Construction is planned to start in 1985 with funds availabledomestically. The second unit, which will be financed under the Project(para 5.04), will be located in western Hungary at the Gedeon Richter Dorogplant and will dispose of wastes generated by pharmaceutical plants in theBudapest area and in the western part of Hungary. These enterprisesinclude Gedeon Richter, Egis, Chinoin and Reanal. Both units will meetstrict environmental specifications relating to air, liquid and solidpollution and will generate signifiednt quantities of steam throughefficient utilization of the heat generated during combustion of thewaste. The design of both units is similar; it has been reviewed by theBank at appraisal and found acceptable. Assurances were obtained from theGovernment that the resources required for the North Eastern incineratorwill be made available so that it can be completed by the end of January1989 and that, should its completion be delayed, take other measuressatisfactory to the Bank to dispose of the organic waste in the meantime.Assurances were also obtained from Gedeon Richter that the Dorog plant willbe completed prior to January 1989.

5.16 (b) Plant Protection Chemicals. The existing centralized wastetreatment facilities at Nitrokemia, which are satisfactory, will be expand-ed as part of the Monochloroacetic acid subproject. In-plant treatmentfacilities will be installed to recover dichloroacetic acid that is cur-rently being discharged into the effluent system. Vent gases will bescrubbed to remove toxic constituents while solid wastes will be inciner-ated in existing facilities. At Chinoin, liquid effluents from the pyreth-

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roids subproject will be detoxified and then discharged to centralizedeffluent treatment facilities now under construction. Since the pyrethroidmanufacturing process uses a number of intermediate materials that arepotentially explosive and thus pose hazards to plant personnel, assurancesfrom Chinoin were obtained that a Hazard and Operability study will becarried out by consultants acceptable to the Bank prior to completion ofdetailed engineering and that the recommendations arising from the analysiswill be implemented prior to start-up of the subproject. Due to the smallquantities of reactants in the process, the hazards are confined to theChinoin site which is located outside of Budapest in a rural environment.

5.17 (c) The MDI Subproject. For the MDI plant, all gases releasedto the atmosphere pass through caustic scrubbers to remove the toxic gases;the scrubbers are designed to remove all the phosgene in the system in theevent of an emergency. Liquid effluents are treated to remove traces ofaniline, MDA and formaldehyde which are toxic to aquatic life. The finalliquid effluent, which contains sodium chloride (salt), will be recycled tothe chlorine/caustic plant so that there are no liquid discharges from theMDI plant. A number of materials used in the subproject are hazardous andstrict handling procedures must be observed. Most of these materials areliquids (aniline, formaldehyde solution, caustic solution, hydrochloricacid) or solids (MDI) under ambient conditions and are easily handled andstored. Phosgene, however, forms a dense poisonous gas at ambient condi-tions and requires very stringently designed production and handlingsystems to ensure that no discharge occurs. Due to the extremely hazardousnature of -he materials, and since the phosgene plant is only 750 metersaway from the Company's housing development and about I km away from thenearest village, assurances were obtained that BVK will carry out: (i) aHazard and Operability Study3/ for the existing phosgene plant coveringalso modifications for its debottlenecking; (ii) a Hazard and OperabilityStudy for the MDI plant; (iii) a Risk Assessment Study4 / for the MDI,phosgene, and related facilities. The studies and anailysis will usespecialized international consultants, where required, on terms andconditions satisfactory to the Bank. The scope and methodology for thesestudies and analysis were agreed with the Bank during negotiations.Assurances were obtained that the Hazard and Operability Study will becompleted prior to completion of detailed engineering; the Risk AssessmentStudy will be completed prior to mechanical completion; their recommenda-tions will be forwarded to the Bank for review; and that the recommenda-tions will be implemented as soon as possible and in any case prior to thestart-up of the MDI plant, including those for safety procedures,specialized training and equipment, liaison and consultation with theoutside community and regular drills. Finally, a copy of the safetyinspector's annual reports on the phosgene plant will be required as partof the Project reporting requirements (para 7.05).

3/ This Study is carried out by a multidisciplinary team of engineers toreview the consequences of mal-operation and equipment failure and torecommend modifications and/or procedures to minimize the risk andconsequences of such incidents.

4/ This Study quantifies the risk identified by the Hazard andOperability Study posed by the process plant, storage and facilitiesto plant personnel and the communitv at large and the measures andand procedures required to deal with such hazard.

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5.18 (d) Other Subprojects. Liquid effluent discharges from the IonExchange Resins plant at Nitrokemia will be stripped for removal of hydro-carbons and then neutralized in existing facilities, which are satisfacto-ry. Regarding the Caola Sulfonation Plant, gaseous discharges from thesulfur trioxide facilities will be scrubbed with caustic soda to ensure nodischarge of sulfur trioxide. Liquid effluents will be treated in theexisting waste water facilities for reduction of biochemical oxygen demandto acceptable levels.

D. Research and DevelopEent

5.19 The R&D component of the Project would support improvements inscreening and testing capabilities of the enterprises and researchinstitutes most concerned with the development of new drugs and plantprotection chemicals. Regarding pharmaceuticals, the Project will thusprovide the R&D departments of the Gedeon Richter, Chinolra, and Egispharmaceutical companies and the GYKI research institute (para 2.33) withmodern equipment necessary to meet the higher analytical standards nowrequired to: (i) control the purity and uniformity of new chemical entitiesto be used as active ingredients; (ii) elucidate the structure of new,extremely complex molecules; and (iii) carry out pharmakinetic studies ofnew drugs to trace over time the drug's metabolism in test animals. Theseactivities utilize highly sensitive and sophisticated equipment (gas andliquid chromatographs, spectrometers, etc., many of which are computercontrolled) for the isolation and analysis of pure materials occurring inextremely low concentrations. Biochemical testing is carried out withlevels of the test compound of 1 billionth or 1 trillionth of a gram; suchtesting is impossible to perform by traditional methods. New multi-channel automatic equipment must also be used for pharmacological testingwhich today requires the simultaneous monitoring of several physiologicalfunctions (e.g hl-od D-nT :, heart rate, respiratory rate, EEC muscularconditions); a: - .cdectronic computers is mandatory for thiswork and will a2 a inder the Project.

5.20 With respect to plant protection chemicals, a comprehensivetoxicological screening program has to be carried out for each new plantprotection chemical before organizations such as the EPA and other OECDregulatory bodies will register the product for sale in their respectivecountries. Until now, such tests have had to be carried out, in part, inoverseas R&D institutions whose operation and equipment meet the interna-tionally recognized standard of Good Laboratory Practice (GLP). Hungariancompanies wishing to have such tests carried out on new pesticides to besold in these countries have had to incur considerable outlays in foreignexchange, since NEVIKI, the institute carrying out pesticide screeningtests in Hungary (para 2.33), has not had the facilities nor operatingstandards to meet GLP. The problem is expected to become more acute in thefuture as there has recently been a stepping up of R&D in this field andmany new promising compounds, particularly herbicides (which are likely tobe of interest in CC export markets), are awaiting toxicological screen-ing. This component of the Project would therefore finance the foreignexchange cost of upgrading and expanding the herbicide toxicologicalscreening facilities at NEVIKI and ensure that GLP standards and proceduresare adopted throughout the Institute. Besides equipment for central labo-ratories, the Project will also finance equipment for animal houses, sani-tary engineering equipment, air conditioning and refrigeration equipment,

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fodder pelleting, feed preparation units and incinerators. The analyticalfacilities currently available at NEVIKI have sufficient capacity toprovide all necessary analytical services to the new ittit.

5.21 Implementation Schedule. It is expected that R&D equipment forpharmaceuticals will be procured and installed by the end of 1986.NEVIKI's toxicological facilities will be completed by the end of 1987.

E. Pharmaceuticals Pre-marketing Pilot Operation

(a) Objectives and Description

5.22 As discussed in paras 2.15 and 2.16, in order to consolidate itsfuture growth, the Hungarian pharmaceutical industry should attempt topenetrate OECD markets with formulated products sold under its own, orjointly owned, brand names. This attempt will be on a pilot basis, toestablish the optimum strategy for such penetration, and its scope has beensized so that the companies can afford the associated financial burden andrisk (para 7.10). This pilot operation is independent from the subprojectsfinanced under the Project, the incremental output of which is expected tobe sold entirely through the industry's traditional methods and channels)(para 3.08).

5.23 As a result of research activities in the last decade, theHungarian pharmaceutical industry has developed a number of new drugs, someof which have already been approved for marketing and others which are invarious stages of clinical testing (which should be completed in the next3-4 years). Because of the necessity of having a 'basket" of products withthe maximum number of "original" products, a joint operation by several ofthe major Hungarian research-based companies would be preferred. Ifnecessary, the companies would also provide some Hungarian generics of goodquality to be sold as brand-name generics. If the clinical trials inselected OECD countries are successful, these products could provide thebasis for a pilot marketing operation in one or two countries. Together,these products could generate enough sales volume to justify the expense ofthe necessary promotion and marketing efforts by the Hungarian companies orany appropriate joint venture or subsidiary company. The pilot operationcould take various forms from a newly established company, to a jointventure (possibly with a buy-back clause) with a foreign partner or theacquisition of a national company already established on the selectedmarket (para 2.16). The form of such an operatior should not be prejudgedat this time as it will depend on the options available on the selectedmarket(s).

5.24 As a necessary preliminary to marketing of brand name formula-tions, the Hungarian industry will need to pay fo:- the clinical trials ofthese products abroad and register them in its owi name. Simultaneously,preparations will be made for setting up or findi-t7 selling organizations(for joint ventures or acquisition) in one or two Western European count-ries. Because of the long lead time necessary between clinical trials andreceipt of revenue from product sales, a special form of longer term creditw- 1 be needed. If the pilot operation is successful, the operation couldbe gradually extended to other countries and products.

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5.25 World Bank assistance under the Project will take the form of:(a) funding foreign consultants necessary for the review of an action plan(prepared by the four major pharmaceutical companies) for the evaluation ofalternative marketing strategies and for selection of the best alterna-tive(s); for the development of market plans for the products eventuallyselected; and for the training of the companies' staff in associatedmarketing and/or negotiating skills; and (b) financing of a credit line forclinical trials and subsequent registration procedures. Because clinicaltrials and registration procedures are expected to take at least 3 yearsand because production for the selected markets must await the upgrading ofmanufacturing facilities to GMP standards (paras 5.04, 5.06 and 5.07), theProject does not finance the costs of actually marketing these products orof acquiring a company or contributing equity into a joint venture.However, assurances were obtained that the Government will make therequired foreign exchange available to the companies at the proper time.

(b) Implementation and Schedule

5.26 The marketing strategy study and the preparation of the plan ofaction will be carried out under jointly by Gedeon Richter, Chinoin, Egisand Biogal, the aegis of the Hungarian Association of PharmaceuticalManufacturers. The draft Plan of Action would be ready by the end ofDecember 1985; and the foreign consultants to review in such a study willbe recruited no later than March 30, 1986. The Plan will then be forwardedto the Bank for review together with the consultant's report. Theindividual companies will then submit subloan applications to NBH tofund clinical trials and registration expenses of the selected products andwill submit to the Bank terms of reference for contracting consultants forthe detailed market studies. It is expected that product registrationwill be completed between 1988 and 1990, by which time marketingarrangements would have been finalized and manufacturing to GMP standardswould start. At negotiations, assurances were obtained from the four majorcompanies (Gedeon Richter, Chinoin, Egis and Biogal) that they willcomplete recruitment of the consultant, the presentation of the plan ofaction and the marketing arrangements by the specified dates.

F. Studies, Training and Engineering Design

5.27 (a) Objectives and Description. Under the Project, six sub-sector studies will be undertaken to establish an optimum strategy fortheir future development. These studies will cover the following indus-tries: fertilizer, some basic petrochemicals, intermediates for fine chemi-cals, detergents, paints and varnishes, and drug and plant protectionintermediates. Agreed terms of reference are available in the ProjectFile, reference G. The fertilizer study will examine the nitrogenproduction facilities (65Z of the ammonia capacity is considered to beobsolete) to determine which plants cannot be made economic througheconomically justified investment and should thus be closed and whichplants can be improved. In addition, the justification for replacing thoseplants that must be shut down will be examined. The study is expected toresult in firm proposals for the restructuring of the nitrogen fertilizerindustry. The study will also review fertilizer distribution aspects,including trading margins. The studies for the phosphate fertilizer and

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other industries will examine the medium- and long-term position of theindustries and propose areas where they have competitive advantages and arethus worthwhile developing.

5.28 In order to enhance the capabilitier of Hungarian chemicalcompanies in strategic planning (para 4.08), the Project will finance atwo-step training program: (a) a study trip for about 10 top managers ofselected companies to specialized institutions and relevant companiesabroad; and (b) the subsequent orgatization in Hungary of training seminarsfor the staff of all chemical cr-apanies with the assistance of foreignspecialists and lecturers. The Project will finance the cost of travel andsubsistence abroad of the managers selected for the study tours, and alllocal and foreign costs of the seminars in Hungary (including the purchaseof training materials).

5.29 In addition, under this component, equipment will be financedto assist VEGYTERV--the major engineering design company serving thechemical and pharmaceutical sector (para 4.04)--to improve its basic anddetailed design activities both regarding quality and timely completion.The equipment consists of reproduction equipment and desk top-t,pe computersystems. The computers will also act as terminals for the existingVEGYTERV main frame computer, thus allowing more widespread access withinVEGYTERV to* existing computerized design data bases and programs.

5.30 (b) Implementation Schedule. The studies will be carried out byVEGYTERV with assistance from foreign consultants, particularly on nitrogentechnology questions and for market research expertise. The studies willbe coordinated and controlled via working groups drawn from the relevantproducer associations and the Ministry of Industry, which will providefunding for local costs (50Z of the financing required). Assurances wereobtained that the foreign consultants will be contracted by the end ofJune 1986. All studies are expected to be completed by the end of June1987, at which time the results would be reviewed by the Bank and theGovernment. Training in strategic planning will be organized by theManagement Training Center of the Ministry of Industry, which is located inEsztergom, and will take place in the second half of 1985 and during 1986.Assurances were obtained that the necessary foreign specialists will becontracted by the end of June 1986. VEGYTERV will install the designequipment by the end of June 1986.

G. Overall Project Coordination and Supervision

5.31 A condition of effectiveness will be that the Gi.vernment estab-lishes and maintain a coordination office, which will be directly responsi-ble to the Ministry of Industry, with the responsibility of overall coordi-nation, supervision and evaluation of the Project. Its main functions willbe the following: (a) to bring to the attention of proper authorities allmatters related to the Project requiring high level policy decisions;(b) to assist in the preparation and signing of all subloan agreementsreferred to in para 6.06; (c) to ensure timely selection and appointment ofthe engineering agencies responsible for implementation supervision andprocurement; {d) to provide overall supervision of procurement; (e) to helpthe executing entities in the preparation of disbursement applications andin the interpretation of Bank guidelines for procurement and selection ofconsultants; (f) to supervise the overall implementation of the project

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(including thorough periodic field reviews) and other monitoring methodsand report to NBH and to the Bank on compliance by the Project entitieswith their respective obligations under the Project Agreement (para 6.06);(g) to ensure timely preparation of, and consolidate, progress and auditreports referred to in paras 7.05 and 7.06, before forwarding to the Bank;(h) to evaluate overall Project impact and be responsible to NBH for thepreparation of the Project Completion Report; and (i) generally to act as aliaison between the Bank and the executing entities. The major part of thestaff of this coordination office (approximately five at the peak period)is expected to be provided by one of the local engineering consultancyfirms.

VI. CAPITAL COST, FINANCING PLAN, PROCUREMENT AND DISBURSEMENTS

A. Capital Costs

6.01 Total financing required for the Project is estimated atUS$311.5 million, including incremental working capital, physicalcontingencies and price escalation. Interest during construction will bepaid annually by the companies from funds generated by their currentoperations and does not therefore require financing under the Project. Thedirect and indirect foreign exchange component (in convertible currencies)amounts to US$132.3 million. Summary estimates of Project costs bycomponents and companies are presented on the next page; details bysubprojects are presented in Annex 6-1.

6.02 Base cost estimates for production facilities are derived fromfeasibility studies carried out by each of the companies according to cri-teria and methodologies agreed upon with the Bank. Local consultants wereused extensively in compiling the feasibility studies. In the case of theBVK MDI subproject, the feasibility study was reviewed by foreign consul-tants financed by the Bank under Loan 2397-HU. In all cases, costs arebased on quotations for major imported and domestic supplies; in mbnyinstances fo- the pharmaceutical industry, similar projects have beenrecently implemented, giving a good data base for other non-quoted costs.Base costs, which are presented in the feasibility studies at prices ofmid-1984, were updated to February 1985 (the planned date of negotia-tions). Physical contingencies are estimated at 10% of total base costs(excluding incremental working capital). Price escalations for foreigncosts are based on forecasts of international inflation (Manufacturing UnitValue index) of 8% in 1985, 9% annually from 1986 to 1988 and 7.5% in1989,and, for local costs, on escalation factors of 8% in 1985 and 1986,and 7% in 1987 and 1988, and 6.5% in 1989. All costs are converted intoUS$ at Ft 50 per US$, the estimated exchange rate at the time ofnegotiations. Import duties and taxes on equipment and materials,totalling US$14.4 million, excluding contingencies, are included in totalcosts.

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S UirT or PROJOCT COSTS

Million Forints US$ WllionsTotal

ForeLgn as 2 ofas of Bse

Local Foreign Total Local Foreign Total Total CostA. Productlon Investments

1. Pbarmaceuticals and Intermediates6edeon Richter 1,831.8 1,007.5 2,839.3 36.6 20.2 56.8 35Z 23.4SChinoin 593.4 453.9 1.047.3 11.9 9.1 20.9 432 8.6%1gms 383.5 422.2 805.7 7.7 8.4 16.1 52S 6.6SBiogal 878.8 548.0 1,426.8 17.6 11.0 28.5 382 11.7%Reanal 45.3 35.3 80.6 0.9 0.7 1.6 44S 0.72

Sub-total 3.732.8 2.6. 6,199.7 74.7 49.3 124.0 402 51.0%

2. Plant Protection ChemicalsChinoin 199.9 86.5 286.4 4.0 1.7 5.7 302 2.3ZNitrokemla 32.8 49.2 82.0 0.7 1.0 1.6 60S 0.72

Sub-total 232.7 135.7 368.4 4.7 2.7 7.4 37Z 3.0S

3. lDI and PolyurethaneSystem a (aNM 1.409.2 1,356.4 2,765.6 28.2 27.1 55.3 492 22.8Z

A. ron Exchange Resins (Nitrokemia) 692.5 237.0 929.5 13.9 4.7 18.6 252 7.72

5. Detergent Intermediates (Caola) 47.1 56.6 103.7 0.9 1.1 2.1 552 0.9S

Total Fied Assets 6.114.3 4,252.6 10,366.9 122.3 85.1 207.4 412 85.42Incremental Vorking Capital 715.6 180.5 896.1 14.3 3.6 17.9 202 7.4ZTotal Production Investments 6,829.9 4.433.1 11,263.0 136.6 88.7 225.3 402 92.82

B. Research and Devlopmet 149.9 239.7 389.6 3.0 4.8 7.8 622 3.22

C. Pilot Pbarmaceatical Pre-Marketing a; 5.0 415.3 420.3 0.1 8.3 8.4 9S 3.5%

D. Studies, Training, Design Equipment 30.6 39.3 69.9 0.6 0.8 1.4 562 0.5%

Total Baseline Cost 7,015.4 5,127.4 12,142.8 140.3 102.6 246.4 422 100.0%

Physical Contlgencies 627.0 454.0 1,081.0 12.5 9.1 21.6 42Z 8.92Price Contingencies 1,315.8 1.033.5 2,439.3 26.3 20.7 47.0 462 19.32

TOTAL PUrJEcr COSTS 8,958.2 6,614.9 15.573.1 179.2 132.3 311.5 432 128.2Z

aI Including market-related studies (paras 5.17 and 5.32)

6.03 As estimated 230 manr-months of foreign consultant and engineeringservices will be financed under the loan for a total base cost (excludingcontingencies) of US$2.77 million, including: (i) US$60,000 for thefertil'zer study and US$190,000 for the studies on future prospects in thechemical industry (para 5.27); (ii) US$70,000 to assist BVK in preparingdetailed marketing arrangements for polyurethane systems (para 5.09);(iii) US$350,000 to assist the pharmaceutical industry in preparing a planof action, a marketing strategy and market plans for the pilot

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pre-marketing operation (para 5,25); US$60,000 for training in strategicplanning (para 5.28); (v) US$2.0 million for engineering services for theMDI subproject and associated Hazard and Operability Studies and RiskAssessment Study and risk analyses (para 5.17); (vi) US$15,000 for Chinointo carry out the risk analysis for the pyrethroids subproject (para 5.16);and (vii) US$25,000 to assist NEVIKI in pre-operation training of plantpersonnel (para 5.20). Assurances were obtained from the Government andthe companies that all consultants will be selected according to Bankguidelines, on terms and conditions acceptable to the Bank.

B. Financing Plan, Borrowing and On-Lending Arrangements

6.04 Financing Plan. The proposed Bank loan of US$73 million wouldcover about 23% of total estimated financing requirements and 55% offoreign exchange requirements (in convertible currencies). NBH will pro-vide the balance of foreign exchange requirements for all incremental work-ing capital and investment, studies, training, design equipment andclinical trials and drug registration expenses, necessary to complete theProject. At negotiations, assurances were obtained from the Governmentthat NBH will have access to the required foreign exchange for thatpurpose, and from NBH that it will make it available to the Project enti-ties. The State Development Bank (SDB) will provide local currencysubloans for the Dorog waste incinerator of Gedeon Richter. The companies,research institutes and VEGYTERV would provide abouit US$70.1 million out oftheir own resources, or 22% of total Project costs. The Government wouldprovide about US$0.4 million out of budget funds in order to meet the localcosts of the proposed studies and of the training program and US$8.4million to help meet the local costs of the Dorog waste incinerator. NBHwould provide the balance of funds (US$154.1 million) in the form ofsub-loans to Project beneficiaries. NBH is seeking cofinancing fromforeign commercial banks to finance the foreign exchange gap (US$59.3million) as well as part or all of local currency subloans (US$100.3million). The financing plan is summarized below and further detailed bycompanies and subprojects in Annex 6-2. Assurances were obtained from NBH,the Government and the Project entities that they will promptly providetheir share of financing as detailed above.

Financing Plan(USS million)

Debc E:uicy

Cofit- Cofin-anciers anciers Projec: (ovt.

IBRD q'BH SDB Entciies Budget Toral

A. Production Investmentsa/

Fixed Assets 62.7 122.2 5.5 68.8 8.4 267.6Inc. Working Capital - 22.2 - - - 22.2Subtotal 62.7 144.4 5.5 68.8 8.. 289.8

B. Research & Development 1.8 S.9 - 1.0 - 9 p

C. Pilot larketing Overstions8a 7.6 2.8 - 0.1 - 10.5

D. Studies, Training &Design Ecuipment 0.9 - - 0.2 0.4 1.5

Total Prolect Costs 73.0 154.1 5.5 70.1 8.8 311.5

a/ Including related market studies (perar 5.10 and 5.26).

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6.05 Borrowing and On-Lending Arrangements. The Bank loan would beextended to NBH, which would carry the foreign exchange risk. The proceedsof the Bank loan would be relent by NBH to the companies, the researchinstitutes, VEGYTERV and the Government (for the studies and training com-ponents), except for the Dorog waste incinerators, for which the proceedsof the Bank loan would be through SDB. All subloans would be at terms andconditions described in para 6.07. NBH and, for the Dorog incinerator,SDB, would also make subloans to Project beneficiaries out of their ownresources or co-financing funds, at terms and conditions specified in paras6.07 and 6.08.

6.06 In order to regulate the flow of resources from NBE to the bene-ficiaries and set out the respective obligations of the various entities,the following agreements would be signed:

(a) a loan agreement between the Bank and the National Bank ofHungary;

(b) a guarantee agreement between the Bank and the Hungarian People'sRepublic;

(c) a Project agreement between the Bank and the Project entities(BVK, Gedeon Ritcher, Chinoin, Egis, Biogal, Reanal, Nitrokemia,Caola, GYKI, NEVIKI and VEGYTERV);

Cd) subsidiary loan agreements for the transfer of Bank funds betweenNBH and SDB to finance the Dorog waste incinerator; and betweenNBH and the Government for the study and training components;

(e) subloan agreements between NBH and each one of the Projectentities; and

Cf) a subloan agreement between SDB and Gedeon Richter for the Dorogwaste incinerator.

Signature of the subsidiary loan agreements satisfactory to the Bank,listed under section (d) and of the subloan agreements between NBH and BVK,Gedeon Richter, Chinoin, Egis and Biogal (Section (e)) would be a conditionof effectiveness. Signature of the remaining subloan agreements would be acondition of disbursement under the respective subprojects.

6.07 Lending Terms and Conditions. All proceeds of the Bank loan willbe relent to the Project entities at a rate at least equal to the Bankstandard variable rate plus a 30% mark up, comprising the 10% mark upnormally required from commercially-oriented entities and a 20% mark up tocover the estimated foreign exchange risk. The resulting rate (14% at thetime of appraisal) is strongly positive since domestic inflation (9.5% in1984) is projected to decrease to 8% in 1985 and 1986. The interest ratecharged on subloans extended to beneficiaries by NBH and SDB (for the Dorogincinerator) from other resources will be the standard rate specified inthe Credit Policy Guidelines of NBH. These guidelines, which are revisedannually and approved by the Council of Ministers, set all credit policiesfor the Hungarian Banking System. At present, the standard rate is 14%.

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6.08 Subloans from the proceeds of the Bank loan would have maturitiesof not more than 15 years, including grace periods of not more than 4years. It is expected that these terms would be the same for the Bank, NBHand SDB portions, and would be determined according to the economic life ofthe investment and cash flow requirements, within the limits set by theCredit Policy Guidelines which became effective in January 1985.Presently, starting from the date of first disbursement to the company,maximum maturities are of 12 years on NBH subloans and 13 years on SDBsubloans including 3 years maximum grace period. Estimated terms for eachsubproject are shown in Annex 6-3. For drug registration expenses andclinical trials under the pilot pharmaceutical pre-marketing component,subloans would have a maximum maturity of 8 years. At negotiations,assurances were obtained that the actual terms of the subloans in therespective subloan agreements with the companies would be acceptable to theBank.

C. Procurement

6.09 The procurement arrangements for the Project are summarizedbelow:

Procurement Method(USS Million)

TCB LCB Other Y1.A. Total Cost

Equipment and Materials 70.4 61.1 9.4 18.7a/ 159.6(48 .l)b/ (7.0) (55.1)

Engineering and Licenses 9.7 8.1 17.8(7.8) (7.8)

Civil Works 50.5 50.5Erection and CanmissioninX 2.n 35.6 12.5C/ 50.1

(2.0) (2.0)

Studies and Training 1.3 1.3(0.9) (0.9)

Pharmaceutical Pre-marketing 10.0 10.0(Clinical Trials) (7.2) (7.2)

Wlorking Capital - - 22.2 22.2

Total 72.4 156.9 41.3 40.9 311.5(50.1) (22.9) (73.0)

LCB - Local comperitive bidding. N.A. - Sot applicable.a/ Import duties.b/ Figures ihown in brackets correspond so Bank financing.c/ 25: of erection (for a total local cost of USS48.1 million equivalent)

vould be by force account.

Equipment financed by the Bank loan will generally be procured throughinternational competitive bidding (ICB) using procedures consistent withBank guidelines. Hungarian will compete for equipment contracts butcompanies are not expected to successfully bid for contracts amounting tomore than US$15 million in aggregate since the equipment to be financed bythe Bank is generally either not available in Hungary or the deliveryperiods are too long. Hungarian companies competing under ICB will beeligible for a 15% preference on the CIF value of such bids. Exceptions toICB will be made for equipment proprietary to the process design, itemswhose supply is critical for efficient Project execution and small itemsunder contracts each with estimated value of less than US$200,000, which

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may be procured through limited international bidding from qualifiedsuppliers from at least three Bank member countries. The aggregate' ofequipment contracts under the Bank loan to be procured under proceduresother than ICB will not exceed US$7 million equivalent. The Bank loan willalso be used to finance the foreign exchange costs of the erectioncomponent of equipment contracts expected to be awarded on a supply anderect basis after ICB, licenses, consultants' design and engineeringservices for the process plants. Design and engineering services (for theMDI plant and the incinerator) will be contracted in accordance with Bankguidelines; the method for award of the contracts for the clinical trialsfinanced under the pilot marketing component will be determined after theplan of action has been completed (para 5.25). Competition will bemaximized to the extent possible. Consultancy services for the variousstudies will be procured in accordance with Bank Guidelines. Equipment,local expenditures in services and works will be procured under prevailinglocal procedures which provide for efficient and economic procurement.

6.10 All bidding packages for equipment and materials estimated tocost over US$1.0 million equivalent and bidding packages for licenses,engineering and consultants services would be subject to the Bank's reviewof procurement documentation resulting in a coverage of about 80Z of thetotal estimated value of contracts. In addition, the first 10 packages,regardless of size, will be subject to Bank prior review. The balance ofcontracts would be subject to random post review by the Bank after contractaward. NBH will submit to the Bank for review a list or lists of allprocurement packages to be financed under the loan. In the case of smallitems urgently required and not exceeding US$50,000 in aggregate, NBH, willnotify the Bank that these are proposed for financing at the time ofissuance of the equities. Assurances were obtained in these respects.

D. Disbursements

6.11 The Bank loan would be disbursed against direct foreignexpenditures and local currency costs ex-factory (excluding incrementalworking capital) incurred by all Project entities and by the Government forthe implementation of their respective subprojects. The proposedallocation of the Bank loan is summaiized on the following page:

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Allocation of Bank Loan(thousand US$ e-quivalent)

- Equipment LicensesSpare Parts Consultant& Materials Services Other Total

Gedeon RichterIncinerator 4,900 - - 4,900Other 5,550 50 - 5,600

ChinoinPyrethroids 800 - - 800Other 6.935 65 - 7,000

Egis 6,050 50 - 6,100Biogal 6,Z50 50 - 6,300Reanal 400 - - 400Nitrokemla 3,000 - 3,000Caola 700 -- 700BVK 16,650 2,500 - 19,150GYIKI 600 30- 600KEVIKI 1,320 30 1,350VEGYTERV 400 6 - 400Clinical Trials - 6,400 - 6,400Studies and Training - 300 - 300Unallocated - - 5,000 5,000Special Account 55- 9,000

Total 53,555 9,445 10,000 73.000

of the US$73 million Bank loan, about US$50.1 million will be used tofinance equipment materials and spares procured under ICB, (includingforeign assistance required in mechanical erection) and US$3.0 million forforeign engineering services for the Project and US$4.8 million forlicenses. It is anticipated that the Project will be completed by the endof June 1989 and that the Bank loan will be completely disbursed by the endof June 1990, in accordance with the disbursement schedule set forth inAnnex 6-4. The schedule corresponds closely to the disbursement profile ofBank-financed fertilizer and chemical industry projects.

6.12 Statement of expenditures will be used to disburse against con-tracts valued at US$10,000 or less. NEH will not submit applications forreimbursement totalling less than US$20,000. To accelerate payments of ICBsuppliers and reduce administrative work in the Bank for small disburse-ments, a Revolving Fund (RF) would be established at NBH. Deposits intothe RF would reflect actual need for financial resources as estimated. TheRF would maintain a constant floor of Bank deposits of the equivalent ofthe average four months' expenditures which are estimated to be about US$5million and would be allowed upon request by NBH to increase at the time ofmajor ICB bid opening. Records of the RF proceeds and outlays would bekept in a special Project account to be held at the NBH and run parallel tothe master Project account. A record of all contracts financed and apermanent accounting record of operations financed would be kept by NBH andbe available for review by Bank supervision missions upon request. Pay-ments from the RF would only be made for eligible expenditures indicated inthe Loan Agreement. An audit report by an independent auditor on the RF

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account and the statement of expenditures would be prepared and submittedto the Bank not later than 5 months after the end of each fiscal yearduring Project implementation (para 7.06).

VII. FINANCIAL ANALYSIS AND RISKS

A. Revenues, Costs, Profitability and Cash Flows of Subprojects

7.01 Key financial results from the subprojects (in current terms) aresummarized in Annex 7-1, for the year 1990, which is, for all but threesubprojects the first year of full production and of heaviest debtservice. All subprojects show good profitability (net profits range from18% to 43% of sales), consistent with average profitability of sales in thefine chemicals and pharmaceutical industries. With the exception of theGedeon Richter injections plant, cash generated by the subprojects (net ofthe 40% share of depreciation allowances transferred to the Government) issufficient to cover the associated debt, even in that year. In the case ofthe Gedeon Richter injection plant, the incremental profits generated anddepreciation are insufficient to cover debt service payments in thatparticular year, because only incremental revenues from additionalproduction have been shown, while a large portion of the costs areassociated with the reconstruction or modernization of the existing plantto bring it up to GfP standards (para 5.04). The projected financialstatements for the companies, however, show that this debt can easily beserviced from existing as well as future operations (para 7.04).

B. Financial Rates of Return

7.02 Financial rates of return for the subprojects are presented inAnnex 7-2. They vary between 18% (for the MDI subproject) and 78% (for theChinoin Active Ingredients subproject). These rates of return were calcu-lated over incremental costs and incremental benefits valued at prices ofmid-1984. For the pharmaceutical and pyrethroids subprojects, outputprices have been assumed to decline over time in real terms (para 8.03).For the Gedeon Richter injection plant, the Biogal formulation plant andthe Egis liquid formulation plant, an assumption was made that present CCexports associated with the existing plants would be lost unless theexisting facilities were brought up to GMP standards (para 8.04). Thecompanies' standard allocations of R&D costs were included in operatingcosts. Detailed assumptions and calculations are available in the ProjectFile, Reference C.

C. Projections of Companies' Financial Statements and Financial Covenants

7.03 Financial statements (income si:atement, balance sheet and sourceand application of funds) were projected for BVR, Gedeon Richter, Chinoin,Egis, Biogal and Nitrokemia. For Reanal and Caola, the proposed invest-ments represent less than 10% of their 1983 total assets; required averageequity contributions per year, less than 15% of total 1983 internal cashgeneration; and incremental revenues to be derived from the subproject,less than 15Z of their 1983 revenues. Their present and future financialsituation as well as those of VEGYTERV, NEVIKI and GYKI were reviewed indetail by NBH, which found those entities creditworthy and in a position to

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service their existing debt as well as that associated with thesubprojects. The projected income and cash flow statements prepared bythese 5 companies are available in the Project File, Reference F.

7.04 The projected financial statements and key ratios for BVK, GedeonRichter, Chinoin, Egis, Biogal, and Nitrokemia are summarized in Annex7-5. Full details of the projections and assumptions used are available inthe Project File, Reference F.5/ Projections show that all six companiesare in a position to put up their share of financing requirements for thesubprojects out of funds generated from their existing operations. Theyalso show that the companies will be in a position to repay the associateddebt while maintaining adequate financial ratios. Between 1984 and 1990,the pharmaceutical companies are expected to maintain long-term debt/equityratios varying between 7/93 and 33/66; current ratios between 1.5 and 3.5(except for Egis, with a ratio of 1.1 in 1983); and debt service coverageratios between 1.5 and 3.4, all of which are consistent with experience inthe pharmaceutical industry worldwide. With the recent rescheduling of itslong-term debt (para 4.11), BVK is expected to maintain a long-term debt/equity ratio below 45/55, a current ratio of at least 1.5 and a debt ser-vice coverage ratio of 1.4 in 1985, increasing to 2 and above by 1990,which are also consistent with the range of ratios maintained by similarpetrochemical companies worldwide. Nitrokemia is expected to maintain along-term debt/equity ratio below 20/80, a current ratio of above 2.0 and adebt service coverage ratio of above 2.5. At negotiations, assurances wereobtained that BVK, Gedeon Richter, Chinoin, Egis, Biogal and Nitrokemiawill maintain a long-term debt/equity ratio at or below 55145; a currentratio at or above 1.3; and a debt service coverage ratio at or above 1.0 in1985, and at or above 1.3 in subsequent years.

D. Auditing and Reporting Requirements

7.05 Each one of the Project entities (BVK, Gedeon Richter, Chinoin,Egis, Biogal, Reanal, Nitrokemia, Caola, GYKI, NEVIKI and VEGYTERV), theMinistry of Industry (for the study and training components) and NBH willsubmit quarterly progress reports to the Project Coordination Office (para5.32), which will consolidate them and forward them to the Bank no laterthan four weeks after the end of each quarter. Such reports will includeprogress and procurement status reports, including updated implementationand disbursement schedules on each one of the subprojects. BVK, GedeonRichter, Chinoin, Egis, Biogal and Nitrokemia will also submit theirfinancial statements at the end of each semester. NBH will retain thefinancial statements of the other entities for Bank review duringsupervision missions. BVK will include a copy of the safety inspector'sannual report on the phosgene plant in the relevant progress report (para5.17). Finally, within four months after the closing date, the Projectentities, NBH and the Ministry of Industry will provide the ProjectCoordination Office with the information necessary to prepare and furnish

5/ In early 1985, the Government changed the taxation system for theenterprises. Depreciation allowances are now fully retained by thecompanies. On the other hand, the companies are now subject to aproperty tax and an investment tax. We have reviewed the impact ofthe changes in the projected financial statements and concluded thatthey will not materially affect the results of the projectionssummarized in this report.

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to the Bank a Completion Report on the Project dealing with itsimplementation, initial operation and the costs and benefits derived andexpected to be derived.

7.06 All Project entities, the Ministry of Industry, the ManagementTraining Center of the Ministry of Industry and NBH will keep separateProject accounts. All Project accounts, the Revolving Fund, statements ofexpenditures (para 6.12), and the financial statements of BVK, GedeonRichter, Chinoin, Egis, Biogal, and Nitrokemia will be audited at the endof each fiscal year by independent auditors acceptable to the Bank. Onesuch auditor, the General Bank and Trust Company in Hungary, has been pro-posed by the Government and has been assessed by the Bank as acceptable.Short form annual audit reports would be forwarded to the Bank no laterthan by the end of May each year. The financial statements of the otherProject entities, audited in accordance with local procedures (para 4.10),will be retained by NBH for Bank review during supervision.

E. Major Risks

7.07 Risks associated with the Project technology, start-up andoperations are moderate as the Project is based on commercially proventechnologies and adequate arrangements have been made for training person-nel for operation and maintenance. Some of the pharmaceutical subprojectsinvolve scaling-up pilot operations to commercial size plants, but thescale-up factors have been examined and are reasonable. Experience of theconcerned production and engineering companies with similar plants orplants of similar complexity has shown that the risks of seriousimplementation delays are minimal.

7.08 The major risks facing the Project concern the MDI and pharmaceu-tical components. The pharmaceutical subprojects are largely multi-purposefermentation, synthesis and formulation plants. Their profitabilityultimately depends on the companies' ability to maintain their position inthe very competitive environment of the world pharmaceutical industry.This in turn will depend on the effectiveness of the companies' researchand development efforts in continuously producing new, marketable drugsand/or continuously improving process technologies of existing drugs toreduce costs. This risk, however, is inherent to the pharmaceutical indus-try everywhere in the world, and given the past experience of the Hungarianindustry (para 3.09) is considered acceptable. In addition, the financialand economic analyses have been based only on those products which havealready been developed and scheduled for production during the first yearsof operation, with appropriate assumptions concerning their likely rate ofobsolescence (paras 7.02 and 8.03). Even under these conservative assump-tions (particularly since costs include standard R&D allocations), thesubprojects show adequate rates of return.

7.09 Another risk is that the companies' present sales do not keep upwith inflation. However, it would take a 20% decrease in the companies'total projected revenues by 1990 (or a 25% to 30% decrease in existingsales in current terms) for two of the major companies to startexperiencing difficulties with some of the required liquidity ratios (thedebt device coverage ratio would decrease to 1.0 for Biogal). However,such a 20% decrease in revenues, for each of the four major companies would

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mean that: (a) either that they have failed to market any new productbetween 1983 and 1990 and that all the existing products are becomingobsolescent (at the average rate of real price decrease assumed for thesub-projects); or (b) 70% to 100% of incremental sales from the Projectfail to materialize; or (c) all companies lose 80% to 100% of their presentCC exports to their competitors. Such occurrences are however veryunlikely (para 3.09).

7.10 Regarding the pharmaceutical pre-marketing expenditures whichwould be funded under the Project on a pilot basis, the financial risk forthe companies i's small, even if none of the selected products achievesregistration or is subsequently marketed in the selected country(ies).Assuming that the four major companies share the associated financialobligations in proportion to their total sales, the repayment obligationswould in all cases represent less than 10Z of the companies 1983 internalcash generation (ICG) and less than 5% of their projected ICG in 1990 andwould in no case cause the financial ratios to fall below the prescribedlevels. Total spending on this pilot component accounts for only 5% oftotal Project investments in pharmaceuticals.

7.11 Regarding the MDI subproject, the main risk lies in BVK's inabi-lity to develop competitive polyurethane systems for CC markets and appro-priate sales strategies and back-up service, which would compel BVK to sellstraight MDI on CC markets at discounted prices. However, the risks arebeing minimized by steps already taken by BVK to build up its R&D capabili-ties, by the proposed marketing consulting assistance (paras 3.17 and 5.09)and by the planned changes in BVK's internal organization (para 4.11).Another risk is that MDI prices fail to recover to the projected levels(para 3.14). However, in both events the subproject would still remaineconomically and financially justified and BVK would still be in a positionto repay the associated debt (were BVK's total projected revenues to fallby 20% below projected levels, the company's current ratio would decreaseto 1.2 and the debt service coverage ratio to 1.0).

VIII. ECONOMIC ANALYSIS

Introduction

8.01 Economic rates of return were calculated for each individualproduction subproject, accounting for 84% of total Project costs. Theoverall economic rate of return for the Project (excluding the incinerator,the pilot marketing operation, the cost of the studies and the research anddevelopment investments) is estimated at 36%. The aggregate net presentvalue, assuming a 12% opportunity cost of capital, is estimated at aboutUS$201.6 million.

A. Assumptions

8.02 Gene al Assumptions. Financial incremental costs and benefitsin 1984 terms were adjusted to exclude import duties and taxes on equipmentand raw materials and all sales taxes (the latter are negligible).Financial prices of outputs and inputs reflect efficiency prices (para2.22) since they are based on international prices (whatever the destina-tion of sales), after adjustments have been made to take into account dif-ferences in transportation and distribution costs. Except as specified in

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the following paragraphs, no adjustments have therefore been made to baseprices. The cost of energy was adjusted to reflect the long run marginalcost of power (US$0.044 per kwh).

8.03 Pharmaceuticals and Plant Protection Chemicals (pyrethroids).Although almost all Project facilities are multi-purpose and permit quickchanges in production plans depending on market and price conditions, thecost/benefit analyses (financial as well as economic) of all pharmaceuticaland of the pyrethroids subprojects are based on the continued productionover ten years of specific, already developed products which thecompanieshave selected for the first years of plant operation and for which theyhave provided market justifications. Their prices have been projected todecrease over time as patents expire and because pharmaceutical and plantprotection industries worldwide continuously develop new, better productsand/or less costly competing processes. In order to take these factorsinto account, prices have been assumed to decrease by 3% per year in realterms, except when different rates of change were found justified (pricesmay decrease rather sharply when patents expire). In che case offormulation plants, prices of active ingredients were decreased corres-pondingly, but in the case of plants producing active ingredients prices ofintermediates were maintained constant over time in real terms. Detailedassumptions on each subproject are available in the Project File,Reference C.

8.04 Three pharmaceutical subprojects consist of the reconstruction orupgrading of existing formulation facilities (as well as their expansion)so that they can conform to international standards (paras 5.04, 5.06 and5.07). For these, part of the benefits of the Project consists of exportlosses avoided, since failure to comply with these standards would certain-ly entail losses of practically all CC exports associated with these faci-lities within the coming five years and probably of Ruble exports as well(in the base case, only CC exports were taken into account). In 1983,these export revenues were as follows:

Export Revenues from Existing Plants(1983)

--- Million Forints--CC Ruble

Gedeon Richter - Injections 288.2 930.0Egis - Liquid Formulations 46.4 48.1Biogal - Formulations 52.0 356.0

494.9 1,435.8(in US$ million): (11.0) (32.0)

8.05 Intermediates. For the Caola Sulfonation and the NitrokemiaMonochloroacetic acid subprojects, which essentially aim at import substi-tution, benefits were valued at the CIF equivalent prices. These weremaintained constant over the whole period since these products have a widevariety of uses and do not therefore depend on market prospects for speci-fic specialities.

8.06 Ion Exchange Resins. Economic Rate of Return (ERR) calculationsare based on a weighted average price of ion exchange resins (both types)of US$1,850 per m3 (corresponding to US$814 per m3 of cation exchangeresins and US$2,280 per m3 of anion exchange resins), which correspond to

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prices received by Nitrokemia on its 1984 sales of resins in Western Europe(prices in the US were substantially higher). Because continuousdevelopments occur in zhe type and variety of ion exchange availableworldwide, obsolescence has also been built into calculations (prices inreal terms were forecast to decrease by 3% per year).

8.07 MDI. The MDI plant is expected to start operation in early1988. Capacity utilization has been projected at 60% in 1988, 80% in 1989and 95% subsequently. The output mix has been assumed to be 20% pure and80% polymeric MDI. As discussed in Chapter III (para 3.16), prices of MDIare expected to recover by 1987. In real terms this would represent a 15Xto 20% increase over their 1984 level. Subsequently, they are expected tofollow projected trends in prices of aniline (the main raw material) whichare expected to decrease slightly in real terms between 1987 and 1990 andslowly increase afterwards. Prices for the plant output were consequentlyderived from average market prices for bulk material in Western Europe,adjusted for transportation (US$ 35 per ton) to arrive at the borderprice. MDI price assumptions used in both the financial and economicanalyses are detailed in Annex 7-3.

8.08 The structure of MDI production costs (assuming 10OZ capacityutilization) is summarized in Annex 7-4. Projected prices for raw materi-als and utilities are presented in Annex 7-5. Aniline, the single mostiaportant cost item, has been valued at prices charged by East Europeanproducers on their exports to Western Europe (although it is expected thatBVK will purchase its aniline requirements from Czechoslovakia in exchangefor MDI). These prices are presently low, at about US$600 per ton. Thereis at present a large surplus capacity of aniline in Western Europe (capa-city utilization is only 70%) and worldwide, and this overcapacity isexpected to persist beyond 1990. Prices of aniline are therefore expectedto further decline until 1992, at which date they are projected to slowlyincrease to keep pace with projected increases in prices of benzene, itsmajor raw material. Details on price projections for benzene, aniline,other raw materials and MDI are available in the report of Arthur D. Littleon the MDI subproject (Project File, Reference D).

8.09 Besides excluding import duties and taxes from capital andoperating costs and adjusting energy costs to reflect their efficiencyvalue (para 8.01), the following adjustments were made to financial pricesto arrive at the economic rate of return: (a) Chlorine has been valued atits marginal cost of production (USS 25 per ton), after deducting the valueof its by-product, caustic soda (sold to the alumina industry at US$200 perton); this assumption is justified by the fact that BVK's existing chlorinefacilities are at present underutilized; and (b) carbon monoxide, a bypro-duct of existing ammonia production has been priced at fuel equivalent (US$41 per ton). However, it is possible that the present old ammonia plantwill be replaced (which could occur by 1992). In a modern unit carbonmonoxide will not be a by-product from the process and it will have to bemanufactured (at a small additional capital cost) from synthesis gasdiverted from ammonia production. Beyond 1992, carbon monoxide has conse-quently been valued at the price of ammonia production foregone CUSS 150per ton).

B. Economic Rates of Return and Net Present Value

8.10 ERRs and net present values for each one of the subprojects aresummarized in Annex 7-2. ERRs, which are all acceptable, vary between 19%

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C. Sensitivity Analysis

8.11 A series of tests were carried out on each subproject, which aresummarized in Annex 8-1. For the pharmaceutical subprojects, the mainrisks include a faster rate of obsolescence than expected, resulting insteeper price declines. These adverse effects are generally compensated byoften changing production plans and continuous product development andappropriate R&D allocations have been included for that purpose. It would,however, require a 20% further decrease in revenues, or a 30% increase inoperating costs for some subprojects to become uneconomic (the EgisVeterinary Preparations and the Biogal Surgical Plasters subprojects).This is unlikely though, because of the stringent assumptions used in thebase case (at least 3% annual price decrease in real terms).

8.12 Regarding the MDI investment, the subproject shows most sensiti-vity to the price of aniline, its main raw material, and of MDI (Annex 8-1,page 2). However, given the world overcapacity of aniline production, andthe planned contractual arrangements between Hungary and Czechoslovakia, itis unlikely that prices of aniline will increase substantially over thecoming 10 years and the subproject remains justified even with a 50%increase in aniline prices (USS 900 per ton). As explained earlier (para8.07), MDI prices are expected to recover from their presently depressedlevel by 1987. However, even if they were to remain constant at presentlevels, the subproject would still be economically justified. MDI pricesmay also be below expected levels if BVK fails to develop systems and hasto sell straight MDI to systems houses at a discount (estimated at about10% below levels shown in para 3.16), in which case, the economic rate ofreturn would decrease to 14%. On the other hand, the markup on MDI ifinnovative systems are successfully developed may increase significantlythe returns of the subproject.

D. Foreign Exchange Savings

8.13 Net CC savings and earnings prior to repayment of the foreigndebt (CC) incurred under the project are estimated at about USS105.8million per year at Project completion. These savings result from aboutUS$90.5 million of increased exports (net of associated incremental rawmaterials imports) and US$15.3 million of import savings (raw materials andintermediates). A breakdown of these earnings and savings by subproject isprovided in Annex 8-2. Since the foreign exchange component of the Projectis estimated at US$132.3 million, the foreign exchange pay-back period forthe Project is less than 2 years.

E. Other Benefits and Policy Measures

8.14 Important energy savings are expected from t'-e availability inHungary of MDI-based insulation material for the building industry. Assum-ing that 40% of the domestic MDI consumption is used for buildinginsulation, energy savings may be estimated at between 60,000 and 120,000tons of oil equivalent (TOEs) per year. Such savings could result inadditional foreign exchange savings (net of imported materials required formanufacturing PUs) of about USS 4 to 8 million per year.

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8.15 The proposed measures leading to the removal of obsolescent drugsfrom compulsory production or proper compensation of pharmaceutical compa-nies (para 2.26) should help improve their profitability. The proposedfunding of clinical trials and registration expenses abroad at terms andconditions consistent with those charged for investment in fixed assets,and the associated assurance that the Government will provide the foreignexchange necessary for the subsequent marketing of the successfullyregistered products will reflect a new recognition of the importance ofmarketing activities in the pharmaceutical industry.

IX. AGREEMENTS

9.01 The following assurances and agreements have been obtained fromthe Government, NBH and the Project entities:

A. From the Government that it will:

(a) take action as specified in Para 2.26 to promptly removeobsolescent drugs from the list of drugs which the companieshave the obligation to produce or compensate them for lossesincurred in their production (paras 2.25 and 2.26);

Cb) take all action (including the enactment of new airpollution regulations and the provision means for theirenforcement) to ensure that the subprojects are carried outin accordance with environment, health and safety standardssatisfactory to the Bank (para 5.14);

Cc) make available funds and other resources required for thecompletion of air incinerator in the North Eastern part ofHungary prior to the end of January 1989 (para 5.15); andprovide its share of financing for the Dorog incinerator sothat Gedeon Richter can complete it by January 1989 (para6.04);

(d) make the foreign exchange required for the actual marketingof the products selected for the pharmaceutical pilotpre-marketing operation available to the companies at theproper time (para 5.25);

(e) maintain a coordination office for the Project withfunctions as detailed in Para 5.31;

(f) make available to NBTi the foreign exchange required tocomplete the Project (para 6.04);

(g) provide the necessary funds to complete the studies andtraining program (para 6.04);

(h) ensure that consultants for the studies referred to in para5.27 are contracted not later than by the end of June 1986;that the strategic planning specialists are contracted bythe end of June 1986 (para 5.30); and that all consultantsare selected in accordance with Bank Guidelines and on terms

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and conditions satisfactory to the Bank (para 6.03); and

(i) follow auditing and reporting requirements as stipulated inparas 7.05 and 7.06.

B. From NBE that it will:

(a) make available to the Project entities the foreign exchangerequired to complete the project; and provide its share oflocal funds required to complete the Project (para 6.04);

(b) make subloans to Project entities at terms and conditionsspecified in paras 6.07 and 6.08;

(c) submit to the Bank for review a list or lists of procur_mentpackages for financing under the loan (para 6.10);

(d) follow auditing and reporting requirements as stipulated inparas 7.05 and 7.06.

C. From the Project entities that:

(a) BVK will submit to the Bank for review a comprehensivemarket plan, including detailed marketing arrangements, forMDI-based polyurethane systems no later than June 1987 (para3.17); and for that purpose will hire specializedconsultants no later than by the end of June 1986 (para5.09);

(b) BVK would present to the Bank, no later than by December1985 a proposal satisfactory to the Bank on the managementstructure of the polyurethane activity (para 4.07);

(c) BVK will contract foreign engineering services for the MDIplant no later than by end of August 1985 (para 5.12);

(d) all entities will ensure that all Project facilities aredesigned and operated in accordance with environment, healthand safety regulations satisfactory to the Bank and withdesign features agreed upon with the Bank (para 5.14 andAnnex 5-3);

(e) Gedeon Richter will complete the organic waste incineratorat Dorog prior to January 1989 (para 5.15);

(f) Chinoin will carry out a Hazard and Operability Study forthe design of the pyrethroid facilities prior to completionof detailed engineering and for that purpose will contractconsultants acceptable to the Bank and will implement therecommendations arising from the study prior to plantstart-up (para 5.17);

(g) BVK will carry out (a) a Hazard and Operability Study forthe phosgene plant; (b) a Hazard and Operability Study forthe MDI plant; (c) a Risk Assessment Study for the MDI,

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phosgene, and related facilities; (d) carry out such studiesand analysis prior to completion of detailed engineering forthe Hazard and Operability Studies and prior to mechanicalcompletion for the Risk Assessment Study using specializedinternational consultants, where required, on terms andconditions satisfactory to the Bank; forward the studies tothe Bank for review and (e) implement their recommendationsprior to the MDI plant start-up (para 5.17);

(h) Gedeon Richter, Chinoin, Egis and Biogal will complete thedraft plan of action for the pre-marketing operation byDecember 31, 1985; and recruit a consultant for its reviewby March 30, 1986 (para 5.27);

(i) all entities will promptly provide their share of financingfor the various components (para 6.04);

(j) BVK, Gedeon Richter, Chinoin, Egis, Biogal and Nitrokemiawill maintain financial ratios as specified in para 7.04;

tk) the relevant entities will ensure that the consultantsreferred to in paras 6.03 (ii), (iii), (v) and (vi) areselected according to Bank Guidelines and on terms andconditions satisfactory to the Bank;

(1) all entities will foilow auditing and reporting requirementsas detailed in paras 7.05 and 7.06.

9.02 The signing of subsidiary loan agreements between NBH and SDB andbetween NBH and the Government and of subloan agreements between NBH (BVK,and Gedeon Richter, Chinoin, Egis and Biogal satisfactory to the Bank, asset out in para 6.06 and the establishment of the Project CoordinationOffice (para 5.30) will be a conditions of effectiveness. The signing ofsubloan agreements between NBH and Nitrokemia, Reanal, Caola, NEVIKI, GYKIand VEGYTERV and between SDB and Gedeon Richter; and of a marketingcontract for the Pyrethroids subproject would be conditions ofdisbursements under the respective subprojects.

9.03 On the basis of the staff appraisal and the aboverecommendations, the Project is considered suitable for a Bank loan ofUS$73 million at the Bank's variable interest rate, for 15 years includingthree of grace. The establishment of a Revolving Fund of US$5 million(para 6.12) is recommended under the proposed loan. This loan would bemade to the National Bank of Hungary (NBH) and would be guaranteed by theGovernment.

Industry DepartmentFebruary 1985

- 5I -

ANNEX 2-1Page 1 of 4

HUNGARY

FINE CHEMICALS PROJECT

THE CHeMICAL SUBSECTOR

Table 1 - GROSS PRODUCTION VALUE AND VALUE ADDED OF MANUFACTURINGAND CHEMICAL INDUSTRIES

(in coastant prices)Billion Forints

---- 1976 prices--- -- 1981 prices----1960 1970 1975 1980 1980 1981 1982

Gross Production Value

Total Manufacturing 294.7 424.9* 582.2 688.7 876.3 899.9 922.7Chemical Ind. 16.8 55.4 91.4 124.4 197.8 202.4 205.5(Z) (5.7) (13.0) (15.7) (18.1) (22.6) (22.5) (22.3)

Value Added

Total Manufacturing a.a. 115.3 168.5 210.6 186.7 201.7 213.5Chemical Ind. n.a. n.a. 28.0 38.2 28.6 30.2 32.4(Z) n.a. n.a. (16.6) (18.2) (15.3) (15.0) (15.2)

Source: Central Statistical Office, Statistical Yearbooks.

* - Estimated.

Table 2 - ANNUAL GROWTH RATES OF GROSS PRODUCTIONVALUE OF INDUSTRIAL SUBSECTORS - 1970-82

Constant 1980 prices (Z)

Growth Rate1970-80 1980-82

Industry Total 4.8 2.6

Mining 1.3 -0.1Metallury 3.3 -2.4Engineering 5.5 4.9Building Materials 4.7 0.1Chemical Industry 8.4 2.0Light Industry 3.9 1.3Food Industry 4.0 3.8Others - -

Source: Central Statistical Office, Statistical Yearbooks.

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ANNEX 2-1Page 2 of 4

HUNGARY

FINE CHEMICALS PROJECT

THE CHEMICAL SUBSECTOR

CHEMICAL INDUSTRY

Table 3 - GROSS PRODUCTION VALUE BY BRANCHES, 1982

zIncluding Excluding

Ref ining and Refining andMillion Town Gas Town GasForints Production Production

Refining 87,899 40.3Town gas production 20,165 9.3 -

Inorganic chemicalsa/ 5,185 2.4 4.7Fertilizers 13,790 6.3 12.6Basic and intermediate

petrochemicalsb/ 28,442 13.1 25.9Plastics processing 13,174 6.0 12.0Pharmaceuticals 19,554 8.9 17.8Plant protection chemicals 8,382 3.8 7.6Other fine chemicals 9,219 4.2 8.4Rubber processing 7,742 3.6 7.0Non-chemical activities 4.374 2.1 4.0

Total 217,896 100.0 100.0

Source: VEGYTERV (from data provided by the Centeral Statistical Officeand enterprises).

a/ Caustic soda, chlorine, industrial gases.bI Olefins, aromatics, intermediates, monomers and polymers (for

plastics, resins and fibres).

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ANNEX 2-1Page 3 of 4

HUNGARY

FINE CHEMIC;LS PROJECT

THE CHEMICAL SUBSECIDR

Table 4 - ANNUAL GROWTH RATESIN GROSS PRODUCTION VALUE OF VARIOUS CHEMICAL BRANCHES

(in constant prices)

1970-78 1979 1980 1981 1982

Petroleum refining 5.5 5.5 -9.0 -1.6 -0.2Town gas manufacturing 10.5 3.2 17.3 7.8 10.4Organic and inorganic chemicalsa/ 2.2b/ 2 2b,Fertilizer and plant protection 12.2 9.2 1.5 1 3 1, 1*3b/Synthetic chemicalscI 2.8' 2.8 oProcessing of synthietic chemicals 9.5 2.6 -2.5Pharmaceuticals 13.5 5.7 -0.6 12.3 7.1Rubber processing 10.9 0.5 -2.9 1.3 -3.7Household chemicals and comestics n.a. n.a. n.a. 11.1b/ 1 1.1 b

Total Chemical Industry 9.6 5.9 -2.2 2.9 2.0

Source: Central Statistical Office, Industrial Statistical Yearbooks.

a/ Esentially: Inorganic: Chlorine, caustic soda, industrial gases,sulfuric and nitric acids.

Organic: Olefins and aromatics, petrochemicalintermediates, and monomers.

b/ Average annual growth rate between 1980 and 1982.c/ Polymers (for plastics, resins, fibres, paints, varnishes, etc.)

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ANNEX 2-1Page 4 of 4

HUNGARY

FINE CHEMICALS PROJECT

THE CHEMICAL SUBSECTOR

Table 5 - STRUCTURE OF ImPORTS AND EXPORTS OF THE CHEMICAL INDUSTRY - 1982(billion Forints)

Imports ExportsRuble Convertible Ruble ConvertibleTrade Currencies Total Trade Currencies Total

Raw materialsa/ 4.5 7.7 12.2 0.6 3.0 3.6Intermediates7sem-finished products 9.3 32.0 41.3 6.7 19.0 25.7Finished products 8.5 2.0 10.5 8.3 4.9 13.2

Total 22.3 41.7 64.0 15.6 26.9 42.5

a/ Excluding crude oil and fuels.

Source: Statistical Yearbook of External Trade, 1982.

Industry DepartmentDecember 1984

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ANNEX 2-2

HUNGARY

FINE CHEMICALS PROJECT

THE REGULATORY SYSTEM FOR APPROVAL OF NEW PHARMACEUTIVAL PRODUCTS

1. Most countries require that new pharmaceutical products, beforebeing allowed to go on sale, should be approved by their regulatoryauthorities. To receive such approval, the product will need to satisfythe authorities on safety, quality and efficacy standards. The initialprocess consists of ensuring that a New Chemical Entity (NCE) passescertain ..pecific pharmacological and toxicological tests in animals. Onlywhen these tests have been completed successfully can an application bemade to the authorities for clinical trials in humans to commence.

2. Phase I clinical trials involve testing the NCE on healthy humanvolunteers under very carefully controlled conditions. Phase II clinicaltrials involve testing the NCE, also under carefully controlled conditions,on a limited number of patients suffering from the condition which the drugis intended to alleviate. These trials include double-blind techniques toensure objectivity. Phase III clinical trials involve testing the NCE on amuch larger sample of patients (500-1,000) under normal hospitalconditions, and only when these trials have been successfully concluded canthe dossier requesting regulatory approval for marketing be put forward tothe authorities. Typically, the whole process can take from eight totwelve years and the clinical trials alone can take up to seven years andcost anything between $5 million and $10 million in Western Europe (andconsiderably more in the U.S.). Apart from government approval, each setof clinical trials needs to be agreed with 'ethical' committees (whichinclude laymen) where the risks involved are fully explained.

3. After marketing, there is an additional process of Phase IVtrials and post-marketing surveillance studies so as to pick up any sideeffects of adverse reactions that have not been made apparent duringearlier clinical trials because of the limited number of patients involved.

4. The total cost of marketing a NCE includes toxicological andpharmacological testing and also takes account of the fact that out ofevery ten to fifteen thousand substances studied for biological activity(screening process at the research stage), only one goes forward forfurther development. Also that out of every 8 drugs that reach theclinical stage only one reaches the market.

Industry DepartmentDecember 1984

- 56 -

ANNEX 3-1

HUNGARY

FINE CHEMICALS PROJECT

PAST AND PROJECTED WORLD PHARMACEUTICAL TRADE ANDHUNGARIAN CC EXPORTS

(US$ million)in 1984 Constant Terms

Developed DevelopingCountries Countries Total

World Imports (Market Economies)

1980a/ 8,900 4,300 13,200199ov-/ 13,300 7,200 20,500Incremental Imports 4,400 2,900 7,300

Hungarian CC Exports

1983a/ 71 48 1191990 99 87 186of which:Incremental Exports fromthe Project 28 39 67

Hungarian CC Sales as Z of World Imports

1983 0.8 1.1 0.91990 0.7 1.2 0.9

Hungarian Incremental CC Sales as Z ofWorld Incremental Imports

(1983-1990) 0.6 1.3 0.9

a/ Adjusted to 1984 prices using the Unit Value Index of ManufacturedExports.

bI Assuming that world trade continues to grow at the same pace as worldproduction (and consumption); that the latter grows at 4.5% per yearin real terms; and that the distribution of imports betweendeveloped and developing countries remains identical.

Sources: For actual data - U.N. Yearbook of International TradeStatistics, as adjusted as indicated above, and MEDIMPEX (forHungarian data). For projections - Bank estimates, based on thereview of UNCTAD, industry and independent consultants sources.

Industry DepartmentJanuary 1985

- 57 -

AMUC 3-2

FfE AS PW

MJEBD W.1W CWIPUR AND Nl2NxL s (F M UTEES P XimW= B! lSERiMCiCLAS

Ofimon US$)

* brld aounu±Lon Project Inmertal Outpitin contant 1980 tens in Z Of

AchLal Pro 1984 a/ 1990 n i11980 1990 lacren. TePn Deid Rt

&bman Use

&azdiorasculars 13,100 25,000 11,900 14 0.1 0.2Ati-Ifetie

hiti-cancer 14,700 24,300 9,600 30 0.2 0.5InterLl liine 11,900 16,800 4,900 - - -Pain Coatrol 11,100 16,300 5,200 2 ... 0.1Nutritioca 6,000 10,400 4,400 11 0.2 0.4Ppfratory 6,400 9,100 2,70 ... -Mental Health 6,300 8,800 2,500 1 ... 0.1Otler 12,200 19,400 7,200 22 0.2 0.5

Total 81,700 130,000 48,300 80 0.1 0.2

Veeiay UsAitibacterial 2,000(82) 4,075 2,075 3 0.1 0.2dAt1bJmdntirs 450 2,320 1,870 4 0.3 0.3

a/ Mhese values sbor little cionge ih deflated by the tLit Value Tndex of -enufactred~cport t brig 2n to 1980 tem,

.. ie te US$0.5 mnl1isn.

Source: Actu1 and Projected Irld onstmptim of Drugs for PAne Use: Arkw D. LittleProect outpit: Subprojects uiret stdies.Drog for Veteriary Use: Medbwcex Veterinary Study - 1983.

LO& try eprtlntecember 1984

- 58 -

ANNEX 3-3

HUNGARY

FINE CHEMICALS PROJECT

PAST AND PROJECTED GROWTH OF HUNGARIANPHARMACEUTICAL SALES AND EXPORT - 1983 - 1990

(millions US$)

In Constant In Current Average Annual Growth1984 Terms Terms Rate (Current Terms) (Z)

1983 1990 1983 1990 1975-83 1983-90

Total Sales 425 503 411 767 10 8of which: Project (-) (92) (-) (138)

Other (425) (425) (411) (629)

Total Exports 300 385 290 570 9 9of which: Project (-) (85) - -Z128)

Other (300) (3,000) (290) (442)

CC Exports 119 182 115 279 9 12of which: Project (-) 67 - (103)

Other 119 119 (115) (176)

World Sales Annual Growth(in current terms) 15a/ 12b/

a/ 1975-90 Actualbl Projected 1980-90

Industry DepartmentJanuary 1985

- 59 -

ANNEX 3-4

HUNGARY

FINE CHEMICALS PROJECT

ESTIMATED INCREMENTAL PHARMACEUTICAL SALES FROM THE PROJECTBY TYPE OF PRODUCTS AND MARKETS - 1990

(Million US$)in 1984 constant terms

-- … …--Destination of Sales-----Domestic CMEA Conv. Currency Countries

Type of Product Market Countries Developed Developing Total

A. Active Ingredients

Generics 1.0 1.2 3.0 3.4 8.6Own Process Patent 0.7 1.1 1.2 1.3 4.3Manufactured underlicense 1.7 0.2 1.7 1.0 4.6

Originals 0.2 1.4 13.2 - 14.8

Sub-total 3.6 3.9 19.1 5.7 32.3

B. Formulations

Generics 4.4 5.2 6.1 29.6 45.3Own Process Patent 0.2 1.3 2.6 1.8 5.9Manufactured underlicense 2.3 2.9 0.1 0.8 6.1

Originals 0.1 1.7 0.2 0.8 2.8

Sub-total 7.0 11.1 9.0 33.0 60.1

Total 10.5 15.0 28.1 38.7 92.3

industry DepartmentDecember 1984

- 60 -

ANIES 3-5

HUNGARY

FINE CHEMICALS PROJECT

ESTIMTED L PAMACEUTICAL SALES FROM THE PROJECTBY THERAPEUTIC CLASSES - 1990

(uj111Dion USS)

Active Ingredients Formlations TotalNo. Value No. Value Value

Drugs for }mmn Use

Ant-infcstivers 3 5.4 13 22.6 28.0Cardiovasculars 5 7.0 7 6.7 13.7Vitamns - - 3 10.6 10.6Osteoporosis 1 6.8 - - 6.8muscle relaants 1 4.7 L 1.0 5.7Gastroirtestl1al - - 3 2.9 2.9Antiparklnsonisi 1 2.0 - - 2.0Dermatological 1 1.4 - - 1.4Cytostatics - - 1 2.0 2.0Anaesthetics - - 3 1.7 1.7Antiallergics - - 2 1.0 1.0Phychotherapeutics - - 3 0.6 0.6Analgesics - - 1 0.5 0.5Respiratory Tract - - 1 0.4 0.4Oxytocics - - 1 0.5 0.5Hormones- - - 1 0.1 0.1Other - - - 0.6 0.6Diagnostic Agents _ - - 1.6 1.6

Sub-total 12 27.3 -0 52.8 80.1

Drugs for Veterinary Use

Aatheluintics (hatiinfectives) 2 2.6 1 0.7 3.3Antibacterial (Antiinfectives) 3 2.4 3 1.5 3.9Ozytocics - - 1 4.9 4.9Anaesthetics - - 1 0.2 0.2

Sub-total 5 5.0 6 7.3 12.3

Total 17 32.3 46 60.1 92.4

Industry DepartmentDecember L984

- 61 -

ANNEX 3-6

HUNGARY

FINE CHEMICALS PROJECT

IDI - ESTDIATED MARKETS FOR PROJECTED OUTPUT(thousand tons per year)

1988 1989 1990 1995

Domestic Sales 4.5 5.0 5.5 7.5Exchanges with:Czechoslovakia 3.2 3.9 4.1 4.1Yugoslavia 4.8 5.6 6.4 6.4

Other exports 2.5 5.5 7.8 5.8

Total Output 15.0 20.0 23.8 a/ 23.8 a/

Source: Arthur D. Little.

a/ Assuming that the plant is operated at 95% of capacity.

Industry DepartmentJanuary 1985

- 62 -

ANNEX 3-7

HUGARY

FINE CHENIC&S PROJECT

IO1 EXCHANGE RESINSACTUAL PROOWCTION. PROJECTED WORLD MAKET IEQuIREMEINTS AM SUPPLY

AND DESTINATION OF PROJECT OUTPUT(thousand =.-I)

ProjectedWorld NITROKEIA Incre-

World Require- Esti- mentalProduction ments and mated Projected Project

in 1983 Supply a/ Sales Sales Output(Actual) 1990 1984 1990

Hungary 1,200 2,000 800Western Europe 63,500 75,000 700 5,800 5,100North America 72,500 82,500 1,820 3,200 1,380Other CC Countries 25,000 27,500 - 1,500 1,500CMEA 6 5 ,0 0 0 b/ 85 ,000/ 2.300 3,000 700

Total 226,000 270,000 5,020 15,500 9,480

Source: Nitrokemia.

a/ 'Including from the project.bI Including Hungary.

Industry DepartmentJanuary 1985

- 63 -

ANNEX 4-1Page 1

NEZIONAL BANr OF UNGARY - FNANCIAL STATEMIEW (1979-83)A - BALANCE SHEET

(as of December 31)

(Billion Forints)

1979 1980 1981 1982 1983

Assets

Gold, currency. foreign exchangeholdings, secure. & accounts 74.8 78.4 65.1 38.9 78.5

Advances, loans & creditsMedium & long term:Banks 143.7 152.6 162.2 170.6 170.4Enterprises 185.8 188.7 189.5 185.7 186.6State budget 20.3 23.7 26.7 31.7 32.4Subtotal 349.8 365.0 378.4. 388.0 389.6

short-tern credit:Banks 17.8 19.2 24.8 37.4 33.7Enterprises 75.4 92.0 103.0 114.2 120.4State budget 0.5 0.6 0.3 0.9 1.0Subtotal 93.7 111.8 128.9 152.6 155.1

Other Assets 28.1 26.4 27.3 68.1 84.7Total Assets 546.4 581.6 599.7 647.6 707.9

Liabilities & Equity

Authorized capital 6.0 6.0 6.0 6.0 6.0Reserves 2.1 2.3 3.5 4.4 4.5Profit 10.4 9.8 10.5 7.5 13.0

Total Equity 18.5 18.1 20.0 17.9 23.5

Term deposits:Banks 215.6 219.8 225.2 297.8 291.7Enterprises 80.2 88.5 90.9 46.1 41.1State budget 1.5 1.3 1.8 1.9 7.0Subtotal 297.3 309.6 317.9 345.8 339.8

Sight deposits and accountsBanks 79.8 82.8 84.7 68.2 82.0Enterprises 60.5 67.4 70.0 79.6 78.5State budget 10.8 12.6 6.0 8.6 9.6Other 8.5 -10.6 10.5 10.9 10.8Subtotal 159.6 173.4 171.2 167.4 181.0

Notes and coins 63.5 72.8 81.3 87.3 97.9ID Deposits - - - - 46.7Other liabilities 7.5 7.7 9.3 29.2 19.0Total liabilities & equity 546.4 581.6 599.7 647.6 707.9

- m

Source: National Bank of Hungary

Industry DepartmentDecember 1984

-64-

ANNEX 4-1Page 2

NATIONAL BANK OF HUNGARY - FINANCIAL STATEMENTS (1979-83)B -INCOME STATEMENT (1979-83)

(as of December 31)

(Billion Forints)

1979 1980 1981 1982 1983

Income

Interest earned 37.2 41.5 45.3 51.9 54.2Commissions charged 4.3 4.6 5.2 5.2 6.3Fees, charges and other 0.5 0.5 0.3 0.2 0.4

Total 42.1 46.6 50.8 57.3 60.9

Expenditures

Expenditures on moneycirculation 0.7 0.6 0.7 1.0 0.9Interest 30.0 35.0 37.9 47.3 45.3Commissions 0.2 0.2 0.5 0.4 0.6Ad&inistrative costs andother costs 0.8 0.9 1.2 1.1 1.1

Total 31.7 36.7 40.3 49.8 47.9

Profit 10.4 9.9 10.5 7.5 13.0

Total 42.1 46.6 50.8 57.3 60.9

Source: National Bank of Hungary

Industry DepartmentDecember 1984

- 65 -

ANNEX 4-2Page 1 of 7

HUNGARY

FINE CHEMICALS PROJECT

THE PROJECT ENTITIES

A. Production Enterprises

(a) Borsod Chemical Works (BVK)

1. BVK, which is located near Miscolc, in the northeastern part ofHungary (map), was founded in 1949 and is today the second largest petro-chemical enterprise of Hungary. It employs a total of 6,700 workers.Total sales in 1983 amounted to over Ft 10 billion (US$206 million). BVKis essentially a producer of commodity chemicals. PVC products andfertilizer are its major activities, accounting in 1983 for 58Z and 16Z ofsales, respectively. Other activities include plastic processing (15%), acaprolactam plant (to be shut down soon), plasticizers for PVC and variousintermediates for plant protection chemicals and pharmaceuticals.

2. In spite of high capacity utilization, increased production andefforts to save energy and to develop downstream products, profitabilitydeclined significantly in 1982 and 1983 due to the combined effect ofimportant world price decreases in both fertilizers and plastics in theearly 80s. Ex-factory PVC prices, in particular, dropped from US$750 perton of PVC powder in 1981 to US$300 per ton in 1983. Although recovering(US$500 to US$550 in 1984), they were at the time of appraisal stillsignificantly lower than in 1981. Lower than expected profits strained thecompany' s cash flow to such an extent that, in 1984, it was unable to repaythe accrued maturity on the large outstanding debt with the StateDevelopment Bank (Ft 4.5 billion as of end of December 1984), which wascontracted to finance the VCM plant and associated chlorine and PVC plants,all of which were commissioned in 1978. In December 1984, the Governmentresolved to reschedule repayments of the outst:anJing debt. Payments ofmaturities due in the years 1985 through 1987 have been spread over theperiod 1985 through 1990 and associated incremental interest paymentsincurred as a result of this rescheduling will be paid to SDB out ofGovernment funds. The company is now in a financial condition soundenough to implement the MDI investment. Diversification into the produc-tion of MDI-based polyurethanes is considered by the Government and theCompany as a means of decreasing the company's dependence on fertilizer andplastics world market fluctuations and help restore the company's profita-bility.

3. BVK is organized functionally into five divisions (technical,financial, commercial, personnel and legal, and planning and investments),headed by deputy managers. Because of the critical need for continuousfeedback between marketing operations and product development, flexibilityin management is essential, which the integration of MDI operations inBVK's functional lines may not allow to the extent required. Consequently,while the investment department would be in charge of implementing the MDIproject, the MDI activity would be subsequently organized into a businessarea or a subsidiary, with its own management gathering all the production,

- 66 -

ANNEX 4-2Page 2 of 7

R&D and marketing and market follow-up functions for the company'spolyurethane operations. Assurances were obtained that, by December 1985,BVK would present a proposal, acceptable to the Bank, to that effect (para4.07).

(b) The Pharmaceutical Companies

4. The essential features of the five pharmaceutical companies aresummarized below:

Key Features of the Pharmaceutical Companies(1983)

GedeonRichter Chinoin Egyt Biogal Reanal

Date of Creation 1901 1910 1912 1951 1930

Staffing

Total 5,700 4,890 3,800 2,100 520R and D Department 820 497 340 182 25of which - graduatescientists 320 224 152 64 17

Total Sales (US$ million) 184 158 102 69 21

Total R and D spending:

US$ Million a/ 11 7 6 2 n.a.Z of Turnover a/ 6.1 5.2 5.5 3.2 n.a.

Breakdown of Sales (Z)

Pharmaceuticals:Active ingredients 16 17 25 17 -Formulations 74 44 59 45 1

Other activities 10 39 16 38 99 b/

Total 100 100 100 100 100 c/

Domestic Market 22 16 33 66 65CMEA Markets 53 44 37 17 32CC Markets 25 40 30 17 3

Total 100 100 100 100 MC/

a/ 1982b/ Laboratory and analytical chemicalsc/ Excluding Reanal's trading activities.

- 67 -

ANNEX 4-2Page 3 of 7

5. Chemical Works of Gedeon Richter. Gedeon Richter is the oldestand the largest of the pharmaceutial companies. It has its headquartersand main production facilities in Budapest and factories in three otherlocations (Dorog, Szazhalombatta and Tiszafured). Total sales in 1983amounted to US$8.3 billion (US$184 million). Pharmaceuticals represent 90%of total sales. Other products, including herbicides, cosmetics and animalfeed additives, account for the balance. The company accounts for 392 oftotal Hungarian production of pharmaceuticals, but less than 3% ofHungarian production of herbicides and cosmetics. The company produces alarge variety of active substances (300) and formulated products (250) in153 different therapeutic groups. It is a pioneer and a world leading pro-ducer of steroids (hormones), which account for about 30Z of total produc-tion value. Other strong areas include drugs in the cerebrovascular,cardiovascular and chemotherapeutic groups. Original products account for17Z of the company's total sales, specialties produced under license for22% and imitative drugs and generics for the balance (612). Under the Pro-ject, the company will modernize and expand its manufacturing facilitiesfor steroids and revamp and expand its injection making facilities to bringthem up to GMP standards. It will also be responsible for carrying out theproposed waste incinerator subproject (para 5.04).

6. Chemical and Pharmaceutical Works Ltd. Chinoin. Chinoin is todaythe second largest pharmaceutical company in Hungary. Its head offices andmain production facilities are in Budapest (Ujpest). It also has plantslocated in three other sites (Vac, Nagyteteny and Diosgyor). In 1983,total revenues amounted to Ft 7.1 billion (US$158 million). Pharmaceuti-cals accounted for 60% of the total, plant protection chemicals for 342 andintermediates for 6%. Diversification into plant protection chemicals isrelatively recent, since these accounted for only 2.5Z of total revenues in1970 and 15% in 1975; in this area, Chinoin has specialized in the produc-tion of fungicides and insecticides (pyrethroids). Chinoin is today amongthe 3 largest producers of plant protection chemicals in Hungary. LikeGedeon Richter, Chinoin produces a wide variety of pharmaceutical special-ties and active ingredients in many different therapeutic groups. It isespecially strong in the production of spasmolytics, cytostatics, anti-infectives and cardiovasculars. Under the Project, Chinoin will expand itsinjections making facilities, its fermentation plant (for antibiotics), itssynthesis plants (for active ingredients in various therapeutic groups) andthe production of pyrethroids and their intermediates (paras 5.05 and5.08).

7. Egis Pharmaceutical Works. Egis's headquarters and mainproduction facilities are located in Budapest. Its other factories arelocated at Kormend. Total net sales amounted to Ft 4.6 billion in 1983(US$102 million). Pharmaceuticals for human use constitute about 852 oftotal sales, veterinary drugs about 52, food preparations for infants about72 and other products about 3%. Egis produces a total of about 140different preparations. Among drugs for human use, the most important arespasmolytics, anti-infectives, psychotropics and cardiovasculars. Underthe Project, Egis will expand and bring its liquid formulation facilitiesup to GMP standards, and increase its production of cardiovasculars andveterinary preparations (para 5.06).

- 68 -

ANNEX 4-2Page 4 of 7

8. Biogal Pharmaceutical Works. Biogal was founded in 1951. It islocated at Debrecen, in the North Eastern part of Hungary. Total sales in1983 amounted to Ft 3.1 billion (US$69 million). Pharmaceuticals representabout two-thirds of the company's turnover, including veterinary drugs(about 14%). Other manufacturing activities include animal food supple-ments (17%), surgical plasters and cosmetics (16%). The company's mainlines are the production of antibiotics, galenicals and enzymes. Under theProject, Biogal will expand and bring all its formulation plants up to GMPstandards and expand its synthesis plant for antibiotics (para 5.07).

9. Reanal Factory of Laboratory Chemicals. Since 1954, Reanal hasspecialized in the production of over 1,200 different analytical andlaboratory chemicals and medical diagnostic tests, which together represen-ted 94% of total manufacturing sales in 1983. The company also manu-factures limited quantities of high purity intermediates for plant protec-tion chemicals and pharmaceuticals, and of plant protection chemicals usedfor biological control, which all together account for 6% of total sales.Total revenues in 1983 amounted to Ft 928 million (US$20.6 million). Thecompany also distributes its own as well as imported laboratory anddiagnosis chemicals in Hungary and this trading activity accounted in 1983for about half of total revenues. Under the Project, Reanal will expandits manufacturing capacity of diagnostic tests (para 5.07).

Cc) Other Companies

10. Nitrokemia Industrial Works. Nitrokemia was founded in 1921. Itis located at Fuzfogyartelep, near Lake Balaton. Nitrokeoia has a verydiversified production of a wide range of fine and specialty chemicals andresins. It employs about 4,800 persons, 500 of which work in its R&Ddepartment. In 1983, total sales of the company amounted to about Ft 6billion (US$133 million) and total R&D spending to Ft 180 million (3% oftotal sales). Nitrokemia's wide range of products may be grouped in thefollowing major categories: (a) plant protection chemicals, which repre-sent half of total sales; the company is the largest plant protectionchemical producer in Hungary, accounting for close to 40% of total produc-tion; (b) resins and plastic manufacturing, which account for about 26% oftotal sales, consist for the major part of urea formaldehyde and unsaturat-ed polyester resins, polystyrene foams (from imported polystyrene), and ionexchange resins; (c) inorganic chemicals (chlorine) and a number of inter-mediates partly used in its own production and partly sold (15% of sales)and specialty products such as oil additives, lubricants, nitrocellulosefor lacquers and hunting cartridges (9% of sales). Exports represent about20% of total sales: over half of these exports (US$20 million) are to CCmarkets and the balance to CMEA countries. Under the Project, Nitrokemiawould replace and expand its ion exchange resins production facilities(para 5.10) and increase the capacity of monochloroacetic acid, a key

- 69 -ANNEX 4-2Page 5 of 7

intermediate in the manufacturing of the company's plant protectionchemicals (para 5.08).

11. Factory for Cosmetics and Household Chemicals (CAOLA). Caola wasestablished in 1963 and resulted from the merger of six independentcosmetic enterprises. It is located in Budapest and has 4 factories (3 inBudapest, one in Zalaegerszeg) which produce over a thousand types ofcosmetics and household chemicals. Total staff was 1,617 in 1983. Totalproduction value in 1983 amounted to Ft 2.6 billion (US$57 million), about

e 8% of which was exported, about half to CC areas and half to CMEA coun-tries. Under the Project, Caola would build a sulfonation plant to producenow imported intermediates for cosmetics and fine detergents (para 5.11).

B. Research and other Institutes

12. (a) The Institute for Drug Research (GYKI). GYKI was founded in1950; it has a staff of 850, of which just over 300 are university graduateresearch scientists. Virtually all the work of the Institute is controlledand paid for by the pharmaceutical enterprises through a steering andcoordination committee. The Board of the Institute is made up of theresearch directors of the Pharmaceutical Companies. It closely coordinatesits work with that of the individual research groups of the enterprises. Asmall amount of fundamental work is supported by finance from the Ministryof Industry and OMFB. The Institute's R&D program has shifted increasinglytowards discovering and developing new and original therapeutic compounds.This program led to the establishment of a department within the institutefor testing and screening of new products. New biological laboratorieshave been opened and pharmacological, microbiological, toxicological,teralogical and pharma-kinetic groups established. The Institute hasentered into a joint venture in animal husbandry to breed the necessaryanimals for the tests.

13. The future program of the Institute is dedicated to R&D inpharmaceuticals for which the increased average age of developed countriespopulation should lead to a rising demand. The four main areas of R&D are:(a) cardiovasculars; (b) chemotherapeutics; (c) drugs for the centralnervous system; and (d) oligopeptides (anticoagulants, etc.). The Insti-tute has cooperative agreements with organizations outside Hungary, includ-ing the USSR Antibiotics Research Institute and similar organizations inPoland and the GDR, with the Karolinska Institute in Sweden, and with theR&D departments of some TNCs including Hoechst, Montedison and severalother TNCs.

14. The Institute's facilities now meet international Good LaboratoryPractice (GLP) standards, Some U.S. firms have already commissioned toxi-cological trials on their own prcducts from the Institute, which willshortly be capable of carrying out virtually all pharmacological and toxi-cological tests (Annex 2-2); currently long-term toxicological trials stillhave to be carried out by overseas laboratories, but this situation will berectified in the next 2-3 years. The Institute must still acquire,however, very modern analytical equipment, of sufficient accuracy to meet

- 70 -

ANNEX 4-2Page 6 of 7

the demands of western regulatory agency tests. This equipment will befinanced under the Project (para 5.19).

15. Total resources of the Institute amounted in 1983 to Ft 230million (US$5.1 million). Half of these resources were derived fromcontracts with enterprises, 25% came from the Central R&D Fund (para 2.34)and the remaining 25% from royalties, license and patent payments, incomefrom joint ventures and profits. The institute reported a profit of Ft 27million in 1983.

16. (b) The Research Institute for Heavy Chemical Industries (NEVIKI).NEVIKI, which is located in Veszprem, was founded in 1949 to provide R&D inthe area of inorganic chemical industries and coal processing. In the1960s, as the importance of inorganics and coal tar derivatives decreased,the Institute's work changed direction and it began to operate in thefollowing main areas: (a) plant protection chemicals and fertilizers;(b) corrosion protection in the chemical and power industries; (c) processcontrol technologies; and (d) air pollution control. Today, more than 60%of the research capacity is spent on R&D work in plant protectives (herbi-cides, rodenticides, insecticides and fungicides) and the Institute is thesole provider of new product screening and testing studies for plantprotection chemicals in Hungary. There is a need to increase this capacityas Hungarian R&D is producing a number of new possible products whichrequire toxicological testing. The required investments will be financedunder the Project (para 5.20).

17. NEVIKI undertakes all stages of testing of plant protectionchemicals, from the analytical screening stage (to determine if a chemicalcompound has any fungicidal, herbicidal or insecticidal properties), to thebiological and toxicological (to determine the toxicological effect of thechemical in several concentrations) and to the testing of effectiveness,application technology and environmental impact under laboratory, green-house, and small- and large-scale field trials. NEVIKI's tests(particularly toxicological) must give positive results before a Hungarianlicense for use can be obtained. The Institute has for many yearscooperated with sister institutes in other socialist countries, and otherresearch projects in plant protection chemicals have been undertaken withpartners--the USSR, GDR, Czechoslovakia and Cuba. Cooperative researchprojects have been and are being undertaken with ICI, Dupont, Chemie Linz,AG and Montedison.

18. NEVIKI employs 467 persons, including 190 research scientists.Total resources of NEVIKI in 1983 amounted to Ft 195 million (US$4.3million), including Ft 111 million from its R&D activities (funds fromenterprise contracts and allocation of central R&D funds), Ft 41 millionfrom industrial process control and development and sales of agriculturalehemicals manufactured on a pilot of semi-commercial scale, and Ft 12million from royalty and other payments on license and know-how. In 1983,NEVIKI reported a net profit of Ft 16 million (US$0.36 million).

- 71 -

ANNEX 4-2Page 7 of 7

(c) Hungarian Chemical Industries Engineering Center (VEGYTERV)

19. VEGYTERV was created in 1950 and is today the major (though notexclusive) design and engineering institute for the chemical industry(except refineries). VEGYTERV has full scope engineering capabilities,including preparation of feasibility studies, basic and detailed design,procurement, organization and supervision of construction and assemblywork. VEGYTERV has a staff of 1,273, including 1,000 engineers andtechnicians. Total income amounted to Ft 451 million in 1983 (US$10million), 822 of which from domestic contracts. VEGYTERV is in need ofmodern designing equipment, which will be financed under the Project(para 5.29).

Industry DepartmentFebruary 1985

- 72 -

ANNEX 4-3HUNCAR

FINE ClElICALS PROJECT

FINANCIAL PERFORMANCE OF PROJECT COMPANIIIS - 1981-83(rmilion Forinta)

Profit Profit Profit over Sales Growth Long Term Debt ServiceTotal Net Before After Before After of Current Debt/Equity CoverageAssets Revenues Tax Tax Tax Tax Sales (2) Ratio Ratio Ratio

1981 13.158.2 8.885.8 731.8 545.( 8.2 6.1 3.2 2.6 51/49 1.41982 13,497.1 9,163.2 286.2 172.9 3.1 1.9 3.1 1.7 48/52 1.21983 12.809.8 t0,305.6 419.8 180.1 4.1 1.7 12.5 1.5 46/54 1.1

Cedeon Richter

1981 7.735.9 6,401.1 715.9 334.7 11.? 5.2 6.8 3.4 32/68 1.21982 8,772.9 7.429.2 1.033.7 439.7 13.9 5.9 16.1 3.2 31/69 2.01983 9,755.3 8,275.5 1,113.7 483.5 13.5 5.8 11.4 2.9 30/70 1.5

Chinoin

1981 5.326.3 5.918.9 462.5 216.2 7.8 3.7 17.6 3.8 11/89 3.e1982 6,214.3 6,251.9 537.9 228.8 8.6 3.7 5.6 2.6 7/93 2.61983 6,772.0 7,120.3 722.8 300.0 10.2 4.2 13.9 3.1 5/95 3.1

EgIS

1981 4,261.2 3,818.5 229.0 94.0 6.0 2.5 5.0/ 2.6 27/73 1.01982 5,025.7 4,177.6 337.9 106.9 8.1 2.6 9.4 2.1 23/771983 5,708.7 4,635.3 537.4 240.1 11.6 5.2 11.0 2.1 18/82 1.4

Biogal

1981 1.683.9 2,000.2 182.4 70.9 9.1 3.5 30.6 2.1 19/81 0.71982 2.142.2 2,559.5 295.1 115.1 11.5 4.5 28.0 2.5 20/80 1.11983 2.792.6 3.098.1 404.1 188.4 13.0 6.1 21.0 2.9 25/75 1.7

Reanal

1981 560.7 821.3 82.3 38.5 10 4.7 27.0-/ 8.0 0/100 1.81982 676.8 859.1 120.5 55.6 14 6.5 4.6 18.5 0/10n above 101983 . 792.1 928.2 87.1 40.5 9.4 4.4 8.n 11.6 0/100 6.0

Nitrokeaia

1981 4.933.5 5,630.0 827.4 431.7 14.7 7.7 12.2a/ 3.4 12/88 2.31982 5,357.9 5.997.0 777.0 375.5 13.0 6.2 6.5 3.1 12/8A 2.91983 5,481.6 6,610.7 969.' 439.0 14.7 6.6 10.2 3.0 13/87 3.0

Caola

1981 1,539.9 2.603.0 456.3 189.1 17.5 7.3 13.1a/ 5.2 11/89 3.61982 1,564.9 2,420.5 359.3 137.7 14.8 5.7 -7.0 5.7 7/93 1.51983 1.599.0 2,558.4 416.4 192.9 16.3 7.5 5.7 4.9 8/92 3.3

a/ Average annual sales growth - 1978-1981.

Industry DepartmentFebruary 1985

- 73 -

H Ann 5-1

rngX amcas PrSCTFINK! 0 IZLWITA flOM UUEIUU

s wq oir rsnez _LO

CD_V Suboroiect TechnologY Esinerins Project tuasesn_t Coe-tructieo

3IOCGL Synthsi-s *iogl 'in o4ue' Vigyterv (1,300 Stagf) bDioIl Iavestment General contractorDept. (26 staff)

Surgical Plasters Eeiersdorf (W. Garrny) Vagyterv (with Ipsrturv as sub- Biogal nd Veyter. Gsneral contractor.contractor

Foralations Not applicable Vegyterv Blogml and Vsgyterv Gsneral contractorwith supply sod erectcontracts for uehof the equip_mt

Dm "Dl *oreign Suppiter F torsig Consultants and Vsgyterv Foreign Cooaultaetsa Approximately It sub-Sr, Inventant Dept. contractors will be(60 istaff) and used. ssnfed andVegytarv coordina ted by BVK's

lnvest_at Depsrtent

CAeLA Sulfonttlon Foreign Supplier Yorsiga Consultants and Vsgyterv Vegyterv with General contractorassistance froeforsigs consultants

CaDUN Pyrsthroids Vegyterv Vegyterv snd lpsrterv Chwisls and Velyterv General coatrectorInsatasr_t Dept.(32 staff)

Injections Not Applicable Vegyterv and lparterv */ Chinoin and Vegyterv General contractorsupply and erectcontrast: !or etchof the equlp_nt

Active Substnces Chinoin 'in house Chinoin Technical Depsrt_nt Chinoin Csral contractor54 Staff

nerewntacion Chinoin 'in house' Vagter'v snd ipecterv Cbinoln and Vegyterv General contractor

ECIS Liquid Forsulations Not Applicable Egis Dsvelopent Departmsnt (40 Egis lnvestsnt General contractor withstaff) with assistance fros local Departsnt (55 staff) supply and erectconsultants 9/ contracte for euch

of the equipsat

Cardiovaeculsr 4im 'in hoa"' Egi (about 702) and Vegyterv (30I) Egis and Vegyterv General Contractor

Veterinary Products Egis 'in house E4li Egls Approximately 5 sub-contractore "aaged

4gi.

SEVlt! Taxicological Not Applieble Vegyterv !l Vagytarv and NEVICI CGnral ceetrector withTesting Facilities (10 staff) om equipent supply

and erect contracts

NITROMIA Ion Exchange BAsins Nitrokeia Vergyterv NltroNeis Investment Approiately S sub-Deprttsnt CR0 stsff) contractors managedsnd Vegyters by litrokheis Dept.

whicb speciliava incoestruction aork.

4onochioroaCetic Dc-lel/Susitoeo Dsciel/Suaitoso with Nitrokesia with assist- Nitrobki- Mechanicalacid (Japan) Vegyterv for offsicsa snce fron Deciell Dept. whicb specializes

Susitoso in construction work

31A1A. Diagnostic Tests Reanal/CGlenophara Veayterv Reanal Inveat_nt CGneral Contractor(Switzerland) Dept. (11 staff) and

Vegytera

RiCiTaR Fer ntation/ Cedeon Richter Gedeon Rlchter Technical Gedeo Richter loest- Csneral ContrectorSteroids 'in house' Dspart_nt (20 staff) with set Dept. (Z4 staff)

civil works by Iparterv and lpartil

Injections Not Applicable Vegyterv */ Vegyterv and Gedeos 2 min contrectors forRicbter civil aed erectiou with

supply and erectionco-tracts for bchof the equip_et

Incinerator Foreign Supplier as Vsgterv. Iparterv and Foreign equipment General contractorpert of equIp_snt Uvarterv sl supplier l and witb sm* quipestcontracts Vegyters on supply ad erect

contracts

A sJDr part of the enioseriog is intrinsic to equipentsupply contracts.

Industry DspartsentFebruary 18N5

7- - -

RNECHOIASRIOJCIpcidSdwdd

1 s 8 J~ 3 4 4 2 2 1 a 2

0- _-__---=_ _

_>WC -p1 1 1 1

D -iv--I I III_7

S-

- L

-I-- II

lm - aowX I

n a--a"o

SwinpU.WIW Op-aw..64

- 75 -

ANNEX 5-3

HUNGAR

FINE CHEUICALS PROJECT

PLANT DESIGN REQUIREMENTS TO MINIMIZE ENVIRONMENTAL PROBLEHS

In the desiga of the subprojects plants, particular attentionwill be paid to incorporating the folo-ing, so that project facilities canconform with acceptable environmental standards:

1. Feeding of solids into batch reactors, above 50 kg perbatch, should be through a closed system. Dustelimination should be incorporated for unloading ofdusty and/or hazardous solids.

Feeding of smaller quantities of solids into reactorscontaining toxic materials during a lengthy period(above 5 minutes), should also be done through a closedsystem.

. Feeding of liquids into batch reactors should always bethrough a clo&ed system.

3. Venting of equipment to atmosphere should always bethrough a recovery or removal system.

4. Closed process buildings should be ventilated. Ten tofifteen volume changes per hour should be applied. Tosave energy, used for air heating during cold seasons,air heat recuperators should be used.

5. Safety relief devices for process systems should bevented to atmosphere through a proper blow downsystem. Lethal emissions to atmosphere should beavoided by using scrubber system or other suitablemeans.

6. Glass walled closed process building should includerelief panels to avoid shattering of glass in the eventof an explosion.

7. Offices and amenity facilities should not be locatedabove process areas.

Industry DepartmentJanuary 1985

- 6 -

Mills e _riam 099 fIlls..

hr.9.A Fmg Total locl seti mrsg rots

A. tro&tctls .uf

-. m

tuu.atlosmlteud. 4ft.70 103.o 590_3 1.13 347 11z.1 31trEuation lnt 709.60 3n9. 1.09.90 14.2 7.80 21.9 35Z

-admragr 715.50 434.10 1 349.60 14.31 8." 6 2.9 =9eb-ttal Turn flR i319 f 3fl Uk

uj_ue Ptant 225.00 270.90 495.0 4.50 5.42 9.92 Suttmumututlo tvie 19.20 72.90 271.10 3.96 1.4 5342 27Xhen.. lagruoilst 170.20 110.20 230.40 3.A0 2.20 5.61 397

tsb-tota nw rw rw 2.

C _rdio,auc.laru t53.90 174.90 330ao 3.12 3.50 6.62 532Formultion t1ut 00.10 15'.ZG 287.10 240 3.14 5.74 55XVat. ftruwuanlms 97.50 90.30 137.40 1.93 1.31 3.76 462

sub-total ur mw -urn -or S." 36. 11 522

3yur0.1. rlit 216.40 119.40 335ao 4.33 2.39 6.72 361omaflatio. flat 537.10 353.60 90B.70 11.14 7.03 18.17 392

SurgImi ti_ter. 105.30 77.0 12.30 2.31 3.54 3.65 42=Sub-total To-. 5 T3 ii r" 2o. W

_S

Dviawelc Trst. 43.30 35.30 80.60 0.91 0.71 1.61 Z1

rural thorms. Iu-ufuts 3.732.ao 244.90 6.199.70 74.6 49.34 124.00 A 0Z

2. tnm_ Prrtselo C zculs

cairnetyntuSas 19.90 86.50 2Z6.40 4.a 1.73 5.73 3DS

tmeblrusecttc Acld 12.80 49.20 82.W 0." 0.98 1.66 GOT

Total tInt crotcunts 232.70 135.70 368.40 4.65 2.71 7.37 37-

3. 3D: _ Palm. S (am 1.09.20 1.3564A 2.765.60 28.16 27.13 55.31 492

_I r.en. Dust CXrMUIDaa) 692.30 237.00 929.50 13.35 4.74 1S. 25X

5. Oienturnt lunterdiat, (CALA) 47.10 56.60 103.70 0.9 1.13 2.07 55

rural nhud ustso 6.116.30 4.252.60 10.366.90 122.29 85.06 207.3n 4I1

ncremental tbitug Caplt 715.60 1D.50 696.10 14.31 3.61 17.92 20X

Trtul tProduet.in Pattllt 6.329.90 4.433.10 11.263.00 136.60 36.67 225.27 402

3. Ros_reh a avllo_ t

Cadmus Uebtat 0.00 41.50 41.90 0.00 0.84 0.84 IO1SCtoAt. 0.30 43.40 43.40 0.00 0.87 0.47 1002

c7t 0.00 41.60 41.0 . 0.00 0.34 0.84 1002cM 0.00 41.0 43.60 0.00 0.64 0.64 IOD1=Wm 149.50 70.60 220.70 3.00 1.42 4.41 mZ

Sub-total 149.50 239.70 369.60 3.0D 4.79 7.79 622

C. tbarseuuttcu tru-Ilthuls 5.00 415.30 420.30 0.10 3.31 3.43 992

D. Studlou. 7rulsE a odals

Ibnftaur study 3.90 2." 6.70 0.0 0.06 0.13 432Plan Caltalm Study 12.50 9.60 22.10 0.25 0.19 G." 432tratugie timing TraIning 6.00 6.00 12.00 0.12 0.12 0.24 302

ncr? hIul Eqpmt 6.30 20.90 29.10 0.17 0.42 0.56 712tb-roaa 30.60 39.30 69.50 VW w .W

TOTAL BA.IS CWT 7.015.40 S.L27.40 12.142.10 340.31 102.54 242.47 422

thyalc-l Cbti_PusE1_a 627.00 454.00 1.061.00 12.54 9.06 21.62 "22ti. Cuc_inguda 1.315A0 1.033.0 2.349.30 26.32 20.67 46.99 44

M50 P tiC COS 3,959.20 3.614.0 135.D73.10 179.16 132.32 311.48 432

tbuary 1965

DATAILED FINANCINO PLAN

-------- - ......... illon Porints ................. .................. illion 's 60-…---- .- …-- ----lib-Leain Sob-l4ons Sub-Loans Sub-LAOngfor Direct for Other Pinioct lot Direct for Dthar Project

-....f wh.ich ---- o.. f n9.lch-.-Total 1330 1111 5DB Lim Sol bolits Couarnmant Total Iai.Oj. iitk- flj LO& LB32_ M0 BooSts flvoyajj 1*

UIQAII AND IPISPJBCT

Prinastatloo/Itaraidu 214.1 02. * 111.0 - 104.1 2102 -21-2.Pormclotion Flint 1l0.0 919.0 - ~~~~~~ ~ ~ ~~~~~~249.0 - ,04. .1 19.4 50,0-1.

Inturoor0062 - 1500,0 041.0 420.0 I.019.7 3,2 3.0 - 10 113 .4 10,9a andD0 021 - il. s

subtotot gur Tn 11Tr" r1 T1T 11 u171 ii:3 1;9T" TM TI7r ti tn 1R7CHINOIN

injection plant 06 1111.9 1 40.0 - 4. .2 1,6 1 .4 -1.

Fermntatoro n Plant 44.S 212.9 - 92.9 - 121 0.9 0.1 - 1.9-1.Agtiva logre4ilinto 100.1 191.0 - 10M. 194.4 2.0 1.9 2.1 1.pyr.throIdo 41.2 101,1 128.9 - 01.0 2.2 0.0 -2,4 -9.4

010. R3 111 OTT ÷ &:4 -r4 nv T.T *R7Y - - 1

Cordlonoocolors 18.1 100,4 210.0 001.9 1.9 1.1 - 1,0 -10.1

Ltquid Foritjiottns III.1 91.1 - 11.0 - 94.0 1.4 1,9 - 2.4 - .9Vat. arprii 91.0 00.0 - 0.0 MA21. 1.9 2,0 1.6 .

tondO 02.4 -~ ~ ~ ~~~~~~~ ~ ~~~~~~~ - 0. 1.o2 - --

subtatal Tin. IU WT- t,21.7 10.2 El7 T.' -

IIIOGALsynthesiso Plant 112.0 251.2 - 0.0 7. 2.2 - .1 1.0 9,0porvuclattn plant 141.n 160.0 211.1 - 2,19.1 6.9 21.1 -4.4 -2,lorirat PI 'store 39.1 48i I - 2.6 - 110. 1.8 I 13 - .1

subtotal TTrT 17E 76T7 T71TfT - IE irn43. TE T.- TrT ~- IPT - -.

Diagnostic Toot 14.4 21.0 11.4 - 41.4 - 21.1 101.1 01.1 0. 0.2 - 0.9 -0.0 - .1

NITROIIIAIsonoclorooalic Arid 00.4 291 - 28.0 -111.9 1.1 0.0 0.4 2.2

Ionlokingo .teet 100.i ____02 1 - 10. (I 1,194.4 1.2 __ _ 10 .:.L - 21 9Subtotal 22. 1, I. TR4202108.1 M. 1T1 0.% - 01,4 - . -1T

Iultonation Plant 09.9 40.0 19.9 - 0.1 - 11,0 -104.2 1.2 0,8 0.4 - 1.? 0,1. ,

M Il! I,02.1 1,110.0 418.1 2,04,42 - 80.0 - ,2. 0.6 22,? 6.4 - 29.9 - 1.2 74.4

Iod0 12.0 11.0 11.4 - 2.4 1.0 0,1 0,1 - - -i0

I nan D 88.0 00,0 6.0 - 121.0 2. 212.1 1.0 1,4 0.2 - 2. .0 - 0.

DesTle Equipment 3S.1 20.0 1,1 - - i.2 - 2.1 0,0 0.4 0.1 - - 0.2 -0.1

Pbir.i,outicaloPrO-lirksting !I 020.0 110.0 140.0 - . 20,0 10,4 1.4 2.6 - 0.2 10.0

studies and Training 21.0 21.0 - - - - 2. 10 0.4 0.4 - - - At -

Total Plnanclna Asqaslrd 0,079,2 1,449.0 1,30i,2 120.0 4,192.4 i 11 ,01,10,4 410.4 10,111,1 101,1 11.0 24.1 2,0 220,0 1,0 70.1 61.01 li.0

j Inclu"Ing aenhe. etodp (1560.1 otllion)Including cooeoltanto (10*0.4 olIlleal)

Indusitry DopirtucotJimoor, 1980

- 78 -

ANNEX 6-3

FlNE CHEMICALS PROJECr

NATUTImS AND GRACE PERIODS

IncludingTtbal Grace

MaturityA/ Perioda/(Years)

Cedeon Richter

Incinerator 13 3 -

Fermentation/Steriods 12 3Injections 12 3R and D 10 2

Chinoin

Pyrethroids 10 3Active Ingredients 12 3Fermentation 12 3Injections 12 3R and D 10 2

Cardiovasculars 10 3Liquid Preparations 12 3Vet. Preparations 12 3R and D 10 2

Biogal

Formulation Plant 12 3Surgical Plasters 12 3Synthesis Plant 12 3

Reanal

Diagnostic Tests 12 2

Caola

Sulfonation Plant 12 2

Mitrokemia

Ion Exchange Resins 12 3Monocbloroacetic acid 8 2

BVK

MDI 12 3

Vegyterv

Design Equipment 9 2

Neviki

R and D 12 3

CYKI

R and D 10 2

a/ From date of first distribution to the companies.

Industry DepartmentDecember 1984

- 79 -

ANNEX 6-4

HUNGARY

FINE CHFMICALS PROJECTESTIED DISBURSEMENT SCHEDULE FOR BANK LOAN

(US$ million)

Fiscal Yearand Semester Disbursements Cumulative Ulndisbursed

1986 I 2.0 2.0 71.0II 4.6 6.6 66.4

1987 I 7.0 13.6 59.4II 9.8 23.4 49.6

1988 I 12.0 35.4 37.6II 14.2 49.6 23.4

1989 I 9.4 59.0 14.0II 6.0 65.0 8.0

1990 I 5.0 70.0 3.0II 3.0 73.0 0.0

Industry DepartmentDecember 1984

SuonART

FInE CHDIICALS PIOJECT

SumW T O StUIPROJECTS INAMCIAL RESULTS - 1990

Incrassntal Ineresentat Profit 'tt Profit Internal Cash Principal Total Debt Debt ServiceCodeon Richter lwRanus Cash Costa / Dpracltion Interest Relare Tan Altar Tae Goneretjg3l Vayrmnt Seoieo Caysrase Raiol

Ferinntation/lteroida 459 -111 68 9* 416 264 3219 4t 13 2.Sinjctions Plan: M1 474 141 IlA -$9 -69 76 8I 262 I0Incinerator 210 10 92 SS 19 is 110 S2 107

lob-total l.T nr 1 m m7 m m1I m m ;Chinoin

Injoetions Plant 29S 521 59 54 109 194 2S1 4* lOn 1.1Fers ntition Plant 411 255 29 11 14A 92 III 2U 81 2.7Actiwa Ingredienti 1,251 905 17 27 441 282 119 13 60 1.8Pyrathrolds I ISO 59 0 40 411 312 342 S2 92 4.1

Sub-total tW T3I 1w DI TR! VTI J,

CardIovaesulara I10 314 46 11 119 214 Z60 S0 ol 3.6Liquid Pormultlons 472 249 27 17 160 98 125 18 S1 2.0Vat. Prsperetlonn 291 1I2 24 22 AS Sl 7S IS 17 2.6

Sub-total 1,IT UT TI! Ti m i 3.2

Synthesis Plant 319 2715 41 52 II I 42 24 79 1.2Porlmatlon Plant 90 S00 119 144 21 124 242 72 228 1.8Surgical Plasters (1991) 3I 21 26 22 S6 Ii Si lo 52 1,1

Suob-total 1Ti! 111 I 17 __ 212 -' T

easnat

Diagnostic Tlsts 102 94 10 9 l0 1i iS 8 17 2.2

Rail

Cardlovasculara 730 114 4I 11 119 214 2hO S0 Al 31 * Liquid Formulationa 472 249 27 17 150 9t 125 li 13 1.0Vet. PreparatIons 291 162 24 22 83 51 7S IS 17 2.6

Sub-total 1.494 TI 1W TT II! III-1 iiT 3.2

liosal

Synthasie Plant 179 27S 41 51 II I A7 24 79 1.2Formlation Plant 908 100 1I9 144 217 124 241 72 228 2.8Surgical Plasters (1991) 3II 227 26 32 56 31 S7 16 92 I

sub-total riii 8 m 79 ITT i

lEssnal

Diognoatte Tests 101 94 10 9 10 18 28 a 17 2.2

Casts

Sullonation Plant 289 297 I6 I6 70 49 62 14 10 2.1

IVK

IIDI 22660 21000 112 606 872 479 Ahl 154 6no 2.0

SitrsbeLia

Ionochloraeetie Acid 224 IS1 7 12 92 12 11 24 26 2.0Ion Inxchans Resina 2 038 1 041 101 131 765 491 596 94 164 4.3

L tflTR TU T17 T" m-0 Tn m r.*/ Including standard allocation of R and 0 costs.kb Aususing equal Inettalltnts.

Industry DepartsntFebruary 196

.4

- 81 -

NM 7-2

FDE CHEMMILS ECr

tWE FDWCL - ENOEMCROE5 OF E

Fli a nomic Aim i s-ctopmuius and Atu m Okt. of N11 PetSdbprojUts Prntawn Uial

Injetious 37 39 24.0Fei entatimlSuradds 40 4 17.4

loiotinm 37 41 13.9Active lugrtedes 78 BB 25.3Fermntatian A2 34 4.9P,rehroids 69 71 16.5

Egi

Liqoid Formulationh 41 44 9.0Cardiovasculars 56 60 15.3get. Prertions 21 24 1.4

liopi

Fmlatim 21 24 13.4Sgm*.sis 18 20 2.1%ugLcod Paters 2 25 1.5

bana

Dagustic Tets 43 52 2.0litrumia

INmmdxloro. Acid 43 46 3.1Ion Exduup buins 4 43 26.1

Sulfoution Plant 52 57 4.1OK

IDI s1 19 20.2

TOTaL P 0O&ET 36 201.6

uduut O rWth t.huumrg 1995

- 82 -

AEM= 7-3

HUNGARY

FINE C9EMICALS PROJECT

PROJECTED PRICES OF MDI (BULK MATERIAL)(Free Hungarian Border)

in constant 1984 termsUS$ per ton

Polymeric PureMDI MDI Average

1984 (Actual) 1,215 1,615 1,295

1987 1,424 1,880 1,5151988 1,410 1,863 1,5011989 1,393 1,839 1,4821990 1,378 1,819 1,4661991 1,406 1,857 1,4961992 1,428 1,885 1,5191993 1,446 1,909 1,5381994 1,458 1,925 1,5511995 1,465 1,933 1,5581996 1,502 1,983 1,5981997 1,532 2,023 1,6301998 1,557 2,055 1,6561999 1,575 2,080 1,676

Source: Arthur D. Little

Tndustry DepartmentDecember 1984

- 83 -

ANNEX 7-4

HUNGARY

FINE CHEMICALS PROJECT

STRUCTURE OF MDI PRODUCTION COSTS

(US$ million) Z

Raw materials 12.1 58of which: Aniline 11.0 52

Chlorine 1.3 6Carbon Monoxide 0.2 1Formaldehyde 1.5 7Hydrochloric acid (Credit) (-1.9) (-9)

Catalysts and Chemicals 3.5 ''

Utilities 2.7 13

Total Variable Costs 18.3 88

Labor 0.2 1Maintenance 1_4 7Domestic Transportation 0.3 1Development Costs 0.3 1Overhead 0.5 2

Total Fixed Costs 2.7 12

Total Costs 21.0 100

Industry DepartmentJanuary 1985

ANNM 7-5

HUNGARTPFIE CdHMICALS PROJgCT

MH3 - SUBPROJECTFINANCIAL ANALTSI1 - SUHHAIAT oF MAJOR OPERATING COST ASSUMPTIONS

ASE CASE ASSUMPTIONS(in constant 1984 teru)

CulSS)

It.e Units 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

Wood ote8-roduct Va!uos

AnilLne $/T 600.00 592.89 587.60 581.,2 575.47 574.n0 589.16 604.24 619.32 634.40 649.48 664.39 679.30 694.22 709.13Chlorine S/T 92.00 91.30 90.60 89.90 89.21 18.51 91.n7 93.63 96.19 98.75 101.32 104.81 108.30 111.80 115.29Carbon Monoxide S/T 50.00 49.62 49.24 48.86 48.48 48.1n 49.49 50.89 52.28 53.67 55.06 56.96 58.86 60.76 62.66Forueldehyde (1O00) S/T 409.00 405.89 402.79 399.68 396.S7 393.47 404.86 416.25 427.64 439.03 450.42 465.95 481.48 497.01 512.54HCL (IOO) S/T 213.00 211.38 209.76 206.15 206.53 204.91 210.84 216.77 222.71 228.64 234.57 242.66 250.75 258.84 266.92

Catalysts A Chemicals Costs

OUCB $/Kg .91 .90 .89 .88 .87 .87 .89 .91 .94 .96 .98 1.01 1.03 1.05 1.07Caustle (1002) S/T 243.00 241.15 239.31 237.46 235.62 233.77 240.54 247.31 254.07 260.84 267.61 276.84 286.06 295.29 304.52MIsc. Chain. A Materials VIT $ 43.57 43.24 42.91 42.s8 42.25 41.92 43.13 44.34 45.56 46.77 47.98 49.64 51.29 52.9S 54.60

Utilities Costs

Fuel S/T .00 .00 .00 .00 ,00 .00 .00 .W0 .00 .00 .00 .00 .00 .00 .00 'Eteas HP S/T 8.63 8.56 8.50 8.43 8.37 8.30 8.54 8.78 9.02 9.26 9.50 9.83 10.16 10.49 10.81 ISteam LP $/T 8.63 8.56 8.50 8.43 8.37 8.30 8.54 8.78 9.02 9.26 9.50 9.83 10.16 10.49 10.51Power $/Kwh .03 .03 .03 .03 .03 .03 .03 .03 .03 .03 .03 .03 .03 .03 .03Water (cooling) $/Kn3 34.59 34.33 34.06 33.80 33,54 33.28 34.24 35.20 36.17 37.13 38.09 39.41 40.72 42.03 43.35Water C/ 0ess) 5/a

3.47 .47 .46 .46 .46 .45 .47 .48 .49 .50 .52 .54 .55 .57 .59

Other . ent air) S/Mn3 9.24 9.17 9.10 9.03 8.96 8.89 9.15 9.40 9.66 9.5"2 10.18 10.53 10.88 11.23 11.58

Total fixe. .oat

Labor (inel. tax) 000 223.00 223.00 223.00 223.00 223.00 223.000 223.00 223.00 223.00 223.00 223.00 223.00 22m.00 223.00 223.00KaIntenance O00S 1,409.00 1,409.00 1,409.00 1,409.00 1,409.00 1,409.000 1,409.00 1,409.00 1,409.0tl 1,409,00 1,409.00 1,409.00 1,409.00 1,409.00 1,409.00Dometic Trcnsp. 000 320.00 320.00 320.00 320.00 320.00 320.000 320.00 320.O0 320.00 320.00 320.00 320.00 32(0.00 320.00 320.00Develop. 6 Misc. Coats OOOS 350.00 350.00 350.00 350.00 350.00 350.000 350.00 350.00 350.00 350.00 350.00 350.00 350.00 350.00 350.00

Overheads (ind. costs) 000$ 446.00 446.00 446.00 446.00 446.00 446.00 446.0n 446.00 446.00 446.00 446.00 446.00 446.00 446.00 446.00

Sourcei Arthur D. Llttle

Industry DepartmentDecember 1984

~~~~~~~~~~~~~~~~~~~~~~~~~~~~~I,

-85 - ANNEX 7-6

Page 1 of 2

HUiCARI

FINE CIIENICAIS PASJECT

SICXY OF COMPANIES PROJECrED FINANCIAL STATEMEITS a/

(Actual) - Projected- -1983 1985 1988 1990

- (million Forl nca)-

Revenues 10,305.6 12,565.8 18,943.1 22,435.0Net Profit before tax 419.8 2,820.0 4,429.8 5,396.8Net Profit after tax 180.1 978.6 1,627.4 Z,194.4Internal Cash Generation b/ 951.1 1,451.6 2,2b666 2872,7Debt Service:

Principal 758.6 952.7 1,293.9 1,056.0Interest 847.8 311.5 399.5 348.9

Current assets 4,173.9 4,419.2 6,523.7 7,674.1Current Liabilities 2,301.6 2,746.7 4,227.2 4,031.6Outstanding long term debt 4,694.1 3,446.2 2,908.1 1,523.7Equity 5.815.6 6,953.0 1,003.6 13,054.6

Current ratio 1.8 1.6 1.5 1.9Long-term Debt/Equity ratio 44/55 33/67 23/77 11/89Debt service coverage ratio 1.2 1.4 Ib 2.3

Gedeon Richter

Revenues 8,275.5 9,251.0 12,701.0 14.485.0Net Profit before tax 1.113.7 1,433.2 2.100,0 2.508,4Net Profit after tax 483.5 668.6 977.7 1,168.6Internal Cash Generation b( b25.8 833.8 1.279.8 1,501.3Debt Service:

Principal 343.3 402.4 308.1 487.0Interest 287.3 387.4 567.5 520.3

Current assets 5,481.7 5,985.4 8,217.5 9.371,8Current liabilities 2,038.7 2,0b7.3 2,417.9 2,649.6Outstanding long term debt 2,378.4 2,287.5 3,624.8 2.985.0Equity 5,442.2 7,259.8 10,508.6 '.090.7

Current ratio 2.7 2.9 3.4 :.5Long-term Debt/Equity ratio 31/69 24/7b 27/73 19/81Debt service coverag: ratio 1.5 1.6 2.2 2.0

Chinoin

Revenues 7,120.3 7,701.0 10,963.0 13,311.0Net Profit before tax 722.8 895.7 1,135.7 1,429.1Net Profit after tax 296.6 418.7 530.9 668.1Internal Cash Generation b/ 383.1 524.2 656.1 864.9Debt Service:

Principal 268.3 - 141.5 55.6 201Interest 72.6 54.3 216.7 212.9

Current assets 4,276,7 4.466.6 6,358.5 7,720.4Current liabilities 1,611.9 1,644.0 2.438.3 3,105.0Outstanding long ter's debt 242.6 435.6 1,581.2 1,217.5Equity 4,764.1 5,337.0 6,242.6 7,060.9

Current ratio 2.6 2.7 2.6 2.5Long-term Deht/Equity ratio 5/95 8/92 20)80 5/85Debt service c.wverage ratio 1.3 3.1 3.4 2.8

*/ In early 1915. the Covernment changed the taxation system for theenterprises. Depreciation allowances are now fully retained by thecopanies. On the other hand, the companies are now subject to aproperty tax and an investment tax. We have reviewed the impact ofthe changes in the projected financial statements and concluded thatthey vill not materially affect the results of the projectionssumarized in this report.

ki Profit after tax (net of distributed shartng fund), plus retaineddepreciation allowances (402 of depreciation allowances are returnedto the Government).

- 86 -

ANNEX 7-6Page 2 of 2

HUNGARY

FINE CHEMICALS PROJECr

SUKIARY OF COMPANIES PROJECTED FINANCIAL STATEMENTS a/

(Actual) ---- Projected------1983 1985 1988 1990

---- --- (aillion forints)-----Nitrokeia

Revenues 6,611.0 7,22b.0 8,488.0 9,635.0Net profit before tax 969.0 1,194.0 1,333.U 1,544.0Net profit after tax 439.0 558.0 b23.0 722.0Internal cash generation b/ 536.4 702.0 806.0 910.0

Debt Service:

Principal 113.9 196.0 137.0 199.0Interest 116.2 95.0 181.0 175.0

Current assets 2,535.7 2,327.0 3,438.0 3,403.0Current liabilities 846.0 1,166.0 1,448.0 1,607.0Outstanding lono-ters debt 616.9 516.0 1,220.0 965.0

Equity 4,006.0 4,744.0 6,078.0 7,084.0

Current ratio 3.0 2.5 2.4 2.4Long-term debt/equity ratio 13/84 10/90 17/83 1Z/8Debt service coverage ratio 3.0 2.7 3.1 2.9

Eais

Revenues 4.635.3 5,379.5 7,923.7 9.471.3Met profit before tax 537.4 473.8 658.9 797.7Net profit after tax 241.1 220.7 304.9 372.2Internal cash generation b/ 320.1 338.3 480.2 592.7

Principal 231.2 3Z2.0 1d8.9 153.8Interest 88.4 113.6 206.4 236.6

Current assets 3,718.4 3,604.3 5,308.9 6,345.8Current liabilities 1,899.4 1.958.0 3,040.5 3.7b8.7Outstanding long-term debt b92.5 696.2 1,356.8 1,610.0Equity 3,113.4 4,070.9 5,755.3 7.196.0

Current ratio 2.0 1.5 1.7 1.7Long-term debt/equity ratio 18/82 15/85 19/81 18(82Debt service coverage ratio 1.4 1.1 1.8 2.2

Blogal

Revenues 3,098.1 3,876.0 5,454.8 61792.4Net profit before tax 404.1 496.6 559.1 749.8Net profit after tax 188.4 232.2 Z61.4 350.5Internal cash generation b/ 215.2 288.5 390.5 506.2

Principal 92.3 84.8 90.8 240.6Interest 92.8 96.3 275.3 289.2

Current assets 1,526.9 1,976.8 2,781.9 3,464.1Current liabilities 689.4 986.6 1,776.7 2,322.1Outstanding long-term debt 533.7 595.5 2.061.7 1,77:.;

Equity 1,585.8 2,329.9 3,256.5 3,o7OJ

Current ratio 2.6 2.0 1.6 !.5Long-term c-btIequity ratio 25/75 20/80 20/80 31/69Debt service coverage ratio 1.7 2.2 2.2 1.b

a/ See footnote on previous page.

k See footnote on previous page.

Industry DepartmentFebruary 1985

Cespamles 1tca.alg U1111.ati- u - OeratiaU guts- aita Caissad S"*jus ku CIs" W 1 701 -101 -MI -31 410 +4 *n 4:0 M

Cs_si Rtchtw

lujcitss 3 37 36 34 a6 aa a a7 ao U 35 UFwuulmtasnt.e1id 40 40 s 85 40 IT 34 40 41 40 9 36

ZajgcUsas 41 as a 21 Oa f It 26 31 6 U 36ktlivslsgdlsats 6 77 57 75 63 49 as 7 n1 ae 75rwm.SiMsn 34 B e1 13 Ed 16 2 29 25 19 St apvruthwuLds 71 62 SI 39 57 41 19 U 55 46 6 1

Elio

Liqid ramlht, ls 44 40 3a 30 so 92 25 41 U 34 40 UCard lsvlars 61 54 46 38 52 40 at 57 54 50 86 UVst. hIvatiess 24 19 i3 6 14 Mg nq 16 10 si 21 19

Eersrlsiins 24 21 17 l 1e It 3 20 16 10 U 2aSinthn1s 20 16 12 9 12 a wg 15 9 2 is 16Surgical Plsws 25 19 14 7 14 Mg u" 17 9 rAg a 0

Olagreusi Tusts Be 4 a 29 41 t 9 is 46 40 14 47 44Witloao.1a

buanchlore. kid 46 4 as a a Ua 16 sq 3S a l6 4Q 40to" Ex da sbeins 49 S aa 2e 354 as 9 U Is 27 19 E6

IStlftim Plans 57 51 44 32 40 a No 40 27 4 512 40

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- 88 -

ANNEX 8-1Page 2 of 2

HNGARY

FINE CHEMICALS PROJECT

SENISITIVITY ANALYSIS

MDI Subproj ect

EconomicRate ofReturn (Z)

Base Case 19

Capital Costs:+10%+20Z 17

15Ainiline Prices:

$700 per ton 17$800 per ton 14$900 per ton 12

MDI prices:-10% 14at present levels ($1,330 per ton) 12

-20Z 8

Capacity Utilization90Z 1880% 1670% 14

Industry DepartmentFebruary 1985

- 89 -

ANNEX 8-2

HUNGARY

FINE CHEMICALS PROJECT

PROJECT NET IMPACT ON CONVERTIBLE CURRENCY TRADE BALANCE in 1990Million Forints

(in Constant 1984 terms)

Convertible CurrenciesRaw Incremental

Import Incremental Materials Raw material NetCompany and Subproject Substitution Exports Savings Imports Impact

(1) (2) (3) (4) (1)4(2)+(3)-(4)CHinoin

Active Ingredients - 348 - 42 306Injections - 389 - - 389Fermentation - 238 - 31 207Pyrethroids - 331 - 84 247

Gedeon RichterInjections - 305 - 74 231Fermentation!Steroids - 230 134 100 264

EgisLiquid Preparations - 745 - 4 741Caridovasculars - 242 - 28 214Vet. Preparation - 190 - 24 166

BiogalFormulation Plant - 393 - 24 369Synthesis Plant 36 60 - 33 63Surgical Plasters (1991) 20 133 - 10 143

ReanalDiagnostic Tests 59 4 - 7 56

NitrokemiaMonochloracetic Acid 91 - - 63 28Ion Exchange Resins - 890 - 260 630

CaolaSulfonation Plant 245 - - 141 104

BVKMDI 180 1,000 - 50 1,130

Total 631 5,498 134 975 5,288US$ million 12.6 110.0 2.7 1q.5 105.8

a; Actual Imports in 1983.

Industry DepartmentFebruary 1985

H UN GARYFINE CHEMICALS PROJECT

Locafion of Production Plants

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CarolsR.wers

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-s .- International boundaries

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