of the PRESIDENT to the EXECUTIVE DIRECTORS on the August 26, 1953

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized - ~~~~~~~~~~~P.-51 RESTRICTED This report is restricted to use within the Bank. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS of the PRESIDENT to the EXECUTIVE DIRECTORS on the TWO PROPOSED LOANS TO THE REPUBLIC OF ICELAND August 26, 1953

2 INTERNATIONAL BANK FOR RECONSThUCTION AND DEVELOPMENT REPORT AND RECON'EMNDATIONS OF THE PRESIDENT TO DHE EXECUTIVE DIRECTXRS ON THE TWO PROPOSED LOANS TO THE REPUBLIC OF ICELAND 1. I submit the following report and recommendations with regard to the two proposed loans to the Republic of Iceland for agricultural development and the erection of a radio transmitter building. PART I - HISMORICAL 2. The Bank has made the following loans to Iceland totalling the equivalent of $4.3 million: (a) 1.875,00Q (02,450,000) for hydroelectric power development on the Sog and Laxa rivers; (b) 1360,000 ($1,008,000) for agricultural development in 1952; (c) $854,ooo for a nitrogen fertilizer plant. All three loans will be disbursed enlirely in European currencies. 3. In discussions in the fall of 1951, before the second loan was made, I indicated that the equivalent of $2 million was in my view a reasonable amount for Iceland to borrow over the next two years. This limit was practically reached with the fertilizer plant loan made in August 195a. 4. In the next few months the Bank received from the Government of Iceland applications for three new loans: (a) A loan of $1.35 million in juropean currencies for the develcpment of agriculture in continuation of the program for which the earlier agricultural loan had been made. (b) A loan of $270,000 in pounds sterling to finance the cost, foreign and domestic, of a radio transmitter building; (c) A loan of $2.7 million in European currencies to finance the foreign exchange cost of a cement plant. 5. After reviewing the whole position early in 1953, I felt that while further loans might be justified, the Bank should reexamine Iceland's economic situation before going any further. Accordingly, at the invitation of the Government, a Bank mission went to Iceland in May. As a result of the mission's findings, the Bank offered to open negotiations for loans to promote agricultural investment in 1953 and 1954, and to finance the proposed radio transmitter building. The cement plant proposed seemed too large for Iceland's needs, and it was agreed that the probable demand for cement and the size of the plant required should be examined further.

3 -2-6. Negotiations of loans for the agricultural project and the radio transmitter building were opened in Washington on July 27, The authorized negotiators were: Mr. Mr. Thor Thors, Minister of Iceland in the U.S.A., on behalf of the Republic of Iceland, and Benjamin Eiriksson, General Manager of the Iceland Bank of Development, on behalf of the Borrower, PART II - DESCRIPTION OF THE PROPOSED LOAN The Borrower A. Agricultural Loan 7. The Borrower would be the Iceland Bank of Development, a government institution formed in A brief description of the bank is attached as Appendix I. The Guarantor 8. The Guarantor would be the Republic of Iceland. Amount 9. The loan would be in various European currencies equivalent to $1.35 million. The goods to be bought out of the proceeds of the loan would come from Great Britain, Denmark, Federal Republic of Germany, France, Belgium, Sweden, Italy, Netherlands and Norway. It is hoped that these governments will release funds from their 18% subscriptions in the amount required. To the extent that these funds are not enough the Bank will use part of the issue of I 5 million made in London in Purpose 10. The purpose of the loan would be to finance some of the irmported goods required in Iceland s agricultural development plan in 1953 and Terms 11. The loan would be amortized by 34 semi-annual payments designed to redeem the loan by its maturity. The first payment would be due on September 1, 1958 and the last on March 1, The loan would bear interest (including 1% conmission) at the rate of 5% per annum. There would be a commitment charge of 3/4% per annum. Legal Instruments 13. Drafts of the Loan Agreement between the Bank and the Icelandic Bank of Develqpment, and of the Guarantee Agreement betwieen the Republic of

4 - 3 - Iceland and the Bank are attached as Appendices II and III. The Agreements incorporate Loan Regulations No. 4 dated October 15, 1952 and follow the general pattern. An exception arises from the fact that most of the goods (cement, iron, steel and builders' hardware) are to be imported by numerous private merchant houses and may be used for a variety of purposes. Such goods financed by the bank cannot be traced to the.project, but the Borrower covenants that goods of this type will be available for the project as required. The kronur equivalent of each withdrawal from the Loan Account will be paid into a special fund to be used by the Agricultural Bank in loans for farm improvements forming part of the agricultural development program in 1953 and The Borrower B. Transmitter Building Loan 14. The Borrower would be the Iceland Bank of Development. The Guarantor 15. The Guarantor would be the Republic of Iceland. Amount 16, The loan would be in the amount of L 90,000 (about $250,000); it would be disbursed entirely in pounds sterling from the proceeds of the issue of E 5 million made in London in Purpoos The loan would be used to cover the cost of a building to house radio transmitter equipment to serve the North Atlantic air traffic. Terms 18. The loan would be amortized by 24 semi-annual payments designed to redeem the loan by its maturity. The first payment would be due on July 15, 195h and the last on January 15, Ihe loan would bear interest (including 1% commission) at a rate of 4 3/4% per annum. There would be a commitment charge of 3/4% per annum. Legal Instruments 20. Drafts of the Loan Agreement and of the Guarantee Agreement arp attached as Appendices IV and V. The Agreements incorporate Loan Regulations No. 4 dated October 15, 1952 and follow the general pattern. An ex%eption arises from the fact that the loan is to be used to meet not only foreign but also domestic expenditures. 'The most appropriate basis for disbursement, therefore, is to allow the Borrower to withdraw from the Loan Account amounts correeponding to the progress of expenditures on the project.

5 PART III - APFRfiISkL OF TH- PRCPOSED LOANS Recent Economic Developments 21. A report entitled "Iceland Economic Report" (EA-17a) was circulated to the Executive Directors on July 30, 1953 (R-708). 22. During the past two years considerable progress has been made towards financial stability. The budget is balanced and savings have been increasing since the spring of On the other hand, the inflationary pressure, though diminishing, persists; this is because investment expenditures, financed partly by Central Bank credit expansion, continue to exceed the amount of available savings. In fact, the gap between investment and savings has narrowed to the point where a slight contraction of investment should bring Iceland into equilibrium, both internal and external. A decline in willingness to invest may close the gap. A decrease in a hitherto high rate of investment is probably inevitable, as receipts from foreign grants will cease by tlie end of this year and Iceland will have to finance future investment largely from her own resources. 23. The immediate outlook is favorable. During the first five months of 1953, fish catches, particularly of herring, have been larger than in A record hay harvest is expected, which will save fodder imports and help the farmers to keep a greater number of animals for breeding. 2h. Progress has been made towards solving the marketing difficulties fish exporters have been experiencing since the beginning of An agreerment has been reached between Icelandic trawler oamers and a British me c-ant firm to provide new landing and marketing facilities for iced fish-. Furthermore, a new two-year trade agreement has been signed between Iceland and USSR. The value of trade contemplated for the first year would be at lea;' $6 million and might reach $9.5 million in each direction, enabling Iceland to dispose of much of her abnormally large fish stocks and to obtaini commodities which she would otherwinse hav- to buy in dollars or in EPU currencies. The agreement should strengt-aen Iceland's balance of payments and permit the Central Bank to rebuild its foreign exchange reserve which has been greatly depleted during the last year., DESCRIPTION AND JUSTIFICATION OF THE PROJECTS A. The Agricultural Project 25. The agricultural project is described in a "Report on the iroposed Second Agricultural Loan to Iceland" (TO-13) which was circulated to the Executive Directors on July 30, 1953 (R-708), and in a Supplement attached hereto as Appendix VI. 26. The project to be financed under the proposed loan is part of a longterm program covering the ten years from 1951 to The main objectives of the progiram are to overcome the consequences of nearly 20 years of devastating sheep diseases, to keep the farmers on the land and to assist

6 them in developing and exploiting the country's agricultural resources. The program envisages an extension of the cultivated area to permit the further mechanization of hay making and to make possible a considerable expansion of sheep flocks and a further moderate increase in the number of cattle. This involves the drainage, ploughing, reseeding and fencing of natural grasslands, and the construction of farm buildings, to store winter feed, to shelter the animals and to provide better dwellings for farmers and their families. 27. The loan application, made in September 1952, was intended to relate to 1953 only. Since it was already well into 1953 before the mission reached Iceland, it was decided to discuss needs up to the end of The mission found that the investment contemplated for the two years would not exceed an annual rate of Kr. 100 million ($6 million) which might be computed to involve annual foreign exchange expenditure equivalent to $1.2 million a year for construction and land reclamation materials and $580,000 for farm machinery. Taking into account Iceland's prospective foreign exchange resources, it appeared that an amount equivalent to $1.35 million would cover essential needs during the rest of 1953 and in The investments proposed for the years 1953 and 1954 represent a substantial contribution towards carrying out the Ten-Year Program and are of high priority and consistent with the general economic interests of the country. It is estimated that if the full program could be carried out, it would increase agricultural production by about one-half by 1965 and would save imports and increase exports by perhaps as much as $7 million. B. The Radio Transmitter Building 29. At the end of the war, civil aviation lines operating in the North Atlantic region needed additional air navigation services based on Icelancd. Iceland could not be expected to bear the whole financial burden of these services. A system was, therefore, worked out whereby the other countries whose airlines operate across the North Atlantic pay Iceland a major share of the costs. This system is maintained by the International Civil Aviation Organization (ICAO), and the participating countries are Belgium, Canada, Denmark, France, Iceland, the Netherlands, Norway, Sweden, Switzerland, the United Kingdom and the United States. Annual contributions are assessed against the participating countries, payable in the currencies of the respective countries. Canada, Switzerland and the United States provide more than one-half of the contributions. 30. The Icelandic Post and Telegraph Administration owns and operates a radio transmitter station at Rjupnahaed, near Reykjavik. The transmitters are at present inadequately sheltered in a temporary building put up during the war and this presents a considerable fire risk. The project is to construct a new building to house a set of radio transmitters which furnish air-ground telecommunication services i.e. operational and traffic control messages and meteorological information, and to transfer the transmitters and other equipment to it. The Bank has examined plans, specifications and cost estimates for the building, and found them satisfactory. They have also been approved by ICAO. Contracts were signed and building work started

7 at the end of July. of The station should start operating towards the end 31. The cost of the building is estimated at the equivalent of $264,000 of which about 30% represents direct foreign exchange expenditures. The proposed loan is equivalent to about $250,000, the rest being provided by Iceland. Although located in Iceland, the project has an international character in that it is for the benefit of ICAO member countries engaged in the trans-atlantic air traffic, and the loan will be amortized out of their contributions. It will help to increase Iceland's foreign exchange earnings from international aviation. On these grounds there is a good case for a loan in foreign exchange. 32. The ICAO charter does not permit it to borrow money and the basis on which it operates precludes an increase in individual members' contributions so as to cover the whole capital cost during the construction period. Members were willing, however, to increase their contributions to enable Iceland to service a medium term loan. Consents to these increases have been obtained from all members and an agreement was signed on July 13, Contributions from the participating countries, for the operation of all air navigation services provided by Iceland, will now amount to the equivalent of about $260,000 a year. These contributions are available for any purpose under the basic agreement, including the service of the proposed loan. If a member should withdraw, it has to maintain its contributions until outstanding capital expenditure has been fully amortized. The portion of contributions applicable to the cost of the transmitter building is measured in terms of sterling, and since the proposed loan is also to be in sterling, Iceland would run no exchange risk. 34. Working papers dealing with the technical aspects of the transmitter building are available for consultation. PART IV - PROSPECTS FOR THE FULFILLIjIU'T OF OBLIGATIONS 35. A report entitled "Creditworthiness of Iceland" (ha-3) was circulated to the Executive Directors on July 30, 1953 (R-708). 36. Iceland's foreign exchange income is primarily dependent on fish. As the projects financed by the Bank become productive, this dependcnce should decline, but it is not to be expected that fishing will cease to domninate the Icelandic outlook in the foreseeable future. Fortunately Icelandic waters contain large quantities of high quality fish and Iceland ha:s a modern and efficient trawler fleet and up-to-date processing plants and factories. Long term marketing prospects are fairly good, and if costs can be kept down, she should retain her competitive position in world markets. 37. Although a shift is now taking place in the geographical distribution of Iceland's foreign trade, about one-half of her trade continues to be with EPU countries and about one-fifth with the dollar area. As long as the principal European currencies remain inconvertible Iceland can service debt in these currencies with less difficulty than she can dollar debt.

8 Iceland's foreign debt, including undisbursed portions of previous Bank loans, is the equivalent of $14 million of which about one-half is in sterling and two-fifths in dollars. The addition of the proposed agricultural loan of $1.35 million equivalent (excluding the loan for the transmitter building which does not impose any direct charge on Iceland's resources) would bring total debt service payments to a peak of about $1.1 million equivalent in This would represent only about 2% of Iceland's expected future foreign exchange earnings. PART V - COMPLIANCE NITH ARTICLIS OF AGREEIMENT 39. Appendix VII contains the report of the committee provided for in Article III Section 4 (iii) of the Articles of Agreement of the Bank. 40. I am satisfied that the proposed loans comply with the requirements of the Articles of Agreement of the Bank. PART VI - RECOi11ENDATIONS 41. I recommend that the Bank at this time grant to the Republic of Iceland on such terms as are specified in the Loan and Guarantee Agreements attached hereto: (a) (b) A loan in various currencies equivalent to 01,350,000 for a total term of 22 years with interest (including commission) at 5% per annum, A loan of b 90,000 for a total term of 12 years with interest (including commission) at 4 3/4% per annum. Eugene R. Black August 26, 1953 Washington, D. C.

9 APPENDIX I The Iceland Bank of Develonment 1. The Iceland Bank of Development (IBD) was established by an Act of the Althing on February 3, 1953 following the technical advice made available to the Government by the Bank. It is an investment institution entrusted with major responsibilities for the programming and the financing of development in Iceland. It is owned by the Government, but has its own management which is in the hands of a Board of Directors and a General Manager. The Board of Directors consists of five members: the Secretary General of Finance, a representative of the Central Bank and three members elected by the Althing. The General Manager, appointed by the Board, is Mr. Benjamin Eiriksson, former economic adviser of the Government. 2. A pro forma balance sheet of the IBD at February 15, 1953 shows the following position: Assets 1. a Millions of Kronur Sog and Laxa Hydroelectric Authorities and Fertilizer Plant Inc On deposit with the National Bank a. Blocked account b. Debt retirement account 50.0 c. Current account 5.2 Liabilities Total Assets Capital Counterpart fund Total Liabilities The initial capital of Kr. 95 million ($5.8 million) was provided by the transfer to the IBD of bonds issued by the two hydroelectric corporations and the Fertilizer Plant Inc. and previously held by the Government. 4. The present assets of the IBD of Kr. 315 million (equivalent to about $19 million) come from the counterpart of ECA/N'A grants. The legislation under which the IBD operates limits the rate at which it

10 - 2 - may invest its assets: Kr. 50 million is to be set aside to be used only for retirement of Government debt, and the blocked account at the National Bank is to be released in 25 annual installments of about Kr. 5 million ($1,300,000) each into a current account available for lending purposes. In this way the inflationary consequences of too rapid a use of counterpart funds are minimized. 5. The current income of the IBD will amount to about Kr. 14 million ($0.86 million) annually. The hydroelectric and fertilizer companies pay interest of 5-1/2% per annum on their bonds, and the National Bank is expected to pay about 5% interest on the blocked account. On the other hand, the Bank of Development does not pay interest on its liabilities and it is free from taxation. 6. The Act establishing the IBD enables it to borrow abroad and authorizes the Minister of Finance to guarantee, on behalf of the Treasury, foreign loans and other foreign obligations which it undertakes. August 26, 1953