FILE COPY. Document of The World Bank FOR OFFICIAL USE ONLY REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF PORTUGAL FOR A SMALL- AND MEDIUM-SCALE INDUSTRY DEVELOPMENT PROJECT May 7, 1979 FILE COPY Report No. P-25:8-PQ This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

2 CURRENCY AND EQUIVALENTS Calendar 1978 March 1979 Currency Unit = Portuguese Escudo (Esc) Esc $1 = Esc Esc = $ Exchange rate used in the Staff Appraisal Report $1 = EBC (Floating Exchange Rate) FISCAL YEAR January 1 - December 31 GLOSSARY OF ABBREVIATIONS BFN Banco de Fomento Nacional CGD Caixa Geral de Depositos EC European Communities EFTA European Free Trade Association EPPI Public Enterprise for Industrial Estates (Empresa Publica de Parques Industriais) FFE Export Development Fund (Fundo de Fomento de Exportacao) FGRC Exchange Risk Guarantee Fund GIT Textile Industry Office (Gabinete Industria Textil) IAPMEI Institute for Support to Small- and Medium-Size Industrial Enterprises (Instituto de Apoio as Pequenas e Medias Empresas Industriais) IMF International Monetary Fund ITC International Trade Center KfW Kreditanstalt fur Wiederaufbau LNETI National Laboratory for Industrial Engineering and Technology (Laboratorio Nacional de Engenharia e Technologia Industrial) SMI Small- and Medium-Scale Industrial Enterprises UNDP United Nations Development Programme UNIDO United Nations Industrial Development Organization

3 FOR OFFICIAL USE ONLY PORTUGAL - SMALL- AND MEDIUM-SCALE INDUSTRY DEVELOPMENT PROJECT LOAN AND PROJECT SUMMARY Borrower: Beneficiaries: Amount: Terms: Relending Terms: The Republic of Portugal Small- and Medium-Scale Industrial Enterprises (SMI), the Public EnterprLse for Industrial Estates (EPPI), Export Development Fund (FFE), National Laboratory for Industrial Engineering and Technology (LNETI), Textile Industry Office (GIT). $45 million equivalent 15 years, including two years of grace witn interest at 7.9 percent per annum. For Banco de Portugal: A subsidiary loan ($33 million) to bear the same interest rate as the Bank loan; its amortization to follow a fixed schedule reflecting the estimated aggregate amortization schedules of SMI subloans. For SMI: Subloan amortization period to conform with subproject life but not to exceed 12 years, including up to 3 years grace at the floating interest rate applied to comparable loans (currently a maximum of percent per annum, but subject to interest subsidies, paras. 32, 33, 59). For EPPI: A subsidiary loan ($9.5 million) for 15 years including 5 years grace, and the same interest rate as the Bank loan. The Exchange Risk Guarantee Fund would bear the exchange risk on the SMI credit line against the payment of a full fee (para. 34). EPPI would assume the exchange risk under its subsidiary loan. Project Description: The project objectives are: (i) to assist, through a package of financial and technical assistance, the restructuring, modernization and expansion of selected SMI; (ii) to generate or save foreign exchange by promoting SMI exports and efficient import substitution; (iii) to maintain jobs in existing SMI and to create new ones at a moderate capital cost per job; (iv) to develop industrial estates in a number of less developed regions; (v) to assist the Government in developing technological support to industry in particular to SMI; and (vi) to help prepare a rationalization and investment plan for the textile subsector. To attain these objectives, Banco de Portugal, will refinance credits to eligible SMI out of a subsidiary loan; EPPI will build industrial estates with the help of another subsidiary loan, and rent them to SMI; LNETI's technology institutes and laboratories will be This document has a restricted distribution and may be used by recipients only in the performance of their omcial duties. Its contents may not otherwise be disclosed without World Bank authorization.

4 - ii1 - equipped to provide better technological support to industry; the export promotion component will provide technical assistance to devise marketing arrangements and to review incentives; the textile and technology studies will recommend development programs, rationalization measures and future projects in their respective areas. There are moderate risks concerning the implementation of a project involving complex institutional arrangements, the progress in SMI investments, and evolution of occupancy on industrial estates (para. 65). Estimated Costs: % of Local Foreign Total Total $ million SMI Credit Line / EPPI Industrial Estates Program (investment in the period ) Export Promotion Program Technical and Technological Assistance Program, Fellowships Textile and Technology Policy Studies TOTAL /2 Financing Plan: $ million Bank Loan Other Foreign Sources 5.88 Government Contribution Other Domestic Sources TOTAL /1 Includes $50.8 million fixed investment cost and $15.2 million working capital. /2 Includes physical and price contingencies of $3.6 million and $8.2 million respectively for items other than SMI lending program; of the contingency total, $9.3 million in local cost and $2.5 in foreign exchange.

5 - 1ii - Estimated Disbursements: Bank FY $ million Annual Cumulative Rate of Re urn: Appraisal Report: Credit line (56.7 percent of total cost), at least 11 percent economic rate of return on individual subprojects. EPPI component (40.5 percent of total cost), 22 percent economic rate of return on the estate program (paras. 50, 61). No.: 2312 PO Date: April 24, 1979

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7 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF PORTUGAL FOR A SMALL- AND MEDIUM-SCALE INDUSTRY DEVELOPMENT PROJECT 1. I submit the following report and recommendation on a proposed loan to the Republic of Portugal for the equivalent of $45.0 million to help finance a project for developing small- and medium-scale industry. The loan would have a term of 15 years including 2 years of grace, with interest at 7.9 percent per annum. Most of the proceeds would be onlent to Banco de Portugal for establishing a line of credit for small- and medium-scale industry, and to Public Enterprise for Industrial Estates (EPPI) for constructing industrial estates (para. 59). United Nations Industrial Development Organization (UNIDO), European Free Trade Association (EFTA) Industrial Development Fund for Portugal, and Kreditanstalt fur Wiederaufbau (KfW) would contribute about $5.9 million towards project financing in grants and loans (para 48). PART I - THE ECONOMY 1/ 2. An economic report entitled "An Updating Report on the Portuguese Economy" (No PO) was distributed to the Executive Directors on September 8, Country data sheets are attached as Annex I. 3. Between the revolution of April 1974 and September 1975, Portugal's political and economic systems were radically transformed. The colonies were given their independence. There was movement towards a representative political system which became a reality in mid There was nationalization of the banks, insurance companies, power companies, major transportation agencies and the large industrial groups. A comprehensive land reform was carried out in the central and southern parts of the country. Trade union activity was legalized and workers' rights safeguarded. Minimum wages were established and restraints were put on the highest salary levels. Prices were controlled. Unemployment and social security benefits were increased. This was a very different Portugal from two years earlier. There was a new relationship between management and labor, and at first there was lack of discipline, absenteeism and reduced productivity. Perhaps most important of all for the longer term, the revolution created expectations of a substantial increase in consumption. Such an increase did indeed take place initially, financed in large part through the substantial foreign exchange reserves which had been accumulated before During 1976 and 1977 there was an increasing awareness that such growth of consumption could not be maintained without seriously prejudicing the country's medium-term growth. The governments which have held office since the elections of 1976 have had the unenviable task of persuading the population to accept stagnant or declining levels of real consumption. 1/ Substantially unchanged from Part I of the President's Report for the Second Highway Loan which was distributed to the Executive Directors on May 4, 1979.

8 In terms of the world economy and its impact on the domestic situation, the Portuguese revolution could not have found a time more. likely to complicate the adjustment and impede future growth than April The oil price increase brought with it a substantial worsening of the country's terms of trade, while the economic downturn in Western Europe meant the slackening of demand for Portugal's exports, less earnings from tourism and, perhaps most serious of all, the levelling off of the demand for Portuguese workers. The Portuguese labor force in Western Europe had risen to 745,000 by Combined with the growing colonial army, this had meant very low levels of open unemployment in Portugal. After 1974, the increase in the labor force could no longer be absorbed by other European economies. To this was added the once and for all impact of demobilization and the return of about 500,000 people from the colonies. At present about 350,000 or about 8 percent of the labor force, are unemployed, although there is widespread underemployment. 5. This is the background against which the management of the Portuguese economy in the years since the revolution must be viewed. In trying to describe the events of that period, one is faced with the problem of portraying sequentially a series of simultaneous adjustments. One should not, however, infer a chain of causality from this. The convenient starting point is the rapid increase in money wages which took place after the revolution. Sharp increases in money wages combined with loss of productivity in many enterprises as labor relations deteriorated. The take-over of industrial and commercial enterprises and farms was often associated with an initial loss of production. In addition demand was sluggish for enterprises producing for export or for domestic middle and upper-middle class consumption. The consequence was that a large number of firms were in severe financial difficulties and the government, rather than risk a spate of bankruptcies with associated unemployment, used the nationalized banking system to provide liberal credit facilities to these firms. The fiscal system was also used to provide direct subsidies to public enterprises and to subsidize basic food items. 6. The evidence is that, by end 1977, real consumption per capita rose by about 10 percent over the 1973 level. In the context of virtually stagnant GDP per capita over the period (i.e. it kept pace with the 10 percent increase in resident population which was due to returnees from the colonies and natural growth in population, not compensated by emigration as in the past), the increase in consumption was at the expense of domestic savings. The increase in demand did not have a major impact on production in the short-run for a number of reasons. First, Portugal's structure of production did not fit the new structure of demand, which was oriented towards items of lower middle-class and working class consumption. Second, even in industries operating at full capacity, entrepreneurs were reluctant to invest when such investment meant hiring additional labor. Third, with the increase in population came a proportionate increase in demand for food products, most of which had to be imported because of sluggish agricultural growth. Fourth, the availability of foreign exchange constituted a constraint for domestic production, as restrictions were placed on the import of certain intermediate goods at various points in time. As a consequence of these factors, much of the

9 -3- increase in demand showed up in the 23 percent per annum average rate of inflation and/or in the increasing trade deficit. 7. The expansion of domestic demand put severe pressure on the balance of payments, which gradually began to loom as the dominant feature in the economic policy mix. Portugal's export receipts (both goods and non-factor services such as tourism earnings) fell by about 30 percent in real terms between 1973 and There was a combination of factors which led to this; the loss of the colonial markets, the recession in Western Europe, the deterioration in Portugal's competitive position, lower production in some industrial enterprises, and the diversion of some production to meet the expansion in domestic demand. In addition there was a severe terms of trade loss. As a consequence, the current account surplus of $348 million in 1973 turned to a deficit of $817 million in 1975, $1.25 billion in 1976 and $1.5 billion in It should be noted that it was the decline in exports and the terms of trade loss which produced this effect, rather than any sharp increase in imports which were only 6 percent above the 1973 level in real terms by Sustaining deficits of this magnitude has meant the depletion of Portugal's previously ample foreign currency reserves, and substantial borrowing against its gold reserves. 8. The task that successive governments in Portugal have faced is that of reducing domestic demand and imports and increasing savings and exports. There has been little or no disagreement on the need for such measures--the art has lain in stabilizing at a pace which is politically realistic. It should be recognized that the prevailing conditions in the country, especially for the first two years after the revolution, were not conducive to achieving quick results. However, efforts in the right direction were initiated by the first elected government of Portugal, but conditions remained difficult--the expectations of the population were still high, and the principal sectors of the economy were under the lingering effects of the radical political and social changes of 1974 and 1975 (paras. 3 and 4). Numerous measures have been introduced to reduce consumption--higher taxes, ceilings on increases in real wages, rise in utility prices, reduction of price subsidies and relaxation of price controls, etc.--but governments have not found themselves able to deny to enterprises and agricultural cooperatives access to credit at levels which have sustained the rate of employment, and which have largely negated the cuts in other areas. Various direct methods have been used to try to improve the balance of payments--depreciation of the escudo (by 62 percent between end 1973 and end 1977), surcharges on imports, interest rate subsidies for exports, etc.--but again these have had limited impact in the face of buoyant domestic demand. Obvaously deficits at the 1977 level could not be continued. The IMF diagnosed the need for even more stringency, and in mid-1978, agreement was reached on a stabilization program aimed at bringing the deficit down to $1 billion in the 12 months ending April This implied smaller GDP growth than in the previous two years and the shaking out of the less efficient units in the manufacturing sector as well, with some consequent increase in unemployment. The estimates for 1978 now indicate that the current account deficit was about $940 million and the GDP growth about 3.8 percent. The measures taken to achieve this included a 6.5 percent devaluation and the

10 - 4 - continuation of the crawling peg depreciation of the escudo over the period, and a 3 to 4 percentage point rise in interest rates. The evidence indicates that these measures have been particularly effective in reducing the very high rate of expansion of stocks of imported goods in 1977 which was brought about by the expectation of further devaluation and the substantially negative level of real interest rates. The measures also resulted in a 20 percent increase in the value of merchandise exports and a rise of about 40 percent in tourism earnings and workers' remittances in 1978, as compared with The large current account deficit of the past four years are in one sense a function of the decline in the savings rate, but can also be looked at as a consequence of maintaining the level of investment at around 20 percent of GDP, in spite of the savings decline. A high level of investment is crucial to Portugal in the long run, and ordinarily the maintenance of this level during a difficult period such as the past four years would be a cause for satisfaction. 10. If the Portuguese economy is to support even a modest growth in private consumption in the medium-term and come to terms with the very serious unemployment problem, increased investment and output will be necessary in two major areas: export-oriented manufacturing and agriculture. The restructuring of the Portuguese economy requires a vast improvement in agricultural productivity and the rapid recovery and expansion of exports. The investments which have been undertaken in the past years have not for the most part contributed much to the achievement of these objectives. 11. The stabilization program, which ended in April 1979, will only have an impact on improving Portugal's long-term prospects to the extent that increased public savings can be built into the fiscal system, and insofar as the composition of public investment addresses important structural problems. Through its stabilization program Portugal is buying time till both private and public sectors have the confidence to invest in new capacity for export and till the institutional changes have taken place which can improve Portugal's agricultural production. Portugal is currently negotiating another standby with the IMF, which will involve a further year of stabilization. If the encouraging results of 1978 can be sustained in 1979, a modest beginning in reflating the economy can be made from early By that time private investment can also be expected to gather momentum. Over the long-term ( ), Portugal should be able to achieve and sustain a growth rate of about 5.5 percent per annum. The outlook for this is encouraging, given the good economic performance in The industrial sector will obviously remain the leading sector in Portugal's future growth. Here the problem is that the export of manufactures is mainly done by the private sector which has been reluctant to invest for reasons quite unrelated to the profitability of exports. These include the general uncertainty and the difficulties of dismissing labor once it has been hired on a permanent basis. The Government has made a substantial effort to restore the confidence of the private sector. Thus provision has been made for compensation for nationalized assets, the law on dismissal has been eased, and profitability has been improved through lowering real wages in 1977 and

11 , depreciating the exchange rate and providing special incentives. The private sector is likely to be the major contributor to the economic growth rate foreseen for the 1980s. Restoring private sector confidence may require further incentives and clear evidence of a Government commitment to private initiative. For the rest, it is partly a matter of time, as increasing confidence develops in the stability of democratic government in Portugal, and as a new relationship evolves between management and labor similar to that in other Western European countries. The Government could perhaps do more to try to orient the manufacturing units in the public sector in the direction of exporting from their present capacity, and investing in new capacity for export production. 13. The focus of economic management in Portugal during the past four years has understandably been on the short-term. The time is long overdue to analyze the medium- and long-term needs. At the aggregate level, the domestic savings rate needs to be restored to levels which permit adequate sustainable rates of investment without crippling balance of payments deficits. At the sectoral level, there is a need to restructure investment in a way that will permit rapid growth overall and a slow resumption in the growth of private consumption. A medium-term plan was prepared in 1977 but was not finalized due to political difficulties. Government changes since that time have prevented agreement being reached on the framework for a new medium-term plan; work in that direction is continuing. External Assistance and Creditworthiness 14. The Bank has an important role to play in Portugal at present in helping the Government focus on the implications of short-term actions for medium-term development, in making the Government more aware of the role that institutions play in the growth process, and in assisting the Government in evolving a set of functioning institutions. It will continue to assist the government in its efforts to restructure the economy, and to bring about the long overdue institutional reforms which will be necessary preconditions to rapid and more balanced development in the future. 15. Multilateral and bilateral agencies have responded well to Portugal's need for external assistance, both for balance of payments support and for long-term project loans. With gold as collateral, the Bank of Portugal has obtained short-term loans for balance of payments support from the Bank for International Settlement and European central banks. The short-term debt of the Bank of Portugal and of the commercial banks amounted to about $2.1 billion at the end of In addition, the IMF has so far extended about $340 million as gold tranches, oil facilities, compensatory financing, and two credit tranches. The Bank has so far approved $299 million in seven loans during FY In addition, the EC/EIB, EFTA, as well as bilateral agencies have committed significant funds to Portugal in emergency concessionary aid and for long-term projects. In 1977, Portugal received $750 million in medium- and long-term aid commitments from 14 countries, mainly the US, Germany and Japan, as balance of payments support, which are now being disbursed. Commercial banks were relatively inactive in Portugal until May

12 , because of the Government's prolonged negotiations with the IMF and the general uncertainty. But in August 1978, the Government was able to attract two medium-term loans from consortia of commercial banks in the Euro-currency market for a total of $450 million at an interest rate of 1 percent over LIBOR for a term of 7 years including 4 years grace, to restructure its short-term debt. Portugal will continue to require sizeable external inflows for the investment necessary to restructure its economy, while it lowers its balance of payments deficit in the future. The multilateral lenders, and in particular the EC/EIB, EFTA and the World Bank, will have to continue to play a vital role in meeting Portgual's capital requirements. 16. Portugal's public and publicly guaranteed medium- and long-term debt (disbursed and outstanding) was about $1,304 million at end 1977, with a debt service ratio (debt service/earnings from exports, non-factor services and workers' remittances) of 3.7 percent. Total (public and private) mediumand long-term external debt reached about $2,230 million at end 1977 with a debt service ratio of about 11.9 percent. There still remains a gold stock of about 690 metric tons (June 1978) valued at about $4.8 billion, at a price of $200 per ounce, serving as a safety net, of which about one-third is pledged for short-term borrowings by the central bank. In the future, Portugal's total medium- and long-term debt service ratio will be around 17 percent during the period. However, the Government has already begun to make efforts to restructure its short-term foreign debt so as to improve the maturity profile (see para. 15). In the light of these facts, of the stabilization efforts made by the Government, and of the prospects for growth, Portugal can be considered creditworthy for Bank lending. PART II - BANK GROUP OPERATIONS IN PORTUGAL 1/ 17. The first phase of Bank lending to Portugal was during the period and lending was concentrated in the power sector, in line with government priorities which reflected the power needs of a rapidly developing industry. Five loans totaling $57.5 million helped finance three thermal and two hydropower projects, which were successfully completed to meet the country's increasing power requirements. 18. The turbulent events of the more recent past and the ensuing dislocation of human resources and the transition to an open political system have revealed social and economic weaknesses which are unusual for a highincome developing country. The recent governments in Portugal were preoccupied with these weaknesses; after some degree of social and political peace and stability was achieved, they addressed themselves to restructuring the economy and the social services, and to carrying out the wide institutional reforms required for that purpose. The dual task of tackling the short-term problems and restructuring the economy over the medium-term for integration 1/ Substantially unchanged from Part II of the President's Report for the Second Highway Loan, which was distributed to the Executive Directors on May 4, 1979.

13 -7- within Europe will require far-reaching efforts from the government and the people of Portugal. Meanwhile, to overcome pressing short-term economic problems and to eliminate the structural deficiencies without postponing developmental efforts, Portugal will continue to require sizeable external assistance, both financial and technical, in the years ahead. 19. The Bank has responded to Portugal's needs both through identification, preparation and financing of projects and through economic and sector work. The proposed loan would finance the Bank's fourteenth project in that country, the ninth since the resumption of lending in / At that time, demand for power had outstripped supply once again and a power project was selected as the Bank's first new operation in this familiar sector. A loan to finance a portion of Electricidade de Portugal's investment program for was approved on June 24, Seven further operations followed: a loan for a highway project, involving maintenance and construction, preparation of a transport master plan, a railway rehabilitation plan and a road investment plan, approved on October 19, 1976; a loan to Banco de Fomento Nacional (BFN) for industrial finance was approved May 24, 1977; a loan for a water supply project was approved on March 28, 1978; a loan for an education project was approved on April 27, 1978; a loan for an agricultural and fisheries credit project was approved on June 27, 1978 a loan for a fertilizer modernization project was approved on January 4, 1979 and a loan for a second highway project is to be considered by the Executive Directors on May 17, Excluding the Second Highways, these Bank loans amount to $299 million. Disbursements under the initial loans (FY1976 and FY1977) are low due mainly to the Portuguese agencies' lack of experience with Bank procedures and slow action on procurement. These difficulties are now being overcome. Under the FY1976 and FY1977 loans, commitments have reached high levels and disbursements are accelerating; under the subsequent loans, procurement is proceeding satisfactorily. Nevertheless, as of March 31, 1979, total Bank exposure in Portugal stood at only $41.7 million. Annex II contains a summary statement of Bank loans as of March 31, 1979 and notes on the execution of ongoing projects. 20. In an intensive parallel effort at the macro-economic and sectoral levels, the Bank assisted the government in reviewing policy and management issues. The economic missions and the discussion of their reports have provided a basis for a review of policy at the macro-economic level. Reviews of the water supply (together with WHO) and the education sectors were carried out and were discussed with the government in March Agriculture and manufacturing export industries were also studied, and were reviewed with the government in November The report entitled "Manufacturing Export Industries in Portugal" (No. 1695a-PO) was distributed to the Executive Directors on January 13, 1978, and the report entitled "Portugal - Agricultural Survey" (No. 1689b-PO) was distributed to the Executive Directors on March 24, In the light of the economic and sector discussions mentioned above, agriculture and industry have been identified as the concentration areas for 1/ The Second Highway loan to be considered by the Executive Directors on May 17, 1979 would finance the Bank's thirteenth project in the country.

14 - 8 - Bank lending. In the industrial sector there is need for major structural improvements such as merging firms, eliminating uneconomic enterprises and modernizing equipment. Improvements in these areas are being introduced in the fertilizer subsector, are being studied for the metalworking, pulp and paper subsectors and are proposed for the textile subsector with Bank support and advice. Another important constraint is insufficient financial and technical assistance and technological support to small- and medium-size enterprises. The proposed project for the development of small and medium industry (SMI) would address this need. The importance of developing the industrial sector cannot be over-emphasized, since this sector will be the main force in the Portuguese economy, primarily for the urgently needed export expansion and competitiveness in the European common market but also for efficient import substitution. The main objectives of Bank lending to industry are structural reform, export promotion and employment creation or preservation. In agriculture, a sector beset with major problems, there is considerable scope for stepping up growth. The major constraints are the still unsettled land tenure conditions, institutional weaknesses and a shortage of trained technicians for promoting improved technologies. The Bank has assisted the Government in creating a sound agricultural credit institution and future operations in this sector are likely to foster irrigation, forestry, livestock and fisheries development. The trained manpower requirements of the industrial and agricultural sectors would be addressed through projects in those sectors as well as through the FY78 first education project and a recently appraised second education project. The improvements in transportation required to sustain the increased output of the agricultural and industrial sectors would be addressed by the FY76 first highway project, the second highway project and a third transportation project which is in the process of being identified. 22. Thus, essentially through its involvement in industry and agriculture, the Bank would continue its efforts aimed at: (i) easing the immediate foreign exchange constraint; (ii) improving the longer-term balance of payments situation by supporting projects aimed at export expansion and selected import substitution; iii) assisting public investment in previously neglected social areas; and (iv) supporting government efforts toward the institutional and policy reforms needed to restructure the economy. 23. Sizeable and timely long-term external assistance is crucial if Portugal is to deal successfully with the problems that confront its economy. It is the Bank's objective to contribute to this effort while providing advice on developing the new institutions and reforming old ones, an institutional effort which is indispensable if Portugal is to achieve its overall long-term economic objectives. PART III - THE MANUFACTURING INDUSTRY Industrial Development 24. Manufacturing has traditionally been the leading sector in the Portuguese economy. In 1973, its share of GDP was about 35 percent, it

15 employed 27.8 percent of the labor force and accounted for 70 percent of exports. Currently it maintains this position and metalworking, machinery and transport equipment, as well as textiles, clothing and footwear subsectors, contribute significantly to GDP, to employment and to exports. 25. Manufacturing, particularly export-oriented manufacturing, was the driving force behind the remarkable growth in the Portuguese economy in the period The performance of that period took place, however, within a seriously unbalanced structure. Growth was concentrated in a relatively small number of large and modern enterprises enjoying privileged access to credit and foreign technology, while the medium and small enterprises, which constitute the bulk of the manufacturing industry, were given little assistance and few incentives to modernize and reach an adequate size. Artifically low wages (supported by a ban on trade-union activities), cheap raw materials and energy, restrictive industrial licensing, protective tariffs and captive markets for Portuguese exports in the former overseas territories hampered efficiency in general. 26. This unbalanced industrial structure proved particularly vulnerable following the profound changes in the domestic and international environment in the period (paras. 3 and 4). The consequence for a large number of enterprises was a sharp decline in industrial profits. Private firms (which, despite the nationalization in March 1975 of many major industrial groups, still account for 85 percent of value added, 88 percent of manufacturing employment, and more than 90 percent of manufactured exports) reacted to the depressed post-revolutionary financial and political environment by an almost complete halt in investment. 27. Measures introduced by the Government as well as increased demand, eased industry's most immediate problems and prompted a marked recovery of private investment in 1976 and 1977 (para. 12). However, industry's full long-term potential will be realized only through a difficult restructuring process, the opening of new lines of activity and the development of new markets. This will take some time, particularly as private entrepreneurs' attitude towards new investment continues to be cautious as a result of past losses, and of the deflationary impact of the stabilization program. Essentially for the same reasons, enterprises are running arrears, mostly on short term debt to banks. 28. Manufacturing is concentrated in the coastal regions between Viano do Castelo and Oporto in the north and Lisbon and Setubal in the south, particularly in the Lisbon and Oporto districts. In recent years industrial activity in the coastal regions has continued to increase, while that in the non-coastal regions has declined in relative terms. The industrial estates program under the proposed loan aims at encouraging greater regional balance. Small- and Medium-Scale Industry 29. The Portuguese authorities define small- and medium-scale industrial enterprises (SMI) as those employing less than 400 workers and with annual sales not exceeding Esc. 150 million ($3.3 million equivalent). In

16 /1977 SMI represented 97 percent of the manufacturing enterprises employing at least 5 workers and accounted for about 60 percent of manufacturing employment and an estimated percent of manufacturing value added. SMI are predominant in export-oriented sectors, such as woolen textiles, clothing and footwear, wooden furniture, fish processing and metal products; however, realization of their full export potential would require improvements in the incentive structure and provision of increased financial and technical assistance. 30. Labor productivity is lower in sectors dominated by SMI; although partially a result of lower capital intensity, this also stems from deficiencies in production technology and management. The technology component of the project, together with IAPMEI (para. 40) technical assistance, would help increase productivity in SMI. The Financial System and SMI Financing 31. The principal institutions of the Portuguese financial system are Banco de Portugal (the Central Bank); ten Portuguese commercial banks; Caixa Geral de Depositos (CGD), the major savings institution; and Banco de Fomento Nacional (BFN), the major development bank which was the beneficiary of an earlier Bank loan (paras 19 and 45). The commercial banks and BFN were nationalized in March 1975; and CGD has been a public institution since its inception, but these institutions nevertheless retain a significant degree of autonomy. 32. Banco de Portugal sets mandatory interest rates for both deposits and loans. Interest rates were raised five times between July 1974 and August Since Portugal uses a floating interest rate system, these rate increases affected all outstanding loans regardless of their term and not just new loans. The. maximum lending rate on term loans for over 5 years rose from 11.5 percent to 18.7 percent during that period, but these increases were not sufficient to eliminate the gap between interest rates and inflation (20 percent in 1975, 18 percent in 1976, 27 percent in 1977). As part of the stabilization program, interest rates were raised again very substantially in May Following this increase which applied to all outstanding loans, the maximum rate on term loans (22.25 percent) became marginally positive in real terms as the inflation rate has been declining and was about 22 percent in The expected further declines in the rate of inflation (to about 18 percent in 1979, 15 percent in 1980, 10 percent and below in 1981 and thereafter) gives scope for interest rates to attain significantly positive levels in real terms even with possible reductions in nominal levels of interest rates. The Government intends to maintain interest rates at positive real levels as inflation subsides and to review these interest rates (including interest subsidies) with the Bank at regular intervals. 33. The structure of interest rates is modified by surcharges levied on, and subsidies paid to, borrowers by the Central Bank. The subsidies structure as well as levels, were established in 1977 when interest rates began to rise steeply and when the investment climate was unfavorable. The main subsidies for investment credit affect about 10 percent of loans to industrial

17 projects and are geared to the labor intensity of the project and the impact of the investment on the balance of payments. This system is expected to be improved to give more emphasis to foreign exchange earnings or savings. It is not known whether subsidies have led to sub-optimal investments while it is accepted that they have mitigated the adverse psychological effect of the large increases in interest rates on SMI investment decisions. Subloans under the proposed SMI line of credit will be eligible for subsidies as long as these are maintained. Over the life of a twelve-year loan, these interest rate subsidies would lower the effective lending rate to a simple average of 19.6 percent per annum (discounted average would be 17.5 percent). This effective rate would be marginally positive during the first few months of project implementation late in 1979 and significantly so as applications for the SMI line of credit gain momentum in It is expected that reductions in the interest rates in nominal terms in the interim would be accompanied by reductions in subsidies. Moreover, the Government is examining new policy proposals which would eliminate interest rate subsidies for larger projects, and replace them with other incentives; if the new policy is successful it may be extended to smaller projects. 34. To reduce the adverse impact on industrial investments, notably SMI, of the high uncertainty of future depreciation of the escudo, the Government, in February 1977, established the Exchange Risk Guarantee Fund (FGRC) under the supervision of Banco de Portugal. The FGRC absorbs the exchange risk associated with selected foreign borrowipgs for high priority projects. In return the Fund receives fees corresponding to the difference between the domestic (floating) interest rate and the interest rate on the foreign borrowings, after deduction of a commission for the intervening Portuguese financial intermediary. The subloans under the SMI line of credit will benefit from FGRC coverage which, given the nature of SMI, is an appropriate arrangement. The fees paid to the fund are fixed with a view to achieving self-sufficiency. Exchange rate adjustments are expected to compensate for the differences in local and international inflation rates. 35. Until Portugal's efforts, starting in 1978 to reduce overall domestic credit expansion, liquidity in general had not been a constraint to industrial investment. Rather, most financial institutions have been ill-equipped to appraise investment projects and commercial bank loan terms have been inadequate. SMI have confronted special problems in securing financing because of insufficient equity, a lack of suitable collateral, and reservations on the part of the financial intermediaries to lend to unknown entities. 36. Before 1977 term credit was only available from BFN and CGD. Commercial banks were restricted, except under special conditions, to operations not exceeding one year; their principal exposure to term lending was through roll-over arrangements of short-term loans reserved for prime customers. Legislation of August 1977 permits banks to lend for up to ten years and requires them to direct a given amount of resources to medium- and longterm credit operations. Commercial banks are now building up a project appraisal capability. The Government has agreed not to modify the statutory maximum amortization period in the August 1977 legislation without consultation with the Bank (Loan Agreement, Section 3.06).

18 Due to decentralization and expediency, commercial banks have been and remain the best conduit of credit to SMI. BFN, which specializes in large scale projects, has satisfactory but slow appraisal procedures and a relatively small network of branches. CGD has an extensive network of branches and has been intensifying its efforts to serve SMI; however, it has had the reputation of operating slowly and putting too much emphasis on the adequacy of collaterals. 38. As a result of losses suffered during the post-revolutionaryears, many potentially viable SMI are undercapitalized and they do not meet local bank criteria for further borrowing. However, channelling of much needed equity funds to SMI has been delayed due to statutory constraints and fears on the part of firms about equity participations from government-owned banks in view of past nationalizations. Capital participation schemes are nevertheless under consideration in Portugal at this time. 39. Most Portuguese credit institutions have recently been affected in varying degrees by arrears (in most cases arrears amounted to about percent of the credit portfolio), essentially on short-term loans which are frequently rolled over as a matter of course. This is explained by the financial difficulties in the wake of the revolution, and the austerity measures constraining investments (to rationalize operations), liquidity and profits. A modest decline in arrears was registered in the first quarter of 1979 and it is expected that arrears will subside progressively as overall economic conditions continue to improve. The Bank has been discussing the issue with the Government since mid-1978 and an understanding has been reached that the Government will continue to review arrears with the Bank at regular intervals. The Government has helped the ailing SMI through viability contracts under which the company commits itself to financial, production, and profitability targets, and the Government helps with debt rescheduling and other financial support. The Government has approved proposals for a new agency to continue this assistance, and it is preparing a special scheme for the SMI; the Bank would be afforded the opportunity to comment on the new scheme. Financial and Technical Assistance to SMI 40. The Institute for Support to Small- and Medium-Size Industrial Enterprises (IAPMEI). In May 1974, the Government established a commission to help SMI to adjust to the changes in the economic environment after the revolution. This commission was transformed in May 1975 into IAPMEI, an agency in the Ministry of Industry and Technology. Although not a credit institution, IAPMEI facilitates SMI access to institutional credit particularly through guarantees it can offer on behalf of the State for investment financing. It also provides technical advisory services to SMI and plays a catalytic role in training, in investment promotion, and in mergers and other forms of collaboration among SMI. IAPMEI has 3 regional offices and 7 branch offices. IAPMEI's major impediment in the past has been a significant staff turnover, largely a result of uncompetitive salaries. IAPMEI needs to further decentralize its activities and decision-making power, and over time intends to set up additional branches, particularly at the industrial estates. To

19 better serve its purpose IAPMEI should have wider autonomy and offer a more competitive compensation package to its staff. The Government and the Bank have discussed the amendments to be made to IAPMEI's statutes for reaching these objectives. The government approval of draft legislation, acceptable to the Bank, to amend IAPMEI's statutes would be a condition of effectiveness of the proposed loan (Loan Agreement, Section 6.01(e)); the remaining legislative formalities would be completed by December 31, 1979 (Loan Agreement, Section 3.07). The Government is also considering permitting IAPMEI to take equity participation in SMI by means of the proposed changes in statutes. IAPMEI is developing into a strong institution capable of giving SMI the assistance they need and has therefore been selected as the pivotal agency for the proposed Bank project, particularly for providing technical assistance to SMI, and appraising and authorizing projects for the SMI line of credit. 41. The Industrial Estate Program. Portugal's industrial development has been heavily concentrated on the northern littoral above Lisbon. A potential for industrial (particularly SMI) development exists, however, in a number of other regions, but has been constrained in the past by inadequate infrastructure, a lack of incentive measures and of financial and technical support. The absence of planning in allocation and equipment of land for industrial use has also been an obstacle. This is particularly the case (a) in a number of medium-sized towns in the northern and central hinterland which possess industrial traditions but are confronted with problems of industrial restructuring and (b) in certain districts of the southern regions where significant manpower and natural resources provide good prospects for industrialization. These regions face serious problems arising from migration to the coastal urban/industrial centers - a trend which the Government has been trying to slow down. Following the completion of studies and regional development plans in the early 1970's, the Government in 1973 began preparing an industrial estates program involving the less developed regions, and created the Public Enterprise for Industrial Estates (EPPI) to implement the program. An investment plan covering the period and involving six estates (see map) was adopted in A follow-up plan involving another six estates is under preparation but would not be implemented until the first six are substantially completed and occupied. 42. The first phase of the first industrial estate in Braga was constructed by the end of 1977 and became available for factory rental in early Space in this facility was not sufficient to meet the strong demand from the newly formed industrial enterprises; all of the 22 factories in the first phase are now occupied or committed, and 44 industries have registered themselves for space in the subsequent phases. Also under construction starting in 1979 are three estates, in Guimaraes, Covilha and Evora; work on the remaining two estates is scheduled to start by the end of The industrial estates component under the proposed loan would support the Government's efforts in this area and help complete the financing plan for the tranche of the industrial estates program (paras 48,52) which includes the bulk of the total planned expenditures.

20 Export Promotion. The 10-year old Export Development Fund (FFE), under the Secretariat of State for Foreign Trade within the Ministry of Commerce and Tourism, is the main government body in charge of export promotion. It organizes preferential credit for exporters at low or subsidized interest rates, administers a number of other export incentive schemes and, with the help of its overseas branches, assists in direct export promotion. FFE appears to have spread its activities too thinly and to have inhibited the application of some potentially effective incentives by excessive delays and red tape. Moreover, it has not concentrated sufficiently on export promotion activities directed to SMI. The Government plans to reorganize and reinforce FFE with the assistance of the International Trade Center (ITC), and this is expected to strengthen institutional support for exports. The proposed project would assist the Government efforts in this field (para. 54). 44. Technology Assistance to Industry. Technology assistance is provided to industry by a number of specialized laboratories, and information and training centers. The Government is consolidating the services offered by many of these institutions, which in the future will be coordinated or controlled by the National Laboratory for Industrial Engineering and Technology (LNETI), a new institution under the Ministry of Industry and Technology. LNETI is successfully implementing the industrial management training centers financed under the FY1978 First Education Loan (para. 19). The technology study component of the proposed project is expected to assist the Government in more clearly formulating its policies of assistance to industry, particularly as they relate to SMI. Bank Operations in the Sector 45. With the 1977 manufacturing export industries review (para. 20), a fruitful policy dialogue was established between the Government and the Bank. Among other things, the review recommended more investment in the laborintensive export industries, notably measures to encourage entrepreneurship in this area. More specifically, it suggested (i) making the banking system more responsive to the investment needs of the industry including provision of equity, (ii) the Government financing factory buildings directly and leasing them to industries, (iii) the banks assisting the industry in project preparation, and (iv) the Government and the banks improving project selection methods. The review also recommended measures aimed at raising productivity such as management training, technical assistance and plant modernization, combined with restructuring weak industrial units. The Government is implementing the recommended measures in close collaboration with the Bank, and operations in the industrial sector, notably the proposed project, are geared to supporting the Government's efforts (para. 21). The focus of Bank strategy in its development finance lending is to assist viable industrial enterprises and to strengthen the institutions which give them needed financial and technical assistance. The Bank's first loan in the sector (No PO) became effective in March 1978 and was made to Banco de Fomento Nacional (BFN), which supports larger industrial ventures. Despite an initial six month delay, about half of the $50.0 million loan was committed as of April 15, 1979, and commitments are increasing rapidly. BFN's performance has been

21 highly satisfactory; however, like the other financial institutions it is affected by arrears amounting to about eleven percent of its credit portfolio (para. 39). The proposed project would be the Bank's first integrated SMI development project in Portugal and would be complementary to the BFN loai, since BFN concentrates primarily on larger scale enterprises. At present, there is substantial scope for development in SMI and their labor-intensive nature makes SMI suitable for employment generation. SMI are also suitable for export production since one of Portugal's main comparative advantages is its relatively cheap skilled labor. The Government considers SMI as a prime vehicle to accelerate Portugal's economic recovery, and is intensifying assistance to them. PART IV - THE PROJECT Project History 46. The project was identified by a Bank mission in November/December Preparation assistance was provided to the Government during a Bank mission in April 1978, and the project was appraised in June/July Negotiations took place in Washington from April 4 to 11, The Portuguese delegation was led by Mr. J. Salgueiro, President of the BFN, and included the representatives of the Ministry of Finance, IAPMEI and EPPI. A Staff Appraisal Report entitled "Small- and Medium-Scale Industry Development Project" (No PO) dated April 24, 1979, is being circulated separately to the Executive Directors. The main features of the loan and project are listed in the Loan and Project Summary and in Annex III. Project Objectives 47. The objective of the proposed project is to provide a comprehensive and well coordinated support package consisting of credit, technical and technological assistance to SMI - the backbone of the Portuguese industry. It would mainly (i) assist the restructuring, modernization and expansion of SMI; (ii) encourage foreign exchange earnings or savings; (iii) develop the industrial base of the less developed regions of the interior and extend support to SMI in those areas; (iv) ensure the viability of existing jobs in SMI and create new ones at a moderate cost per job. Project Components, Cost Estimates, and Financing Plan 48. The project to be implemented over four and one half years has a total cost of about $116.4 million of which about $45 million, or 39 percent, is in foreign exchange. It comprises five components: (i) $66 million for credits to small- and medium-size industry, of which the proposed loan would finance $33 million which is the estimated foreign exchange cost of fixed investments to be financed, and the financial intermediaries and borrowers, the balance; (ii) about $47.2 million for an industrial estates program, of which the proposed loan would finance about $9.5 million corresponding to the foreign exchange costs of the program; the balance (local costs) is expected

22 to be financed by a European Free Trade Association (EFTA) escudo loan of $1.1 million equivalent for 12 years including 2 years grace at percent interest per annum (but enjoying interest subsidies), a Kreditanstalt fur Wiederaufbau (KfW) loan of $4.7 million equivalent, for 20 years at 4.5 percent interest per annum; the Government would provide about $18.8 million equivalent in equity and $2.4 million equivalent in a long-term subordinated loan with grace period and interest capitalization extending through 1982 (this loan may be converted to equity) and local financial intermediaries about $10.7 million equivalent in loans; (iii) a $300,000 export promotion component, of which about $240,000 to be financed by the Bank loan and the rest by the Government; (iv) about $2.3 million for a technology component of which the Bank loan would finance about $1.9 million corresponding to the foreign exchange component, and the Government the balance; (v) a textile study and a technology study costing about $580,000 in total, of which the proposed loan would finance $410,000, UNIDO (a grant for the textile study), $80,000, and the Government, the balance. The above costs include price and physical contingencies for items other than the credit line (loan and project summary). A total of about 119 man months of consulting services would be used for items (iii) and (v) above; the average total cost of consulting services is estimated at about $7,400 per man month. A. The SMI Line of Credit 49. This component would help provide credit to SMI for industrial ventures. The ten Portuguese commercial banks, as well as Banco de Fomento Nacional (BFN) and Caixa Geral de Depositos (CGD) would operate the credit line under the coordination of Banco de Portugal, as the apex institution, and the Institute technical adviser. For this purpose, the Government would onlend $33 million of the loan proceeds to Banco de Portugal and the latter would channel it to the SMI by financing eligible subloans extended by the above intermediaries to SMI. While Banco de Portugal would be responsible for financial coordination, for disbursements and repayments under the SMI line of credit, IAPMEI would be in charge of appraising subborrowers and their projects and following up on project implementation. The operation of the credit line would be governed by the Loan Agreement, the Project Agreement with IAPMEI, a subsidiary Loan Agreement between the Government and Banco de Portugal, and a protocol between Banco de Portugal and IAPMEI on one side and the participating financial intermediaries on the other. The latter instrument would, among other things, establish the respective roles and responsibilities of all the institutions involved in operating the credit line. In view of its crucial role, the signing of such a protocol by at least three intermediaries representing at least 40 percent of the 12 intermediaries' total assets (as of December 31, 1977) would be a condition of effectiveness of the loan, as would be the signing of the subsidiary loan agreement between the Government and Banco de Portugal (Loan Agreement, Section 6.01 (b) and (c)). The above agreements and protocol would regulate, inter alia, the eligibility criteria for the SMI line of credit, spell out procedures for appraisal and commitment of funds and set the subloan terms. Under a new system (under preparation) for fixing credit ceilings for each financial intermediary, Banco de Portugal would give preferential treatment to intermediaries who make special efforts to use selected types of credits (i.e. exports, agriculture). The SMI credit line would be included among these credits.

23 Eligibility Criteria. The proposed SMI line of credit would finance the foreign exchange cost of projects eligible for IAPMEI's assistance, i.e. firms with 5 to 400 employees (600 for multi-shift operations) and sales not exceeding Esc. 150 million (about $3.3 million equivalent) provided that they are in sound financial position and also meet the following criteria simultaneously: (a) have a technically and financially viable project which is also economically efficient; for projects above $57,000 equivalent total cost, efficiency would be demonstrated by a satisfactory ratio (corresponding to at least 11 percent economic rate of return) between annual cash flow and investment cost (both adjusted to border prices); (b) have, with the proposed investment, the capability to export directly or as input in other products at least 20 percent of the output generated by the project, or to successfully compete with imports. An understanding has been reached with IAPMEI that it would make a special effort to use at least 50 percent of the funds available under the credit line for financing export oriented industries; (c) have a total investment cost (including permanent working capital but excluding land) which must not exceed Esc. 30 million (about $570,000 equivalent) at end 1979 prices; in the case of enterprises proposing an expansion or modernization project, fixed assets, excluding land, revalued to end 1979, must not exceed Esc. 75 million (about $1.4 million equivalent) in end 1979 prices before expansion or modernization; and (d) have an investment cost per job created or maintained not exceeding Esc 1.25 million ($23,800 equivalent) at end 1979 prices. Exceptions for meeting this last criterion would be made for SMI projects when more than 50 percent of the output of the enterprise may reasonably be expected to be exported; or, with prior agreement of the Bank and IAPMEI, when the investment per job criterion is fulfilled if the investment enterprise is taken together with other enterprises that sell or purchase from the investment enterprise. In view of the limited experience in SMI project financing in Portugal, cut-off points in the above criteria may be subject to minor adjustments from time to time by agreement between the Government and the Bank; any adjustments, however, would not change the SMI orientation of the project. With regard to the application of the export criterion under (b) above, an understanding has been reached with IAPMEI that export projections would be supported by past performance record, orders, or by a market study satisfactory to IAPMEI. IAPMEI would monitor the achievement of export targets, as part of its general supervision effort, and report progress annually to the Bank. The financial intermediaries would require best efforts from export oriented borrowers to achieve the projected export targets. 51. Procedures for Appraisal and Commitment of Funds. Projects with a total investment cost of over Esc. 15 million (about $285,000 equivalent) in end 1979 prices would require prior Bank approval, which would be based upon appraisal reports prepared by IAPMEI or the sponsoring financial institutions, and summary forms which IAPMEI would prepare and which would include the main features of the project. After the Bank will have reviewed 10 such reports, it would decide, on the basis of IAPMEI's appraisal performance, whether IAPMEI could thereafter authorize commitment of Bank funds for these larger projects with selective prior review of appraisal reports by the Bank for supervision purposes. From the start, IAPNEI would authorize commitment of Bank funds for smaller projects costing between Esc 3 million (about

24 $57,000 equivalent) and Esc 15 million (about $285,000 equivalent) in end 1979 prices, and the sponsoring financial intermediary would authorize commitment of Bank funds for the smallest projects costing below Esc 3 million, with an a posteriori control. Projects costing less than Esc 15 million would require only schematic appraisal reports on the basis of which IAPMEI would forward to the Bank, at periodic intervals, summary tables on projects financed. B. Industrial Estates 52. The $9.5 million subsidiary loan from the Government to EPPI out of the proceeds of the proposed Bank loan, would help finance two or more self-contained phases in each of the six industrial estates during (para. 41). Disbursements on each phase would be subject to prior Bank approval which will be based on a satisfactory appraisal by EPPI, including a separate assessment by IAPMEI of the feasibility of EPPI's estimates of occupancy for the particular phase, and a secured financing plan (Loan Agreement, Schedule 1, para. 4(c) and EPPI Project Agreement, Section 2.01). EPPI and the Bank have already appraised one phase of four of the industrial estates. The main contribution to the financing plan would come from the Government partly in the form of equity (40 percent) and partly in the form of a subordinated long-term loan (5 percent). The commitment of the equity funds would be a condition of disbursement of the Bank loan for this component (Loan Agreement, Schedule 1, para. 4(b)). Local banks, the EFTA industrial fund for Portugal, and KfW would also contribute to the financing of the program (para. 48). Should any estate phase appear unjustified and not be replaced by others, the unused portion of the subsidiary loan would be reallocated to the SMI line of credit. EPPI and IAPMEI would prepare a detailed program of collaboration by June 30, 1979 for promotion of the estates and to work out a plan whereby at least $5 million out of the SMI line of credit would be channelled for financing SMI on the estates (EPPI Project Agreement, Section 2.03, IAPMEI Project Agreement, Section 2.05). Export oriented enterprises would be given priority for at least half of the occupancy on the industrial estates (EPPI Project Agreement, Section 3.05). 53. EPPI, an efficient institution, has successfully completed and rented the first phase of the Braga estate. It operates as an independent revenue earning public enterprise under the supervision of the Ministry of Industry and Technology. It has a small competent staff of 41; in line with the implementation of the investment program, an increase to 65 by end 1979 has been planned. Hitherto EPPI has been more concerned with technical aspects of developing industrial estates but would direct more attention to attracting suitable SMI to the estates in the future (EPPI Project Agreement, Section 3.04). The main source of EPPI's present revenues is the rent it receives from the Braga estate which started operating in While heavily subsidized originally, EPPI's rental rates for new contracts have been increased to market levels recently. In the absence of specific regulations applicable to industrial estates EPPI's existing contracts would be subject to general rent regulations and can only be revised every five years. Any increase in rental rates for new contracts is subject to prior Government

25 approval. A more flexible rental policy which ensures adequate returns and routine adjustment to inflation is needed. In this connection agreement has been reached with the Government that in the future EPPI will determine the initial rents for factory buildings and equipped plots ready for rental at such levels as to ensure, on the assumption of 90 percent occupancy of the estate in question, a net revenue of 7 percent on EPPI's actual investment costs accountable to those facilities. To determine initial rents in this manner, EPPI's investment costs will be revalued to the prices of the fiscal year when factory space or a plot is first offered for rent. Rental fees thus determined for factory buildings and plots would be revised each following year to reflect inflation, until the facilities are rented (EPPI Project Agreement, Section 4.04). When a contract is signed for a building or plot the rental fees would be fixed for a three-year period and would thereafter be adjusted every three years in line with domestic inflation. The coming into force of the new EPPI rental policy, which has been discussed by the Government and the Bank, would be a condition of disbursement of the proposed Bank loan on the industrial estates component (Loan Agreement, Schedule 1, para. 4(b)). With this rental policy, EPPI is expected to have a positive cash flow after debt service in 1982 and a net revenue of about $1.1 million in 1986 when substantial occupancy on all six estates will have been achieved; net revenue would increase significantly thereafter. Prior to 1982, the Government would meet EPPI's cash deficit (Loan Agreement, Section 4.04). In view of the long gestation period associated with the industrial estates, these results are satisfactory. EPPI currently has no long-term debt and its debt/equity ratio is not expected to exceed 1.5 at any time. Its long term debt service coverage is projected to be 1.4 by 1986 and not to fall below that level thereafter. Agreement has been reached with EPPI that it would maintain the above ratio and achieve the above coverage (EPPI Project Agreement, Section 4.05). C. Export Promotion 54. Export-led growth is the center piece of the Government's economic strategy towards overcoming the pressing short-term constraints facing the economy, and towards preparing Portugal for European Communities (EC) membership. The International Trade Center (ITC) of UNCTAD/GATT has prepared a proposal for an integrated large scale technical cooperation program for Portugal over the period, which includes a number of export promotion and market development activities, as well as technical assistance towards strengthening the Export Development Fund (FFE) (para. 43) and the Secretariat of State for External Trade. The proposed Bank loan would finance priority activities under the ITC program, mainly technical assistance for establishment of joint export marketing schemes, export marketing studies for selected product groups as well as some urgent export related activities not in the ITC program, including a study on the system of export incentives. Multilateral and bilateral aid agencies are financing other activities under the same program but outside the scope of the project. A small committee would be established to coordinate the activities proposed for financing and to approve individual expenditures (Loan Agreement, Schedule 2, Part D2). Conclusion of an agreement between the Government and ITC on the execution of the Bank financed activities would be a condition of disbursement on this component

26 (Loan Agreement, Schedule 1 para. 4(d)). An understanding has been reached with the Government that FFE would prepare by December 31, 1979 a plan of activities for the next five years involving, inter alia, concentration on selected products and export markets, improvements in the export subsidy system, exports by subcontracting, and streamlining of export development support. D. Assistance to Technological Institutions 55. This component is designed to reinforce and render more effective the institutions which provide technological support to SMI. Improved technological support would help SMI develop new products, provide quality checks, meet export demands and increase competitiveness. It encompasses consultant services, training abroad, pilot plants, and urgently needed quality control and testing equipment for three institutes operating under LNETI: (i) the Food Industry Technology Institute; (ii) the Ceramics and Essential Oil Departments of the Industrial Technology Institute; and (iii) the Physics Laboratory (including Metallurgy, Electronics and Optics Sections). IAPMEI would provide the liason between the SMI and LNETI while LNETI would supervise the installation of equipment. The component would be administered, under the supervision of LNETI by a small committee, consisting of one senior representative each from the Ministry of Industry, LNETI and IAPMEI, which would have to approve individual expenditures (Loan Agreement, Schedule 2, Part C2). E. Studies 56. Textile Study. The textile industry, which accounts for 35 percent of SMI registered with IAPMEI, is in difficulty due to the changes which occurred after the 1974 revolution. It needs to be modernized and restructured to reinforce its viability, particularly to help it regain its export potential. The proposed textile sector study would identify the necessary measures and priority investments required for modernization, restructuring, and ensuring export competitiveness; and it would help prepare a textile industry project to support the recommended strategy. The Textile Industry Office (GIT), a special administrative unit within the Ministry of Industry and Technology in charge of formulating and implementing the Government's policy towards the textile sector, would set up a Portuguese team to work closely with foreign consultants for the implementation of the study. 57. Technology Study. Portugal has substantial investment in a network of laboratories and institutes to provide management training and technological support and guidance to the industry. However, technology institutions will have to rationalize their operations and adapt to the requirements of the industry, notably SMI. The Technology Study would evaluate industrial technology institutions, delivery systems, and incentives for promoting transfer of technology, recommend ways and means of supporting industrial development objectives with emphasis on exports, employment and SMI development, suggest a medium term technology policy and identify the investments required by this policy. LNETI, a capable organization under the Ministry of Industry and Technology, would supervise the implementation of this study, which is expected to lead to a future technology project.

27 Disbursement and Procurement 58. The proceeds of the proposed Bank loan, to be disbursed over the period September 1979-December 1983, would finance (a) 65 percent of SMI fixed investment costs estimated to represent the full foreign exchange costs ($33 million), with procurement according to standard procedures applicable to development finance operations which are acceptable to the Bank,(b) 20 percent of EPPI investment costs estimated to represent full foreign exchange costs ($9.5 million) of goods and construction contracts to be procured in accordance with EPPI's procurement procedures (local competitive bidding), (c) 100 percent of the foreign expenditures on equipment for the technology institutes (1.8 million), procured through solicitation of at least three bids or price quotations, fellowships for staff involved with the implementation of the technology component ($50,000), and (d) 80 percent of total expenditures for consulting services (para. 48) for export promotion activities, technology and textile studies ($650,000). The SMI credit line would be administered through a special account in Banco de Portugal. The opening of this account and the establishment of a small unit to administer it would be a condition of effectiveness of the proposed loan (Loan Agreement, Section 6.01(d)). Disbursements under the SMI credit line would be made against withdrawal applications made by Banco de Portugal acting as representative of the Government. For small subprojects (investment costs under Esc. 15 million), Banco de Portugal would certify that the expenditure has been made and that satisfactory documentary evidence is available for Bank review. Prior submission of full documentation would be required for disbursement against large projects (20 percent of disbursements). Advance contracting of consultants (up to $500,000) is required for starting the studies as early as possible since urgently needed improvements in two crucial areas in the industrial sector depend on these studies. Execution of the industrial estates program according to the schedule for EPPI's investment plan would also require advance contracting of about $2.5 million. Retroactive financing of $150,000 for the studies and $500,000 for the industrial estates is therefore recommended for expenditures after December 31, 1978 on consulting services, and on construction and equipment respectively. The Government has appointed consultants in agreement with the Bank and UNIDO for the textile study. The terminal date for the submission of SMI (except the smallest projects) and EPPI projects is October 31, 1982 and the closing date of the proposed loan is December 31, Onlending Arrangements and Terms 59. Onlending arrangements would be necessary for the SMI credit line and the industrial estates components. (a) For the SMI credit line, the Government would make a $33 million subsidiary loan to Banco de Portugal, to be repaid according to a fixed amortization schedule reflecting the estimated aggregate amortization schedules of SMI subloans. The subsidiary loan would bear the same interest rate and commitment charge as the proposed Bank loan. Banco de Portugal would use the proceeds of the subsidiary loan to refinance eligible subloans from financial intermediaries to SMI. The SMI subloans would have an amortization period corresponding to project life but in no case exceeding 12 years, including up to three years grace; they would bear the floating interest rate applicable to similar loans (currently percent

28 per annum but subject to subsidies). Out of this, the financial intermediaries would retain a 3.5 percent commission and pass on the rest to Banco de Portugal. The latter would pay IAPMEI a one percent fee for technical services and retain a 0.75 percent fee for itself to offset the commitment charges under the Government subsidiary loan. After a further deduction of 7.9 percent for the interest charges on the Bank loan, the balance, or 9.1 percent, would be paid to the FGRC as a fee against the coverage of the exchange risk on the SMI subsidiary loan. (b) For the industrial estates component, the Government would make a $9.5 million subsidiary loan to EPPI for 15 years, including five years grace. This longer grace period is justified by the longer gestation period associated with investments in industrial estates. The subsidary loan would bear the same interest rate and commitment charge as the Bank loan, and EPPI would assume the foreign exchange risk. Onlending arrangements would be governed by subsidiary loan agreements between the Government and Banco de Portugal and between the Government and EPPI. The conclusion of these agreements would be a condition of effectiveness (Loan Agreement, Section 6.01(a) and (b)). Refinancing arrangements between Banco de Portugal and financial intermediaries would be governed by a protocol (para. 49). Benefits and Risks 60. The prospect of Portugal becoming a competitive exporter and an economically stable EC partner depends on the export performance of its manufacturing industry where SMI predominate. As mentioned previously, while manufactured exports increased in 1978, Portugal's performance was unsatisfactory during the preceeding years; it was poor compared both to Portugal's historical performance and to that of the least-developed countries vis-a-vis the main trading partners of Portugal. SMI is a long neglected sector and improvements in this area will require the administration of successive, well-coordinated assistance packages including financial, technical and technological support. The proposed loan would-help meet the minimum immediate needs in this area through availability of credit, industrial infrastructure in less-developed regions, better technological support, and technical assistance in project appraisal, financial management, structural change and export promotion. The main impact of the project would be in strengthening the institutions which assist the SMI and in improving coordination between them. IAPMEI and EPPI would substantially increase their capacity and experience in handling new investments; LNETI would receive support and Bank technical advice during a far-reaching reorganization aimed at achieving higher efficiency. FFE would also receive substantial assistance, both through the acceleration of the ITC assistance program and through direct contributions under the proposed loan. With this assistance it would plan its activities for the next five years and concentrate on areas where Portugal has a comparative advantage. Institutional development would not be restricted to the above mentioned public agencies, but would also involve commercial banks which would develop or increase the project identification and appraisal capabilities required for term lending. A boost in term lending by commercial banks and the technical support which will accompany this lending are expected to contribute significantly towards re-establishing small investor confidence.

29 The 300 to 400 subprojects to be financed under the SMI line of credit would help create about 2,500 new jobs at a relatively low investment cost ($13,000-$15,000 per job), by ensuring the long-term viability of many SMI which are in the process of adjusting to new conditions after difficult years. In addition, the industrial estates program would stimulate the creation by 1985 of 15,800 jobs at a low average investment cost of about $3,000 per job for infrastructure and buildings, and of about $8,500 per job for the locating enterprise in 1977 prices. Under both components, exporting industries would receive encouragement through incentives (access to credit) and institutional support (joint marketing, export credits by FFE; technical assistance by IAPMEI, access to space on industrial estates) to increase competitiveness, initiate or increase exports. The establishment of industrial estates would encourage regional development and help attract hitherto non-existent financial and technical support to SMI in less-developed regions. It would also help to alleviate the industrial concentration in the Lisbon- Oporto coastal strip. the economic rate of return on the industrial estates program (40.5 percent of total cost) is estimated to be 22 percent, with variations between 15 to 25 percent for individual estates; the economic rate of return for SMI subprojects (56.7 percent of total cost) would be at least 11 percent (for subprojects with investment cost below $57,000 equivalent, a detailed rate of return calculation is not required; the merits of these subprojects would be judged by the financial intermediaries according to their standard practices). 62. The major project specific risk relates to the overall implementation of a complex and novel project requiring the coordination of many institutions; for this reason, at the initial phases, commitments and disbursements may be slow. This makes the effective functioning of IAPMEI a key to success. The past performance of IAPMEI suggests that it will be able to discharge responsibilities effectively. The expected new statute of the IAPNEI would help to further increase the efficiency of this organization (para. 40). The project may also face the risk that the financial intermediaries may not be sufficiently active in promoting the line of credit or that the expected demand for credit may not materialize. However, this risk is minimized by offering an adequate spread and other incentives to the intermediaries (paras. 49, 59), and by making conservative demand estimates based on a thorough survey of SMI investment plans by IAPMEI. In addition, an understanding has been reached with the Government that it would create additional incentives if needed, after consultation with the Bank. A third risk may be inadequate demand for some of EPPI's currently planned industrial estates. However, the provision for a thorough assessment of demand among SMI in each region by IAPIVI prior to Bank approval of each phase of individual estates is designed to safeguard Bank financing non-viable industrial estate projects. All of the above risks are well worth taking in view of the central importance in Portugal's economic recovery of restoring confidence and initiative to the private sector.

30 PART V - LEGAL INSTRUMENTS AND AUTHORITY 63. The draft Loan Agreement between the Republic of Portugal and the Bank, the draft project agreements between the Bank and IAPMEI, and between the Bank and EPPI, and the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement, are being distributed to the Executive Directors separately. 64. Special conditions of the project are listed in Section III of Annex III. As special conditions for the effectiveness of the proposed loan, Banco de Portugal would open an account for the SMI line of credit and set up a small administrative unit for the account; the Government would approve the draft legislation to change the statutes of IAPMEI; subsidiary loan agreements would be concluded between the Government and Banco de Portugal and the Government and EPPI; a protocol would be concluded between Banco de Portugal and IAPMEI on the one side and at least three financial intermediaries on the other (Loan Agreement, Section 6.01). The revision of EPPI's rental policy, commitment of the Government's equity contribution to EPPI and approval by the Bank of each phase of each industrial estate would be conditions of disbursement for the EPPI subsidiary loan; conclusion of an agreement between the Government and ITC regarding Bank financed export activities would be a condition of disbursement for the export promotion component (Loan Agreement, Schedule 1, Para. 4(b),(c),(d)). 65. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 66. I recommend that the Executive Directors approve the proposed loan. Attachments May 7, 1979 Washington, D.C. Robert S. McNamara President

31 Annex I TABLE 3A Page 1 of 5 PORTUGAL - SOCIAL INDICATORS DATA SHEET REFERENCE GROUPS (ADJUSTED AVERAGES LAND AREA (THOUSAND SQ. RM.) PORTUGAL - MOST RECENT ESTIMATE) TOTAL 92.1 SAME SAME NEXT HIGHER AGRICULTURAL 41.7 MDST RECENT GEOGRAPHIC INCOME INCOME 1960 Lb 1970 Lb ESTIMATE Lb REGION /c GROUP /d GROUP Le GNP PER CAPITA (US$) ENERGY CONSUMPTION PER CAPITA (KILOGRAMS OF COAL EQUIVALENT) POPULATION AND VITAL STATISTICS TOTAL POPULATION, MID-YEAR (MILLIONS) * URBAN POPULATION (PERCENT OF TOTAL) POPULATION DENSITY PER SQ. KM PER SQ. KM. AGRICULTURA LAND POPULATION AGE STRUCTURE (PERCENT) 0-14 YRS YRS YRS. AND ABOVE POPULATION GROWTH RATE (PERCENT) TOTAL 0.7 /f 0.1 If URBAN CRUDE BIRTH RATE (PER THOUSAND) CRUDE DEATH RATE (PER THOUSAND) GROSS REPRODUCTION RATE FAMILY PLANNING ACCEPTORS, ANNUAL (THOUSANDS) USERS (PERCENT OF MARRIED WOMEN) FOOD AND NUTRITION INDEX OF FOOD PRODUCTION PER CAPITA ( ) PER CAPITA SUPPLY OF CALORIES (PERCENT OF REQUIREMENTS) / PROTEINS (GRAMS PER DAY) a OF WHICH ANIMAL AND PULSE CHILD (AGES 1-4) MORTALITY RATE 5.2 /h HEALTH LIFE EXPECTANCY AT BIRTH (YEARS) INFANT MORTALITY RATE (PER THOUSAND) ACCESS TO SAFE WATER (PERCENT OF POPULATION) TOTAL URBAN RURAL ACCESS TO EXCRETA DISPOSAL (PERCENT OF POPULATION) TOTAL URBAN RURAL POPULATION PER PHYSICIAN POPULATION PER NURSING PERSON POPULATION PER HOSPITAL BED TOTAL URBAN RURAL ADMISSIONS PER HOSPITAL BED HOUSING AVERAGE SIZE OF HOUSEHOLD TOTAL URBAN RURAL AVERAGE NUMBER OF PERSONS PER ROOM TOTAL UR8AN RURAL ACCESS To ELECTRICITY (PERCENT OF DWELLINGS) TOTAL URBAN RURAL

32 TABLE 3A PORTUGAL - SOCIAL INDICATORS DATA SIEET Annex I Page 2 of 5 BEFERZNCE GROUPS (ADJUSTED AVERAGES PORTUGAL A - MOST RECENT ESTIIATE) SAIIE SAME NEXT HIGHER MOST RECENT GEOGRAPHIC INCOME INCOME 1960 Ab 1970 Lb ESTIMATE lb REGION LS GROUP /d GROUP Le EDUCATION ADJUSTED ENROLLMENT RATIOS PRIMARY: TOTAL FEMALE SECONDARY: TOTAL /i FEMALE VOCATIONAL (PERCENT OF SECONDARY) PUPIL-TEACHER RATIO PRIMARY SECONDARY ADULT LITERACY RATE (PERCENT) CONSUMPTION PASSENGER CARS PER THOUSAND POPULATION 17.0 RADIO RECEIVERS PER THOUSAND POPULATION 95.0 TV RECEIVERS PER THOUSAND POPULATION 5.0 NEWSPAPER ("DAILY GENERAL INTEREST") CIRCULATION PER THOUSAND POPULATION CINEMA ANNUAL ATTENDANCE PER CAPITA EMPLOYMENT TOTAL LABOR FORCE (THOUSANDS) Li PEMALE (PERCENT) AGRICULTURE (PERCENT) /: INDUSTRY (PERCENT) /f PARTICIPATION RATE (PERCENT) TOTAL MALE FEMALE ECONOMIC DEPENDENCY RATIO INCOME DISTRIBUTION PERCENT OF PRIVATE INCOME RECEIVED BY HIGHEST 5 PERCENT OF HOUSEHOLDS Ik.l 56.3 /k.m HIGHEST 20 PERCENT OF HOUSEHOLDS Jk,j 78.6 /k LOWEST 20 PERCENT OF HOUSEHOLDS /tj 7.3 /k.m LOWEST 40 PERCENT OF HOUSEHOLDS /k /k POVERTY TARGET GROUPS ESTIMATED ABSOLUTE POVERTY INCOME LEVEL (US$ PER CAPITA) URBAN RURAL ESTIMATED RELATIVE POVERTY INCOME LEVEL (US$ PER CAPITA) URBAN RURAL * ESTIMATED POPULATION BELOW POVERTY INCOME LEVEL (PERCENT) URBAN RURAL Not available Not applicable. NOTES /a The adjusted group averages for each indicator are population-weighted geometric means, excluding the extreme values of the indicator and the most populated country in each group. Coverage of countries among the indicators depends on availability of data and is not uniform. /b Unless otherwise noted, data for 1960 refer to any year between 1959 and 1961; for 1970, between 1969 and 1971; and for Most Recent Estimate, between 1973 and /c Europe; /d Upper Hiddle Income ($ per capita, 1976); /e High Income (over $2500 per capita, 1976); /I Due to emigration, population grawth rate is lower than rate of natural increase; aj Av ; /h 1965; /i disrupted enrollment due to political unrest; /f Estimtes based on inquiry of esloyment conducted by Institute of National Statistics; /k Highest 252 and 502 and lowest 252 and 502 of households; /f 1968; /m * Revised population figure for 1977 is 9.7 million. SIptember ** This figure is for The estimate for 1977 is $480.0

33 Annex I DEFINITIONS OF SOCIAL INDICATORS Page 3 of 5 kiota: The adjusted group averages for each indicator are population--eighted geometric means, excluding the extreme velnes of the irdicator and ths moo. populated country hi each avoup. Coverage of ceuntries among the indicatoe- depends on availability ef data and in not aniform. Doe to lack of dat, group averages foe Capital 'orplas Oil Epeeters and indicators ef access to eaten and esreta disposal., housing, in.em. distributien and poverty are simple population-weighted geometric Means without the eclusien ef extreme values. LAND AREA (thnosand sq. kh) lepslatinn per hospital bed - total. urban. ad rural - Fopulation (total, Total - Total surface 0-00 comprising lacd aea. and iui-,c n unh amd raral) divided by their rnupvctive nueber of hospital bed. ARri-ultoral - Most cecent estimate of agricultural area used temporarily availebih is public asd prieate general and speciali-ed hospital and reor permanently for crops, pastures, market and kitchen gardens or to habilitation renters. Hospitals are establishkents perm.sestly staffed by lefulloc. at lea..t ass physioiam. Etstalishm..ats pr-vidiog priocipallp. tadind1a efo.ase rea oea in ded. Rarsl hospitals, h-weve, inoluie health and -ed<- (lp PER CAPITA ( - GNP) INP yen capita automates at current market pri-es, ral centers cot pernanestly staffed by a physiciar (but by calcuiated a medical ky same as- converstoo method as meld Bank Atlas ( basis); sistant nue, midwife, et..) which ofeer is-patient accotnodation and 1960, 1970, and 1977 data. penvide a limited mange af sedical facilities. Admissions pey hospitai bed - Total number of adntasioas Cc cr discharges ENERGY CONSUMPTION PER CAPITA - Annual consumption of commercial enengy from hospitals divided by the snken ni heds. (coal and lignite, petroleum, satural ga. and hydre-, nuclear and geothermal electricity) in kilograma of coal eqaivalent per capita. HOUSING Average sie of hounshold (pesens per hosehoid) - tonal. urhan, and rcaal- POPULATION AlD VITAL STATISTICS A household consists of a grasp of individuala who share living q.a.tern Total population, mid-year (=illions) - An of July 1; if not available. and their main meals. A boarder or lodger may or may not be included is avevage of ran end-year entinaceo; 1960, 1970, and 1977 dana. the hounehold for statistical purposes. Statistical definitiocs of haste- Urban populatia (rerones of - Rocal) Rtcit of urbha to total popula- hold vary. tion; diffevent definitiocs of -rbac areas may affect comparability Average nu=ber of persons Der room - total, arban, and ranal - Average 0cmof data among countries. ber of persess per roon in all. anbhn, and rural occupied conventional Popolation density dwellings., respectively. Dwellings enclude non-pernanent structures and Peer sq. k. - Mid-year popultilon per square kil.o=eter (100 hectares) anoccupied parts. of total on-o. Ancess Ca electrit ity (perent of dt elliags) - total, arban, and rnaal - Per sq. ion. nriculture land - Computed as ahove for agricultaral land Coaventional dwellings naith electricity in living quarters as percentage only. of total, urban, and rntal dwellings respectively. Population age structure (perceot) - Children (0-14 years), working-age (15-64 yearn), and retired (65 years asd over) as percentagea of mid- EDICATION year population. Adijoted enrollmacteasios Pnpalation grtf.th rate (Percent) - total, and ubnan - CG=pnund annual Primary school - total, and female - Total and female enrollment of all ages growth nates of total and arbha mid-year popalations for , at the primary level as percentages of respectively primary school-age 1960-_l, and popalatiann; normally inlsdes children aged 6-11 years kut adjusted for Crude hirch rate (per thousand) - Annual live binths per thousand of different lengths nf primary eduaetion; for coantrien with universal edamid-year population; ten-year arithmetic averages ending in 1960 end cation enrollment asy eareed 100 percent sin-e none p.pils are helow or 1970 and fine-year uverage ending in 1975 for mast recent estimate. above the official school age. Crude death rtac foer thnusand) - Annual deaths per thouaand of mid- Secondarv schoel - total, and female - Caspnted as ahove; secondary educayear populatioc; ten-year aritlntetic aeecsgs ediag in 1960 and 1900 ion requires at least four yearn at appreved primary instruction; pro- _nd five-year average ending in 1975 for most -reent estimate. vides general vocational, or teacher training instructions for pupiln GInss reprodnetion rate - Average numhee of daughters a unman will bear usually of 12 to 17 years of age; correspondence -- urses ane gen-ally in hot normal seprod-ctive period if she experienees present age- e-eluded. specific fertility rates; usually five-year averages ending in 1960, tocational enroll. est iprercent of secondary) - Veationsl institaticns in- 1970, and elude teohnical, industrial, or other program- which operate iudnpeodc-tly Family planninga- acceptons, actual (thousands) - Annual n=bker of or an departmenta nf serendary institutions. acceptors of hirth-control devices under auspices of natianal family topil-ceanhen ratio - eri=ary, and secondarv.- Total students enrolled in planning progran. primary and secondary levels divided by nu-bern of teachers in the co-re- Eamily planning -uers (percent of married womee) - Percentage of spanding levels. married ennen of child-bearing age (15-44 years) who -ae birth-eontrol Adalt litner-c rate (percent) - Literate dolts (abla to read and weits) ac devices to all married women in name age graup. a percentage of total adult population aged 15 years and over. POOD AND NUTRITION CONSUhPTION lode of oodprodctio pe capta (ilolol)-indee sunken ef per Passenger car (perhouan VpupuatiPn aas.esgerscner coprise motor-a-r capita annual production of all fond coameodities. seating lens than eiaht persons; exlcude aeance, hars and milt ary Per capita supply of calorien (percent of requireeenss) - Copputed fro= vehicles. energy equivalnet of net food supplies available in country per capita Radio receivers (per thoasand peoulatiam) - All types of reo-ivern fcr radic per day. vanil gbl i sopplien Nrc it 5 dnmstic preduttian impsrte a ies brod.a.ts to genre1 public per thousand of pepalatios;nxm ds ucenotd enot,ad changen in scci. Net anpis _srlde animal feed, seeds, reiasis cutries and in years hnrgitration of.adi.vsetnwss.in qusotities used in food proeensing, and loses in distribution. Re- effect; date for recent years may not be canparakbe since most countries qauremeniswerer istmated by FAO baaed ye phyniologieal needs Eor nor- abolished licensing. =al activity end helith ennside,ing environmental tempe-atune, body TV receivers (yen thoasand populunion) - TV receivers for broadoad t to genera weights, uge and ne distribations of population. and allowing 10 per- public per thousand population; emclsdes unlieenssd TV receivers inrcaucent for waste at household level. tries and in yearn when registration of TV sets was in effect. Pen capita ouppol of proteio (gramsoper day) - Protein content of per Newspaper circulation (per thousand papalation) - Shews the average circulacapita net supfly of rood per day. Net nupply of food in defined an ties of 'daily general interest newsp-pep.r", defined as periodical pshliabove. Requirements for all countries establiahed by USDA provide for -ation deveted primarily to recording general sewn. It iacnu -idred minimum allo.ance of 60 grana of total protein per day and 20 grams be "daily" if it appears at leani four times a week. to of animal and plse protein., of which 10 grams should be animal proaei. Cinema annual attendance Penrcapita per year - eased on the nab-er of tickelt These stondarde are lower than those of 75 grams of total protein and sold daring the year, including admissions to drive-in c-nemos and nobile 23 gra_n of animal peontin an an average for thc woeld, proposed by a-its. FAO in the Thitd World Food S.rvey. Fer capita protein supply from eninal and pulse - Prntein supply of focd EteLOYMENT devived fenn animals and pulese in gre.. per day. Totel labor fore (thoasands) - Economically active person., includiog arced Child (ages 1-u) mortality rate per thousand) - Annual deaths per thous- forcns and une=ployed bht exclading housewives, and in age group 1-4 years. tc child-en in thiu age gr-of. tions to vanioas eenntsies are not co-papsble. students, etc. Defint- HEALTH Female (perent) - Female labor force an percentage of total labor force. Agriculture (Percent) - Labke force in farming, forestry, hunting and fisichg Life eacrctoucy at liuth (years-) - Average anhber of years of life an penntage of total labor foene. re=nining at birth; asually fite-year averages ending in 1960, 1970, IndusEty (percent) - Labor force in mining, conatructito, man-facturi-g and eleoc-tiity, cater and ean as percentage of votal lahoe foce. and Infant mortality rate (per thousand) - Annual deaths of infants under Participation rate (percent) - total, male, and female - Total, male, aad one year of age pen thousand live birhts. eesle labor force at percertages of their respective populations Acrens to su e waten mnrcant cc pepulesien) - tetal, urban, and rueal - Tsese are ILca adjanred parntiip-yion races reflecting N-ober of people (total, urban, and rutal) with reaesnable access to strur re of the poplultics, and onig tine tcend. ace-sec nafe water nupply (inclade- treated surface waters on untreated but Econneic dependency resti - Ratio uf popalatioc uncontaminated water sach an that frem protected borehol-s, springs, the labkr for-e in age group of ea-s. under 15 avd b5 atd over so and saoatcry aello) us percentages of thei mespeonive ppoplations. In an arban area a public fountain or standpost lated not mare INCOMn DISTRIBUTION thas 200 meters from a house may be considered as being within rea- Percentage of private ineome (both in rash and kind) teceived by richest 5 sonable -ccesn of that inane. t raral areaa eaasonable acces would percent, richest 20 percent, poorest 20 percent, and po-rest 40 percent imply thut th: housecife or mrmbers of the household do aot have to of houneholds. spend a disproportionate part of tha day in fetchiag the family's cat er needi. POVERTY TARGFT GROtPS Accets to eacreta disposal of copulation) - total, arban, and Eceronet Esti=ated absolute yensy income level (f1) pee capita) - urban and roral - income level is that iscome level blow whih -in1 rural - Nanber of people (total, urban, and rural) setemd by eaceeta Absolute poverty dip_sal as perrentages of their resp-tti-e populationn. teeta utrit.enal.py disposal may Inclode the collecutin and disposal, with or without affordabi.r dequate diet plus essenti o-od require e is n Eltlmated relative eovnntv ineome level (Oil oar capita) - crban cod rural - of pit pfivien nd sitlar installations. Relative poverty innome level is that income level less than one-third Population cer physician - 7fpulation divided kp nuyebr ef practicing pee capita personal income of the country. trest=ent, on thy use of hkaan excreta and waste-water by water-bone systems phys-ci-nn qualified from a nedicnl sehool ast univsiny level. ascinated coculoilo helow poverty income level (percent) - unhao and natal Population ten nursing person - Population divided by nu=ber of Percent of population (ubnan snd rural) whe ave either "absolute poor" or practicing male and female aiscant nurses. graduate nurses, practical nases, and "relanive poor" whichever is greater. Economic and Social Data Ditvsion Economic Analysts and Projectioma Oe-arcsroc

34 Annex I Page 4 at S ECONOMIC DEVELOPMET DATA (A-sats in Millions of US Dollar) Astual Enti-at.d P197.5t NA_TION-ALCCOUNTS Ana osa 1975 Price nod ExhneRte of $1 Ens Annua Groth Rote As Pe n of cdi' Gros D-netia Pradat 15,233 15,340 14,773 16,117 17,020 17, Colas iron To- of Tr-dr Gras D-sotia Insan 13,759 15,725 14,775 16, ,955 17, Iprs((sal. NFS) 6,170 6,464 4,758 0,067 6,286 6, isora RaI. NWO) , j : ERsor Gap 2,208 3,124 1,859 2,529 5,051 2, Coa-aptilo Enp-nditur-A 1 12,723 14, ,503 16,001 16, vostoa Eaposdit-r (i-1. Stoabs) 4,718 4,452 2,409 5,143 4,010 5, Da-otis SavIgn 61 2,510 1, ,234 : aia-l 0an10g5 4,055 2,620 1,595 1,465 2, MROCHANDISE T.RADE Annua Data at Current ebi- 0 As Prr--t of Tate1 C.piali goads Irtrn-diato goads 1,769 2,635 2,185 2,431 3,043.. n-la 58.4 and 06.1 rlnltad astrln.le Conss,sai ads Total Mlaro. In.parlts (ali.f.) 5,051 4,640 5,893 4,529 4,964 5, Agr--istol praduots food and Cork Pr-duot Toals clothing & foatanar Muahi-oyn tranport aquipn-t Other _ T-1o M-rh. Eaports (f.a.b.) 1,843 2,278 1,933 1,822 2,022 2, MERCHlANDISE TRIADE 0IND1CE Eap-r Priso Indro I.pors Prino Index Gonn of Trado Indon fapo- Vol1-c loden t ill 120 VALUE BY 1OCT01 (Annua Data at1975 PIls an-d Enahana Rota of $1 E ns 25.55) goaulaa2,231 2,189 2,131 2,1163 1,$947= 2, lodartrn ~~~~~ ~~~~~6,080 6,323 0,731 5,9708,0 6, ` Sorniass ~ ~~~~~~~~~~5, J Total 13,750 13,973 13,410 14,064 15,394 15, T PLaLIC 700AN00 Carrest Prlars Ar P-r.e.t of 007/Markt Carroasroseipta Prices ~~~~~ ~~~~~1,657 1,056 2,256 2,456 2, Carrena enpondlanrer , ,493 2,901 2,008 3, tha Stoma Baan- of A,,tanorsa F-sdr and sc-- ~~~ ~~~~~~~~~ Currat Dofjo it of Central Govt B.alansa 0.0 o La-al aarnns Balanno Oxoarity of Soalal System ~~~ ~12-14 Cartns- 0.6 fiitof Public Orator Capital Enp-adistare , 1,040 1, Onora1 I6fiolt ,610-1,188-1, LA SOTIIT PIEWOOKER- OA ACsFRE VALUE ADDED PER 0011D17 RCS00 EXCHANGE1 RATE 01 - Era 25.55) in Thonsands Pe-et of Tatni Ans.al in US Dolinrs Percen.t of An-sea A-erexe RA-a Groth fate Goerrh Ants Agrli-lturo 1974_77 1,300 1, ,684 1, I'dasry1, , ,837 5, Sriass ~ , Total 3,787 3, ,709 4, a!stati-tinal dinarepu...y is ixeladed in the soonuaption data. b/ 1ooudor sakern' reit t-ecen c! Total employed labor farc eusladiag srker abroad and usnrployod. d/ sisotos O Enhungo Eater 1923: 51 -Era 24.67; 1074: ; 1973: 51 Ira ; 1928: 51 = Era 30.23; 1977: 51 - ins ; 1978: 51 Ee.. 43 Negligible

35 Page 5 of OP BALANCE OP PAYMENTS BALANCE OF PAYMENTS AND EXTERNAL ASSISTANCE AND DEBT (Amousts In Milli.os of U.S. Dollars at Current Prices) Actual Estinated Etports (F.o.B.) 1,843 2,278 1,935 1,823 2,027 2,437 Innerts (F.O 4.B.) , Trade Balance (X-} ' ,989-1,670-2,109-2,506-2,396 Net Non Factor Services Tourism RecciPts (Gross) (550) (513) (360) (332) (403) (583) Resource Balance ,063-1,839-2,083-2,454-2,201 Net Investment Incone Net Transfers_/ 1,097 1,111 1, ,134 1,585 eoonren nn C,,,-s=net sr,.n,t _ Direct Foreige Investment Public MLT Loans Disbursements A -orti-ation Net Disbursenents Other MLT Loans Net Disbursenents Sheet-Tern Capital and Errors and Onissions Other Capital (N.E.I.) ,046 Changes ic Official Liquid FPreigo Exchange Reserves ( - = Increase) Official Reserves iceon End of YearS! 2,813 2,292 1,535 1,385 1,450 Of Which: Gold 1,149 1,181 1,137 1,125 1,025 -oreige Enchange 1,633 1, GRANT AND LOAN COMMITMENTS DEBT AND DEBT SERVICE Official Grants & Grant-like - _ 3 _. Public Debt Outstanding And Disbursed ,005 1,304 Public M&LT Loann IBRD 36 i4 Interest vs Public Debt IDA Repaynentn on Public Debt Other Multilateral _ - _ Total Public Debt Service Goves-nents Other MALT Debt Service Suppliers Total M&LT Debt Service I Financial Markets Public Leans n.e.i. - BURDEN ON EXPORT. NON FACTOR Tctal Public MALT Lons SERVICES AND WORKERS REMSITTANCES (%)7 Public Debt Sernice Total MALT Debt Service Actual Debt Ogustanding On Dec. 31, 1977 DEBT EXTEBNAL Disbursed Only Pet Average Teens of Public Debt I0RD IDA - - Interest as 70 Prior Year Other Multi-laternl D04D Goverenents Anort. as 7 Pricr Year Suppli-es D4OD Fitancial Markets Public Debt n-.., - IBRD Debt Out. & Disbursed Total Public M&LT Debt 1, IBRD DO&D as '4 Public Debt Out. & Disbursed IBRD Debt Service as 7 Public Debt Service a Largely iaterest payments. b/ Largely workers' renittances. c/ Gold is valued at official prices. dl Debt service as a ratio of earnings fron enports, son factor services and workers' renittaones. Not available Europe, Middle East and North Africa Regian Asril

36 ANNEX II Page 1 of 3 STATEMENT OF BANK GROUP OPERATIONS IN PORTUGAL A. STATEMENT OF BANK LOANS (As of March 31, 1979) Amount (less cancellation) Loan No. Year Borrower Purpose Bank Undisbursed Five loans for power development fully disbursed Electricidade de Portugal Power Republic of Portugal Highways Banco de Fomento Development Nacional Finance Republic of Water Portugal Supply Republic of Portugal Education Republic of Agricultural Portugal Credit /a Quimica de Fertilizer Portugal, E.P. Modernization /a TOTAL /c of which has been repaid 29.2 TOTAL now outstanding Amount sold 2.6 of which has been repaid TOTAL now held by Bank /b TOTAL undisbursed B. STATEMENT OF IFC INVESTMENTS (As of March 31, 1979) None. /a Not yet effective. lb Prior to exchange adjustment. /c In addition a $40 million loan for a Second Highway Project was approved in May, 1979.

37 ANNEX II Page 2 of 3 C. PROJECTS IN EXECUTION 1/ Loan No Sixth Power Project; $36.0 Million Loan of September 24, 1976; Effectiveness Date: December 23, 1976; Closing Date: June 30, While the loan is now fully committed project completion is expected to be delayed more than one year because of organizational changes in the Power Authority (EDP), revisions in the Project scope and in the list of goods. These factors delayed procurement under the loan, and the start of significant disbursements. EDP is being reorganized with emphasis on decentralizing management and merging municipal and small private electricity undertakings with EDP. Mergers are expected to be completed by After a poor year in 1976 owing to the bad hydrological conditions, EDP's earnings in 1977 were better. In 1978, EDP generated only 4 percent internal cash, in spite of a 50 percent increase in tariffs, owing to large increases in the interest rates. EDP estimates that it will be able to generate 18 percent cash in 1979 and reach a self-financing level of 30 percent in Loan No Highways I; $24.0 Million Loan of March 3, 1977; Effectiveness Date: July 8, 1977; Closing Date: July 31, Road rehabilitation is on schedule, but other project items are behind schedule. The Government's decision to postpone bidding until the effectiveness of the loan resulted in a 12-month delay in purchasing highway maintenance and workshop equipment. Delays in land acquisition (which is now completed) has caused an 18-month delay in the construction of the Covilha bypass road; the contract for this road has now been awarded. The railways study and the transport master plan are also 18 months behind schedule due to delays in the selection of consultants. Selection is now completed and work is progressing. Loan No Development Finance Company Project; $50.0 Million Loan of December 19, 1977; Effectiveness Date: March 21, 1978; Closing Date: December 31, 1980 While loan signing was delayed due to legal questions raised by the Attorney General's office, it is expected that project implementation will catch up with appraisal estimates. Approximately half the loan proceeds were committed, as of April 15, / These notes are designed to inform the Executive Directors regarding the progress of projects in execution, and in particular to report any problems which are being encountered, and the action being taken to remedy them. They should be read in this sense, and with the understanding that they do not purport to present a balanced evaluation of strengths and weaknesses in project execution.

38 ANNEX II Page 3 of 3 Loan Lisbon Region Water Supply Project; $40.0 Million Loan of June 6, 1978; Effectiveness Date: January 19, 1979; Closing Date: June 30, The contract for the Castelo do Bode pipeline (about $33 million) has been awarded. Works are expected to proceed without delay. Loan Education Project; $21.0 Million Loan of June 6, 1978; Effectiveness Date: September 6, 1978; Closing Date: December 31, Consultant architects for all project institutions, including management training centers, have been selected and have started work. All sites for project institutions have been or are being acquired. In general, overall progress is satisfactory. Loan Agricultural and Fisheries Credit Project; $70 Million Loan of September 28, 1978; Effectiveness Date: (not effective); Closing Date: June 30, The staffing of the Agricultural and Fisheries Credit Fund (IFADAP) is practically completed. Consultants have been selected for the groundwater survey, and for the fish stock assessment survey; contract negotiations are underway. Loan Fertilizer Modernization Project; $58 Million Loan of March 14, 1979; Effectiveness Date: (not effective); Closing Date: June 30, The selection of engineering consultants is underway.

39 ANNEX III Page 1 of 2 PORTUGAL SMALL- AND MEDIUM-SCALE INDUSTRY DEVELOPMENT PROJECT Supplementary Project Data Sheet Section I: Timetable of Key Events (a) Time taken by the country to About 7 months from prepare the project: November 1977 to June (b) The agencies which have prepared Institute for Support to Smallthe project: and Medium-Size Industrial Enterprises (IAPNEI) Public Enterprise for Industrial Estates (EPPI) National Laboratory for Industrial Engineering and Technology (LNETI) Banco de Portugal (c) Date of first Bank mission to consider the project: November 18, 1977 (d) Date of departure of Appraisal Mission: June 26, 1978 (e) Date of completion of negotiations: April 11, 1979 (f) Planned date of effectiveness: October, 1979 Section II: Special Bank Implementation Actions No specific action. Section III: Special Conditions (a) For effectiveness: * (i) Government approval of draft legislation amending IAPMEI's statutes (para. 40). (ii) Signing by at least three financial intermediaries accounting for at least 40 percent of the total assets of the 12 intermediaries involved (as of December 31, 1977) of a protocol acceptable to the Bank (para. 49); (iii) Opening of a special account in Banco de Portugal for the purpose of the SMI line of credit with a small unit to administer this account (para. 58);

40 ANNEX III Page 2 of 2 (iv) Subsidiary loan agreements to be concluded between the Government and Banco de Portugal and between the Government and EPPI (para. 59). (b) For disbursement of the EPPI subsidiary loan: a change in EPPI's rental policy, commitment of the government's equity contribution to EPPI, and Bank approval of each phase of each estate (para. 52, 53). For disbursement on the export promotion component: conclusion of an agreement between the Government and ITC (para. 54). (c) Other conditions spelled out in the Loan Agreement with the Government and in the Project Agreements with EPPI and IAPMEI: (i) Government to consult with the Bank if the ten years maximum amortization period on commercial loans is to be reduced (para. 36). (ii) Effectiveness by December 31, 1979 of a revised statute for IAPMEI acceptable to the Bank (para. 40). (iii) EPPI and IAPMEI to prepare a detailed program of collaboration by June 30, 1979; EPPI to increase promotion and marketing activities, to give priority to export oriented enterprises (paras. 52, 53). (iv) Government to appoint a small committee and a suitable counterpart team, to implement ITC's technical assistance program to FFE (para. 54).

41 I BRD ~~~~~~~~~~~~~~~~~~~~~~~ t < N NV7J v dn S _ 'I ~ J t N o w ' \r E C \ i H ;) a L X %, )~~~~~~~~~~~~~~~~~~~~~~ R R R 7 Iv 7 d v V~~~~~~~~~~~~~~~~~~4-4 0 JW V II