FILE Copy Report LA- 3G -PD INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE

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1 LA- 3G -PD Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized FILE Copy Report RESTRICTED No. p-347 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON PROPOSED LOANS TO HIDRO-ELECTRICA DO DOURO AND EMPRESA TERMOELECTRICA PORTUGUESA October 21, 1963

2 . I'IPRESA INTERMATIONAL BANK FOR RECONSTRUCTION AND DEIELOPMEXT REPORT ANID RECOPEjENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON PROPOSED LOANS TO HIDRO-ELECTRICA DO DOURO AND TERMOELECTRICA PORTUCUESA 1. I submit the folloving report and reconmendations on twto proposed loans to Portuguese electric power compan-ies, one to Ridro-Electrica do Douro in an amount in various currencies equivalent to US $7.5 million and the other to Empresa Termoelectrica Portuguesa in an amount in various currencies equivalent to US $5 million. PART I - HISTORICAL 2. Portugal became a member of the Bank on March 29, An economic mission visited Portugal in June, 1961, and on the basis of its findings the Bank agreed to consider lending for suitable electric power projects in Metropolitan Portugal. Subsequent discussions indicated that several changes were desirable in the power development program to give greater emphasis to the expansion of thermal capacity. After these changes wtere made, the Government requested assistance from the Bank in financing the projects of two companies, Hidro-Electrica do Douro (HED) and Empresa Ternoelectrica Portuguesa (ETP). It was proposed that the loan to HED be made for two hydro-electric projects, one of which is under construction at Bemposta and the other of which was to be started next year at Carrapatelo; the ETP project consisted of the expansion of an existing thermal station in the Oporto area. 3. A mission visited Portugal last January to appraise these projects and to reviewi the economic situation. Subsequently, as a result of its continuing review of the power development program, the Government decided to postpone the start of construction of the Carrapatelo project and to advance the date at which a new thermal plant in the Lisbon area would be started by ERP. Negotiations on the basis of the revised program were completed in Washington in August. 4. If the loans are approved they would be the first Bank loans to Portugal. A part of the loan to ETP would be used to finance the study of the new thermal power plant near Lisbon, and the Banlc has agreed to consider a loan for this project when it is ready for appraisal next year. The estimated amount of the Bank loan for this project would be $12.5 million, which would bring the total of Bank lending presently under consideration for Portugal to $25 million. PART II - DESCRIPTION OF THE PROPOSED LOAJS 5. The main characteristics of the proposed loans are as follows:

3 -2- a) Hidro-Electrica do Douro Borrower: Guarantor: Amount: Purpose: Amortization: Hidro-Electrica do Douro Portugal The equivalent in various currencies of $7.5 million. To help finance the construction of a 210 ihw hydroelectric plant at Bemposta In 47 semi-annual installments beginninig September 1, 1965 and ending September 1, 1988 Interest Rate: 5jg per annum, including 1% comnission Commitment Charge: 3/4 of 1$ per annum b) Empresa Termoelectrica Portuguesa Borrower: Guarantor: Amount: Purpose: Amortization: Empresa Termoelectrica Portuguesa Portugal The equivalent in various currencies of $5 million To help finance (i) the construction of a 50 {1W thermal power unit at Tapada do Outeiro and (ii) preliminary engineering studies and cost estimates for a new' thermal power plant near Lisbon. In 33 semi-annual installments beginning September 1, 1967 and ending September 1, Interest Rate: 5Vg per annum, including 1% cormission Commitment Charge: 3/4 of 1% per annum

4 - 3 - PART III - THE. PPOJECTS 6. An appraisal report on the two projects (TO-37kb) is attached (No. 1). Electric Power Industry 7. The primary system of generation and transmission consists of five companies organized with government help between 1945 and 195. There are three hydroelectric companies, one of which is RED,I each with a 75- year concession to develop a specific river basin or area; one thermoelectric company (ETP); and a natiomnide transmission company (Companhia Nacional de Electricidade - ONE). The primary system is operated as though it were under a single ownership. The four generating companies sell their output to CNE, the national transmission company, in accordance with instructions from a national load dispatching organization. CNE, in turn, sells in bulk to the utilities which comprise the secondary system and to large power-intensive industries. The tariffs for COEts purchases and sales, and all other tariffs, are fixed by the Ministry of Economy. 8. Total energy consumption has increased rapidly since the early lo'50s, at an annual rate of about 13%. Installed capacity at the end of 1962 was 1,322 NlVJ, of which 1,170 MUf were hydro and 152 NWr thermal. Expansion plans assume that energy requirements will grow at the same rate as in the past. 9. Portugal has substantial hydro energy resources but domestic fuels are scarce. The Portuguese authorities have therefore stressed hydro expansion, using thermal plant only as standby. The authorities now recognize, however, that additional thermal capacity has become necessary to firm up and balance the system. It has therefore been decided to begin as soon as possible the construction of a new thermal plant in the South, consisting of four units each of W. Tn addition to the hydro plants now under construction, the only major new hydro project planned is Carrapatelo, which is to corme into service in The five companies of the primary system are organized in the forn of private corporations. The Government is permitted by law to hold up to 50% of the share capital and directly or indirectly is the most important shareholder of RED and ETP. The Government also regulates the companies' access to the capital market, and public or quasi-public financial institutions hold most of their debt. 11. Revenues from the sale of hydro power to ONE are divided among the three generating companies in accordance with percentages fixed by the Goverrment on the basis of the revenue requirements of each company. ETP is expected to become part of these arrangements in the near future. Existing tariffs do not provide RED and ETP with sufficient revenues to finance a part of their expansion from internal sources, and the Government is now revising the whole tariff structure.

5 - 4- Utilization of the Loans 12. The proposed loan to HED would finance the acquisition of equipment required for the Bemposta plant, located on the Portuguese section of the international Douro river. Use of the waters of the international Douro is based on a Portuguese-Spanish agreement of 1927, which gives to Portugal the right to develop the stretch of the river on which the project is located. The estimated cost of the project, including interest during construction, is the equivalent of about $35 million. Capacity of the Bemposta plant will be 210 MWN. The project is technically sound and the cost estimate reasonable. 13. Construction of Bemposta is well advanced and the three 70 M14 units should be in operation by the end of Most of the equipment for the project was procured in Portugal, but all major contracts were awarded after international competitive bidding. Bid evaluations were made before customs duties, which range between 10 and 40%, and with a preference of some 10-15% to local suppliers. The Bank loan would finance 21% of total construction costs; including reimbursement of expenditures made since the beginning of 1963, the loan would cover about 40% of the remaining costs. It would be used to finance expenditures both in foreign exchange and in local currency, with the majority of the expenditures in local currency. 14. The proposed loan to ETP would finance the acquisition of equipment required for a third 50 MW unit to complete the existing station at Tapada do Outeiro, in the Oporto area. Installation presents no problems, since the third unit is identical in all important respects with the existing units. The scheduled completion date of mid-1966 should easily be met. 15. The third unit is expected to cost the equivalent of about S9 million, including interest during construction, of which about 54% would be financed by the proposed loan. All important contracts would be awarded following international competitive bidding. During negotiations it was agreed that bid evaluations would be made before customs duties and that the preference for goods manufactured in Portugal would not exceed 15%. The division of expenditures between foreign exchange and local currency would be determined by the outcome of the bids. 16. Some $150,000 of the ETP loan would be used to finance preliminary engineering studies for the new thermal plant near Lisbon. The Borrowers Hidro-Electrica do Douro 17. HED was formed in 1953 to develop the resources of the Douro River and some of its tributaries. It operates two power stations on the Douro, at Miranda and Picote, with capacities of 180 M'4 and 156 MW respectively. Bemposta is the last of the three hydro developments on Portugal's stretch of the international Douro. HED has also taken over the management of a project now under construction at Tavora.

6 Returns on net fixed assets ranged between 4.1% and 6.8% during the years 1959 through Dividends were paid at 5% from 1958, the first year of operation, through 1960, and at 6% in 1961 and In connection with the proposed loan, the Government has agreed to a rate covenant for HED that will raise tariffs to a level sufficient to cover: a) all operating and administrative expenses, including taxes; b) adequate depreciation (or its equivalent) or amortization, whichever is larger; c) cash dividends; and d) a surplus amounting to 10% of expansion requirements. With these rate increases, which are to take effect early in 1964, HED would earn a return on net fixed assets ranging between 6.6% in 1963 and 9.4% in Capital expenditures during the next three years, when the Bemposta and Tavora projects will be completed, are expected to total Ese. 947 million, including interest during construction. Funding of outstanding advances and short-term credits and providing an increase in working capital bring the requirements of the period to a total of Ese. 1,851 million. Under the proposed financing plan, RED would provide Esc. 507 million from internal.cash generation and new share capital, and Esc. 1,344 million from borrowings, of which $7.5 million or Esc. 216 million from the proposed Bank loan. Sale of new share capital in 1963 is expected to amount to Esc. 200 million and is a condition to the effectiveness of the loan. Also as a condition of effectiveness, HED is to replace in 1963 its short term indebtedness to the National Development Bank (Banco do Fomento Nacional) and the National Savings Bank (Caixa National de Credito) with at least Esc million of loans for a term of at least 15 years. Other shortterm debt is to be repaid as it matures and replaced, if necessary, with long-term borrowings on terms reasonably related to future earnings. The incurrence of future long-term indebtedness is also limited by a debtequity ratio of two to one. Short-term borrowing for the pre-financing of expansion will be limited to amounts that can reasonably be expected to be paid on maturity out of share capital issues, long-term borrowings, or earnings. 20. While the borrower has primary responsibility for obtaining the required funds, the Government has agreed to take all steps necessary on its part to facilitate the financing of the project and to ensure that funds are provided to carry it out. Empresa Termoelectrica Portuguesa 21. FTP was formed in 1954 to provide thermal facilities required to firm up the system in critically dry years. The first 50 MW unit of its thermal plant at Tapada do Outeiro was completed in The second unit is expected to be completed by the end of 1963 and the third (to be financed in part through the Bank loan) by the end of ETP will also construct the new thermal plant near Lisbon. 22. ETP's return on net fixed assets amounted to 5% in 1960 and 1961 and 4.5% in Dividends of 5% have been paid since The rate covenant is similar to that of HED. With the proposed rate increases, ETP's returns are forecast at 7% in 1963, 15% in 1966, and 9% in 1968.

7 Capital requirements in the four years through 1966, when the third unit at Tapada do Outeiro will be completed and work begun on the first and second units of the Lisbon plant, total Esc. 946 million including capitalized interest. About 47% will be provided from ETP's own resources, including Esc. 290 million of new share capital, and 53%D from borrowing, including the proposed Bank loan of $5 million (Esc. 143 million). A new share issue of at least Esc. 65 million, and the issue of new bonds or long-term borrowings of Esc. 40 million, are conditions of effectiveness. The arrangements with respect to long-term borrowing, including the debtequity ratio, and provision of funds by the Government are similar to those of HED. PART IV - LEGAL INSTRhUIENTS AND LEGAL AUTHORITY 24. Attached is a draft Loan Agreement between Hidro-Electrica do Douro and the Bank (No. 2), a draft Guarantee Agreement between the Republic of Portugal and the Bank for the hydroelectric project (No. 3), a draft Loan Agreement between Empresa Termoelectrica Portuguesa and the Bank (No. 4), and a draft Guarantee Agreement between the Republic of Portugal and the Bank for the thermoelectric project (No. 5). 25. The draft Loan Agreements conform to the normal pattern of the Bank's Loan Agreements for similar projects. Attention is drawn to the follotwing provisions: (a) Section 5.08 concerning the debt-equity ratio described under paragraphs 19 and 23 above. (b) Section 5.10 under which the Borrowers shall take all steps required on their part to obtain the revenues described under paragraphs 18 and 22 above. (c) Section 7.01 concerning the conditions of effectiveness described under paragraphs 19 and 23 above. 26. The draft Guarantee Agreements generally follow the usual pattern except that they contain an additional covenant that the Guarantor shall take or cause to be taken all governmental action necessary to permit the Borrowers to obtain the revenues from the supply of electricity described under paragraphs 18 and 22 above (Section 3.03). 27. Also attached, for each project, is the report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement of the Bank (Nos. 6 and 7). PART V - THE ECONOMIC SITUATION 28. A report (No. EA-141a) on the current economic position and prospects of Portugal is attached (No. 8).

8 Since 1960 the growth of the Portuguese economy has averaged 7% per annum, which compares favorably with the 4% rate reached in the 'fifties. Population growth, net of emigration, has been about 0.8% annually in the last ten years; per capita income has therefore been increasing substantially, but the present level, about $215, is still one of the lowest in Western Europe. 30. The Portuguese economy is characterized by a dualism between the new and technically efficient industrial concerns in steel, chemicals and electricity and a large number of antiquated enterprises, operating at low levels of productivity, in food processing, textiles, and other industries. The accelerated pace of economic growth in recent years is due primarily to the rapid expansion of activity in the formier group. The Government has recently increased its efforts to strengthen the industrial structure through the provision of financial and fiscal advantages. Prospects for a continued and rapid expansion of industry are favorable. 31. Agriculture, which absorbs some 40h? of the labor force, remains the most backward sector. Productivity is low, owing partly to difficult natural conditions and partly to archaic techniques of production and systems of land tenure. Although steps have recently been taken to increase productivity, mainly by enlarging the irrigated area, it is unlikely that agriculture will show any major improvement in the near future. Under-employment is widespread in agriculture, but the gradual movement of rural population to industrial centers is easing the problem somewhat. 32. To finance the growth of the economy, more savings will have to be mobilized and the organization of the financial market strengthened. The Government has shown an interest in reforming the tax system and adapting it to the needs of development, and some measures to this end have already been adopted. The Government has requested technical assistance from the Bank in developing policies with respect to the tax system, the budget, and the capital,market and the Bank is now considering this request in ccnsultation with the International Monetary Fund. Conservative monetary and fiscal policies have consistently been pursued, and the increased military spending of recent years has been financed largely from additional revenues although there has been some increase in borrowing. 33. Portugal has an excellent record of monetary stability, both internal and external. Prices remained virtually unchanged over a long period of years. Some upward movements were registered during the last two years, as a conseauence both of the brief financial crisis that followed events in Angola, Goa and elsewhere and of the acceleration of economic growth, but the general situation remains satisfactory. Moreover, the accumlation of large gold and foreign exchange reserves at the Bank of Portugal ($777 million at the end of August 1963) represents a considerable source of strength for the escudo. While increased military spending, together with the Government's intention to promote rapid development both in Metropolitan Portugal and overseas,may subject the economy to additional strains, the situation at present is well under control.

9 Portugal has close economic relations with its Overseas Provinces. The balance of payments of these Provinces with foreign countries has consistently been positive, while Metropolitan Portugal has usually earned a considerable surplus in its transactions with the Provinces. This surplus, through which Metropolitan Portugal has gained access to the foreign exchange earned by the Provinces, has for many years been more than sufficient to balance the deficit of Metropolitan Portugal with foreign countries and was the main factor responsible for the accumulation of reserves by the Bank of Portugal. Due to exceptional circumstances, the balance of payments of Metropolitan Portugal showed a large deficit in 1961, but this situation was reversed in Portugal has recently joined international institutions such as EFTA, GATT, the Bank and the Fund, and its economy is becoming more closely integrated with those of other countries. 35. Until 1962 Portugal had little recourse to foreign capital, but in that year some $m112 million was provided from both public and private sources, mainly in the U.S. and Germany. At the end of 1962, the external public debt was still rather modest, amounting to some $165 million. At their peak, annual payments on this debt represent only 4.6% of the value of exports of Metropolitan Portugal to foreign countries in Portugal has therefore a substantial margin to increase its external debt, including the proposed borrowqing from the Bank. PART VI - COMPLIANCE,TITH ARTICLES OF AGREEIENT 36. I am satisfied that the proposed loans would cofply with the requirements of the Articles of Agreement of the Bank. PART VII - RECOMIENDATIONS 37. I recommend that the Bank make a loan to Hidro-Electrica do Douro in various currencies equivalent to $7.5 million for a term of 25 years including a grace period of about two years at a rate of interest of 5 B with the guarantee of the Republic of Portugal and on such other terms and conditions as are specified in the draft Loan and Guarantee Agreements attached, and that the Executive Directors adopt a Resolution to this effect in the form attached (No. 9). 38. I recommend that the Bank make a loan to Empresa Termoelectrica Portuguesa in various currencies equivalent to $5 million for a term of 20 years including a grace period of about 4 years at a rate of interest of 5 % with the guarantee of the Republic of Portugal and on such other terms and conditions as are specified in the draft Loan and Guarantee Agreements attached, and that the Executive Directors adopt a Resolution to this effect in the form attached (No. 10). October 21, 1963 Washington, D.C. George D. Woods Attachments