FILE COPY Report No. P-769

Transcription

1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized RESTRICTED FILE COPY Report No. P-769 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 The report may not be published nor may it be quoted as representing their views.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 RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO BANCO DO NORDESTE DO BRASIL, S. A. December 31, 1969

2 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMM0ENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO BANCO DO NORDESTE DO BRASIL, S.A. 1. I submit the following report and recommendation on a proposed loan in an amount in various currencies equivalent to US$25 million to the Banco do Nordeste do Brasil (BNB). PART I - HISTORICAL 2. The proposed loan would be the first one to a development finance company in Brazil. While Bank lending to industry in Brazil began only last year, with the $22 million loan for the Alcominas aluminum project, we have long felt that the Bank could make an important contribution to Brazil's industrial development by strengthening local financial institutions which are major sources of long-term capital for private industrial firms. BNB is an official entity which serves as the regional development bank for Northeast Brazil; it plays a leading role in the Government's industrialization program for a large and populous region whose development is far behind that of the rest of the country. It is hoped that the proposed loan will be the first of a series of loans for industrial financing in Brazil over the coming years. 3. The proposal was appraised by a mission which visited Brazil during April/May 1969 and the mission's report was supplemented by the findings of the industrial policy group attached to this year's Bank economic mission, which made a special study of industrialization in the Northeast. Negotiations were held in Washington during September and November 4-7. BNB was represented by its President, Mr. Rubens vaz da Costa,and the Government by Mr. Jayme Alipio de Barros, the General Counsel of the Ministry of Finance. 4. The proposed loan would be the 27th Bank loan to Brazil. It would increase the total of Bank loans to $658 million (net of cancellations). The following is a summary statement of Bank loans to Brazil as of November 30, 1969:

3 -2- Loan Amount Less No. Year Borrower Cancellations Undi.sbursed Loans fully disbursed Central Eletrica de Furnas - Estreito I. Power Centrais Eletricas de Sao Paulo - Xavantes. Power Centrais Eletricas de Minas Gerais - Jaguara. Power Central Eletrica de Furnas - Estreito II. Power Cia. Brasileira de Energia Eletrica Power Cia. Forca e Luz do Parana Power Cia. Paulista de Forca e Luz. Power Cia. Forca e Luz de PLinas Gerais. Power Brazil. Livestock Cia. Minera de Alumino - Aluminum Alcominas. Project Central Eletrica de Furnas. Power Cia. Forca e Luz de Minas Gerais. Power Brazil Roads Total (less cancellations) of which has been repaid to Bank and others: Total now outstanding Amount sold 10.3 of which has been repaid: Total ncw held by Bank L81.9 Total undisbursed The undisbursed figure includes the full amount of the $40 million livestock project loan which was signed in September 1967 and became effective in December The establishment of regional offices for this project proved to be time-consuming, and ranchers initially displayed less interest in participating in the project than had been expected. More recently, however, there has been an encouraging increase in the amount of loans applied for, and the processing of loans in the project offices has been accelerated. At the end of Noveniber, 49 applications for loans totalling USi6.3 million had been approved; 28 loan contracts for a total of US$4.25 million had been signed. A disbursement request has recently been received. A mission to determine the principal causes of the slow progress and to recommend means of speeding it returned from Brazil in mid-december and is preparing its report.

4 -3-6. The above table also reflects initial delays in disbursements on saoe of the power loans made in ; work on these projects is now progressing well and present completion schedules appear realistic. The fcur generating units financed under the first Bank loan for the Estreito Project (403-BR) were scheduled to be in service by the end of 1969 and the entire project, including the two generating units and the transmission line subsequently added (474-BR), should be completed in You were informed of the status of the Xavantes Project (404-BR) in connection with my proposal last month (R69-235) that an additional transmission line be included in the project and the Closing Date postponed to December 31, It is now estimated that the Jaguara Project (442-BR) will be completed in the first half of 1972, about a year later than originally scheduled. Disbursements under the four power distribution loans (475/478-BR) are expected to rise rapidly in the coming months since by October some $54 million of the total of $61.6 in the four loans had either already been c ammitted or would be catmitted under contracts being tendered for. Loan 576-BR for $26 million made in October 1968 became effective in May 1969 and the first disbursement request has recently been received. 7. IFC has made investments in 10 ccmpanies in Brazil for a total of $41.1 million (net of cancellations). The following is a summary of IFC investments in Brazil as of November 30, 1969: Amount Undisbursed TUh$ Ivh ion) Investments fully disbursed 32.7 Investments not yet effective Total (net of cancellations) 41.1 Of which has been repaid to the Corporation: Amount sold 8.5 Total now held by Corporation 28.5 Undisbursed The Bank is actively cooperating with the Government and private agencies in Brazil in preparing projects in transportation, agriculture, power, industry, mining, education and water supply and sewerage which appear to be suitable for Bank loans. In the coming months I intend to present to you for approval substantial loans for a second highway construction project and for the Marimbondo hydroelectric project.

5 9. PART II - Borrower: Guarantor: Amount: Purpose: DESCRIPTION OF THE PROPOSED LOAN Banco do Nordeste do Brasil S.A. Government of Brazil. The equivalent in various currencies of $25 million. To enable the Borrower to finance the foreign exchange costs of industrial projects of private enterprises in the Northeast of Brazil. Amortization: Interest rate: Commitment charge: Relending terms: PART III - In semi-annual instalments expected to begin on Februa ry 15, 1973, and end on February 15, Payments will be based on a composite amortization schedule made up of the amortization schedules of the individual sub-loans financed under the project. Seven percent. 3/4 of 1 percent. To be relent by BNB to ultimate borrowers at not less than 9-1/2 percent; the foreign exchange risk to be borne by the ultimate borrower. THE PROJECT 10. A report entitled "Appraisal of Banco do Nordeste do Brasil S.A." (DB-52a) is attached. 11. The Northeast of Brazil contains 27 million people (about 30 percent of the nation's population) whose per capita product at $200 is about two-thirds of the average for the whole country. It has lagged behind the rest of the country in economic development and has long been considered a potential source of social and political unrest. Since the late fifties, the Government has carried out a coordinated program for industrial and agricultural development there, and the rate of growth in the region in the last ten years has been in excess of that of the rest of the country. An important instrument in the Government's program is the so-called 34/18 system under which firms choosing to invest in the region may obtain a full tax credit of up to 50 percent of their

6 income tax liability by placing funds in special non-interest-bearizig accounts with BNB pending their investment in industrial, agricultural and telecommunications projects approved by the regional planning organization. These 34/18 tax credits may by law be used in certain cases to provide up to 75 percent of the non-loan financing of suitable projects; in practice such funds have financed about 45 percent of the total cost of projects approved in recent years while the owners' contribution frcm non-34/18 funds has averaged scme 22 percent. By the end of 1968, approval had been granted for more than 600 projects with a total investment of about $900 million. 12. The Bank mission which studied the Northeast industrialization program found that it had been highly successful in mobilizing resources and stimulating investment in industry, and that the individual projects financed were almost all economically sound and capable of yielding high financial returns. However, the mission also came to the conclusion that the very success of the program cast doubt on the continued need for the very generous incentives it provided and recommended measures that would reduce the portion of 34/18 funds and increase the amount of the ownerst equity. During negotiations, assurances were received frcm BNB that its policy was to seek to assure that the maximum feasible amount of non-34/18 funds was invested in the projects it financed, and that projects in which non-34/18 funds accounted for less than 25 percent of the total cost would not be submitted for financing under the proposed loan except in special circumstances. 13. BNB was established in 1954 to further the economic development of the Northeast by financing productive investments in industry and agriculture. The Government owns 72.9 percent of BNB's share capital, state and local gcvernments 1.5 percent and some 40O,000 private shareholders, two-thirds of them in the Northeast, the remaining 25.6 percent. BiB's Board consists of a president, appointed by the President of the Republic for an indefinite term, and four directors elected by the Government at a time when its holding was over 80 percent of the share capital. Since private shareholders ncwj own over 25 percent of the share capital, they will be able to elect one of the four directors when the term of the present Board expires in lvhile BNB must naturally be responsive to the Government on policy matters, the Government does not intervene in day-to-day management or in lending decisions. BIB is a well organized institution with energetic management and a well-paid and highly competent professional staff. 14. BNB is both a development bank and a commercial bank lending to industry, agriculture and public utilities. During its lending expanded in real terms by nearly 150 percent; investment loans to private industry accounted for 21 percent of total loans at the end

7 - 6 - of June 1969, while agricultural loans made up 31 percent of the total. The temporary deposits deriving from the 34/18 system have provided the bulk of BNB's local currency resources; foreign currency resources have been provided mainly by the Inter-American Development Bank through six loans totalling $53.3 million. BNB's capital structure is conservative. The ratio of total debt to equity at the end of June 1969 was 4.4:1 and it has been agreed during negotiations that BNB could prudently increase total debt up to ten times equity and longterm debt up to four times equity in order to afford BNB's management the flexibility it needs in conducting its diverse operations. Agreement was also reached during negotiations on the application of a liquidity formula which would limit BNB's maximum exposure in long, medium and short-term lending in accordance with the availability of suitable resources. 15. BNB's rate of return on equity, in real terms, has been high owing to the leverage provided by the availability of low-cost funds, principally 341/18 deposits, even though in conformity with Government policy it was until recently charging interest rates on its loans which were in effect negative after taking into account the rate of inflation. There has, however, been a fall in profitability in the past few years and, in order to assure that BNB's capital would not in the future be subject to erosion by inflation and that BNB's industrial lending wculd be on a sound basis, the Government has agreed that positive interest rates should be charged on its long-term industrial loans. A recent decision of the National Monetary Council permits the major national development banks from January onwards to apply a full monetary correction, and to charge interest rates of 4 to 12 percent, on loans for over five years made from cruzeiro resources. The bulk of BN\B's industrial lending has been in this category and its management intends to charge a 10 percent "real" interest rate on such loans. With respect to loans of less than five years, the Monetary Council's decision permits BNB to charge an interest rate of 22 percent. BNB has undertaken to the Bank that it will earn an annual return on its equity capital exceeding by not less than five percentage points the annual rate of inflation in Brazil. 16. BNB is the only local source of long-term financing for the average industrialist in the Northeast. During BNB made more than 225 new industrial loans, with a total value exceeding NCr$260 million ($75 million); nearly half of these loans being to new enterprises. Over the years BNB has acquired a considerable expertise in industrial lending. Project appraisals are based on sound eccnomic criteria and carefully carried out and project supervision is thorough. This is done at reasonable cost and industrial lending has been making a satisfactory contribution to BIB's net earnings. It was agreed during negotiations that BNB would seek to earn on its future industrial lending a "real", net rate of return at least equal to the interest rate at which the Bank proposed to lend to BNB.

8 An increasing backlog of loan applications indicates that, despite the steady expansion of its ind-ustrial lending, BEN has not been able to keep pace with the demand. The proposed Bank loan would provide BNB with the foreign currency it will need over the next two years. The funds provided by the Bank will be lent to or otherwise invested in private industrial firms in the Northeast. Loans wall be for periods up to 15 years at an interest rate of not less than 9-1/2 percent, with the exchange risk being assumed by the borrower. Loans or iinvestments of more than " 250,000 will require the prior approval of the Bank. As a condition of effectiveness of the proposed loan, BNB will make arrangements satisfactory to the Bank to ensure the availability of the additional long-term cruzeiro funds required by BNB for its industrial lending program. These arrangements are now under discussion with the Government. PART IV - LEGAL INSTRUIENTS AND AUTHORITY 18. The draft Loan Agreement between the Bank and Banco d.o liordeste do Brasil, the draft Guarantee Agreement between the Federative Republic of Brazil and the Bank, the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement and the text of a Resolution approving the proposed Loan are being distributed to the Executive Directors separately. 19. The draft Loan Agreement follows the usual pattern of agreements for Bank loans to development finance companies. The following provisions are of special interest: (a) Section 5.07 sets forth BIB's undertaking to earn the annual return on equity capital mentioned in paragraph 14 above. (b) Section 5.03 (e) requires BNB, upon request by the Bank, to assign and transfer sub-loans and investments made out of the proceeds of the Loan to the Bank. Certain of the loans to BNB from the Inter- American Development Bank mentioned in paragraph 13 above include similar arrangements for assignment of sub-loans, and this provision seeks equivalent treatment for the Bank's loan. (c) Section 7.01 (c) specifies as a condition of effectiveness that BNB's 1969 financial statements be audited by an independent accountant or accounting firm and that BNB's financial condition as disclosed by such audited financial statements be satisfactory to the Bank.

9 The draft Guarantee Agreement is in the usual form. Section 3.06 sets forth the undertaking of the Guarantor to take such measures as may be necessary to assure the realization of positive interest rates for industrial lending by the major national development banks. The Guarantor has taken the necessary measures to ensure positive interest rates for industrial lending by such banks at present rates of inflation, as indicated in paragraph 15 above. PART V - THE ECONOMY 21. A Bank economic mission visited Brazil in 1l"arch-April Its report (WII-195a) is being distributed to the Executive Directors separately. It concludes that the Government is generally continuing to follow reasonable stabilization and development policies and that Brazil remains creditworthy for substantial amounts of external borrowing. PART VI - COMPLIANCE WITH ARTICLES OF AGREEMENT 22. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VII - RECOMMENDATION 23. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President By J. Burke Knapp Attachments December 31, 1969