of the PRESIDENT to the EXECUTIVE DIRECTORS on the PROPOSED LOAN and to the in the July 9, 1953

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized P - 49 RESTRICTED This report is restricted to use within the Bank. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS of the PRESIDENT to the EXECUTIVE DIRECTORS on the PROPOSED LOAN to the COMPANHIA DE ELECTRICIDADE DO ALTO RIO GRANDE (CEARG) and to the CENTRAIS ELETRICAS DE MINAS GERAIS S.A. (CEMIG) in the UNITED STATES OF BRAZIL (ITUTINGA HYDROELECTRIC POWER PROJECT) July 9, 1953

2 Currency Unit: Cruzeiro (Cr.) Official Rate (parity): US$ 1 - Cr plus 8% tax - Cr US$ 1,000,000 = Cr Cr. 1 US$ Cr US$ 50,050- Free Exchange Rate US$ 1 = about Cr. 45. US$ 1,000,000 = about Cr Cr. 1 = about US$ Cr = about US$ 22,222

3 REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE COMPANHIA DE ELETRICIDADE DO ALTO RIO GRANDE, AND TO THE CENTRAIS ELETRICAS DE MINAS GERAIS, S.A., OF THE STATE OF MINAS GERAIS IN THE UNITED STATES OF BRAZIL 1. I submit herewith the following report and recommendations on a proposed loan of $7,300,000 to the Companhia de Eletricidade do Alto Rio Grande, (hereinafter referred to as CEARG), and to the Centrais Eletricas de Minas Gerais, S.A. (hereinafter referred to as CEMIG), to finance the foreign exchange cost of the construction of a hydroelectric power generating plant at Itutinga and of transmigsion facilities in the State of Minas Gerais of the United States of Brazil. PART I - HISTORICAL 2. The Joint Brazil-United States Economic Development Commission, in cooperation with the State of Minas Gerais and CEARG, has prepared a hydroelectric power development project which the Commission classified as of high priority in the Brazilian development program. The Commission's report on this project, with supporting data, was received by the Bank in July, Upon the passage by the Brazilian Congress in December 1952 of legislation setting up a free foreign exchange market for capital transactions, the Bank sent a mission to Brazil to discuss the basis upon which the Bank might participate in financing this and various other projects. The mission arrived in Brazil on January 18, 1953 and remained there until March 19, On April 30, 1953, the Bank made a loan of $3, to the United States of BrazLl for road construction and maintenance equipment for the Highway Department of the State of Rio de Janeiro 5. As I have already informed the Executive Directors, work is continuing on two other projects studied by the mission (a hydroelectric plant and a project for suburban cars on the Central Railway), and on a project for a thermoelectric plant being built by the Brazilian Traction, Light and Power Company at Sao Paulo. These projects may be presented to the Executive Directors shortly for consideration. 6. Formal negotiations for a loan began in Washington on June 26, Dr. Walther Moreira Salles represented the Brazilian Government and the State of Minas Gerais, and Dr. Luoas Lopes and Dr. M4ario Bhering represented CEARG and CEMIG.

4 -2- PART II - DESCRIUPTION OF THE PROPOSED LOAN Co-Borrowers 7. The Co-Borrowers would be CEARG and CEMIG. CEaIG is a holding company, controlling CEARG and three other similar operating subsidiaries. A majority of CEMIG's stock will always be owned by the State of Minas Gerais, but the State seeks as a matter of policy to place minority interests in CEMIG and in CEARG in the hands of private holders. CEARG is authorized by law to proceed with the Itutinga project. Guarantor 8. The Guarantor would be the United States of Brazil, a member of the Bank. Amount 9. The loan would be in the amount of $7,300,000 or its equivalent in other currencies. Purnose 10. The proceeds of the loan would finance the foreign exchange costs of the project, including interest during the period of construction. The project consists of the construction of a dam across the Rio Grande river at the Itutinga Falls in the State of Minas Geraia, of a power house including the installation of two 12,000 kw. generating units, and of about 170 km. of transmission lines, and three sub-stations. Part of the proceeds would be used to reimburse CEARG for service and equipment purchased since April The total cost of the project would be equivalent to about $16,000,000 at the official rate of exchange. Interest. Commission and Commitment Charges 11. The loan would bear interest at the rate of 5% per annum including the statutory commission of 1%. The commitment charge would be 3/4 of 1% and would accrue from the effective date of the Loan Agreement or a date sixty days after signature, whichever is the earlier. Amortization 12. The loan would be for a period of 20 years. It would be amortized by semi-annual payments of principal beginning January 15, 1957 and ending July 15, 1973 as set out in Schedule 1 of the proposed Loan Agreement.

5 _ I consider that the proposed schedule for the repayment of principal, and the rate of interest and other charges in connection with the proposed loan, are reasonable and are appropriate for the project. Legal Instruments and Legal Authority 14. Appendix I contains drafts of the following legal instruments to be issued to give effect to the proposed loan: (a) (b) (c) a Loan Agreement between the Bank and CEARG and CR/1IG, a Guarantee Agreement between the United States of Brazil and the Bank, a ProJect Funds Agreement between the State of Minas Gerais and the Bank. 15. The Loan and Guarantee Agreements are in substantially the usual form except that the Co-Borrowers would undertake in the Loan Agreement that the long-term debt of CEMIG and all of its subsidiaries considered as one unit would not exceed their consolidated capital and surplus. The Government of Brazil is authorized under Law No of December 24, 1951, to enter into the Guarantee Agreement. In the Project Funds Agreement, the State of Minas Gerais would undertake to provide CEMIG each year with amounts which, on the basis of present estimates, would be ample to meet the local.currency costs of its overall program. Before the Loan Agreement becomes effective, the Guarantee Agreement must be registered with the Brazilian Tribunal of Accounts and the Project Funds Agreement with the Tribunal of Accounts of the State of Minas Gerais. 16. The report of the Oommittee provided for in Article III, Section 4(iii) of the Articles of Agreement of the Bank is attached as Appendix II. PART III - APPRAISAL OF THE PROPOSED LOAN 17. A technical report summarizing and appraising the project to be financed by the Bank is attached as Appendix III. Justification of the Project 18. The project will serve the southeastern part of the State of Minas Gerais. While this area is not favorable for agriculture, having a relatively poor soil, it does contain important deposits of iron ore, manganese and tin-bearing ores. The economic development of the area will therefore largely be determined by progress in mining and manufacturing industries, for which ample cheap power is of primary importance.

6 Nearly all the forests in this area have now been exploited and the wood used as fuel for domestic and industrial purposes. Cheap hydroelectric power will help greatly to alleviate the growing shortage of fuel by permitting the use of electric furnaces, by eliminating the need for diesel engines, and by increasing the use of electricity by small industries. 20. Industry will take about 80% of the power to be generated at the plant. The principal consumers will be a ferro-alloy plant soon to be constructed, which will be the largest single customer; a cement mill now under construction; and a tin mine. The remainder of the load will be taken by the utilities serving three small towns. 21. CEARG has already entered into contracts to supply power to the ferro-alloy plant and to the cement mill. The production of ferro-alloys is important to meet the demands of Brazil's expanding steel industry; the production of cement will make it possible to reduce imports of this material by about US$ 8 million in foreign exchange annually. Should present plans for these two plants fail to materialize as rapidly as now envisaged, power would become available to other types of industry which intend to operate in the area as soon as power is obtainable or which may move fran the city of Rio de Janeiro where they now are being placed on the waiting list because of the power shortage. Itutinga is strategically placed within the Volta Redonda, Rio de Janeiro and Belo Horizonte industrial complex and will therefore always be attractive to industries requiring a large quantity of low-cost power. 22. The Itutinga plant is expected to begin operations in January 1955, but will not be completed and capable of carrying its full output until the beginning of In the opinion of the Bankts Technical Operations Department, the project is well-planned and justified. CEARG is a well-organized campany with a management qualified to supervise the construction of the project and to operate the Itutinga plant upon completion. Economic Situation 24. The economic background against which the proposed loan may be considered was presented in the report (WH-2b dated April 22, 1953) entitled "Current Economic Conditions and Prospects of Brazil" which was distributed to the Executive Directors on April 22, 1953 under cover of R Import licensing restrictions have been maintained, The rate of issue in the period from January through May, 1953, was-slightly less than in late 1952, the greatest reduction being in licenses for imports

7 - 5 - in convertible currencies. In the first quarter of 1953, actual total imports averaged $94 million equivalent monthly, compared with $118 million in the preceding quarter and $202 million in the first half of The short-term balance of payments situation, however, does not yet reflect this improvement. 26. This is due primarily to falling export values. In the first quarter of 1953, total exports averaged $104 million equivalent monthly, compared with $117 million in 1952 and $149 million in The new free exchange market has not yet encouraged shipment of minor exports, apparently because exporters hope that the regulations will be changed to permit them to sell in the free market a higher proportion of export proceeds than is now permitted. Coffee shipments have been sluggish, as both in Brazil and New York the trade is waiting to see whether there will be changes affecting the exchange rate applicable to coffee. 27, It cannot yet be said that the free exchange market is fully established, since the behavior of the coanercial community is still based upon expectations of changes affecting exports, and few imports have so far been licensed for payment with free,market exchange. It is, however, reported that the market has been operating completely freely for invisibles, without any official intervention, although it has so far been somewhat thin. 28. Visible trade showed a small surplus of about $30 million equivalent in all currencies In the first quarter of 1953; it has been announced that the surplus in convertible currencies was $32 million. The re-emergence of trade surplus is encouraging, although it is as yet too small to permit any great reduction of short-term indebtedness. The commercial backlog in both dollars and pounds sterling continued to grow through May 1953, although the Banco do Brasil achieved a sizeable reduction in its shortterm borrowings from New York banks. Disbursements under the Eximbank backlog funding loan are proceeding, and the Brazilian authorities are currently discussing commercial backlog problems with the British and the German Governments. 29. Thus, up to May 1953, short-term balance of.payments difficulties were persisting. The key short-term objectives remain the encouragement of exports and the limitation of imports to the minimum consistent with the maintenance of essential domestic output. 30. In the domestic situation, the increase in the cost of living has been causing mounting difficulties including serious strikes for compensating wage increases. The cost-of-living index for Sao Paulo, whi h increased 23% in calendar 1952, increased a further 15% in the first four months of Expansion of bank credit continues, the Banco do Brasil

8 ,_ 6 - alone increasing its domestic loans and investments by 14 billion cruzeiros, or 42%, in the 12 months ended February The difficult situation which confronts the new Minister of Finance is aggravated by water shortages which have forced a 20% reduction of electric power consumption by rationing in the Rio and Sao Paulo areas. 31. The published statements of the new Minister of Finance, who assumed office on June 18, 1953, indicate that he is deeply aware of the gravity of the present economic situation, and promise drastic and realistic action. He is quoted as saying: "We are determined to pay our debts. We are going to have a regime of real austerity. We do not want to assume new debts and must change our habits to conform with our resources". No specific new policies have yet been announced. It is, however, to be hoped that the recent Ministerial changes imply a political recognition of the persistent economic difficulties and will lead to vigorous remodial action. Prospects of Fulfillment of Obligations 32. The local currency amounting to Cr. 154 million (equivalent to about US$ 8 million at the official exchange rate) required for the carrying out of the project (except for the secondary transmission system described in Paragraph 33) will be provided by QEHIG, which will purchase that part of CEARG's stock not subscribed to by private investors. CEIIGIs funds are provided from the State Electrification Fund, into which is paid a part of the proceeds of the State Economic Rehabilitation Tax. Under the Project Funds Agreement, the State would guarantee that CEMIG would receive as a minimum the sums estimated to be needed for its over-all program. 33. The three local utilities which will purchase power from CEARG will reconstruct and expand their own distribution systems at a cost in local currency equivalent to about US$ 1 million at the official rate of exchange. This wlll be financed partly out of local borrowings and partly out of the three utilities' own resources. The industrial consumers will install their own sub-stations. 34. On the basis of the power rates now contemplated, CEARGts net revenues are estimated to be sufficient not only to cover the cruzeiro equivalent at the present official rate of exchange of the debt service on the proposed loan but also to leave surplus funds amounting to about 11% per annum on CEARG's share capital. Furthermore, CEMIG as the co-borrower will be deriving revenue from State-wide electricity operations, and will also have a continuing source of funds from the State Electrification Fund, at least until such time as the taxes provided thereunder may be modified or terminated.

9 35. This loan, together with the proposed loans for three other projects now under active consideration, would total about $49 million. Brazil should be able to make available, without undue strain, the additional foreign exchange required to meet the service on this group of loans. PART IV - COMPLIANCE-WITH ARTICLES OF AGREEMENZ 36. I am satisfied that the proposed loan would oomply with the requirements of the Articles of Agreement of the Bank. PART V - RECOMMENDATIOQNS 37. I recommend that the Bank make to the Companhia de Eletricidade do Alto Rio Grande 9 and to the OehtftaiD Eletrikaj de N?nta G 1, Sa. 3vAt, with the guarantee of the United States of Brazil, a loan of $7,300,000 or the equivalent thereof in other currencies for a term of 20 years with interest (including commission) at the rate of 5% per annum, and on such other terms as are specified in the draft agreements attached as Appendix I. Eugene R. Black Washington, D.C. July 9, 1953