INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized stv RESTRICTED %ti~v~ y5 gty Report No. P-531 This report was prepored 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 The report may not be published nor may it be quoted as representing their views.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 T HE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE NATIONAL POWER CORPORATION OF THE PHILIPPINES March 2Z, 1967

2 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THIE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE NATIONAL POWE CORPORATION IN THE PHILIPPINES 1. I submit the following report and recommendation on a proposed loan in an amount, in various currencies, equivalent to US$12 million to the National Power Corporation in the Philippines for a Fburth Power Project. PART I - HISTORICAL 2. The Bank has made three loans to the National Power Corporation (NPC). The first, US$21 million, later reduced to US$18.4 million (183-PH), was made in 1957 for the Binga Hydroelectric Project in Northern Luzon. The second, US$34 million (297-PH), was made in 1961 for the Angat Hydroelectric Project near Yanila, and the third, US$3.7 million (325-PH) was made in 1962 for the expansion of the Maria Cristina Hydro-Station on Mindanao Island. The Binga project was completed successfully in The Angat and Maria Cristina projects are still under construction. 3. NPC has applied for a loan of US$12 million to cover the foreign exchange costs of a 75MW thermal power station to be built on Bataan peninsula across the bay from Manila, and of a 50MW extension (unit 4) to the existing Maria Cristina hydro-power station on Mlindanao. The total cost of the two plant additions would be about US$22 million, including interest charges during the construction period. 4. The project has taken a long time to work out. A first appraisal in February 1964 indicated that a decision in regard to the proposed thermal plant could not be taken until the expansion plans of the Manila Electric Company (MERALCO) were settled and that the power market on Mindanao did not appear to be expanding rapidly enough to justify immediate installation of the fourth unit at Maria Cristina. The uncertainty in regard to MERALCO's plans was removed in July 1964 after it obtained a 30-year extension of its license. Further visits to Manila and discussions with NPC led in the fall of 1965 to the conclusion that the fourth unit at Maria Cristina was justified by the growing industrial load. Negotiations were then held in June 1966 with a delegation headed by the Honorable Andres V. Castillo, Governor of the Central Bank of the Philippines, and Mr. J. Lahoz, the General Manager of NPC. 5. However, the Bank was in the meantime becoming increasingly concerned about the unsatisfactory progress of other Bank-financed projecte in the public sector, the uncertainty concerning the availability of adequate peso funds for them, and the lack of evidence that the Government was making a determined effort to inprove on past performance. The project was therefore not presented to the Executive Directors and the Government of the Philippines w.as informed that consideration of further lending in the public sector (including the presentation of the present project) would

3 be dependent upon the findings of an economic mission in October/November specifically in regard to improvements in the execution of public sector projects. The mission's report (No. AS-120, distributed to the Executive Directors on January 27, 1967) confirms that there has been some improvement and that the Government is making serious efforts to overcome past deficiencies in overall performance. 6. By that time, however, revised financial forecasts had been received from NPC which showed lower revenue forecasts than had previously been assumed. The Bank also learnt of a major leak in the Angat Dam which, if not closed promptly, could delay plant operations and thereby reduce NPC's earnings and increase construction cost. A mission therefore visited Manila in January 1967; its findings and information received subsequently show that the leak has been sealed and that NPC, with the help of funds the Government has undertaken to provide, will be able to meet its financial commitments. In addition, as a safeguard against unexpected shortfalls in earnings, assurances have been obtained from Government that it will assist NPC, if necessary, during the fiscal years 1966/67 and 1967/68 to meet its financing plan. 7. If approved, this will be the Bank's tenth loan to the Philippines, and will increase the total amount lent to US$146.7 million net of cancellations. The following is a summary statement of Bank loans to the Philippines as at February 28, 1967.

4 3- Amount (less Undis- Loan Cancellations) bursed Year No. Borrower Purpose (US$ millionf National Power Corp. Power - Binga Republic of the Phil. Dredging National Power Corp. Power - Angat National Power Corp. Power - Maria Cristina Phil. National Bank. Relending to the Private Developm.ent Corp. of the Phil. (PDCP) National Waterworks Manila Water Supply & Sewerage Authority (N\WSA) Republic of the Education (University Philippines of the Phil. - College of Agriculture) Central Bank of the Agriculture 5.o 4.2 Philippines Phil. National Bank Relending to the Private Development Corp. of the Philippines (PDCP) Total net of cancellations of which repaid 7.6 Total outstanding Amount sold 10.1 of which has been repaid Net amount held by Bank Total undisbursed 77.1

5 IFC's loans and investments in the Philippines consist of an equity investment of P800,000 (equivalent to $205,000) in the Private Development Corporation of the Philippines and an equity investment of $14 million equivalent and a loan of $8 million in the Manila Electric Company. NTo IDA credits have been made to the Philippines. 9. As noted above, the new administration has brought about some improvements in the administration of Bank-financed projects. Recently arrangements were made to provide the peso funds required to complement the loan funds for two on-going Bank projects. 10. The Dredging Project of 1961 (Loan No. 290-PH) has been a disappointment but improvements have been evident of late. All flcating equipment has now been procured but the operation and maintenance of the fleet had been unsatisfactory until recently. The Government is taking steps to remedy the situation. A contract to construct the slipway was not awarded until late 1965 and work is progressing slowly. The undisbursed balance was cancelled. 11. The Angat Power Project of 1961 (Loan No. 297-PH) is expected to be completed early in 1968, about 3 years after the originally scheduled date. The start of this project was delayed because contracts were not awarded on time and construction was seriously delayed by typhoon damage in 1963 and 1964 and major cave-ins in June 1905 which led to the replacement of the main civil works contractor. In late 1966 leakage occurred around one of the gates of the diversion tunnel but the situation is now under control, the leakage having been permanently sealed. 12. Thle Maria Cristina Hydro Project of 1962 (Loan No. 325-PH) was scheduled for completion in late 1964; the delay in completion is mainly due to problems experienced with the local contractor. The project is now estimated to be in operation within the first half of The delay has not had serious consequences for the power supply of the area because some important industrial loads did not materialize as scheduled. 13. The National lwaterworks and Sewerage Authority (NWSA) Project of 1964 (Loan No. 386-PH) has been delayed about one year owing to slowness in awarding civil works contracts, poor contractor performance and litigation over the principal pipe contracts. One civil works contract has been terrjnated and re-awarded to a new contractor. Another civil works contract has been renegotiated to give NWSA more control over the contractor's operations. Some of the principal supply contracts have recently been let. 14. No other projects have yet reached the appraisal stage. Discussions on general lending policy took place between Bank representatives and the Philippine authorities in late February early March this year. The Philippine authorities were informed that the Bank would not be prepared to consider lending beyond this proposed project unless measures were taken to raise taxes to a satisfactory level and remedy other deficiencies (referred to in Part V, The Economy) and there was evidence of substantial improvement in the performance of the public sector.

6 PART II- DESCRIPTION OF THE PROJECT Borrower: Guarantor: Amount: Purpose: Amortization: Interest: National Power Corporation. Republic of the Philippines. The equivalent in various currencies of US$12 million. Construction of a thermal power station on Bataan Peninsula with a capacity of 75BM; and the installation of 501.OU^ generating capacity to supplement facilities at the Maria Cristina hydro-station in Northern Mindanao, including control works on Lake Lanao. 20 years including 3½z years of grace; semi-annual installments from December 1, 1970 to June 1, % per annum. Commitment Charge: 3/8 of 1% per annum. PART III - THE PROJECT 15. A detailed appraisal of the Project (TO-512b)is attached (No. 1). 16. NPC is a goverrment-owned corporation responsible for the generation and supply of power throughout the Philippines and with a particular responsibility for the development of hydro-electric resources. However, generation and distribution of power in the greater Manila area, the country's largest and fastest growing load center, is undertaken by the Manila Electric Conpany (I4ERALCO). There is also a considerable number of small companies operating under franchises which empower them to supply electricity to meet the needs of particular towns. Thus NPC's sales are generally confined to the wholesale level, particularly to 1hEALCO and many of the smaller companies. 17. NPC's construction program, in addition to the completion of the Angat Dam and the Maria Cristina hydro-electric plant in Yifndanao (see paragraphs 11 and 12 above) comprises the Bataan Thermal Plant and the fourth unit for the Maria Cristina Hydro Plant, the constituent components of the proposed project and transmission facilities. 18. The 75FMW Bataan Thermal Plant will be built at a site near the Esso Bataan Refinery, from which high viscosity fuel (pitch) would be pumped direct to the plant. The site is large enough for future plant expansion

7 - 6 - and foundation conditions are good. NPC and Esso have negotiated a long-term fuel contract for the delivery of fuel "to the boiler" - an advantageous feature for NPC. Bunker C oil would be used in the case of interruption of the normal fuel supply, and a 24-hour storage tank would be provided. 19. The plant layout and cost estimates were prepared by NPC's consultants, Electroconsult of Milan, Italy. Electroconsult will be retained to carry out the detailed design, bid evaluation and engineering supervision of construction. Responsibility for initial start-up of the plant and training of NPC personnel will also rest with the consultant. 20. The plant, excluding contingencies, is estimated to cost US$154 per KW installed. Contingency provisions of about 10% on civil works, equipment and its erection have been included in the cost estimates, and are considered adequate. All equipment will be procured on the basis of international competitive bidding. 21. The Maria Cristina Station. The Maria Cristina hydro plant now serves a largely industrial area; and transmission lines are being extended to nearby towns. Ioad growth should result from expansions of existing industrial enterprises, in particular a steel mill, and the establishment of new enterprises in the area attracted to it by the availability of low cost power. 22. The total cost of the additions to the Mindanao system now proposed would be about US$7.86 million, including foreign exchange requirements for imported machinery and equipment of about US$2.17 million. Contingency provisions of about 20% on civil works and 10% on equipment are included. Equipment to be imported was purchased on the basis of international competitive bidding during the past year. No payments were required as of the end of 1966 and no reimbursements are contemplated for expenditures made prior to the approval of the proposed loan. 23. Of the total construction expenditures over the four fiscal years ending June 1970, 80o will be met from loans, about 3% from capital receipts and about 17% from NPC's internal cash generation. 24. The work at Mindanao is expected to be completed in 1968 and that in Bataan in The total cost of the Bataan Plant and the works in Mindanao, excluding interest during construction, will be about US$20.5 million including foreign exchange costs of about US$11.0 million. The proposed loan of US$12 million will cover the foreign exchange costs and interest charges on the Bank loan during the construction period. 25. NPC and the Government have agreed to maintain rates sufficient to provide a return of not less than 8% on revalued fixed assets in operation and to retain management consultants to help in revaluing its fixed assets and to recommend changes in the organization and operating procedures. The present debt limitation covenant will be continued. NPCIs forecast debt/equity ratio will remain at about 50/50 provided that an amendment to NPCIs capitalization act would be passed prior to 1970 as explained in paragraph 46 of the appraisal report; the. Government has undertaken to support this amendment. All these arrangements form an acceptable basis for a loan.

8 - 7 - PART IV - LEGAL INSTRUM'ENTS AND AUTHORITY 26. The following documents are being distributed to the Executive Directors separately: the draft Loan Agreement between the Bank and the National Power Corporation, the draft Guarantee Agreement between the Republic of the Philippines and the Bank, and the Report of the Conmmittee provided for in Article III Section h (iii) of the Articles of Agreement. The draft Loan and Guarantee Agreements conform generally to the pattern of loan and guarantee agreements for loans to autonomous agencies for power projects, and follow closely the corresponding agreements covering the Bank t s three previous loans to NPC. 27. Section 5.09 of the draft Loan Agreement requires that rates for the sale of electricity be maintained at levels, after covering operating expenses, to produce a reasonable annual return on NPC's net fixed assets in operation. By Section 3.07 of the draft Guarantee Agreement the Guarantor would grant NPC rates at levels sufficient to meet these requirements. These provisions on rates are different from those included in the documents of the three previous loans to NPC. The covenant limiting NPC's power to incur new debt (Section 5.10) is substantially the same as that used for previous loans to NPC. Article VI of the Loan Agreement modifies the three previous Loan Agreements with NPC by substituting the new rate covenant and the re-worded debt-limitation covenant for the corresponding provision of those Agreements. PART V - THE ECONOMY 28. The Philippine economy has long suffered from lack of financial resources in the public sector and shortcomings in their utilization owing to administrative weaknesses. There have been no substantial new taxes since 1959, and meanwhile, the Special Import Tax expired under the terms of the U.S.-Philippine Trade Agreement, and the large profits on exchange operations ended with the unification of the exchange rate in November NIational revenue as a percentage of GNP declined from about 11% in 1962/63 to about 9% in 1965/66. This is lower than most other developing countries of cozparable income levels. Since current government expenditures remained relatively stable at around 10% of GNP, the amount available as public savings for development has been minimal. The portion of total investment undertaken by the public sector in the Philippines is only about 15%, much smaller than in most other countries with similar requirements for infra-structure and other public investments. Roads, other transportation media, and irrigation facilities have not only failed to keep pace with the requirements of the private sector during miost of the last decade but have actually deteriorated in absolute terms. An exception is the power sector where necessary expansion has been financed by foreign and domestic borrowing and some net operating income has been generated. 29. The Philippines is rich in resources and has a dynamic private sector which has responded very well to the devaluation of the peso in Exports have grown at about 10% annually and for the first time in many years the Philippines had a surplus of commodity exports over imports in 1966.

9 - 8 - There is a substantial potential for further improvement in the balance of payments. Economic growth, which reached 7% of GNP in the 1950's, fell to an average of less than 5% during the last four years. The performance of domestically oriented agriculture has been particularly disappointing. However, an upturn in both agricultural and industrial production occurred in In respect of general economic performance, the economy has failed to meet the targets projected by the Bank mission of That mission felt that a growth rate of 6% was well within the capability of the econormy. W4hile savings has grown much faster than National Income, investment has lagged and the economy has not evidenced an adequate capacity to attract and utilize foreign capital, and there has been a net capital outflow of considerable proportions during the last four years. Ibnetary management has been generally conservative and reasonable financial stability has prevailed. 31. Thus, while the economr has not achieved the progress it might have in recent years, this period has been one of adjustment to the removal of controls over foreign transactions and to a new exchange rate. The strength shown by the export sector throughout this period is reassuring. Therefore, wihile economic performance has been mixed, basic policy measures have been taken that should lead to more rapid growth along sounder lines than during the period of import control preceeding The new administration of President Marcos, which came to power in January 1966, has attacked the economic problems of the nation on several fronts. Its short-run fiscal policy has been directed towards the containment of increases in current government expenditures by the reduction of surplus personnel and by improving revenue collections. Reorganizations have been effected in the crucial revenue collecting agencies, and internal revenue and customs collections for the first seven months of the current fiscal year (ending June 30, 1967) were up by nearly 20% over the same period of last year. This compares with only a 3.6% increase in 1965/66. Bqually important is the improved administration of customs where rampant smuggling was not only depleting government revenues but also exposing domestic industry to more external competition than is contemplated by the Government's tariff policy. Another notable event has been the development of a market outside the banking system for Treasury bills and medium-term bonds. The anticipation of larger revenue collections and curtailment of increases in current expenditures made it possible for the Central Bank to relax credit restraints to the private sector in January of last year. However, an upward trend in private credit occurred only toward the end of the year. Bank credit to the Government rose only moderately - much less than in the two preceding years. There was a very marked improvement in foreign exchange reserves primarily as a result of favorable exports which rose by much more than imports. Reserves went up from about $90 million at the end of 1965 to around $200 million at the end of August There was a decline thereafter to about $150 million at the end of the year. This is equivalent to about two months' imports.

10 -9-33 While recent increases in internal revenue and customs collections have improved the fiscal situation, revenues and government savings are sti1l inadequate for a satisfactory public development effort. This is conceded by the Philippine Administration in discussions with the Bank and revenue measures have been introduced in the current session of the Philippine Congress which would substantially improve the finances of the Government if supplemented by measures to further improve revenue collection. Whether the proposed revenue measures will win congressional approval in the present session remains uncertain. 31h. Owing to the relatively large proportion of medium-term debt in the total external public debt, the service ratio on existing debt, which at present is about 9.3%, will decrease rapidly. Total public external debt is now about $440 million or slightly more than a third of annual foreign exchange receipts. The basic strength of the econormy and its foreign trade prospects support the conclusion that the Philippines can service substantial additional foreign borrowings on conventional terms. PART VI - COMPLIANCE WITH ARTICLES OF AGREEMENT 35. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VII - RECOMENDATION 36. I recommend that the Executive Directors adopt the following resolution: Attachment RESOLVED: Washington, D.C. March 22, 1967 RESOLUTION NO. Approval of Loan to National Power Corporation (Fourth Power Project) in an amount equivalent to US$12,000,000 to be guaranteed by Republic of the Philippines. THAT the Bank shall grant a loan to the National Power Corporation to be guaranteed by the Republic of the Philippines, in an amount in various currencies equivalent to twelve million United States dollars (US$12,000,000), to mature on and prior to June 1, 1987, to bear interest at the rate of six percent (6%) per annum, and to be upon such other terms and conditions as shall be substantially in accordance with the terms and conditions set forth in the form of Loan Agreement (Fburth Power Project) between the Bank and the National Power Corporation, and the form of Guarantee Agreement (Fourth Power Project) between the Republic of the Philippines and the Bank, which have been presented to this meeting. George D. Wbods President