The President. January 24, 1975 PROPOSED CONSOLIDATION LOAN AND CREDIT

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized FROM: The President BANGLADESH - January 24, 1975 PROPOSED CONSOLIDATION LOAN AND CREDIT 1. Since the independence of Bangladesh on December 16, 1971, the question of the division of liability for external debt incurred by Pakistan before that date has troubled the relations of Pakistan, Bangladesh and the creditors of Pakistan. When Bangladesh became a member of the Bank and the Association in August 1972, it agreed to accept liability with respect to all uncompleted projects wholly located in Bangladesh which had previously been financed with credits to Pakistan, subject to a case-by-case review of each project. Over the remainder of FY 1973, 11 "reactivation" credits were made, covering all of the uncompleted projects; these credits made funds available to help complete the projects and provided for the assumption of liability by Bangladesh for amounts previously disbursed. 2. On September 15, 1973, in an Aide-Memoire to the members of the Pakistan Consortium, Bangladesh indicated its readiness to enter into negotiations with the members with respect to projects completed before independence and which fell wi thin the description "visibly located in Bangladesh" The Bank Group welcomed this initiative by the Government but felt that, with respect to Bank Group debt, it was appropriate to ask Bangladesh to assume liability for all debt which was incurred for the benefit of Bangladesh, including program lending. The Bank Group staff conducted a lengthy and comprehensive review of all available records concerning disbursements to Pakistan, and determined the amounts which had been disbursed for the benefit of Bangladesh. A letter was sent to the Government of Bangladesh requesting it to accept liability for these amounts. Bangladesh indicated its willingness to enter into detailed negotiations. A senior member of the Legal Department, Mr. Douglas Fontein, was appointed to negotiate on behalf of the Bank Group. He was assisted by Mr. Stanley Perch of the Controller's Department and by Mr. David A. Dunn of the South Asia Department The negotiations on the Bangladesh side were handled by the Planning Commission, whose Secretary, Mr. M. Syeduzzaman, was the chief negotiator. 3. The progress of negotiations was deliberate, owing to an understandable desire on the part of the Government of Bangladesh to be completely satisfied as to the amounts involved and because a number of questions of principle, which also involved the Government's position with respect to other creditors, had to be resolved. Ultimately, the negotiators reached an agreement in London on June 11, 1974, on principal amounts to be assumed by Bangladesh at this time. These amounts represent about 84 percent of the amount the Bank Group originally asked Bangladesh

2 - 2 - to assume. Most of the rest have been reserved for further discussion at a later date. It was also agreed that July 1, 1974 would be the date as of which Bangladesh would assume liability. Our negotiators made it clear that the agreements, as detailed below, were subject to the approval of the Executive Directors. 4. The amount originally attributed by the Bank Group to Bangladesh and estimated to be outstanding as of July 1, 1974 (calculated at July 1, 1974 exchange rates) is about US$113.1 million (see attached Table). Of this amount, Bangladesh agreed to accept liability for about US$92.4 million, consisting of about US$54.9 million of Bank debt and about US$37.5 million of IDA debt. Of the remainder of about US$20.7 million, about,us$17.7 million is for four IDA credits where, without prejudice to the Association's rights in this matter, the Association has agreed to defer further discussion to a later date. The four credits involved are the two program credits (Credits Nos. 81 and 98) and the first two Agriculture Development Bank project credits (Credits Nos. 71 and 117). Tne Government remained unwilling to assume liability for program lending. Further, it argued that the Agriculture Development Bank projects were also in the nature of program credits; this argument was not accepted by the Bank Group's negotiators but, in the interests of achieving a resolution now on the great majority of the total amounts involved, it was agreed to reserve this matter for later discussion. 5. The Government claimed credit on account of damages inflicted during the hostilities on certain assets financed under Bank Group loans and credits. On this point, it was agreed that the amounts for which Bangladesh would be asked to assume liability would be reduced by about US$2.1 million in the case of four Bank loans to (Loans Nos. 382, 421,509, and 590) and about US$0.2 million in the case of the three railway projects (Loans Nos. 241 and 321 and Credit No. 56), subject in all cases to satisfactory proof of damage beina furnished. Relevant documentation is being assembled. 6. The remaining amount of about ljs$o.7 million pertains to loans and credits where, in the circumstances explained below, it was agreed to reduce the amounts for which Bangladesh was asked to assume liability: a. about US$O.2 million for Credit No. 11 and about us $0.4 million for Credit No. 16, where it was agreed to give Bangladesh credit for amounts representing principal and interest payments made by the erstwhile Government of East Pakistan to the Government of Pakistan, under subsidiary loan agreements, in excess of the amounts repaid by Pakistan to the Association; agd b. about US$O.l million, the total amount attributed to Bangladesh for the third Agriculture Development Bank project, Credit No. 157, for which Bangladesh was allowed a deduction because the goods never arrived in Bangladesh.

3 The terms on which Bangladesh would be asked to assume debts were the subject of considerable discussion among the creditor members of the Pakistan Consortium. The country members requested the Bank, in its role as Chairman of the group, to make recommendations on terms. In this capacity the Bank recommended that, in view of the poverty of Bangladesh, all country members offer terms on the debt to be assumed which would have a grant element of at least 84 percent. It was noted, and country members understood, that while -these terms could be met for the IDA amounts, the Bank itself could not be so generous because of its institutional constraints. All but one of the country members have been able to indicate their agreement to the Chairman's recommendations. 8. For the Bank Group, I believe it is desirable to consolidate all of the amounts into one new Bank loan and one new IDA credit, on the most lenient terms which can be provided without departing from accepted Bank Group policy, and it is on this basis that we concluded our negotiations with Bangladesh. Accordingly, as in the case of the reactivation credits, the IDA amounts would be incorporated into a new credit for which standard IDA terms would begin from the date of signing. (The grant element would be 86 percent.) For the Bank, the amounts would be incorporated into one new loan with a term of 30 years, including 10 years of grace. Interest would be charged at 6.15 percent, which is the weighted average of the original interest rates on the amounts for which Bangladesh would assume liability. (The grant element would be 33 percent.) The weighted average grant element of the proposed loan and credit would be 55 percent. 9. The Bank Group terms and the recommended terms for other creditors will result in a minimal burden on Bangladesh's externalresources position over the next several years. To date, Bangladesh has incurred very little in the way of long-term debt service obligations. As a result of the negotiations under way with the Bank Group and other creditors, it is expected that about US$450 million will be added to Bangladesh's external debt. However, in order to achieve the grant element of 84 percent, the terms will resemble those of IDA credits, and thus the exercise is expected to add very little to Bangladesh's debt-servicing requirements over the next 10 years. Allowing for the debts to be assumed and also for required amounts of new debt obligations, Bangladesh's debt-service ratio is projected to be less than 10 percent over the next decade. 10. On the Effective Date of the proposed consolidation loan and credit, the proceeds thereof would be applied immediately (i) in repayment of the maturities of the original Pakistan loans and credits which were outstanding on July 1, 1974 and have become due since that date; and (ii) in prepayment of the remaining outstanding maturities. Interest on the proposed consolidation loan and service charge on the proposed consolidation credit would accrue as from July 1, Amounts paid by Pakistan since that date on account of principal and interest on the original loans and of principal and service charge on the original credits

4 - 4 - would be refunded to it. With one exception, I propose that, in accordance with standard Bank and IDA practice, prepayments be applied in inverse order to the outstanding maturities of the respective loans and credits. (In the case of five of the loans, Loans Nos. 286, 330, 382, 421 and 509, where the amortization schedules are a composite of the amortization schedules agreed by in respect of the subprojects financed by it out of these loans, the prepayments would be applied to the outstanding maturities pertaining to the particular investments or credits made by in respect of which the prepayment is made; as a result, all such maturities would be extinguished.) In one case, however, that of the last loan, Loan No. 590, which has a fixed rather than a composite amortization schedule, applying the prepayment in inverse order would result in a substantial reduction in the term of the loan, and I propose to provide some relief to Pakistan and, as authorized under the provisions of the loan agreement for that loan, to apply the prepayments pro ~ to outstanding maturities. In the case of all the Bank loans, the premium chargeable on prepayments would be waived. 11. Pakistan will remain the legal debtor or guarantor for the amounts for which Bangladesh does not assume liability. The Government of Pakistan has given assurance that it will continue to service all such amounts. 12. The draft Loan Agreement and the draft Development Credit Agreement between the People's Republic of Bangladesh and the Bank and the Association, and the text of draft resolutions approving the proposed loan and credit, are attached. The draft resolution for the proposed credit, and the draft Development Credit Agreement, refer to amounts of US$31.0 million, but these are expressed in US$ of the weight and fineness in effect on January 1, 1960; the value of the currencies used for disbursement, and which must be repaid, was about US$37.5 million at July 1, 1974 exchange rates, the figure which appears in paragraph 4 above. Rather than incorporate all of the substantial covenants of the previous loan and credit agreements into the proposed Loan and Credit Agreements, they would be replaced by one covenant in each Agreement requiring Bangladesh to operate, maintain, and repair, or to cause the responsible agencies to operate, maintain, and repair, the assets involved in such a manner as to ensure their efficient and economic use for the purposes for which they were acquired. This covenant appears as Section 3.01 of both the draft Loan Agreement and the draft Development Credit Agreement. Since the proposed loan would not require the Bank to hold funds pending disbursement (for its proceeds would immediately be applied to prepayment of amounts already disbursed on the original loans to Pakistan), a commitment charge on the proposed loan would not be appropriate and is not proposed. Also being distributed to Executive Directors is a letter which makes explicit the understandi:l.g between the Government, and the Bank and the Association, about the application of the proceeds of the proposed loan and credit and about the accrual of interest and service charge.

5 I am satisfied that the proposed loan and proposed credit would comply with the Articles of Agreement of the Bank and Association. 14. I recommend that the Executive Directors approve the proposed loan and the proposed credit. Robert S. McNamara President Attachment

6 IBRD --. Wholly Bangladesh 321 Joint IDA IBRD Project Railways Railways FleIC Total ~ PROPOSED ASSUMPTION OF IBRD/IDA DEBT BY BANGLADESH ($ thousands). (1) (2) Attrib~ted by Bank Group Orig. Amt. Net of Cancell. 4, , , , , , , to Bangladesh and Outstanding at 7/1I7h At 7/1/74 Including Exchange Exchange Rates Adjustment 3, , , , , Disposition of Column (2) Amount Claims Discussion Assumed by Allowed Deferred Banglades~ a 84.8 / / Tl 786.0/ , , L~0.3 2, , , ,895.7 Wholly Bangladesh Dacca Irrigation 1,000.0 Inland Ports 1,985.6 Brahmaputra 5,000.0 Chandpur Irrigation 5,250.0 Railways 9,968.5 Inland Water 5,206.3 Tech. Ass1st.2, , , , , , , , / , , ,) , , ,412.7 Joint 177 Indus. Dev. Bank Subtotal , , ,511.1 )7,452.4 Discussion Deferred 81 Road Vehicles 98 Indust. Imports 76 Agric. Dev. Bank 117 If If 157 It If Subtotal IDA Total. IBIID/IDA TOTAL 25, , , , a OOO.O 1671~10.~ 353,835.,2 57, ,)05.3 4, ,187.) 3, , , l2.: , ,305.) 4, ,187.3 ), , ,5) tl. Subject to satisfactory proof of damage being furnished; relevant documentation is being assembled. 12/)0/74 south Asia and Controller's ]}3partments