/'- J. Documen; of The World Bank FOR OFFICIAL USE ONLY. Public Disclosure Authorized. Report No. 4938a-PO. Public Disclosure Authorized

Transcription

1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Documen; of The World Bank FOR OFFICIAL USE ONLY /'- J / ' s STAFF APPRAISAL REPORT PORTUGAL TEXTILE INDUSTRY RESTRUCTURING PROJECT April 24, 1984 Report No. 4938a-PO Industry Department This document has a restricted distribution and may be rised by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

2 PORTUGAL TEXTILE INDUSTRY RESTRUCTURING PROJECT CURRENCY EQUIVALENTS Calendar Year 1983 March 1984 Currency Unit = Escudo (Esc.) US$1 = Esc.135 US$1 = Esc. Esc.1 = US$ WEIGHTS AND MEASURES 1 kilogram (kg) = pounds 1 metric ton (MT) = 1,000 kilograms = 2,204 pounds 1 meter (m) = yards 1 square meter (m 2 ) = 1.2 square yards ABBREVIATIONS AND ACRONYMS BESCL Banco Espirito Santo e Commercial de Lisboa BFN Banco de Fomento Nacional BPA Banco Portugues Atl.antico BPSM Banco Pinto Sotto hayor BdP Banco de Portugal CGI) Caixa Geral de Depositos EEC European Economic Community EFTA European Free Trade Association IAPIEI Institute for Assistance to Small and Medium Enterprise ITC Internal Trade Center MFA Multi-Fiber Agreement MIE Ministry of Industry and Energy PFI Participating Financial Institutions SFP Sociedade Financiera Portuguesa Sill System of Industrial Investment Incentives SMI Small and Medium Industry SPI Sociedade Portuguesa de Investimentos TA Technical Assistance TC Textile Committee TI Textile Institute TRU Textile Review Unit FISCAL YEAR Government: January 1 - December 31 PFIs: January 1 - December 31

3 PORTUGAL FOR OFFICILL USE ONLY TEXTILE INDUSTRY RESTRUCTURING PROJECT TABLE OF CONTENTS I. INTRODUCTION II. THE INDUSTRIAL SECTOR A. Characteristics and Structure B. Past Trends and Recent Performance C. Prospects and Priorities D. Development Issues E. Industrial Policies F. Industrial Strategy III. THE TEXTILE INDUSTRY... 8 A. Introduction... 8 B. Structure... 8 C. Machine and Labor Productivity... 9 D. Financial Performance E. The Textile Market F. Problems and Issues in Restructuring G. Investment Requirements H. Priorities for Investment.. 14 IV. POLICY AND STRATEGY FOR THE TEXTILE INDUSTRY Az. Policies B. Textile Development Plan V. THE PROJECT A. Project Origin B. Project Objectives and Scope C. Coordination with Other Bank Operations D. Project Costs E. Project Components and Their Financing VI. PROJECT IMPLEMENTING AGENCIES A. Background B. The PFIs C. The MIE/Textile Review Unit *. 28 D. The Bank of Portugal... o. 28 E. The MIE/Textile Institute This report was prepared by L Nguyen, A. Sandig, L Zamani of the Industry Department, and R. Ihonsary (Consultant). I This document has a restricted distribution and may be used by recipients only in the perfonnance of their off cial duties. Its contents may not otherwise be disclosed without World Bank authorization. Page

4 - ii - VII. PROJECT MANAGEAENT A. Textile Restructuring Credit Line B. Technical Assistance Component C. Training Component VIII. BENEFITS AND RISKS IX. AGREEMENTS Page ANNEXE:S 3-1 Textile Industry Production Balance Production Imports, Exports, and Apparent Consumption of Textiles, Exports and Imports by Textile Products, Portugal's Utilization of EEC Textile Quotas Projections of Import, Export and Domestic Consumption of Textiles, Banking System: Some Characteristics (as of end 1982) Banking System: Sectoral Credit Outstanding by Term at year end, Caixa Geral de Depositos-Non performing Loans and Bad Debts at year end, The Textile Institute and Textile Training Facilities The Projected Commitment and Disbursement Schedule for the Credit Line Component Draft Terms of Reference for Technical Consulting Services to the Textile Review Unit Draft Terms of Reference for the Textile Training Study List of Equipment for Textile Training MAP Map of Portugal (IBRD No )

5 - iii - DOC'JNENTS CONTAINED IN PROJECT FILE 1. Portugal - Policies for Industrial Restructuring, Report No PO, August 4, Analysis of the Portuguese Textile Industries, statistical tables by IND staff. 3. Study of Textile Industry in Portugal, Werner International, Draft Textile Development Plan ( ), MIE, November Review of Proposed Textile Incentives, Consultant, December Sample of Textile Investment Projects in Portugal, Report by IND staff. 7. A Review of the PFIs Organization, Lending Portfolio and Loan Performance, December 1983, Report of IND staff and consultant. 8. Checklist for Subproject Appraisal, WB staff. 9. Guidelines for Calculating Financial and Economic Rates of Return for DFC Subprojects, Gary Hyde. 10. B-Subproject Summary Note. 11. Questionnaire for Financial and Technical Data of PFIs.

6 - iv - PORTUGAL TEXTILE INDUSTRY RESTRUCTURING PROJECT LOAN AND PROJECT SUMMARY Borrower: Beneficiaries: Amount: Terms: Relending Terms: Republic of Portugal Textile enterprises US$34.7 million Repayable in 15 years, including three years of grace, at the standard variable interest rate. The Government would bear the foreign exchange and interest rate risks. Beneficiaries would receive credit with maturities not to exceed 12 years, including a maximum of three years grace, at floating interest rates equal to the floating interest rate payable on local currency loans with similar terms. Project Description: The proposed project would assist the Government in initiating its textile subsector development plan through a program of policy improvements, and technical and financial assistance. The credit line would be channeled through participating financial intermediaries to support investment and rehabilitation programs of textile enterprises for strengthening their productivity and competitiveness. It also seeks to enhance the ongoing efforts at strengthening appraisal and support capacities of financial intermediaries and technical assistance institutions by upgrading their textile expertise. The project faces moderate risks associated with possible slow utilization of the credit line and lower than expected returns from the enterprise-specific restructuring programs. Appropriate incentives have been introduced to maint_in the interest of the participating financial institutions and as well as measures to strengthen the appraisal and support capacities of the financial and technical institutions serving the textile sector. A special incentive has been provided under the project to facilitate the use of expert services in preparation of economically and financially viable investment programs for the beneficiary textile enterprises.

7 -v- USS million (equivalent) Project Cost Foreign Local Total Investments Technical Assistance Training Total US$ million (equivalent) Project Finance Foreign Local Total Bank Loan Investor self-finance Domestic Banks Total Estimated Disbursements: US$ Million Equivalent FY1985 FY1986 FY1987 FY1988 FY1989 Annual Cumulative Appraisal Report: No. 4938a-PO, dated April 24, 1984

8 I. INTRODUCTION 1.01 The Government of the Republic of Portugal has requested a Bank loan of US$34.7 million to help finance the restructuring investment needs of the textile industry 1/ in Portugal. US$33.0 million of the proposed loan would be channeled through the participating financial institutions to help finance the eligible restructuring investments to be implemented by textile enterprises. Of the remainder, US$1.1 million (including contingencies) would be used to fituance part of the specialized technical assistance services to the eligible enterprises to improve their efficiency, and to the Ministry of Industry and Energy to strengthen its capacity to monitor the impact of the textile restructuring process; US$0.6 million would be used to finance a comprehensive training study and specific textile training equipment. The proposed project with a total cost of US$68.9 million would finance about 30% of the textile restructuring investments expected over the period. The balance would be financed with the industry's own funds and by domestic financial institutions and bilateral sources (e.g., suppliers' credits) The proposed project is expected to assist about 40 textile restructuring investment projects. About 75% of these would be in the more labor-intensive textile activities of finishing and garment making accounting for 50% of the US$33.0 million credit line. The restructuring investments to be financed are expected to create/maintain about 1,700 jobs, at an average cost per job ranging from US$10,000 to US$85, During implementation, the proposed project would also assist the Government to further the gains already made in the policy environment (e.g., revision of the investment incentive system and amendment of labor regulation), particularly in designing new and effective textile incentive measures. The Government's adoption of the textile restructuring strategy and restructuring eligibility criteria as defined for the proposed project, as well as the Government's agreement to the principle of a streamlined, fiscal-based and less costly textile incentive scheme mark important steps in the appropriate direction The proposed project is the direct result of the Government's desire to promote subsectoral restructuring. The Bank's first review of the textile industry was conducted in August Subsequently, a reconnaissance mission visited Portugal in June 1980 at the Government's request to review the restructuring needs and prospects of the industry as proposed in a report by Werner International prepared for the Government. After extensive discussions with the Government of the different technical and institutional approaches possible for the Bank's involvement in textile restructuring in Portugal, a satisfactory framework was evolved, and the project was appraised in September/October 1983, by a Bank mission consisting of Ms. K. Nguyen, Messrs. A. Sandig and K. Zamani of the Industry Department and R. Khonsary (consultant). This would be the first loan made by the Bank to Portugal to support specifically a subsectoral 1/ The textile industry is defined to include spinning, weaving, finishing, knitting and making-up (garments and household goods).

9 -2- adjustment program. As restructuring is a long-term evolving undertaking, the proposed project is a first step and an important vehicle for the Bank's involvement in the policy issues related to the industrial sector in general and the textile industry in particular. Together with other ongoing industrial operations, this and future subsectoral loans currently being planned would help ensure that structural change takes place at the industry level in a consistent manner and with minimum disruption. II. THE INDUSTRIAL SECTOR 2.01 The existing role of the industrial sector in Portugal, and the major issues affecting industrial development, have been discussed in the 1982 industrial sector report 2/ which analyzes the restructuring problems of the sector and discusses the policies needed. A. Characteristics and Structure 2.02 The industrial sector is a leading sector in the Portuguese economy accounting for about 30% of GDP, 35% of employment, 40% of capital formation and about 90% of merchandise exports in The public sector controls the large capital-intensive industries (i.e., steel, oil refining, chemicals, fertilizer, pulp and paper, cement and shipbuilding) accounting for about 35% of the manufacturing capital stock. These industries are primarily oriented towards domestic markets. The private sector predominates in the other industries, such as textiles, food processing, transport equipment (other than ship-building), electrical-mechanical products, wood, and cork. As the Government increasingly encourages a larger role for the private sector, and as exports represent a key element in the country's economic development, the textile industry is a priority subsector in Portugal's industrial development strategy. Its characteristics and performance are discussed in Chapter III. B. Past Trends and Recent Performance 2.03 During the period, industry (growing at 10% p.a.) was the driving force of the remarkable growth of the Portuguese economy (6.9% p.a.). The Revolution of April 1974 and its aftermath have resulted in serious disruptions in industrial growth (3% in 1974, -9.7% in 1975, and 4.5% in 1976). Sibstantial recovery took place, however, by 1977 with a 9.4% growth during the year, essentially based on general improvement in the productivity of the labor force. In the period, performance of industry continued to be good (about 3% p.a. or the same as for the economy as a whole), in spite of the deflationary effects of the stabilization program started in During , the performance of the industrial sector has been mixed and not as dynamic as in the last years of the 1970s. Whereas, in 1980, the 6% overall industrial growth rate continued to be based on strong export performance as in the late 1970s, in 1982 (when industrial production rose by about 2%) production in many of the 2/ Portugal: Policies for Industrial Restructuring, Report No PO, August 4, 1982.

10 - 3 - main exporting subsectors such as textiles and electrical mechanical industries actually declined, and the increase in overall output was only sustained by the stronger performance in subsectors more reliant on domestic demand. As the country's policies were progressively adjusted to the long-term needs of an export-based industrial sector, industrial exports resumed their pre-1974 role as the driving force of industrial progress, growing at some 26% p.a. in real terms over (compared to a decline of 30% p.a. during the period ). Growth of industrial exports during the last several years has slowed down to an average of about 10% p.a. in real terms. C. Prospects and Priorities 2.04 The couparative advantage of Portugal lies in the relative cheapness and abundance of skilled labor (although limited by labor productivity below international standards) (para 2.05) and its geographical preximity to the EEC markets. Although its timing is at present uncertain, Portugal's planned membership of the EEC will radically change the environment in which Portuguese industries operate. On the one hand, there is a potential for export expansion in industrial activities with the above-mentioned comparative advantage, once the demand level recovers. These activities include shoes/leather, pulp and paper, ceramics, garment-making and various branches in the engineering subsector. On the other hand, Portugal will face increased inport competition from the EEC partners, and most importantly from non-eec countries because of expected lower protection vis-a-vis these countries (para 2.08). The textile industry is a prime target to experience these changes. Because of its role in the industrial sector in terms of employment and exports, it has been designated by the Government as a priority subsector for restructuring and is the focus of the proposed project. D. Development Issues 2.05 Portuguese enterprises (large and small, public and private alike) have long been suffering from structural weaknesses. These include factors such as uneconomic size of the enterprises, unbalanced production capacity, less than optimum product mix and market development, inadequate product design and quality control, outdated technologies and shortage of competent management. The above deficiencies are reflected in the low productivity of many Portuguese industries. Rough estimates of total factor productivity suggest a serious fall in the period averaging 2.5% p.a., and only very modest gains thereafter, compared to increases of between 2-4% p.a. in other countries for which broadly comparable estimates are available. Currently available data suggest that, even though small improvements in productivity were achieved in 1980, the situation was reversed in 1982 and the overall productivity position remains weak At the subsectoral level, the above trends suggest a disturbing situation: productivity growth in many of Portugal:s traditional export activities such as textiles (notably garment-making), engineering, pulp and paper, and footwear, has not been sufficiently strong to allow full exploitation of their labor cost advantage and, more importantly, to

11 -4- withstand the intensified competition from outside the EEC. One reason for this is the post-1974 labor legislation which severely restricts the ability of enterprises to reduce employment, which now stands at some 20-40% above international standards for many subsectors (e.g., as much as 50,000 superfluous jobs in textiles). E. Industrial Policies 2.07 In addition to the important role of overall Government policies like regulation and monetary policies, the key elements of the Government's policy toward industries are the system of fiscal and financial incentives, and trade protection (notably import regulations) Protection. External nominal tariffs in Portugal are now quite low, averaging about 8% overall, 5% vis-a-vis the EEC and 3% vis-a-vis the European Free Trade Association (EFTA). 3 / Footwear and clothing are the only major exporting industries for which the overall protective tariff exceeds 10%. The tariff adjustments of the last 4 years are thus consistent with Portugal's planned EEC membership, and further reductions to accommodate free entry from future EEC partners should pose few problems. More serious problems will result from the acceptance of EEC's common external tariffs against third countries (which would lower Portugal's independent tariffs from an average of 15% to 9%, and much more sharply for many traditional Portuguese industries such as textile, footwear, furniture, engineering products), and particularly from the dismantling of the currently very cumbersome import regulations which have operated as fairly strict tariff barriers on certain goods (e.g., garments) Industrial Incentives. As discussed in the 1982 industrial report, the Bank's review of the Portuguese system of industrial investment incentives (SII) concluded that, since its inception in 1980, the system has not been very effective. During discussions with the Government, the following modifications have been recommended: (i) simplify the complex administration of the scheme; (ii) introduce more selectivity in the many forms of incentives to strengthen the signals intended for would-be investors; (iii) reduce the magnitude of the investment subsidies granted; (iv) introduce separate incentives for restructuring of existing industries; (v) remove the bias against investments for equipment replacement and rehabilitation; and (vi) replace the incentives for regional development with more effective instruments such as provision of better infrastructure. In March 1983, the Government modified the SIII to extend the eligibility definition of investments to include replacement of equipment, eliminate the regime of special incentives which formerly offered very generous benefits, simplify some aspects of the eligibility formula, streamline some of the application review and processing procedures, and incorporate a 30% minimum equity requirement for eligible investments. The revisions have responded in varying degrees to the issues raised in recommendations (i), (ii), (iii) and (v) listed above. More recently, in the context of the first consultation on the incentive policy 3/ This does not include the temporary surcharge of 30% set up in 1983, and reduced to 10% for 1984.

12 - 5 - with the Gov'ernment as agreed under the Bank's second project for Small and Medium Industry (SMI), 4 / the Government indicated that it is considering a drastic revision of the investment incentive policy, and may 3bandon the broad SIII framework altogether to replace it with separate incentive measures tailored more specificall.y to individual subsectors, and adopt the EEC's incentive approach for regional development. The Covernment has asked for the Bank's continued collaboration to elaborate furthler the new incentives. Such follow-up would be carried out during our ecnnomic nnd sector work, project work, and for the textile subsector, during the implementation of the proposed project (para 4.03). The Government's agreement to the eligibility criteria for textile restrtuctrinig investments (para 7.01) marks an important step in this regard Labor Policies. The labor legislation set tip in 1975 to ensure the security of labor has made worker releases extremely difficult, and resulted in chronic overmanning in many industries, including textile, engineering and shipbuilding. Contributing to these difficulties is the collective labor conventions agreed between the enterprises and labor unions after which among other constraints have limited the enterprises' ability to transfer employees from one function to another. The rigidities in the labor market have gradually eased in recent years, as a result of several factors. Notablv, the Government has been increasingly authorizing the use of temporary, renewable labor contracts of one year or six months' duration. The available legal instrtments have also been used in more imaginative ways by enterprises (e.g., early retirement offered to an employee in exchange for a temporary contract for a vounger relative). Recognizing that the competitivenmss of Portuguese industries cannot be achieved without accepting job losses in kev subsectors, the Covernment has in November 1983 approved an important amendment to the existing labor regulation, which defines the procedures and compensation arrangements whereby industrial enterprises can apply for official authorization to reduce or suspend temporarily the work force and/or work hours when the financial and economic viability of the enterprises is jeopardized as the result of one or several of the following factors: poor market conditions, poor competitiveness due to excessive labor, technological deficiencies, in addition to the currently allowed condition of bankruptcy. The provisions proposed seem to be reasonable partial measures, but the general qiuestion of labor mobility will need carefully designed long-term solutions as well, such as retraining, expansion of the production units, etc Monetary Policy. The large public deficits have, since 1980, caused the growth of credit to the public sector to increase more rapidly than the growth of other forms of credit. This has been the major constraint on monetary policy, which has continued to rely mainly on credit ceilings to hold down total credit. There have also been stuccessive adjustments in interest rates. The recent increases in interest rates on deposits have rapidly expanded the value of savings in the form of bank deposits. In order to control the expansion of credit, the Bank of Portugal (BdP) since 1978 has established monthly credit ceilings for individual banks, determined within an overall limit for aggregate credit expansion. Initially, purely quantitative ceilings were applied, but in 4/ SAR No PO dated March 11, 1983, Loan No PO.

13 a qualitative approach was adopted in determining the base monthly credit ceiling for each bank, with the various forms of credits and loans carrying a different weight (depending on their degree of priority). The base ceiling is adjusted in consideration of the degree to which the respective bank extends priority credits relative to the proportion of such credit being extended by the system as a whole. In addition, genuinely punitive penalties on banks for exceeding the ceiling were established Interest Rates. As the Portuguese interest rates were quite low before the Revolution, the gradual increases after the Revolution were not sufficient to compensate for the then accelerating inflation. During the last five years, however, six interest rate increases were implemented, raising the maximum lending rate from 14.75% to 32.5% and the maximum deposit rate from 13% to 30%. All loans in Portugal are subject to a floating interest rate which is adjusted when BdP changes interest rate levels. In the last four years, interest rates on long-term loans have been positive in real terms as follows: Portugal - Interest Rate Trends Long-term Annual Rate Lending Rate of Inflation Difference July April March August a/ 7.50 a/ estimated. The above pattern of positive real long-term interest rate is expected to continue as the Government under the October 1983 IMF stand-by arrangement is committed to maintain a flexible stance with respect to interest rate policy in order to ensure the relative attractiveness of holding domestic financial assets and to control the demand for credit. Confirmation that the Government intends to maintain real interest rates at positive real levels was already obtained in the context of Bank's recent SMI II loan. Currently, some changes are under consideration, including the possibility of a decline in the final lending rates to reflect the expected reduction in inflation during F. Industrial Strategy Against this background, two of the main objectives for Portugal's industrial development strategy should be (i) to restructure and modernize key industrial subsectors and existing enterprises (private and public) which have potential for efficient growth, and (ii) to increase investment in and output from new production units and/or new private enterprises, which can export and, among other things, may help absorb the labor released from the industries to be restructured. Industrial rescructuring would involve: (i) industrial reorganization (e.g.,through

14 - 7 - phasing out non-viable units or merging them into larger, more efficient plants); (ii) rationalization in output structure (e.g., through better design and quality for existing products, phasing out of some products and introduction of new ones in the higher value-added categories); and (iii) improvements in plants' efficiency (e.g., through measures to reduce production costs, improve management practices, train workers and modernize equipment). Other priority areas for industrial strategy are optimization of use of national resources and development of new and existing industries with advanced technologies Although the restructuring approach to be adopted for each subsector will need to be tailored to its specific problems and needs, it will basically involve one or more of the three elements defined above. The basic action package for a coherent restructuring program should include the following components: (i) appropriate policies (e.g., industrial incentives, labor laws) to guide and support the following elements of the restructuring action program; (ii) technical assistance and training services; and (iii) financing for the corresponding investment requirements. In the formulation of these policies, emphasis should be given to allow market signals, rather than direct Government intervention, to set the direction and pace of restructuring In a recent draft law for industrial development (which is being reviewed within the Bank at the request of the Government), the above restructuring objectives are given high priority for traditional industries such as textile and mechanical industries. With Bank assistance the Government is already implementing specific restructuring programs for a number of specific public enterprises (e.g., in fertilizers, hydromechanical equipment, steel casting and valves). 5 / The Government has also commissioned a number of subsectoral studies for key industries such as textile, engineering and pulp/paper.6/ The textile subsector study is already available, and together with the Bank's 1983 report on Industrial Restructuring, has served as a basis for technical and policy discussions between the Government and Bank during the past three years. These continuing discussions have led to the Government's new draft plan for textile restructuring (reviewed in Chapter IV), and form the basis for the proposed project (Chapter V). Discussions about other subsectoral adjustment programs are expected to take place between the Government and Bank within the coming two years, as the remaining subsector studies are completed, and in the course of the Government's efforts to develop programs/measures to increase the dynamism of the Portuguese industrial sector. 5/ The Bank is currently also assisting the Government in reviewing the problems of public sector enterprises to formulate a more comprehensive restructuring action program. 6/ These last two studies are funded under ongoing Bank-financed projects.

15 - 8 - III. THE TEXTILE INDUSTRY A. Introduction 3.01 The textile industry in Portugal is wholly owned by the private sector. It was largely a creation of the import substitution policies implemented in the 1930s and its growth since 1946 can be ascribed to export opportunities created by the disruption of European economies following the second World War as well as significantly lower labor costs in Portugal as compared with Western Europe. The industry reached its peak output in Following a severe drop due to the 1974 Revolution, it has been gradually increasing its production; in 1982, output reached only 76% of the 1973 level The industry makes an important contribution to manufacturing output and in 1980 it accounted for 9.6% of the GDP, 17.5% of the employment in manufacturing and 26.6% of the total exports. Out of the total 175,000 people employed in the textile industry, 105,000 are engaged in primary textiles and 70,000 in downstream activities like garment and making-up activities The industry produces a comprehensive range of products, and includes all stages of manufacturing from spinning to ready-made garments and household goods. Portugal imports all its cotton and about half of its man-made fibers; imported fibers account for about 86% of total fiber consumption in the primary textile mills. The relative proportion between the natural and man-made fibers (46% in 1980) has remained practically constant since the 1970s. Most of the textile mills use conventional technology, i.e., ring spinning and shuttle looms. In 1980, out of 1.6 million spindles installed, only 0.6% were of the high-speed open-end type and out of 28,000 looms, only 6.4% were modern shuttleless weaving machines. B. Structure 3.04 Most Portuguese firms are too small to benefit from economies of scale. In the primary sector, 81.5% of the companies employ less than 200 workers and only 4% of the companies employ more than 500 people. Inadequate scale is less of a factor in knitting and making-up industries, but even here there are many companies which do not achieve a viable scale of operations as 83.2% of the enterprises employ less than 100 workers The industry is well developed at all stages of production, i.e., spinning, weaving, finishing, knitting and making-up industries. This, combined with a higher level of protection on finished goods (para 4.02) explains the high share of consumption met by domestic production. The material balance of the textile industry production is shown in Annex 3-1. In marked contrast to such successful textile exporter as Hongkong, which imports yarn and most of the fabrics and concentrates on more labor-intensive and profitable downstream operations, the Portuguese production structure indicates an excess of yarn and fabrics as compared with the downstream operations. The structure of the industry is shown in the following table.

16 - 9 - Portugal - Structure of the Textile Industry Active % of % of Operations Companies Workers Production a/ Primary Textiles: Cotton & Blends Wool & Blends Knitting b/ Garments & Making-up Other Products c/ Paper, Cordage, etc Man-made Fiber Manufacturing Total 1, a/ By value. h/ Including making-up of knitted articles. c/ Trimmings, laces, canvas, etc. Source: Study of the Textile Industry in Portugal, by Werner International, 1980 (hereafter referred to as the Werner Report) Most of the companies are relatively small and family owned, the degree of vertical integration within any given company is not significant. It is estimated that not more than 25% of the mills in the primary sector are fully integrated, i.e., simultaneously opetate spinning, weaving and finishing facilities. In cotton and man-made fibers, 540 weaving mills are serviced by 110 spinning companies indicating a large number of independent weavers. This structure allows a fair degree of specialization but as the units are small, the problem of economies of scale still exists. C. Machine and Labor Productivity 3.07 Further problems arise from the large proportion of aging equipment. The figures in the following table indicate that over 40% of the industry's spindles and looms were installed before Portugal - Age of Installed Plant (1979) (X.) Spindles Looms Pre After Total %

17 Both machine and labor productivity in the Portuguese mills are well below European and North American standards. The relatively small size of the enterprises, obsolescence of the equipment, and less than optimal method of operation contribute to low machine productivity. For example, the average efficiency in cotton spinning in Portugal is 81.5% compared with the international standard of 93%. The efficiency level in weaving is about 76% vs. 91%, respectively. The labor productivity is also affected by the high degree of absenteeism and overstaffing in the enterprises, as shown in the following table: Portugal - Labor Productivity Expressed as % of International Levels Spinning Weaving Finishing Making-up The productivity problems are exacerbated in many cases by poor management practices, high waste, low product quality and poor maintenance resulting in excessive downtime required for mechanical repairs. These factors contribute to high cost and low profitability for the majority of the textile enterprises. D. Financial Performance 3.09 The financial structure of the textile companies is very weak. Traditionally, the enterprises in Portugal have been highly leveraged with borrowed funds. Also after 1974, the unit labor costs increased drastically while labor discipline collapsed and production volume decreased 7/ resulting in lower profits and deterioration of the financial position. According to the Werner Report, almost half of the companies in the sector had equity below 20% of total assets. About 27% of the Portuguese textile companies reviewed in the study were making losses and only one third showed reasonable profits, while the others were marginally profitable. This is the position of the industry taken as a whole and it should be qualified as there are a limited number of larger, modern, integrated and well-managed companies which have been operating efficiently and profitably, and successfully exporting a large proportion of their output. Nevertheless, discussions with the banks and enterprises indicate that the deteriorating financial performance of textile enterprises has brought into much sharper focus the urgent need for efficient restructuring of the industries. E. The Textile Market 3.10 The recent development of the textile market in Portugal is shown in Annex 3-2. As noted earlier, textile production in Portugal reached its peak in 1973 when production was 294 thousand metric tons (TMT) with exports amounting to 60% of the production. Domestic consumption per capita was 17 kg. Imported textile articles (apart from raw materials) 7/ In 1975 production dropped by 46.3% as compared with 1973.

18 accounted in 1982 for only about 40% of the domestic consumption, as compared with 60-70% for EEC countries. After 1974, production dropped precipitously and in 1978, yarn production of all types amounted to 209 THT, fabric production to 187 TMT and the volume of garments and making-up goods produced was 74 TMT. Domestic consumption per capita was 8 kg in 1978, aad reached 8.7 kg in Since 1976, the first year the industry started recovering after the Revolution, the production of textiles increased at an annual rate of 4.5% until After 1980, however, production decreased sharply, and in 1982, the industry was operating at 80% capacity utilization and still 24Z below the 1973 level. In the same period the consumption per capita decreased by about 30% (Annex 3-2), despite a small increase in GDP per capita. Traditionally, the industry has been export oriented and exports have been increasing steadily from TMT in 1976 to TMT in 1982, or at the rate of 6.4% per annum. In 1982, exports amounted to 77.3% of production, the first year that the volume of exports exceeded the 1973 level. At the same time, the value of exports has grown from Esc billion (US$477 million) to Esc billion (US$1,234 million). In 1973, yarns and woven fabrics accounted for 45% of the volume, while garments and other make-up articles accounted for only 25%. In 1982, the respective figures were 27% and 42% (Annex 3-3), indicating a trend towards exportation of higher value added articles (value added per kg increased in real terms by 144% between 1973 and 1982). As far as the destination of exports is concerned, there has been a steady increase in the proportion of exports to EEC and EFTA countries which in 1982 amounted to 88.8% of the total, as compared to 66.4% in 1973, while exports to other countries declined (e.g., share of exports to the US and Canada decreased from about 18% in 1973 to about 6% in 1982) The growth of textile exports to Western European countries, particularly to the EEC, can be explained in several ways. The geographical location of Portugal allows for faster deliveries and lower cost of freight as compared with South American and Far Eastern sources of supply. On average, the cost of labor in Portugal is about 70% lower than in EEC countries; even allowing for 4C% lower productivity, the unit labor costs in the Portuguese textile sector are about half of those in the EEC. Furthermore, the growth of Portuguese exports to EEC can be traced to the provisions of the Multi-Fiber Agreement (MFA) regarding international trade in textiles. The MFA regulations apply to imports of nearly 130 categories of textile products from 40 countries. Several types of products (mostly cotton yarn, fabrics and garments) in the so-called sensitive categories V are subject to strict quotas negotiated with the individual exporting countries. In the last five years, the EEC quotas for imports of Portuguese textile products in the sensitive categories have been increasing at the rate of 4-5X p.a. On the whole, MFA appears to have had a beneficial effect on Portuguese textile exports as it allows them, within 8/ Sensitive import categories are defined as those which, due to the relatively low level of investment needed, the easily transportable nature of textile products, the relatively unskilled nature of the work and unsophisticated level of technology, are likely to cause disruptions of the domestic (EEC) markets.

19 the agreed quotas, to compete with higher priced EEC domestic products, while at the same time they do not have to compete directly with low priced imports from South American and Far Eastern countries. While textiles account for about 26% of Portugal's total exports, the role of Portugal as a supplier of textiles to the world markets is rather small. In 1982, Portuguese textile exports (except fibers) accounted for about 4.6% of EEC imports from outside EEC sources, and less than 0.5% of US imports. Most of the EEC quotas assigned to Portugal (except for knitwear and household goods) were only partially filled (Annex 3-4) The date of Portugal's accession to the EEC was originally planned for 1983, but in view of many unresolved problems, 1986 is considered more realistic. Regarding textiles, an agreement was reached in September 1982 that after 1983 and prior to the accession, the overall growth of Portuguese exports of textiles to the EEC will be limited to an average 8-15% p.a. (depending on the product). The same level of growth would continue during the first three years following accession-after that, export limitations would be eliminated. Imports of finished textile products into Portugal currently are subject to tariffs (para 4.02) as well as licensing through import permits administered by the Textile Institute on behalf of the Ministry of Commerce. This limited the growth of imports (other than raw materials) in the last decade to about 3.5% p.a.; however, this situation will change under the rules of accession. Portugal will have to share the EEC import program governed by MFAL. This share for Portugal is estimated at about 1.5% of the EEC's external imports, or 25 TMT as compared with about 11 TMT of finished textile products (other than fibers) which are currently imported by Portugal from non-eec sources. This estimated loss of the domestic share would be certainly a strong inducement for textile enterprises to restructure to improve their coupetitiveness. No substantial increase of textile imports is expected from Spain, even though Spain may be joining the EEC at the same time as Portugal as the labor costs in Spain are considerably higher than in Portugal and current Spanish exports to EEC countries are negligible Projections for the textile market are shown in Annex 3-5. As GDP is projected to increase by 2% in 1985 and 3% p.a. thereafter, the prospects are for about a 30% increase in production of textiles by As by that time Portugal would be a full member of EEC, it is projected that imports would eventually reach the level of domestic consumption prevailing in EEC member countries (73%), while consumption would follow the growth of GNP, subject to the observed elasticity of demand for textiles. On this basis the volume of textile exports in 1993 would amount to TMT, growing at about 4% p.a. between 1982 and 1993, about the same rate as actually observed for The actual growth could be higher but would depend on the timing of the accession as well as the success of the restructuring program, especially in controlling costs by increasing productivity to compensate for the inevitable increase in the cost of labor after accession. In view of the relatively lower unit cost of labor in Portugal (para 3.12) and the smaller share of labor in the production cost structure (12% of the cost of spinning, 25% for weaving and about 40% for making-up industries, 9/) Portugal is culrently enjoying a 9/ International Production Cost Comparison (ITMF) (1983).

20 considerable comparative advantage. Thus, in terms of Portugal's penetration into the EEC markets (assuming 3% p.a. growth of EEC textile imports 10/ by 1993) the Portuguese textile goods are projected to increase to about 2.5% of the EEC's total textile imports as compared with 1.6% of the imports in F. Problems and Issues in Restructuring 3.15 Restructuring of the industry through rationalization and modernization of the upstream facilities and expansion of the garment and making-up sector should bernefit the industry by: (i) lowering the production costs and improving the competitive position vs. foreign manufacturers; (ii) maximizing the comparative advantage; (iii) increasing the value added of output and return on in-estment; and (iv) minimizing the number of employees facing redundancy through redeployment of manpower from upstream to downstream activities. Moves towards restructuring the industry along the lines described above are likely, however, to face several constraints. One of the main problems is the inverted pyramid structure of the sector wherein the upstream facilities (spinninrg) produce more than can be absorbed by weaving which, in turn, has an output in excess of the capacity of the downstream garment and making-up industries. Spinning and weaving are considerably more capital-intensive than garment and make-up manufacture (the cost per new job ranges from $8,000 for making-up to $150,000 for integrated primary textile operations). Therefore the present structure of the industry is not compatible with Portugal's comparative advantage of low-cost labor. The major objective of restructuring should be therefore to balance the production structure which would reduce capital costs of investment required, change the composition, and increase the value added of exports. A first step would be to freeze the total yarn spinning capacity and limit the growth of the weaving capacity 11/ which may involve closing down of some obsolete and financially non-viable enterprises. Such a move would take some time to carry out due to the typically lengthy negotiations between mill owners and labor unions. Another problem is that in the capital-intensive upstream operations, most Portuguese companies are too small to achieve economies of scale and even in the knitting and making-up sectors, where size is less of a problem, there are many enterprises below economically viable minimum production volume (para 3.04). Because these small enterprises are privately owned, and managed by family members, structural changes like mergers, take-overs or joint ownership of upstream or downstream operations would take time to materialize The problem of overmanning of the textile factories in terms of operating and non-operating personnel (estimated to amount to 40% in excess of international standards or as many as 50,000 jobs) presents yet another constraint for successful restructuring. The labor legislation has made shedding of excess labor extremely difficult both in terms of the legal procedure as well as the cost of severance pay which in many instances may exceed the net worth and force bankruptcy of the company. Apart from the long awaited action by the Government to amend the labor legislation 10/ As implied by MFA. 11/ Essentially limiting investment to replacement and rehabilitation.

21 (para 4.04), the proposed restructuring of the industry in the direction of expanding the more labor-intensive knitting, garment and making-up manufacturing is expected to help redeployment of jobs and alleviate at least part of this problem. Rough calculations indicate that, if the excess of workers in the primary textile industry is reduced by about 25,000 and productivity in the downstream industries increased from 70% to 80% (reducing employment by 9,000), the opportunities created by projected growth of exports of knitwear, garments and making-up articles could absorb most of the labor to be shifted in the sector. G. Investment Requirements 3.17 In addition to the overmanning and low labor productivity discussed above, the other structural problem is the high average age and obsolescence of the equipment resulting in low machine productivity. The market forecast (Annex 3-5) indicates 1993 production of 289 TMT, an increase in exports by 80 TMT, and in imports by about 50 TMT (to include yarn and grey cloth/fabrics when these products may be available more cheaply from the high-volume low-cost producers in other countries after Portugal's accession to EEC) (para 3.14). Based on the applications submitted for SIII incentives, investments in the textile industry during actually averaged about US$100 million p.a. consistent with import data for textile machinery into Portugal which has averaged about US$90 million p.a. over the period. Consequently, the investment projected to take place over the commitment period of the proposed loan ( ) would be of the order of US$75-80 million p.a., while the total investment requirements for restructuring the industry may be of the order of US$1.3 billion over the next decade. This investment rate may not be fully realized, however, as availability of investment capital for restructuring may be limited in this period of expected relatively slow domestic and EEC growth and restrictive domestic monetary and fiscal policies (paras ). This would have consequences for funds internally generated by the textile companies, availability of credit from the commercial banks (because they are subject to credit ceiling restrictions) as well as the availability of foreign currency (in view of the Government's policy to control the expansion of foreign debt). H. Priorities for Investment 3.18 As it appears that funds available for investment may fall short of the total financial requirements of the textile subsector, it is necessary to establish certain priorities in terms of access to credit for the various subsectors within the industry. Consequently, the first priority should be given to projects in knitting, garment manufacturing and making up industries in view of the low investment costs per job created, higher value added and comparative advantage of the outputs in the export markets. Next in priority would be investments for dyeing, printing and finishing facilities because of the paramount importance of that stage of manufacturing for the quality of the export items, both fabrics as well as garments and making-up articles; availability of extra capacity would also allow the industry to convert low-cost imported grey cloth, a practice currently successfully used in the EEC countries.

22 As far as weaving is concerned, returns on investments in rehabilitation are usually higher than those from new projects. Consequently, selective rehabilitation should be given priority over expansion and new installations (particularly in view of the present state of technology allowing only a limited increase of width for the existing looms) as well as boosting production capacity through conversion from shuttle to shuttleless operation. A detailed recent Bank study 12/ indicates that replacement vs. rehabilitation decisions need to be made on a mill-by-mill basis but generally rehabilitation appears worthwhile only for post-1960 installations. In case of older equipment, shortage of spare parts for looms originally supplied by manufacturers which may no longer be in business, as well as limitations in the width and speed increase which can be achieved, make the rehabilitation option economically nonviable. In the case of spinning, the new high performance spindles operate at speeds about 40% higher than anything that can be achieved through rehabilitation of the old equipment and also the labor requirements in new installations can be reduced by 30-50%. Consequently, while the capital cost of new spinning equipment may be up to three times higher, when the difference in volume and operating costs is taken into consideration, rehabilitation is likely to be less profitable than replacement with new modern machinery, particularly when the existing spinning machinery is more than 20 years old A ranking of priorities for investment following from the discussion above would thus be: (i) Knitting, garment manufacturing and making-up; (ii) Dyeing, printing and finishing; (iii) Rehabilitation and/or replacement of weaving facilities; (iv) Expansion of weaving facilities; (v) Rehabilitation and/or replacement of spinning facilities. IV. POLICY AND STRATEGY FOR THE TEXTILE INDUSTRY 4.01 Along with the rest of the industrial sector, the textile industry is both assisted and controlled by the system of investment incentives, tariffs/import restrictions, and the labor policies discussed in Chapter II. These policies and future directions for the restructuring of the textile industry are discussed below. A. Policies 4.02 Protection. The tariff adjustments made by the Government over the last few years in anticipation of the upcoming EEC membership have 12/ Philippines - Textile Sector Restructuring Project, Report No PH.

23 considerably lowered tile protection received by the textile industry. In particular, the tariffs applicable to textile imports from EEC countries now range between 3-11%, and those for imports from non-eec countries are between 10X and 70% (these levels not incorporating the temporary surcharge of 30% set up for 1983, and to be reduced soon to 10% for 1984). Further tariff reductions to accommodate free entry from future EEC partners should not immediately create serious problems for the Portuguese textile industries. The competition, however, will be more severe from non-eec countries after Portugal's accession to the EEC, when these tariffs would have to be lowered to a range of 2-16%, and the current import restrictions for textile goods would be replaced by the MFA provisions. After EEC entry, the effective protection for textile activities would become negligible, except for garments (13%). Under the rules of accession agreed during 1982, within seven years following the accession date (currently expected for 1986), Portugal will have to eliminate all tariff and non-tariff barriers towards EEC countries, and adjust its external tariffs and import restrictions towards non-eec countries to the EEC level. The anticipated loss of some market share to result from these last adjustments will certainly exert strong pressures on enterprises for efficient restructuring Investment Incentives. Under the existing SIII scheme discussed in Chapter II, the textile subsector is eligible for the same incentives as available for other subsectors. In a recent draft textile development plan (para 4.05), the Government proposed to supplement the modified SIII with additional incentives to address more specifically the restructuring objectives for the textile industry. Our preliminary review of these proposals 13/ indicates that the additional measures being envisaged for textiles merely extend the existing SIII, and this linkage would add to the existing problems of complex administration and excessive budgetary costs. Also, the proposed subsectoral precision (e.g., 4 broad activities divided into 58 sub-categories) to be introduced into the textile incentive eligibility formula seems excessive and counterproductive when considered against the magnitude and probable effects of the differential benefits thus made available. Against this background, the current thinking within the Government for abolishing the SIII scheme, and in particular the intention to set up separate restructuring incentive measures tailored to specific subsectoral needs, is a desirable policy development, and should have beneficial effects on the restructuring of the textile industry. As textiles is the first subsector for which this new incentive policy will be applied, further analyses are needed to design specific and coherent incentive measures for the subsector. The Government has appointed a working committee (consisting of representatives from the Ministries of Finance and Planning, Industry and Agriculture) to formulate proposals for a new overall incentive policy. Bank staff will be working closely with the committee in this process with regards to both the broader incentives (e.g., for regional development) and the more specifically focussed incentives (e.g., for subsectors), in the context of regular sector, project and economic missions to Portugal. The dialogue with regard to the textile subsector has already begun (para 5.03). 13/ Available in the Project File.

24 Labor Regulations. The labor market conditions appear recently to have become more flexible in the textile subsector than in some other subsectors. One reason is the current high unemployment in the textile industry (4,918 workers were laid off during the first 6 months of 1983, or double the total number for 1982) which has been caused by the serious financial position of many enterprises and has softened the demands of labor unions. In 1981, the Government issued a decree to generalize for all future labor conventions in the textile subsector new provisions whereby workers' rights are modified from those agreed to in the 1975 labor convention. The most recent legislation approved by the Government to set out provisions for suspension of work contracts and temporary work reduction and/or layoffs (para 2.10) should benefit the textile industry and its labor force in the long run, in spite of inevitable losses of jobs in the short term. This economic case seems to have been accepted--albeit with difficulty--by the parties concerned in the textile industry. B. Textile Development Plan 4.05 After several changes of Government and versions of the textile plan since 1980, a new draft Development Plan for the Textile Industry 14/ to cover the period has recently been prepared by the Ministry of Industry and Energy (MIE). At present, its finalization is expected by the end of The draft Plan provides a diagnostic of the present and expected problems of the subsector and offers a broad policy framework as well as two possible alternative approaches for its efficient development over the next several years. The objectives and basic approach for restructuring the subsector as postulated in the draft plan are in line with those described in paras 2.13 and Namely, restructuring initiatives should be left to the private sector and market forces, the size and output structure of the industry need to be reorganized and its efficiency improved. Within the subsector, indicated priorities are in line with comparative advantage considerations and are given first for modernization and expansion of the downstream activities (finishing, knitting and garment making), and then, efficient rehabilitation/ modernization of the upstream activities (spinning and weaving) as discussed in paras Consistent with para 2.14, there are three basic elements as follows: (a) Policy Changes. These include the tariff reductions and import liberalization, restructuring incentives and labor regulation as discussed in paras above. The new textile restructuring incentives are to be set up in connection with the proposed project with eligibility criteria to be consistent with the ones defined for the proposed project (para 5.03). (b) Technical and Structural Improvements. Increased productivity levels for the different types of activities within the subsector (e.g., spinning, weaving, finishing, garment making) and better output structure would be promoted through technical assistance measures to: (i) improve the firm's utilization of production capacities, management practices, product development and quality 14/ Available in the Project File.

25 control, and marketing approaches; (ii) phase out uneconomic plants and/or reorganize them into more efficient production units; and (iii) rehabilitate and/or replace aging equipment. The Government would encourage firms to acquire technical assistance with a two-pronged approach: namely, through offering special incentives to help eligible firms pay for the technical assistance services needed to prepare and implement their restructuring investments as well as to train their staff and through providing incentives to the local consulting firms to strengthen their capabilities to respond to the industry's technical assistance needs. The proposed private initiative approach to technical assistance is consistent with the one adopted for the proposed project (paras ). Training is an element of the proposed project (para 5.11). (c) Financing. The last element elaborated in the Government's Textile Plan is the estimated financing requirements for each restructuring scenario. The resources to meet these investment requirements (para 4.06) would come in part from the proposed Bank loan (paras ) as well as investors' own resources, external credit (e.g., suppliers' credits) and credits from the Portuguese financial system Restructuring Investment Estimates. The draft Plan offers a set of detailed targets which could be achieved by 1987 for each of the main textile activities (spinning, weaving, finishing and garment making) in the areas of production output, exports, consumption, employment, capacity utilization and produc-ivity improvements. They are based on the expectations of, on average, a 5% growth p.a. between in output quantity; a higher 7% p.a. growth in output value to reflect the higher value added of the future product mix; almost no growth for spinning; a reduction of about 13,400 workers from all textile activities; and an increase in labor and equipment productivities for each of the main textile activities to internationally competitive levels (particularly for weaving and garment making).1 5 / The corresponding investment requirements ale estimated as shown in the following table: 15/ Available in the Project File.

26 Portugal - Textile Industry Restructuring Project MIE's Draft Textile Development Plan ( ) Estimated Investment Requirements (Esc. 10Y) Optimum Intermediate Approach a/ Approach b/ Equipment: Replacement/Rehabilitation Additional New Equipment Buildings and Installation Working Capital (Subtotal) (136.8) (90.6) (65.1) (90.6) Technical Assistance Fund for Acquisition of Coupanies Total (in US$ million) (1,119.3) (532.0) a/ The optimum approach is based on the hypothesis that equipment would be rehabilitated/replaced such as to have equipment not more than 15 years old by b/ The intermediate approach is based on the hypothesis of equipment not more than 25 years old by Even though the intermediate approach with the investment envelope of US$532 million equivalent seems to reflect correctly the real medium term investment needs of the subsector, it still appears too optimistic. As indicated in para 3.17, a more reasonable target is considered to be about US$ million during the period. The proposed project would be a pilot program to initiate the intermediate development approach, with follow-up programs to be prepared based on the restructuring progress to be made during the coming years and additional resource requirements. V. THE PROJECT A. Project Origin 5.01 As indicated in Chapter III, the Bank has been involved since 1977 in reviewing the restructuring problems and prospects for the textile subsector in Portugal. Different technical and institutional scenarios for textile restructuring have been extensively discussed with the Government. The Bank's involvement in this process has thus evolved to reflect a broader subsectoral approach, and is proposed to be implemented via a textile restructuring credit line channeled through Portuguese financial

27 institutions.16/ This approach is adopted to allow a timely and concrete opportunity for assisting the Government in the formulation of sound policies for its textile development plan, as well as to support the Government's desire to give all textile enterprises equal possibility of access to the restructuring process. B. Project Objectives and Scope 5.02 The proposed project would assist the Government and enterprises in implementing the objectives of the Textile Development Plan (paras ). The main project objectives are to help the Portuguese textile industries strengthen their competitiveness through improvements in labor and machine productivity, product design and quality, manpower skills and the policy environment. These objectives require actions on the following: (a) provision of specialized textile consulting services to assist eligible enterprises and participating financial institutions (PFIs) in the design/preparation, appraisal and implementatica of viable restructuring projects, and to assist MIE's Textile Review Unit (TRU, para 6.08)) in monitoring the implementation of the textile restructuring process, developing a textile information system, and carrying out the necessary studies for improving subsector performance, e.g., marke studies; (b) financing, through a number of PFIs, of the physical rehabilitation, modernization and expansion of existing enterprises and creation of new production units in the textile activities which meet the guidelines of the Government's Textile Development Plan, as further specified in the eligibility criteria (para 7.01); (c) financing of a training component to include a study to develop a comprehensive training program and the purchase of equipment for the quality control and training facilities being operated by existing textile technical and educational centers in Portugal; and (d) assistance to the Government to further the gains already made in the policy environment, and in particular to assist it in designing a textile incentive structure and finalizing the draft Textile Development Plan (paras 5.03 and 7.11) The Bank's assistance to the Government on the textile policy front (para 5.02 (d)) represents the most important contribution of the proposed project to the restructuring of the Portuguese textile subsector. One such contribution is already in the project's institutional design which emphasizes reliance on private initiatives, in particular the need to keep separate the policy and financial functions. Another is the establishment of specific and consistent restructuring criteria (para 7.01) to guide the financial institutions and the textile enterprises. In effect, in the face of growing problems in their textile portfolios, the banks have already tried financial rescheduling, but with marginal success because these actions most of the time do not address the roots of the -problems. About'two-thirds of the textile enterprises at present are faced with an increasingly precarious financial position (para 3.09), and do not have a clear concept of the future potential of the industry nor the 16/ Preparation of the proposed project has yielded several restructuring investment projects which subsequently had to be financed with other resources, such as the Bank's second credit line to BFN (FY81). Profiles of these projects are in the Project File.

28 specialized technical expertise to guide them in the restructuring process. The above profitability problems, to be aggravated with the anticipated loss of some market share after the EEC accession (paras 3.13 and 4.02), are already putting heavy pressures on both the textile enterprises and their bankers for efficient restructuring. Finally, there is the formulation of textile restructuring incentives which the Government intends to set up within the (draft) Textile Development Plan (para 4.03). These incentive measures, if well formulated, would be helpful to encourage further the enterprises toward improving efficiency and competitive-zss. The Government has agreed to the principle of a new textile incentive scheme which is characterized by fiscal-based benefits, concentratec in a few simple instruments, with simple administration procedures and smaller budgetary requirements than the existing SIII. In adeition, the Government has agreed that the new textile restructuring incentives will be governed by eligibility criteria which are consistent with the criteria developed for the proposed project (para 7.01). The Bank will be working closely with the Portuguese authorities in the formulation of these textile incentive measures, providing the services of expert consultants as needed. As discussed above, because there are already strong natural pressures on both the enterprises and the banks for restructuring in the textile subsector, and the proposed project provides the resources, technical assistance, and the technical/financial guidelines (as part of the agreed eligibility criteria) to launch such restructuring at the enterprise level, the immediate availability of the Textile Development Plan and incentives would not be crucial to the proposed pilot project. Rather than waiting for the formal promulgation of the Plan to participate, our active involvement will facilitate the launching of the needed restructuring exercises at the enterprise level which are justified on the basis of the enterprises' economic and financial conditions. It has been agreej that satisfactory textile incentive proposals would be formulated in collaboration with the Bank and incorporated in the final draft legislation to implement the Textile Development Plan for the Government's consideration by December 31,1984. C. Coordination With Other Bank Operations 5.04 Within the Bank's program of support to the industrial sector in Portugal, the proposed loan would be complementary to the US$30 million SKI II loan (Loan No PO) to finance eligible SMI investment projects in all activities of the industrial sector. Since the Government has requested that SMI II continue to finance textile SMIs, special arrangements have been agreed with the implementation agencies of SMI II to ensure a consistent approach towards restructuring of the textile industry (para 7.15). Coordination with the US$100 million Bank loan to BFN (Loan No PO) is ensured via the proposals in para D.- Project Costs 5.05 The total cost of the proposed project is estimated to be US$68.9 million of which the proposed Bank loan is US$34.7 million. A breakdown of project costs by major components is shown in the following table:

29 Portugal - Textile Industry Restructuring Project (US$ million) Foreign a/ Local Total Project Costs 1. Eligible restructuring investments to be financed a) in high-priority activities b/ b) in other activities b/ c/ 33.0c/ Technical assistance a) to eligible enterprises b) to MIE/T%U Training a) training study & training abroad b) training equipment Contingencies Total Project Financing Bank loan Investor self-financing Domestic Banks Total a! This includes direct and indirect costs in foreign exchange. b/ For definition, see para c/ For explanation, see para E. Project Components and Their Financing 5.06 Restructuring Investments Component. The proposed allocation of Bank funds of US$33.0 million for financing of eligible restructuring investments is based on: (i) the expected investment requirements and demand for restructuring the Portuguese textile subsector for the period (paras 3.17 and 4.07); (ii) the PFIs' projected 3-year pipeline of textile investment projects and the expected proportion thereof which would meet the eligibility criteria as elaborated in para 7.01; (iii) the projected pipeline of textile SMI projects to be financed under the on-going SMI II loan over (para 5.04); and (iv) the expected domestic resource availability (para 2.11) and the continued uncertainties in the present investment climate in Portugal and in the EEC Of the estimated total project costs (US$68.9 million), the proposed Bank loan of US$34.7 million equivalent would be lent to the Government at the applicable variable Bank interest rate (currently 10.08%) and for a term of 15 years including 3 years grace. The proposed textile restructuring credit line (US$33.0 million equivalent) would be channeled through the BdP to the PFIs. The onlending rate from the PFIs to the

30 textile enterprises is given in para Although Bank funds may be used to finance up to 65% of the individual investment costs, on average it is expected that the credit line amount actually would cover 50% of the estimated US$66.0 million total restructuring investment costs. The balance would come from the investors' own funds (about 30%, para 7.01), and borrow:ings from the PFIs and/or other external sources (e.g., suppliers' credit). The total investment costs of the projects to be financed in part under the proposed credit line would represent 30% of the investment requirements for as estimated in the Government's textile restructuring plan (para 4.07). The proposed credit line would be a pilot program, to be extended in view of the restructuring progress to be made over the next years and additional resource requirements when these are justified The proceeds of the restructuring zredit line would be used to finance textile investment projects which meet the eligibility criteria elaborated in para 7.01 and involve the rehabilitation and/or modernization of existing fixed assets and/or acquisition of new fixed assets (excluding land, but including permanent working capital and technical assistance services). The proposed credit line is expected to finance about 40 textile investment projects. As defined in para 7.01(a), about 75% of these would be in the higher priority textile activities of finishing and garment making with an expected investment cost per job of less than US$45,000 and US$10,000 respectively. The average size of investment cost is expected to be about US$1.0 million for these higher priority textile activities, and about US$2.5 million for the other activities - spinning and weaving. Based on average costs per job ranging from US$10,000 to US$85,000, the restructuring investment projects to be financed under the proposed credit line are expected to create a total of about 1,700 jobs Technical Assistance Component. This component consists of a special scheme to finance part of the consulting services to be provided to eligible enterprises and the Textile Review Unit (TRU). Of the proposed loan, US$1.0 million would be allocated to the technical assistance component. This amount would not require Government budgetary support for its initial startup and for its repayment to the Bank (para 7.22). This amount would cover on average about 34% of all the services to be provided under the project. Of the US$1.0 million, US$0.8 million is expected to be expended for textile technical assistance (TA) to enterprises and US$0.2 million for technical assistance to the TRU (paras ). The balance of the technical assistance expenditures would come from the beneficiaries (own funds or borrowings, para 5.07) The technical assistance services would be provided by consulting firms as described in paras These services consist of advising on investment project preparation and designing of action programs to improve operating practices, management and accounting procedures, design new products, adopt new marketing approaches for the enterprises; assessment of the technical design of investment projects, their choice of technology, provision of market, EEC productivity, price and cost information for the enterprises, PFIs and TRU. Based on the total technical assistance cost estimated in para 5.05, it is expected that not less than 285 consultant-months would be available during for

31 technical assistance at the enterprise level, or on average 7 man-months per subproject. The consulting services for the TRU would consist of a total 24 man-months to be spread over the same period Training Component. This conponent would consist of: (a) a study to develop a comprehensive training program for the textile industry; (b) equipment for training/quality control for facilities of the Textile Institute (TI) in Oporto and Covilha, and training/testing equipment for the University of Minho in Guimaraes; and (c) some advanced training abroad for staff of related Government agencies (MIE, Institute for Assistance to Small and Medium Enterprises (IAFMEI), TI). The cost of this component is estimated to be US$0.6 million. The Bank loan would cover 100% of the estimated cost of this component, and would be disbursed to the Government who would channel it to the MIE/TI for implementing the training component through its normal investment budget allocation process (paras ). The estimated cost of the proposed component is broken down as follows: Portugal - Estimated Cost of Training Component US$ (a) The Study based on 20 man-weeks of consulting time plus travel and contingencies 50,000 (b) Equipment for University of Minho 250,000 Equipment for the Textile Institute 150,000 (c) Advanced textile training Three persons - two year courses leading to Master Degree 60,000 Ten persons - six months textile technology courses 50,000 Contingencies 40,000 Grand Total 600,000 VI. PROJECT IMPLEMENTING AGENCIES A. Background 6.01 The proposed project would strengthen the Government's efforts to foster private initiatives by relying on a broad-based institutional set-up for the implementation of the textile restructuring program. In addition to the beneficiaries which would be responsible for implementing the restructuring subprojects, the project relies substantially on the PFIs, with the MIE and its specialized agencies also to be involved in some aspects of the project implementation and in the monitoring thereof. B. The PFIs 6.02 There are at present 17 financial institutions involved in industrial financing in Portugal: the Bank of Portugal (Central Bank); nine nationalized commercial banks; Caixa Geral de Depositos (CGD) which is the major public savings institution; Banco de Fomento Nacional (BFN) which

32 is the Portuguese industrial development bank; and two investment conpanies, the public sector Sociedade Financiera Portuguesa (SFP) and the first privately owned, recently established Sociedade Portuguesa de Investimentos (SPI); and three new leasing companies established in the last two years. At tne time of appraisal, five financial institutions agreed to participate in the proposed project, based on the objectives and conditions established for the proposed credit line (Chapter VII). The first four are the largest in the banking system in terms of net assets (Annex 6-1), namely CGD, Banco Portugues Atlantico (BPA), Banco Pinto Sotto Mayor (BPSM) and Banco Espirito Santo E Commercial de Lisboa (BESCL). Together, they account for over 50% of the total outstanding credit portfolio as of the end of The fifth PFI is the smaller, IFC-assisted SPI which can offer equity financing in addition to conventional medium and long-term investment credit to industries. Since the appraisal mission, two other banks namely, Banco National Ultramarino (BNU) and Banco Borges Irmao (BBI) have also expressed interest in participating in the proposed project. These two institutions (and eventually, others in the banking system) would be added to the list of PFIs when a satisfactory Bank assessment is made of their textile appraisal capabilities Textile Financing. Loans from the banking system have been the major source of finance for all industries in Portugal. As shown in the following table and detailed in Annex 6-2, as of the end of 1982, the total credit portfolio of the banking system was about Esc. 1,661.7 billion (US$21.0 billion equivalent at end of 1982 exchange rate), about evenly divided between short-term credit (49.7%) and medium- and long-term credit (18.3% and 32.0%, respectively). Portugal - Banking System Loan Portfolio - December 31, 1982 (billion Esc.) Industrial Total Credit Credit Textile Credit Value % Value % Value %_ Up to one year One to five years Over five years Total 1, (% Share) (100.0) (36.1) (6.8) Of the total credit outstanding, industrial credit accounted for more than one third (36.1% in 1982, decreasing from 40% in 1978), while the textile industry has continued to maintain about a 6.8% share of total credit outstanding. At the same time, the commercial banks held about three fifths of the total banking system credit portfolio (60.2%) while the savings and investment banks' share was about two fifths (39.8%). As seen in the following table, at the end of 1982, the credit portfolio of the commercial banks, at about Esc. 1,000.9 billion (or equivalent to US$12.7 billion at end of 1982 exchange rate), was heavily concentrated on the short-term (74.4% of the total) although the share of term credit has

33 been gradually increasing. This reflects in part the fact that the commercial banks were allowed to lend medium- and long-term only since As shown in Annex 6-2, while the share of industzial credit in the total credit portfolio has been decreasing over the last five years (from 50.2Z at the end of 1978 to 43.6% at the end of 1982), the textile industry share has remained at about 10% over the last five years. The concentration of industrial and textile portfolio of the commercial banks on short-term credit was even heavier than in total credit, accounting about 80%, although the situation has improved over the last five years (from about 91% at the end of 1978). Portugal - Commercial Banks Loan Portfolio - December 31, 1982 (billion Esc.) Industrial Total Credit Credit Textile Credit Value % Value X Value _ Up to one year One to five years Over five years Total 1, (Z Share) (100.0) (43.6) (10.0) 6.04 Together, the five PFIs accounted for 50% of the total outstanding credit portfolio extended to the textile industry as of the end of As detailed in the Project File and summarized in the following table, the PFIs' textile share has been relatively constant at this level since Their textile portfolio is characterized by a high concentration in short maturity credit. Most of these short-term credits tend to be rolled over a longer duration as needed by the enterprises. Of the five PFIs, CGD has been the most active in term lending to industries and to textiles with over 90% of its textile lending in long-term credits during Although growing considerably from the 1% share in 1978, CGD's role in textile financing is still very small (only 6% of the total portfolio of the banking system in 1982). BPSM continues to be the most important financier of the textile subsector, maintaining over a 17% share of the total textile portfolio of the banking system. A large share of BPSM's loans for textiles (just as for industries in general) has however very short maturity (84% in 1982, although already declining from a share of over 98% in 1978). BPA and BESCL have been moving steadily into industrial and textile financing since The PFIs' role in textile financing is shown in the following table.

34 PORTUGAL - PFIs and Textile Financing as of December 31, 1982 (billion Esc.) TOTAL CREDIT INDUSTRIAL CREDIT TEXTILE CREDIT ST HT + LT TotaL ST MT + LT Total ST Kr + LT Total vllue S Value _ Value Z Value Z Value Z Value _value a Z v liuu a e BESCL a SPSF BPA CCD Spi PFIS All banks a/ , a/ This includes all comercial banks and savittgs institutions (e.g., CGD) Institutional Set-Up and Capabilities of PFIs. All private Portuguese owned financial institutions, with the exception of the small saving banks, were nationalized in CGD has always been public. The nationalized credit institutions are legal entities with administrative and financial autonomy, organized in the form of public sector enterprises. Each is managed by a Board of Directors, consisting of a Chairman, a Vice Chairman and five Board Members. While the board is jointly responsible for the overall management of the institution, board members also have specific individual responsibilities for staff and line functions. Board members are appointed by the Council of Ministers from among public administrators, with experience in the financial sector either in banking or public sector finance. As nationalized entities, the total equity of the banks is held by the Treasury. More details on the organization and operations of each of the PFIs are found in the Project File Based on the Bank's experience under the SKI projects as well as our recent review of their textile appraisal reports, the overall standard of the PFIs' project appraisal is generally satisfactory. Their appraisal reports are usually of good quality (with the level of details and depth increasing with the size of projects), although there are variations from report to report depending on the staff and regional office involved. The financial standards maintained by the PFIs for their lending are reasonably stringent, and their appraisal reports/loan agreements contain specific relevant covenants for the financial rehabilitation of existing enterprises when appropriate. A most critical common weakness in the appraisal is however the market evaluation. This is now being addressed in part with

35 the macro and sectoral supply/demand information which is becoming available from the subsectoral surveys/analyses undertaken by MIE and specialized trade associations. Improvements in this area would also come from more consistent verification of the market information presented in the appraisal reports with relevant marketing sources (e.g., International Trade Center (ITC), specialized consulting firms). For the textile investment projects, the PFIs are being encouraged (via incentives provided within the proposed project) to seek more specialized advice to improve their analyses of market competitiveness and prospects. Another area for improvement is the technical appraisal. At present, the five PFIs have 13 competent mechanical and chemical engineers with some experience in the textile industry. In addition, 2 PFIs are regularly using qualified consultants for appraisal of textile subprojects. The PFIs have taken steps to improve the textile knowledge of their engineering staff through attendance at special courses and seminars organized by the Universities of Minho and Beira. Some PFIs have also recruited additional technicians with textile experience. The PFIs have agreed in the context of the proposed project to increase utilization of external textile specialists to complement and provide on-the-job training for their own technical staff. Measures for future technical improvements have been discussed and agreed with the PFIs during appraisal, and will be followed up during project supervision (e.g., training and hiring of staff as needed, closer collaboration with trade associations and technical departments of universities) Quality of PFIs' Portfolio. As detailed in the Project File, during the last several years, the percentage of the PFIs' non-performing loans (i.e., overdue, arrears and bad debt) tended to decline from a range of 12-18% in 1978 to about 8-10% in 1982, except for CGD for whom the percentage has remained at about 3% over the same time period. The loan performance data for the industrial sector and the textile subsector available only for CGD (Annex 6-3) show that about 71% of bad debts on the CGD portfolio correspond to loans extended to industry. Bad debts among loans to the textile subsector represent 9% of CGD's total bad debts at the end of 1982, which is a high percentage if one considers the low (1.6%) share of total CGD portfolio represented by textiles. Textile bad debts as a share of the CGD's textile loan portfolio were 3.7% in 1982 which is such higher than the CGD average. It is nevertheless an improvement over the 4.5% share of bad debt in textile loans at the end of 1979, although it has increased slightly from the end of 1981 (3.4%). The performance of loans extended to textile enterprises should improve as the restructuring program for the textile subsector would in time yield a significant improvement in the financial condition of the enterprises. C. The MIE/Textile Review Unit 6.08 To maintain a global view of and coordinate the future development of the textile industry, the MIE will maintain a Textile Review Unit (TRU) to be located within the MIE. The main activities of the TRU will be to: (i) monitor the impact of the overall restructuring program; (ii) carry out studies for improving subsector performance such as in the areas of marketing, energy conservation, environmental control, etc.; and on this basis, (iii) develop a textile information system for use by the

36 banks and the enterprises. In particular, the TRU will also collaborate with the PFIs to review the overall nature and direction of the restructuring investments being financed by the PFIs (as detailed in paras ). In all the activities above, the TRU will coordinate with existing institutions with relevant expertise. The TRU will have a basic core of two full-time textile specialists who are the MIE staff currently working on the draft Textile Development Plan. To strengthen its present technical abilities, the TRU would be assisted by textile consultants to be financed under the project (para 5.10). The TRU will report to an interministerial Textile Committee (TC) which would meet twice a year to instruct the TRU in its activities, review its findings and recommendations, and make policy adjustment as needed. The TC would consist of representatives of the MIE, the Textile Institute, the Industrial Planning Department of the MIE, the Ministry of Finance and Planning/Treasury, and the Ministry of Labor. The documentation to formalize the TRU (including designation of its core staff and responsibilities according to the principles above) has been reviewed during negotiations and found satisfactory. D. The Bank of Portugal 6.09 The Bank of Portugal (BdP) has the usual powers of a central bank, including the setting of mandatory reserve requirements, maximum interest rates and credit ceilings (paras 2.11 and 2.12). It finances credit institutions through its rediscount facilities. Under the Bank's SMI I and II projects, 17 / BdP acted on behalf of the Government as the apex organization in channeling the funds to the PFIs. This arrangement proved very satisfactory and is used under the proposed loan (para 7.06). E. The MIE/Textile Institute 6.10 The Textile Institute (TI) is an autonomous public agency supervised by the MIE. It has been effective in monitoring textile inport/exports, negotiating and administering textile trade agreements, establishing product quality standards and carrying out necessary laboratory testing. The TI on delegation from the MIE and in collaboration with other relevant training institutions (e.g. University of Minho), would administer the training elements included in the proposed project (para 7.22). More detailed discussion of TI and the training facility is found in Annex 6-4. VII. PROJECT MANAGEMENT A. Textile Restructuring Credit Line 7.01 Design Features. The proceeds of the proposed credit line would be channeled through the BdP to the PFIs for financing textile investment 17/ All nine commercial banks, CGD, BFN, and SPI participate in these projects.

37 projects. These investment projects will need to meet the following restructuring eligibility criteria: (a) At least 50% of the credit line amount would finance investment projects belonging to the following higher priority textile activities: manufacturing of woven and knitted garments, making up of household articles, and textile processing activities such as dyeing, printing and finishing. These higher priority investment subprojects should have an investment cost per job created/maintained not to exceed US$10,000 for garment making, and US$45,000 for textile processing and knitting activities. (b) The balance of the credit line would finance investment projects in spinning and weaving subject to the following conditions: (i) for spinning, no new additional capacity would be financed; no equipment older than 20 years would be rehabilitated and replacement of existing facilities would be financed only if the resulting productivity improvements for labor and equipment would allow productivity levels 18/ higher than those prevailing in EEC (para 7.04); (ii) for weaving, no equipment older than 20 years would be rehabilitated, and all new or modernized looms should have a minimum width of 190 cm and be able to operate above 200 picks per minute; and (iii) for both spinning and weaving, the investment cost per job would not exceed the current costs of jobs in the EEC for similar activities (para 7.04). (c) All investment projects should be financially and economically viable with a financial rate of return to be at least 12% for all subprojects, and an economic rate of return to be at least 12% for project with investment cost above US$1.0 million. The ex-factory price should be at most equal to the border price EEC for the main products of investment projects. In case of investment projects involving forward integration for an existing enterprise, the transfer price for the main products to be used in the downstream operations equal to the border price EEC woild be used in calculating the economic rate of return (para 7.,4). (d) All investment projects to set up new production units/ enterprises should show labor and machine productivity levels 19/ commensurate to the levels in the EEC for similar products (para 7.04), and in the case of existing enterprises, investment projects should show the productivity improvements and cost savings for the enterprise as a whole. 18/ Such as kg output/operator hour for spinning. 19/ Such as km or weft yarn inserted/operator hour for weaving, and meters of fabrics processed/operator hour for dying, printing and finishing.

38 (e) The investor (particularly in the case of existinj enterprises) should accept to undertake an appropriate technical assistance program as a condition of the subloan when considered necessary by the FFI (para 7.04). This program should contain clearly established objectives, scope of actions, targets for the expected performance improvements and timetable for implementation and monitoring of the action programs. (f) The minimum of investor's own funds 20/ in the investment project should be 30% of total investment costs in the case of a new company; in the case of expansion or rehabilitation, own funds should initially be at least 20% of the total assets (excluding land) of the whole existing enterprise (including the proposed investment project) to increase to 30% within 3 years of investment completion. 2 i/ Investor's own funds is defined as paid-in share capital plus retained earnings plus investor's personal loans. These investor's personal loans would not exceed 30% of the total own funds and would be subordinated to all other enterprise debts, and could be serviced only: ti) after principal, interest, and other charges on enterprise debts have been fully serviced, including arrears, and (ii) after such payment, investor's own funds are not less than 30% of total assets. These investor's personal loans could not be prepaid or accelerated so long as any amount due on all other debt remains outstanding The eligibility criteria (a) and (b) are designed to address the need to reorient the present production capacity structure towards textile activities where Portugal has a comparative advantage and export potential (para 3.19), while still catering to the upgrading need of the other textile activities (paras ). Criteria (c) through are to help improve the productivity and competitiveness of the enterprises. Criterion (f) aims to correct the financial structure of the enterprises (see also para 7.04 below) Implementation. In brief, the proposed credit line would be implemented by the PFIs, MIE/TRU and BdP. The primary responsibility rests with the PFIs who would identify, appraise, approve eligible subprojects for financing (subject to the Bank's prior review for certain categories as indicated in para 7.05 below), identify their technical assistance need as appropriate, and supervise their implementation. The TRU would review the FFIs' subproject reports to obtain a global view of and monitor the subsector restructuring program, as well as keep records of the disbursement of TTA grants (para 7.22). The BdP would centralize the administration of the textile credit line and keep accounts on the approved subloans. 20/ Special reserves resulting from the revaluation of assets according to fiscal laws (which takes place from time to time) would be included. 21/ This is defined to be the date at which commercial production related to the investment project can start.

39 The PFI would be responsible for identifying and appraising textile investment projects in accordance with the criteria spelled cii? in para 7.01 above. The subproject appraisal report will cover all technical, managerial, marketing and economic aspects, as well as the financial position and performance of the subproject and its sponsors. 2 2 / In this context, the PFI should be guided by the following financial targets: (a) the current ratio for the enterprise (including the investment project) should not be less than 1.2 to be achieved within 3 years of investment completion; and (b) the debt-service ratio for the enterprise (including the investment project) should not be less than 1.2 to be achieved within 3 years of investment completion. The calculation of financial and economic rates of return required for all subprojects will be carried out according to the Bank's guidelines 23/ and will be presented in the subproject appraisal reports. In addition to the above eligibility criteria and performance target guidelines, the investment cost estimate for the textile subprojects should include appropriate physical and price contingencies (on average, expected to be up to about 20% of the value of civil works, equipment and other services) to allow for possible changes in construction, cost increase due to inflation and/or unexpected delays in project implementation. The PFI would also be responsible, with assistance from specialized consultants when needed (para 5.10), for verifying the output prices, productivity levels and cost per job proposed for the subprojects with corresponding EEC levels (para 7.01(b)(i) and (iii), (d), and (e)); for ensuring that the appropriate procurement procedures are followed when relevant (para 7.07); and for assessing the technical assistance need of the subprojects during :heir subproject appraisal and incorporating it in the subproject appraisal report. The PFI would refer the enterprises to select from the approved list of textile consultants (para 7.17) for implementation when need for such services is indicated. Should the PFI feel that these actions are essential for the success of the subproject, an appropriate technical assistance program would be made a condition of the subloan agreement by the PFI. In its monitoring of the subprojects, the PFI would ensure that the agreed action program is properly implemented by the textile borrowers The PFIs alone would decide whether to finance a textile project using the proceeds of the Bank credit line and their own resources as appropriate. The PFIs will bear the credit risk for the totality of credit granted to the enterprises. For existing enterprises, the financial covenants, when imposed by the PFIs in their loan agreement, will cover both the Bank's subloans and the PFIs' portion of the credit granted. In view of the complex nature of the restructuring exercise and in order to allow meaningful Bank involvement in the subproject review for institution building purposes, Bank staff would appraise jointly with PFI staff the first 3 subprojects of each PFI regardless of investment size. If satisfied with the PFI's textile appraisal quality, for each FFI subsequently there would be a free limit set at US$1.25 million for review and approval as follows: 22/ A comprehensive checklist for subproject appraisal, distributed to the PFIs for reference, is available in the Project File. 23/ The -Guidelines for Calculating Financial and Economic Returns of DFC Projects," by C. Hyde, June 25, 1982 (already given to the PFIs) is available in the Project File.

40 (a) eligible subprojects with investment cost less than US$1.25 million (to be called B-subprojects) would be appraised and approved by the PFIs in accordance with the eligibility criteria and standard guidelines provided in paras 7.01, 7.02 and 7.04 above. Promptly after its approval of a B-subproject, the PFI would send: (i) a note (describing briefly the subproject and listing the eligibility criteria which the subproject has satisfied) 24/ to BdP who would convey on behalf of the Bank formal authorization to withdraw from the credit line proceeds for the B-subproject in question; and (ii) a copy of the B-subproject dossier to che TRU for information. Every month, BdP would send a list of these B-subprojects for information to the Bank, which may request to review in detail with the PFI concerned any of the listed B-subprojects during its periodic supervision missions of the credit line; and (b) eligible subprojects with investment cost greater than US$1.25 million (to be called A-subprojects), the PFIs would simultaneously send (i) one copy of the appraisal report (in English or French) of these subprojects to the Bank for its review and approval; and (ii) one copy to the TRU for its review on the basis of no-objection within 15 days. This means that, for the A-subprojects where the TRU may have questions or reservations, these would be communicated within the 15-day period mentioned above to the Bank, with copy to the concerned FFI. After consultation with TRU when relevant, and upon satisfactory review of the PFI's subproject appraisal, the Bank's approval of these A-subprojects would be telexed to the PFI concerned, as well as to TRU and BdP for information. It is stressed that, as agreed during appraisal, the subproject review by the TRU would be sector oriented, covering the scope and directions of the restructuring efforts, rather than involving a detailed project-by-project review and control. The objective is for the TRU to monitor the progress of the restructuring program in general as well as of the proposed project in particular (para 6.08). It is estimated that under the above subproject review procedures, the Bank would closely review and directly approve at least 50% of the total number of subprojects. If durii. 6 the initial subproject co-appraisal and/or subsequent subproject review process, the textile appraisal quality of any PFI is not satisfactory to the Bank, that PFI would take appr-priate remedial actions as agreed between the Bank and that PFI. Until saaisfactory quality is shown, the Ban'- would continue to require all subproject appraisal reports for its review and approval The responsibilities of BdP would be carried out by a small unit (already designated during appraisal for the proposed textile credit line) and will be to: (i) maintain an accounting system for subprojects for which commitment of Bank funds is approved; (ii) request withdrawal of funds from the credit line special account (para 7.08) and channel them to the PFIs; (iii) prepare and send to the Bank a monthly statement of expenditures requesting replenishment of the credit line special account; 24/ Format distributed to the PFIs is available in the Project File.

41 (iv) collect from the participating banks the payments of interest and principal, and transfer these funds to the Treasury for servicing of the Bank loan; (v) hold all documentation related to each subloan for commitment and disbursement amounts as well as update them to take into account possible increases or cancellations when the subprojects are completed; and (vi) prepare the quarterly commitment/disbursement status report for the credit line (para 7.09). The signing of an Agency Agreement between the Government and BdP satisfactory to the Bank would be a condition of effectiveness of the proposed loan Procurement Procedures for Subprojects. When a subproject involves the purchase of a single package of equipment with value equal to or greater than US$1.0 million, the Bank's International Competitive Bidding (ICB) procedures, with prior review by the Bank, will be followed by the PFIs and enterprises. For equipment purchase valued at less than US$1.0 million but more than US$200,000 at least three price quotations will be obtained from qualified suppliers from more than one country. Within this latter category the Bank's prior review would be required for single packages exceeding US$500,000. Procurement of goods costing less than US$200,000 equivalent would follow local competitive procedures of the PFIs Disbursement Procedures for Subprojects. A special account for the credit line would be set up in a financial institution in the form of a revolving account with ap initial deposit of US$3.6 mil'lion, to simplify disbursements under the proposed credit line. In line with the procedures currently used in the Bank's ongoing SKI credit lines, BdP would receive from the PFIs documentation justifying expenses actually incurred for approved subloans, the maximum amount of these subloans being 65% of the corresponding total investment costs. BdP would verify, in collaboration with TRU, when technical advice is needed that the documentation for these expenses is satisfactory. The Bank would replenish the initial deposit of US$3.6 million upon receipt of a certified monthly statement of expenditures to be sent by BdP. No Bank reimbursement would be made for expenditures made more than: (i) 90 days prior to the BdP's formal withdrawal authorization for the subprojects in the cases under the free limit; and (ii) 120 days prior to the Bank's date of receipt of the subproject dossier, if the subprojects are above the free limit. The estimated disbursement schedule for the proposed credit line is discussed in para Audit Procedures. The records and accounts maintained by BdP for the credit line and the approved subprojects (para 7.06) would be audited each fiscal year by the Audit Council of the BdP, which would prepare a report certifying that the amounts received and paid by BdP for the credit line and individual sub-loans together with the documentary evidence used by BdP as basis for withdrawal of Bank funds are satisfactory. This report will be sent to the Bank no later than six months after the end of the fiscal year in question. The Bank has examined the legal provisions establishing the Audit Council as well as the Internal Audit Department, and found that this Council together with the staff support from the Internal Audit Department do meet the normal standards of independence from the entity under audit, suitable qualifications and satisfactory experience.

42 Periodic Review of the Credit Line and Reporting Procedures. The PFIs would supervise the Bank-financed subprojects in terms of risk assessment, eligibility and technical assistance, and BdP in terms of the subloan disbursement. The TRU would collaborate with the PFIs and BdP to prepare for the TC and the Bank a semi-annual restructuring report based on an agreed sample of approved textile subprojects and corresponding data provided by the PFIs and BdP. The format of this semi-annual report would contain an analysis by: (i) the FFIs of the progress in project implementation (e.g., construction, equipment installation, production, financial covenants if any) for each subproject compared to the original implementation schedule as proposed in the appraisal report, the problems encountered by each subproject together with the status of their resolution and the actual capacity utilization, sales, production costs, exports, etc., of the enterprise as compared with tne projections made in the appraisal report, and of the sub-borrower's repayment performance; (ii) the BdP of the status of subloan commitment and disbursement; and (iii) the TRU of the status of the incentives granted, the overall results and progress of the restructuring exercise being implemented, and a review of the TRU's own activities (para 6.08). In addition, every 3 months, BdP would prepare for the Bank a short progress report presenting actual total commitment and dirbursement by the PFIs under the credit line, to include any change in the committed amount for each subloan Terms and Conditions of Bank Financing. The Bank credit line would finance up to 65% of the total investment cost of each eligible textile subproject, this percentage being estimated as corresponding to the maxinum foreign exchange component (direct and indirect) of the types of investment eligible under the project. For all subprojects, the expected average would be 50% of total investment costs. The terms of subloans financed out of the proposed credit line would be in line with the repayment ability of the investment enterprise, as determined by the PFIs. Although the average term of subloan is expected to be about 7 years, including a grace period of 1 to 2 years for principal repayment, subloan terms may be up to 12 years including a grace period of up to 3 years. The textile investors would pay to the EFIs the floating interest rate applicable to similar medium-term credits available in Escudos (currently 32.5% and positive as discussed in para 2.12). The difference between this onlending rate and the Bank's lending rate would be allocated as follows: 3.0% to the PFI, 0.5% to BdP, and the balance to an account to be set up for the proposed project by the Treasury for the Government to cover the foreign exchange and interest rate risks on subloans, as well as the repayment of principal and interest related to the US$1.0 million of the proposed loan allocated to technical assistance (para 7.17). In view of the changing conditions now expected in the financial community (e.g., possibility of a decline in final lending rates and reduction in the inflation rate in 1984), the Government has agreed to carry out by December 31, 1984 an analysis of the basis for allocating the above interest differential, and after review with the Bank of the findings/conclusions of such analysis, take the necessary measures to revise as needed these allocation amounts (in particula,, the margin for PFIs which would need to reflect their costs of intermediation under the proposed credit line, their efficient use of resources, and the general economic conditions such as inflation and investment risks). Finally, until the Government's draft

43 Textile Development Plan is enacted into law (para 5.03), the Government has agreed that the PFIs would follow the principles of the agreed textile eligibility criteria and appraisal standards in all their lending operations for investment in the textile subsector. The PFIs have also agreed to the principle above In January 1982, BdP has agreed to grant a credic ceiling incentive to the PFIs utilizing Bank's credit lines, whereby a PFI's monthly credit ceiling is adjusted by the amount of the credit line it used during the previous month. 2 5 / This credit ceiling incentive is considered by the PFIs as a key factor in maintaining their interest in utilizing the funds available under the Bank's credit lines. To ensure continued interest from the PFIs in the proposed textile credit line, BdP has agreed to maintain the credit ceiling incentive for this project. This has been confirmed at negotiations Textile Restructuring Protocol. All the above subproject eligibility criteria, terms and conditions, the respective roles and responsibilities of BdP, PFIs and TRU for implementation of the proposed loan would be incorporated in a textile restructuring protocol, a draft of which was discussed during negotiations. The signing of this protocol by BdP, PFIs and MIE would be a condition of effectiveness of the proposed loan Completion Dates and Disbursement Schedule. The final date for subproject submission and the closing date would be September 30, 1987 and June 30, 1989 respectively, both dates already incorporating a 6-month contingency. Based on the commitment experience of other credit lines and the disbursement profiles for the industrial sector in Por.ugal, commitment and disbursement estimates for the credit line component are given in Annex Coordination Between the Proposed Credit Line and Ongoing Projects. To ensure consistency in approach between the SMI II credit line and the proposed textile restructuring line (para 5.03), the Government, BdP and IARMEI have agreed during appraisal to: (i) apply the same textile eligibility criteria, appraisal standards and procedures (as specified in paras above) in addition to the already agreed SMI II criteria; and (ii) IAPMEI would become party to the textile protocol (para 7.13) only when the funds under the SMI II credit line are fully committed, and would then play an advisory role in the channeling of eligible SMI textile subprojects originating from the banks which are not yet signatories to the textile protocol, or who may not wish to become signatories to the protocol (because they may not be prepared to incur the higher overhead costs expected with such direct participation, paras ). The Portuguese authorities have agreed that, under these conditions, the SMI II protocol 25/ This incentive does not work counter to the Government's stabilization program, because, although the Bank's credit line is not included in the individual bank's credit ceiling, it is included in the overall country credit ceiling; thus the sum of the individual bank credit ceilings is set at a lower level than the country ceiling decided on by BdP.

44 would be amended at the latest by date of effectiveness of the proposed textile project, to reflect the textile restructuring eligibility criteria guidelines and appraisal aspects (paras ). Agreement was also reached that IAFMEI would provide its SMI textile subprojects with appropriate technical assistance through hiring, when needed, of specialized textile consulting services from the same approved consultant list mentioned in para 7.17 below to be paid out of its own consultant budget, a principle already agreed in the context of the SMI II credit line With regard to the coordination procedure for the Bank's BFN II credit line, the Government and BFN have agreed that the BFN's loan agreement would also be amended appropriately to reflect the same principles and technical assistance arrangements as outlined above for IAPMEI. However, due to the slow utilization of the BFN II loan, it is not likely BFN would become a PFI under the proposed project. B. Technical Assistance Component 7.17 Technical Assistance for the Enterprises. As described in para 5.09, US$0.8 million would be available to all investment projects eligible for Bank financing, when a specific technical assistance action program is assessed by the PFIs as necessary for the successful implementation of the proposed investment projects, and/or performance improvements to be achieved by the enterprises (para 7.04). These funds would be disbursed from a technical assistance (TA) special account (para 7.22) and be used to obtain technical services for the preparation/design of their investment projects, elaboration and implementation of specific action program aimed at improving the productivity and/or financial performance of the enterprises. The cost of these textile technical assistance services is estimated to be on average 3% of the total investment cost of the subproject. The TA special account would contribute, as a grant, 50% of this cost subject to a maximum total limit of US$20,000 per subproject, with the investor paying for the balance (with own or borrowed funds). Budgetary requirement may not be needed to cover these TA grants given to enterprises, because they would be covered by the 1.25% of the interest payments made by the textile enterprises financed under the proposed credit line fparas 7.11 and 7.18). Because the local consulting industry does not yet have adequate textile advising experience, foreign consulting firms would be selected jointly by the Government and Bank staff 26/ according to Bank's guidelines to establish an approved list from which the beneficiary enterprises can choose or be referred to by the PFIs to obtain the needed technical assistance. To induce further development of the Portuguese textile consulting industry, the selection of consulting firms would give extra weight to foreign firms with satisfactory arrangements of collaboration and/or joint venture with a Portuguese company. It was agreed at negotialions that this list of approved consultants would be finalized and available by October 31, Technical Assistance for the TRU. The TA special account would also finance the US$0.2 million technical services to assist the TRU in 26/ Preparation work to invite interested firms is under way.

45 setting up an information system to monitor the implementation of the textile restructuring program in general and the proposed project in particular and carry out necessary studies for improving sector performance (e.g., market studies). The costs of these services would also be recovered through the 1.25% of the interest payments as described in para Analysis shows that these payments would be sufficient to repay the US$1.0 million over the life of the Bank loan to the Government. It is envisaged that there would be one man-year of general textile expertise available on a part-time basis to support the TRU staff over the period. This general expert would be strengthened whenever necessary with a total of 12 man-months of services from specialized textile experts for specific subsectoral issues. The draft terms of reference and timetable for the assignment for these technical assistance services have been finalized during negotiations (Annex 7-2). It was agreed that the timetable for the consulting assignment would specify that the first work session with TRU will take place not later than October 31, The PFIs would use the above approved list of consulting firms and/or would call on the services of other qualified consultants to help them in their technical appraisal and procurement for the subprojects (para 7.04). C. Training Component 7.20 The MIE/TI would coordinate with existing relevant institutions (Ministry of Labor, universities, technical/vocational schools) to carry out the training study. The draft terms of reference for the study was finalized during negotiations (Annex 7-3). The study would be initiated by October 31, 1984 and its recommendations expected to be available by May 30, 1985 for review by the Government and Bank. Orders for the equipment for the TI's laboratories and University of Minho would be placed by May 1,1985 (lists in Annex 7-4). The draft proposals for advanced training of the Government staff involved in textiles (para 5.10) would be finalized by June 30, Disbursements for this component would be as described in para 7.22 below Procurement. The above equipment would be purchased according to normal Government procurement practices, which have been found satisfactory to the Bank Disbursement Procedures for the TA and Training Components. The TA special account would be set up in a financial institution in the form of a revolving account to simplify disbursements for the TA and training components. Of the total US$1.6 million allocated to these two components, this TA special account would receive an initial deposit of US$160,000. (a) The US$800,000 allocated to cover the TA services for approved subprojects would be disbursed by the Treasury based on the technical assistance action program included in the subproject reports prepared by the PFIs and/or the subloan agreements signed between the PFIs and the beneficiary enterprises. Disbursements from the special account would be at 50% of the TA costs or up to a total of US$20,000 per subproject on presentation of actual

46 invoices submitted by the beneficiary enterprises via MIE/TRU, with copy to the sponsoring FFI for information. The Government has agreed to allow promptly the necessary foreign exchange conversion for the beneficiary enterprises to pay the balance of the technical assistance costs. (b) The US$200,000 of technical assistance to the TRU, would be disbursed by the Treasury from the TA special account at 100% of the costs on presentation of actual invoices submitted by the consultants via MIE/TRU. (c) The total of US$600,000 allocated for the training component would be disbursed from the TA special account at 100% of the costs, on presentation of actual invoices submitted by the MIE/TI The total of US$1.0 million allocated for the TA component (parts (a) and (b) above) is expected to be disbursed over the 3-year commitment period of the proposed project (para 7.14). The Bank would replenish the initial US$160,000 deposit in the TA special account upon receipt of a monthly statement of expenditures to be sent by the Treasury for all contracts under US$10,000 equivalent in foreign exchange or US$20,000 equivalent in local expenditures; full documentation would be necessary for contracts with values in excess of the above limits. The MIE/TRU would keep all records for review by the Bank's supervision missions. This TA special account would be audited every year by an independent auditor whose report would be sent to the Bank within 4 months of the end of the year. The opening of both the special accounts for the credit line (para 7.08) and TA (para 7.22) will be a condition of effectiveness of the proposed loan. VIII. BENEFITS AND RISKS 8.01 Benefits and Policy Impact. This is the first Bank loan designed to address subsector restructuring in Portugal. The major benefit expected from the proposed project is that it would help initiate the much needed restructuring program for the textile industry in Portugal. In this sense, the most important benefit of the proposed project would be help the Government develop a coherent restructuring framework to guide the Portuguese textile enterprises in their performance and profitability improvement. The Ministry of Industry and Energy has prepared a new draft Development Plan for the subsector elaborating alternative restructuring scenarios which are consistent with comparative advantage considerations. The Government and financing institutions have agreed with the set of textile restructuring criteria formulated for the proposed project which provide the technical and financial guidelines for efficient restructuring of the subsector. The Government is currently thinking of abolishing the existing cumbersome and overgenerous investment incentives system, and agreed to work out in the context of the project new proposals for more effective, fiscal based incentives. The specific proposals for textile restructuring would be incorporated in the final draft legislation

47 implementing the Textile Development Plan for Government's consideration by December 31, 19B The project would also have important institution-building effects on the financing institutions (in line with the efforts ongoing under the Bank's SMI credit lines), particularly in terms of strengthening their capacity for viable long-term textile financing based on better project analysis and follow-up. The technical assistance component and, more importantly, the financing arrangements as designed, should help promote more responsible involvement in the technical assistance program from the entrepreneurs themselves. In addition, the broad-based technical assistance delivery approach proposed should help develop the domestic textile management consulting capabilities, thus further encouraging private initiatives to achieve a successful restructuring exercise. The technical assistance for the Textile Review Unit is another key element of the institution-building efforts of the project. It should strengthen the existing Government ability to monitor the restructuring program and help formulate effective policy adjustments to ensure its successful implementation Risks. The major risk involved in the proposed project is the potential slow utilization of funds by the participating financial institutions, in spite of their commitment to the objectives of textile restructuring in general and of the proposed project in particular. First, the PFIs may be less active because of the current interest rate structure and credit ceiling policy of the Bank of Portugal. To minimize this risk, care has been taken to provide the participating banks with sufficient incentive to use the Bank funds: the subproject review, approval, procurement and disbursement procedures are kept streamlined while still allowing for the Bank's involvement; also, the Bank of Portugal's credit ceiling incentive would be maintained for the PFIs. Second, the PFIs may be less successful in their investment promotion because the present investment climate may be worse than expected, thus depressing further the rate of textile investment. This risk should be reduced somewhat by the very conservatively estimated amount of the credit line. The TA grants to assist companies in preparing market-oriented, viable restructuring programs should help ensure that the optimal decisions are taken in investments. Another risk relates to the fact that implementation of the needed restructuring approaches as well as technical assistance/training actions are complex and may be more difficult than expected. The intensive supervision which the Bank intends to give to the subprojects should help the participating banks better appraise and coordinate the design features of individual restructuring cases, and thus, help limit the above risk. Serious disruptions and/or departures in the implementation of the project objectives should also be avoided with the monitoring and coordination arrangements set up for the Textile Review Unit. The proposed project would lay the foundation for a necessarily long-term and complex restructuring process supported by sound policy actions for an important industry. In this context, the above risks are judged to be acceptable with the safeguards provided.

48 IX. AGREEMENTS 9.01 The following would be conditions of effectiveness for the loan: (a) the Agency Agreement satisfactory to the Bank to be executed on behalf of the Government and the Bank of Portugal (para 7.06); (b) a protocol (or financing agreement) to be signed by Banco de Portugal, MIE and the participating financial institutions identified to date. This agreement would spell out all principles and procedures listed in paras in accordance with the draft discussed during negotiations (para 7.13); and (c) the special accounts for the credit line and technical assistance/training be opened in a financial institution (para 7.23) Agreement was also reached on the following points: (a) that the final draft legislation to implement the Textile Development Plan, incorporating the restructuring incentive proposals to be developed in collaboration with the Bank, be submitted by MIE by December 31, 1984 for consideration by the Government (paras 4.03 and 5.03); Cb) that the Textile Review Unit set up within the MIE have the agreed staffing and responsibilities (para 6.08); Cc) that appropriate subproject procurement, disbursement, audit of the credit line special account, and reporting procedures be followed (paras ); (d) that until the above textile legislation is enacted (para 9.02(a)), the PFIs follow the principles of the textile restructuring eligibility criteria, guidelines and appraisal standards as established for the proposed project for all their textile restructuring investment financing (para 7.11); (e) that the Government carry out by December 31, 1984 an analysis of the basis for allocating the differential in the interest rate charged by the Bank and the on-lending rate and, after review with the Bank, revise as needed the allocated amounts, in particular the PFIs' margin (para 7.11); (f) that the BdP maintain the credit ceiling incentive for the proposed project (para 7.12); (g) that the approved list of textile consultants for use by eligible enterprises be established by MIE and available by October 31, 1984 (para 7.17);

49 (h) that the technical assistance services for the TRU be available according to the discussed terms of reference and schedule (para 7.18); (i) that the training component be carried out according to the discussed terms of reference, schedule and procedures (paras 7.20 and 7.21); and (j) that the Treasury would disburse for the textile technical assistance grants to eligible enterprises, TRU, and the training component from the TA special account and keep records of this account which would be appropriately audited (para 7.22) Based on the above agreements, the project is suitable for a Bank loan of US$34.7 million. Industry Department April 1984

50 POR1UGAL TEXTILE RESTRUCTURING PROJECT Textile Industly Production Balance ~~~~~~~~~~~~~~~~~~I txtle IMAM try SOCtjrit" WANCE (i lae) 1974 ULIASECtOR te N FABC micuprncls OESnCM Ii MVWS ~~~~~Al itirs Am YOMl 2wo ~~~~~mcoh AS Lt&4jp Altb6 1W410 M0.650 IS ContrwmzaA Yawn 14ran Flin 3500 ODIO } 3 3 IZ~~~~~~~~~~~~~~~~~~~~~~A Fabri MIAMI PROOMMN M130 _ 4~~~MFb _ Spun Ycxn WAPMeClh UbE bhv i0mm 101 making-up Secio ava jca7.0 _0tens As _ IkI"Kfh"I 251 I Rope Atetbrc. 28, I I 9*_l Ihw 1T50 Mau *,. hy l * Capl s*iu ShAi Pkg - C koamo ft*jct. Repor No om 19M4

51 URIW.AL - ThFILE INJSiRY REsnJCREDG FiCr Producticn, Lqports, Exports and Apparent Conumption of Taxiles, ('OOO m torn) Rate Production a/ (2) Inports otf Fibers , Plus: Producticn of Hanmade Fibers Total ,5 Less: Exports of Fibers bl , Projctim , 1.2 iports (Not) Tbtal Tiports ness: Imports of Fibers liports (Nat) M.T 3.2 Exports (Nat) 4 Total Exports les: ports of Fibers b/ Exports (Net) vpRat Copcicn PromLctiln Plus: Imports (Nat) Ibtal less: Exports (Not) Apparent Cm tin MIT (5.2) Poplatien ('000) 9, , , , , , ,877&0 9,967.0 [0,067.7c/ 10,167.30/ 1.1 Apparent Conmption Per Capita (kg) o (7.0) (Op_ing iwnwtory Is asuad to be eq ul to claslng Invtory.,/ Exports ef flbacs in 1978 are eadeted. / Fatited. bwrns: Tiutitute of Textlles; World Bank Atlas, 1980; World Tibles, 198); Taxtlla Orgam, various lsaes; an staf estites. JrIstry Dapartnut Mrdh 1984

52 -45- ANNEX 3-3 PORTUGAL - TEXTILE INDUSTRY RESTRUCTURING PROJECT Exports and Imports by Textile Products (1982) Exports Imports Balance TRTaj MCa/ TMT MC T MC Fibers (183.0) (22.7) Yarns (1.3) Woven Fabrics Knitwear Garments Other Productsc/ Total d/ 50.2 a/ Thousand Metric Tons b/ Million Contos; in 1982 one Conto - US$13. if/ Mainly household articles and cordage. t/ plus domestic man-made fiber production - 40 TMT. Source: Instituto dos Texteis. Industry Department March 1984

53 POKI1:AL - TEXrE DIUSWY RESCIUREG PMD=JEC Portugal's Utilization of EEC Mie lle Qxotas Cat. Iten a/ lhits b/ Ac/%d/ A Z A X A % 9 Ae/ X f/ 1 (ottci Yarns 'Off/ Cotton Fabrics DIM Hui-made Fabrics it Knitted Underwar wtlh/ (6) (3) (3) (5) Knitted Outerear MP (6) (3) Man's & Boys' Trousena MP i/ i/ l&mnts 6 Girls' Blouses MP (23) I-n's & Boys' aiirts MP (16) (3) Ibusehold l'xtiles IMfI (6) (4) (21) Other Huin-mde Textiles I (9) a/ Within 10C, itema in categpries 2 and 3; 2 or 3 vs. 20; 4, 5, 7; 6 and 8; and 33 and 90; are interchmnlable; tire are also within each category carry-fonxard and advanced shipwaet provisions. / Qjota. c/ Actual shipots. j( 2 Ixlcw or (above) the quota. e/ First eight mxths of f/ Projected over 12 mxths. / lmhand uetric tons. h/ Hillion pieces. / Qiota for the lk oaly. Sourc: Instituto dos TexteLs. Lmiustry Departant Mardi 1984

54 -47 - AMNEX 3-5 PORTUGAL - TEXTILE INDUSTRY RESTRUCTURING PROJECT Projections of Import, Export and Domestic Consumption of Textiles (Thousand Metric Tons) Annual Growth Production a/ % Imports b/ % Population c/ Z Consumption per Capita d/ % Domestic Consumption % Exports % a/ Based on mill consumption and assuming GDP growth per capita of -0.5 for 1983; -1.5 for 1984; 2.0 for 1985; and 3% in b/ Growing at the rate (3.2X p.a.) until 1993 reaching 73Z of the domestic consumption in 1993, in line with the average for EEC countries; excluding import of fibers. c/ Growing at the rate of 1.0% p.a. (million). a/ Assuming 0.85 elasticity of demand in the period. Source: FAO: World Apparel Fiber Consumption Survey, Industry Department March 1984

55 PORIJGAL - MUIE IkUSflrY BESUCRJ PRPECr Banking System: Some Characteristics (as of end 1982) MllUons of conmtos c/ [epoeitt, Nkt = Dbposits = Credit No. of No. of Institutions Assets Sigft At notice Total granted branches employew and tem b/ Caixa G'eral de D epaito st...o ,482 Other savings and investment banks Banro do Fonento Naional.oe Credito Predial Pbrtu u ge ,503 Muitepio Coral - CO. Economica de Lisboa ,000 Comaercial banks a/ Banco Pbrtugues do AtIanticosee ,564 Banco Pinto & Sotto Mayor ,581 Banco Espirito Santo e Comercial de LlAsboa ,592 Banco 1acional Ultramarino ,621 Lanco Borges & I nm a o ,369 Bunco Tbtta & ADoreSo.opooo* ,774 Uhkao de Bancos Pbrtugueses..., ,358 Banco Fcnsecas & Burnay*oeest...ae ,026 Banco Comercial dbs Acores r...es a /Only nrtional banks. b/ WithoLut deduction of provisions. COnto - 1,000 escuidos. Source: Bank of Portugal, Industry Departmet March 1984

56 P.ER1JL - TMa1 INWUSI RESgJCIwR FJwcr ys-m Sectoral Credilt Outstanling by Term at Year-end E6c. (000,000) Percentages 19788/ a/ Ibtal Credit < i year 380, , , , , years 74, , ,784 2D9, , > 5 years 102, , , , , , , ,204 1,329,688 1,661, = % of Total Credit Cutstandivn Industrial 1978P/ < I year 189, , , , , yeams 22,681 34,893 45,626 70,479 91, > 5 years 13,285 43,409 67,422 98, , , , , , , Textile Kiu try % of Total Credit < 1 year 33,190 42,933 54,467 75,823 83, years 3,564 4,106 6,874 14,460 18, > 5 years 2,481 4,535 5,383 10,091 12, ,235 51,624 66, , , X of Industrial Credit <1 year 'a' 1-5 years ' 19.8 >5 years x a figures exclude Investnint Banks, Source: Banco de Fbrtugal, Boletim 'Mmstral.

57 EFORMAL - lora E SeX REb1nRDUliRWNr WECT Carclal Banks Sectorial Credit Outstandi,ng hy Term at Year-end E- (000,000) Percentages Total Credit < I year 346, , , , , years 40,817 53,843 73, , , > 5 years 4,723 12,849 24,188 51,246 86, , , , ,740 1,000, _ -s _* _2_---- of Total % Credit Outstanding Industrial Credit < 1 year 179, , , , , in 1-5 years 15,595 22,578 30,483 48,339 63, > 5 years 1,797 4,948 8,923 17,791 24, ,4'78 241, , , , Textile Inkutr_y < I year 32,972 42,512 53,138 73,531 79, years 2,706 3,021 5,493 12,456 15, > 5 years ,583 3,556 4, ,902 46,371 60,214 89, , Source: Banco de lbrtugal, Eolatim Trimestral. In&uwtry Department Mhrdh 1984 Ph%N

58 -51 ANNEX 6-3 PORTUGAL - TEXTILE INDUSTRY RESTRUCTURING PROJECT Caixa Geral de Depositos - Non-Performing Loans Esc (000,000) and Percentages Value 4,841 6,724 7,053 13,294 Overdue Arrears 4,096 5,897 6,036 9,820 Bad Debt ,017 3,474 x Composltion Overdue Arrears Bad Debt Z of Loan Portfolio Provision Value ,107 2,614 Z of Loan Portfolio Arrears & Bad Debt Bad Debt Bad Debt at Year-end Esc (000,000) and Percentages Total Bad Debt ,017 2,614 Sectoral Distribution Industry ,867 Agriculture Housing Other Textile Industry Value of Bad Debt % of Industrial Bad Debt Bad Debt by Age: < I year years > 5 years Bad Debt as X of Sectoral Loan Portfolio Agriculture n.a. Industry n.a. Textile Industry Source: CGD Financial Statements and data to mission. Note: Non-performing public sector, public enterprise or state-guaranteed loans are maintained in arrears, not transferred to bad debt and not provided against. Industry Department March 1984

59 -52- ANNEX 6-4 Page 1 of 2 PORTUGAL - TEXTILE INDUSTRY RESTRUCTURING PROJECT I. The Textile Institute 1. The Textile Institute (TI) is primarily engaged in compiling statistical data on export and import of textile articles, negotiating nad administering of textile quotas under MFA and other bilateral agreements, as well as issuing of import permits on behalf of the ministry of Commerce. TI is also operating two laboratories (one in Oporto for cotton and synthetic fibers and one in Covilha for wool), which are responsible for establishing quality standards and testing of raw materials imported and articles exported by the textile and garment industries (para. 20 below). TI is financed through special taxes paid by the manufacturers, exporters, and importers of textile articles, based on their annual revenues. This arrangement gives TI some degree of autonomy but as the levies do not cover all the expenses and the difference is paid by the Ministry of Industry, TI is subject to the same rules and regulations (including salaries) which apply to Government employees. TI has a staff of 400, including about 50 professionals. Because of the recent budget restrictions, TI has difficulties however in recruiting and retraining well qualified textile engineers, as there is practically no funds available for training of personnel or modernization of the existing laboratory facilities. TI plays a most important role for the textile industry in the collection, diffusion of textile knowledge, and more importantly as -spokesman for the subsector. Consequently, it is in the best interest of the subsector that TI should be involved in the training and technical assistance components of the proposed Bank project. II. Textile Training Facilities 2. Traditionally, high school level textile training was carried out in Portugal in vocational schools and the last three years of the curriculum in these schools was directed to teaching of trades including up to 50% of practical experience. Following the 1974 revolution the vocational training system has been changed and the students in the last two grades (10 and 11)) have now an option of choosing either a vocational or a general instruction program and usually eiect either the general program which qualifies them for university entrance or other trades which are believed to open better prospects for employment than the textile industry. Currently.only-about 3% of the students take textiles as a subject at any time during vocational training and less than 1% of the students 1/ elect textiles as a career, in spite of the fact that the industry accounts for 25% of the manufacturing jobs in the areas served by the schools (Porto, Guimaraes and Covilha). 3. Apart from the image of the textile industry which is perceived to offer lower than average wages and limited career opportunities due to the cyclical nature of the business, the other reasons for the low interest 1/ In 1981 only 18 students graduated in textiles.