IFD- 5 INTERNATIONAL FINANCE CORPORATION DISCUSSION PAPER NUMBER 5 The Development Contribution of IFC Operations Economics Department FILE COPY RECENT IFC DISCUSSION PAPERS No. 1 Private Business in Developing Countries: Improved Prospects. Guy P. Pfeffermann No. 2 Debt-Equity Swaps and Foreign Direct Investment in Latin America. Joel Bergsman and Wayne Edisis No. 3 Prospects for the Business Sector in Developing Countries. Economics Department, IFC No. 4 Strengthening Health Services in Developing Countries through the Private Sector Charles C. Griffin No. 5 The Development Contribution ofYC Operations. Economics Department, IFC No. 6 Trends in Private Investment in Thirty Developing Countries. Guy P. Pfeffermann and Andrea Madarassy INTERNATIONAL FINANCE CORPORATION DISCUSSION PAPER NUMBER 5 The Development Contribution of IFC Operations Economics Department The World Bank Washington, D.C. Copyright @ 1989 The World Bank and International Finance Corporation 1818 H Street, N.W. Washington, D.C. 20433, U.S.A. All rights reserved Manufactured in the United States of America First printing July 1989 The International Finance Corporation (IFC), an affiliate of the World Bank, promotes the economic development of its member countries through investment in the private sector. It is the world's largest multilateral organization providing financial assistance directly in the form of loan and equity to private enterprises in developing countries. To present the results of research with the least possible delay, the typescript of this paper has not been prepared in accordance with the procedures appropriate to formal printed texts, and the IFC and the World Bank accept no responsibility for errors. This is a study by the staff of the Economics Department of the IFC, and the judgements in it do not necessarily reflect the views of the Board of Directors or the governments they represent. The material in this publication is copyrighted. 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Library of Congress Cataloging-in-Publication Data The Development contribution of IFC operations / Economics Department. p. cm. -- (Discussion paper / International Finance Corporation ; no. 5) ISBN 0-8213-1275-8 1. International Finance Corporation. 2. Investments, Foreign- -Developing countries. I. International Finance Corporation. Economics Dept. II. Series: Discussion paper (International Finance Corporation) ; no. 5. HG3881.5.W57D47 1989 332.1'53--dc2O 89-16572 CIP Synopsis Development is not only growth in output and financial effects of taxes on inputs and outputs, incomes, but also change-new technologies, bet- price controls that lower prices of outputs, and ter management, improved financing techniques. overvalued exchange rates. These results support The activities of the International Finance Corpo- the notion that, for most projects, economic devel- ration promote growth as well as support these opment contribution went hand in hand with the changes. Therefore, this paper reports not only on financial success of the enterprise rather than growth effects measured by economic rates of re- being in conflict with it. turn, but also on the process of transformation set The paper then focuses on the crucial process in motion by IFC's activities. by which IFC translates potential benefits into real- Perhaps the most fundamental way in which the ity. It is during the appraisal process that IFC uses Corporation contributes to development is by in- its technical, financial, and managerial expertise vesting only in projects that offer a satisfactory to improve the viability of a project. Another im- ex-ante economic rate of return (ERR). The Cor- portant development contribution is the help that poration does not invest in any enterprise whose IFC provides companies in trouble; without finan- financial feasibility depends on policy-induced dis- cial viability there can be no development benefit. tortions such as protection or subsidies. This paper Further sections of the paper illustrate other im- presents the results of an analysis of 110 IFC pro- portant development contributions such as the jects for which comparable data are available. achievement of externalities as well as IFC's role in Drawn from Operations Evaluation Unit (OEU) helping governments to attain sectoral or broader studies and from project completion reports policy objectives. (PCRs), the sample is far from perfect because Lastly, the paper deals with noninvestment oper- OEU studies have focused on problem sectors and ations: technical assistance to capital markets, cor- PCRs do not capture the long-term performance porate restructuring, the Caribbean and African of enterprises. Still, the results are revealing. Ex- Development Facilities, and the Foreign Invest- post ERRs averaged 10 to 11 percent in real terms- ment Advisory Service (now a joint service of IFC well in excess of the real cost of the US dollar and the Multilateral Investment Guarantee funds, which during the 1980s was around 5 Agency). Perhaps the most important IFC advance percent. in recent years has been in creating a synergy Ex-post financial rates of returns (FRRs) were between project finance and technical assistance. roughly similar, but it is worth noting that ex-post The combination of project finance and non- ERRs, on average, were equal to or higher than project activities has contributed much to IFC's ex-post FRRs. This suggests that any assistance IFC development impact and will probably be even projects may have received through subsidies or more important in the future. import protection was outweighed by the negative  Table of Contents I. IFC's Mandate 1 H. Quantitative Development Impacts 2 A. Application of Economic Investment Criteria 2 B. Translation of Economic and Financial Analyses into Reality 3 C. Quantitative Analysis of Investment Performance 4 IH. Other Impacts of IFC Project Financing Activities 7 A. Classifying IFC's Development Contributions 7 B. The Transforming Role of IFC's Technical and Financial Inputs 7 (i) Making Profits in a Cleaner Environment 8 (ii) Help for Companies in Trouble 9 C. The External Benefits of IFC's Project Investments 10 (i) External Benefits to Producers and Consumers 10 (ii) IFC Investments Lead to Creation of Other Good Companies 10 D. Assisting Sectoral Development and Broader Policy Goals 11 (i) Sectoral Impact 11 (ii) Breaking Down Country Risk Barriers 12 (iii) Assisting Privatization 13 E. Saying No 14 IV. IFC's Noninvestment Operations 15 A. Technical Assistance to Capital Markets 15 B. Corporate Restructuring 16 C. Caribbean Project Development Facility (CPDF) and Africa Project Development Facility (APDF) 16 D. Foreign Investment Advisory Service (FIAS) 17 V. Conclusions 19 Annex 1: Economic Rate of Return Analysis in IFC 20 Annex 2: Quantitative Estimates of IFC Investment Returns 22 List of Tables Table 1: Distribution of Real Ex-Ante Returns by Sector 22 Table 2: Distribution of Projects by Difference Between Ex-Ante ERR and Ex-Ante FRR 22 Table 3: Distribution of Real Ex-Post Returns by Sector 22 Table 4: Distribution of Real Ex-Post Returns as Percentage of Total Projects in Samples from Project Completion Reports and the Operations Evaluation Unit 23 Table 5: Distribution of Earning Ratios (%) 23 牟 1. IFUs Mandate The International Finance Corporation was es- pects of the project design) or render technical tablished over thirty years ago to promote the assistance that its staff, with its special experience development of its (developing) member coun- and expertise, is unusually well qualified to give. tries. That remains its only purpose. Its special Whatever IFC's particular contribution, it must mandate was and is to do this by assisting and increase the likelihood that the activity will have a promoting productive private sector activities. positive development impact compared with the Consequently, the companies in which it invests situation that would be likely to prevail if IFC were must be financially sound. If they appear to be not involved. unprofitable then no private investors will under- In pursuit of its development objectives, IFC has take them, and if they are unprofitable in practice, evolved from a purely project investment body to a they will also fail economically, wasting the re- diversified group that offers a range of advisory sources invested in them and thus by no means and management services as well. Project invest- promoting development. Moreover, the Corpora- ments, nevertheless, remain IFC's dominant activ- tion itself is intended to be self supporting, and ity. At the end of 1988, IFC held investments in 449 this imposes a further requirement that its activi- firms in 79 countries, a significant increase over ties, as a whole, generate a positive income stream the 288 firms in the investment portfolio in FY80. for its own account. Any highly risky activities or This growth in the number of active investment any not-for-profit services that it might choose to projects reflects higher rates of project approvals, pursue to promote development must be balanced which increased from fifty-five in FY80 to ninety- by some less risky and/or more profitable activi- five in FY88. In addition to its project investments, ties. But these profitability requirements-both on IFC seeks to promote development through its the companies in which IFC invests and on IFC's Capital Markets Department. Established in 1971, own operations as a whole-arise out of, and do this department has become the focal point for not modify, its single basic objective of promoting World Bank/IFC capital markets activities. development. The format of this paper is as follows. Part 11 In practice, the Corporation's development examines the quantitative impacts of IFGs devel- mandate has been interpreted to mean much opment contribution, focusing on the application more than simply making investments that have of economic investment criteria, technical inputs positive payoffs in both the developmental and made during the appraisal and design phase of financial dimensions. IFC's Board and its manage- prcjects in which IFC invests, and ex-post measures ment require that the Corporation not only partic- of economic and financial returns. In Part III, ipate in such useful activities, but also that it IFC's development contribution is assessed from actively contribute something to their success that the viewpoint of its nonquantifiable impacts, with otherwise would be unavailable. The Articles of particular attention given to the benefits arising Agreement refer to "cases where sufficient private from the Corporation's nonfinancial inputs and capital is not available on reasonable terms." Over the externalities that have emerged from its pro- time the concept has been expanded, and now the jects. Part IV then discusses the Corporation's non- Corporation is expected to have some distinct and investment activities, including technical important role. For example, it might bring invest- assistance to capital markets, corporate restructur- ors together who probably would not have come ing, the Caribbean and African project develop- together otherwise. It might provide financing on ment facilities, and the Foreign Investment reasonable terms if such financing was not avail- Advisory Service. The main conclusions of the able elsewhere. It might provide expert advice report are presented in Part V. (usually on technical, financial, or economic as- II. Quantitative Development Impacts A. Application of Economic Investment Criteria ect are getting higher returns than the host coun- try; if this difference is significant and notjustified The most fundamental way in which the Corpo- by the circumstances, IFC staff try to restructure ration contributes to development is by investing the project's financing to achieve an acceptable only in projects that offer a satisfactory ex-ante distribution of the returns. Annex 1 contains more economic rate of return (ERR). The ex-ante ERR details on how IFC estimates and uses ERRs. measures the real value added that is expected to In its early years, the Corporation had no system- result from the investment activity; unless this ex- atic procedures for assessing or screening projects ceeds the real cost of capital (plus a margin for on the basis of economic impact. About 1970, risk), IFC will not pursue the project proposal. however, IFC began to adopt the methods of eco- This criterion is consistent with the pursuit of nomic cost-benefit analysis. Since that time it has higher real GDP for the economy as a whole, and used these methods to screen all projects in which it underscores real income growth as the center- it has invested. IFC's overall project screening pro- piece of IFC's development objective. cess now results in the rejection of some two-thirds In applying the ERR criterion, IFC measures the of all project inquiries that warrant serious consid- inputs and outputs of a project according to their eration. While reasons for rejection vary, failure to opportunity cost to the economy. This means that satisfy economic criteria has been important. a traded good is valued at its c.i.f. import price or The requirement that a project must have a f.o.b. export price (depending on whether the satisfactory ERR means that the Corporation does good is importable or exportable) and not at an not invest in any enterprise whose financial feasi- internal price that may be affected by price con- bility depends on some policy-induced distortions trols, import duties, export taxes, or subsidies. such as protection or subsidies. The Corporation Nontraded goods (such as local transport or labor may invest in projects where distortions make the costs) are valued at their international equivalent expected financial return (FRR) different from prices using conversion factors to adjust for any the expected economic return, but in all cases the distortions on account of regulation, taxes, and expected benefits must be satisfactory in both di- currency valuations. Furthermore, cost and reve- mensions. The judgment whether a project offers nue items are counted or not counted in the ERR satisfactory prospective returns depends upon the calculation depending on whether they are actual risks involved in the enterprise as well as the cost of costs to the country, rather than to the company capital. involved in the project. For instance, domestic In the real world, a project has little chance of taxes on the company are not counted as costs in delivering development benefits in the form of the ERR calculation, whereas the costs of con- higher national income unless it can also deliver a structing a road just to service the factory would be profit to its sponsors. Private investment projects counted even if the company does not pay them. that fail financially also fail economically. There- Projections of costs and returns are made on a fore, IFC must consider both the ERR and FRR in constant price (i.e., net of inflation) basis so that project selection and appraisal. Typically, the ERR the ERR figures cited by IFC are measured in real and FRR on a given project differ to some extent, terms and should be evaluated against the real cost which is to be expected given the prevalence of of funds. protection, taxation, and regulatory distortions in Because most projects involve both foreign and many developing countries. However, analysis of a domestic financing, IFC also calculates ERRs in sample of 110 IFC projects shows that the ex-ante terms of their GNP (rather than GDP) contribu- ERR and FRR values of these projects are usually tion and refers to this as "return to the domestic relatively close (see Annex 2 for details). In more economy." Whereas the standard ERR considers than two-thirds of the projects, the two rates of the impact of all economic costs and benefits on return were within 5 percentage points of one the host-country economy, the GNP-based ERR another. In only three projects were there high net considers only costs and benefits to host-country positive distortions (i.e., FRR more than 10 per- nationals. Costs and benefits accruing to foreign- centage points higher than ERR), while in thirteen ers are excluded. The return to the domestic econ- projects there were high negative net distortions omy may be higher or lower than the standard (i.e., ERR more than 10 percentage points higher ERR. If it is lower, foreign participants in the proj- than FRR); see Table 2 of Annex 2. 2 Not only are the ERRs and FRRs usually similar, investment firms, IFC brings its wide technical and but in the sample of 110 projects, the ex-ante ERRs financial experience to bear to ensure that ex- were on average higher than the expected FRRs. pected benefits are translated into practical busi- The average ex-ante ERR of the sample was 23 ness reality. This "hands-on" treatment is part of percent compared with 20 percent for the FRR, a IFC's unique development function. In a high pro- result that is contrary to some common beliefs portion of IFC investments, the Corporation about protected or otherwise subsidized invest- makes a significant contribution to both financial ment activities in developing countries. In fact, out and economic viability through the application of of the total sample of 110 projects, the ex-ante FRR its in-house skills (business, engineering, and fi- exceeded the ex-ante ERR in only 39 cases (35% of nance), particularly at the stage of project total sample), indicating a relatively low incidence appraisal. of profit-enhancing distortions in the sample of In the majority of the projects that it finances projects. In 65 percent of the projects, taxes or (and in some others that it appraises but does not levies on inputs, price controls that may raise finance), the Corporation promotes development prices of inputs and lower prices of outputs, and by improving the structure of the proposed project overvalued exchange rates combined to outweigh during appraisal. Many, if not most, of the project any assistance the projects may have received proposals that come to IFC are deficient in either through subsidies or protection from imports. The financial or technical aspects. The most common data indicate that the projects selected by IFC are financial weakness is undercapitalization relative more often penalized than assisted by the prevail- to the size of investment being planned. Unless ing government incentives. In general,t istib n es corrected, this often can lead to cash flow short- In gnerl, he istibuton f bnefts rom ages early in the life of the project and sometimes IFC's projects tends to favor the host economy. Out to complete project failure. Corporation staff seek of the sample of 110 projects, 72 had information to overcome these weaknesses durin the appraisal available on the return to the domestic economy s calculated at the ex-ante stage. Within this group g y g g of seventy-two projects, the average return to the posed equity/loan structure. This negotiation may dometicecoomywas29 prcet cmpaed ith involve a considerable redistribution of risks and domestic economy was 29 percent compared with rwrsaogtepooe netr n ed an average project ERR of 22 percent. In only er s tpof fa r estr as ben twelve out of the seventy-two projects was the re- turn to the domestic economy lower than the total found to be very important in reducing the risk of project ERR. As explained in Annex 1, this out- project failure once funds are committed and the come reflects project arrangements (financing, project has commenced. On the technical side, managerial and technical fees, and royalties), IFC engineering staff frequently encounter pro- which typically benefit the host country. posals based on technologies that are neither cost In sum, IFC seeks to achieve a positive develop- effective nor technically efficient. In these cases, ment impact by investing only in those projects the Corporation makes a substantial effort to rede- that ex-ante are assessed to be efficient in their sign the technology of the project and to provide utilization of resources and that do not depend on advice on sourcing, installation, and initial opera- distortions for their financial viability. The project tion of equipment as well. In technical as in finan- screening procedures performed by IFC assist the cial inputs, this "hands-on" approach during the development process not only by directing scarce appraisal stage has led to an overall increase in the capital toward productive and profitable ends, but development impact of the Corporation's projects. also by laying a foundation for the project ap- The transforming role that IFC plays in many of praisal inputs that follow. These inputs are dis- its projects is described further in Part Ill. By its cussed next. nature, this type of contribution has payoffs that are difficult to quantifyr and may not always be B. Translation of Economic and Financial apparent, but should not be underestimated. IFC Analyses into Reality spends an average of $300,000 per project ap- praisal (not including overheads), reflecting the It is one thing to carry out an ex-ante economic staff time and effort that goes into making sure and financial analysis that suggests that an invest- project money is well spent. On a number of occa- ment will have positive developmental effects; it is sions, the diligence of IFC at the appraisal stage quite another to translate these benefits into real- has led to it being replaced as financier by lenders ity. Unlike many purely commercial lenders and less concerned with economic impact. 3 Not every project succeeds as planned. Project pleted cover cement, nonfuel minerals, agricul- failures and disappointments on occasion must be tural processing and storage, agricultural produc- expected, particularly in view of the risks that IFC tion, and textiles.' These sources give ex-post rate has been willing to take. However, in view of the of return estimates for fifty-seven projects. Details resource costs and waste of effort associated with of the returns on these projects are given in Annex project failure, the Corporation makes every effort 2. Some of the sectors in OEU's sample were cho- to ensure that all projects have as high a probabil- sen for study because they were unusually prob- ity of success as possible once they are com- lematic. Therefore, the sample should not be menced. Where losses do occur, the Corporation regarded as fully representative of the works with the sponsor to minimize the damage or, Corporation's overall portfolio. if possible, rehabilitate the venture. Even so, loss The other source of information on re-esti- provisions and capital write-offs (in recent years at mated rates of return are project completion re- the rate of two to three projects per year) have ports (PCRs).2 These re-estimations are carried been and will continue to be part of IFC's portfolio out at the end of the project investment phase, experience. usually soon after the commencement of opera- The success rate that IFC has achieved as a result tions. Unlike the OEU re-estimates, the PCR calcu- of its appraisal and restructuring efforts has also lations are often based on little or no project had development payoffs that go beyond the par- operating experience. They provide only an ap- ticular projects in question. Demonstration effects proximate indication of what the actual economic on other potential investors are important in any or financial net benefits will be, but they are better developing country, and just as successful projects than the ex-ante appraisal estimates because they have a positive influence on investors' perceptions, are more up-to-date. The PCR figures do have the so, too, do project failures have a negative influ- advantage, however, of incorporating known con- ence. IFC is conscious of the damage that poorly struction or installation costs for the project, and conceived and poorly implemented projects can they embody more up-to-date assessments of tech- do through negative demonstration effects, and it nical and market conditions than do the ex-ante makes every effort to minimize this type of damage reports. Since 1982, eighty-five PCRs have con- with its own projects through its appraisal activi- tamed re-estimates of ERRs.3 Of these, fifty-three ties. Further discussion of these indirect effects is projects were selected for analysis; the other thirty- included in Part III. two projects were either present in the OEU stud- C. Quantitative Analysis of Investment ies previously referred to or had incomplete Performance information. These PCRs, together with the OEU reports, give a sample of 110 projects for which The most important question, however, is what summary results are presented in Section 3 of results have been achieved in practice. Ideally, one Annex 2. would like to know the economic rates of return The main findings from the analysis of this sam- actually achieved by all of IFC's projects but com- ple of partially ex-post ERR data are as follows. As plete evidence is not available. Virtually the only shown in Table 3 of Annex 2, the ex-post ERRs source of ERR re-estimates after a project has been averaged 11 percent in the PCR group of projects operating for a significant length of time are the and 10 percent in the OEU group. These average sectoral studies by IFC's Operations Evaluation returns are in excess of the real cost of corporate Unit (OEU) and by other IFC staff before that unit funds, which averaged around 5 percent for US was created in 1984. OEU studies already cor- dollar funds in the 1980s (up from the I to 2 1. The CEU studies are available from the Economics Department of IFC, 1818 H Street, N.W., Washington, D.C. 20433. 2. PCRs have recently been replaced by investment assessment reports (tlARs). These are subsumed under PCRs in this paper. 3. In 1988, it was decided that ERRs would be re-estimated in all project completion reports. While these will not be true ex-post ERRs, owing to the short time elapsed since project completion, they will provide more comprehensive data forljudging the economic impact of IFC investments. 4 percent real cost that prevailed in the 1960s and government interventions affecting the firms in 1970s).4 In other words, the net economic impact which the Corporation invests (i.e., the net im- of IFC's project investments appears to have been pacts of taxes, subsidies, tariffs, price controls, reg- positive overall, even for this negatively biased sam- ulations, etc.) has on average a neutral to negative ple of projects. effect on cash flows. Rather than being assisted by However, the group averages conceal a large distortions, a majority of the Corporation's client degree of variation in economic returns from sec- firms either receive little help or are being penal- tor to sector (see Table 3, Annex 2). In both the ized. These findings confirm the analysis of ex- PCR and OEU samples, projects involving agricul- ante economic and financial returns in Part II, tural production have performed poorly, generat- Section A, above. The results also show that the ing ERRs of only 2 percent on average. 110 IFC projects, on average, performed well fi- Agricultural processing projects, on the other nancially relative to the cost of capital, and they did hand, gave only adequate real returns (7 percent so without overall reliance on protection or subsi- ERR) in the OEU sample compared with the more dies. Business success appears to have been trans- satisfactory returns (11 percent ERR) of the PCR lated into positive development impacts. sample. While all other sectors have performed Since financial performance and economic per- satisfactorily (a positive return over the real cost of formance of IFC projects usually do not differ funds), the two samples gave different indicators widely, further insight into the probable develop- of the strength of each sector's performance. Sam- mental impact of IFC's project finance can be ple variations in the distribution of returns can obtained by examining the overall financial per- also be seen in Table 4, Annex 2. As a more com- formance of the companies it assists.5 IFC's invest- prehensive set of ex-post estimates is assembled ment portfolio grew rapidly during the 1980s, and (from PCR and OEU sources), it is anticipated that by the end ofJanuary 1989, 460 investments were variations in sectoral estimates due to small sample classified as "active." The majority of these invest- effects will be reduced, and a more representative ments have not operated long enough to yield firm gauge of IFC's investment performance will be information about their financial performance. available. Therefore, financial performance statistics were As noted earlier, a project's financial return is as collected on all companies in IFC's active portfolio much an ingredient of its development impact as for which six or more years had elapsed since the its economic return: in fact, financial viability is a last commitment date. Leaving out 18 cases for sine qua non for good economic performance. which complete information is not available, the Based on the ex-post assessments reported in list covers 136 firms; their performance is mea- Table 3 of Annex 2, the real financial return on sured by the ratio of earnings to assets for the last IFC's investments has varied between very good in full year (generally 1987) for which information is the case of textiles, chemicals, and pulp and paper available (see Part 4, Annex 2). (PCR sample), to poor in the case of agricultural The average return on assets (before taxes) for production (both samples) and agricultural pro- these 136 companies was 9.5 percent (nominal). cessing (OEU sample). These sectoral results high- For comparison, the average return on assets (be- light the extent to which good economic returns fore taxes) reported by developing-country affili- and good financial returns go together in IFC's ates of U.S. firms in 1986 was 8.6 percent (source: projects, which in turn reflects the low overall US Department of Commerce). This suggests that incidence of economic distortions in the projects the companies in IFC's portfolio are at least on a themselves. financial par with purely commercial operations, As in the case of the ex-ante estimates, ex-post and that IFC's pursuit of development objectives in ERRs in the sample were somewhat better, on its investments appears to have been a help, and average, than FRRs. In fact, ERRs were equal to or not a hindrance, in the achievement of satisfactory greater than ex-post FRRs in all sectors but one of financial returns. the OEU sample and in half the sectors of the PCR To summarize this section, the economic and sample. The reason for this is that the pattern of financial performance measures show that IFC's 4. The real cost of corporate funds was calculated as the difference between the US AAA ten-year corporate bond rate and the US GDP deflator. For purposes of comparison, the average real LIBOR rate on US dollar funds from 1980 to 1988 was 5.7 percent. 5. Obviously what is significant here is the performance of the companies, not the performance of IFC's assets. 5 investments, on average, appear to be achieving excess of the real cost of long-term corporate fi- positive development impacts through their con- nance and exceed the average ex-post FRR as well. tributions to the GDP of the host country and the The financial returns in IFC companies that have profitability of the companies concerned. The been operating for some time also suggest satisfac- Corporation's ex-post ERRs are, on average, well in tory average performance. 6 III. Other Impacts of IFC Project Financing Activities A. Classifying IFC's Development Contributions pacts were planned for at the project design stage and instances where unforeseen external benefits The purpose of this part of the paper is to emerged only after commencement of project op- examine the nonquantifiable features of IFC's de- erations. The third area is where IFC's work goes velopment contribution, highlighting in particular beyond the micro project level to contribute in a the Corporation's appraisal inputs (referred to significant way to sectoral development and broader briefly in Part II, Section B, above), the externali- government policy goals. This includes IFC's role in ties that flow from its efforts, and the broader guiding the development of sectors such as capital sectoral and policy development goals it has markets and in helping governments to imple- helped governments to achieve. The features of ment policy objectives such as privatization and IFC's work examined here further illustrate the private sector investment growth. The final issue differences between the activities of the Corpora- examined is the development contribution that tion and those of other, strictly commercial, finan- IFC makes by saying no to projects that are un- cial intermediaries. sound and that would waste money for the Corpo- The development contribution that IFC makes ration and for the country concerned. through its project finance activities extends be- The first three of these topics are not mutually yond the benefits captured in ERR calculations. exclusive. Many projects in IFC's portfolio illus- The return calculations reveal the results achieved trate success in more than one category of devel- by client companies, but they do not show how opment impact. For the purposes of the discussion much IFC's intervention contributed to those re- that follows, projects have been chosen on the sults. IFC's appraisal and design work and techni- basis of their principal impact category. cal assistance can transform a doubtful project into a successful operation or rescue a project that B. The Transforming Role of IFC's Technical and otherwise would have failed. ERR estimates also do Financial Inputs not capture all the external benefits that may ac- crue to the country. These contributions are The most frequently cited and perhaps most among the basic reasons for IFC's existence; as important type of input by IFC is technical or mentioned earlier, the Corporation was not cre- financial advice on how to improve the perfor- ated for, and is not content with, simply investing mance of a project. This type of advice is given in sound enterprises. special mention in about 80 percent of the 110 Just as IFC's contributions to development are projects sampled, and it is usual for this type of not fully reflected in statistics, they are not easily input to be made at the project appraisal stage. described by general statements. They have to be The second most frequent type of contribution is illustrated by particular examples. IFC is a develop- IFC's key role in mobilizing investors for a project. ment institution concerned primarily with reality This important contribution-cited in about 50 at the micro level, and every investment IFC makes percent of the sampled projects-highlights IFC's is treated as a special case. There is no standard unique ability to play a bridging role between IFC product. In a broad way the proper measure of sponsors and other investors. A quarter of the IFC's contribution to development is the number projects involved formation of a new company that of companies in member countries that owe their assists private-sector development by diversifying success in some degree to IFC; but the nature of the corporate base. Mentioned less frequently, but IFC's contribution to their success differs in every nevertheless important, are projects that have pos- case. itive demonstration effects on other investors, lead The following discussion is organized under to introduction of new technology, or play a path- four broad headings. First, the development con- breaking role by being the first investment in a tributions arising out of IFC's technical and financial sector. A number of projects would not have gone appraisal skills are examined, with particular em- phasis on the transformation in design and im- The contributions made by IFC to improve proj- provement in performance that IFC brings to its ect viability are extremely diverse, as the following projects. Second, the externalities that have been examples selected at random illustrate. identified in connection with IFC's projects are One project that required a high level of staff discussed, including instances where external im- input, given its size, was a dairy processing plant in '7 C6te d'Ivoire for the production of concentrated Another major project that required IFC's tech- and sterilized milk and other forms of milk prod- nology and financial inputs at the appraisal stage ucts. Through its suggestions regarding plant was the corporate restructuring of a large Argen- equipment and the specifications of civil works, tine company involved in the production of cloth- IFC significantly reduced the establishment costs ing and footwear. This unique project concept was of this project. The Corporation's technical exper- aimed at turning the company's financial fortunes tise was essential since the local sponsor was rela- around by targeting all aspects of its operations in tively inexperienced in dairy industry technology. the production, marketing, and finance fields. Another example of technical advice leading to IFC's main contribution during the appraisal stage improved production efficiency was a textile plant was to advise on the simultaneous design of pro- in Zambia. IFC recommended wider looms that duction and financial plans that were compatible would increase production of wider-and more with each other and that would be consistent with salable-fabric. At IFC's suggestion, the company the overall requirements of Argentina's debt-eq- also decided to introduce advanced weaving tech- uity conversion program. IFC also reviewed the nology by purchasing forty shuttleless looms that company's plans for production at plants in differ- lowered production costs and increased flexibility. ent locations and was able to suggest modification If the project had proceeded as proposed by the in the proposed investment program to improve sponsors, it would have been a high-cost producer e production and the flow of materials among of less salable cloth. the company's plants. Both creditors and share- In India, a project for a sponge iron works holders looked to IFC to play the honest broker lookedrole and welcomed its initiatives in structuring and taining financing. The main concern of local lend- cioriutin to tef projet onss fiboth ers was that the project was a "green field" londrequit funds. operation involving new technology. IFC was re- on of t areasi quested to review the technological merits of the Oned to ired proct perfrmanea operation. The Corporation undertook consider- t risae ta inte dei oman e t able research in assessing the technology proposal, g gn g including evaluation of existing plants in otherhotel pro- countries. IFC suggested additional metallurgical fou it nece n eal in to des testing and designed guarantee tests for plant per- and stucr m ngement performnceg formance that placed a greater burden of the risk mnsthat atenteolanere on the technical partner. IFC also assisted in the objective is to define agreements that ensure that negotiations between the Indian sponsor and the management's incentives relate to net revenues technical partner to obtain an appropriate agree- and that management fees and capital costs are ment on consequential damages in the event of competitive. IFC's accumulated experience in the nonperformance. With these arrangements in design of these agreements, coupled with its place, the project became bankable. unique ability to play the honest broker role, make In another project in the iron and steel sector, this an important aspect of its ongoing develop- this time in Venezuela, the proposal was for refur- ment contribution. bishing and privatizing a government-owned plant Similar types of inputs have been made by IFC in that had been shut down for several years. Foreign virtually every project. On occasion, circumstances investors were to play a major role in the owner- require the Corporation to undertake major in- ship of the new company and in the introduction volvement in project planning when problems are of new technology. At the request of the local seen at the appraisal stage and in rescue opera- sponsors, IFC undertook a complete technical tions when projects run into trouble. Further illus- evaluation of the proposal, which led to the rede- trations of this involvement are presented in some sign of certain key elements of equipment and detail below. The first section shows how IFC has plant layout. Based on the assessment of technical reconciled profitability and environmental objec- risks in the project, IFC then designed production tives; the second deals with companies in need of and performance guarantees to give appropriate rescue. protection to lenders. Design of these guarantees required a specialized combination of engineering and financial skills not commonly found in finan- IFC has devised methods for reducing industrial cial institutions. pollution while improving the efficiency and prof- 8 itability of manufacturing operations. In some when employment and linked impacts on other cases IFC's insistence on meeting environmental companies are considered. IFC's experience has standards has rendered its assistance unacceptable shown that a long-term commitment to companies to the sponsors, but in other cases the Corporation is often required to ensure success, and it is normal has been able to help companies meet environ- practice for the Corporation to continue to work mental as well as profitability goals. with companies in the portfolio as long as there is In the case of an aluminum smelter in Yugosla- something useful that can be done for them. Each via, IFC was asked to help finance a moderniza- year the Corporation successfully rehabilitates tion/expansion/pollution control project. This companies that for various reasons are unable to was vital to the future of the smelter works, which meet loan commitments; in FY88 fourteen firms faced closure if the work was not undertaken. Not (representing 27 percent of all IFC client compa- only was much of the existing technology and nies with nonperforming loans) were restruc- layout obsolete, but severe pollution from the old tured; in only two firms IFC's loan had to be smelting works was becoming intolerable. Before written off. approving any financing, IFC analyzed the The difficulties that call for continued IFC assis- company's technical, pollution control, and finan- tance may make the returns on the project as a cial planning systems. This analysis led to recom- whole rather low with IFC help, but without IFC mendations for redesign of the project scope, assistance the returns would have been even lower; which in the light of subsequent market weakness indeed, in many cases the company would have proved to be of considerable value in maintaining failed and resources would have been completely the company's viability. By mid-1988, equipment wasted. A typical example is a polyethylene project installation and upgrading had been completed, in Argentina that was one of four downstream pollution problems were under control, and pro- users of the ethylene to be produced in a ma duction and sales were at capacity levels. petrochemicals complex. Because the other three Another example was a pulp and paper com- plants were delayed due to their sponsors' finan- pany in Argentina, which by the late 1970s had a cial difficulties, and because the ethylene could plant that was undersized, out of date, and envi- not be economically exported, the entire complex ronmentally damaging as well. IFC was called in to was in crisis. Without sufficient users for the ethyl- assist in a redesign to allow expansion, moderniza- ene, the cracker and the IFC-assisted company tion, and installation of pollution control mecha- would be mothballed until other downstream nisms. Because of the extreme difficulty of plants could come along. The gas that would have obtaining long-term financing for any private com- been used to make the ethylene would continue to pany in Argentina at the time, IFC's financial par- be flared, Argentina would continue to import ticipation was crucial to the realization of these petrochemicals, and the mothballing would be not objectives. IFC also provided valuable technical only expensive but also a very embarrassing repeat appraisal and financial planning inputs that were of another mothballing of the cracker at an earlier beyond the resources of the sponsor to provide. stage of construction. All this in a country whose IFC was instrumental in introducing the company abundant natural gas, location, and market size to international commercial banks, in the context give it clear potential cost advantages in of a bank syndication. In particular, IFC's assis- petrochemicals. tance with the design and installation of pollution IFC, its Argentine partner, and the sponsor of control systems enabled the company to become the cracker analyzed the options. They decided to one of the first pulp and paper manufacturers in replace one of the two planned production lines of Argentina to undertake a comprehensive environ- the client with a much larger, barge-mounted plant mental control program. that would use a recently developed technology. (ii)This technology looked promising but had not yet (ii)Hel forComanis inTroblebeen proven in full-scale production. IFC, as the During the 1980s there were many instances only partner with international experience in pet- where temporary business problems in IFC's mem- rochemicals, devoted considerable staff time to ber countries resulted in closure of potentially on-site reviews of pilot plants and other relevant viable and economically efficient enterprises be- installations in the United States and Europe, to cause of the lack of timely and competent assis- visits tojapan where the barge was being built, and tance. Short-term cash flow problems that lead to to strengthening the financial structure of its Ar- bankruptcy and closure can represent a substantial gentine partner so that it could play its role in resource loss to developing countries, particularly completing the project. (This last was accom- 9 plished by a standby loan to the partner.) The work technology has stimulated competition from was completed essentially on time, permitting the eleven other milk suppliers, and the same technol- start-up of the gas separation plant and the ethyl- ogy has now been applied to fruitjuice marketing, ene cracker. The companies have been successful with subsequent benefits for fruit producers and financially and economically, and in time other consumers. None of these external benefits could downstream projects also emerged. Again, how- have been anticipated, much less measured, at ever, the profitability or rate of return estimates of appraisal, and some of them took years to appear. the project do not reflect the avoidance of the Sound companies are indeed the engines of indus- negative returns that would probably have accrued trial development, and the creation of a company without IFC assistance. able to develop and seize new opportunities is, over time, even more significant than the success C. The External Benefits of IFC's Project of the original project. Investments (ii) IFC Investments Lead to Creation of Other Good A second category of benefits arising out of Companies IFC's project investments are externalities. These In some instances IFC investments have led to externalities may be intended (as in the case of the the creation of very similar companies; at other pollution control measures referred to previously) times the new firms have been suppliers or con- or unforeseen at the time of project implementa- sumers. Some companies are within one country, tion. On occasion, external benefits have been while others spread among many countries. Quite significant. Externalities can take many forms. The a few of the companies are in the capital markets company's success may lead to the creation of sector, from which the following two examples are other good companies; it may increase the profit- chosen. ability of other enterprises; and it may provide In 1982, the Government of the Republic of trained personnel for other companies in the Korea asked IFC to assist in structuring and pro- country. IFC's investments can generate many im- moting a new closed-end mutual fund, to be sold portant external benefits, as the following exam- to foreign portfolio investors and to invest in Ko- ples show. rean companies. There was considerable skepti- cism on Wall Street about the idea. It was doubted (i) External Benefits to Producers and Consumers whether the international investing community A milk treatment and packaging project in Paki- would be prepared to place its money in a market stan produced significant external benefits to both as young, as small, and as comparatively undevel- producers and consumers. Pakistan once suffered oped as the Korean market. Also, the Korean Gov- from severe deficiencies in its system of milk collec- ement was anxious to ensure that the institution tion, preservation, and distribution. Whereas did not become a vehicle for short-term, specula- urban areas had milk deficits, surplus milk in rural tive funds. IFC structured the fund and was its areas was either wasted or converted to lower value co-lead manager and underwriter. In the event, products. To meet nutritional needs of city dwell- the youth and size of the Korean market did not ers, milk powder was imported at a cost of $35 prove to be problems, and the Fund was a great million in 1978. The project overcame these prob- success. Sixty million dollars were raised through a lems by introducing sterilized milk technology to public offering in 1984, the shares began trading Pakistan. This allowed milk to be preserved, trans- at a premium to the Fund's net asset value, and two ported, and sold in "long-life" packs. The company years later a second successful offering of $40 mil- established new economic links between the milk lion worth of shares was made. surplus (Punjab) and milk deficit (Sind) regions of Following the success of the Korea Fund, a num- Pakistan and provided a direct income boost to ber of similar funds have been established in other around 12,000 small dairy farming families. Other countries, bringing to them the benefits of foreign benefits from improved nutrition have been portfolio investment and a qualitative increase in significant. the sophistication of their equity markets. Other Developmental benefits through demonstration publicly offered funds assisted by IFC include one effects have been important in this project. The in Malaysia, three in Thailand, and one in Brazil. company itself is now diversifying to include pro- (In Brazil, IFC did a lot of work setting up the fund duction of premium-quality powdered milk and and designing laws and regulations to permit such baby food (both of which were previously im- funds, but did not participate financially.) There ported). Further, the project's success with the new have also been three privately placed funds in 10 which IFC was involved, the Equity Fund of Brazil (i) Sectoral Impact and two funds that are not country specific-the On the macro level in purely financial terms, Emerging Markets Growth Fund and the Emerg- IFC s a small part of total capital flows to ing Markets Equity Fund. Together, these public i dap acway and private funds have raised over $500 million in deloping memberctis. But th d o new foreign money for investment in developing- always limited to individual projects. Continued country stock markets, have contributed to the IFC support has played a special role in the devel- creation of some twenty similar funds that have ment of a whole sector in a articular country- raised over $1.3 billion, and have ended the isola- op p y tion of developing-country markets from devel- Brazil and capital markets in Korea. oped-country portfolio investors. This has been Petrochemicals in Thailand. After natural gas was particularly important in light of the slowdown in discovered in the Gulf of Thailand in the mid- private long-term capital flows to developing coun- 1970s, the Thai Government received a number of tries in the 1980s. trie in he 180s.proposals to develop its petrochemical industry. IFC has also played a prominent role in intro- These reports were based on different assumptions ducing equipment leasing to many developing and objectives, and therefore each arrived at fun- countries. Well established in developed countries, damentally different conclusions and recommen- leasing has a number of advantages over conven- dations. Conscious of the problems (and lost tional bank finance as a form of asset financing. opportunities) that other countries had encoun- First, the collateral requirements are much less tered in their resource development projects, the onerous, making it attractive to small- and me- Thai Government sought the assistance of IFC to dium-scale enterprises and especially useful in help it plan and implement a development strat- countries with financial systems unaccustomed to egy for the gas fractions suitable for petrochemical evaluating credit risks. Second, leasing works well production. even when the overall market is small, thus making From the very beginning, IFC was actively in- it suitable for small economies where the market volved in the design and evaluation of alternative would not support a range of banking institutions. development strategies. Working with the Petro- IFC has helped to create nineteen leasing compa- leum Authority of Thailand (PTT), it developed an nies in as many countries. Virtually all of these integrated economic model to determine the opti- companies have been pioneer institutions, and mum size and configuration for the petrochemical IFC has been heavily involved in providing techni- complex under different sets of assumptions. A cal assistance in drawing up the necessary legal joint IFC/PTT report was produced and accepted and regulatory framework. The success of IFC's by the Government of Thailand. This ultimately leasing companies has led to competition; often formed the basis for the development proposal for several additional companies have appeared dur- the complex, which was scheduled to be com- ing the first few years of an IFC company's opera- pleted in 1989. tion. IFC's pioneering initiatives have sparked For its consulting work IFC received a fee, most growth of the leasing industry in Sri Lanka, Jor- of which was used to purchase shares in the devel- dan, Peru, Pakistan, Tunisia, Bangladesh, India, opment company that was established to imple- and Turkey. ment the proposal. Subsequently, IFC helped finance the development of the upstream unit and D. Assisting Sectoral Development and Broader some of the downstream companies in the first Policy Goals complex. The Corporation is currently undertak- ing a somewhat similar role in the development of A third area of development contribution by IFC a second petrochemical complex in Thailand. has involved investment activities with impacts well Petrochemicals in Brazil When IFC began its con- beyond the normally limited boundaries of a sin- tribution to the development of the petrochemical gle project. In some cases IFC has contributed to industry in Brazil some twenty years ago, no signif- the development of an entire sector, while in oth- icant modern petrochemicals sector existed in that ers the participation of IFC has helped govern- country. In 1969 and 1970, IFC financed Brazil's ments to achieve broader policy goals related to first large-scale integrated petrochemical com- private sector investment. Examples of this type of plex-four companies (a cracker and three down- development contribution are given in the follow- stream) in the state of Sao Paulo. Beyond this ing case studies. financing, the Corporation played a crucial role in 11 supporting development of what has since become petrochemicals sector in Brazil that today is a suc- a well-known model of such development. This cessful, modern, efficient world-class industry. model includes (a) the tripartite division of owner- Capital markets in Korea. In 1971, a dialogue be- ship among local private, local public, and foreign tween IFC and Korea resulted in the formation of private shareholders, so that the public authority Korea Investment Finance Corporation (KIFC), has an incentive to adopt policies supportive of the the first institution allowed to set its own interest development of downstream companies, but pri- rates for raising and relending short-term funds. vate owners have a majority interest in these com- The banking environment then was one of regu- panies; (b) a pricing mechanism for inputs and lated commercial banking and deposit rates and a outputs that permits efficient projects to earn a shortage of credit. Companies unable to obtain reasonable return but avoids exploitation of mo- credit allocations from the banks were forced to nopoly positions; (c) an open door to foreign borrow in the high cost "kerb" market. KJFC dem- technology with adequate returns to providers of onstrated the ability to mobilize working capital the best up-to-date processes and incentive struc- funds with low intermediation costs while offering tures to ensure the technical partner's commit- both borrowers and providers of funds improved ment to the success of the project; and (d) a terms. Korea now has over thirty finance institu- sharing of common services in the complex that tions similar to KIFC. This institution-building ef- provides cost savings for all. The presence of IFC, fort was repeated by IFC in 1977 for leasing in its willingness to participate, and its assistance in Korea, again in 1977 for securities margin finance, negotiations helped to rally the necessary support and in 1983 for venture capital. This track record for these concepts. of IFC institution-building investments, followed IFC engineering staff made important contribu- in each case by competing institutions established tions to project management and technology as- to provide similar services, illustrates a deepening pects of this complex venture, the first time any of the domestic financial markets, an impact not major petrochemical plant was created in Brazil amenable to economic rate of return calculations. without the full control of a multinational. Among In retrospect, IFC contributed even more to the many other inputs, IFC first suggested and then development of Korea's capital markets through helped develop the first use of a tar-like residue as the technical advice and support it gave the Ko- a raw material to produce carbon black, a process rean Finance Ministry during the critical establish- that has since been replicated worldwide. On the ment and transitional phases than through the financial side, IFC also mobilized equity invest- funds that it subsequently helped to marshal.6 The ments from subsidiaries of two large money center Corporation's advice was particularly valuable dur- banks in the United States. ing reform of the Korean securities market, when After the success of the first complex, a second the Ministry had to overcome problems of both was constructed in Northeast Brazil during the inexperience and opposition to reform. The even- 1970s. Financing was readily available, notably tual development of the Korean capital market from an IDB line of credit, and IFC participated clearly benefited from the managerial expertise initially in only one company. Later, in a second and sound practices that IFC helped bring to bear round of developing downstream industries in the during the crucial early stages. early and mid-1980s, financing had become very (h) Breaking Down Country Risk Barriers difficult to obtain in Brazil, and the Corporation assisted several more companies. When in the late Helping a member-country government to over- 1970s the third complex was being set up, in the come perceptions of high-risk or other adverse South, the World Bank financed the cracker and conditions on the part of foreign investors has IFC participated in three downstream companies, become an important part of the Corporation's mobilizing large loan participations from interna- project finance work. IFC seeks out and supports tional commercial banks. The Corporation's con- sound projects in countries that other investors tinued and multifaceted support for the industry's regard as too risky. Such initiatives have been im- development (which includes many additional ac- portant in China, Eastern Europe, and in recent tions not mentioned here) has resulted in a basic times in Latin America, where foreign capital is 6. This view was expressed strongly by Dr. D. W. Nan, the former Prime Minister of Korea, during an address to the Asian Development Bank in Manila, November 18-22,f1984. 12 scarce and where the demonstration effect of IFC nancing in which the banks' funding was chan- participation may be significant. neled through IFC. The Corporation also pro- IFC's investments in China, in conjunction with vided the additional equity needed to balance the advisory services provided by FIAS, have helped to company's financial structure, agreeing to future improve China's investment climate as well as sale of such equity to Mexican investors so as to other investors' perceptions of it. This is exempli- preserve the necessary balance between domestic fled by an automobile project-IFC's first under- and foreign ownership. This not only permitted taking in China. IFC played a major role in the planned expansion to proceed, but it also led finalizing the complex joint venture contract to to some renewal of foreign financing in similar the satisfaction of both the foreign investor and situations in Mexico and elsewhere in Latin the local partner. Another example is Indonesia America. after the late 1960s, when foreign investors were Much of IFC's recent syndications of project extremely wary of dealing with the new govern- financing (some $200 to $300 million per year) has ment, which itself was inexperienced in dealing been in countries where commercial banks have with foreign investors. IFC took the initiative by been unwilling to make voluntary new loans ex- organizing a cement project that subsequently be- cept under the Corporation's "umbrella." These came the first publicly listed company in Indone- countries include Argentina, Chile, Mexico, Phil- sia. Other IFC initiatives taken in Indonesia about ippines, Uruguay, Venezuela, and Yugoslavia. this time included the successful rehabilitation of a major hotel project; promotion of technical and (iii) Assisting Privatization marketing arrangements with foreign textile firms; Another way the Corporation responds to the and efforts to provide a stimulus to oil palm plan- needs of member-country governments is by help- tations through reform of government ing them privatize public companies. Some gov- regulations. ernments have recently decided to transfer A more recent example is the establishment in selected publicly owned and controlled produc- 1987 of a joint venture in Hungary to produce tion and marketing activities to private companies. synthetic lysine, a feed supplement for pigs and This process has turned out to be fraught with poultry. The project marked an important oppor- multiple difficulties, and in many cases the prob tunity to introduce a new technology into Hungary lems have been beyond IFC's capacity to help. In a through the participation of the foreign partner, few cases involving investor confidence, however, who was not prepared to enter any joint venture in the Corporation has been able to play a role. These the country without IFC's participation. The proj- are instances where the basic business aspects ect was IFC's first industrial sector project in Hung- make good financial and economic sense, but pri- ary and was the result of requests by the Hungarian vate investors (local or foreign) are held back by authorities for IFC to encourage foreign invest- adverse circumstances in the country, or by fear of ment. This project represents one part of the re- renationalization by a new government with differ- form process that the Hungarian economy is ent views. undergoing to introduce commercial discipline to One example is a forestry, timber, and plywood business enterprises. operation in Liberia that had operated profitably IFC's actions to overcome country risk and con- in private hands during the 1970s, but went bank- fidence problems are not limited to countries rupt after a takeover by the Government in 1980. newly open to foreign investment. The Corpora- When, after a few years, the results of nationaliza- tion has recently financed many worthwhile pro- tion became evident, the Government was eager to jects in Latin America for which satisfactory reprivatize the company but no investors could be financing could not be obtained elsewhere be- found. This was a problem with many companies cause of lenders' withdrawal. A typical example is a in Liberia at the time, and at the World Bank's cement company in Mexico, where IFC's assistance request IFC agreed to try to help. began with financing an expansion in the 1970s. In In this process, IFC was approached with a pro- the early 1980s, another expansion, in which IFC's posal that would help a private company take over participation had not been needed, was stalled in and rehabilitate the forestry, timber, and plywood the midst of implementation when foreign com- operation. The proposal had sound technical and mercial banks suspended disbursements shortly marketing aspects, but entailed a number of risks after August 1982. IFC moved into this situation, to investors. IFC was able to help negotiate appro- working with the company and its bankers to de- priate security arrangements, and the facilities sign and implement a new syndicated foreign fi- were successfully privatized. IFC's participation 13 was important not only to the private investor, but project caused the other bilateral agencies, which also to the Government of Liberia, which gained were potential financiers, to withdraw, effectively confidence that the deal was fair. Aside from the halting the project. fiscal benefits to the Government, getting the com- In another case, IFC affected the development pany operating again increased badly needed ex- of the petrochemical sector in a country by saying port revenues, generated employment for about "no" to a downstream petrochemical project, 700 workers, reopened hospital facilities operated which would have been the first, and possibly the by the company, and raised the standard of living only, domestic producer in the medium term. throughoutpany,oandte. While there appeared to be adequate domestic throghou thelocaity ~demand to sustain an economic-sized unit of the kind proposed, the plant would have depended on E. Saying No imported intermediate feedstock for the duration of its economic life. Internationally, the industry is Although it may seem paradoxical, the Corpora- essentially integrated back to the feedstock stage, tion has also promoted development by refusing to and IFC had serious reservations about the avail- finance bad projects. These projects, for want of ability and pricing of such feedstock on the market IFC's participation or from IFC's demonstration of for extended periods of time. The nonavailability their weaknesses, are then dropped by the spon- (or extremely high prices) of feedstock would have sors. Of all the investment inquiries IFC receives econo viait inpthealon for the that warrant serious consideration each year, it eveloment f tre u ndtr the proceeds, on average, with only one-third. In ef- sponsor was not willing to accept IFC's recommen- fect, the Corporation says "no" two-thirds of the dations on the need for long-term supply arrange- time. Of course, not all of ments for the feedstock, and hence IFC did not IFC's dropped projects are halted completely proceed with the project. Ongoing developments (some end up being financed by other institu- in the industry confirm that IFC's caution was tions), and not all of those that are dropped are justified. At this point, the project has not been economically unworthy. IFC's refusal to participate able to proceed without IFC. may be based on commercial risks. However, IFC's A further case involved a proposal to produce, diligence in project screening and appraisal has a rather than import, extruded aluminum shapes to benefitce be used in door frames, windows, and other parts that appear on the Corporation's books. of modern buildings. The extrusion requires a thatappar o th Cororaion' boks.press, and to produce a satisfactory range and There are cases where IFC's negative judgment variety of shapes a certain size press is needed. IFC on project viability has influenced the structure of concluded that to produce more than just a few important sectors of industry in individual coun- small shapes, the size of press required (and in- tries. In one instance, IFC was asked to consider deed proposed by the sponsor) would yield a ca- financing a large polyester fiber plant-the first in pacity more than three times current consumption the country and, given the expected level of de- in the country. Production costs would be consid- mand, likely to be the only producer in the me- erably higher than imports, but the sponsors were dium term. IFC's review indicated that the project unconcerned about this problem since they ex- had no real comparative advantage; technology, pected not only tariff protection against compet- capital equipment, and raw materials would have etd aluinm by ann s Altogh th to be imported, and expatriate management etue lmnmb noees.Atog h to b imortd, nd xpatiat maageent proposal appeared satisfactory from the financial would be required. The project was capital and side (there was then a construction boom in the technology intensive, and no benefits would ac- country), IFC declined to participate because of crue from the relatively low level of wages in the the adverse development impact, and the project country. The project's viability was based solely on was never implemented. Of course, there is no protection in the domestic market resulting from ERR or FRR on IFC's books that measures this the country's import tariff structure. Moreover, benefit. implementation of the proposed project might have adversely affected the cost structure of a com- petitive and growing textile and garment industry in the country. IFC's decision not to finance the 14 IV. IFC's Noninvestment Operations To meet the development needs of its members, the Capital Markets Department has studied and IFC is providing an increasing number of services advised on financial systemsin twentight coun- other than project finance. The oldest of these is tries, securities markets in forty-three countries, technical assistance on capital markets and finan- regulatory systems in twenty-eight countries, ac- cial sector development. Newer initiatives include counting systems in nine countries, tax policies in the Caribbean Project Development Facility twenty-two countries, and ways to increase access to (CPDF), the African Project Development Facility international capital markets in fourteen (APDF), the Foreign Investment Advisory Service countries. (FIAS), and technical assistance on corporate fi- Technical assistance rendered to capital and fi- nancial restructuring and privatization, which has nancial markets falls into one of two categories: (1) been growing for the past several years and for broad, open-ended assignments that review capital which the Corporate Financial Services Unit has markets in whole or in significant part, identify just been formed. (The Africa Enterprise Fund, problems, and recommend improvements and (2) several different kinds of activity under the Techni- more focused and detailed assignments, where the cal Assistance Trust Funds, and the Technology government has a specific aim (such as establish- Service Unit are even newer activities and there- ing a leasing industry or improving clearing mech- fore are not discussed here.) anisms in a stock exchange) and calls on IFC for specific policy guidance to help it meet this aim. A. Technical Assistance to Capital Markets Work in the second, more specific category may be more likely to succeed than in the first because While most other IFC project finance primarily the host government typically has already decided affects one productive enterprise, work in capital to do something before it asks IFC for advice on markets and financial institutions promotes, cre- how to do it. Nevertheless, the more general work ates, or strengthens companies that serve a large is often productive and helps define the specific number of other productive, private sector firms. steps that would be appropriate in a particular Thus, not only the technical assistance but also the country at a particular time. project finance in this sector have development In Kenya, for example, IFC has been closely impacts throughout the economy. The involved with efforts to develop the money and Corporation's efforts in this field improve business capital markets. A financial markets study was con- access to finance: they increase savers' access to a ducted jointly by IFC and the Central Bank in greater range of savings opportunities and thus 1984, and after some delays the Government of increase the supply of funds; they improve the Kenya recently initiated the establishment of a allocation of scarce funds among alternative uses; Capital Market Development Authority to imple- and they allow banks, borrowers, and intermediar- ment the recommendations. ies the opportunity to balance their portfolios in In Pakistan, IFC staff participated in a World line with their risk preferences and the flow of Bank-led financial-sector review mission and pre- their receipts and disbursements over time. In pared a report on the country's capital markets. A sum, IFC's efforts in capital markets can increase number of the recommendations made to stimu- the efficiency of the entire financial system. late the stock market have since been adopted. IFC Apart from project finance and policy advice also provided a detailed review of the procedures directly related to it, IFC's Capital Markets Depart- of the Karachi Stock Exchange with a view to ment also provides free-standing technical assis- upgrading the trading, clearing, and market infor- tance. Slightly less than half of all this activity is mation systems, and it advised on regulations done in collaboration with the World Bank, a col- needed to facilitate the establishment and opera- laboration which is growing, especially in Africa. In tions of private investment banks in an environ- the past three years alone, IFC has contributed to ment dominated by nationalized banks. The twenty-six Bank studies of the financial sector. recommendations were accepted and incorpo- The range of technical assistance that the Cor- rated into regulations for private investment banks poration provides directly to developing countries issued by the Government. Having helped to lay is extremely wide, covering virtually all aspects of the groundwork for this new set of institutions, IFC regulation of financial and securities markets as is now helping to create and finance a new invest- well as international financial flows. Since 1971, ment bank. 15 B. Corporate Restructuring companies have been in Latin America and most of the rest in Africa and Asia. The mechanisms of In the wake of the sovereign debt crisis that these restructurings are complex and their details began in 1982, the economic and financial prob- vary, but the recent example of Grupo Visa in lems of many countries, and unprecedented insta- Mexico illustrates the important points. bility in exchange rates, interest rates, and Visa is an integrated consumer products com- commodity prices, have left many private sector pany mainly involved in brewing, soft drinks, and companies in developing countries overburdened mineral waters with supporting manufacturing with debt. Heavy debt limits the money available (cans, bottles, plastic packaging, etc.) and distribu- for maintenance of plant and equipment, restricts tion activities. In addition, Visa had extensive hold- new investment, and makes it difficult for the com- ings in convenience stores, food processing, pany to respond to new business opportunities. automotive components, hotels, and bio-industries These effects are compounded by structural re- and employed more than 40,000 workers through- form policies, such as the opening up of the econ- out Mexico. The group's rapid expansion and di- omy (outward orientation), which alter the versification, achieved during Mexico's oil boom economic environment in which firms must and financed mainly with foreign borrowings, left operate. it in serious financial difficulties after 1982, and it The widespread nature of these problems led ceased to service its debts in late 1986. Although its IFC to expand its assistance from companies al- debt was trading in the secondary market for as ready in its portfolio (mentioned earlier in this little as 30 cents on the dollar, many of the group's report) to other worthwhile private sector enter- businesses continued to make well-regarded prod- prises. The restructuring activity is supported by ucts and were operationally profitable. The re- charging fees. The thrust of IFC's restructuring structuring devised by IFC resulted in a net efforts is to identify companies or corporate reduction of $1.3 billion in Visa's total debt of $1.7 groups where the core business is fundamentally billion, including $1.1 billion of foreign debt. The sound, but where the debt burden is the main net reduction was achieved by selling some non- factor that inhibits the development of the busi- core businesses (including a hotel chain and an ness. A package can then be put together that automotive parts factory), buying back some of the restructures the company financially, and often outstanding debt at a substantial discount, debt-to- the physical operations as well, thus reducing the equity swaps, issuance of bonds in the local capital debt burden, mobilizing debt and equity financ- market, new equity raised through private place- ing, and injecting new money into the core busi- ment and a local public offering, and rescheduling ness. IFC's financial and industry expertise, of some of the original debt. Importantly, the re- coupled with its credibility as a multilateral devel- structuring allowed the creditors to choose from a opment institution engaged in private corporate clearly defined range of options that balanced risk finance, render it uniquely well placed to offer this and reward and allowed the market place to deter- kind of service as well as to act as the "neutral mine the pricing of the main features of the party" and "honest broker" in necessarily difficult restructuring. and complex negotiations. Its project-finance ex- perience allows it to assess a company's prospects C. Caribbean Project Development Facility and help devise operational and technology im- (CPDF) and Africa Project 1 provements as well as the appropriate capital struc- Development Facility (APDF) ture to revitalize the company. At the same time, IFC's expertise at the negotiation table, its market The Caribbean Project Development Facility orientation, and its reputation in world capital was established in 1981 under the auspices of markets allow it to retain the confidence of the UNDP, with IFC as the executing agency Its aim is creditor banks. IFC's ability to put its own re- to help small- and medium-sized enterprises, sub- sources into restructuring increases confidence in stantially owned by Caribbean citizens, to raise the soundness of the restructuring proposal and funds for new investments. It does not provide helps mobilize financing to fill critical gaps in the funding itself rather it assists in the preparation of firm's revised capital structure. market and prefeasibility studies and of other doc- IFC has participated financially in forty-eight uments that financial institutions require in evalu- restructurings, provided technical assistance to an- ating proposals. other fourteen companies, and given informal ad- Since its inception, the Facility has worked with vice to many others. About one-half of these project sponsors in twentone Caribbean coun- 16 tries and territories, evaluating their projects and, Guarantee Agency, RAS gives technical assistance where appropriate, helping them to raise loan and to governments of developing member countries, equity funds for those projects. CPDF's efforts have and conducts research on how to attract more resulted in the financing of forty-five projects in- foreign direct investment and how to utilize it volving total investments of almost $100 million more effectively. Its work is similar to the free- and generating employment for about 3,300 peo- standing technical assistance given by the Capital ple in the region. These projects have been widely Markets Department in that, unlike other IFC ac- spread across agriculture, agro-processing, manu- tivities, its advice is given to government agencies facturing, and tourism sectors and have been lo- or officials and concerns improvements in laws, cated in fifteen countries. CPDF emphasizes small- regulations, institutions, and practices relevant to and medium-sized projects that play an especially a particular aspect of the government's develop- important role in those smaller economies. Of the ment objectives. forty-five projects that have been funded, thirty- FIAS's work has expanded rapidly as many coun- one were of a total size of $2 million or less. tries have shifted their views on the usefulness of The Africa Project Development Facility is de- foreign investment and are seeking help in attract- signed to provide to African entrepreneurs the ing more of it. In its first two years of operation, services that CPDF provides in the Caribbean. It is FLAS advised fifteen different countries on promo- cosponsored by IFC, UNDP, the African Develop- tion and regulation of foreign investment. In six of ment Bank, and seventeen countries. Its offices those countries, FAS did at least one repeat proj- (located in Abidjan and Nairobi) opened in No- ect. FLAS often begins by diagnosing the invest- vember 1986. APDF has received over 1,000 re- ment climate and identifying specific aspects quests for assistance from local entrepreneurs. Of where change would be most productive. More these, seventy project proposals have been pre- focused work then follows. In China, where FIAS's pared and submitted to possible donors, and ap- formal work began, the first activity was a seminar proximately one hundred more are being in which the practices of other countries, and prepared with the assistance of APDF staff. Thirty foreign investors' views of China, were analyzed have secured funding (two in the first year and and discussed. Attended by about 100 officials twenty-eight in the second). The total cost of these from all over China, the seminar was especially projects was $47 million (an average $1.6 million valuable because Chinese officials have relatively per project), of which $32 million was secured by little experience with foreign investors. A second APDF ($3.4 million in equity and $28.6 million in project focused on a law to regulate one of the six loans). These projects will create 2,300 jobs in forms of foreign investment permitted in China. A thirteen countries and will produce foreign ex- third project concerned ways to reduce problems change savings (or earnings) of $22.3 million. for foreign joint ventures caused by China's at- None of these projects has had a long enough tempts to make virtually every one of them self-suf- life to be evaluated, but the beneficial impact of ficient in foreign exchange-a policy previously APDF's activities goes beyond the number of pro- identified as the biggest single inhibitor of invest- jects implemented. Substantial consulting re- ments in high-technology activities, which the Chi- sources have been committed by APDF to help nese very much want to attract. During this time, a develop projects, and the capabilities of local con- FAS staff member took part in a major World sultants are being improved by their contact with Bank mission to China and wrote the part of the APDF. The facility also helps to redesign projects if report on foreign investment. initial study indicates this is appropriate; for exam- The advisory services of FIAS, like those of the ple, a flower export project in Nigeria was de- Capital Markets Department, are given only in signed to grow anthuriums for the North response to the request of a government. In seven American market, but APDF advised the sponsor of the eleven countries in which advisory projects that the European market for roses represented a have been completed, the recommendations of better opportunity. A revised business plan was FAS were followed. In China, the Government is compiled, tests are under way, and full implemen- implementing the key recommendation to tation is scheduled for 1989. strengthen and integrate nationally a secondary market for foreign exchange, so that until such D. Foreign Investment Advisory Service (FIAS) time as the currency is made convertible, foreign joint ventures will not have to depend on govern- Begun in 1986 and recently structured as ajoint ment allocations of foreign exchange (which have service of IFC and the Multilateral Investment often been very difficult to obtain), but rather can 17 buy it at its market value. In Thailand, the Govern- packages, each tailored to a particular objective ment implemented FIAS advice to rationalize in- (e.g., development of poor regions of the centives by designing a small number of incentive country). 18 V. Conclusions Project finance: measurable results. The develop- seldom produce impressive profitability figures or ment impact of IFC's investments has been posi- other quantitative indices of development impact. tive, according to the available quantative data. Policy and technical assistance. The growing kinds Two samples of IFC projects for which ex-post of assistance other than project finance are even economic rates of return were available had aver- more difficult to evaluate in a rigorous way. With age economic returns of 10 percent and 11 per- policy advice to governments, such as that fur- cent in real terms. (One of these samples was from nished by the Capital Markets Department and by sector studies that focused on some problem sec- FAS, failures are usually evident, while successes tors and therefore has worse results than IFC's are seldom provable. Leverage is high in such investments as a whole.) These returns are well in activities, however; one successful advisory project excess of the real cost of corporate funds in the can produce improvements that induce numerous United States, which has been around 5 percent investments that would not otherwise have taken during the 1980s. Financial profitability of compa- place. The African and Caribbean project develop- nies assisted by the Corporation, which is a sine ment facilities are more labor intensive, but they qua non of development impact, has also been are clearly excellent ways to help incipient entre- satisfactory, although some sectoral investments preneurs start small businesses in many small econ- (agricultural production in particular) have not omies. Corporate restructuring is even more labor performed as well as others. Given the troubled intensive, requiring considerable time by senior state of the economies of many of IFC's developing investment officers in complex and difficult work. members, these results can be considered good. While it is too soon to be sure of the long-term Project finance: beyond measurable results. IFC's results, the work is obviously something badly project finance activities produce many important needed in many developing member countries. development impacts that are not fully reflected in A developing synergy. Perhaps the most important the rates of return. Some of these benefits are not IFC advance in recent years has been in creating a captured in profitability or ERR estimates because synergy between project finance and technical as- they do not accrue to the company, are difficult to sistance. Project finance has important develop- quantify, or are not apparent for some time. Oth- mental benefits. It continues to be, and should be, ers are partially reflected in the numbers, but are the backbone of IFC's work. But even after full the kind of IFC contribution that has transformed efforts to maximize catalytic effects, project fi- a negative return into an acceptable but not spec- nance is still somewhat limited in impact. The tacularly positive one, or a nonbankable idea into other activities meet different needs, and in some a bankable project. Improving a project's pro- cases have potentially greater effects. But without posed financial or technical structure during ap- project financing, the Corporation would have far praisal and sticking with a company and less standing and far less expertise for these other continuing to assist it through hard times are ex- efforts. The combination of project finance and amples of the latter; both are routine for IFC, done nonproject activities has contributed much to in many, many cases. They are a major part of the IFC's development impact and will probably be Corporation's contribution to development, but even more important in the future. 19 Annex 1 Economic Rate of Return Analysis in IFC price, and the cost of inputs is either their actual import cost (if directly or indirectly traded) or The need for economic analysis arises in IFC their alternative export value in the case of domes- because (a) distortions have been prevalent in tically supplied, exportable items. many market prices in the developing countries, The economic rate of return calculation can and (b) externalities or "hidden" economic costs and should capture many of the external costs and and benefits sometimes result from investment benefits associated with projects. For example, ad- projects. While the financial impact of a project on ditional infrastracture provided by the state solely a company must be based on market prices, the for a project would be included as a cost in the economic impact of the project on the country must economic analysis. On the other hand, if excess be based on opportunity costs, if they are different capacity is available in a nontradeable commodity from market prices. Price distortions generally (or in a tradeable bulky commodity that is difficult arise because of the effects of protection, subsidies, to transport), the marginal economic cost might taxes, price controls, and other forms of state in- be substantially lower than the financial price ne- tervention in the marketplace. External costs arise, gotiated between buyers and sellers. If domestic for example, when projects displace existing pro- production reduces inventory requirements for ducers or require supportive state investments in previously imported goods, the net economic infrastructure or pollution control. Sources of ex- working capital cost attributed to the project might ternal benefits include the training of local em- be zero or even negative (i.e., a benefit accruing ployees and inventory or other savings accruing to from the project). If substantial training costs are downstream industries. Since business decisions incurred, they might not be fully classified as eco- are based on commercial signals that may not nomic costs if trained labor can be expected to reflect the true value of a project to an economy, remain in the economy even after leaving the par- the possibility of conflicting conclusions arises ticular project. when economic analysis is performed. Forecasting future international prices of inputs The mechanics of economic and financial anal- and outputs is often the most difficult part of the ysis are broadly similar, and both start with the analysis. IFC's wide experience helps in some same set of pro forma financial projections for a cases. It permits reference to studies done for project. Economic analysis goes beyond the finan- other projects and/or to costs in other projects cial projections to identify the opportunity or that give an index of the proposed project's rela- "shadow" prices for key outputs and inputs that tive efficiency In addition, the analyst needs to reflect the economic impact of a project. For items examine long-term price trends and margins, the that are tradeable, the main focus of the international market situation, and factors deter- economist's search for shadow prices is the deter- mining comparative advantage in the industry mination of the appropriate "border" or interna- (scale, location, and access to raw materials and tional prices (free of taxes and other charges energy). imposed at the border). The appropriate border Besides focusing on industry and sector costs price has to reflect long-term supply and demand and prices, economic analysis of projects also in- conditions so that project analysis is not biased by volves analysis of country factors and project-spe- temporary price aberrations. For items not directly cific calculation of returns and other parameters. tradeable, and whose values cannot be assessed on These include the basic economic policy frame- the basis of components that are tradeable, em- work of the country, trade and tariff policy, public phasis in the analysis switches to the determination enterpnse prcing, exchange rate policy, and do- of the proper shadow exchange rates. With the mestic price controls. Grasp of these policies en- latter, local currency costs and benefits can be ables preliminary decisions to be made as to where converted to foreign currency equivalents. the main adjustments to the financial analysis will The use of international prices for project anal- be required. Knowledge of the country's prevail- ysis is based on the notion that these show oppor- ing economic situation also provides the back- tunity costs or values from the country's viewpoint. ground for judgments on growth prospects Thus, an import-substituting project implies a (market), inflation (costs), balance-of-payments "make or buy" decision for the country in which (foreign exchange availability), and the exchange the true value of output is the alternative import rate (equity risks). Finally, the trends in policy, the 20 components of structural adjustment programs, returns, failing which IFC may decide not to sup- and other expected changes are tracked so as to port the project. permit their accurate reflection in the basic Economic analysis of proposed investments has projections. provided a number of other benefits to IFC's deci- IFC economists use readily available country sion making in addition to its primary function of and industry information from the World Bank assessing the developmental impact of investments and the International Monetary Fund, previous on host countries. The economic analysis, for ex- IFC project experience, and engineering knowl- ample, serves as a barometer of the investment's edge of industry characteristics. However, where underlying commercial viability. This is because information is not available or is of unacceptable shadow pricing reveals whether a project would be quality, additional analysis is necessary. Often mac- likely to survive when fully exposed to market roeconomic information from the World Bank has forces-without government protection or to be adapted for use at the project level. Some- subsidies. times World Bank staff do not have up-to-date, or Economic analysis of projects can also be used as even any, information of some factors relevant to a a basis for dialogue with host governments about particular IFC project, and in such cases IFC staff the effects and the desirability of changes in gen- are required to develop basic parameters or pro- eral or sectoral policies that affect the profitability jections themselves. of investments. There is a natural spillover effect After the various country and industry parame- into IFC's attempts to articulate its own investment ters needed for the analysis are estimated, the strategy in particular countries. quantitative indicators of economic viability-eco- Moreover, the country-specific experience to nomic returns and returns to the domestic econ- which staff economists are exposed enables them omy-are calculated. In most cases, this is the least to provide a substantial input into IFC's growing time-consuming aspect of the exercise because a array of free-standing technical assistance activi- standard methodology is employed. ties. For example, project economists have been The standard ERR, as calculated by both Bank useful to FLAS because of their understanding of and IFC staff for proposed projects, considers the how a particular country's policies affect the prof- impact of all economic costs and benefits on the itability of foreign investments. This kind of spillo- host-country economy. In economists' terms, it ver should also be useful in the Corporation's new measures the effect of the project on the GDP of and growing work on privatization and on finan- the country. Because many IFC projects involve cial restructuring. both foreign and domestic financing, the Corpora- IFC has more practical experience in the eco- tion also calculates a second ERR, which it calls nomic evaluation of projects with foreign sponsors "the return to the domestic economy." This calcu- than practically any other development institution. lation includes only costs and benefits to host- Both directly as part of FIAS, and outside it, IFC is country nationals (individuals and business firms). now being sought out to provide assistance and Costs and benefits accruing to foreigners are ex- training in this field. In 1987, two Malaysian offi- cluded. This second ERR thus compares the re- cials with responsibilities for foreign investment turns that accrue to host-country owners of factors evaluation spent a week examining various aspects of production, to the costs incurred by host-coun- of IFC's approach to the problem-and its applica- try factors. It measures the impact of the project on bility in the Malaysian context. Two bilateral aid the GNP of the host country. It can be higher or agencies, DEG (Germany) and IFU (Denmark), lower than the standard ERR. If it is lower, foreign recently began carrying out economic evaluation participants in the project are getting higher re- of project proposals as part of their standard oper- turns than are local ones; if this difference is signif- ating procedures. IFC advice was informally sought icant and not justified by the circumstances, IFC by both institutions, and as a result the Corpora- staff try to restructure the project arrangements tion organized a seminar in Copenhagen in April (financing, management, and technical fees and 1988. royalties) to achieve a fairer distribution of the 21 Annex 2 Quantitative Estimates of IFC Investment Returns The frequency distribution of these projects, defined according to the difference between ex- Background to Data Sample ante ERR and ex-ante FRR, is shown in Table 2. Whereas every project approved by lFC contains Table 2. Distribution of Projects by Difference detailed ex-ante estimates of ERR and FRR, there Between Ex-Ante ERR and Ex-Ante ERR is less than complete project coverage when it comes to estimation of ex-post returns. For this erRmnus ERR study, a sample of 110 projects was identified for which ex-post estimates of both economic and Less than -10.0 3 financial returns were available. The total sample -5.01 to -10.0 7 of 110 projects was drawn from two sources: data Zero to -5.0 29 on fifty-seven projects were obtained from sectoral Zero to 5.0 47 studies undertaken by IFC's Operations Evaluation 5.01 to 10.0 11 Unit (OEU), and data on fifty-three projects were Greater than 10.0 13 obtained from project completion reports (PCRs). 110 Further details of these data sources are given in Ex-Post Returs on ffC Projects Part II. For purposes of ex-ante return analysis, the total sample of 110 projects has been analyzed as a As outlined in Part 11, an important difference single group, as shown in Section 2 that follows. between the OEU and PCR estimates of ex-post For purposes of ex-post return analysis, the data project returns is the amount of actual operation sample is split into OEU and PCR groupings to the.project has experienced at the time the re-eval- reflect the different measurement basis of the data uation is made. Projects evaluated by OEU have sources. The ex-post results are discussed in Sec- more than two years' operational experience at the tion 3. time that re-evaluation is made, while the PCR To provide further insight into the financial per- re-estimates reflect little or zero operational expe- formance of IFC's project investments, this Annex rience. Both the OEU and PCR re-estimations in- contains profitability data derived from the ac- corporate forecasts of costs and returns. counts of companies in which IFC has invested. Therefore, they are not "true" ex-post evaluations These financial data are shown in Section 4. in the sense of being based on, say, fifteen or twenty years of operational data. Ex-Ante Returns on FC Proects Summary statistics on the ex-post ERRs and Summary statistics on the ex-ante ERRs and ERRs taken from the OEU and PCR samples are FRRs for the total sample of 110 projects, grouped shown in Tables 3 and 4. by sector, are shown in Table 1. Table 3. Distribution of Real Ex-Post Returns Table 1. Distribution of Real Ex-Ante Returns by Sector by Sector PCR Sample OEU Sample No. of Ex-Post Ex-Post No. of Ex-Post Ex-Post No. of Ex-Ante Ex-Ante Sector Projects ERR FRR Projects ERR FRR Sector Projects ERR FRR Agricultural Agricultural Production 15 21% 20% Production 2 2% -3% 13 2% 3% Agricultural Processing 19 24% 20% Agricultural Cement 20 27% 19% Processing 6 11% 14% 14 7% 4% Chemicals 5 22% 25% Cement 11 11% 7% 9 20% 11% Mining 13 28% 25% Chemicals 4 15% 15% Manufacturing 11 21% 21% Mining 4 8% 11% 9 16% 13% Pulp, Paper 4 17% 23% Manufacturing 1 18% 10% Textiles 15 19% 19% Pulp, Paper 4 14% 15% Tourism 6 19% 14% Textiles 3 17% 20% 12 10% 8% Other 2 18% 17% Tourism 6 11% 9% Group Average (unweighted) 110 23% 20% Other 2 17% 16% Note: Data refer to 110 projects from combined OEU and PCR Group Average 53 11% 11% 57 10% 7% samples. NOTETCR and OEU samples are not overlapping. 22 Table 4. Distribution of Real Ex-Post Returns as made to facilitate comparison with U.S. Depart- Percentage of Total Projects in Samples from ment of Commerce data on earnings of U.S. com- Project Completion Reports and from the pany affiliates abroad. Earnings and asset Operations Evaluation Unit. valuations were available for 136 of the 154 mature Percentage of Percentage of investments currently on EFC's active portfolio. PCR Project OEU Project Data were recorded for the most recent year avail- Ex-Post ERR Sample Sample able, which for most companies was 1987. On Zero or negative 19% 33% average, the 136 firms earned a return of 11.7 Positive and less than 10% 28% 21% percent (EBIT) and 9.5 percent (EBT). The distri- 10% to 20% 36% 26% bution of returns are shown in Table 5. Greater than 20% 17% 19% 100% 100% Earning Ratios (%) No. of Companies Earnings Performance of Mature FC Investments EBrr EBT Data on the earnings performance of compa- Zero or negative 13.2% 15.5% nies in which IFC has mature investments (i.e., Positive and less than 10% 39.7% 42.6% where investment commitments were made in 10% to 20% 26.5% 25.7% FY83 and earlier) were compiled from company Greater than 20% 20.6% 16.2% records. Earnings are measured as EBIT (Earnings 100.0% 100.0% before Interest and Taxes) and as EBT (Earnings Note: These data are preliminary and in many cases are derived before Taxes), and they are expressed as a percent- from unaudited company accounts. age of company assets. The EBT calculation is 23 Distributors of World Bank Publications ARGENTINA FRANCE MEXICO SPAIN Calo HIrsch SRL Warld Bank Pubicatims INFOTEC Mndl-Prera ibre, SA. 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