Report No. 656a-IS RETURN To Appraisal of an R REPORTS DzSK Industrial Development Project WITHIN in Israel May 7,WFILE COPY Industrial Credits and Development Finance Companies Division F L C O PY Regional Projects Department Europe, Middle East, and North Africa Region Not for Public Use Document of the International Bank for Reconstruction and Development International Development Association This report was prepared for official use only by the Bank Gcroup. It may not be published, quoted or cited without Bank Group authorizatiors. The Bank Group does not accept responsibility for the accuracy or completeness of the report. CURRENCY EQUIVALENTS C 0. JAN 12 1979 Prior to November 10, 1974 US $1.00 = IL 4.20 IL 1 . US$ o.24 After November 10, 1974 US $ 1.00 = IL6.0o IL 1= US $ 0.17 LIST OF ACRONYMS AND ABBREVIATIONS IDBI Industrial Development Bank of Israel Ltd. OCS Office of the Chief Scientist IFC Industrial Finance Corporation Limited Histadrut Federation of Labor Unions GTEI General Telephone and Electronics International, Inc. GOVERNMENT OF ISRAEL FISCAL YEAR April 1 to March 31 APPRAISAL OF AX 1`rtJSTRIAL DEVELOPMENT PROJECT IN ISRAEL TABLE OF CONTENTS Pae No. BASIC DATA SUMMARY AND CONCLUSIONS ................................. i-v I. INTRODUCTION ......................................... 1 II. THE ENVIRONMENT. 1 A. Economic Performance. 1 B. The Industrial Sector. 3 C. Financial Setting .5 III. APPRAISAL OF THE INDUSTRIAL DEVELOPMENT BANK OF ISRAEL (IDBI). 7 A. IDBI's Structure. 7 Ownership and Control. 7 Management and Staff. 7 Policies and Procedures. 8 B. IDRI's Operations. 9 Summary of Operations ........................ 9 IDBI's Role and Development Impact. 9 Progress in Meeting the Objectives of the Third Bank Loan .10 C. IDBI's Financial Situation .10 Resource Position .10 Resource Mobilization Effort .11 Quality of Portfolio .11 Financial Performance and Position .11 D. IDBI's Prospects .12 The Environment .12 Forecast of Operations and Resources .13 Projected Financial Situation .13 The present report is based on the findings of an appraisal mission to Israel in October-November 1974, composed of Messrs. George C. Maniatis, James L. Theodores, Henry B. Thomas, H.K. Work (R&D consultant) and J.C. Jones (con- sultant on technical training). Mr. Charles Weiss collaborated in the ap- praisal and selection of the R&D subprojects. TABLE OF CONTENTS (Continued) Page No. IV. APPRAISAL OF THE RESEARCH AND DEVELOPMENT COMPONENT ...... 14 A. The Role of R&D in Israel's Development ........... .. 14 B. The Proposed R&D Project .............. .............. 16 Objectives .......................................... 16 Selection of R&D Subprojects ..........* .............. 17 Nature of R&D Project Appraisal ...................... 17 Major Features of R&D Subprojects ............... .... 19 The Risk Element .. ................ ........ I....... . 22 Cost Estimates and Financing ............... ...... #.. 23 Disbursement and Procurement ....... ............... 25 C. Project Implementation ..... ......................... 26 The Project Unit .................................... 26 Development of OCS's Organization and Appraisal/ Supervision Capability ........... ................... 27 V. APPRAISAL OF VOCATIONAL/TECHNICAL TRAINING COMPONENT ..... 29 A. Educational System and Development Strategy in Israel ........ ..................................... 29 B. The Proposed Vocational/Technical Training Component . . ......... I ............ 30 General ........................................ 30 Vocational Training Centers ........ ............... 31 Technician Training Institutions ................... . 31 Cost of Vocational/Technical Training Component ..... 32 C. Implementation and Disbursement ...................... 33 Project Administration ...... ........................ 33 Procurement .......... 33 Disbursement ........................................ 34 Design and Implementation .................. .. 34 VI. THE PROPOSED LOAN - OBJECTIVES AND JUSTIFICATION ......... 34 VII. RECOMMENDATIONS ............................... .. . ........ ....... 36 A. IDBI Component ..... . ............... 36 B. R&D Component ................................... ..... 37 C. Vocational/Technical Training Component .......... .... 38 LIST OF ANNEXES Annex 1. ISRAEL: Summary of Investment and Export Incentives to Industry 2. ISRAEL: Interest Management and Its Implications 3. IDBI: Shareholders as of October 31, 1974 4. IDBI: Board of Directors and Committees as of October 31, 1974 5. IDBI: Organization and Staff Chart as of March 1, 1975 6. IDBI: Subsidiaries 7. IDBI: Computer System 8. IDBI: Loan Operations Table 1: Summary of Loan Operations 1968-1974 Table 2: Summary of Loans Outstanding by Industrial Sector 1972-1974 Table 3: Analysis of Loans Approved 1958-1974 9. ISRAEL: Sources of Finance for Industrial Fixed Investment 10. IDBI: Resources Position as of September 30, 1974 11. IDBI: Loans Portfolio Analysis as of June 30, 1974 Appendix: Note on Arrears 12. IDBI: Income Statements 1970-1974 13. IDBI: Balance Sheets 1970-1974 14. IDBI: Analysis of Spread 1970-1974 15. IDBI: Projections of Loan Operations 1974-1979 16. IDBI: Projected Cash Flow Statements 1974-1979 17. IDBI: Projected Statements of Income 1974-1979 18. IDBI: Projected Balance Sheets 1974-1979 19. IDBI: Projected Disbursement Schedule 20. ISRAEL: Organization of R&D Activity Appendix: Organization Chart of Research and Development in Israel 21. Multipurpose Facility for Industrial R&D in Negev Appendix 1: Organization Chart Appendix 2: Key Scientific Personnel of Research and Development Authority as of January 31, 1975 Appendix 3: Budget April 1, 1974-March 31, 1975 Appendix 4: Analysis of Expenses for Year Ended March 31, 1974 22. Solar Ponds Appendix 1: Scientific Research Foundation - Organization Chart Appendix 2: Scientific Research Foundation - Balance Sheets 1973-74 Appendix 3: Scientific Research Foundation - Budget - April 1, 1975-March 31, 1976 23. Liquid Wax Production from Jojoba Beans Annex 24. Rural Telephone System Appendix 1: Financial and Economic Calculations Appendix 2: Tadiran's Projected Market Share Appendix 3: Summary Balance Sheets 1972-1977 Appendix 4: Summary Profit and Loss Statements 1972-1977 25. Prime Movers (Engines) for On-Site Power Generation Appendix 1: Financial and Economic Calculations Appendix 2: Summary Balance Sheets 1972-78 Appendix 3: Summary Profit and Loss Statements 1972-78 26. Transverse Section Tomographic Scanner Appendix 1: Financial and Ecomomic Calculations Appendix 2: Surmary Consolidated Balance Sheets 1972-1976 Appendix 3: Summary Consolidated Profit and Loss Statements 1972-76 27. Projections of R&D Expenditures 28. Functions of the Office of Chief Scientist Appendix 1: Industrial Research Administration - Board of Directors as of October 31, 1974 Appendix 2: Office of Chief Scientist - Research Committee as of October 31, 1974 29. Office of Chief Scientist: Organization Chart as of October 31, 1974 30. R&D Component: Schedule of Estimated Quarterly Disbursements 31. ISRAEL: Education and Training System 32. ISRAEL: Ministry of Labor - Structure of Vocational Training Department, 1974 33. ISRAEL: Population by Age Group and Enrollment by Educational Level, 1973 34. ISRAEL: National Expenditure on Education FY1963-72 35. ISRAEL: National Expenditure on Education by Agency and Type of Expenditure FY1972 36. ISRAEL: Projection of Employment by Sectors 1970-1985 37. ISRAEL: Estimated Requirements of Middle and High Level Technicians 1970-1985 38. ISRAEL: Estimated Output of Project Institutions in 1980 39. Project Costs by Type of Expenditure 40. Contingency Allowances 41. Estimated Recurrent Expenditure for the Project Institutions 42. Vocational/Technical Component: Estimated Disbursement Schedule 43. Implementation Schedule Map of Israel IBRD No. 11483 - a - BASIC DATA A. INDUSTRIAL DEVELOPMENT BANK OF ISRAEL LIMITED Year of Establishment: 1957 Ownership (as of October 31, 1974) IL (OO) Percent Ordinary A (voting) Shares Government 3,925 26.0 Private domestic 9,775 614.7 Foreign 1 400oo 9.3 Sub-total 15,100 100.0 Non-Voting Shares Government 189,718 52.7 Private domestic 2,106 o.6 Foreign 79,839 22.2 Mixed 1/ 88 279 24.5 Sub-total 359,939 100.0 Total 375,039 Resources Position (as of September 30, 1973) (IL million) Domestic Currency Equity 5D3 9 Perpetual deposit 467.0 Long-tenn debt 323.0 1,293.9 Foreign Currency IBUD loans ($38.8 million) 162.5 Capital notes 71 .4 Other long-term debts 832.5 1,066.h Total resources 2,360.3 Loans outstanding 2,009.2 Equity investments outstanding .5 Sub sidiaries 1.5.1 2,028.8 Resources available for disbursement 331.5 1/ Entities owrned jointly by dorrestic and foreign shareholders. -b - Jan. - Sept. 1971 1972 1973 197h …( --- IL Million7s)------- Loan Comnitments 267.8 366.1 101.9 WIJ3.9 Loan Disbursements 331.2 31.0 401 .3 310.0 Earnings Record - - - - - - (percentages) - - - - - - - 1/ Profits before tax to average total assets A.8 .2 3.9 h.0 Profits before tax to average equity 1l1.5 15.7 17.0 18.6 Net profit to year-end share capital 8.2 9.0 9.7 10.5 Net profit to adjusted year-end share capital 2/ 13.1 114.8 16.1 n.a. Gross dividends paid to year-end share capital 7.1 8.o 8.0 n.a. Financial Position (as of June 30, 1974) Total debt/equity ratio (agreed maximum 3:1) 3:1 Reserves and provisions to loan and investment portfolio 7.0% Interest Rates and Charges (as of September 30, 197h) Interest rates on loans Variable, ranging from 8 to 15% p.a. Commitment fee None Commission charge 0.6 to 1% on amount of each loan Guarantee fee 2% p.a. B. BANK LOANS TO IIBI Status as of March 31, 1975 (US$ Million) Loan Date Rate of Net No. Signed Exchange Amount Committed Disbursed Outstanding 124 9/16/65 5½ 20.0 fully 20.0 5.9 519 11/15/67 var. 15.0 fully i5.0 6.1 689 6/15/70 7 25.0 fully 22.4 21.0 1/ On annual basis 2/ Excludes Government-owned Ordinary B and Preference A shares and dividends thereon. APPRAISAL OF AN INDUSTRIAL DEVELOPMENT PROJECT IN ISRAEL SUMMARY AND CONCLUSIONS i. This report appraises a composite industrial development project involving three complementary components: (a) a (fourth) loan for the Industrial Development Bank of Israel (IDBI); (b) industrial research and development (R&D); and (c) vocational/technical training. The Bank loan, in the amount of US$35 million, will be made to the Government for 15 years. The Government will on-lend US$25 million to IDBI, while the R&D and vocational/technical training components will each be funded with US$5 million. The IDBI Component ii. Since its establishment in 1957, IDBI has shown continuous growth and, at September 30, 1974, its total assets stood at IL 2.4 billion. IDBI has an experienced management team and a competent staff, is efficiently run and has a notable record of performance in terms of both financial assistance to industry and overall development impact. IDBI continues to be the largest development finance institution engaged in term lending in Israel and an im- portant instrument for the implementation of the Government's industrial policy. IDBI stresses the promotion of technologically sophisticated and export-oriented industries, and the location of industry in less developed regions. During 1969-73, IDBI contributed 30% of the total financing for industrial investment. Approximately 50% of IDBI-financed projects are located in the less developed areas, while 40% by amount of loans approved by IDBI during 1969-74 were allocated to science-based industries. IDBI has continued to succeed in raising new capital abroad. At home, however, untoward Government policies have limited considerably the scope of IDBI's resource mobilization effort. iii. IDBI's loan approvals have increased in terms of amounts during 1968-74 at 30% per annum. IDBI's portfolio is diversified and sound. Ar- rears are well within acceptable limits and provisions for losses adequate. Earnings have shown steady growth and have represented a return in recent years of 15% to 16% on non-Government held share capital. IDBI's satisfac- tory appraisal/supervision work and continuing good record of operations warrants the raising of its debt/equity ratio from the present level of 3:1 to 5:1. Similarly, the free limit under the proposed loan should be raised from US$750,000 to US$1 million. iv. IDBI's business prospects appear good. The Government will conti- nue to lay heavy stress on industry to improve export earnings, to generate employment opportunities, and to develop the more backward regions. It can therefore be reasonably expected that a relatively high level of industrial investment will be maintained in the next several years, despite the enun- ciated austerity program. IDBI forecasts commitments of IL 8.4 billion during 1975-79 and of IL 2.8 billion over the two-year period July 1975-June 1977, based on realistic growth rates of industrial investment and the size of its pipeline. About half of the projected commitments of IL 2.8 billion - ii - will be in local currency and will be covered by internally generated funds, debentures, and loans or other transfers from the Government, with the latter covering any shortfall. Of the remaining IL 1.4 billion, or some US$240 mil- lion, about half will be covered from existing lines of credit or new loans already identified and at various stages of negotiation. The rest will be covered by as yet unidentified sources. The proposed Bank funding of US$25 million, to be repaid over 15 years including a grace period of about 2 years, would help to fill part of that gap (or about 10% of the total foreign ex- change gap). Perforce IDBI will have to continue, and to further intensify, its resource mobilization effort abroad. v. Bank funds will support projects in the less developed regions of the country as well as export-oriented projects regardless of their location, in consonance with the Government's development objectives. Furthermore, a good part of these projects would be in industries employing sophisticated technologies, which the Government is eager to promote. IDBI will on-lend at 10-11%, on average. The R&D Component vi. R&D is a key element in Israel's strategy of promoting export- oriented industries based on sophisticated product design and production tech- niques. This strategy requires a high-level research capability closely in- tegrated with sophisticated marketing and commercial skills at the enterprise level. It is based on the conviction in Israel that continuing reliance on foreign investment and licensing to acquire technology and know-how does not generally provide a sufficient competitive edge in export markets, and is in- tended to take advantage of one of Israel's major resources: its wealth of technical talent. vii. Israel has traditionally carried out mainly basic research in uni- versities and Government laboratories. In an effort to re-orient research toward commercial application, the Government in 1966 initiated a 50-50 matching grant program to encourage R&D in the private sector. To give a further impetus, the Government now proposes to support industrial research more generously through grants to industry and research institutes for up to 80% of the cost of selected projects of "national importance", i.e. projects with significant potential payoff, but which private enterprises for the most part are presently unable to undertake because they are relatively new and small by international standards, the required R&D outlays are substantial in relation to their available resources, the risk on new and sophisticated products is high and cannot be spread over many research projects (as they would in a larger firm), and the supply of private risk capital is far short of expansion targets. The program is well-conceived. viii. In view of Israel's limited capabilities in evaluating the commer- cial and technical risks involved in developing new products and in launching them in international markets, the Government proposes: (a) to launch a first set of projects of national importance on the basis of the best evaluation possible with present staff; and (b) to build up its own internal capability to review proposals presented to it by private firms. The Office of the - iii - Chief Scientist in the Ministry of Commerce and Industry (OCS), now handling inter alia the matching grant program, will be the entity responsible for carrying out the Government's objectives. It will also serve as the project unit for the R&D component. ix. The proposed R&D project is intended to assist the Government (spe- cifically the Office of the Chief Scientist) to improve its capability to evaluate proposals for commercially oriented R&D. This will involve the development within the Government, not only of the purely technological ap- praisal capability typical of a scientific research granting agency, but also of technical, financial and commercial expertise sufficient to allow it to promote and competently review proposals for R&D on a commercial time- table leading to commercial prototypes and to specifications and selling prices dictated by a market. As a vehicle for the development of OCS's capabilities, the proposed project will support: (a) three subprojects aimed at developing commercial prototypes, which appear promising on the basis of preliminary evaluation (rural telephone systems, prime movers, and tomographic scanner); (b) two projects involving applied research at the early stages (solar ponds and jojoba liquid wax); and (c) a multi-disciplinary regional technological institution (the Negev R&D Authority) which will ex- pand facilities of an infrastructure nature. In consultation with the Bank, a sum up to US$150,000 may be allocated to OCS from Bank funds to enable it to obtain expertise and services abroad, if needed. The Bank's direct and inti- mate involvement in the review of R&D subprojects provides a better opportun- ity to influence and accelerate the development of the OCS's appraisal/ supervision capabilities, than if it were merely to provide technical assist- ance, particularly through the discipline that a financial intervention is likely to impose. x. In selecting these subprojects, the following criteria were employ- ed, as appropriate: non-defense orientation; technological feasibility; possibility of market success; overall capability of the undertaking entity; possible technological spin-offs; benefits to Israel's economy; usefulness of the prospective technology to other developing countries; inability of the sponsoring private firms to borrow for R&D or to self-finance; experience and capability to commercialize technology, and financial strength of the private firms. All R&D projects carry a measure of risk, but the risks in the proposed subprojects are reasonable. On the other hand, if the sub- projects are successful, the potential financial results and technological spin-offs can be substantial in relation to the R&D investment. xi. The proposed R&D subprojects were initially appraised as follows: the technological and marketing aspects of each proposal were reviewed with the assistance of specialized expertise drawn from inside and outside the Bank. The appraisal mission visited and evaluated the laboratory facilities, interviewed the technical staff and management of the sponsor, and evaluated the sponsor's commercial strategy and financial status. The financial and economic rates of return of each subproject, except for those whose potential benefits are not amenable to quantification, were estimated in order to de- monstrate that, if commercially successful, each of the subprojects promises a reasonable rate of return. The rates of return obtained are necessarily - iv - based on rough estimates of sales revenues and costs, including R&D expendi- tures, for the products to be developed. They will need to be recalculated periodically as development progresses. Financial rates of return (after taxes) range from 30% to 43%; economic rates of return from 13% to 41%. They are high or acceptable. xli. Progress against the proposed timetables, technological and market developments related to the ultimate success of the product, the market studies presented by the sponsors as the projects advance, as well as all aspects of the normal supervision procedure, will be followed closely by the Office of the Chief Scientist and by the Bank. The progress made by the Office of the Chief Scientist toward the development of a capability to appraise risk capital propositions will also be regularly reviewed. The Bank will thus be a participant in an institution building process, gaining new insights from this experience which may be turned to good use in other developing countries. In addition, this scrutiny would permit an early decision to terminate the financing of a sub-project whose probability of success is low. xiii. The total cost of the R&D component is estimated at US$22.3 million, of which US$8.4 million (38%) would be in foreign exchange. The Bank funds would cover US$5 million, or about 60% of the foreign exchange costs. The grant element for all subprojects amounts to US$14 million, or 63% of the total cost of the R&D component. The Government expects to recoup part of the grants from the profits of successful subprojects. xiv. The Bank will not finance the civil engineering works, which amount to only US$1.4 million and involve several subprojects in different locations. R&D equipment is to a considerable extent specialized and proprietary. The individual items are of relatively small value and procurement is spread over a period of up to five years; bulking is not feasible. Furthermore, there is adequate representation of foreign suppliers locally to ensure competition. As at present, the Office of the Chief Scientist would satisfy itself about the need for the equipment, the actual purchase and use, and its cost. How- ever, the Office will require applicants to request quotations for equipment from at least three suppliers if the value of each item is over US$20,000. xv. The R&D component is suitable for Bank funding of US$5 million, to be repaid over 15 years, including a grace period of 5 years. The industrial R&D component will enhance the developmental impact of the over- all loan and Bank funding should have considerable institution building effects. The Vocational/Technical Training Component xvi. Israel's industrial effort is increasingly hampered by a shortage of skilled workers and middle and high-level technicians. The Government is attempting to alleviate the situation through a comprehensive program of tech- nical training designed to meet the projected needs of the expanding industrial sector. The Government's program and priorities are soundly conceived. The program involves expansion of vocational and of post-secondary technical edu- cation, including retraining and refresher programs, on-the-job training, apprenticeship programs, youth centers, and rehabilitation programs. xvii. The proposed component would provide for the expansion of training facilities and programs sufficient to meet about 35% and 30%, respectively, of the projected shortage of skilled workers and technicians for 1985. To improve the quality and efficiency of existing training programs, the compo- nent would also provide the additional equipment needed to meet new program requirements and/or to replace obsolete equipment which heretofore has limited the type and level of training opportunities available to youths and adults. The project would be directed specifically toward meeting the existing and projected manpower constraints, particularly in the industrial sector. Fur- thermore, the project would help reduce economic and social disparities by providing increased training opportunities for early leavers from the formal education system as well as for adult workers requiring retraining to enable them to be productively employed in a changing labor market. xviii. A project unit would be established as part of the existing struc- ture for project implementation within the Ministry of Labor. The unit would supervise the implementation of the proposed component, coordinate activities within the Government and with private bodies and provide liaison with the Bank. In addition, the establishment of a project implementation unit would provide a new and viable link to external sources, including the Bank, for the exchange of planning, costing, evaluation and implementation procedures and methods different from many currently in use by the Ministry of Labor. xix. The component comprises: (a) construction and/or extension and equipment of three vocational training centers and one technician/practical engineering institute; and (b) provision of equipment for one vocational training center and two technician/practical engineering institutes. The construction of project items would be based on standardized schedules of accommodations already established. All contracts for civil works and equip- ment would be awarded on the basis of the Bank's guidelines for international competitive bidding. xx. The total cost of the vocational/technical training component is estimated at US$15.8 million and the foreign exchange component at US$5.2 million. The project is suitable as a basis for Bank funding of US$5.0 mil- lion, to be repaid over 15 years, including a grace period of 5 years. The proposed funds would finance 96% of the foreign exchange costs and be equiva- lent to about 32% of the estimated project cost. I APPRAISAL OF AN INDUSTRIAL DEVELOPMENT PROJECT IN ISRAEL I. INTRODUCTION 1.01 This report appraises a composite industrial development project, involving: (a) a (fourth) loan to finance the Industrial Development Bank of Israel (IDBI); (b) industrial research and development (R&D), with the Office of the Chief Scientist in the Ministry of Commerce and Industry as the proj- ect unit; and (c) vocational/technical training, with a project unit to be set up in the Ministry of Labor. The Bank loan, in the amount of US$35 mil- lion, will be made to the Government of Israel, which in turn will on-lend US$25 million to IDBI. The R&D and technical training components will each be funded with US$5 million. The proposed multi-purpose project is expected to contribute to the implementation of the Government's industrial development policies. ! 1.02 IDBI was established in 1957 and has received three Bank loans totalling US$60 million. IDBI is an efficient development financing institu- tion with a solid record of performance in terms of both financial support to industry and overall development impact. This report first appraises IDBI for the new funding and focuses on IDBI's overall performance since the last Bank loan was made in June 1970. The R&D and technical training components of the Bank loan are appraised in turn. A detailed review of the Israel's economy can be found in "Current Economic Position and Prospects of Israel," which is being distributed separately to the Executive Directors. The pre- sent report is based on the findings of an appraisal mission to Israel in October-November 1974, composed of Messrs. George C. Maniatis, James L. Theodores, Henry B. Thomas, H.K. Work (R&D consultant) and J.C. Jones (con- sultant on technical training). Mr. Charles Weiss collaborated in the appraisal and selection of the R&D subprojects. The opinion of specialists in R&D was also solicited. II. THE ENVIRONMENT A. Economic Performance 2.01 Remarkable growth in national and industrial output, full employ- ment, high level utilization of productive capacity, and considerable improve- ment in the balance of payments, were the dominant features of the Israeli economy between the 1967 and 1973 wars. GNP increased at 10% per annum in real terms during 1968-72. Total fixed capital formation increased at 17% per annum in constant prices, raising the investment rate from 20% of GNP in -2- 1968 to 29% in 1972. During the same period, fixed investment in the indus- trial sector increased at 17% a year in real terms (11% on average in 1970-72). Despite manpower shortages, industrial output increased at 13% a year. In- dustrial exports (excluding diamonds) increased at 16.5% per annum, stimulated by fiscal and financial incentives. Reversing the past trend, the balance of payments showed a surplus of US$585 million in 1972 compared with a deficit of US$94 million in 1968. 2.02 The October 1973 war caused major economic dislocations and a sud- den contraction of the economy. However, by the end of 1973, civilian employ- ment and production were about 20% below prewar levels. Real GNP increased by 7.5% in 1973. Total fixed capital formation increased by 7% but indus- trial investment declined by 8%, adversely affected by manpower shortages, transportation bottlenecks and the uncertainty about the economic outlook. Industrial output rose by approximately 6% while exports (excluding diamonds, which account for about one-half of industrial exports) by 21%, reaching US$637 million. Due to the greatly increased defense imports during and fol- lowing the October war, the overall deficit on goods and services account more than doubled in 1973, reaching US$2.6 billion. However, in response to the emergency, unilateral transfers and capital inflows increased substan- tially, and the balance of payments showed a surplus of about US$600 million. In 1973, wages rose by 23% (compared with 16% in 1972), partly as a result of cost of living increases and partly as a result of competition for labor in a tight labor market. Despite the Government's restrictive monetary and fiscal policies and price controls, the price level rose by 20%. Rising import prices, stepped-up defense expenditures, and wage increases far ex- ceeding productivity rises, were major causes of inflationary pressures. 2.03 Real GNP increased by an estimated 6-7% in 1974, due to the Gov- ernment's anti-inflationary measures and the decline of total gross invest- ment by 1% over 1973. Industrial investment, however, picked up considerably from the 1973 low level and rose by about 14% in real terms (to some IL 2,150 million in current prices). Industrial production continued to recover during 1974, rising at about 12% over 1973. Earlier in the year, wages were in- creased by sizable cost of living adjustments. As a result of the substan- tial rise of defense imports, the deficit on goods and services increased further in 1974 and reached US$3.4 billion; the overall balance of payments showed a deficit of about US$500 million. 2.04 In July 1974, the Government took further policy measures to sta- bilize the economy and to strengthen the external account. Fiscal and mone- tary measures included increases in direct taxes, a freeze on social public expenditures, restrictions on public sector construction, increased interest rates on development loans, and a freeze on the prices of basic consumer goods. To improve the external account, the surcharge on imports (excluding basic foodstuffs and fuel) was increased from 25% to 35%, while export rebates were further raised. These measures did not produce the expected results and, on November 10, 1974, the Israeli Government launched a severe austerity pro- gram in an effort to improve the country's rapidly deteriorating balance of payments situation, bolster its declining foreign exchange reserves, and curb -3- the mounting inflationary pressures. The Israeli pound was devalued from 4.2 to 6 to the U.S. dollar, imports of luxury consumer durables were banned for six months, a 15% import surcharge was imposed on all other imports (replac- ing the previous 35% rate), and new taxes were levied on overseas travel, financial institutions and capital gains. The Government is pressing the Histadrut (Federation of Labor Unions) to agree to a freeze in basic wages, while it has promised assistance to low-income groups to alleviate the adverse effects of devaluation. The measures are expected to ensure an unin- terrupted inflow of industrial raw materials and capital goods and, thus, to maintain high levels of employment and industrial investment, output and exports. Price increases in 1974 reached an annual average of 40%, reflect- ing the cumulative effects of the devaluation, world inflation and the state of emergency. The Government appears determined (and prepared) to take the requisite measures to slow down inflation rates. The prospects of the Israeli economy are discussed in paras 3.24-3.25. B. The Industrial Sector 2.05 Industrial Objectives and Policy. In sharp contrast with Israel's relatively poor natural resource endowment, the labor force is well-educated, highly motivated and efficient. In these circumstances, industrial develop- ment based on strong technical ability, R&D, and export-oriented industries is the main way Israel can maintain a high rate of growth, strengthen its balance of payments, and ensure full employment of its labor force, including the absorption of new immigrants. The Government, as reflected in the 1972- 76 Economic and the 1974-78 Industrial Plans, has endorsed this approach to industrial development and is eager to promote the growth of sophisticated science-based industries, such as electrical and electronics goods, scien- tific instruments, chemicals, plastics, and engineering. The promotion of an indigenous industrial technology, a parallel Government objective (see paras 4.01, 4.03), is facilitated by the existence of a sizable pool of highly qualified scientists and a developing entrepreneurial class increasingly responsive to both incentives and realities. 2.06 Although efficient import substitution, especially in selected capital goods, is encouraged, the main thrust of the Government's industrial policy is to expand exports. Export-oriented growth is dictated inter alia by the limited size of Israel's domestic market. The reorientation of the country's industrial effort is entrusted to private initiative and supported by incentives (para 2.10). In addition, the Government is concerned with the comparatively small plant size, fragmented production and family ownership of the Israeli industry, which prevents it from reaping scale economies. Thus, a related objective of the Government's industrial policy is to change the prevailing structure of industry by encouraging mergers of plants and firms, particularly in industries producing consumer durables and catering to the local market. The role of small-scale industry would be limited to filling the interstices. A side-effect of this latter approach is that it would economize on scarce resources such as entrepreneurship, managerial and market- ing skills, and highly-skilled labor. Greater exposure to foreign competition, - 4 - through gradual liberalization of imports (already under implementation), is expected to counter the attendant adverse effects of the greater concentration of industrial power. 2.07 Technical Training. The country's industrial effort is increasing- ly constrained by a shortage of skilled workers and middle and high-level technicians. The Government is attempting to alleviate the situation through a comprehensive program of technical training designed to increase labor mobility and to meet the projected needs of the expanding industrial sector. The program involves basically expansion of vocational and of post-secondary technical education, including retraining and refresher programs, on-the-job- training, apprenticeship programs, youth centers, and rehabilitation programs. 2.08 Research and Development. Industrial and university expenditures on R&D in Israel currently amount to some 1.4% of GNP; however, only 22% is applied research carried out by industry. In an effort to re-orient research toward commercial application, the Government has since 1966 been encouraging R&D in the private sector through a program of 50-50 matching grants to firms demonstrating initiative and ingenuity, but lacking the necessary risk capital. During fiscal years 1971-73, Government matching grants totalled US$10.4 mil- lion. Over half went to the electronics industry, about 25% to chemicals and pharmaceuticals, and the remaining 25% spread among metal-working, food- processing, and other industries. The major part of the Government funds did not exceed US$50,000 per research project, which reflects the rather small scale of the program. Further support to industry for R&D is provided through the funding of science-based industrial parks, access to Government laboratories, low interest rates for construction of facilities and through the sharing of the expense of technology forecasting and information centers. 2.09 To further accelerate the pace of development and commercialization of industrial technology, the Government now proposes to support industrial research more generously through grants to industry and to research institutes for up to 80% of the cost of selected projects of "national importance," i.e., projects with significant potential payoff but which private enterprises are presently unable to undertake because they are relatively new and small by international standards, the required R&D outlays are substantial in relation to their available resources, the risk on new and sophisticated products is high and cannot be spread over many research projects (as they would in a larger firm), and the supply of private venture capital is far short of ex- pansion targets. 1/ The Government's support of R&D projects is also prompted 1/ To a very limited extent, risk capital for research oriented and risky ventures in Israel is provided by two entities: (a) the Discount Bank Investment Corporation which, as of December 31, 1974, had outstanding equity participations (book value) amounting to about IL 6 million and loans to IL 400,000; and (b) the Israel Research and Development Corpo- ration Limited (85% of its shares being owned by the Government and 15% by IDBI) with outstanding equity participations of about IL 3 million. by its concern to generate employment opportunities for a science-trained manpower which is becoming available locally, and through immigration, in increasing numbers. Given the scale and speed intended, it is very doubtful that the proposed program would make headway without Government financial assistance. The program supports these objectives which are reasonable. 2.10 Investment and Export Incentives. Israel operates a complex scheme of development grants, tax exemptions, low interest loans and export incen- tives designed to encourage domestic and foreign investment, to develop less advanced areas and to promote industrial exports. To qualify, investors must meet certain conditions which vary according to the development area and nature of investment projects (see Annex 1). Special benefits are granted to promote investment in science-based industries, including government guaran- tees for term loans. Development loans at concessionary terms and government grants accounted for 51% and 7%, respectively, of the total sources of finance of fixed investment in the industrial sector in 1968-1973 (see Annex 9). Al- though the full range of incentives may not have been necessary in every case to achieve the Government's objectives, on the whole it does not appear that the incentives system, as applied, has been either wasteful or superfluous. Furthermore, incentives have not resulted in misallocation of resources, since the viability of the industrial projects promoted is assessed by sound econo- mic analysis (calculation of the cost to the economy of the foreign exchange saved or earned). Industry's impressive growth and performance in the past two decades attests to the beneficial influence of the incentives scheme. The cost to the Government of the various forms of incentives is estimated at approximately 20% of total industrial investment. The Government proposes to amend the existing incentives in July 1975 to increase their effectiveness and to reduce the costs of administering the system. The Bank has commissioned a study to assess the effectiveness of incentives in several countries, in- cluding Israel, in stimulating economic growth and exports, their impact on resource allocation, fiscal implications, etc. The part on Israel, to be prepared by an economist of the Bank of Israel, has not yet been completed and this report could not benefit from the study. C. Financial Setting 2.11 The Capital Market. Since the mid-1960's, equity capital has been a relatively unimportant means of raising funds, in part due to the steady decline of stock prices and in part because of the more favorable terms of loanable funds enterprises can obtain from Investment Banks under the in- vestment incentives scheme. During 1968-73, industrial enterprises raised only IL 47.5 million in the form of share capital. Also, because of the Government's pre-emptive policies and controls on the new issues market, coupled with the need for indexing new issues, it has been very difficult for industrial enterprises to float bond issues. During 1968-73, industrial bond issues amounted to a meager IL 30 million. Institutional investors, the major source of funds for the capital market, must invest 85-90% of their funds in Government bonds or Government approved securities. In addition, the Government mops up considerable amounts of funds in the form of compulsory - 6 - loans and contributions. In this set-up, the program of Government invest- ment incentives has become a major source of long-term financing for industry, while it enables the Government to exercise wide influence over the alloca- tion of funds of the financial institutions engaging in term financing and the public: sector companies. Since the amount and terms of most Government borrowing are discretionary and a substantial part of the market is captive, interest rates are not determined in competition with other borrowers and do not, therefore, necessarily reflect the prevailing market conditions. Gover- nment bond issues, with principal and interest linked to the cost of living, vary from 4% to 6.5%. The total stock of linked government bonds held by the public directly or through mutual funds exceeded IL 8 billion in mid-1974. 2.12 Interest Rates. There is virtually no free market for term lending. Medium- and long-term financing is made available to industry at official interest rates through the major Investment Banks under Government supervi- sion. On July 2, 1974, the Government increased the interest rates on term loans as follows: Area "All (greatest development priority) from 6.5% to 8%; Area "B" (less development priority) from 8% to 10%; and Area "C" (already developed regions) from 9% to 12% (and to 15% for loans to "marginal" indus- tries). Furthermore, with regard to development loans to Area "C" approved after November 6, 1974, the Government is in the process of implementing its decision that, if the cost of living in a particular year rises more than 20%, the excess will be added to the outstanding principal. The additional principal will bear the same interest rate as the original loan and will be repaid after the repayment of the initial principal of the loan. Interest rate management and its implications are discussed in Annex 2. 2.13 Since 1963, the risk on foreign exchange borrowing has essentially been borne by the Government. In principle, a recommendation that the Govern- ment passes the risk on to the ultimate users of foreign funds would be legi- timate. However, the current difficult balance of payments situation and the attendant uncertainty as to the implications of such an important change, is likely to render the business community extremely cautious and to adversely affect investment activity. This at a time when the Government's major objec- tive is to maintain high levels of industrial investment in order to promote growth and exports, to generate employment opportunities for a large number of immigrants, and to prevent emigration. In light of this, a change in the status quo involves a high element of risk and continuation of the present Government policy appears to be in the best interest of the country. See also Annex 2. 2.14 Interest rates on short-term credits from commercial banks are presently at 20-1/2% per annum or higher, depending on the borrower's stand- ing. Ilowever, since 1970 the Government has introduced a system of "directed" credits for working capital, granted at preferential rates to key sectors of the economy, mainly exports, industry located in priority development areas and agriculture. For exporters the maximum rate is currently 6%, while for industry it was recently raised from 11% to 13%. "Directed" credits account- ed for 53% of the total short-term bank credit during 1970-74. III. APPRAISAL OF THE INDUSTRIAL DEVELOPMENT BANK OF ISRAEL LIMITED (IDBI) A. IDBI's Structure Ownership and Control 3.01 Establishment and Ownership. IDBI was established in 1957 on the joint initiative of the Government, the three largest commercial banks in Israel, the Histadrut and the Manufacturers' Association. The presently authorized share capital of IL 647 million is divided into eleven classes, two of which have not been issued. Of the outstanding share capital of IL 375 million, only Ordinary A shares amounting to IL 15 million carry full voting rights. The Government is the largest shareholder, holding 26% of the Ordinary A shares (see Annex 3). 3.02 Board of Directors and Committees. Holders of IL 250,000 or more of Ordinary A shares are entitled to appoint one director. This leads to a theoretical Board size of 59 though only 50 were appointed on October 31, 1974 (see Annex 4). The Board represents a broad cross-section of financial and business institutions in the country as well as foreign investors and the Government. It meets three or four times a year to review actions taken by the Executive Committee. The Board is responsible for the election of the Chairman and Vice-Chairmen and the appointment of the General Manager(s). To increase its effectiveness, most of the Board's powers have been delegated to three Committees: The Executive Committee, the Loan Committee and the Vice-Chairmen's Committee. These Committees are described in Annex 4. Management and Staff 3.03 Dr. A. Neaman, IDBI's Managing Director since 1961, stepped down on February 28, 1975, having reached normal retirement age. He will, however, remain a member of the Board of Directors and of the Executive Committee. His responsibilities were divided between Messrs. D. Friedmann, IDBI's Deputy General Manager, and Y. Gill, General Manager of IDBI's subsidiaries, who were appointed jointly as General Managers. Both men are experienced and competent. The new organizational structure of IDBI is depicted in the Organization Chart attached as Annex 5. 3.04 The staff is competent and well motivated. IDBI follows highly selective recruitment policies and the overall quality of its staff has further improved in recent years. During the past five years the professional staff has been increased by 44 and now totals 89. Only the Follow-up Depart- ment has suffered a net loss of one professional staff member over this period and with a staff of only seven is stretched rather thin. Management is aware that the follow-up staff needs strengthening and intends to recruit additional staff. The situation appears to be under control. - 8 - 3.05 Subsidiaries. IDBI owns, equally with the Government, the Invest- ment Company for Industrial Development in Israel Ltd., which in turn con- trols several other companies. The operations of these companies are rela- tively insignificant compared to those of IDBI's. The major subsidiary (IFC) concentrates on equity investments and on assisting companies experiencing financial and managerial difficulties. These companies are described in Annex 6. Policies and Procedures 3.06 Policies. IDBI does not have a comprehensive statement of general business policies. 1/ Its lending policy has evolved in the course of opera- tions, guided by its Articles of Association and the Government's policies for industrial development. Individual loan applications are judged on their own merits with financial and economic viability being of critical importance in project selection. Although relations with the Government are close, IDBI maintains a high degree of independence in its day-to-day operations and deci- sions. Its activities have been concentrated almost entirely in industrial term lending. 3.07 Project Appraisal. The quality of IDBI's project appraisals is good. IDBI has made numerous sector studies in connection with its project appraisals, in part with the assistance of consultants. IDBI pays attention to the economic justification of projects, is mindful of the minimum economi- cal size of the plants it finances, and calculates the cost to the economy of the foreign exchange saved or earned in almost all projects. It has agreed to calculate the economic rate of return for large projects and to perform sensitivity tests for key variables. IDBI considers environmental aspects of the projects in its appraisal reports as well as the steps taken to deal with them. 3.08 Follow-Up. Projects under construction are followed up by the Assessment and Checking of Implementation Department, headed by the Chief Engineer. Site inspections are normally made at least twice during construc- tion, though more often for larger projects. Upon completion of construction, the Follow-Up Department becomes responsible for the project. At present there are some 1,400 clients under supervision. Some of these clients re- quire relatively little attention while others are under appraisal for an additional loan and, consequently, pose no burden on the limited staff of the Follow-Up Department. Size of loan, financial difficulties, arrears, indus- try problems, or detection of a problem by the computerized "early warning" system (see Annex 7) are some of the criteria used to select those clients to be visited. The Department undertakes some 120 plant visits a year, preparing a report on each. There is close cooperation and feedback between the Follow-Up and Appraisal Departments. 1/ IDBI's policy guidelines are contained in various internal documents, such as Board Minutes and staff instructions. IDBI will compile and present systematically all such directives in one document, which will be made available to the Bank. - 9 - 3.09 Procur>z - and Disbursement. IDBI usually asks its cliencs for quotations fri. -a than one supplier and satisfies itself that the quality and prices are the best obtainable. It has developed expertise in many in- dus trial fields and so is often able to make its own comparisons and to advise clients. Disbursements are made only after careful checking of the documents and, when appropriate, on-site inspections. Procurement and dis- bursement practices are satisfactory. B. IDBI's Operations Summary of Operations 3.10 IDBI's loan operations are described in Annex 8. IDBI does not invest directly in equity investments, leaving this activity to one of its subsidiaries (see Annex 6). IDBI's loan approvals have been increasing during 1968-1974 at 30% per annum in terms of amounts but only at 7% in terms of number of loans, reflecting the growing average size of its loans. In 1973 loan approvals totalled IL 450 million. Commitments and disburse- ments have kept pace with approvals, though disbursements in 1973 and the first six months of 1974 were adversely affected by the October 1973 war. These results are generally in line with IDBI's forecasts prepared in 1972. 3.11 Besides lending its own resources to projects it appraises, IDBI also administers, with no risk, funds earmarked for particular, often pub- lic sector, projects. In such cases its involvement is limited to handling disbursement and follow-up work, for which it receives a fee of (usually) 3/4 of 1% p.a. of the amounts administered. Some 16% of outstanding loans are in this "administered" category. 3.12 IDBI's loan portfolio is quite diversified and about half is cover- ed by full or partial guarantees by the Government or others. The guaranteed loans are usually to projects which are viable but cannot offer adequate security or are financially marginal but economically attractive (in less developed areas, with good export potential, creating employment, using sophisticated technology, etc.). Included also are all loans administered by IDBI. IDBI's Role and Development Impact 3.13 IDBI continues to be the most important of the five financial in- stitutions engaged in term lending in Israel and an important instrument for the implementation of the Government's industrial policy. During 1969-73 IDBI contributed 30% of the total financing for industrial investment (see Annex 9). IDBI-financed projects account for 60% of the investments in the industrial sector, while IDBI disbursements account for 45% of the sources of finance in the projects it sponsors. With projects becoming larger, IDBI is getting increasingly involved in consortium financing. IDBI does not take part in mergers or rationalization schemes, a function which it has delegated to a subsidiary. - 10 - 3.14 IDBI's lending operations are within the Government's industrial policy framework. About 40% of the amount of loans approved by IDBI during 1969-74, and 60% of its pipeline as of September 30, 1974, were allocated to science--based industries. Approximately 50% of IDBI-financed projects are located in the less developed regions. Some 25-30% of the projects approved by IDBI since 1970 are expected to export over 20% of their production. IDBI estimates that 80 export-oriented projects it approved in 1973 will result in about US$120 million worth of exports a year, representing 10% of the industrial exports in 1973 (19% of exports of diamonds are excluded). Value added to sales in IDBI-financed projects ranges from 40% to 80%, with the higher frequency of occurrence being between 50% and 60%. The cost in local currency of the foreign exchange earned or saved, estimated on the basis of a representative sample of IDBI's projects, varies between IL 3 and IL 5 per US dollar, which compares favorably with the effective exchange rate of IL 5.4 = US$1 prevailing before the devaluation on November 10, 1974. Progress in Meeting the Objectives of the Third Bank Loan 3.15 The third Bank loan of US$25 million became effective on August 25, 1970, and was fully committed by June 30, 1973. The undisbursed amount as of February 28, 1975 was US$3.1 million. The small delay in the utilization of the loan is attributable to the need for IDBI to reappraise several large projects following the devaluation of the Israeli pound in 1971; to the lack of projects with a large enough import content; to the 90-day rule against retroactive financing; and to IDBI's efforts to use existing lines of credits tied to procurement whenever possible. 3.16 Aside from covering part of IDBI's foreign exchange need, a major objective of the third Bank loan was to induce IDBI to continue the search for new capital, particularly abroad. IDBI's resource mobilization effort abroad has been successful, as described in para 3.18. An institution build- ing aim of the third Bank loan was that IDBI would address itself with parti- cular care to the economic justification of projects during their appraisal and that the reports submitted to the Bank would reflect the economic analysis made. IDBI has accepted and acted on the Bank's advice in this respect. C. IDBI's Financial Situation Resource Position 3.17 IDBI's resource position on September 30, 1974, indicated a tech- nical over-commitment of IL 16.3 million (see Annex 10). However, several foreign lines of credit that were under negotiation at the time but not signed are not included as resources; these exceed the over-commitment. Also not reflected is the Government's intention to provide IL 400 million during the three fiscal years 1975-1978; these may be provided as additional perpetual deposits though the terms are still being discussed. These per- petual deposits are convertible into Ordinary B shares at par at the Gov- ernment's request. They are not repayable unless the Government's voting power falls below 20%, in which case the Government has the right to demand repayment over 25 years after ten years' grace. Resource Mo'bilization Effort 3.18 From July 1, 1970 to June 30, 1974, IDBI had raised in the form of foreign loans and debentures some US$155 million equivalent, including loans from a dozen new sources in the US and Western Europe. At home, the Govern- ment, by controlling, setting priorities for and pre-empting the new issues market, dissuaded IDBI from having frequent recourse to the local capital mar- ket. This stand was reinforced by the fact that IDBI's debentures would have to be indexed while IDBI is not allowed to index its loans to industry. Thus, IDBI was able to tap various local sources and issue local debentures (linked to the cost of living index) amounting to only some IL 64 million. For a considerable portion of its requirements in local resources IDBI was accommo- dated by the Government, which willingly met IDBI's needs. As noted above (para. 3.17), the Government plans to remain IDBI's major provider of funds in local currency. Quality of Portfolio 3.19 As of June 30, 1974, arrears were 3.5% of IDBI's loan portfolio (see Annex 11), with some 9% or IL 177.2 million of the portfolio affected by arrears. Of this latter, 74.5% is guaranteed by the Government, leaving only IL 45 million or 2.3% of the portfolio at IDBI's own risk. Arrears are well within acceptable limits. Actual losses likely to be suffered by IDBI are minimal, taking into account the guarantees and collateral security. The auditors are of the opinion that the provision for losses (IL 15.6 million) is adequate. In addition, IDBI has a special reserve for unforeseen losses which totalled IL 21 million on June 30, 1974. Financial Performance and Position 3.20 Income Performance. Recent income statements and balance sheets are given in Annexes 12 and 13. Earnings have shown steady, if not spec- tacular, growth and have represented a return in recent years of 15 to 16% on non-Government held share capital. Administrative expenses have been held to between 0.3 and 0.4% of average total assets, among the lowest of the DFCs associated with the Bank Group. In 1973 the dividend rate on Ordinary A share was 13-1/4% and on other classes of shares from 3% to 11-1/4%. In spite of the increasing dividend amounts, the payout ratio has been declining since 1970, amounting to 61.5% in 1973. IDBI earns a spread of 2.2% on its lending activities (see Annex 14), which is adequate and allows satisfactory increases in reserves after the payment of dividends. 3.21 Financial Position. IDBI has operated over the years with a cur- rent ratio of less than one. This tight liquidity position is a reflection of its practice of keeping its resources fully committed and, at times, even slightly overcommitted (see para. 3.17). It is able to meet its short-term requirements through long-standing arrangements for short-term accommodation with the Bank of Israel. In spite of the liquidity position, IDBI's finan- cial position is sound. - 12 - 3.22 IDBI's increased borrowings are causing its debt/equity ratio to rise. This ratio, as defined in the last Bank Loan Agreement, had reached the three to one limitation on June 30, 1974 and, as a direct result of the November 10, 1974 devaluation of the Israeli pound, most likely exceeds the limit now. A ratio of three to one is very conservative for an institu- tion as financially strong and mature as IDBI and it is proposed to increase this ratio to five to one. This ratio is still conservative for IDBI but it will subject IDBI to pressure to increase its equity base. 3.23 Audit. IDBI's accounts are audited by Messrs. Somekh, Chaikin, Citron & Co., an Israeli firm of independent public accountants. The fi- nancial statements have always been approved without qualification. D. IDBI's Prospects The Environment 3.24 The Development Plan for Industry 1974-78. The Government had prepared an Economic Plan 1974-78 in 1973 which is now out of date and under revision. A Development Plan for Industry 1974-78, produced in 1974, pro- jects a real GNP growth of 7.5% per annum during this period, assuming full employment, a 3.2% growth of the labor force (which implies an influx of some 60,000 immigrants a year), and an annual rise in national productivity of 4.5% (6% in industry). Industrial investment is forecast to increase by 16% a year in real terms, while industrial output by 11%. Industrial exports would increase by some 30% per annum, rising much faster than total merchan- dise exports. The Preferential Trade Agreement with the EEC, inter alia, is expected to facilitate the expansion of exports to these countries. 3.25 The years 1975 and 1976 will be particularly difficult for Israel. Measures to stabilize the economy are bound to have a restrictive effect on public spending, particularly non-industrial development programs, while the import capacity of the country will remain under severe strain. The standard of living will most likely decline and some unemployment may also be created, particularly in non-industrial sectors. According to tentative estimates of the Bank economic mission, real GNP may grow only slowly during 1975 and 1976, although it may pick up thereafter. The economic mission also projects con- tinuing annual deficits on goods and services of about US$3-3.5 billion in the next five years. However, the basic balance, except for 1975 when the deficit may reach US$300 million, is projected to show small surpluses of around US$100 million each year, reflecting rapid growth of exports and a projected gradual rise in unilateral transfers and other capital inflows. In light of the above remarks, the targeted growth rates of GNP, industrial investment and exports in the Plan appear to be optimistic, even assuming an easing of the political situation. Achievement of the Plan's targets is heavily conditioned on the country's export performance and the magnitudes of such uncertain factors as defense expenditures, immigration and inflows of foreign capital. Forecast ot-Upeiwaticns and Resources 3.26 Forecast of Operations. IDBI's business prospects are good. The Government will continue to lay heavy stress on induistry as the main way to improve export earnings, to absorb new immigrants and prevent emigration, and to develop the more backward areas. It can therefore he reasonably ex- pected that a high level of industrial investment will be maintained despite the enunciated austerity program and the slowdown in the world economy. This view is reinforced by the fact that 75-80% of industrial investment in Israel is in expansion projects. Industrial investment in Israel can reasonably be expected to increase by 14% in 1975 and 1976 and about 15% annually in 1977- 79 in real terms. IDBI forecasts commitments of IL 2.8 billion over the two- year period July 1975-June 1977 and of IT, 8.4 billion during 1975-79, based on the above more realistic growth rates of industrial investment and on the size of its pipeline (over IL 1.5 billion on September 30, 1974). This would result in IDBI financing about 27% of total industrial investment. IDBI's projections appear attainable. 3,27 Resource Requirements. IDBI's projections of loan operations and cash flow statements (see Annexes 15 and 16) indicate that during the five years 1975-1979 IDBI will disburse some IL 7.3 billion (US$1.2 billion equiv- alent) in new resources. Arrangements have been made or at least begun for about IT, 3.3 billion of this amount. Well over half of these IL 7.3 billion is expected to be in foreign exchange, including all of the amount to be raised from as yet unidentified sources. 3.28 Local Currency. IDBI estimates that half of its loans will be in local currency and half in foreign exchange. For the two-year period July 1975 through June 1977, during which the proposed Bank loan will be committed, IDBI is expected to make commitments of IL 1,420 million in local currency. These will be covered by loans or other transfers from the Government, local debentures, retained eaniings and loan collections, with the Government covering any shortfall. 3.29 Foreign Exchange. IDBI's projected foreign exchange commitments over the same two-year period are some US$240 million equivalent. About half of this amount will be covered from existing lines of credit or new loans already identified and at various stages of negotiation. The rest will have to be covered by as yet unidentified sources. The proposed Bank funding would help to fill part of this gap. Projected Financial Situation 3.30 Projected Profitability. Projected income statements are given in Annex 17. Net earnings are projected to grow from 1974 to 1979 at 13% a year. IDBI will probably allocate the proposed Bank funds to each of the three development areas in roughly equal portions, resulting in an average onr-lending rate of 10 to 11% for the Bank funds (see para. 2.12). The Gov- ernment, assuming the foreign exchange risk and providing a good portion of IDBI's capital, maintains IDBI's spread on most of its lending activities at 1-3/4%. IDBI's weighted average on-lending rate for all funds it employs comes close to 11%. Administrative expenses are forecast to continue to be held to the low level of about 0.4% of average total assets. 3.31 Because the forecast assumes that all new resources (other than retainecd earnings) will be in the form of debt, the share capital becomes progressively more highly leveraged. The return on non-Government held share capital is projected to grow from 22% in 1974 to 45% in 1979. While it is likely that additional equity will have to be obtained, much of this will no doubt be issued to the Government with a low (perhaps 3%) dividend rate, so the return to the private shareholders will remain satisfactory. The pay-out ratio is expected to increase in 1974 and 1975, reaching 73.5% in the latter year, before beginning again to decline. This is a result of the November 1974 devaluation which increased the cost in Israeli pounds of dividends payable in dollars. Nevertheless, the build-up of reserves is satisfactory. 3.32 Financial Position. IDBI's projected balance sheets (see Annex 18) indicate that it expects to continue to operate with a current ratio of less than one, using the Bank of Israel's short-term accommodation to meet its short-term requirements. Experience supports the continuation of this ar- rangement. Its loan portfolio is forecast to grow at an annual rate of 28%, somewhat faster than total assets (23%). Provisions for losses, which amount- ed to 0.8% of the loan portfolio at the end of 1973, are expected to amount to 1.3% of the portfolio at the end of 1979. Considering the growth of other reserves, this position is satisfactory. 3.33 As a direct result of the assumption that all new resources will be in the form of debt, the debt/equity ratio, as defined in the most recent Loan Agreement, is projected to exceed the proposed new limit of five to one in 1976 and to reach ten to one in 1979. If, say, IL 300 million of the new resources were in the form of equity, this ratio would not exceed five to one until 1978. 3.35 Interest coverage is forecast to drop from 1 .8 times in 1974 to 1.5 times in 1977 and remain at that level. Loan collections from its bor- rowers are forecast to exceed by substantial amounts loan repayments IDBI must make in each of the years covered by the projections. The cushion is provided by the large amount of resources expected to be made available as perpetual deposits which have no repayment obligations (except in certain highly unlikely circumstances). Debt service coverage is satisfactory. IV. APPRAISAL OF THE RESEARCH AND DEVELOPMENT COMPONENT A. The Role of R&D in Israel's Development 4.01 R&D is a key element in Israel's strategy of promoting export- oriented industries based on sophisticated product design and production - 15 - techniques. 1/ This strategy requires a high-level research capability closely integrated with sophisticated marketing and commercial skills at the enterprise level. It is based on the conviction in Israel that continuing reliance on foreign investment and licensing to acquire technology and know- how does not generally provide a sufficient competitive edge, and is intended to take advantage of one of Israel's major resources: its wealth of technical talent. 4.02 Exports based on sophisticated technology doubled between 1968 and 1973, reaching US$246 million, or 38% of industrial exports excluding dia- monds. This is a remarkable effort for a country the size of Israel, accom- plished in a short period of time. The Government projects that exports of science-based industrial products will grow at over 30% per annum in the next five years. This implies that an increasing number and range of industrial enterprises would have to strengthen their ability toconmercialize technical innovation. 4.03 Israel has traditionally emphasized basic and applied research in university and government laboratories, and has paid insufficient attention to developing the requisite capabilities for actually using and commercializ- ing the available knowledge. In Israel R&D is by and large not initiated by enterprises, as is the rule in a mature technological environment, but rather in research laboratories; the link with prospective users of the technology and with the market for the product tends therefore to be tenuous. The Gov- ernment is aware of this and is now trying to rectify the situation through a reorientation of research programs toward commercial application (see also paras 2.08 and 2.09). It has already instituted a program of 50:50 matching grants and is proposing to institute a program of "projects of national im- portance" in which the grant element will be higher (up to 80%). Such an en- deavor demands on the part of the Government first, a willingness to impose market discipline on the scientific and engineering staffs of public and pri- vate institutions and second, considerable sophistication in the evaluation of the commercial and technical risks involved in developing new products and in launching them in international markets. Few Israelis have all the requi- site skills and experience at the enterprise level in this field, and those that do are often directly involved in the undertakings the Government wishes to promote. The Government thus faces a two-phase problem: (a) to launch a first set of projects of national importance on the basis of the best evalua- tion possible with present staff; and (b) to build up its own internal capa- bility to review proposals presented to it by private firms or, in the long run, by risk-oriented investment firms. 1/ The Organization of R&D activity in Israel is briefly discussed in Annex 20. - 16 - B. The Proposed R&D Component Objectives 4.04 The proposed R&D component is intended to assist the Government, specifically the Office of the Chief Scientist (OCS), to strengthen its capa- bility to evaluate proposals for commercially oriented R&D. This will involve the development in the OCS, not only of the purely technological appraisal capability typical of a scientific research granting agency, but the develop- ment of technical, financial and commercial expertise sufficient to allow it to competently review proposals for R&D on a commercial timetable leading to commercLal prototypes and to specifications and selling prices dictated by the market. To this end, agreement was reached during negotiations on speci- fic steps to be taken to improve the OCS's existing structure (see paras 4.43-4.45). 4.05 OCS's organization and procedures will evolve continuously for some time as it gains experience of operations, and the Bank will finance a number of projects which will be used as a vehicle for the development of OCS's capabilities. These projects include: (a) three subprojects aimed at devel- oping commercial prototypes, which appear promising on the basis of prelim- inary evaluation (rural telephone systems, prime movers, and tomographic scanner); (b) two projects involving applied research at the early stages of development (solar ponds and jojoba liquid wax); and (c) a multi-disciplinary regional technological institution (the Negev R&D Authority). The subprojects are tabulated below and are described in paras 4.13-4.29 of the report. Foreign Exchange Bank Financing Total Cost Cost Amount _ --------------million US$--------------- I. Infrastructure 1. Multi-disciplinary R&D Facility (R&D Authority- Negev) 8.2 3.4 1.65 49 II. Pre--Commercial Development 2. Solar Ponds (Scientific Research Foundation) 1.7 0.3 0.30 100 3. Jojoba beans-liquid wax (R&D Authority-Negev) 1.6 0.6 0.40 66 III. Commercial Prototype Develop- ment 4. Rural Telephone System (Tadiran) 3.9 1.8 1.00 55 5. Prime Movers (Ormat) 4.6 1.4 0.95 68 6. Tomographic Scanner (Elscint)2.3 0.9 0.55 61 Technical Assistance to OCS - - 0.15 100 Total 22.3 8.4 5.00 60 - 1 7 - 4.06 The B8's direct and intimate involvement in the review of R&D sub- projects provides a better opportunity to influence and accelerate the devel- opment of the OCS's appraisal/supervision capabilities, than if the Bank were merely to provide technical assistance, particularly through the discipline that a financial intervention is likely to impose. Furthermore, by participat- ing in Israeli programs, the Bank will gain valuable experience in dealing with a range of problems to be faced in the near future by an increasing number of developing countries, which aspire to develop the capability to in- troduce new industrial products based on indigenous technology into the world market. Selection of R&D Subprojects 4.07 The six subprojects proposed for Bank funding were selected after appraisal of nine projects of national importance, non-defense oriented, sub- mitted by the Government. All nine were reviewed for their technological feasibility and potential spin-offs; potential benefit to Israel's economy; usefulness of the prospective technology to other developing countries; and overall capability of the undertaking entity. Those projects involving pri- vate firms were also reviewed for possibility of market success; inability of the sponsoring firm to borrow for R&D or self-finance; and the experience, ability to commercialize technology, and financial strength of the firms. The ability of the Negev R&D Authority to render R&D services not generally available to the industrial community was considered in the appraisal of this subproject. The general approach and considerations applied to the initial appraisal process followed by the Bank are discussed in paras 4.10 and 4.30. An essential part of the decision to support the proposed subprojects was the confidence in OCS's ability, properly strengthened, to keep them under con- stant review. Nature of R&D Project Appraisal 4.08 The distinguishing feature of the appraisal of a commercially oriented R&D project is that it is a continuous process. The initial appraisal takes place before the product is even designed. It is based only on a general notion of likely production method. For this reason, the initial appraisal answers only the question whether a particular project should be begun. This initial decision is based on a tentative assessment of the potential financial and economic benefits of the project, the risk of failure or partial success, and the R&D cost of the project. This judgment is based in turn on a "best" estlmate of the technological feasibility of the proposed product, of the market for this product, its projected price, and of the practicability of the development and sales timetables. These estimates are buttressed by a calculation of the estimated rate of return of the proj- ect, if it is successful and if sales and cost targets are met.# An important part of the decision to support a project is based on confidence in the over- all ability of the sponsor to undertake the proposal -- confidence based on his past record in successfully carrying out R&D projects on a commercial timetable. - 18 - 4.09 Once initially appraised, the progress of the project must be constantly monitored against the targets and timetables originally drawn up during appraisal. The timetables must be regularly revised and updated, and the prospects for success, the risks, and the prospective costs and benefits constantly reviewed and revised. If targets are not being met, and if revisions of the targets would endanger the commercial success of the project, the management of the firm must take appropriate steps either to improve performance or to terminate the project. Since the appraisal is car- ried out as an ongoing process rather than "once-and-for-all", the undertaking is never faced with an "all-or-none" risk. The decision at each point is whether to continue with the next phase of the project or to terminate it and accept the loss of the investment up to that point. 4.10 The proposed R&D subprojects were appraised as follows. The tech- nological and marketing aspects of each proposal were reviewed, with the assistance of specialized expertise drawn from inside and outside the Bank. The appraisal mission visited and evaluated the laboratory facilities, inter- viewed the technical staff and management of the sponsor, and evaluated the sponsor's commercial strategy and financial status. The financial and eco- nomic rates of return of each subproject, except for those whose potential benefits are not amenable to quantification, were estimated in order to demonstrate that, if successful, each of the subprojects promises a reason- able rate of return. The rates of return obtained are necessarily based on rough estimates of sales revenues and costs, including R&D expenditures, for the products to be developed. They will need to be recalculated periodically as development progresses. The risk element in the subprojects selected is discussed in para 4.30. 4.11 In all subprojects financed by the Bank, progress against the pro- posed timetables, prospects (including technological and commercial develop- ments related to the ultimate success of the product) as well as all other aspects of the normal supervision procedure, will be followed regularly by the Office of the Chief Scientist (see paras. 4.43-4.46) and by the Bank. The progress made by the Government toward the development of a capability to appraise risk capital propositions will also be regularly reviewed, and tech- nical assistance will be provided as necessary. The latter will take the form of recommendations to the OCS to obtain the requisite expertise at its expense, regular supervision missions, and desk reviews of reports, etc., to be submit- ted regularly by the OCS. The Bank will thus be a participant in an institu- tion building process, gaining new insights from this experience, applicable in other developing countries. In addition, this scrutiny would lead to an early decision to terminate the financing of a subproject whose probability of success, in light of intervening events, might fall below a critical level. 4.12 The success of an organization's research program cannot be judged by the outcome of a single project or small group of projects. It can only be assessed on the overall outcome of a large number of projects, i.e. on whether the fruits of the overall successes, including indirect benefits of technological and economic nature, outweigh the total costs of the research and development effort. This implies in effect that the success of the pro- posed R&D project should be judged retrospectively by the success of the - 19 - Government's industrial R&D program as a whole, and not exclusively (and narrowly) by the success of the R&D subprojects financed by the Bank. Simi- larly, the success of any particular subproject should be judged in the con- text of the overall success of the R&D program of the sponsor. Major Features of R&D Subprojects Infrastructure Multi-Purpose Facility for Industrial R&D in the Negev 4.13 The Negev has been designated by the Government as the major region for extensive industrial development due to its proximity to natural resources and its present low level of development. A range of industrial enterprises has already been established in the area while many new ones are appearing. Industrial output of the Negev industries is projected to reach some US$500 million by 1978 compared with US$140 million in 1973. Provision of R&D facil- ities is viewed as part of the region's infrastructure. 4.14 The proposed expansion of existing facilities, to be undertaken by the non-profit R&D Authority of the University of Negev, would provide special- ized R&D and other technical services not only to large industrial enterprises but also to firms whose size does not allow them to conduct their own R&D. The facility will elso perform work for university laboratories on a contract basis. These services would in large part be an expansion of the Authority's program of contract research and services to industry. The explicit under- standing with the Government is that the subproject facilities will be used only for non-defense purposes. Local industry shows a keen interest in the Authority's expanded research programs and facilities. In fiscal 1974-75, about half of the Authorityts IL 9.4 million income will come from research and technical services. This relatively high proportion of earned income is a sign of good management and close relations with industry. 4.15 The proposed expansion facility consists of: (a) the establish- ment of a Unit Process Laboratory, containing multipurpose intermediate sized equipment, to scale up processes developed in the laboratory; the facility would allow an in-depth study of processes and products including costing and marketability; and (b) a Testing Service Facility to provide support for R&D and manufacturing, including some quality control. Service charges to industry for the use of the facility are expected to be sufficient to cover its operating costs. The prospects for this happening are good (see para 4.14). Management and staff of the R&D Authority are experienced and capable. More details on this subproject in Annex 21. 4.16 OCS has agreed to report annually on the Authority's degree of autonomy, activities, emphasis on contract applied research, budget, staffing, work program, project selection methods, and internal financial controls. OCS will also furnish regularly updated assessments of the likely demand by industry for R&D infrastructure facilities. - 20 - Pre-Commercial Development 4.17 Solar Ponds. The non-convecting pond is an innovative approach to the problem of collecting and storing solar energy. A layered shallow black- bottomed pool of salt water is set up so that the salt solution is maintained denser at the bottom than at the top. The absence of convection allows solar heat, absorbed by the more concentrated solution at the bottom, to be trapped there. The heat can be extracted for conversion into electrical energy or used directly. The project will be undertaken by the Scientific Research Foundation, and will be directed by Dr. H. Tabor, a pioneer in the field. It will consist of: (a) study of the technical problems and economic feasibility of commercial scale operations; (b) building and putting into operation a small scale prototype and providing a conceptual design for a desalination plant and for the production of electric power in the range of 10 megawatts. 4.18 The commercialization of this project is inherently speculative and a number of technological and economic questions remain to be resolved. Preliminary estimates by the Scientific Research Foundation indicate that power from solar energy could be produced at about 34 Mils/KW hr. This rate would be competitive with small power plants, usually diesel, but could not compete with conventional production of electrical energy in large installations. If successful, initially therefore it could be used for small-scale production of electrical energy and for direct use of low temperature heat in hot areas. With rising fuel costs, the proposed technique could lead to expanded use of this type of energy. More details in Annex 22. 4.19 Wax Production from Jojoba Beans. The jojoba (pronounced "ho-ho-ba"), is a desert plant producing beans which, when pressed, yield a liquid oil with unique and useful properties resembling those of sperm oil. By hydrogenation, the oil can be transformed into a wax with additional and unique properties. 4.20 The subproject consists of research intended to convert jojoba from a wild plant to a commercial crop in the Negev and to develop a family of chemical compounds of even higher commercial value than those presently derived from sperm oil and carnauba wax. The research will be carried out within the R&D Authority and will constitute an individual project budgeted separately from the core institutional support being provided to the Author- ity (see paras. 4.13-4.16). Extensive chemical tests of the products, under the auspices of the National Academy of Sciences in the U.S., have stimulated favorable interest. 4.21 The primary benefit of this project would be the ultimate establish- ment of an attractive agrochemical business, producing a wide array of valua- ble commercial products and using arid land of limited value. Preliminary estimates of market possibilities and production costs are encouraging. De- tails in Annex 23. Commercial Prototype Development 4.22 Rural Telephone System. This project consists of the development of an electronic telephone system especially designed to provide a means of telephone communication to communities of 100 to 400 potential subscribers. This is a challenging commercial opportunity for a relatively small but sophis- ticated firm to capture part of a market that has not been a principal target of dominant suppliers of world telecommunications equipment. 4.23 The system will consist of an integrated package of an exchange, a multiplexer, and a radio link. The exchange will be compact, relocatable, modular, all-electronic, pre-packaged and pre-installed. Developed and developing countries have an increasing need for rural exchanges but the market now is dominated by a few big suppliers and is difficult to break into. 4.24 The R&D will be done by Tadiran, Israel's largest electronics manu- facturer and a company with a proven record of success in the telecommunica- tions field. Tadiran will design, assemble and test the prototype in its excellent facilities. Market studies will be integrated with design activi- ties to assure precise knowledge of customer requirements, adaptation of the equipment to the clients' needs, and efficient sales promotion. When the development is complete, the company will manufacture the product in its own plants and would be willing to install plants in other countries. The finan- cial (after taxes) and economic rates of return, if the project is success- ful, are estimated at 34% and 33%, respectively. Its association with the multinational firm of General Telephone and Electronics International will strengthen its international marketing capability, whereas the Government subsidy encourages this multinational firm to do part of its R&D in Israel. For details see Annex 24. 4.25 Prime Movers. This project consists of the development of a family of five prime movers (engines) with appropriate prototypes and market studies. They would be designed so as to be compatible with a variety of energy sources, such as solar, wood, waste products and geothermal. The items to be developed may include: (a) 1-5 horsepower village engine which could use wood, agricul- tural waste or biogas as a supplementary fuel; (b) engine for pumping drinking water; (c) 100-1000 watt power generator for rural TV educational systems and for local telecommunications; (d) 5-15 horsepower engine for locally assembled multipurpose tractor; and (e) conceptual design of a 1-10 megawatt turbogen- erator for production of electricity from geothermal, solar or ocean thermal gradients. 4.26 The company, Ormat Turbines, Ltd., is a pioneer and technological leader in the field of Rankine cycle turbines, using organic working fluids. Some of its related products, which were developed from prior solar energy research, have given 8 years of reliable maintenance-free service in remote areas. 4.27 Major advantages of the proposed engines would be their high relia- bility, unattended and maintenance free operation, and use of non-conventional low cost fuels. The market therefore for the family of engines would be in - 22 - isolated areas where maintenance of diesel engines is difficult, or where conventional fuel is expensive or not readily available. A major problem in the product development will be to identifv and definie this markot procisjtv. to eliminate product ideas which do not have a market potential, and to de-- sign a product line accordingly. Ormat's experience with and appreciation of the special requirements of developing countries should facilitate this market definition. The financial (after taxes) and economic rates of return of the project, if successful, are estimated at 41% and 43%, respectively. However, since the underlying technoeconomic and marketing studies at present lack the requisite sophistication and depth, Ormat will carry out initially a thorough study of product lines, while limiting engineering to aspects likely to be required in any case. This will allow time for a more precise definition of the proposed product lines before detailed engineering studies are undertaken. Further details on this subproject in Annex 25. 4.28 Tomographic Scanner. Tomography (from the Greek "tomos", a section, and -graphy), a new technique for using a computer and X-rays to locate tumors and other diseases, is thought to be one of the most important recent innova- tions in the field of radiology. Currently, there are two tomographs on the market and several more are known to be under development. This project, to be undertaken by Elscint Ltd., proposes to develop a more versatile and higher performance scanner than is currently available, by reducing the scanning time, enlarging the field of view of the scanner, and by reducing the price of the equipment. 4.29 Elscint, a well-managed, aggressive and financially sound enter- prise, has an impressive record of product development. The largest part of the output will be exported, mostly to developed countries. Competition exists and is likely to increase. At the same time, entry of new firms in this field attests to the good market prospects of this type of equipment and adds to the justification for its development. The project will enable Elscint to build a competent product development team. The financial (after taxes) and economic returns of the project, if successful, are estimated to be 30% and 13%, respectively. Details in Annex 26. The Risk Element 4.30 All R&D projects carry a measure of risk, in that satisfactory tech- nical solutions may not be found for developing a commercial prototype, or solutions may be too costly, or there may be changes in the prospective mar- ket. The risks involved in the subprojects presented here are reasonable and taking them is an essential part of the Government's long-range strategy for industrial growth. These risks are as follows. The Negev R&D Authority is an infrastructure project and carries only the risk that the research and tech- nical support services provided to local industry might not always lead to commercial results, or that the Authority might not be able to fully utilize its facilities and break even. This risk is inherent in the establishment of any new research undertaking; indeed, similar risks are involved in the establishment of any new institution. With the two projects involving "pre- commercial development", the risk is that the researchers may not succeed in developing a commercially viable technology for jojoba bean agriculture or -23 - lor so'ar pc- -: aese are nonxial risks tor pioneer applied researcn proj ecz of this nacure. The projects are very promising, but many hurdles remain to be overcome before commercial success can be achieved. With the three commercial prototypes, the risk is of a different nature. The three israeli companies must hold their own in highly competitive international markets involving soph'Lsticated technologies. The risks in such efforts are high but necessary. The calculations in Annexes 24-26 show that rates of return for these sub- projects are high but sensitive to relatively small changes in operating costs and sales revenues. This is normal in the launching of new high technology products and points to the need for constant review of the targeted costs and benefits. If the subprojects are successful, the potential financial results and technological spin-offs could be large in relation to the R&D investment. The decision to accept the risks is part of the ongoing appraisal procedure referred to earlier (paras 4.08-4.10). OCS will assess the extent and varia- tion of these risks as development proceeds and, subject to Bank approval, will withdraw financial support from any subproject whose probability of suc- cess declines below a critical level. The Government concurs that not more than one substitution of a new subproject for any of those already approved by the Bank is coatemplated, provided a convincing case could be made for it and that the in4 tial appraisal of the substitute subproject would not pose serious expertise or manpower problems for the Bank. Cost Estimates and Financing 4.31 Project Cost. Total project cost is estimated at IL 134 million (about US$22 million) over a five-year period, of which 38% would be in for- eign exchange. A breakdown of expenditures for each subproject and details on the inflators used are presented in Annex 27. Estimated price increases are based on detailed analysis of price trends during the time of appraisal. Cost estimates for each R&D subproject are summarized below; they include an allowance of 54%O for price contingencies. No provision was made for other uncertainties (e.g., delays, unforeseen technical problems, etc.), since their assessment in R&D projects would be extremely speculative. Project Cost /1 Foreign IL Million US$ Million Exchange SubIrojects Local Foreign Total Local Foreign Total Component % Mlultipurpose R&D Facility 29.0 20.7 49.7 4.8 3.4 8.2 41 Solar ponds 8.6 1.4 10.0 1.4 0.3 1.7 18 Jo1o.a Beans (liqu'd wax) 5.6 3.7 9.3 1.0 0.6 1.6 38 Rural Telephone System 12.7 10.9 23.6 2.1 1.8 3.9 46 Priq)e Movers 19.3 8.2 27.5 3.2 1.4 4.6 30 To0ographic Scanner 8.3 5.3 13.6 1.4 0.9 2.3 39 ToLal 83.5 50.2 133.7 13.9 8.4 22.3 38 i) Includes 54% price contingencies. - 24 - 4.32 Financing. Bank funding in the amount of US$5 million is proposed, which would cover about 60% of the estimated foreign exchange component of the total R&D expenditure of the proposed subprojects. Project financing would be provided by the following sources. Project Financing (IL million) Grant Element % of Total Subprojects Sponsors Loans Gov't IBRD Total Amount Project Cost Multipurpose R&D Facility 16.0 14.3 9.5 9.9 49.7 28.6 58 Solar Ponds 3.9 2.8 1.5 1.8 10.0 5.2 52 Jojoba Beans (liquid wax) 1.8 3.5 1.6 2.4 9.3 7.0 75 Rural Telephone Syst. 4.6 4.6 8.4 6.0 23.6 17.6 75 Prime Movers 3.2 10.6 8.0 5.7 27.5 17.7 64 Tomographic Scanner 4.1 1.3 4.9 3.3 13.6 8.7 64 Total 33.6 37.1 33.9 29.1 133.7 84.8 63 …----------…US$ million------------ 5.6 6.1 5.6 4.911 22.3 14.0 63 /1 Including US$150,000 earmarked for "OCS Technical Assistance't, total Bank funding amounts to US$5 million (see Table in para. 4.05 and para. 4.36). The Bank funds would cover 22% of the estimated total R&D outlays over the period required for the completion of the subprojects; sponsors would be required to contribute from their own resources 25%, which is considered reasonable and within their financial means, and to borrow from investment banks another 28%; the Government would supply the balance of 25%. Since the amount of the grant element (see paras. 2.09 and 4.34) is estimated at IL 85 million (US$14 million), or 63% of the total cost of R&D expenditures for all proposed subprojects on average, the sponsors would in effect contribute only 37% instead of the 53% initially financed. The Government has agreed to pro- vide the requisite funds to cover both the foreign exchange requirements of the subprojects over and above the part to be financed by the Bank, and the local currency requirements (grants) for all Bank-financed subprojects, as appropriate. In addition, the Government has undertaken to ensure the avail- ability of funds for construction and equipment from investment banks. - 25 - Disbursement and Procurement 4.33 OCS Disbursement Procedures. According to current practice, which is to be continued, the contract signed between OCS and the sponsor indicates the intention of the Government to finance the project for the estimated pe- riod required for the completion of the proposed R&D, but disbursements are approved and effected only for one year at a time (usually projects take 2 to 5 years to be completed). Following the annual assessment of the tech- nical progress made, the contract is renewed for another year and so on. There has been no adverse reaction to this policy of disbursement in annual tranches. In projects of national importance, such as those to be financed by the Bank, the review committees (see paras. 4.43-4.44) will recommend the extension of the contract every year, following a comprehensive review of the subproject (e.g. progress made, new developments in the researched field, changes in size of prospective markets, etc.). 4.34 The Government (OCS) will fund outlays on R&D in approved projects of national importance, including those to be financed by the Bank, in the following way. The Government will bear the entire cost of highly specialized equipment (a rather small proportion of the total expenditure on equipment). This type of equipment will be used free of charge by the sponsor until com- pletion of the project, with the Government always retaining ownership. For other equipment, upon the recommendation of the OCS, the sponsor will receive a concessionary medium-term loan from an investment bank at 8% per annum. The sponsor, however, will be reimbursed by the Government for 80% of the cost of this equipment over a period of five years. Furthermore, the Government will assume the entire cost of supplies and services purchased abroad by the sponsor; salaries and related costs of the additional R&D staff the sponsor will hire; administrative expenses strictly related to R&D; and expenses for foreign travel of the sponsor's staff made in connection with the R&D. Funds for construction, for which Bank funds will not be used, will be provided from financial institutions at the OCS's recommendatiorn at 8% per annum. The Government will ensure in the contracts with individual enter- prises that, in successful cases, part of the profits--1% to 4% of sales for a period of 10 years, as judged appropriate by OCS 1/--will go to a special fund to support future research in projects of national importance. The proposed arrangement appears satisfactory and allows for flexibility in the light of experience and the financial structure and performance of the com- panies involved (see also para. 6.03). 4.35 Disbursement of Bank Loan. On submission of appropriate documenta- tion, certified by the OCS, the Bank would reimburse the Government for the foreign exchange cost of: (a) imported equipment and materials; and (b) ser- vices obtained from outside the country and salaries and travel expenses of 1/ As an order of magnitude, in case of success a charge of 3% on sales would imply a levy of US$10 million on Ormat, US$2.4 million on Tadiran, and US$2.7 million on Elscint over a period of ten years of commercial pro- duction on the basis of sales projections by the companies (in 1974 prices). - 26 - foreign experts, as required and up to the limit indicated in the Table in para. 4.05 for each subproject. An estimated disbursement schedule is given in Annex 30. This approach is recommended in view of the inherent uncertain- ties as to the ultimate success of the proposed subprojects and the desire to finance part of as many eligible subprojects as possible. 4.36 A sum up to US$150,000 may be allocated from the Bank funds (see Table in para. 4.05), with the Bank's approval, to cover the foreign exchange costs of consultants, travel and other equipment and services needed to enable the OCS to: (a) strengthen its institutional appraisal/supervision capability (see paras. 4.43-4.45) for projects of national importance, in- cluding those financed by the Bank; (b) undertake studies needed to evaluate the contribution of projects of national importance and other policies or programs sponsored or considered by the OCS, to the commercialization of industrial technology in Israel, including the possible application of such technology to related problems in other developing countries; and (c) enable OCS to resolve ad hoc problems expeditiously. 4.37 Procurement. Bank funds will not be used to finance civil engineer- ing works, which amount to only US$1.4 million and involve three subprojects in different locations. R&D equipment is to a considerable extent specialized and proprietary. The individual items are of relatively small value and procurement is spread over a period of up to five years; bulking is not fea- sible. Furthermore, there is adequate representation of foreign suppliers locally to ensure competition. As at present, OCS would satisfy itself about the need for the equipment, the actual purchase and use, and its cost. How- ever, OCS should require the applicant to request quotations for equipment from at least three suppliers if the value of each item is over US$20,000. C. Project Implementation The Project Unit 4.38 The project unit for the R&D component will be the Office of the Chief Scientist (OCS) in the Ministry of Commerce and Industry, which has been in existence for four years. The OCS has the basic responsibility of implementing the Government's policies for industrial R&D, and operating responsibility for administering Government industrial laboratories, the matching fund program, and the new program of R&D projects of "national importance". The functions of the OCS are described in Annex 28. An Organ- ization Chart is attached as Annex 29. 4.39 Management. Professor Y. Yaakov, Chief Scientist since March 1974, has wide technical and managerial experience, provides competent leadership, and has an excellent understanding of the problems of industrial technology in Israel. His deputy, Dr. M. Zirin, also Director of the Industrial Research Administration, is experienced and capable. _I27 _ 4.40 Staff. OCS is presently understaffed but it is expanding. At the end of the last fiscal year (March 31, 1975), the permanent staff of profes- sionals had increased from 9 to 13 by the addition of 2 technical experts (one of whom was appointed as Chief Technologist) and 2 economists. More- over, as is current practice, OCS will continue to rely on part-time special- ists who can be readily hired and for whose services suitable budgetary arrangements exist. Ability to hire specialists on an ad hoc basis increases the range of expertise OCS can have at its disposal. OCS can also draw on experts available at the Ministry of Commerce and Industry and in the Re- search Institutes it supervises. OCS's staff is experienced and well moti- vated. It is projected that in fiscal 1976, about ten additional profes- sionals of various specialities will be recruited. 4.41 Accounting System. OCS's accounting system is rudimentary as it relies for this type of service on the Ministry of Commerce and Industry and, for audits of grantee enterprises, on a private firm of public accountants. However, steps are being taken to improve the situation, and arrangements to secure normal accountability on Bank-financed activities were agreed upon during negotiations. 4.42 Audit. OCS's activities are reviewed annually by the Internal Comp- troller of the Ministry of Commerce and Industry. OCS's overall performance and financial operations are audited by State Comptrollers. It was agreed that the Government will furnish to the Bank within one month after publica- tion the part of the Accountant General's (Ministry of Finance) annual fi- nancial report submitted to the State Comptroller dealing with OCS operations as well as any evaluation reports of OCS operations produced by the State Comptroller, with special reference to Bank-financed subprojects. Further- more, the firm of public accountants employed by the OCS will also prepare an annual report for the Bank on OCS's activities, including recommendations for possible improvements. Development of OCS's Organization and Appraisal/Supervision Capability 4.43 OCS's appraisal and supervision work needs to be upgraded. The Chief Scientist is cognizant of this and is setting up standing review commit- tees, composed of up to seven experts, of which at least two will be OCS staff members. One of the latter will be designated to monitor each subproject, including those financed by the Bank. In the absence of a qualified OCS staff member to serve as monitor, OCS will appoint a staff member as assistant monitor and will seek an outsider as monitor, who will train and supervise the work of the assistant monitor. The members of the review committees will have technological, financial, marketing and business planning competence, and are expected to be drawn from universities, scientific institutes, the Government and the business community. Recruitment of qualified staff is OCS's major concern and will be reviewed by Bank supervision missions. 4.44 The review committees will scrutinize appraisal and supervision reports of R&D projects of national importance and will advise the Chief Scientist on their merit, being directly responsible to him. The establish- ment of review committees is an important step toward strengthening the - 28 - appraisal/supervisory capability of the OCS, and the Bank will follow closely the progress and quality of their work. Three such review committees, cover- ing the fields of electronics, mechanical engineering and industrial crops, have already been established and will supervise four of the six subprojects to be funded by the Bank. Others will be set up for solar ponds and the R&D Authority of the Negev, and for other projects of national importance as necessary. Constitution of an appropriate review committee for a Bank funded subproject is a condition for disbursement of Bank funds. 4.45 The review committees will have responsibility for up to four proj- ects at a time. The committee will review the feasibility study prepared by the sponsor and will agree with him on a development program schedule, which will serve as a yardstick for monitoring the progress. The sponsor will produce quarterly reports which will be reviewed by the monitor and by the Chief Scientist. As the project progresses, the committee, through the monitor, will be in frequent contact with the sponsor to review the technical progress made, the currently projected costs, changes in market conditions and price structures, technological advances in the field, etc. If targets are not achieved, the committee will recommend to the Chief Scientist either assistance to resolve the difficulties or termination of the project. The thoroughness of this review will increase as the OCS gains experience and, over the next several years, the OCS should evolve a greater capability to review proposals for the development of commercial prototypes according to principles of risk capital analysis. The committee is expected to meet at least quarterly and to review the quarterly reports and the comprehensive annual report to the Chief Scientist prepared by the monitor. Such quarterly and annual reports prepared for the Bank funded subprojects, including the committee's and the Chief Scientist's recommended action, will be submitted to the Bank. OCS has agreed to employ independent foreign consultants to review the progress of Bank financed subprojects, if the Bank so requests. OCS may also, in consultation with the Bank, employ consultants to assist it in appraising and reviewing other R&D projects of national importance (see also para. 4.36). Consultants' services are estimated at 25 man-months. 4.46 Two years after the completion of each R&D subproject, OCS will fol- low up arLd prepare a full report on the accomplishments of the R&D undertaken-- whether the product was actually developed; market success, profitability, and export earnings of the product; market success in developing countries and evidence of benefit to them; evidence of benefits to Israel over and above the commercial success or failure of the particular product. The Bank will also receive and review these reports on the subprojects it financed. Further- more, within one year after completion of all Bank financed subprojects, the OCS will prepare and submit to the Bank a comprehensive report assessing the overall impact of the R&D component. 4.47 To counterbalance the disproportionate influence of the academic scientists on Israeli science policy and to help determine priorities for R&D programs funded by OCS, the latter will establish a Policy Advisory Com- mittee, which would include representatives of the business, Government and academic community. - 29 - V. APPRAISAL OF THE VOCATIONAL/TECHNICAL TRAINING COMPONENT A. Educational System and Development Strategy In Israel 5.01 Israel has a well structured, technically oriented and efficiently run educational system. Compulsory education begins with kindergarten (age 5 years) and continues through eight years of primary education, or where the new "reform" system is in operation, to six years of primary education fol- lowed by three years of lower secondary education. Under the old system, still operative in two-thirds of the country's schools, secondary education extends over four years (grades 9 to 12) as compared with the new system of three years each in lower (grades 7 to 9) and upper secondary education (grades 10 to 12). The educational system is described in greater detail in Annex 31; an Organization Chart for vocational/technical training is attached as Annex 32; enrollments up to secondary level in 1973 are shown in Annex 33. 5.02 During fiscal years 1963 to 1972, total expenditures on education increased by about 20% per annum (Annex 34). Of the fiscal year 1972 recur- rent expenditures (Annex 35), about 34% of the total (mainly at the primary level) is provided directly by the Government; local authorities account for 16% (mainly at the secondary level); and various non-profit institutions and private organizations supply the remaining 50% (mainly at post-secondary levels). The distribution of capital expenditures among the Government, local authorities and non-profit institutions is 12%, 34% and 54%, respec- tively. 5.03 Technical education is being emphasized at the secondary school level by the establishment of new multi-lateral secondary schools with indus- trial arts as a compulsory subject in the lower school and technical options provided in the upper school. About 65% of boys and 35% of girls are present- ly taking technical subjects either in the old technical secondary schools or in the new multi-lateral schools. 5.04 To meet the need for a skilled labor force able to contribute effec- tively to an expanding industrial sector (see para. 2.07), the Government has initiated action (a) to raise overall educational standards and (b) improve and expand training facilities and programs at the craft and technician levels. As part of this effort, the Government has prepared a program providing for an increase in the number of vocational training centers and trades taught, and the gradual replacement of the small and thus uneconomical centers now in operation by larger centralized institutions offering improved facilities and programs; all new centers will also be used for short-term up-grading and retraining courses. The Government's program and priorities for the develop- ment of vocational/technical training are soundly conceived; however, imple- mentation continues to be constrained by limited financial resources and will need to be accelerated in order to meet the projected requirements for train- ed manpower. - 30 - 5.05 In order to meet the current and projected demands for all types of adequately trained manpower (Annex 36) and of middle and high level techni- cians, particularly in industry and commerce (Annex 37), the proposed compo- nent would increase the existing training capacity of the project institu- tions by about 167% and 54% in vocational and technician training, respective- ly; the output of project institutions would be sufficiently increased to meet about 35% and 30% of the projected shortage of skilled workers and tech- nicians for 1985. The explicit understanding with the Government is that the project facilities will not be used for military purposes. B. The Proposed Vocational/Technical Training Component General 5.06 The proposed vocational/technical training component would assist the Government in improving and expanding its system of vocational/technical training consistent with the country's socio-economic development strategy. Specifically, the items proposed herein would enable the Government to: a) replace existing uneconomical training centers with expanded regional facili- ties offering a wider range of training opportunities; b) improve the quality and level of courses at one existing training center and two technician institutes by replacing obsolete equipment; and c) increase emphasis on the training of skilled craftsmen and technicians for industry. The proposed institutions, consisting only of academic and communal facilities and equip- ment, are listed below, and further detailed in Annex 38; boarding accomoda- tions and staff housing were not requested, consistent with the Government's policy of minimizing the additional costs of constructing and maintaining such facilities. Output from the proposed facilities would meet about 35% and 30%, respectively, of the shortage of skilled workers and technicians, projected for 1985. Student Places Estimated Annual Institutions Grades Existing Added Total Output Three technician/practical engineering institutes 13-14 1,400 760 2,160 1,630/1 Construction and equipping of the expansion of one in- stitute (Beer Sheva) and equipment only for two institutes (Haifa and Jerusalem) Four vocational training centers ungraded 510 850 1,360 1,825/1 Construction and equipping of the expansion of three centers (Haifa, Jerusalem and Holon) and equipment only for one center (Tel Aviv). /1 Combined output of day and evening classes. - 31 - Vocationa.l -: t Centers 5.07 Three of the four vocational training centers already exist and Bank lending would be utilized to provide instructional equipment and 10 additional classrooms, 7 laboratories and 39 workshops. The fourth center (Kiryat Hamelaka) will be relocated in an industrial building now being con- verted for training purposes and the project would provide for equipment only. The four training centers are located in the main growth regions of the coun- try and would increase the number of training places to 1,360 by 1978, or about 167% over their present capacity, while making possible the replacement of three small obsolete and uneconomic centers. 5.08 The basic courses to be given at each center vary in length from 3 to 13 months according to the craft taught and to their designation as t"youth" or "adult" courses. The former is normally concerned with boys or girls of 16 to 18 years of age who have completed nine to ten years of full- time day schooling. Depending upon family circumstances, youth trainees may be awarded small subsistence and travel allowances and exemption from course fees; adult trainees normally are 18 to 21 years of age and receive subsist- ence and travel allowances according to the course followed and personal circumstances. 5.09 Course offerings in the four vocational centers concentrate on metal work, mechanics, electricity/electronics, carpentry, needle trades and drafting. In addition, the centers are used for specialized up-grading and re-training courses and for seminars of shorter duration. In the above fields, vocational centers also offer apprenticeship courses (about 10% of total course offerings) requiring attendance from one to three days per week; how- ever, most such courses are given in specially designated apprenticeship training centers. Technician Training Institutions 5.10 Two of the three proposed institutions (Beer Sheva and Haifa) are already in operation but are in a period of transition from widely dispersed temporary facilities to more centralized accommodations. The third institu- tion (ORT School of Engineering, Jerusalem) expects to operate in buildings now under construction by September, 1975. In all three cases, continuing phases of construction are planned. Under the proposed component, accommoda- tions would be increased by 760 new places or about 54% over existing levels; the output of technicians and practical engineers on a double shift basis would increase by about 63% by 1980 from the present annual output of 1,000. 5.11 Courses leading to recognition as a "technician" are of one year's duration (two years in evening courses) and for senior technicians or practical engineers are of two years' duration (four years in evening courses). As part of the certification requirements for trainees, an additional six to twelve months are devoted to the preparation of a technical research project in their respective fields of specialization. Consistent with development objectives, the proposed project institutions will concentrate on training programs in electrical/electronics fields, mechanical, instrumentation and controls and automation technology. - 32 - Cost of the Vocational/Technical Training Component 5.12 The estimated cost and foreign exchange components of the various parts of the proposed component are summarized below and set out in Annexes 39 and 40. Israeli i (millions) US$ (millions) Items Local Foreign Total Local Foreign Total % Technician/practical engineering insti- tutes (3) 16.3 13.0 29.3 2.7 2.2 4.9 47.1 Vocational training centers (4) 22.5 10.5 33.0 3.8 1.7 5.5 52.9 Base Line Costs (Subtotal) 38.8 23.5 62.3 6.5 3.9 10.4 100.0 Contingencies: Physical 3.6 1.8 5.4 0.6 0.3 0.9 Price 21.0 6.0 27.0 3.5 1.0 4.5 (Subtotal) 24.6 7.8 32.4 4.1 1.3 5.4 51.9 Total Project Cost 63.4 31.3 94.7 10.6 5.2 15.8 5.13 Construction costs (Annex 39) were estimated on the basis of actual bids on similar recent construction in Israel and adjusted to reflect regional cost differences. Space standards are based on detailed schedules of accommoda- tion consistent with curricula requirements. Equipment and furniture costs were estimated for each category of goods and detailed lists would be compiled during the design stage and presented for Bank approval prior to procurement. Use factors for project schools would be economical with all facilities being used on a double-shift basis. 5.14 Based on actual construction costs of similar facilities obtained from the Department of Public Works, project costs would include contingency allowances (Annex 40) for unforeseen physical conditions equal to 10% of the estimated costs of site works, construction and professional services and 5% for furniture and equipment. Estimated price increases during the implementa- tion period are based on a detailed analysis of the construction cost index and price trends at the time of appraisal. From 1975 through 1977, site work costs are expected to increase annually by 20,15 and 12% for both local and foreign costs; local construction costs and professional fees would increase by 30, 25 and 20%, and the foreign exchange costs by 20, 15 and 12%. For furniture and equipment, local and foreign exchange cost increases are esti- mated at 12, 10 and 8% respectively. The total contingencies would amount to about 52% of base line costs or about 34% of total costs including contin- gencies. - 33 5.15 .Tne.2.-i foreignr exchange component is estimated at $5.2 million or 33% of the total costs; the proposed funding of $5.0 million would meet 96% of the foreign exchange cost with the balance (consisting of $0.2 million for furniture) being provided by the Government. Foreign exchange costs were calculated as follows: site works, 10%; construction, 19%; professional serv- ices, 5%; furniture, 30%; and equipment, 95%. 5.16 At full capacity, the proposed institutions would require about US$5.7 million a year in operating costs, corresponding to about 2.1% of pro- jected recurrent expenditures on education in fiscal year 1979 (Annex 41). In view of the high priority assigned to the expansion and upgrading of vocational/technical training, the Government can be expected to meet these expenditures, as well as its share of the capital costs. C. Implementation and Disbursement Project Administration 5.17 A Project Unit would be established within the existing structure of the Ministry of Labor (Annex 32) to implement and coordinate all aspects of the project. The Director of Planning and Organization in the Ministry's Department of Vocational Training is expected to assume the responsibilities of Project Director; the remaining professional and support requirements for project implementation would be carried out by existing staff now assigned to similar functions in on-going programs. The appointment of the Project Direc- tor, Equipment Procurement Coordinator, and Accountant would be a condition of effectiveness of the Loan Agreement. Procurement 5.18 Civil works and equipment -supply contracts, except for residual equipment, would be awarded in accordance with the Guidelines for Procurement under World Bank Loans; furniture would be locally procured and financed. Up to 20% of equipment contracts may be won by local bidders, including 10% (or US$300,000) in residual items. Local manufacturers of equipment would be al- lowed a preferential margin of 15% of the CIF costs of competing imports or the existing rate of customs duty, whichever is the lower. Bid comparisons would be made in accordance with the Bank's guidelines on the application of domestic preferences in bid evaluation. Items would be grouped to the extent practicable to form sizeable bid packages and to permit bulk procurement. The Project Unit would be responsible for all aspects of bidding on equipment and would coordinate with the Department of Public Works with respect to bidding on civil works. No foreign firms are expected to submit bids on civil works, given the relatively small size and widespread locations of project items and the well developed construction industry in Israel. 5.19 Total construction costs of the proposed component would correspond to less than 1% of the estimated value of public construction completed in 1974. An adequate number of qualified building contractors are available for the project and an appropriate pre-qualification system is in operation. - 34 - Disbursement 5.20 Disbursement (Annex 42) for equipment would be on the basis of 100% of the CIF cost or ex-factory price up to the amount of US$3.22 million which is the estimated foreign exchange cost, including all contingencies. About 18% of the estimated total cost of civil works, including professional serv- ices, would be financed by the proposed funding; these percentages would be adjusted as necessary to distribute disbursements over the period of imple- mentation. About 10 man/years of professional architectural services would be required for design development and construction supervision. Design and Implementation 5.21 Due to the urgent need for the extension of facilities included in the proposed project items, qualified consultant architects have been selected by the Ministry of Labor for preparing preliminary design studies in accordance with criteria acceptable to the Bank. Field supervision of proj- ects would be conducted on a periodic basis by the consultant architects and on a daily basis by the participating institutions under the coordination of Public Works Department engineers and the Project Unit. 5.22 The constructing and equipping of project institutions is expected to be completed in about three years after the signing of the Loan Agreement (Annex 43). A one year period would be allowed for guarantees and closing of accounts following the completion of equipment installation. The closing date for disbursement would be June 30, 1979. VI. THE PROPOSED LOAN - OBJECTIVES AND JUSTIFICATION 6.01 The proposed composite industrial credit project is expected to con- tribute to the implementation of the Government's industrial development poli- cies, in part through a development finance type operation and in part through the funding of R&D and technical training, given the complementary role of these components. A loan to finance all three components in the amount of US$35 million will support high priority objectives and is justifiable and appropriate. The particular contribution of each component to the achieve- ment of these objectives is discussed briefly below. 6.02 IDBI Component. The proposed funding of IDBI, to be on-lent on average at about 10-11% per annum, 1/ will support projects exclusively in the less-developed regions of the country (Areas "A" and "B") and export-oriented projects regardless of their location, 2/ in consonance with the Government's 1/ The Government is in the process of implementing its decision of partial indexation mentioned in para. 2.12 and, when implemented, it would be applied to IDBI's subloans. 2/ A firm is defined as export-oriented if it exports a minimum of 20%, 30% and 50% of its output according to its location in zones "A", "B" and "C", respectively. - 35 - development objectives. Furthermore, a major part of these projects would be in science-based industries which the Government is eager to promote. Thus, IDBI will continue its developmental role, being the most important financial instrument for implementing the Government's stated industrial policies. On these grounds, the proposed funding of US$25 million to IDBI appears fully justified. Bank funds will cover only a small part of IDBI's projected foreign exchange resource gap in the next two years (10%). IDBI would perforce have to continue, and to further intensify, its resource mobilization effort abroad with the same diligence as in the recent past. The funds will be used to finance the foreign currency component of fixed capital costs of private sector projects with demonstrable economic viabil- ity. Projects financed from the Bank loan will be located within the borders of Israel as of January 1, 1967, and will not be defense oriented. 6.03 The R&D Component. The industrial R&D component will enhance the developmental impact of the overall loan. It will assist Israel in making more effective use of its substantial body of scientists and technologists in export-oriented expansion of science-based industries and in the more intensive use of its limited natural resources. This addition to Government funds will provide the needed incentives to relatively small private firms to offset the risk of large losses inherent in attempts to commercialize new technology and to offset the dearth of risk capital in the country. On these grounds, the Government's decision to share up to 80% the R&D expenditures of the grantees appears justified. It is very doubtful that these projects would go ahead without Government support. At the same time, the grantees have a considerable stake in the proposal R&D program, in terms of own funds to be sunk, high opportunity costs of technical staff involved in the project, loss of prospective profits, past record of innovative projects, and prestige. It can therefore be reasonably expected that the grantees would do their utmost to achieve the best results. 6.04 Bank funding will also have institution building effects. It will help to further develop institutional mechanisms to link research activity to production and marketing functions at the enterprise level. The appraisal and supervision arrangement for OCS and the proposed set of subprojects should provide opportunities to the Bank to suggest changes and to introduce new approaches in the OCS's structure and operations, and thereby strengthen the appraisal/supervision capabilities of the OCS. This being the first R&D project, the Bank also stands to gain valuable insights in the appraisal and implementation processes. Furthermore, the product and process innovations to be developed under the funded subprojects can have important side benefits for other developing economies in the form inter alia of design and engineering services that are implicit in some of these subprojects (solar ponds, jojoba beans, rural telephones). 6.05 Based on rough and tentative cost and benefit estimates, the finan- cial and economic rates of return for three of the proposed subprojects, if they are successful, were calculated; they are very satisfactorv. Similar calculations for the multi-purpose facility of the Negev, the solar ponds and the jojoba beans subprojects were not undertaken, as they would not have been - 36 - meaningful. The tentative character of the cost and benefits estimates is underscored, since it should be borne in mind that the very purpose of the prototypes the sponsors would develop is to obtain the information needed to assess more accurately the manufacturing and financial viability of the sub- projects. 6.06 The Vocational/Technical Training Component. All proposed compo- nents are fully consistent with the Government's overall strategy and priori- ties for promoting greater efficiency and qualitative improvements in the area of vocational/technical training, increasing the types and levels of training opportunities and meeting the demand for a properly trained and sufficiently flexible labor force. These objective are soundly conceived. The project institutions would respectively meet about 35% and 30% of the projected shortage of skilled workers and technicians for 1985. The total amount of estimated expenditures would be directed specifically toward meeting the existing and projected manpower constraints, particularly in the industrial sector. 'The vocational/technical training component would also help reduce economic and social disparities by providing increased training opportunities for early leavers from the formal education system as well as for adult workers and the sizeable number of immigrants requiring retraining to enable them to be productively employed in a changing labor market. VII. RECOMMENDATIONS AND AGREEMENTS REACHED A. IDBI Component 7.01 IDBI continues to be a suitable, deserving and creditworthy borrower of Bank funds. It is expected to continue to play an important role in financ- ing private industry in Israel. Although it might contribute only marginally to local currency resource mobilization due to constraining Government policy, it has been successful in raising resources from abroad. It is expected to continue to do so, with Government encouragement, and a Bank contribution will provide effective support in these endeavors. Bank lending of US$25 million is appropriate and recommended. The funds would be disbursed to finance: (a) 100% of c.i.f. cost of imported equipment; (b) 50% of the cost of imported equipment purchased in Israel; and (c) 20% of the cost of equipment produced in Israel from imported components. 7.02 As noted in paragraph 6.01, the funds going to IDBI will be part of a larger loan to the Government, which will include R&D and technical train- ing components. They will be on-lent by the Government to IDBI for 15 years, including about 2 years of grace, under an agreement between the Government and IDBI the signing of which will be a condition of effectiveness of the Bank loan. There will be a separate Project Agreement between the Bank and IDBI covering the normal provisions and covenants for DFC loans. - 37/ - 7.03 IDBI will repay the Government, and the latter will repay the Bank, according to identical amortization schedules which will be flexible and will conform substantially to the aggregate repayment schedule of loans IDBI makes to its borrowers with the proceeds of the Bank funds. IDBI's sub- loans will have a maximum maturity of thirteen years, including an appropri- ate period of grace. An initial tentative amortization schedule was agreed upon during negotiations. 7.04 IDBI's continuing good record of operations permits the raising of its debt/equity ratio, as defined in the previous Loan Agreement, from 3:1 to 5:1, and of the secured (by floating charges) debt to equity ratio from 2:1 to 5:1. Similarly, the free limit should be raised from US$750,000 to US$1 million with an aggregate free limit of one-half of the amount relent to IDBI (as before); this should result in the Bank reviewing between six and ten projects, an appropriate number. B. R&D Component 7.05 The proposed R&D project deserves the Bank's support in view of its significant contribution to the country's industrial development and institu- tion building. To this end, Bank funding of US$5 million equivalent is pro- posed. This is a reasonable amount, given that the R&D component is the first of its kind to be undertaken by the Bank and in view of the element of risk involved; yet, it is sufficient to give the Bank a significant stake in this component. Bank funding will cover 60% of the foreign expenditures on import- ed equipment, materials and services. Bank funds will not be disbursed until an agreement satisfactory to the Bank has been entered into between OCS and the sponsors. 7.06 During loan negotiations, agreement was reached with the Government that: (a) it will place at the disposal of the OCS the necessary funds to cover both the foreign exchange requirements over and above the part to be financed by the Bank and the local funds (grants), promptly as needed (para 4.32); (b) it will ensure the availability of the necessary funds at investment banks to be drawn upon by the prospective sponsors of Bank-financed R&D subprojects for construction outlays and purchase of equipment (para 4.32); (c) OCS will establish review committees to meet at least quarterly to assess the progress of each project assigned to them; they shall not have responsibility for more th.3n four projects at a time; they will submit their reports to the OCS and the Bank. No disbursements would be made for a Bank-funded subproject until a review committee for it has been established and approved by the Bank (paras 4.43-4.45); - 38 - (d) OCS will establish a Policy Advisory Committee (para 4.47); (e) before making any major change in the agreed research program in each subproject, OCS would seek the Bank's concurrence. In case of failure and consequent termination of subprojects, the undisbursed balance would remain available for possible reallocation; (f) OCS will enter into contracts with sponsors whose research is supported by Bank funds providing that technologies developed directly or indirectly from such research will be licensed to developing countries under reasonable conditions. The sponsors will also agree that Bank support for R&D will not be represented as approval of technologies or products resulting from such R&D and will not be mentioned in product advertising or other pro- motional literature. Furthermore, in successful cases, firms will agree to contribute 1% to 4% of sales revenue for a period of ten years to a special fund to support research in projects of national importance (para 4.34). 7.07 The portion of the Bank loan for the R&D component would be repaid by the Government over 15 years, including five years of grace, given the long gestation period for R&D projects. The repayment schedule will be fixed and form part of the composite single repayment schedule for the entire loan. C. Vocational/Technical Training Component 7.08 The proposed vocational/technical training component will help al- leviate increasing manpower constraints both quantitatively and qualitatively. The project is suitable as a basis for Bank funding of US$5.0 million, to be repaid by the Government over 15 years, including a grace period of 5 years. The proposed funding, which would finance 96% of the estimated foreign ex- change costs, would be equivalent to about 32% of the estimated total cost of the project. It will finance 100% of foreign expenditures or of ex-factory local expenditures for equipment, and 18% of total expenditures (representing the estimated foreign exchange component) for civil works, including profes- sional services. 7.09 Establishment of a Project Unit and appointment of a Project Director, Equipment Procurement Coordinator and Accountant will be conditions of effectiveness (para 5.17). 7.10 The repayment schedule for the vocational/technical training com- ponent will be fixed and part of the composite single repayment schedule for the entire loan. * * * - 39 - 7.11 With the foregoing arrangements, this industrial development proj- ect is suitable for a Bank loan of US$35 million to be repaid over 15 years, including about two years of grace for IDBI and five years for the R&D and vocational/technical training components. iat NY!X lvge 1 ISRAEL: Summary of Investment and Export Incentives to Industrv 1. The Law for the Encouragement of Capital Investments 1/ distinguishes four categories of projects, as follows: a. Approved Enterprise, in which are included new or expansion (of at least 50% increase in fixed investment or production) projects undertaking to export a minimum of 20%, 30% or 50% of their production, depending on whether they are located in a "A" zone (greatest development priority), "B" zone (less development priority), or "C" zone (other areas already developed). In particular branches of industry, export re- quirements may be even higher. On the other hand, in zone "A" investors may be exempted from the export requirements. These projects are entitled to cash grants, development loans, tax concessions, full exemption from duties on imported machinery and equipment and other indirect taxes on locally produced machinery, equipment and building materials, and deferment of fees (i.e., stamp fees, registration fees, capital fees, etc.). b. Recognized Enterprise, referring to companies which manufacture products used as inputs to exporting industries, replace imports, meet defense needs, or introduce new technologies. These firms are eligible for tax concessions, development loans and deferment of fees. c. Approved Investment, in which are included foreign currency equity investments in or long-term loans to enterprises that do not enjoy the approved status. Under this category, the investor is entitled to income tax and estate duty concessions, deferment of fees, and the right to repatriate his capital. d. Approved Property, referring to foreign currency investments (by foreign residents) in immovable property in Israel. The investors are eligible for tax concessions and deferment of fees as in the case of Approved Enterprise (excluding exemption from indirect taxes and charges). 2. Grants 2/: Approved enterprises may received cash grants as follows: I/ The Law is administered by the Investment Center. 2/ The right to investment grants is limited to projects to be approved until July 1, 1975, and implemented before June 30, 1977. ANNEX 1 Page 2 Machinery and Buildings and Site Equipment Development Zone A 30% 20% Zone B 20% 15% Zone C 15% 10% To be eligible to receive the grant, which only exceptionally may exceed the paid-up share capital, the enterprise must meet the following conditions: a. Equity. The equity must not be less than: 30% of the fixed assets in Zone "A", 40% in zone "B", and 50% in zone "C". In addition, the Investment Center may require that the investment in equity cover a certain proportion of the working capital needs of the enterprise. b. Export Quotas. In the case of new enterprises, the owners must undertake to fill the following export quotas: 20% in zone "A", 30% in zone "B", and 50% in zone "C". Major expan- sions (involving a 50 percent increase in production or more) are regarded as a new enterprise for the purpose of export requirements. c. Conversion of Grant into Loan. In zones "B" and "C" investors may convert the grant, in whole or in part, into a loan 50% greater in value than the grant on the same terms and conditions as the loans extended by IDBI to approved enterprises in that zone. 3. Special Grant. To promote the purchase of locally manufactured equipment, approved and recognized enterprises are offered a special grant amounting to 15 percent of the value of such equipment. 4. Development Loans. Approved enterprises are also entitled to development loans repayable over a long term and at low interest rates. The amount of the loan can reach 45% of the fixed assets in zone "A", 40% in zone "B" and 33% in zone "C", while the interest rates charged are 8%, 10%, and 12%, respectively. However, the sum of the investment grant and loans cannot exceed 70% of the fixed assets in zone "A", 60% in zone "B", and 50% in zone "C". Development loans to recognized enterprises are extended on similar terms as to approved enterprises, except that the sum of the invest- ment grant and loans cannot exceed 60% of the fixed assets in zone "A", 50% in zone "B", and 45% in zone "C". ANNEX 1 Page 3 5. Tax Incentives. Approved enterprises 1/ are exempt from income tax and pay only a reduced cormpany profit tax (at 33%). These exemptions apply for the first five years that an enterprise has profits within the first ten years after the beginning of operations. Dividends paid out of profits during this period are also exempt from any further income taxes. During the period of benefits, profits from an approved investment are taxed at a maximum rate of 25%. Income from a foreign currencv investment in an approved investment by a non-resident is tax free. The law also provides for accelerated depre- ciation. For the first five years of their use in an approved enterprise, machinery, equipment and buildings may be depreciated at a rate twice that normally permitted (and in cases of unusual wear and tear at a rate two and one-half times the normal). Furthermore, for the first five years (and possibly for another five years) from their establishment, approved enterprises are exempt from two-thirds of the property tax on buildings; they may be exempt for five years (in whole or in part) from local property taxes; and they pay only five-sixths of the property tax on equipment and business inventory for ten years. Approved enterprises are exempt from customs duties, purchase tax and are partly exempt from all other indirect taxes on equipment and building materials. Finally, the payment of stamp tax on the issue of shares and fees normally associated with registration of a new company may also be deferred for five years. 6. Science-based Industries. Science-based ventures, in addition to all other concessions granted by the Law for Encouragement of Capital Invest- ment and the Law for the Encouragement of Industry, are entitled to Government assistance amounting up to 50% of their R & D expenses and a grant for the training of graduate employees. 2/ They can locate in special science-based industrial parks linked with institutions of higher technical education on a lease or ownership basis. Construction in such parks is granted the benefits of approved enterprises in zone "A", regardless of their actual location. The period of repayment for development loans varies between 14 and 20 years. Loans are extended for 50% of the cost of buildings. 1/ The tax concessions granted to recognized enterprises are the same as those extended to approved enterprises. However, recognized enterprises are not exempted from indirect charges and duties on imported machinery, equipment and building materials. The Investment Center though may extend such exemptions at its discretion. 2/ In general, the Government encourages and participates in the financing of industrial research projects, extending grants up to 50% of research projects, following their approval. R & D expenditures for the develop- ment of new products are tax deductible. Capital expenditure on R & D is tax deductible over three years. Imported scientific equipment is exempt from customs duties. For R&D projects of "national importance" see text paras 4.03, 4.34. Similarly, the Government provides finan- cial assistance in the training of workers in new or expanding enter- prises located in zones "A" and "B". ANNEX 1 Page 4 7. Working Capital Loans. In addition to the incentives in the form of tax benefits, concessional loans and grants mentioned above, the Government provides important working capital financing for exports and for projects in the "A" and "B" priority development areas. These are referred to as "directed credits." Export working capital loans are granted at 6% and the development area working capital loans at 13%. 8. Working capital financing for the development areas is provided to approved projects exporting at least 40% of their output as follows: (a) 30% of inventory requirements if the investor is located in zone "A"; and 20% of inventory requirements if the investor is located in zone "B". 9. Assistance to Exporters. To enhance the competitiveness of Israeli exports in the world markets, the Government grants refunds of indirect taxes and charges as follows: % of Value Added Refund of Indirect Taxes (in foreign currency) (IS per US$ FOB) 0 - 25 26 - 35 1.08 36 - 45 1.14 46 - 55 1.20 56 - 65 1.26 66 + 1.30 Moreover, exporting firms receive 100% refund of customs duties, purchase tax and other fees on raw materials or intermediary products, except for the 15% defense levy. Firms exporting at least 25% of total sales are partly exempted from property tax on equipment and inventory. The exemption relates to the percentage of sales exported and ranges from 15% to 80%. The Government par- ticipates up to 50% of the fob value of exports in transshipment costs incur- red and extends travel tax exemption to manufacturing firms exporting at least US$100,000 a year (US$250,000 for general export firms). The Government also covers commercial risks of exports up to 85% and political risk losses up to 95%. Premia are partially refunded, the extent of refund increasing in pro- portion of the exports to total sales. New exporters may benefit from an lb 6,000 grant for the promotion of exports. Loans are available from the Export Promotion Financing Fund and may go up to 75% of the export expenses. They are extended at 6% for up to 2 years. Other governmental assistance for exports includes special subsidies to the textile industry and budgetary sup- port to equAlization funds for wool and synthetic textiles, plywood and leather. 10. Finally, approved export projects are also entitled to: a. financing of 100% of the imported components of export products; b. financing of 100% of raw materials purchased in Israel; c. financing of 100% of short-term export credit granted by the exporter. Page , 11. According to the Law for the Encouragement of Industry (1969), industrial enterprises (except those with an approved or recognized status) may pay 15% income tax (instead of 30%) if they elect to reinvest their pro- fits. Also under this Law, an enterprise is entitled to accelerated deprecia- tion on locally produced machinery and equipment over four years (40% on the first year and 20% in subsequent years) and on imported machinery and equip- ment over six years (25% for the first and second years and 12.5% thereafter). Approved/recognized enterprises have the option to choose the form of accele- rated depreciation for which they may apply. ANNEX 2 Page 1 ISRAEL: Interest Rate Management and Its Implications 1. The prevailing interest rate structure does not reflect actual mar- ket conditions. With the country's financial resources centrally controlled, the Government plays a major role in the distribution of funds which, in turn, gives it a powerful influence over the direction of private investment. In- dustrial enterprises perforce have become dependent on concessionary funding (to the tune of 58% of their investment costs), channelled through financial institutions under Government directives. As a result, interest rates perform neither an intra-industry nor an inter-industry allocative function. This does not imply that project selection has suffered and that costs and bene- fits to the economy of the directed investments have been ignored. Industrial projects are approved after careful evaluation by the Investment Center for their conformity with the national Industrial Plan. Such an approval is a precondition for the enterprise to receive development loans and the other incentives the Center administers. Furthermore, industrial projects are appraised for their financial and economic viability, the latter assessed by calculating the cost to the economy of the foreign exchange earned or saved and comparing it with the effective exchange rate. Thus, the subsidy provided by the low interest rate is not indiscriminate, in that the loans are granted only for investment in industries the Government desires to pro- mote. On, the other hand, the indexing of principal and interest on savings and Government bonds appears to have contributed significantly to the re- source mobilization effort of the Government. 2. Low interest rates, particularly for loans to less developed re- gions at 8% and 10%, are part of the Government's incentives package to in- crease the attractiveness and thus bring forth the large volume of industrial investment necessary to achieve its developmental objectives (see para 2.10). In addition, low interest rates create a bias in favor of capital-intensive techniques, which embody modern technology, help alleviate the chronic prob- lem of labor shortage, increase productivity and enhance the competitiveness of projects. Finally, the incentives, including the low interest rate, off- set in part the relatively high taxes Israeli firms have to pay. 3. The prevailing 12% lending rate under present rates of inflation (40% in 1974) certainly results in a negative real interest rate. Also, it is out of line with returns on savings (4% with principal and interest linked to the cost of living index) and time deposits which yield 14-15% (unlinked). But current unprecedented inflation rates, a worldwide phenomenon, make it hard to determine future trends of real long-term interest rates. The annual average price increase in Israel from 1955 to 1972 was 6%, while from 1965 to 1970 only 4%. It was only in 1973 and 1974 that prices in Israel rose sharply - due in part to world inflation and in part to Israel's emergency situation. Given the historical price behavior and the fact that the Government has taken stern measures to curb inflation (see para. 2.04), it is reasonable to expect that the recent price increases will not be a long-term feature of the Israeli economy and that in the long run a lending rate of 12% will lead to a positive real interest rate. Furthermore, the recent Government ANNEX 2 Page 2 decision that, in loans to Area "C" (12% lending rate), cost of living in- creases in excess of 20% will be added to the principal, safeguards against excessive subsidization and forces borrowers to pay a more realistic price for the funds they use. Also, in the long haul, a 12% on-lending rate should cover the exchange risk on foreign borrowings (borne by the Government. 1/ 4. Subsidization of lending rates could conceivably be avoided by indexing industrial loans, 2/ a system which the Israelis had applied in the past. However, their experience was not satisfactory and the system was dismantled in 1963 due to serious administrative and economic disruptions. 3/ A more overriding reason was the Government's concern that indexing of indus- trial loans, by ushering in an uncertainty as to the actual future cost of capital, would adversely affect industrial investment. Similarly, the Gov- ernment is unwilling to pass on to the borrower the foreign exchange risk on grounds that this may also have a dampening effect on industrial invest- ment. 1/ In return for assuming the foreign exchange risk, the Government allows a bank a spread of only 1-3/4%, the excess being paid to the Government. 2/ It is noteworthy that a recent Bank paper concluded that "the review leads to a similar agnosticism on the effects of indexing on the volume of saving, efficiency of investment allocation and the operation of financial institutions." Index-Linking of Financial Contracts: A Survey of the State-of-the-Arts, Bank Staff Working Paper No. 192, November 1974. 3/ From the mid-1950's until 1963, most loans extended by the financial institutions were linked to the U.S. dollar or the consumer price index. After the 1962 devaluation, the linking of new loans to the dollar was discontinued, while for a large part of the existing loans the dollar linkage was converted into a cost of living index link. Concerning loans to industry (and agriculture), in December 1963 borrowers were given the option between linking the loans to the consumer price index and paying an annual premium of 4% over and above the normal interest of some 8% per annum, thus bringing the effective interest rate to 12%. The major- ity of borrowers chose unlinked loans, expecting that the index would rise in excess of the premiums. (IDBI effectively discontinued linking loans since 1964). In 1967, the lending rate was reduced from 12% to 9% (6.5% and 8% for Areas "A" and "B", respectively) to stimulate indus- trial investment. Loans to the housing and construction sectors also have ceased to be linked to the cost of living index. Pae3 5. In light of Israel's singular circumstances as discussed in paras 2.12-2.14 and Annex 2, paras 1-4, and for the purpose of the proposed indus- trial development project, the interest rate management by the Government appears to be appropriate. The recent changes in the interest rate structure and partial indexing (paras 2.12, 2.14) indicate that the Government keeps the interest rate question under review. ANNEX 3 INIJSTRIAL DEVELOPMENT BANK OF ISRAEL LIMITED Shareholders as of October 31. 129 % of Amount Total Ordinary "A" (Voting) Shares (I '000) Government The State of Israel 3,925 3,925 26.00 Israeli Private Investors Hevra Lehashkaot Shel Israel Discount Bank Ltd. 250 Otzar Letaasiya B.M. 1,050 Investment Fund of Hevrat Haovdim Ltd. 1,560 Hevra Lerishumim Shel Bank Leumi Le-Israel B.M. 1,800 Israel Discount Bank Limited 1,405 Israel American Industrial Development Bank Ltd. 1,060 Workers Bank Trust Co., Ltd. 1,000 Clal Israel Investment Co., Ltd. 250 Hevra Lehashkaot Shel Export Bank Limited 250 Israel Industrial Bank Limited 250 The Israel Central Trade & Investment Co., Ltd. 250 The Weizman Institute of Science 250 Manufacturers Association of Israel 250 Hevra Lerishumim Shel Israel Discount Bank Ltd. 130 Other Shareholders 20 9,775 64.73 Foreign Investors Israel Investors Corporation 500 Edith & Isaac Wolfson Charitable Trust 250 Artina Trading Trust (reg) Vaduz 150 P.E.C. Israel Economic Corporation 250 The Eli Wishnick Foundation 250 1,400 9.27 15,100 100.00 Shares Other than Ordinary "A"l Shares Groups of Shareholders Private Government Domestic Foreign Mixed Total --- -______________---(IL OO)-----------_ Preferred Ordinary - 1,551 - 8,449 10,000 Ordinary B 134,900 - - - 134,900 Preference A 50,500 - - - 50,500 Preference B 611 - 892 1,350 2,853 Preference C - 360 14,366 15,874 30,600 Preference CC - 7 15,437 14,556 30,000 Preference CC1 - - 7,752 44,291 52,o43 Preference D 3,707 188 41,392 3,756 49,o43 Total 189,718 2,106 79,839 88,276 359,939 Percentage of Total 52.71 0.58 22.18 24.53 100.00 j Entities owned jointly by domestic and foreign shareholders. Source: Industri.ii Levelopment Bank of' isrne. Ltd. November 197h ANNEX 1 Page 1 INDUSTRIAL DEVELOPMENT BANK OF ISRAEL LIMITED Board of Directors and Committees as of October 31, 1974 (A) Members of the Board of Directors Name Affiliation Chairman 1. Dr. ZVI DINSTEIN 2 Government Advisor on Petroleum and Energy Vice-Chairmen 2. M.B. GITTER Member, Board of Directors of Israel Discount Bank Limited 3. ERNEST ISRAEL M. JAPHET Managing Director, Bank Leumi Le-Israel B.M. 4. MOSHE OLENIK Joint Managing Director- Bank Hapoalim B.M. 5. MORDECHAI ZAGAGI Director of Companies Other Members Representing the State of Israel - 12 Other Members Representing Private Israeli Investors - 28 Members Representing Foreign Investors - 5 Total membership = 50 Theoretical Membership (A holder or holders of 250 Ordinary "A" shares is entitled to appoint a Director). Entitled to Actual Appoint Appointment State of Israel 15 14 Private Israeli Investors 39 31 Foreign Investors 5 5 Total 59 50 j Represents the State of Israel / Represents private Israeli investors Source: Industrial Development Bank of Israel, Ltd. March 1975 ANNEX 4 Page 2 (B) Powers and Duties, Chairmen, and Members of Committees Executive Committee Vice-Chairmen Loan Committee -Committee _ All powers of the Board, Major administration Reviews and decides on except to elect the and personnel matters loan applications up Chairman and Vice-Chair- and a sounding board to cumulative total of Powers and men of the Board and to for policy matters IL1,000,000 for individ- Duties appoint the General likely to prove con- ual projects. Manager(s). Reviews and troversial. decides on loan applica- tions beyond the authority of the Loan Committee The Board Chairman or, in The Board Chairman or, Both General Managers Chairman his absence, the Executive in his absence, the Vice-Chairman. Executive Vice-Chairman 18 Board Members or their The Board Chairman, the 1b Board members or their Members alternates. Vice Chairmen and the alternates. General Managers. Frequency Twice a month. Once a month, or as Once a week. of meetings necessary. Source: Industrial Development Bank of Israel, Ltd. March 1975 INDUSTRIAL DEVELOPMENT BANK OF ISRAEL LTD. ORGANIZATION AND STAFF CHART As of March 1, 1975 | EX(ECU/TIVE COMMITTEE Z. |m-iIA1.SASC SCT A fill D. Sfd X < _ _ - i JOIT GENERAL ANAGER | | OINT G NERLMMANAGERE GEN RA MAAE MOBILIZATION OF CINTRNA &, GENERAL COUNSEL _FUNDS RESOURCES CONTROLLER rM. Rollnberg __ ID~ H.miW.olrf ASSISTANT ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~~~~DEATEN ee MASSSATAS.MNAGER ECNETRAL ASST. MA.NAGER LASST. VMANAGER INVESTMENT CO MANAGER _ (LOANSI | SECRETARY _ ~~~~~~~~~~~~~~(ACCOUNTANCY) (IFNANCE) 141B B. T-vick F. 8ronholc 1 1 A. Elias s. Fl-min g E. Nn ffs 11ofIsIi1nul sIaf I World Eeok-96 1 f MGATON 1 EAS& 1 | TEXT] LES a TC LEI A ACCOUNTANCY 1 ZEEZONE "B' A= [>7 OThER ZONES Q \ 0 0 CITIES AND TOWNS RIVERS - --- INTERNATIONAL sOLUNDARIES Boo3 iNet-vL . ' . TEL AVIV-JAFFAf"v IX / -372 e, t. 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