.R ES T R I C T E D Report No.P_196 FILE COPY This report was. prepared for use within the Bank. In making it available to others, the Bank assumes no responsibility to them for the accuracy or completeness of the information contained herein. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO -IRAN FOR A ROAD PROJECT May 19,.1959 INTEHI4ThTIONAL BANWK FOR RPCONSTRUCTTON AND DEVELOPMENT REPORT AND RECO11 T7DATION,G OF THE PRESIDENT TO THE FXECUTIVE DIVLECTOIS ON A PROPOS7D LOAN TO IRAT __ __ FOR A ROAD PROJECT 1. I submit the folloiwring re-ort an( recommendations on a proposed loan to Iran in an amount in various currencies equivalent to $72 million. The loan would be used to assist in financing the road pro- gram included in Iran's Second Seven-Year Development Plan. PART I - HISTORICAL 2. The Government of Iran requested the Bank in the spring of 1957 to participate in financing the construction, reconstruction and im- provement of some of Iran's principal roads, a project of the highest priority in the economic development of the country. The Bank exchanged technical viewJs on the project wuith the Government in the summer of 1957 and the spring of 1958, In the summer of 1958, the Bank assisted the Gove.nment in preparing the project, including the working out of arrange- ments betwTeen the Plan Organization (P.O.) and the Ministry of Roads (the M\inistry) for the execution of the project, and made a detailed appraisal of the project. Subsequently the Bank informed the Government that it wiould be prepared to consider a loan up to p60 million (the then estimated foreign exchange cost) for the road project as soon as an understanding could be reached on the Governmentts financial and develop- ment policies. The Bank also agreed to help the Government in obtain- ing private bank participations to supplement the amount of the Bank s loan by covering part of the local currency costs. Four private American commercial banks agreed to participate in the early maturities (up to May l964) in an agcregate amount of j;l2 million, increasing the amount of the proposed loan to `72 million. The estimated foreign exchange cost has increased to "?69.6 million and p9.6 million of the cormmercial bankst participations would be applied towards it, leaving &2.2 million to cover part of the local currency expenditures. 3. An understanding has been reached with the Government on its financial and development policies as set forth in the attached letter of M!arch 16, 1959 from the Prime Minister (1To.1) and negotiations were commenced in Washington on April 22, 1959. They were concluded on May 6, 1959. The Government of Iran was represented in the negotiations by M,Iessrs. Khodadat Farmanfarmaian, Hossein Daftarian, Cyrus Samii, Cyrus Ghani, and Emile Hens of the P.O. and 1'Mr. Mojtaba Soltani of the Roads Department of the AIinistry. 4. This loan if made w˘ould be the Bankls second loan to Iran. The status of the previous loan is as follcws: Amount (fully disbursed; none repaid) $ 75,000,000 Portion sold $ 5,000,000 Net amount held by Bank 70,000,000 -2- As irndicated br the attach-ed chart (No. 2). the rornosed loan wo0lld increase the commitments in Iran to i1L7 ml uilon ielusive of the commercial anks' participations, and to ;130 million excllusive o; SUCi- -rp rticipations. The ma.niumu net investment, including nart5cipations, under both the previous and proposed loans w.-ould not exceed -lf)O million at an,r time and would be reduced to ,j>66 million b- the end of 1962 1;31en the Bank's previous loon to Iran is sch-eduled to be repaid. PATHT II - DfLSCRIPTIOIT OF TIS- PROPOSED LOAN 5. The main characteristics of the proposed loan would be as follows: Borrower: Iran Amount: The eqi:ivalent in various currencies of $4'72 million, including 12 million of commercial banr particinations Amortization: By 31 semi-annual repayments beginning Mlay 1, 1961 and ending May 1, 1976 Interest rate: 6% per annum, including the 1% com- mission Commitment charge: 3/4 of 1%io per annum 6. The loan w;ould be used to finance the foreign exchae e cost of the project, currently estimated at 169.6 million, and local cuirrency costs amounting to $12.4 million. :irost of the loan (j507 million) wi,ould be used to finance the foreign exc-ange cost of panments made by the Borro-er to contractors for construction and reconstruction work. Because of tile difficulty in maintaining and presentino, accounts \rJlth respect to the foreigf,n exchange conponent of sulchi nayments, and because of the desire to relate the Bank's disbiirse,ents to the progress of constru-ction, -it h2as bean agreed that the Banri mill reimburse th7e Borrowrer for 35% of the paym-ments made to contractors fro-, time to time over th.e entire construction period. Th-is nercenitage represents the currently estimated foreign exch-nge com,ponent of such payments and may, be varied if there is any substantial change in eith>-r the estimated total or foreign exc'ange costs of such payments. 7. On the basis of present estinmtes, 1,P2.4 million mrould be used to reimTburse the Borro-wzner for local currency expenditures made tc contractors. This is the amount of the loan in excess of the cu-rently estimated foreign exclange cost of' the project and represents a portion of thFie commercial banks' participations. 8. The remainder of the loan will be used to reimburse the Borrower, or m.ake advances on behalf of the Borrow,rer, for foreign exchanm,e purchases of specific imported goods required for the execution of' other Darts of the project. -3- 9. lJork on the project started over a year ago and it is proposed that the loan cover payments made from April 21, 1953, the d ate to which disbursements were made under the Bainkls previous loan to Iran. 10. The Government intends to devote a substantial portion of its fuiture, as well as current, oil revenues to economic development. Since, as in the earlier Bank loan to Iran, the proposed loan i%ould be in the nature of a borrowing against future oil revenues for the purpose oI maintaining the pace of development projects now under construction, the Government has agreed to make arrangements for the repayment of the proposed loan out of its future oil income. 11. It is reasonable to expect that the project would be completed by June 1962. Howrever, as the final settlement of accounts of the road contracts is likely to take up to ten months after completion of construction, it has been agreed that the closing date of the proposed loan would be Hay 31, 1963. 12. The amortization schedule of the pronosed loan provides for repay- ments of ,8,5 million before the Closing Date, representing maturities falling due under the cormercial bankst participations. This maturity schedule w'las a condition to obtaining such participitions. The average term ofthe com- mercial banks' participations is 3.5 years from the date of signature of the loan. PART III - APPRAISAL OF THE PROPOSED LOAN Description of the Project 13. The project is described in the attached 'Appraisal of a Roads Project in Iran" (No, 3). The project includes (a) the construction and reconstruction of approximately 2,470 km. of the principal main roads in wes~tern and southern Iran, including the trans-Iranian highway from the Persian Gulf to the Caspian Sea; (b) the improvemcnt of a4h0 km. road link that would connect 'hiraz with Irants major Gulf ports, Khorramshahr and Bandar Shapur; and (c) the design and engineering of Iran's next main road program and a series of feeder roads in the important agricultural areas,e 14. The Plan Organization is responsible for the construction and reconstruction of the main roads included in the project and for the engineering of Irants next main road and feeder road programs. The 1,inistry is responsible for the improvement of the road link out of Shiraz and for adequately maintaining the roads included in the project. Justification of the Project 150 Inadequate communication facilities have long been a major handi- cap to the economic development of Iran, an area as large as Germany, France, Italy and Spain combined. Iran's road system of about 25,000 km. carries the bulk of the countryls freirht and passenger traffic, and ranges from -4- caravan trails to a small number of paved all-weather roads. Few of Iranfs roads have been built to standards adequate for motor vehicle traffic and most of Iran's roads are in an advanced sta-te of disrepair, causing damage and delsys in transoorting cargo and increasing the cost of operating trucks which are the principal users of the roads. This has particularly affected the development of agriculture which today employs about 80% of Irants population. The absence of adequate connections to the consuming centers has reduced the incentive for increasing production and, moreover, resulted in the waste of produce, increased prices to consumers and financial losses to cultivators, Bad roads also have been an obstacle to the execution of Gover'lment-sponsored development projects and to the groiwth of private industry. The roads in the project will provide adequate connections between the Gulf ports and the more heavily populated centers of the country and will traverse the areas that account for two-thirds of Irants agricultural pro- duction. !^Then completed and properly maintained, they will contribute sub- stantially to IranTs economic development. Method of Procurement 16. Contracts for the execution of the project have been and will continue to be let on the basis of international competition. Economic Situation 17, The general trends reported in the "Economic Situation and Prospects of Iran" (R58-80),distributed to the Executive Directors on July 2L, 1958, have continued during the past Iranian year ending MIarch 20, 1959. Irants oil income rose to ;'247 million and was the principal element in sustaining the growing prosperity of Iran. The relatively high level of agricultural output was maintained, the pace of governmental development activity con- tinued to accelerate and private investment in industry and residential building have also increased. The rising rate of investment, and the grotwing purchasing poT.er of the population, have resulted in an increase in imports from ;375 million in 1957/58 to more than $450 million in 1958/59. Irants foreign exchange reserves fell during the year from $276 to $228 million, equivalent to about 6 monthst imports at the current rate. 18. Inflationary pressures have continued despite the rise in imports which include a wide range of consumer goods. Money supoly increased about 20' and the cost of living index by 10% during the past year. This was largely due to a substantial expansion in bank credits to the private sector, which wTas stimulated by the Government making credits to finance up to half the cost of expanding and creating private industry. Government funds for this purpose were obtained from the profits derived from the r evaluation of Iran's currency in May 1957 and have now been fully committed. 19. One of the principal developments in Iran's economic and financial position during the year was the 9% reduction in February 1959 in the Persian Gulf price of oil. The Government is discussing with the consortium of companies producing and marketing Iranian oil the possibility of offsetting the price reduction bv increasing exports over and abo'-e the normal rate of incre..se (8% per aannum) expected from the expanding oil market. No understanding has as yet been reached and it is, therefore, possible that Iran's oil earnings this year may not be substantially greater than last year. Jnless there is a further softening of prices, however, it is expected thnt Iran's oil income would again increase about 8% annually beginning in 1960/61. 2C. Tax revenues during the past year were approximately 20% more than in the preceding year but uere still below the Government's operating expenses which increased substantially in recent years. Operating expenses for the current year hsve been budgeted at last year's levels with the exception of small increases for health and education. The Government estimates tha.t its tax revenues during. the current year will be at least 10% more than in the past year. Nevertheless, the Government's ordinary budget forecasts a defitit of .Rls. 1.5 billion (.i20 million) despite diversion of a substantial share of Iran's oil revenues to the financing of current operations. The Government hopes that oil revenues will be sufficiently large this ye.ar to allocate approximately ''100 million to the ordinary budget. However, with the intent of balancing future budgets without borrowing from Bank 34elli and w;7ithout further diversiln of oil revenues from development, the Government has begun the preparaq.tion of a financial plan ifhich will pro-;ram all of Iran's financial operations, including development, and esteblish nolicy with respect thereto. The Go-ernment hns 71lso adopted procedures for a more effective control over the incurring and guaranteeing of newi external indebtedness. 21. The Government has decided to allocate at least ..;130 million of this ycarls oil revenues to the P.,. and to allocate at least 55% in the remaining years of the Plan (ending September 1962). The P.O. expects to receive .`530 million of oil revenues from now until the end of the Plan. It has recently reviewed its activities and considers that a minimum ba-lanced pro,-ram, consisting nearly entirely of projects already under construction, will cost about ;730 million during the same period. The Government is,therefore, seeking credits, including the proposed loan -Add possible further borrowings from LF, to cover the "200 million shortfall in the current P.O. minimum program. 22. The Bank intends to review Irants economic and financial position and prospects in July-August 1959. At that time, the Bank will also consult with the Government concerning Irants financial and development policies. Prospects of Pulfillment of Obligations 23. The Borrower should be able to meet its obligations under the Loan Agreement. The project is sound and the cost estimates appear reasonable. The P.O. and the 11nistry have worked out arrangements, satisfactory to the Bank, for the implementation of the project. Com- petent engrineering consultants and other experts have been, and are being, retained to engineer and supervise the project. The local currency re- quirements will be met out of the P.O.ts own resources, and possible further borrowing from the Development Loan Fund. 24. The Ministry, with the help of the U.S. Bureau of Public Roads, is improving and strengthening its maintenance organization. It is also assigning members of its technical staff to the consultants wr9ith a vievr to building up an experienced road construction deuartment. One of the principal causes of deterioration of Iran's roads is overloaded trucks and the Government has initiated a number of mieasures designed to control the weight of vehicles. 25. Annual service on Iran's existing external indebtedness of -Is55 million and on the pro-posed loan would amount to ll% of current foreign exchange earnings in 1961/62 and 1962/63, to 7% through 1965/66 and to 3% thereafter. Iran's oil revenues are expected to increase at approxirmately 8% annually and the overall foreign exchange earnings are likely to g7row at a rate of at least 5% per year. The proposed loan, therefore, should be 11i.ithin Iran 's capacity to service. PAZT IV - LEGAlI. ITSTRUTE?TS ANi) LEGAL AUTTIORITY 26. Attachied is a draft of the Loan Agreement betweenthe Bank and Iran (Nio. 4) providing for the proposed loan. The draft Loan Agreement generall> follows the form of the Bank 's loan agreements for road projects except as indicated belovw. Also attach-ed is the report of the Coimmittee provided for in Article III Section 4 (iii) of the Articles of Agreement of the Bank (No. 5). 27. The standard withdraxal provisions in the Loan Regulations have been modifi-ed to provide for three t-pes of disbursements: (a) Amounts calculated to represent th!e foreign exchange component of payments to contractors as exqplained in paragraph 6 supra (Section 2.03 (a) (i)). (b) Amounts for (i) reimburserent of foreign exchange exo;erditures made to purc'hase specific goods; and (ii) advances for suic expenditures (Section 2.03 (a) (ii) and (iii)). (c) Amounts representing payments of $;2.L million equivalent made to contractors in excess of amoi.nts paid under (a) above, and vwhich represent a part of the commercial banks' narticipations as explained in paragraph 7 supra (Section 2.03 (b)). Amounts disbursed under (a) and (c) above will be in U.S. dollars or in freely convertible currencies as the Bank nav reasonably determine in consultation with the Borrovwer (Section 2.93 (c)). 28. A debt consultation clause has been included (Section 5.07). 29. The Loan Agreement provides tha-t arrangements wil' be made whereby oil revenues ivll be set aside during eac'n debt serrice reriod in an amount sufficient to cover the service on the loan for that period - see paragraph 10 supra (Section 5.08 (a)). The revenues are paid in pounds sterling and the arrangemnents would include provision that the Borrower woould tak-e all necessary action to assure that the su-ns thus set aside vai be converted into such currencies other than pounds sterling as mitt be required for service of the loan. The Borrowver would agree th-at it would not, without the consent of the Barln, alter these arrangements or take any other action whlich would interfere with thneir effective imlalementation (Section 5.08 (b)). In view of these provisions, th;e customary negative vied,e clause has been omitted. The making of these arrangements is a condition for the effectiveness of the Loan Agreenent (Section 7.01). These arrangements wall be in addition to arid rithout prejudice to the similar arranaements made under the Loan Agreement of January 22, 1957 wilth Iran (Section 5.08 (a)). 30. The Iranian Government has negative pledge obligations under agree- ments with the Export-Import Bank covering credits (including ICA credits) aggregating 395 million. In connection with these credits, the Government of Iran has informed the Export-Import Bank that it is willing to make set-aside arrangements for the servicing, of the Export-Import Bank credits similar to those to be made for the servicing of the proposed IBRD loan and negotiations to this end are in progress. 31. Notwithstanding the set-aside arrangements, re-naTment of thne loan and interest and other charges thereon vi,,i] be a general obligation of Iran (Section 2.09). 32. Before tlhe Loan Agreement becomes effective, authorization or rati- fication b- the Iranian Parliament of the oronosed transaction rithl the Bank waill be reaiuired. PART V - COIJPLIAiTCE WIT-H-i ARTICTES OFr AGREETETIT 33. I am satisfied that t'he proposed loa- complies .w,ith tne requirements of the Articles of Agreenent of thle Bank. PART VI - PrCO1;3JDATICONS 34. I recommend that the BanEk at t' -is time make a loan to Iran in an amount in various currencies eo:ivalent to $S72 million for a total term of 17 years vwith interest (including commission) at 6% per annumi and on such terms and conditions as are specified in the form of the attached draft Loan Agreement and th.at the Executive Directors adopt a resolution to that effect in the form attached (No. 6). J. Burke Knapp, WVce President Attachments for Eugene R. Black, President W2ashington, D.C. May 19, 1959