Document of lThe World Bank FOR OMCAL USE ONLY MICROFICHE COPY Report No. P- 5612-POL Type: (PM) REYES-VIDA/ X32588 / H12101/ SM4AI Rqet No. P-5612-POL NMEMRANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN THE AMOUNT EQUIVALENT TO US$60 MILLION TO THE POLISH DEVELOPMENT BANK WITH THE GUARANTEE OF THE REPUBLIC OF POLAND FOR A PRIVATE ENTERPRISE DEVELOPMENT PROJECT APRIL 16, 1992 This document has a restricted distribution and may be used by recipiens only in the performauce of their offcial duties. Its contents may not otherwise be disclosed witbout World Baek autlorization. CURRENCY EOUIVALENTS Currency Unit - Zloty (ZI) AVERUGE EXCHANGE RATES (Zlotys per US$) (March) US$1.00 Zi 265 430 4,000 9,500 10,957 13,500 WEIGHTS AND MEASURES Metric System POLAND - FISCAL YEAR January 1 December 31 ABBREVIATIOM EC - European Community FY - Fiscal Year GDP - Gross Dome.stic Product IFC - International Finance Corporation NGO - Non-Government Organization P&RP - Privatization and Restructuring Project PDB - Polish Development Bank PHARE - Poland-Hungary Assistance for Economic Reconstruction PSU - Project Support Unit of the Cooperation Fund SME - Small and Medium Size Enterprise USAID - United States' Agency for International Development FOR OFFICIAL USE ONLY POLAND PRTVATE ENTERPRISE DEVELOPMENT CQPJECT LOAN AND PROJECT SIMJARY 12XX212Ve Polish Development Bank (PDB) Guarantor: Republic of Poland * ~B2=ficiaries: Emerging private enterprises, PDB, Office of the Undersecretary for Business Promotion at the Ministry of Industry and Trade, Project Support Unit (PSU) of the Cooperation Fund at the Ministry of European Integration and Foreign Aid Coordination, and non- government organizations (NGOs). Am==nt: US$60.0 million equivalent. Terms: Seventeen year maturity with a five year grace period, at the Bank's standard variable interest rate. Relendinu Terms: The funds for the investment financing component (US$58.0 million) will be on-lent by PDB to participating banks, and by them to enterprises at variable or fixed interest rates in any currency included in the Bank currency pool at the option of the enterprise. Given current trade patterns in Poland, the bulk of on-lending is expected to be in US$ or in DM. Interest rates to be charged by PDB to participating banks will be set with reference to market indices, and will provide for covering PDB's costs of funds, the foreign exchange risk and the interest rate risk associated with the Bank's currency pool and interest rate policies, as well as PDB's administration and intermediation costs, and a reasonable profit margin. PDB's margin will be reviewed with the Bank regularly, at least semi- annually. Participating banks will on-lend to enterprises according to prevailing market interest rates; sub-loans will be for up to seven years maturity with up to three years grace. This doaimnet has a restictedistribution and may be used by repiens only in the perfona_ne t ir offiial dute ts contenb may no odtrwise Ldisclsed without World Bank authoizaio n The funds for the institutional support component (US$2 million) will be on-lent by PDB to the Guarantor under terms and conditions (maturity, interest rate and other charges) similar to those of the Bank loan. The Guarantor will provlde these funds on a non-retmbursable basis (under a cost sharing scheme) to finance eligible activities. local Forelg Total -------US$ million---------- IBRD - 60.0 60.0 Enterprises 45.0 10.0 55.0 Other Commercial Sources 10.0 42.0 52.0 Local institutions 2.0 - 2.0 Other donors A/ 1111 Total Financing 125.1 1 aj Including EC-PHARE program, USAID, UK Know-How Fund. Economic Race of Return: Not applicable Staff Al Maisal Regort: Report No. 9812-POL NIMORANDUW AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPHEN TO THE EXECUTIVE D!RECTORS ON A PROPOSED LOAN TO THE POLISH DEVELOPMENT BANK WITH THE GUARANTEE OF THE REPUBLIC OF POLAND FOR A PRIVATE ENTERPRISE DEVELOPMENT PROJECT 1. I submit for your approval the fol.lowing memorandum and recommendation on a proposed loan to the Polish Development Bank (PDB) with the guarantee of the Republic of Poland for the equivalent of US$60 million to help finance a private enterprise development project. The loan would be at the BAnk's standard variable interest rate, with a maturity of seventeen years, including five years of grace. 2. Backgrgund: The far-reaching Economic Transformation Program (ETP) launched in January 1990 was designed to achieve macroeconomic stabilization; structural reform of the productive base to restore growth; and progressive restoration of creditworthiness. Judging by a macroeconomic yardstick, the results have been mixed. Inflation has subsided from levels of over 240 percent in 1989 and 600 percent in 1990. Average inflation amounted to less than 80 percent in 1991, and is now running at an annual rate of about 40 percent; however, major structural problems remain and the economy has not performed well. In 1991, GDP declined an estimated 8-10 percent; unemployment, which amounted to less than 2 percent of the total work force in early 1990, topped 11 percent by end 1991. 3. The overall production and price statistics, however, mask sharply different trends among sectors of the economy, and cannot portray accurately important underlying changes in the standards of living of the Polish population. Price statistics, for instance, cannot capture the shortage of products and queuing, or the inferior product quality that was the trademark of the output of industries not concerned with the competitiveness of their products. These features are now largely gone from Poland: stores are full of merchandise; lines have disappeared. These improvements are not reflected in real income statistics, but can reasonably be quoted as evidence of some success in the implementation of the ETP. 4. Even when using production statistics as a benchmark for success of policies, important qualifications are necessary. Arguably, the disappointing overall supply response results largely from the inability of the state-owned enterprise (SOE) sector to adapt to the new economic realities. On the other hand, a fundamental objective of the ETP's move towards a market economy is private sector growth. On this account, a noticeable degree of success has been attained: private sector growth was strong in 1990 and 1991 (some 7 and 3 percent, respectively). The contribution of the private sector to total GDP rose from the 28 percent level in 1989 to more than 34 percent of GDP in 1990, and to about 40 percent in 1991. Approximately 1.3 million private sector enterprises have been established, suggesting a rate of growth of approximately 55 percent during 1990 and 1991. Private production (including cooperatives) now accounts for a quarter of total industrial production, over 50 percent of construction, and three quarters of trade. - 2 - 5. Growth of the private sector has occurred in response to the changed market signals, and also as a result of determined Government action. This has consisted of the adoption of comprehensive policy and regulatory measures to create a substantialLy improved business environment for the creation and growth of new private enterprises. A cornerstone of these measures was the policy and regulatory changes introduced in January 1989 by the "Law on Economic Activity", which abolished severe restrictions on licensing, registration, number of employees and economic activities applied to private sector initiatives. Subsequent legislation has reinforced the foundations for the creation of a strong private sector, by modernizing tho commercial code, establishing the basis for a clear regulatory framework in a number of economic sectors, and by laying the grounds for a modern tax system. 6. There remain, however, substantial constraints to contiLiuad private sector growth. Renewed macroeconomic instability would arguably pose the greatest danger to economic transformation. The unsettled state of financial markets, with the resulting limited access to term finar.cing and to credit in general for start-up businesses, also represents a substantial hindrance to new investments. Too many resources still flow to some of the more inefficient SOEs. The success of the privatization program has been largely confined to the smaller scale enterprises, as progress with large and medium-scale units has been slow. Furthermore, insufficient technical expertise and lack of business skills must be overcome, a process that requires time and a concentrated effort. 7. Rationale for Bank Involvement: The proposed project is designed to address some of these problems. The Bank assistance strategy for Poland is geared to back the Government's economic program and the transformation to a private sector-based market economy in a number of mutually reinforcing areas. Private sector growth is sought through; (a) the maintenance of a stable macroeconomic framework, which was one of the main objectives of the program supported by the Structural Adjustment Loan (SAL); (b) SOE privatization and reform, supported by the Privatization and Restructuring Project; and (c) restructuring and enhancement of financial markets (the Financial Institutions Development Loan). In addition, in parallel with the support provided to the privatization of state-owned enterprises, the Bank has also sought to address the complementary process of the creation and growth of new, private enterprises. A Bank review of the constraints to the development of private SMEs conducted in 1990 provided the basis for the development of the Government's initiatives to support private enterprise. The proposed project builds on this effort and is designed to address identified constraints in the access to finance, the provision of financial services and the availability of institutional support needed for rapid growth of this sector. 8. Besides providing scarce term financing for private sector investment, the proposed project would directly contribute to a better development of financial markets. The Bank will lend directly to the Polish Development Bank, instead of to the Government or the Central Bank (National Bank of Poland) as in previous Bank loans. While PDB has been recently established, it has quickly built up a strong management team, a skilled staff complement and sound policies. Within the Polish banking system, PDB has developed as the main apex institutis- for the provision of term credit. A direct loan to PDB will help to refocus the role of NBP as a central bank, and will further strengthen the ongoing relationship with the Bank, initiated - 3 - under the Privatization and Restructuring Project, for which PDB is the apex institution. 9. The project also complements efforts by IFC to support the development of the private sector, including the establishment of the Polish Business Advisory Service. Additionally, the Bank is cooperating with other multilateral agencies which are developing parallel support programs, with a view of maximizing efficiency in the use of resources and thus limiting Bank financing to essential priorities. 10. Prolect Objectives: The principal objective of the proposed project is to support the creation of new private businesses. To meet this objective, the project provides financing for efficient investment in private enterprises, particularly in SMEs, and for a program aimed at overcoming deficiencies of business practices and building support services for private enterprise development. 11. Project Description and Implementation : The proposed project includes two related components: (i) An investment financina component (US$58 million), which will provide sub-loans (channeled through PDB to eligible commercial banks) to finance efficient irvestments in private enterprises. Specifically, this component will finance the procurement of machinery and equipment, spare parts and permanent working capital; the construction and rehabilitation of plants, buildings or storage facilities for start-up and expansion projects; and technical assistance required to address production, marketing and financial management needs of private enterprises; and (ii) An institutional supnort component (US$2 million), which will provide financing for technical assistance to the two key agencies responsible for stimulating private sector development (the Office of the Undersecretary for Business Promotion and the Project Support Unit), and through these agencies (on a non-reimbursable and cost-sharing basis) to local private sector support institutions (such as chambers of commerce, small business support centers and business training institutions) to finance eligible promotion activities. Cofinancing for these programs from the EC is in place and additional cofinancing from other bilateral and multilateral grant funds is contemplated. 12. For the investment finance component PDB, in its role as an apex institution, will on-lend proceeds of the proposed Loan to the participating banks, and they in turn will on-lend to the final borrowers. PDB will also be responsible for the evaluation of potential participating banks according to agreed criteria for participation, which include the banks' capacity to adequately judge the soundness of the sub-projects they propose to finance; and the monitoring of the use of projects funds. For the institutional support component, funds will be on-lent by PDB to the Guarantor, who under agreed arrangements will pass-on funds to eligible institutions. 13. Environmental Aspects: The Government is very conscious of the severity of the environmental problems in Poland, and with the support of the Bank-assisted Enviromental Management Project (Report P-5256-POL), is - 4 - building-up the capability and means to elaborate, enforce and monitor suitable environmental protection policies and legislation. For the preparation of sub-projects under the proposed project, PDB and the participating banks will ensure in their on-lending agreements that all beneficiary enterprises will build facilities and operate their plants, financed under the project, in accordance wit:h environmental and safety standards acceptable to the Bank. The project has been reviewed and placed in environmental screening category B. 14. hCtigns Agreed: Agreements reached at negotiations relate to: (i) policies and procedures to be adopted by PDB to manage the foreign exchange and interest rate risks associated with the Bank currency pool; (ii) periodic review of PDB's on-lending rates; (iii) the arrangements for EC grant funds for an amount of ECU 6 million to cofinance the institutional support component; (iv) the eligibility criteria for the local organizations (non- government, non-profit organizations with adequate management capacity); activities to be funded under the institutional support component; and the arrangements under the institutional support component with the view to ensure full coordination among the institutions involved in its implementation; (v) the participating conditions for banks, which include compliance with banking regulations, satisfactory financial performance and adequate lending policies and procedures; (vi) the legal agreements required to formalize the obligations of the entities involved in the implementation of the proposed project, and regulate the flow of funds from PDB to the beneficiaries; (vii) the maximum size of sub-loans to finance sub-projects (US$2 million equivalent), the maximum amount of loan financing per enterprise (US$4 million equivalent), and financial covenants for eligible enterprises and sub- projects; (viii) free limits for sub-loans; and (ix) procurement procedures, disbursement arrangements, atuditing and reporting requirements. The conclusion of a Subsidiary Loan Agreement between the Guarantor and PDB will be a condition of loan effectiveness. 15. Benefits: The proposed project will assist Poland's economic transformation program by stimulating the creation and growth of new, privately-owned enterprises, and by helping to foster an environment in which they can flourish. The growth of this segment of the economy is expected to contribute to: addressing a fundamental imbalance in the ownership and size structure of the enterprise sector; strengthening the culture of entrepreneurship and improved enterprise management; enhancing competition and related improvements in productivity; and, critically, generating the much needed supply response and growth, including of exports. Additionally, the project would support activities which would help absorb labor shed by the restruct-tring of state enterprises; and promote regional economic development with direct and indirect employment generation. 16. RiVks: The main risk is related to the uncertainty of macroeconomic developments and sustainability of current policies, which may weaken the investment climate and slow down the implementation of the proposed project by reducing the demand for investment funds. Maintaining economic stability is, however, a major priority for the Government. The budget recently presented to parliament incorporates a deficit target that could be financed from identified domestic and fiaumcial sources consistent with a moderate inflation scenario. The proposed budget provides a good foundation for the ongoing negotiations with the IMF on a new Stand-by Arrangement, which are expected to be completed soon. In addition, the Government is discussing the contents of a program of enhanced structural reform, aimed at stimulating the supply response. Measures in this area include accelerating privatization, confronting the crisis in the financial and state-owned enterprise sectors, and improving the cost effectiveness of the social safety net. Agreement on this program of action may lead to substantial Bank support in the months ahead. Additional risks are related to the limited experience of institutions supporting private enterprises and the limited managerial and marketing experience of entrepreneurs. The technical assistance to be provided under the institutional support component, which complements technical assistance provided under other Bank operatXons, is designed to minimize these risks. 17. Rcommendagion. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve it. Lewis T. Preston President Attachments Washington, D. C. April 16, 1992 -6 ToM Proic Cot ad t Locd Foai Totdl - .(US$ mi 'o)- -X- s___ _____ _ _ __ _ _ _ 4 5.0 10.0 55.0 _ SeDonzupo 5t 7.1 13.1 22.2 Total Fh_n Caos 62.1 12S.1 187.2 IBD C R60.0 60.0 E{_ , ~~~~~~~~~45.0 . .. 10.0 ZS.0 O~~~~~the ouca o 10.0 . ......42.0 no. _m __dtf _2_ 0 __ _2.0 Oer Doll0g 5 .1 13.1 18.2 Totat Fina,dcin 62.1 ltS.1 187.2 gl lhin EC-PLR wmi USAI, UKnw-Ho Fud .7 Schedule B PRIV^A ENTERPRISE DEVELOPME =T PROQEC' PZ rment M o and isbsements lztnimational Shopping and Direct Purbhase Other F Total Civil Works 15.0 15.0 (5.0) (5.0) Goods 100.0 49.2 149.2 (30.0) (20.0) (50.0) Conultant Services - 18.0 18.0 (5-0) (5-0) Other" 5.0 5.3 Total 100.00 87.2 187.2 (30.0) (30.0) (60.0) IV Fgureo in puaethss* forinain under the proposd a a h n bcludS goods and services :o be procured accotding to commcl practices of the prive setor. Inlludes tXe, duties ad other local conponena. Prpse isbusmn Catnu Amoun 9 F Component mon invamnmt ~ ~ ~ ~ milin Goods 43.0 100% of foen _kres 100% of loed peures c-factonr oost); or 80% a/ of local cqm&t=um0=1 othresoni procured locally Civl Works 5.0 40%W/ of apenditures Conultas services and 3.0 100%6 of erpenditos Capitalized ineest 4.0 Amounts capitaliod innced with Bank resource bnstutfona m Goods 0.5 100% of fore anpeaures 100% of }ocal expediures ~ex-4aetozy costs); or 80% A/ of local E=qc.dEwu: mcso=r odter tms procured ocally Consultant_ services and 15 100% of ependitues training _alloze 3.0 TOTAL 60.0 EsthnsAc Of forign exchowg compoa mit hrs. Estim&dDLa= Ment IBRDf FY 1992 1993 I 1994 199S 1996 I 1997 I 1998 Anua 05 331 14.9 1731 12.9 7.4 3.7 Cumulative 05 3. 18.7 36.0 489 S63 60.0 PRIVATE ENTERPRISE DEVELPMENI PROJECr Timetable of Key Pmiect ProWs, &vet (a) Time Taken to Prepare: 10 months (b) Prepaued by: Participating institutions with Bank assistance (c) First Bank Mission: April 1991 (d) Appraisal Mission Departure: June 28, 1991 (e) Negotiations: December 9, 1991 (f) Planned Date of Effectiveness: June 1992 (g) List of Relevant PCRs and PPARs: None ,9_ Schedule D Page 1 of 2 POLAND PRIVATE ENTERPRISE DEVELOPMENT- PROECT THE STATUS OF BANK GROUP OPERATIONS A. OF RUM LOANS A/ (As of March 31,1992) Loan Fiscal No. Yar Borower Proiect (Loan Ca ndcaiorsed One Loan ISAL) Fully Disbursed: 3247 1091 Republic of PoLand Structural Adjustment Loan 300.0 Total Fully Disbursed SAL, SECAL and Program Loans 300 .0 Loans Under Disbursement: 3166 1990 National Bank of Poland Ind. Export Devt. 260.0 229.1 3167 1990 National Bawk of Poland Agroindustry Export Devt. 100.0 60.0 3190 1990 RepubLic of Polac Environment Kana8ement 18.0 16.4 3193 100 Republic of Poland Transport 4.8 3.6 3194 1990 Polish State Railwas Transport 145.0 118.5 3215 1990 Polish Oil and Ga Co. Enersy Resources Devt. 25.0 202.9 3319 1991 Polish Post, Telephone and Telegraph Teleco Aunications 120.0 116.4 3338 1991 Republic of Poland Employaent Promotion Services 100.0 98.0 3341 1991 ki Republic of Poland Financial Institutions Devt. 200.0 200.0 3342 1991 Republic of Poland Privatization and Restruct. 280.0 277.9 3343 1981 Republic of PoLand Aricultural Devt. 100.0 100.0 3377 1991 S/)/ Republic of Poland Beat Supply Restructuring 75.0 75.0 3378 1901 _/A/ DBE-Odansk Beat Supply Restructuring 40.0 40.0 3379 1091 g/ DOE-Gdynia Heat Supply Restructuring 25.0 25.0 3380 1991 s/4/ Voivodahip OHE Beat Supply Restructuring 55.0 55.0 3381 1091 4V Municipal 8E-Xrakow Seat Supply Restructuring 25.0 25.0 3382 1991 4/ Capital Region HE Heat Supply Restructuring iO0.0 100.0 3383 1991 Al Wielkopolaki Hank Kredytowy Heat Supply Restructuring 20.0 20.0 Total 2,217.8 Of whict: Repaid _ Total now held by the Bank 2 Z17 8 Total Amount Sold 0.0 Of which Repaid: 0.0 Total undisbursxd 1,162._ S/ The status of these projects is describeci in a separate repQrt on aU Bankl/IDA f4anced projects in execution, which is updated twice yearly and circulated to the Executive Directors on April 30 and October 31. b./ SAL, SECAL or Program Lon. Li Not yet effective. 41 DHE - District Heating Enterprise. Seven loans made for one projecte - 10 - ScheduleD Page 2 of 2 PgI RIVAEM ENTERPRISE DEVELOPMENT PROJE THE STATUS OF BANK GROUP OPERATIONS B. STAT13MENT OF IFC 1 (As of March 31, 199) Groas Cmsitaents Fiscal Type of USe Million Year Oblistor Business Loan Eauitv Total 1989 Hortei Agriculture & Livestock 17.09 - 17.09 1980 Export Development Bank Sales & Export Finance Leasing 26.96 - 26.96 1990 Decmet Sales & Export Finunce Leasing 0.12 - 0.12 1990 Eurocamion Sales & Export Finance Leasing 0.08 6 0.06 1990 Grassi Sales & Export Finance Leasing 0.10 - 0.10 1990 Ital-Pol Co. Sales & Export Finance Leasing 0.30 - 0.30 1990 Marius Mhalkiewi Sales & Export Finance Leasing 0.06 - 0.06 1990 Rotter Sales & Export Finance Leasing 0.09 - 0 09 19S0 Saar Papier Sales & Export Pinance LeaAsin 0.21 - 0.21 1990 Sawena Sales & Export Finance Leasing 0.82 - 0.82 1990 Tadeuxs Mancxak Sales & Export Finance Leasing 0.14 - 0.14 1990 Rybka Ironwork Sales & Export Finance Leasing 0.39 - 0.39 1990 Tworczosc Sales & Export Finance Leasing 0.61 - 0.61 1990 Waldana Maclele Sales & Export Finance Leasing 0.38 - 0.38 1991 Bristol Hotel Botel Development 10.26 10.26 1991 International Bank of Poland Coumercial Banks 3.20 3 .20 1992 Chmagev Real Estate & Business Sevice 10 58 I'm ll 64 Total Gross Coitments 68.18 4.26 72.44 Less: Cancellations, STeminations, Exclange Adjustments, Repaymnts, Write-offs and Sales g92 0L00 7-92 Total Comitments Held by IFC 60.26 3 64L52 Total Undisbursed 42.58 1.92 44.51 Total Outstanding 17.68 2.34 20.01