RES.TRICTED Report No. P-981 FILE COPY This report is for official use only by the Bank Group and specifically authorized organizations or persons. It may not be published, quoted or cited without Bank Group authorization. The Bank Group does not accept responsibility for the accuracy or completeness of the report. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON PROPOSED LOANS TO MINERACOES BRASILEIRAS REUNIDAS, S.A. - MBR AND REDE FERROVIARIA FEDERAL, S.A. - RFFSA FOR AN IRON ORE MINING AND EXPORT PROJECT July 21, 1971 1NTiERiATION.AL BANK FOR PECONSTRUCTTON ATD I3EVELOPI'ENT REPORT AND RECOMENDATION CF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON PRCPOSED LOANS TO MINERACOES BRASILEIRAS REUNIDAS, S.A. - MBR AND REDE FERROVIARIA FEDERAL, S.A. - RFFSA FOR AN IROF ORE MING AND PORT PROJECT 1. I submit the following report and recommendation on two proposed loans, both to be guaranteed by the Federative Republic of Brazil to: (a) Nineracoes Brasileiras Reunidas, S.A. (MBR) for the equivalent of US$50 million for a term of 15 years including 3 years of grace with interest at 7-1/4 percent per annum, and (b) Rede Ferroviaria Federal, S.A. (RFFSA) for the equivalent of Us$46 million for a term of 18 years including 4 years of grace with interest at 7-1/4 percent per annun. PART I - INTRODUCTION 2. Brazil has so far received US998-3 million in loans from the Bank, net of cancellations. If the Executive Directors approve the pro- posed loans, Brazil will become the Bank's largest borrower. The un- disbursed balance of effective loans at the end of May 1971 was US$385.9 million. These amounts reflect the significant increase in Bank lending in Brazil from US$74.9 million in FY69 to US$205 million in 1970 and uS$160o0 million in 1971. The status of previous loans to Brazil is summarized in Annex I. 3. Two-thirds of the Bank's lending for Brazil has been for power. Since 1968, however, there has been a marked shift in the sector dis- tribution of Bank loans. Less than 40 percent of Bank lending since FY68 has been for power and about 34 percent for transportation. In this period, loans were approved for agriculture, industry, education and water supply and pollution control, sectors in which the Bank had not lent before. 4. In financing projects in recent years and in selecting sectors and projects for financing, the Bank has been concerned, not simply with finding suitable vehicles for resource transfer, but also with iden- tifying areas where Bank assistance would be particularly productive in promoting institution building and in supporting policies and actions of public and private agencies which would encourage Brazills economic growth. - 2 - 5. In power Bank lending has been crucial to new investment, particularly in the Center-South of Brazil, helping to finance the installation of over 6,000 MW of generation capacity and complementary transmission and distribution facilities. Furthermore, partly as a result of Bank association with the power sector, the utilities in Brazil have developed a sound tariff structure which enables them to earn a reasonable return on their investments and to generate a sub- stantial part of their investment requirements. 6. The Bankts association with transportation started in 1965 with the Transport Survey, financed by the Bank, the UNEP and the USAID and supervised by the Bank. The Survey pointed to the need for sub- stantial new investments in all modes of transportation and for major institutional and financial reforms. The Government is implementing the recommendations of the Transport Survey in railways, highways and ports. Bank lending for transportation has been in support of high priority investments and the reorganization and reform being undertaken by the Government. 7. Although relatively limited in scale, especially by comparison with support provided for transport and power, Bank lending for industry, agriculture, water supply and pollution control and education in Brazil has been significant and should be regarded as a prelude to additional support in these sectors. The Bank has lent for an industrial credit project in the Northeast in support o th5~Government's effort to encourage-protion and provide employment in this underdeveloped ei a2 93 O11ran aluminum plant to exploit Brazil's bauxite resources. iipgrttuItur,-teVionly loan so far is for livestock production in the Center-South of Brazil. Loans for technical education, water supply and pollution control were signed recently. 8. In general, execution of Bank-financed projects in Brazil has been satisfactory, but has varied from sector to sector. Disbursements have been rising. Disbursements in FY69 were US$28 million, equivalent to about 11 percent of the undisbursed balance of effective loans at the beginning of the year, whereas in FY71 they were US$75 million or about 30 percent. In electric power, where the utilities are well- established and well-managed, the execution of projects is excellent, despite some initial delays in those financed in 1965 and 1966. Bank financing in recent years has been largely for hydroelectric projects and associated transmission lines and it is in the nature of these operations that disbursements are slow and bunched towards the end of the disbursement period. The experience in transportation has been satisfactory, although there have been minor delays in the first and the second Bank highway projects. In agriculture, the experience has been less than satisfactory. The Livestock Project which involves long- term lending based on farm development plans is a completely new concept in Brazil and has required considerable training of personnel, the establishment of new institutions and education of farmers. In the last year there has been an improvement in the execution of this project. - 3 - 9. The institutional reforms and investment programming which the Government is undertaking in various sectors of the economy are designed, among other things, to improve the formulation and execution of projects and it is hoped that in the traditional sectors of Bank lending as well as in new areas there will be steady improvement. 10. The project sponsors, the CAEMI Group of Brazil and Hanna Mining Company of the U.S.A., first approached the Bank for financing in 1965, and numerous discussions took place over the next four years as the proj- ect concept evolved. Appraisal by the Bank could not begin, however, until early 1970, when IBR reached agreement with RFFSA on a rail freight contract and signed a long-term ore sales contract with Japanese buyers. The MBR Project was appraised by missions which visited Brazil in June, October-November, 1970 and in January, 1971. The Railway Project was appraised by a mission which visited Brazil in October-November, 1970. Negotiations for the MBR Project took place April 12 - June 4, 1971. M4BR was represented by Dr. Arnaldo Blank, its President, Mr. Jack W. Buford, a Senior Vice-President of Hanna Mining Company and Mr. James Courtney, a partner of the law firm Jones, Day, Cockley and Reavis. RFFSA was represented by General Antonio Adolfo Manta, President of RFFSA and Dr. Pedro Rocha Santos, Director of RFFSA. The Guarantor was represented in both negotiations by Dr. Jayme Alipio de Barros, Attorney General of the Ministry of Finance. PART II - THE ECONOMY 11. Since 1964 Brazil has been ruled by a leadership drawn from the Armed Forces, although periodically elections have been held for the National Congress and State legislatures. The Governments of Marshalls Castello Branco and Costa e Silva and General Medici have depended on support of the Armed Forces, but have entrusted economic leadership to well-trained and highly qualified civilians, whose main objectives have been to ensure the growth of the Brazilian economy, the improvement of the balance of payments and to a lesser extent the control of inflation. 12. Although there has been considerable progress towards these objectives, major problems await solution. Some of the most serious of these problems, such as unemployment, uneven income distribution, and differences in the prosperity and growth of different regions, can be resolved only if there is rapid economic growth. The Government, has in fact, taken specific measures to improve income distribution and alleviate regional disparities including, inter alia social security reform, housing and urban development programs, a massive adult literacy campaign and other educational efforts and tax sharing and fiscal mea- sures to transfer resources from the richer to the poorer regions of the country. 13. Prospects are that Brazil will continue to be guided, for some time to come, by the Armed Forces with the assistance of carefully selected civilians in the economic and social matters, and that both military and civilian members of the Government will place major emphasis on the resolution of domestic economic and social problems. 1. An economic report on Brazil (WI-203a) dated January 22, 1971 has been distributed (R71-39). A summary of recent economic developments based, among other things, on some preliminary estimates of economic trends in 1970 was included in my report and recommendation on the Sao Paulo Water Supply and Pollution Control Project (P-927), dated May 6, 1971. A Country Data sheet is attached as Annex II. 15. An economic mission has just returned from Brazil and is prepa- ring its report. The following is a brief summary of recent economic devel- opments and prospects of the Brazilian econony,, based on the mission's findings. 16. For three years in succession, 1968, 1969 and 1970, domestic product has maintained a rapid growth, averaging 9 percent during these years. The growth has been led, as in the past, by a rapid increase in industrial production. Agricultural production increased on the average by about 4.5 percent per annum, permitting higher per capita consumption and an increase in agricultural exports. The growth of employment has been more rapid than that of the labor force. Brazil appears to have resumed the rapid growth characteristics of the 1955-62 period although it is now more outward looking. 17. Concurrently with the rapid growth in production and employment, the Government has tried to increase and diversify exports. Merchandise exports, which stood at about US$1.9 billion in 1968, increased to about US$2.7 billion in 1970. Furthermore, despite the windfall from higher coffee prices in 1969 and 1970, the share of agricultural products in exports declined from 70 percent in 1968 to about 63 percent in 1970. Export promotion policies, such as the flexible exchange rate and tax subsidies for manufactured exports, and exploitation of rich natural resources, such as iron ore, have led to a significant diversification of exports. Between 1968 and 1970 exports of iron ore and manganese increased from US$130 million to US$240 million. Exports of manufactures increased from US$130 million to US$330 million. Brazil's manufactured exports range from sports cars to special steels. Markets for these products have been found in Europe, the United States and Asia as well as in the Latin American Free Trade Area countries. Although highly significant from the Brazilian point of view, these manufactured exports in no case account for more than one percent of the total manufactured imports of the various regions concerned. Thus, there appears to be ample room for additional expansion. 18. The rapid growth of output and investment has placed heavy demands on Brazilts capacity to pay for imports, particularly as production and investment accelerated further in the latter part of 1970. Imports were about US$1.9 billion in 1968 and US$2.5 billion in 1970. Most of the increase was in the import of capital goods - a growth of about 50 per- cent over this period - and raw materials for Brazil's growing industry. 19. External capital requirements, averaging about US$800 million in the last three years, have been financed largely by medium and long- term borrowing which averaged about US$500 million per annum. For the rest, Brazil depended on direct investments and, much more substantially, on short-term credits which have increased significantly in recent years. Brazil has also been able to build up its external reserve and to main- tain an adequate margin of liquidity. Net foreign exchange reserves increased from US$0.3 billion at the end of 1968, to about US$15 billion at the end of 1970. External debt, including short-term financial cre- dits, was US$3.7 billion at the end of 1968 and about US$5.2 billion at the end of 1970. Including all interest payments and the amortization of medium and long-term debt, the debt service ratio was 21 percent in both years. While the Government's balance of payments management has been skillful there is need for constant attention to the structure of Brazil's external debt and its possible effect on Brazil's future liquid- ity. At the end of 1970 debts with maturities of up to three years amounted to more than 40 percent of Brazil's external debt. The Govern- ment is keenly aware of this and has taken steps to raise new financial credits for longer terms. In the next few years the management of Brazil's external indebtedness and capital flows will be a crucial ele- ment in Brazil's economic policies. 20. The Brazilian Government has not found a way to reduce signi- ficantly the rate of inflation while preserving its objective of ensuring continuous rapid growth. The annual rate of inflation was reduced to about 20 percent in 1970 from about 25 percent in 1968. The Government feels that a reduction of the rate of production and employment growth which may result from efforts for a more rapid decline in the rate of inflation, would be unacceptable socially and politically. Moreover, to some extent, the Government's efforts to reduce the distortion of prices, such as public utility tariffs, rents, agricultural prices and price of coffee for domestic consumption, have inevitably led to some "cost push." Nevertheless, the Government is committed to continue measures in various fields to minimize the adverse effects of inflation on resource use through flexible prices. 21. The Government is currently preparing a development plan for 1972-74. It is expected to be ready towards the end of this year. Unlike previous plans, this one will be detailed and specific and indicate economic goals, investment priorities and projects and resource mobili- zation. The Government's primary goal is a continuance of economic growth at around the rate achieved in recent years. Towards this end, it proposes to make large direct investments in infrastructure, such as transportation, power and in education and in primary industries, such as steel. To permit continued rapid growth of private industry and agriculture, the Government proposes to extend liberal credit, often directed to specific inputs such as fertilizers, and to specific areas, - 6 - such as the Northeast. To meet the problem of regional disparities, the GovernmentTs policy is not only to divert public and private resources for industrial, agricultural and infrastructure development within the North- east, but also to use large public resources to open up new areas in the Amazon and the western part of Brazil for settlement by unemployed and landless Northeasterners. The construction of the Transamazonica Highway is a step in this direction. 22. The Government has undertaken a series of measures to increase domestic savings to ensure that the investment resources necessary to support rapid growth rates are available. The above mentioned adjustments of public utility tariffs have contributed substantially to the savings capacity of public enterprises in the energy and communications sectors. The current account deficit of the Central Government, which equalled 0-9 percent of GDP in 1967, has been transformed into a surplus equal to 3.3 percent of GDP in 1970, primarily as the result of improved tax performance. To encourage private savings the Government has taken measures to provide adequate returns to private investors channeling their savings into the capital market. Thus, the private savings cap- tured by investment banks, mutual funds, finance companies and savings and loan associations increased by 175 percent in real terms over the 1967-70 period. Efforts to promote domestic savings are likely to con- tinue as investment requirements increase. 23. Brazil's resources are plentiful. The Government's economic management has been efficient. The country has a vigorous private sector and a skilled managerial class. Continuance of growth achieved in the last few years should not, therefore, be beyond reach provided that the Government's efforts to rationalize policies affecting the use of key resources are continued and strengthened. However, a crucial factor in Brazilts ability to achieve its goal would be the extent and the quality of support it receives from external lenders. Ihile the Government is keen on promoting the growth and diversification of exports and the pros- pects for Brazilts exports are bright, Brazil will continue, for quite some time, to depend heavily on foreign capital to meet its development objectives. The Bank's current estimate is that in the next few years Brazil will need more than US$1 billion annually to finance its current account deficit and to make amortization payments on its medium and long- term debt. Additional medium and long-term borrowing may be needed in order to improve the structure of the external debt, reducing the pro- portion of short-term debt in the total. External capital requirements may appear large, but relative to the size of the economy and the imaginative and ambitious developmental objectives which Brazil's eco- nomic managers have adopted, they are modest. Net capital inflow in 1970 was 10 percent of total investments. Brazil continues to be credit- worthy for substantial amounts of Bank lending. 24. Brazil has made considerable progress in the last few years in formulating investment projects suitable for external financing. How- ever, its gross external capital requirements, taking into account heavy charges for service on external debt, cannot be met if external assist- ance is tied entirely to the foreign exchange component of project -7- costs. Although the capital investment needed to support Brazil's economic growth targets is substantial, a large part of the capital equipment com- prising this investment will be produced in Brazil, generating needs for raw material and intermediate goods imports not directly attributable to externally financed investment projects. Hence, it is appropriate for external lenders to finance some local expenditures in Brazil, es- pecially on projects having a relatively low foreign exchange component. PART III - PROSPECTS FOR BANK LENDING 25. Bank commitments to Brazil have increased sharply in the last two years. Nevertheless, Bank loans represented no more than 12 percent of total medium and long-term loan commitments in 1969 and 1970. With substantial new Bank lending for Brazil in prospect for the near future, the Bank's share in medium and long-term lending may well increase. 26. The very large investment requirements of the power sector will necessitate continuing financial assistance from international institu- tions and at least modest support from the Bank. The Bank is, therefore, working on a loan for the installation of generating facilities at Sao Simao on the Paranaiba River and complementary transmission lines. This project was developed within the framework of a very large power develop- ment program which has been formulated for South-Central Brazil. I also envisage continued substantial Bank support for the Government's efforts in transportation. A Bank loan is being prepared for the construction of a number of highways to which high priorities were attributed by the Trasnport Survey. Both of the aforementioned loans should be ready for presentation to the Executive Directors during the current fiscal year. 27. The largest component of the Bank's prospective lending to Brazil during that period consists, however, of the proposal to provide financing, jointly with the IDB, for the expansion of Brazil's three principal in- tegrated steel mills. Nhen completed, these projects will increase Brazil's steel production capacity by 3 million tons. The steel projects are designed to exploit Brazil's rich iron ore resources to meet the rapidly increasing demand for steel at economic costs. Another project likely to be ready for Bank financing during the next 12 months is the creation of a capital market fund designed both to improve the structure of the capital market and to channel private savings into industry. We have also for some time been working with the Government to develop additional projects in agriculture and I hope to have ready for considera- tion by the Executive Directors by mid- or late 1972 a loan for land settlement in the Northeast and one for financing agricultural storage facilities in the principal producing areas. As regards education, the recent Bank loan for technical education includes funds for a study of the education systems and manpower requirements in the two Northeastern states of Ceara and Pernambuco; this study may provide the basis for a future Bank project. - 8 - PART IV - THE PROJECTS 28. Brazil has immense deposits of high quality iron ore. Its re- serves are estimated at over 30 billion metric tons, or 12 percent of known world reserves, and far exceed the needs of its steel industry. Iron ore has, therefore, become a major Brazilian export, now second only to coffee. The development of new ore deposits will make iron ore mining one of the most dynamic sectors during the 1970s. In 1970, Brazil exported about 28 million tons, valued at US$210 million. Current plans are to raise exports of iron ore to about 70 million tons annually by 1975. The long-term market outlook for iron ore is favorable and future prices are expected to remain relatively stable. 29. Although two separate Bank loans are being presented, one to MBR, a mining company, and another to RFFSA, the federally-owmed railway corporation, the projects to be constructed by these enterprises are inter- related and serve a common purpose: to develop the large Aguas Claras iron ore deposit located near Belo Horizonte in the State of Minas Gerais and export the ore. This deposit contains proven and inferred reserves of over 375 million tons of high grade mineable open-pit hematite containing 68 percent iron and very low percentages of phosphorus, sulfur, silica and alumina. Facilities will be provided by MBR to mine and process the ore, and the railway system of RFFSA will be improved to carry the ore 640 km to a new marine terminal to be constructed by MBR at Sepetiba Bay, south- west of Rio de Janeiro. The railway project will be the responsibility of RFFSA arid the mining project of MBR. RFFSA and MBR have already created a high-level committee consisting of representatives of the two organization3 to coordinate the execution of the two projects. Furthermore, both RFFSA and MBR have agreed to retain a single consulting firm to suporvise the construction of both projects. 30. The projects will result initially in the export of 10 million tons of ore annually. It is expected that the facilities provided in the first phase will later be expanded with little additional investment to produce and export 16 million tons or more of ore per year within five years of the start of operations. The Aguas Claras deposit has sufficient proven reserves to produce ore for export at the rate of 15 million tons per year for 17 years. MBR has entered into long-term ore sales agree- ments to sell annually 7.3 million long tons of Aguas Claras ore to five Japanese steel companies, 1.3 million tons to British Steel Corporation and 700,000 tons to SOMISA in Argentina. Eich of these contracts provides for periodic renegotiation of the sales price. These contracts and a further 700,000 tons of expected spot sales will account for the initial planned - 9 - production of 10 million tons a year. MBR has been able to negotiate favorable contract terms, due primarily to the quality of its ore, which gives it a competitive advantage over most iron ore sources elsewhere in the world. The MBR Project 31. A report, "Appraisal of the MBR Iron Ore Project" (PI-10) dated June 16, 1971 is being distributed separately. A summary of it is in Annex III. 32. Companhia Auxiliar de Empresas de Mineracao - CAEMI, a Brazilian holding company, and St. John D'el Rey, a British holding company 52 per- cent owned by the Hanna Mining Company of the United States, propose to consolidate their iron ore properties in MBR in accordance with a re- organization agreement which must be approved by the Government and which the MBR Loan Agreement makes a condition of effectiveness. Through hold- ing companies and subsidiaries, MBR will be owned effectively about 31 percent by CAEMI, 25 percent by Hanna, 10 percent by several Japanese steel and trading companies, 10 percent by a Liberian subsidiary of a U. S. shipping company, National Bulk Carriers, and 24 percent by minority shareholders in St. John. MBR and its subsidiaries, following the con- solidation, will possess mining rights over an area of 45 km2 in the vicinity of Belo Horizonte containing 36 deposits of iron ore with re- serves estimated at over 1.6 billion tons. Aguas Claras, the mine being developed, is the largest of these deposits. Planning for the project reflects the sponsors' extensive experience with iron ore mining in Brazil, Canada and the United States. MBR Financing and Use of Proceeds 33. The cost of the project is equivalent to US$142.6 million to which has to be added US$12.6 million for financial charges on long- term debt during construction to give total financing requirements of US$155.2 million, of which US$86. million would be foreign and US$68.8 million local. This financing would come from the following sources: Sponsors' New Equity 30.0 Long-Term Debt IBRD 50.0 Japanese Trading Companies 50.0 Japanese Suppliers' Credits (to be negotiated) 7.0 a/ U.S. Eximbank and Commercial Banks 26.3 a/ 133.3 Total Financing available to cover ex- penditure estimated at US$155.2 million 163.3 a/ The utilization of Japanese suppliers' credit and the U.S.Eximbank and commercial bank loans will not be known until contract awards have been made. Unused portions of these loans will remain available as addi- tional contingency financing. - 10 - 34. The proposed Bank loan to MBR of US$50 million would be for 15 years, including a grace period of about 3-1/2 years. The Government of Brazil would charge MBR a 2 percent per annum guarantee fee on the outstanding disbursed amount of the Bank loan, thereby bringing the cost of the Bank loan to MBR to 9-1/4 percent. 35. Since IMIR has contracted to start shipping iron ore from its terminal in 1973, some orders for equipment are presently being placed and contracts are being awarded for some civil works, all in accordance with Bank guidelines. It is, therefore, proposed that the Bank loan cover expenditures from June 1, 1971; it is estimated that this would result in retroactive financing of about US$1 million. 36. All contracts in respect of items financed by the Bank will be subject to international competitive bidding. Brazilian manufacturers of equipment and materials will be given a 15 percent margin of preference. The proposed loan would provide some local expenditure financing, estimated not to exceed US$7 million. 37. The proposed Bank loan of Us$50 million and the US$50 million loan being provided by Japanese banks and trading companies at an effective interest rate of about 9.6 percent and with a 15-year term, will be secured by a first mortgage on IMBRs properties and other assets. MBH has agresd that US$0.60 per ton shall be withheld from payment for the first 84 mil- lion tons of ore shipped on the Japanese ore contracts in order to service the Japanese loan. This arrangement may result in full repayment in about 12-1/2 years after project completion. The proceeds of the Japanese loan may be spent anywhere including Brazil; the Japanese suppliers' credits would be used for purchases of equipment from Japan. Of the US$26.3 mil- lion commitment from the Eximbank and U.S. commercial banks, which has an effective interest rate of about 7.5 percent and a term of 12-1/2 years, US$22.5 million is available for purchase of U.S. goods, and US$3.8 million for local expenditures. MBR-Overrun Undertaking; Financial Projections 38. Although it is considered that the project cost estimates in- clude adequate allowances for price escalation and contingencies, and although the financing presently available or under negotiation would pro- vide up to US$8 million over and above the cost estimates, CAEMI and St. John have severally agreed in the Shareholders' Agreement, to provide up to US$20 million to finance cost overruns and working capital deficiencies until the Project is operational. The proportionate responsibilities of the primary sponsors are: CAETI 51 percent and St. John 49 percent. CAEMI's obligation is secured by an agreement not to sell or pledge, so long as the Shareholders' Agreement is in effect, any of its share in - 11 - Industria e Comercio de Ninerios, S.A. - ICOMI, CAEMI's major subsidiary and principal source of income. In the Security Agreement, Hanna Mining Company has agreed to provide US$7.5 million to meet St. John's obliga- tion under the Shareholders' Agreement in case the latter is unable to do so. As further security, St. John has agreed to a pledge of its M1BR shares in favor of the Bank. 39. Projections of MBR's financial statements for the Aguas Claras operation, assuming sales of 10 million tons per annum, indicate an internal financial rate of return, after taxes, of about 19 percent. They also show long-term debt service coverage after capacity is reached, ranging from 1.8 to 2.5 times. The MBR Loan Agreement contains pro- visions to protect MBR's liquidity through restrictions on dividends, borrowings, and non-project investments. The Bank, the Eximbank and the Japanese lenders would be protected proportionately by a provision that if MBR pays out dividends in excess of US$7.5 million in any year, MBR will apply an equivalent amount to repayment of their loans. How- ever, to the extent that dividend payments by MBR are less than an aggregate of US$15 million in any two successive years, in the third year MBR would be able to pay dividends in the amount of US$7.5 million and in addition the above mentioned difference between US$15 million and actual dividends paid,without having to prepay long-term debt. In the case of the Bank loan this could mean pre-payments starting in or after 1979 leading to full repayment two or three years ahead of the scheduled final maturity date. Ecology hO. The findings of a special ecological mission sent by the Bank to the project sites were discussed with the project sponsors and agree- ment was reached during negotiations that the execution and operation of the project would be carried out with due regard to ecological and environmental factors. The iron ore terminal proposed to be built by MBR at Sepetiba Bay is in the vicinity of beaches used for recreation and waters used for fishing. During loan negotiations MBR has agreed to take measures acceptable to the Government and the Bank to deal with oil and other slops from incoming ships, as well as accidental oil spills. Furthermore, 4BR has agreed to consult with the Bank before any decision is made to establish a pelletizing plant at the terminal. The RFFSA Project 4l. A report, "RFFSA - Appraisal of the First Railway Project" (PTR-77a) dated June 1h, 1971 is being distributed separately. A summary of it is included in Annex III. 42. RFFSA was created in 1957 as a publicly-owned corporation group- ing 13 railways which formerly had been publicly-owned but under separate managements. The States and Municipalities hold pieference shares re- presenting 23 percent of total capital, while the Federal Government holds the controlling interest. Management is undertaken by a board of six - 12 - members, chaired by the President. In 1968, RFFSA's organization was re-shaped to provide for four regional systems. Economies in adminis- tration are being sought by concentrating responsibility in regional headquarters for financial and personnel matters and statistics. Government control of RFFSA is exercised in respect of capital expen- ditures, overall budget and tariffs, 43. In 1965 the Government undertook with Bank assistance a Trans- port Survey, including the railways. The Survey pointed to the need for major institutional, financial and managerial reforms in RFFSA, in addi- tion to substantial new investments. In 1968 and 1970 the Government formulated so-called Plans of Action to implement in RFFSA and other transport entities the major recommendation of the Transport Survey. Progress in the reform of RFFSA has been satisfactory. The operating deficit of RFFSA, which was US$200 million in 1964, was reduced to US$100 million in 1970. In this perid some 6,000 km of uneconomic lines were closed and the labor force reduced by 25,000 persons. RFFSA is currently preparing a 5-year corporate plan which would cover investments and a detailed program for the improvement of management, operations and finances in order to eliminate its operating deficits by the middle of the decade. This plan may provide a basis for Bank financing of further railway investments. 44. To provide transport of iron ore for the MBR mining project between the Aguas Claras mine and the Sepetiba Bay terminal, RFFSA will acquire 78 locomotives and 1230 ore cars. RFFSA will also construct a new rail connection to the mine and a bypass line to avoid dense traffic in the Rio de Janeiro area. The existing main line will be improved by track works, resignalling and bridge and tunnel works. The iron ore traffic is expected to make a significant contribution to RFFSA's revenues: transportation of 12 million tons per annum 1/ over the 15-year period ending in 1988 is expected to result in net cash generation to RFFSA of US$117 million after meeting debt service. RFFSA Financing and Use of Proceeds h4. The cost of the project is equivalent to US$128.9 million to which has to be added interest on external loans during construction of US$4.3 million to give total financing requirements of US$133.2 million, This financing would come from the following sources: IBRD 46.0 Suppliers Credits 26.7 Brazilian Government 60.5 Total Financing 133-2 1/_Whereas the MBR projections have covered a build-up from 10 to 15 million tons annually, projections for RFFSA are based on the present projects which covers a build-up to 12 million tons only, beyond which further investment in equipment would be necessary. - 13 - 46. The proposed US$46 million Bank loan would finance 100 percent of the cost of freight cars, rails, workshop and track equipment and the foreign exchange cost of consultant services, thereby covering about 35 percent of the costs of the project. It would have a maturity of 18 years, including a grace period of four years. A longer grace period for the RFFSA loan than for the IBR loan is being recommended because some improvements of the main railway line to be financed from the pro- posed loan would continue until the end of 1974, and disbursements are likely to continue into 1975. Shipments of iron ore would begin, how- ever, in 1973. The longer term of the proposed loan to RFFSA is based on the economic life of assets financed under the loan and the projected cash flow of RFFSA. All Bank financed items, other than consultants services, would be purchased under international competitive bidding, in which Brazilian suppliers would participate with a 15 percent margin of preference. Insofar as some orders for equipment are placed with Brazilian suppliers, a part of the loan, estimated not to exceed US$23 million, would finance local expenditures. The proposed loan would also include retroactive financing of US$100,000 for consulting services incurred since June 1, 1970 in connection with project preparation. 47. Suppliers credits will be used to finance about 80 diesel loco- motives in the United States. The Brazilian Government's contribution, about 45 percent of total project cost, will be provided as a capital grant, and will be used for civil works ald other expenditures. RFFSA-MBR: Iron Ore Transport Contract 48. RFFSA has signed a 15-year contract with MBR for the transport from the Aguas Claras mine to MBR's Sepetiba Bay terminal of a minimum of 9 million tons of ore per year, with provision for higher tonnages if necessary. The contract initially negotiated between RFFSA and MBR pro- vided for a fixed tariff (depending on tonnage transported) in dollars for the life of the contract, and thus provided no protection against price increases in the United States. MBR and RFFSA have now agreed to modify the contract, providing for an annual adjustment of RFFSA's tariff beginning in 1974 on the basis of increases in the U. S. Wholesale Price Index since 1970. To protect MBR against an open ended commitment to tariff adjustments, RFFSA's tariff would not exceed specified per- centages (depending upon tonnages shipped) of iron ore prices obtained by MBR. The escalation formula agreed upon by MBR and RFFSA would pro- vide reasonable protection to RFFSA against cost increases while pro- tecting MBR in case of a substantial lag of world iron ore prices behind prices in the United States. 49. The iron ore transport contract includes a broad force majeure provision, but MBR has agreed that it will not in any lawsuit, arbitra- tion, or cther proceeding take the position that the force majeure clause extends to any commercial risks of MBR, such as a decline in demand or in the price of iron ore, or any increase in the cost of production thereof. 5o. With the above mentioned adjustment of tariffs and assuming iron ore shipment of 10 million tons per annum, RFFSA's internal finan- cial rate of return on its investment in this project should be some 8 to 9 percent. Since about 45 percent of RFFSArs financing will be from the Brazilian Government grant, the return on the new investment should be more than adequate to cover service on the Bank loan and suppliers credits. Benefits to Brazil $1. MBR and RFFSA together propose to invest close to US$290 million in these projects. The economic return on this investment, making the conservative assumption that exports will not exceed 10 million tons of iron ore per year, is expected to be of the order of 18 percent. Net foreign exchange earnings for Brazil, after allowing for debt service, overseas dividend payments and the foreign exchange component of operating costs of MBR and RFFSA, will average about US$50 million per annum. About 84 percent of net financial benefits will accrue to Brazil, 73 percent to the Brazilian Government through various taxes and the guaran- tee fee and 11 percent to Brazilian shareholders. Total direct revenues accruing to the Brazilian Government over the assumed 15-year period with only 10 million tons per year exported are projected to be US$215 million. Net cash generation from MBR ore traffic would reduce the annual operating deficit of RFFSA, currently estimated at about US$100 million, by an average of about US$10 million per annum during this period. Total revenues accruing to the Government and RFFSA taken to- gether over 15 years are thus estimated at US$339 million. With a 50 percent increase in ore sales to 15 million tons annually, total revenues accruing to the Government and RFFSA from the MBR-RFFSA projects would come to about US$585 million. A notable feature of these projects is that the share of total benefits received by the Government is substan- tially higher than that received by the host country in othcr mining projects financed by the Bank. PART V - LEGAL INSTRUMENTS AND AUTHORITY 52. The draft Loan Agreements between the Bank and Mineracoes Brasileiras Reunidas, S.A. and Rede Ferroviaria Federal, S.A.; the draft Guarantee Agreements between the Federative Republic of Brazil and the Bank for both loans; the Shareholders Agreement between the Bank and Mineracoes Brasileiras Reunidas, S.A., and Companhia Auxiliar de Empresas de Mineracao - CAEMI and St. John D'el Rey Mining Company, Ltd.; the Security Agreement between the Bank and Mineracoes Brasileiras Reunidas, S.A., and St. John Drel Rey Mining Company, Ltd., and Hanna Mining Company; and the Reports of the Committee provided for in Article III, Section 4 (iii), of the Article of Agreement and draft Resolutions approving the proposed loans, are being distributed to the Executive Directors separately. - 15 - 53. Most of the major features of these agreements have already been described in this report. In addition, the Loan Agreement with NBR contains debt limitation and dividend and investment restriction covenants which are usual for this type of transaction. As already mentioned the Bank's loan and the Japanese loans will be secured by a first mortgage on all of MBRIs properties and assets. A Lender's Agreement between the Bank and the Japanese Group will provide for consultation before either party acts to enforce the mortgage. 54, I am satisfied that the proposed loans will comply with the Articles of Agreement of the Bank. PART VI - RECOMIENDATION 55. I recommend that the Executive Directors approve the proposed loans. Robert S. McNamara President Attachments. Washington D. C. July 21, 1971 ANNEX I Page 1 STIMARY STATEMENT OF LOAIS AND CREDITS As of June 30, 1971 Loan Amount Less No. Year Borrower Purpose Cancellations Undisbursed (US$ million) Loans fully disbursed 288.9 403 1965 Central Eletrica de Furnas - Estreito I Power 57.0 3.5 404 1965 Centrais Eletricas de Sao Paulo - Xavantes Power 22.5 8.3 4h2 1966 Centrais Eletricas de Minas Gerais - Jaguara Power 49.0 16.9 474 1966 Central Eletrica de Furnas - Estreito II Power 39.0 35 475 1966 Cia. Brasileira de Energia Eletrica Power 6.2 3.2 476 1966 Cia. Forca e Luz do Parana Power 8.1 3.3 477 1966 Cia. Paulista de Forca e Luz Power 41.0 14.9 478 1966 Cia. Forca e Luz de Minas Gerais Power 6.3 2.7 516 1967 Brazil Livestock 40.0 34.5 565 1968 Central Eletrica de Furnas - Porto Colombia Power 22.3 20.0 566 1968 Central Eletrica de Minas Gerais - Volta Grande Power 26.6 23.6 567 1968 Brazil Roads 26.0 13.1 656 1970 Banco do Nordeste do Brasil Industry 25.0 23.9 676 1970 Brazil Roads 100.0 95.2 ANNEX I Page 2 Loan Amount less No, Year Borrower Purpose Cancellations.UndLisbursed 7h$milliol) 677 1970 Central Eletrica de Furnas - Marimbondo Power 80.0 79.1 728 1971 Centrais Eletricas do Sul do Brasil Power 70.0 755 1971 Brazil Education 8.4 1/ 1/ 756 1971 Brazil Ports 45.0 1/ 1/ 757 1971 Superintendencia de Agua e Water Esgotos da Capital Supply 22.0 1 1/ 758 1971 Companhia Metropolitana de Pollution Saneamento de Sao Paulo Control 15.0 1/ 1/ Total (less cancellations) 998.3 of which has been repaid to Bank and others: 168.9 Total now outstanding 829.4 Amount sold 10.3 of which has been repaid 8.2 2.1 Total now held by Bank 827.3 Total undisbursed 377.7 1/ Signed but not yet effective. No IDA credits have been made to Brazil. As of June 30, 1971 IFC has made commitments to companies in Brazil for a total of US$61.8 million and presently holds US$42.3 million for its own account. AINEX I Page 3 SUMMARY STATEMINT OF IFC INVESTMENTS As of June 30, 1971 Amount less Year Borrower Purpose Cancellations Undisburoed 7TJ5 thousand Completed Investments 5,607 1958 D.L.R. Plasticos do Brasil Automotive 450 S.A. parts 1959 Champion Celulose, S.A. Pulp 4,000 1966 1968 Acos Villares, S.A. Steel 4,959 1966 1969 Papel e Celulose Catarinense Pulp and S.A. Paper 7,117 1967 Ultrafertil, S.A. Fertilizer 10,657 1969 Petroquimica Uniao, S.A. Petro- 8,380 1,542 chemicals 1970 Poliolefinas, S.A. Petro- 8,377 3,077 chemicals 1971 Oxiteno, S.A. Petro- 6,O 6,040 chemicals 1971 Industrial de Celulose Pulp Borregaard, S.A. 4,900 _,9D00 Total (less cancellations) 60,h87 Repaid to IFC L770 Total now outstanding 55,717 Of which Amount sold to others 13,393 Held by IFC Loans 30,618 Equity 11,706 42132 Total undisbursed 15655 AN1EX II BRAZIL - COUNTRY DATA Page 1 Area: 8,512,000 km2, 3,286,000 sq mi Population: Estimate, mid-1970: 92.3 million Social_Indicators: Population Growth Rate, % 1960-70 2.6 Urban Population Growth Rate, % 1960-70 4.3 1/ Birth Rate, per 1,000 (1970) 39.0 Urban Unemployment Rate, % Not available Gross Domestic Product: GDP at market prices 1970 Cr$167.9 billion Approximate US$ equivalent US$ 36.5 billion Real Growth in 1970 9.5 percent Average Real Growth, 1965-70 7.3 percent Per Capital GDP in 1970 US$396 Percentage Contribution to GDP 1960 1970 Agriculture 23.4 20.2 Industry 32.1 34 7 Services 44.5 45.1 Saving and Investment: 1968 1969 1.970 Gross Fixed Domestic Investment as Percentage of GDP 17.0 171 18.0 Percentage Composition of Investment and Savings in 1968 Gross Fixed Domestic Investment 95.9 Construction 39.1 Capital Equipment 56.8 Inventory Change 4.1 Gross Domestic Investment 100.0 Private Sector Savings 72.7 Government Savings 18.1 Current Account Deficit 9.2 Central Government Finances: 1968 1969 1970 (Millions of Cruzeiros) Revenues 8,930 12,802 17,661 Total (10,390) (13,953) (19,194) Minus: Revenue Sharing (1,460) (1,151) ( 1,533) Current Expenditures 6,628 8,956 11,629 Current Account Surplus 2,302 3,846 6,032 Investment Outlays 3,465 4,602 6,770 Overall Cash Deficit 1,163 756 738 1/ State capitals only. ANNEX II Page 2 End End End Money Supply 1968 1969 1970 Millions of Cruzeiros 20,230 26,691 34,318 Prices 1967 1968 1969 1970 General Price Index 128 159 192 230 (Annual Averages) Guanabara Cost of Living Index 130 159 194 238 (Annual Averages) End End End Exchange Rate 1968 1969 1970 Principal Exchange Rate, Selling 3.830 4350 4.950 (Cruzeiros per U.S.Dollar) Balance of Payments 1968-70 1968 1969 1970 (Millions of U.S.Dollars FOB Merchandise Exports 1,881 2,311 2,739 (of which coffee) (797) (846) (982) FOB Merchandise Imports -1,855 -1,993 -2,526 Net Services -328 -369 -494 Factor Payments to Foreigners -228 -261 -351 Net Transfers 22 31 10 Current Account Balance -508 -281 -622 Foreign Direct Investment 61 124 85 Import Financing 106 182 278 Financial Credits 1l2 591 653 Errors and missions -104 5 164 Change in Central Bank Reserves -33 621 518 Change in Commercial Bank Reserves 24 -36 -11 External Public Debt End 1969 End 1970 (Millions of U.S. Dollars) IBRD Total IBRD Total Disbursed 198.8 446.9 258.2 5203.6 Import Financing 198.8 2802.2 258.2 2917.9 Financial Credits - 1604.7 - 2257.7 Undisbursed 284.0 2010.0 415.7 2473.2 Import Financing 214.0 2010.0 415.7 2473.2 Financial Credits - - - TOTAL 482.8 6416.9 673.9 7676.8 1969 1970 Debt Service Ratio (excl. rollover of financial credits) 18.8 21.3 ANNEX TT Page 3 End End End 1968 1969 1970 Net External Reserves of the Central Bank Tillions of U. S. Dollars) 342 955 1,473 IMF Position at End of 1970 Quota US$440 million Net Drawings US$ 25 million Fund Holdings of Cruzeiros Cr$1,484 Fund Holdings of Cruzeiros as percentage of Quota 73 percent Rate of Exchange as of May 20, 1971 Cr$5.19/US$1.00 17 Excludes all external debts of the monetary authorities of more than one year term. ANNEX III Page 1 LOAN AND PROJECT DATA SHEET I. LOAN SUMARY MBR Project Railway Project Borrower: Mineracoes Brasileiras Rede Ferroviaria Federal, S.A. Reunidas, S.A. Guarantor: Federative Republic Federative Republic of Brazil. of Brazil. Amount: US$50 million equivalent; US$46 million equivalent; 32 percent of total cost 35 percent of total cost of MBR Iron Ore Project. of RFFSA Project. Terms and Conditions: Payable in 15 years with Payable in 18 years with Y½ year grace period and 4-year grace period and 74 7¼ percent interest. percent interest. Guarantee fee - 2% per annum. Disbursement: 1971/2 US$12 million 1971/2 US$ 3,0 million 1972/3 US$28 million 1972/3 US$10.6 million 1973/b US$10 million 1973/4 US$19.1 million 197h/5 US$13.3 million II. PROJECT DATA Brief Description: Exploitation of iron ore deposit near Belo Horizonte by construction of facilities for open pit mining, of an ore preparation plant and installation of loading equipment at the mine. Improvement of way and structure and purchase and operation of rolling stock of RFFSA to transport ore 640 kms from the mine to a terminal to be constructed at Sepetiba Bay by MBR. The terminal facilities will include machinery for mechanical loading of vessels of 250,000 DWT and the dredging of a channel in Sepetiba Bay. ANNEX III Page 2 MBR PROJECT US$ million Foreign Local Expend- Expend- NBR Estimated Cost iture iture Total Mine and Preparation Plant 22d4 21.4 43.8 Ocean Tfermnal 27.3 15.0 42.3 Engir.ering and Project Management 6.4 8.5 14.9 Administration during Construction, Design and Engineering, Working Capital 6,1 lo6 16.7 Contingencies 11.6 13.3 24.9 Total Cost 73.8 68.8 1J2 6 Interest during construction 12.6 - 12.6 Total Financing Required 86.4 68.8 155.2 MBR Financing Sources Long-Term Debt (US$ mlions) IBRD 50.0 Japanese Trading Companies 50.0 Japanese Suppliers' Credits (to be negotiated) 7.0 a/ U.S. Eximbank and Commercial Banks 26,3 a/ Total 133.3 New Equity 30,0 Total Financing Available 163.3 a/ Unused portions of these loans will be available as contingency financing. Expenditure to be Financed by Bank Loan US$ millions a) Equipment 100 percent of specified equipment sub- mitted to international competitive bidding. 25.4 b) Construction 100 percent of specified construction Materials materials purchased under international competitive bidding. 4.0 c) Civil Works 54 percent of civil works expenditures submitted to international competitive bidding, this fraction representing their estimated average foreign exchange component. 12.6 d) Unallocated US$5 million to finance equipment materials or civil works as in a), b) and c) above. 5.0 e) Interest during US$3 million Construction on Bank Loan 3.0 TOTAL rC, 0 ANNEX III Page 3 RAILWAY PROJECT US$ millions Foreign Local Expend- Expend- RFFSA Estimated Cost iture iture Total Civil Works 5.0 24,8 29.8 Equipment 70.8 9.2 80.0 Engineering and Supervision 0.5 4.9 5h Contingencies 7.6 6.1 13.7 Total Cost 3.90 1 Interest during Construction 4.3 - 4.3 Total Financing Required 88.2 45.0 133.2 RFFSA Financing Sources (US$ millions) IBRD 46.0 Bilateral Lenders 26.7 Brazilian Government 60.5 Total 133.2 Procurement MBR: As shown above. RFFSA: US$6 million will be used to purchase equipment (excluding locomotives) under international conmpti- tive bidding. Retroactive financing: (US$100,000) for consulting services. Under both loans Brazilian manufacturers of equipment and materials will be given a 15 percent margin of preference which may result in some local expenditure financing; perhaps US$7 million in the case of IMBR; perhaps US$23 million in the case of RFFSA. 10 N 15 MM1 tons/yr. tons/yr. Combined Internal Economic Rate of Return 18.3% 22.8% MBR Internal Financial Rate of Return 18.8Z 24.5% RFFSA Internal Financial Rate of Return 11.1% 11.8 Estimated Projects Completion Date: October 1973 4I0 BRAZILB RA BRZL ELO HORIZONTE( O VVITORIA * RIO DE JANEIROITBR SAO PAULO AGUAS CLARASITBR BELO HORIZONTE N )VA ERA 2* RUMA lNHO,. STATE TUBARAO ITA8IRITO , . OF VTO I M BURIER ESPIRITO SANTO SEE MAP 2 JOAQUIM MURTINHO CONS. LAFAIETE STATE OF MINAS GERAIS BARBACENA Legend -s+++++++++++++N-+++EXISTING RAILROADS ++........ PROPOSED RAILROADS ANDRELANDIA JEXISTING HIGHWAYS STATE CAMPOS - - - - - - - PROPOSED HIGHWAYS ORE EVACUATION OF ROUTE 22- TRES RIos RIO DE JANEIRO ARRAO GPIRAlL . -APERI ITAGUA SITAZZURUCA - MANGARA 18A N BRAZIL GRA o 5 AP3 RO0 DE JANEIRO MINERAC6ES BRASILEIRAS REUNIDAS S.A. / MAP 35W/E OF GUANABARA A U SCA A R JC STATE OF SAO PAULO SEPETIBA TERMINAL A U SCA A R JC S40 PAULO ,^GENERAL LOCATION 0 50 100 150 - ~ATLANTIC OCEAN - 0-910MILES 152020 0 50 100 150 200 250 SANTOS KILOMETER APRIL 1971 IBRD 3295R JABOTICATUBAS BRAZIL 1 [TABIRA MINERACOES BRASILEIRAS REUNIDAS SA. TA AGUAS CLARAS PROJECT ORE DEPOSITS IN THE IRON QUADRANGLE ESPASIANO PICO MER OPERATIONS ROCAS NO 0 TWNSSANTA LUZIA GRANDES aERA . VILLAGES * OPERATING MINES O OTHER MINES MONLEVADE IRON ORE DEPOSITS LAGOONS & DAMS CONTAGEM CAET BELO-0 SABARA AT ROADS HORIZONTE RAILRODS ogoRIO PIR ACICABA RAILROADS +++++++++++ PROPOSED RAILROADS BETM A BARBARA 0 5 ID 5 0 ~ SO *BARREIRO OV IA RAPOSOS DAAENT 0 5 10 15 20 25 50 AUSLRS COCAIS Kilometers IBIRITE MUTUCA COSIA S 5 10 20 30 LACERDA Miles RIO ACIMA 11 JAGD GANDARELA CARACA TEJUCO H |ABOBORA MiI. MACAPA 4 BELEM BaLTIMORE 4873 MILES ITABIRITO% ROTTERDAM 530B MILES OEDA 0a RAUAPA M,NAS MARIANA GERAS BEOVAL ORULMBA BELO H RIZONTE a + + RCONGONHA 0 500 1000 1500 JACEA99 MilesJOAQUIM MURTINHO APR l 19 71 IBRD 3296R I *ITO BELO HORIZONTE 44' 0& AGUAS CLARAS 43 30' L.g.nd O - JAPERI RAILROADS (SINGLE TRACK) N V RAILROADS (MULTIPLE TRACK) SAO PAULA ++ +++ RAILROADS PROPOSED ZONE (URBAN AREA) ------ STATE BOUNDARIES QUEIMADOS HIGHWAYS 1 AUSTIN DR-2 REPRTSA DO SEPTI T -22.45' RIBEIRAO DAS LAJES BELFORT224 - ROXO NOVAIGUACU G UAINAAR A STPATE F RIO 1 DRE J NEIR ILHA DO G ERIN GR ," OEOOORO ITA/A 'eo. BANGO V IL (TRANSMISSION UNE C OTERALA CAMPO GRANDE "ELECTRIC SANTA CRUZ RAIA mURIQUI/ GRAND E IT RUCA LHA MADEIR SITE OF FUTURE RIO DE JANEIRO INDU5TRIAL S TA TE OF G U A NA 8 A RA ILHA DE TCURUCA AREA M GARATIBA DUAS IR§AS, .0 MARTINS IBICUI I FURTADA SEPETIBA I ~ ~ * S EP ET I BA UAIBINHA PEDRA D23 - -23 8 A Y GUARATIBA o a I GUAIBA , L AGUANUM g ,, MARINE ACCESS 'BAI ROUTE BARRATDE rl RAlAGAAIBA O 110 c MINERACOES BRASILEIRAS REUNIDAS S.A. A T L AN T IC AGUAS CLARAS PROJECT 05 10 15 0 5 10 4*3-230' LOCATION OF SEPETIBA TERMINAL > A PRI L 1971 IBRD 3297R