RESTRICTEDReport No. TON: Ap-7

Report No. 6772-TON

This Report has been prepared forASIAN DEVELOPMENT BANK the exclusive use of the Bank.

A P P R A I SA L

OF THE

THIRD MULTIPROJECT

AND

TONGA DEVELOPMENT BANK PROJECT

IN

TONGA

May 1986

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CURRENCY E UIVALENTS(As of 30 April 1986)

Currency Unit X Pa'anga (T$) - 100 Seneti

T$1.00 o US$0.7415

US$1.00 T$1.3486

The Pa'anga is tied to the value of the Australian dollar.For the purposes of calculation in this Report, an exchange rate ofT$1.0 - US$0.71 has been used which was the rate prevailing at thetime of the appraisal mission's visit.

ABBREVIATIONS

ADAB - Australian Development Assistance BureauBOT - Bank of TongaCFTC - Commonwealth Fund for Technical

Cooperati.-aCPD - Central Planning DepartmentDP4 - Fourth Five-Year Development PlanDP5 - Fifth Five-Year Development PlanEEC - European Economic CommunityFAO - Food and Agriculture OrganizationGDP - Gross Domestic ProductHF - High FrequencyHWD - Harbours and Wharves Department (within MOF)ILO - International Labor Organization1MO - International Maritime OrganizationIPU - Industrial Promotion UnitJICA - Japanese International Cooperation AgencyNLCI - Ministry of Labour, Commerce & IndustriesMOF - Ministry of FinanceMOW - Ministry of WorksPCC - Project Coordination CommitteeRDF - Rural Development FundRDU - Rural Development UnitSIC - Small Industries CentreSPARTECA - South Pacific Regional Trade and

Economic Cooperation AgreementSPF - Small Project FundTDB - Tonga Development BankTTC - Tonga Telecommunications CommissionTTD - Telegraphs and Telephones DepartmentUNDAT - lnited Nations Development Advisory TeamUNDP - United Nations Development ProgrammeVHF - Very High Frequency

NOTES

In this Report, $ refers to US dollars.

The fiCcal year of thc Government ends on 30 June, and thatof the Tonga Development Bank on 31 December.

PROJECT FOCUS, DESI.N AND RATIONALE

Tongs's main natural resources are agriculture, forestry andfisheries. The Government is attempting to develop these resoarcesthrough selective investment in infrastructure and provisien ofincentives to encourage diversification of agriculture and develomentof manufacturing. The economic development of the country is,however, constrained by its location and its physical and demographiccharacteristics: (i) it is far from the centacs of world trade andindustry; (ii) its land area is fragmented by its archipelagicconfiguration; (ili) the population is dispersed; &nd (lv) the mallsize of the domestic market -- which is scattered -- makes itdifficult to attain economits of scale. The preparation of the FifthFive-Year Development Plan (DP5), covering the period FY1985/86 to FT1989/90, has been delaye4 and it has not yet been finalized. However,the Plan is expected to emphasize the same areas as the previous planby giving the highest priority to agriculture and flsheries followedby industry, transport and communications and social services. Animportant objective of the Plan Is to promote balanced regionaldevelopment by encouraging development of islands outside the mainisland of Tongatapu.

In line with the above obJectives, the Government hasidentified a number of small, high-priority projects in the Industrialand transport and coummnications sectors and has requested Bankassistance to support these projects; in addition, the Government hasrequested a line of credit for Tonga Davelopment Bank to supportgeneral development of the economy. The mall projects have all beenselected to support development of industry, regional development anddevelopment of agriculture; the lina of credit will similarly supportdevelopment of industry and agriculture. In view of the asmll size ofthe individual projects, the multiproject lending modality isconsidered to be the most suitable method of preparing andimplomenting these projects. To further simplify processing of theloan, the multiprojeet loan (the Multiproject) and the line of creditto Tonga Development Bank (the Line of Credit), have been combinedinto one set of loan documents (the Project).

The Multiproject covers: (i) expansion of the existingSmall Industries Centre (SIC) on the main island of Tongatapu; (il)establishment of a new SIC on the northern island group of Vava'u tocater mainly to small-scale service Industries w?iich serve the localmarket, (iii) improvement of Nafanue Harbour on 'Eu Island; (iv)contructlon of about 20 km of agricultural access roads on 'ZusIsland; (v) upgrading telecomunications services between the capitalcity of Nuku'alofa and 'Rua Islands together with provision of localtelephone services on the Island; and (vi) Improvement of about 30 kmof rural roads on the main Island of Tongatapu. The Project alsoincludes technical assistance for: (i) undertaking detailedpreparation of the subprojects to be financed under the Multiprojsct;(il) providing Institutional strengthening to selected ImplementingAgencies; (ill) providing appropriate expertise to advise theGovernmnt on review of interest rate policies; and (iv) contributingto the further institution building of Tongs Development Bank.

The total cost of the Multiproject Is estimated at $2.52million, of which the foreign exchange cost is estimted at $2.00millio and the local currency cost at $0.S2 million equivalent. Itis proposed that the Bank provide a isan of $2.0 million equivalentfrom the Special Funds resources - representing about 79 per cent ofthe total cost of the Multiproject - to finance all of the foreignexchange costs, Including the service charge on the Bank loan duringconstruction, and to provide an additional loan of $1.0 millionequivalent from the Special Funds resources for the Line of Creditwhich the Government will re-lend to Tonga Development Bank foronlending to subprojects that meat appropriate development criteria.

The Executing Agency for the Multiproject will be theMinLotry of Finance and the Secretary for Finance will serve asProject Coordinator for the Multiproject. The Project Coordinatorwill coordinate the preparation and presentation of the appraisalreports for ach of the subprojects to be financed under theMultiproject and will supervise the channelling of funds to thevarious Implementing Agencies which will be responsible for theimplemanattion and execution of the Individual subprojects.

The facilities to be financed under the Multiproject willencourage expansion of the industrial sector, support development of

Eua Island (particularly of the agricultural sector) and will 4 nproveaccess to the rural areas of Tongatapu. Provision has also been madein the Terms of Reference for consultants to ensure that adequateenvironmental protection measures are included In the design andimplementation of each subproject. The subprojects are not expectedto adversely affect women, and the Small Industries Centressubprojects will increase female employmnt.

The major risk in the Multiproject is that implementation ofsubprojects may be delayed. To minimize this risk, the Goverment hasinitiated action to repossess the site required for establishment ofthe SIC on Vava'u, and technical assistance is being provided toassist the various Implementing Agencies in preparing the subprojectappraisal reports and in providing construction supervision forimprovement of Nafanua Harbour.

(i)

TABLE OF CONTENTSPa8e

Map - Location of Project Facilities (i'i)

Proposed Agricultural Access Roads,'Eua Island (iv)

Proposed Five-Year Road Improvement Prooram,Tongatapu Island (v)

I. INTRODUCTION 1

II. BACKGROUND 2

A. General 2B. Rural and Regional Development 3C. Agriculture, Forestry and Fisheries 3D. Industry 5E. Transport and Communications 6F. Tourism 11G. Finance 11H. Construction and Consulting Industry 12I. Need for Further Investment 13

PART A: THE MULTIPROJECT WAN 17

III. THE PROPOSED MULTIPROJECT 17

A. Objectives and Scope 17B. Description of Subprojects 18C. Cost Estimates 20D. Financing Plan 23

1V. PROJECT IMPLEMENTATION 24

A. Executing Agency and Project Coordination 24B. Implementing Agencies 25C. Procurement 27D. Design, Construction Supervision and

Other Consulting Services 29E. Implewentation Status of Previous Bank Projects 30F. Implementation Schedule 31G. Land Acquisition 31H. Operation and Maintenance 32I. Reports, Accounts and Audit 33J. Project Benefit Monitoring and Evaluation 33K. Considerations Concerning the Environment

and Women 34L. Project Administration 34

V. TECHNICAL ASSISTANCE 35

VI. JUSTIFICATION AND BENEFITS 37

A. General 37B. Financial/Economic Evaluation 37C. Risks 38

(ii)

PART B: THE LINE OF CREDIT TOTONGA DEVELOPMENT BANK 39

VII. THE PROPOSED LINE OF CREDIT 39

A. Objective and Scope 33B. Tha Proposed Loan 39C. The Proposed Technical Assistance 42D. Benefits and Risks 44

VIII. THE EXECUTING AGENCY 45

A. Organization and Management 45

1. History, Legal Framework, Share Capitaland Relationship with the Government 45

2. Board of Directors, Organixationand Management 45

3. Staff and Training 47

B. Operations 48

1. Activities 482. Policies 493. Procedures 494. Operational Performance 505. Projected Operational Performance 52

C. Accounting, Audit and Financial Controls 52

D. Financial Performance 54

1. Interest Rate Structure 542. Past and Current Perfonmance 543. Portfolio Management 564. Projected Financial Performance

and Resource Position 58

E. Implementation of Previous Bank Loansand Technical Assistance 60

IX. CONCLUSIONS AND RECOMMENDATIONS 63

APPENDIXES 66

Niaa&o 1140

160 Njua Toputep,. 160

ftm"| LOCATION OF PROJECT FACILITIES

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LOCATION MAP

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VAVAU G GROUP VaauHungo PanI/moiu

Late NoapWu ttape

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Totua FoaIAVAPAI GRROUP LJ(utea

Nomuba Lim

Falcon Nomuete NoepWu ttap

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Tongatapu

TON HGATAPU GROUP L

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[220 -22

Ago 1760 17401 2A-MM-e _-

(Iv)

PROPOSEDAGRICULTURAL ACCESS ROADS

'EUA ISLAND

rFoumao 1 2 3 4 /

KtlonuiterS (

Natanua Harbour

Sno~~nua

TufuvAiU

_lua Settlnemnt

Kten ni ilorOt.ry Road(Apprormate Position)

LEGEND;

AgrIculturdi Road------ Construction 3rd Multi

Prolect Loan

Settiements HaWlu

a...|j Sultable tor food ando cash crop

|Suitabe for coconut

I 7 5 dZOW 17500

1W

PROPOSED FIVE YEAR ROAD IMPROVEMENT PROGRMMETONGATAPU ISLAND

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LEGEND: /f% {

'oad uA f_ > Roods tontollvely propO#ed for funding under the 3rd Muni Project Lown\ tArr . To First Cost (P°riame) S4W ( \ / tFuso 1 2 .0

... , .. To Second Coat (Slurry) S-48 \\0 1 2 3 4 s ^

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I. INTRODUCTION

1. The Government of Tonga has requested Bank assistance tofinance a package of small projects of high priority and to provide aline of credit to Tonga Development Bank (TDB). These small projects,which are to be financed as subprojects under the Multiproject Loan,include expansion of an establi3hed Small Industries Centre (SIC),establishment of a new SIC, improvement of harbor facilities,construction of agricultural access roads, upgrading telecommunicationsfacilities, and improvement of rural roads. The Government's request fora Multiproject and Development Bank loan (the Project) Is Igns1.stentwith the Bank's approach to operations in the South Pacific.-

2. The Project was formulated during the visit of a Fact-Findingmission to Tonga fielded by the Bank's South Pacific Regional Office(SPRO) in June 1985. Two appraisal missions finalized the Project;the first, comprising M. Davey (Financial Analyst, Mission Leader), R.E. Bares (Senior Counsel) and J. Z. Mejia (Senior Assistant)visited Tonga from 13 to 29 January to appraise the line of credit forTDB; the second, comprising Ian G. Heggie (Senior Sector PlanningSpecialist, Mission Leader), R. E. Bares (Senior Counsel), H.J. Youn (Senior Economist) and M. G. Hunter (Staff Consultant)visited Tonga from 27 January to 13 February 1986 to appraise theMultiproject. This Report contains the findings of both Missions;the findings are based on discussions in the field with theGovernment and non-Government agencies concerned, on a review of allrelevant documents and, in the case of the Multiproject, on a visit toall subproject sites. Chapters I and II are common to both parts ofthe loan; Part A (Chapters III to VI) describes the Multiproject,while Part B (Chapters VII and VIII) describes the line of credit toTDB. The final Chapter on Conclusions and Recommendations is commonto both parts of the Project.

1/ Doc. R157-78, A Review of Bank Operations in the South PacificDeveloping Member Countries, dated 14 December 1978; Doc. R39-83,Revision 1, A Review of Bank Operations in the South PacificDeveloping Member Countries, dated 19 October 1983; and Doc. SecM93-83, Addendum 1, South Pacific Regional Office, dated 28December 1983.

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11. BACKGROUND

A. General

3. The Kingdom of Tonga, with a total land area of about 750 sqkm, comprises 171 islands, of which 37 are Inhabited. The 1'ulk of thepopulation lives in three maln Island groups - Tongatapu, Vava'u andHa'apai which are scattered over roughly 360,000 sq km of territorialsea. The total population of Tonga is about 96,500 and has beengrowing at 0.9 per cent a year; 66,000 people live on the mainTongatapu group; 9,000 live on the scattered arebipelagic Ha'apaigroup; and 15,000 live on the northerly Tongan group of Vava'u. Theremaindey, live on 'Eua Island (4,000) and on the Niuas group(2,500).- The population is predominantly rural; only 33 per cent ofthe population is classified as urban.

4i. Tonga is predominantly an agricultural country with alarge subsistence sector and is economically dependent on agriculturalexports: coconut, coconut products, bananas and vanilla are majorsources of cash income and foreign exchange earnings. The country'sforest resources are largely undeveloped and timber and wood productsare lmported to meet local needs. The fishing industry isunderdeveloped -- concentrating on reef fishaing -- and is geared tosubsistence needs. Efforts have been made to diversify the economy byencouraging establishment of secondary industries, by an industrialdevelopment incentives policy and by establishment of small industriescenters. New industrial opportunitie. are also opening up inIndustries such as vanilla processing and the milling of senilecoconut trees for structural timber.

5. The economic development of Tonga is constrained by itslocation, and its physical and demographic characteristics: (i) it isfar from the centers of world trade and industry; (ii) its land areais fragmented by its archipelagic configuration; (i) the populationis dispersed; and (iv) the small size of the domestic market -which is scattered -- makes it difficult to attain economies of scale.

6. The preparation of the Fifth Five-Year Development Plan(DP5), covering the period FY1985/86 to FY1989/90, has been delayed.However, the Plan is expected to continue with the same emphasis asthe previous plan by giving the highest priority to agriculture andfisheries followed by transport and communications, and socialservices. An important objective of the Plan is to promote balancedregional development by encouraging development of islands outsidethe main island of Tongatapu which is already reasonablywell-developed. Most development expenditure is financed throughexternal aid. New Zealand and Australia are major sources ofbilateral aid, with the Federal Republic of Germany assumingincreasing importance. The major multilateral aid sources are theEuropean Economic Community (EEC) and the Bank. Tonga has recentlybecome a member of the World Bank and funds from this source maybecome important in future.

I/ As recorded in the 1984 Mini-census.

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B. Rural and Regional Development

7. The Fourth Five-Year Development Plan (DP4), FY1980/81 toFY1984/85, marked the beginning of the Government's active involvementin rural and regional development. The aim of the Government'sefforts is to more actively involve the outer island regions and ruralareas outside Tongatapu in the development process by integrating andcoordinating the separate development efforts of all gov'r7mentdepartments. To this end, a Rural Development Unit (RDU)- wasestablished within the Central Planning Department to manage andadminister all rural and regional development activities. The RDUsupports its programs through a Rural Development Fund (RDF) and aSmall Project Fund (SPF). RDF assistance is for projects whichdirectly generate income, but are of an innovative, high-risk nature;SPF assistance Is for proje'ets of a social nature which meetcommunity needs, but do not generate income (e.g., village watersupply schemes, agricultural roads, etc.). Between June 1979 and theend of 1985, 312 proqcts valued at $1.31 million received assistanceunder these schemes.-

8. The Government's regional development program initiallyconcentrated on Vava'u, and a number of the projects identified aspart of this inis?l effort were funded under the Bank's secondMultiproject Loan.- In December 1981 a Regional Planning Workshopwas held on 'Eua Island and the Central Planning Department followedthis up by preparing an Integrated Regional Development Program for'E.ua Island. Further assistance was provided in 1982 when the UnitedNations Development Advisory Team (ITNDAT) conducted a study ofIsland and prepared a report entitled "Development of 'Eua Island-which recommended a framework for developing agriculture. SimilarRegional Development Programs have been prepared for Ha'apai, Vava'uand the Niuas.

C. Agriculture, Forestry and Fisheries

9. Agriculture, forestry and fisheries accounted for 42.0 percent of GDP in 1985; agriculture accounted for 33.0 per cent, forestryfor 1.7 per cent, and fisheries for 7.3 per cent. The sector grew ata real rate of 11.4 per cent per annum between FY1974/75 andFY1983/84, with the fisheries subsector growing faster thanagriculture and forestry. The rapid growth of fisheries appears to beattributable to the high level of investment in this subsector.

I/ Established with support from ILO and UNDP.2/ About $0.39 million was made available through RDF and $0.92

million through SPF.3/ Multiproject II, Loan 540-TON(SF)p approved in 1Iovember 1981. The

Project included: (i) vanilla development; (ii) a tourist andhandicraft center; (Wii) health centers; (iv) road construction;and (v) fish marketing, processing and storage.

4/ Published In 1983.

4

10. The Tongan economy is heavily dependent onsubsistence agriculture; it is estimated that about 70 per cent of thepopulation depends primarily on it for its livelihood. The country'sfertile soils and conducive climate offer potential forsubstantially increasing agricultural output, Approximately 90 percent of the value of total crop production (fruit and vegetables) isconsumed locally while the remainder is exported. Exports droppedsharply in FY1982/83 as a result of the cyclone in March 1982 whichwas followed by the worst drought in Tonga in over 40 years. Theexport of coconut and coconut products was badly affected and a largenumber of trees were damaged or blown down. In spite of this, therehas been encouraging progress in agricultural diversification with theproduction and export of vanilla, which is intercropped withcoconut, and the production and export of vegetables assumingincreasing importance. A Coconut Replanting Scheme is beingprepart? to renew senile palms and a Banana Export RevitalizationScheme- has been commenced to, inter alsa, remedy the damage done bythe 1982 cyclone. The reforms to land leasing contained in theFY1983/84 Budget will also remove an important constraint tocomercial agricultural development: a person can now leas/ up to tenrural tax allotments on 20-year leases at negotiated rents.-

I1. The forestry industry is still small and relativelyundeveloped; the Government's long-term aim is to achieveself-sufficiency in sawn timber. Present timber production isinsuffici¶t for domestic needs and substantial imports arerequired.- The only milling of native hardwoods occurs on 'EuaIsland; unexploited reserves exist in Ha'apai and Vava'u. Trial treeplanting is being carried out on 'Eua Island and initial results arepromising. It has been estimat2d that 600,000 senile coconut palms,capable of producing 100,000 cubic meters of sawn timber., wereavailable for milling during DP4. The timber from these trees isbeing used for construction purposes and it is hoped that otheruses -- including production of joinery items -- will develop in duecourse.

12. Fisheries contributed between 4 and 5 per cent of GDPuntil FY1978/79; this then rose to about 11 per cent where it hasremained ever since. Although Tongs has substantial fisheryresources, it is not self-sufficient, and imports of tinned fish andfish products amounted to $620,000 in 1982. There are three malnfishery areas: the inner reef area, the outer reef and deep waterslopes, and the deep sea area. About 80 per cent of the present catch(roughly 1,200 tons per annum) is caught in the inner reef area, andthis could be increased by about 1,000 tons per apum. In the outerreef and deep water slope areas, it is estimated- that about 1,000

1/ The program is being supported under New Zealand bilateral aid inan amount of $3.6 million over five years.

2/ No more than five allotments could proviously be held on 10-yearleases at a fixed annual rental of $8.00.

3/ Domestic sawn timber production in 1983 was about 1,500 cubicmeters; a further 6,000 cubic meters was imported.

4/ Estimated in an FAO/UNDP Marine Resources Development Reportprepared In FY1976/77.

5

tons of bottom fish could be cauglht each year, together with 2,000tons of seasonal species like skipjack and yellowfin tuna. The majorpotential lfs in the deep sea area where the minimum potential catchof albacore- and yellowfin tuna is estimated at 4,600 tons per annum;in addition, the potential seasonal catch of skipjack is estimated tobe at least 10,000 tons per annum. There is thus good potential forself-sufficiency in the fisheries sector and, in the longer term, fordeveloping exports. The Government operates a modern long-linefishing vessel (acquired in 1982) which is currently covering itsoperating costs; the Government is also considering licensing foreignfishing vessels to operate in Tonga's economic zone. However, themain thrust of Government policy is to develop an effective fleet ofsmall (9 to 12 meter) fishing vessels. This is being encouraged byprovision of a grant/loan scheme for construction of small fishingvessels, establishment of fisheries demonstration projects, provisionof training to fishermen and improvement of fish handling, storageand marketing facilities.

D. IndustEy

13. The industrial sector grew at a reel average annual rate ofover five per cent between FY1980/81 and FY1984/85 and, in FY1984/85accounted tor about eight per cent of GDP. Despite Its relativelymodest contribution to GDP, the industrial sector has contributedincreasingly to employment, domestic savings and foreign exchangeearnings2/and has introduced new technology and helped diversify theeconomy.- The sector is predominantly privately-owned; publicinvolvement is largely confined to the Tonga Commodities Board andthe Oil Mills of Tonga Ltd. A Small Industries Centre (SIC) onTongatapu, supported by the Bank, has been establishad toencourage development of small-scale industrial enterprises.- Inmid-1985, all available factory sheds and nursery units in the SICwere fully occupied, and there were about 12 outstanding applicationsfor space that could not be satisfied. Only three of the remainingserviced plots in the SIC are currently vacant. Total production fromthe SIC during FY1984/85 amounted to about $1.25 million (of whichabout $600,000 was exported) and it employed more than 330 people.

14. The establishment of the SIC was supported by theintroduction in 1978 of an Industrial Development Incentives Actwhich accorded high priority to the development of private industry.This Act promoted investment by local firs and encouraged foreigninvestment which would contribute to the import of capital,technology, managerial know-how and would provide better access to

1/ A large pelagic tuna used for canning.2/ In 1984 industrial enterprises (including agro-industry) employed

more than 1,000 persons and produced output valued at $9 million.3/ The SIC was established with Bank assistance under Loan No.

335-TON(SF) approved in December 1977 and expanded under Loan No.435-TON(SF) approved in December 1979 and Loan No. 540-TON(SF)approved in November 1981. The SIC occupies a 20-acre site, butonly 12 acres have been developed. The local and foreign-ownedenterprises occupying the SIC are producing a variety of goods,including textiles, paints, sporting goods, tubular furniture,wooden toys, meta.. fabricated Items, etc.

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overseas markets. Some of the major components of the Act were: (i)five-year income tax holidays; (ii) two-year duty-free importation ofplant and equipment; (iII) reimbursement of duty paid on importodraw materials or products re-exported after processing; and (iv)repatriation of profits, capital and capital gains. The effectivenessof the Industrial Development Incentives Act is currently beingreviewed by a consultant supported under technical assistanceprovided by the Commonwealth Secretariat.

15. Implementation of the Industrial Development Incentives Actis handled by an Industrial Promotion Unit (IPU) within the Ministryof Labour, Commerce and Industries (MLCI). The IPU fpnsists of anAssistant Secretary, an Industrial Promotion Officer,- an AssistantIndustrial Promotion Officer and a Senior Executive Officer. The IPUaugments MLCI's general promotional efforts in helping to attract andset up new industries and follows up projects already licensed underthe Industrial Development Incentives Act. The IPU also providesbusiness counselling services, and helps to identify prospective newindustries and evaluate their suitability. The IPU is adequatelystaffed and fully competent to undertake these tasks. TDB providesfinancial support to assist development of the industrial sector, andthe South Pacific Regional Trade and Economic Cooperation Agreement(SPARTECA) also facilitates development of manufacturing industry byoffering various tariff preferences to Tongan goods in New Zealand andAustralia.

16. The Government's major objectives for industrial developmentare to: (i) accelerate industrial growth in order to raise output,employment, foreign exchange earnings and to reduce dependence onimports; (ii) establish viable industries utilizing local resourcesto maximize domestic value-added; (iii) promote complementary economicactivities essential to and supportive of local industry; and (iv)ensure to the extent possible balanced regional development ofmanufacturing, processing and assembly industries throughout thecountry. The Government is favorably disposed towards theestablishment of industry by foreign entrepreneurs, but joint venturesare preferred.

E. Transport & Communications

1. Roads and Road Transport

17. There are 332 km of formed roads in Tonga and over 1,400 kmof earth tracks; nearly 204 km of formed road are on Tongatapu, 83km are on Vava'u, 31 km are on 'Eua Island, 10 km are on Ha'apaiand 4 km are on the Niuas. About 155 km of road are classed as mainroads which link villages and towns; of this, 52 km have a bitumensurface, while the remainder have a crushed coral surface. Inaddition, there are 40 km of sealed secondary and town roads. Theremaining roads generally link the main roads to groups of rural taxallotments and are all unsealed secondary roads with cotal or earth

1/ The current incumbent is an expatriate supported by theCommonwealth Secretariat.

7

surfaces. The number of registered vehicles at the end of 1983 wasroughly 3,000, and the vehicle fleet has been growing at an averageannual rate of about eight per cent since 1975; the vehicle fleetincluded, among other things, about 450 cars, 340 motorcycles and1,350 trucks and buses. Annual surveys of road traffic carried out bythe Ministry of Works (MOW) on Tongatapu suggest that traffic grew atover 13 per cent per annum between 1979 and 1984.

18. The Ministry ofjorks is responsible for the constructionand maintenance of roads.- The main aims of the Government's roaddevelopment program are to: (i) upgrade and maintain the existingnetwork of main roads at a suitable standard; (11) improve drainageto arrest deterioration; (iii) improve the extensive network ofagricultural roads which link groups of individual rural taxallotments to the main road network; and (iv) support development of aviable and competitive road transport ixestry. The roadconstruction program is financed entirely- through externalassistance (grants and soft loans). DP5 includes a five-year roaddevelopment program involving road improvements amounting to a totalof $6.4 million. Most of this expenditure is concentrated onTongatapu ($4.24 million), followed by Vsva'u ($1.02 million),Ha'apai ($668,000), 'Eua Island ($323,000) and the Niuas ($758,000);about $5.4 million has been allocated for improvement of rural roads.The maintenance program is financed under the Government's recurrentbudget and the annual amount spent on road maintenance -- roughly$400,000 in FY1983/84 3T is sufficient to maintain the road network toan adequate standard.- It is estimated that in FY1983/84, road usercharges in the form of fuel sales taxes, vehicle licenses andregistration fees covered about a third of the roadmaintenance program. The Government is currently reviewing thesecharges with a view to raising more revenue from road users;fuel taxes have recently been raised and license fees have beenincreased, but the new rates are not -et effective (see para 84).

2. Ports and Shipping

19. Nuku'alofa, on Tongatapu, Is the country's maininternational port. During 1984, it handled 183 internationalvessels; imports through the port totalled about 63,000 tons, exportsabout 17,000 tons and 25,000 transit passengers from B cruise shipsused the port. The Queen Salote Wharf project- Is naaring

1/ The Bank provided TA 109-TON, Road Improvement and MaintenanceStudy, approved In May 1974 to strengthen the road sector inTonga and to prepare high-priority projects for possibleconsideration by external funding agencies. Some of the roadsidentified by this technical assistance study were financedunder the First Multiproject Loan, Loan No. 435-TON(SF), approvedin December 1979.

2/ Apart from Government counterpart funding.3/ The average amount allocated per km of formed road Is $860. This

is sufficient under Tongan conditions to maintain the roads toan adequate standard. In practice, road aintenance fundsare sometimes diverted and used for other purposes.

4/ Financed under Australian bilateral aid.

8

completion and will provide two deepwater international berths, aninterisland berth and a loading/unloading ramp; the project alsoincludes provision of ancillary facilities and improved cargo handlingequipment, particularly for containers. The fishing harbor of Fau'a,which is adjacent to the Queen Salote Wharf, is being constructed withassistance from the EEC, while extensive Zoreshore protection works inNuku'alofa are being financed under German bilateral aid. Neiafu onVava'u already has a deepwater harbor; the port has recently beenupgraded with assistance from the EEC and can handle small- to medium-sized container vessdla and large international cruise ships cananchor in the approach channel. Tonga's remaining ports handleinterisland vessels and act as transshipment ports for the smalloutlying islands. Pangai is being developed as the main port in theHa'apai group and it is also being used as the main transshipmentpoint for tha northern Ha'apai islands. Nuku'alofa acts as the 17aintransshipment point for the islands of Nomuka, Ha'afeva and 'Eua.-

20. Tongan ports are administered by the Ministry of Finance(MOF), through its Harbours and Wharves Department (HWD). TheGovernment's development objectives for the sector are to: (i)provide regular, efficient and safe cargo and passenger transport,both internationally and locally; (ii) provide efficient, speedy andeconomic handling of cargo; (iii) ensure adequate shipping servicesand onshore facilities in outer islands to encourage development;and (iv) provide necessary land and facilities for storing andhandling cargo in close proximity to wharves. The Controller ofCustoms is responsible for all of the charges specified under theHarbours Act and the Wharves Act and also for the administration ofboth Acts. Port construction and maintenance are under thejurisdiction of MOW and, although the Prime Minister is concurrentlythe Minister of Marine and is responsible for all fpipping matters,there is no Ministry of Marine. A previous study- suggested thatthe organizations dealing with the marine sector needed to berationalized and that consideration should be given to establishing asemi autonomous Ports Authority. The Government has proposed insteadthat a Marine Department be established -- headed by a Director ofMarine -- to take over responsibility for administering all port andshipping matters. This proposal is still under active consideratiol,and an adviser from the International Maritime Organization (IMO)-is helping to define the responsibilities of the new Department. TheIMO adviser is also reviewing and upgrading the maritime legislationunder the jurisdiction of the Minister of Marine.

1/ The Bank's First Multiproject Loan, Loan No. 435-TON(SF),included improvement of Nuku'alofa Landing Ramp, Ha'apai Wharf,and improvement of Niuatoputapu Wharf and Niuafolou Landing Rampin the Niuas.

2/ Financed under Australian technical assistance and carried out in1979/80.

3/ Financed under Norwegian bilateral aid, with UNDP as theexecuting agency.

9

21. At least seven major shipping lines providi1 internationalservices to Nuku'alofa (including container services);- olie of these- the Warner Pacific Line -- also provides an internatienal serviceto Neiafu. Major domestic services operate between Nuku'alofa and theregional ports of Pangai, Neiafu (including a weekly containerservice), Ha'afeva, Nomuka, and Nafanua (on 'Eua Island), *hile lessfrequent services operate to the Niuas. Small boat services operatebetween these ports and the smaller outer islands. The public sectoris a major participant in both international and domestic shippilservices. The Government is a shareholder of the Pacific Forum Line-and charters a Tongan vessel, the Fua Kavenga, out to the line. TheGovernment also operates inter island services through the ShippingCorporation of Polynesia - 60 per cent is owned by the Government and40 per cent by Columbus Line -- in competition with private operatorswhich currently provide all other interisland services.

3. Telecommunications

22. Telecommunications services in Tonga are provided by theTonga Telecommunications Commission (TTC) which was established as apublic corporation in December 1983 and began operations in July 1984.Prior to that, telecommunications services were provided by theTelegraphs and Telephones Department (TTD) which was a governmentdepartment. TTC acts as the licensing authority and discharges thisfunction on behalf of the Prime Minister's Office under regulationspromulgated by that Office. TTC is charged with operating, maintainingand developing the domestic telecommunications system in an efficientand profitable manner. International telecommunications services(both telephone and telex) are provided through a satellite ear5station located in Nuku'alofa and operated by Cable and Wireless.-The telecommunications services connecting Tongatapu with Ha'apai andVava'u are currently provided by a five-channel ultra high frequencyradio link and a four-channel high frequency (HF) sideband radio linkrespectively. The capacity of these links is limited and service ispoor. To improve the service, the Government has recently signed anagreement with Cable and Wireless u¶ er which the Company will installa tropo-scatter trunk line system- to replace these services. Thesystem has a capacity of 48 circuits (there are two voice channels per

1/ They include Bali Hai Service (to/from Japan), Bank Line (to/fromN. W. Europe), Kyawa Shipping Line (to/from S.E. Asia), PacificForum Line (to/from Australasia), South West Pacific ContainersLine (to/from the South Pacific), Star Shipping Associates(to/from Honolulu and the South Pacific) and Warner Pacific Line(to/from Australasia).

2/ The shareholders are the Governments of Cook Islands, Fiji,Kiribati, Nauru, New Zealand, PNG, Solomon Islands, Tonga, Tuvaluand W. Samoa. Australia also makes ad hoc contributions to theline.

3/ A Public Limited Company registered in United Kingdom.47 This system uses microwaves which are scattered by the

troposphere (the lower portion of the atmosphere) and amplifiedat the receiving end. The normal microwave system involvesdirect transmission from one antenn to another.

10

circuit) and 24 are initially being dedicated to the Vava'u servicesand 12 to the Ha'apai service. One voice circuit -- equivalent to 24teleprinter circuits -- will be leased to provide teleprinter/telexservices to Vava'u.

23. The telecommunic,ptions network is well-developed on themain island of Tongatapu,- but services on the other islands aregenerally poor. Tongatapu has three automatic telephone exchanges witha capacity of 2,000 lines; Neiafu on Vava'u has a reconditioned240-line manual exchange which was originally installed inTongatapu in 1954 and later transferred to Neiafu; and Hatapai has a150-line manual exchange. A very high frequency (VHF) radio system isused to connect the main island of Tongatapu to 'Eua Island and HFradio links are used to provide connections to other islands.

24. TTC has been examining ways of improving the nation}transmission network with the assistance of Australian bilateral ald-and a Corporate Plan (FY1984/85-FY1988/89) has now been prepared byTTC to guide its future development. Based on this, the corporationhas prepared a Five-Year development program costing about $2.4million for inclusion in DP5. Preparation of the development programwas accompanied by revision of tariffs and improvements in accountingprocedures. Tariffs are reviewed from time to time and areperiodically adjusted to ensure that the corporation covers its costs(see Appendix 1 for TTC's accounts for its first financial year).

4. Civil Aviation

25. Fua'amotu airport on Tongatapu is Tonga's main internationalairport; in 1984 it accommodated 2,499 aircraft movements (1,412international and 1,087 domestic) and handled 22,874 passengerarrivals and 21,938 departures. The country's second airport onVava'u handled 1,041 aircraft movements in 1984 and 8,970 passengers(1,958 international and 7,012 domestic). Vava'u airport has a coralpavement which has recently been upgraded to give a 1,000-metereffective runway which can handle 40-seater aircraft withoutdifficulty. The airport on Ha'apai has also recently been upgradedand can now handle 20-seater aircraft. The other airfields on 'EuaIsland, Niuatoputapu and Niuafo'ou have relatively short, coral orgrass runways and can only handle small aircraft.

26. Tonga currently relies on neighboring countries forinternational air service. Airlines providing international serviceinclude Air Pacific, Polynesian Airlines, Hawaiian Air and Air NewZealand. There are no direct services to Australia, although several

I/ The Bank financed a Telecommunications Project, Loan No. 146-TON(SF), approved in November 1973, which replaced the Nuku'alofaexchange, relocated the manual exchange from Nuku'alofa toVava'u, provided a manual exchange in Ha'apai and providedhigh-frequency links between Nuku'alofa, Vava'u, Ha'apai and'Eua; a component of the First Multiproject, Loan No. 435-TON(SF),approved in December 1979, improved the link between Nuku'alofaand Vava'u.

2/ A Report, Feasibility of Inter-Island Telecoimunications,financed by the Australian Development Assistance Bureau (ADAB)was prepared in 1980.

11

airlines have requested permission from the Government to fly thissector. The Government recently established Its own airline -Friendly Island Airways. It will initially proy.de domestic servicesand will later expand to international routes.- The airline offersdaily service to Vava'u and 'Eua Island, a twice-weekly service toHa'apai and once-a-week service to Niuatoputapu. A service toNiuato'ou operates every other week.

F. Tourism

27. The tourist industry has been slow to develop and theaverage annual growth in visitor arrivals between FY1980/81 andFY1984/85 was 4.5 per cent. During FY1984/85, 76.5 per cent ofvisitors consisted of passengers and crew from cruise ships. Suchvisitors stay for short periods of time (2-3 days) and spendrelatively little money within the Tongan economy. Visitors arrivingby air during FY1984/85 numbered 13,713 (16.2 per cent of totalvisitors) and stayed for an average of 7.2 nights.

28. A major constraint on the number of tourists visiting Tonga,and hence on the growth of the tourist industry, has been the rigidairfare structure that, until mid-1984, precluded the use of cheappromotional fares. This policy was effectively controlled by themajor in-bound carrier, Air New Zealand. However, changes in themanagement styles of competing airlines such as Air Pacific,Hawaiian Air and Polynesian Airlines have now resulted in a morecompetitive environment. Both Ansett Airways and Trans AustraliaAirlines are currently negotiating for landing rights in Tonga and,with the expected substitution of Boeing 767s for the Boeing 737scurrently used by Air New Zealand, a doubling in the number ofin-bound passenger seats is likely.

29. Tourist facilities in Tonga are relatively scarce andare of uneven quality. There is no accommodation suitable for use bylarge tour groups and the total number of high-st&ndard beds availableis estimated at 384. Suitable investment opportunities exist,particularly in the Vava'u and Ha'apai groups, for the establishmentof small resorts with good tourist class accommodation andrecreational facilities. A small number (6-8) of such resorts wereestablished during FY1984/85 and they bave generally been successful.

C. Finance

30. The financial sector consists primarily of the Bank ofTongs (BOT) and TDB. There are also a number of small credit unionsengaged in small-scale savings and consumer finance operations, buttheir role is negligible. In prospect is the establishment ofa Central Bank. If established, the Central Bank's primary rolewill be to hold the Kingdom's foreign exchange reserves, a functionat present carried out by BOT. Although draft legislation hasbeen prepared to establish the Central Bank, it is unlikely that adecision to proceed with the legislation will be taken during 1986.

17 Piloting and maintenance are carried out by personnel licensed inNew Zealand and the operation of aircraft must comply with NewZealand rules and regulations. Inspectors from the New ZealandCivil Aviation Authority periodically check the operation of theaircraft.

12

31. BOT was established in mid-1974 as the country*s first andonly commercial bank. In addition to providing the normal servicesof a commercial and savings bank, BOT is the holder of the Kingdom'sforeign exchange reserves and performs the role of a monetary authority.At 30 September 1985, the total assets of BOT were T$41.2 million(US$29.4 million equivalent) which represented an increase of 105.0per cent over the level of December 1980. At 30 September 1985, 36.4per cent of BOT's resources were on-lent to the private sector withinTonga; 56.9 per cent were being held as investments and deposits inoverseas financial markets.

32. Interest rate levels within Tonga are controlledunder the Contracts Act of 1921 which sets a maximum interest ratelevel of 10 per cent. Appendix 2 provides details of interest ratescurrently prevailing in Tonga. BOT currently pays between 5.0 percent and 6.75 per cent for deposits and charges between 8.0 per centand 10 per cent for loans. TDB's lending rates range from 6 per centto 10 per cent depending on the loan amount and the nature of thesector receiving thfi loan. A review of Tonga's interest ratestructure during 1984- revealed that since 1970 the interest ratestructure had resulted in negative real rates of return to savers; therates ranged from minus 5.1 per cent to minus 9.35 per cent. Thisfactor is considered to have contributed significantly to the lowsavings rate of about 9.0 per cent of national disposable income; thisresulted in a resource gap for investment that averaged about 10 percent of GDP between FY1980/81 and FY1983/84.

33. The authorities have recognized the problems created bycurrent interest rate policies and are currently considering two areasof draft legislation that might improve matters. The first isamendment of the Contracts Act of 1921 to remove the currentinterest rate ceiling and to provide the Minister of Finance withpowers to establish new interest rate ceilings as required. Thesecond is establishment of a Central Monetary Authority. Under thesecond proposal, the proposed Central Monetary Authority would havepowers to establish minimum and maximum interest rate levels withinthe financial sector. No decision has yet been made as to which ofthese options is preferable; other options may also be consideredbefore a final decision is taken.

H. Construction and Consulting Industry

34. MOW and the Tonga Construction Company (a branch of theGovernment-owned Commodities Board) have been the traditional sourcesof construction services in Tonga; MOW carries out a variety of civilworks activities, while the Tonga Construction Company concentrates onbuilding construction. MOW's resources are limited; it has onequalified engineer (who is Director of Works), no qualified architectsor quantity surveyors and its heavy plant and equipment is onlycapable of undertaking certain types of civil works. The privatesector has developed rapidly in recent years and there are now atleast four small-sized local companies capable of carrying out

1/ Under Bank technical assistance, T.A. No. 510-TON, approved inApril 1983.

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all types of standard building work from construction of houses toindustrial buildings. There is also one fIre which has the capacityto design, fabricate and erect steel-f ra buildings. Thiscompoany, in association wlth another local firm, is currentlynegotiating for the consfjuction of a steel-frame aircraft hanger forFriendly Island Airways.-

35. The Government has decided that in the future moreconstruction work should be undertaken by the private sector and thatMOW should concentrate on maintenance of public facilities and ondesign and construction supervision of civil works projects. TheGovernment wishes to e,youtage private contractors to acquire theirown plant and equlpment,- and to this ead It is proposing to reviseMOW's plant hire rates to set them on a more comercial bais. It isexpected that this will encourage private Investment In theconstruction Industry and will make private contractors morecompetitive with MOW's force account work.

36. There ar several small consulting firms in Tong. The motsignificant of thse has offices in Nuku'alofa and Neiafu and Is staffedby three qualified architects and other Tongan staff trained at LaeUniversity of Teehnology In Papu" New Guinea. The firm has anassociated office in Auckland, New Zealand. The services of structuralenglneers, mechanical/electrical engineers and quantity surveyors areprovided by consultants In New Zealand as required. Their curretworkload includes design and Implementation of school and churchbuildings, as well as the new Prime Minister's Office I Nuku'alofa.

I. Need for Further Investment

37. Only three of the plots in the existing 12 cre SIC site onTongatapu remain vacant for future developmet.- The present"pipeline" of applications for Industrial space at the SIC includesfive applications for Nursery Units and five for Factory Sheds. Apipeline of siuilar enterprises has been identifid by NLCI, but theprima facie v ,bllity of these enterprises Is still being assessed bythe Ministry.- Shortages of nursery/factory space and of servicedplots are becoming a constraint on development of further Industrialenterprises and there is now a need to extend the present 12-acro siteInto the 8-acre reserve and to erect more nursery/factory sheds on theexisting site.

38. The Government Is eager to extend its industrial developmentpolicy to other areas outside the main island of Tongatapu In anattempt to halt the steady drift of population from the outer Islands.During the past four yars, .the Commonwealth Fund for TechnicalCooperation (CFTC) has supported two studies for Identifying the

11 Scan Tonga Engineering Ltd.2/ One private company, Royco, already has a reasonable range of

equipment some of which it leases to NOW.3/ Two others are currently vacant, but are under offer.4/ Applications have been received for repair of marine enIes,

anufacture and printing of handicraft items, manufacture andrpair of shoes, fish processing, manufacture of autombilewheels, mwaufacture of detergent, manufacture of mails,upholstering, maufacture of spectacle cases and frmao, etc.

14

scope for developing new small-scale Industries /In Tonga ingeneral, and In the northern islands in particular.- The studiesidentified four enterprises which prima facie appeared to be suitablefor establishment on Vavalu, which has the second largestconcentration of population In Tonga: (i) a timber treatment plant;(ii) manufacture of wooden furniture; (iii) an automotive repairworkshop; and (iv) manufacture of polythene film and bags. Formalapplications have already been submitted to NLCI for allocation ofindustrial space for repair and assembly of refrigeration units,manufacture of coral jewellery and manufacture of fencing materials.These three projects currently comprise the firm pipeline ofprojects for establishment on Vava'u. Informal expressions ofinterest have also been received concerning soft drink bottling,manufacture of rubber footwear, and frozen fruit juice and pulpextraction. Apart from fruit juice and pulp extraction, all of theseenterprises are aimed at the domestic market. The need on Vava'u isthus for serviced industrial sites and associated workshop/factorybuildings to serve small-scale service industries designed to servethe local market. In due course larger export-oriented industriesmay also wish to establish there.

39. When the SIC in Tongatapu was first established, it wasenvisaged that it would operate on a no-profit no-loss basis and wouldtherefore require no subsidy from the Government. Rental fees werethus initially set at levels that provided for full cost recovery; itwas planned to revise rental fees every five years. However, theoperating costs of the SIC escalated more rapidly than expectedand the SIC has not managed to break even. In 1985 it is expected toincur a net operating loss of about $16.000 (see Appendix 3) andrental fees would need to be raised by about 38 per cent to breakeven. The Bank'j Project Performance Audit Report on the SmallIndustries Centre- recommended more frequent review and adjustment ofrental fees to reduce the subsidy element. There is thus a need toundertake a thorough review of rntal fee policy to identify theoptions available and the time horizon over which the fees might beimplemented to help eliminate these subsidies (see para 83).

40. It is estimated that 'Eua Island has about 4,340 hectares ofland considered arable by traditional methods of cultivation. By theend of 1985, 3,800 hectares had been allocated as rural tax allotmentsand a further 540 hectares were unallocated and were not beingsystematically cultivated. The Island has a limited system of coraland earth roads, a grass airfield and a small harbor at Nafanua. Theharbor is small and can only accommodate small boats, and the entrancechannel, which is exposed to strong westerly winds, is dangerous anddifficult to enter (see Appendix 4 for a description of current portfacilities). The Island is linked to Tongatapu by a small boatservice and daily light aircraft service; there is a single telephone

1/ Action Plans for the getablishement of Small Industries In theNorthern Islands Group, 1982, and Market Survey for Tonga eProcessed AgRcultural Produce, 1913, Comonvalth Fund forTechnical Cooperation.

21 PPAR No. PE-132, circulated to the Board in December, 1984.

15

connected to Tongatapu by a single channel VHF radio link.Agricultural support services are provided by an Agricultural Colle4,(which needs to be upgraded), four agricultural extension off ik.ers,--a small produce market and a branch of TDB. Despite the Island'spotential for development in agriculture, forestry and fisheries andits proximity to the main island of Tongatapu, it has the lowest percapita GDP in Tonga ($260 in FV1981/82 compared to the average GDP of$430).

41. To facilitate development of 'Eua Island, the CentralPlanning Department has prepared an integrated regional developmentprogram for the Island comprising road, Uarbor and telecoumunicationsimprovements; oXtension and upgrading of the existing agriculturalcollege; improvement of agricultural extension services andagricultural marketing facilities; provision of a bulk fuel store;establishment of a handicraft center; and improvement of water andpower supplies. The initial phase of development, which is designedto remove key infrastructure constraints, comprises: (i)improvement of Nafanua Harbour; (ii) provision of additionalagricultural access roads; and (iii) upgrading of telecommunicationsservices. If the agricultural potential of 'Eua lsland is to berealized in terms of more intense utilization of the 3,800 hectaresalready cultivated as well as the additional 540 hectares awaitingallocation at, tax allotments, key infrastructure constraints need tobe removed;- following that, agricultural support services andsupportive social infrastructure facilities need to be upgraded.

42. The Government has prepared a five-year road program (seeparagraph 18) which, among other things, allocates $4.24 million forimprovment of trunk and feeder roads on Tongatapu. However, whilethe roads to be improved have been tentatively identified, there is aneed to review them with a view to establishing investment prioritiesand preparing a phased program for their implementation over thefive-year plan period. Once these priorities have been established,it is expected that New Zealand an.d Australia may support improvementof the main highway and trunk ro d network; the remaining need willthen be to support improvement of reeder roads.

43. TDB supports the Government's development objectives throughprovision of medium- and long-term loans for projects that meet itsinvestment criteria and contribute to the economic development of theKingdom. TDB's approval levels have shown steady growth since 1983and this growth is projected to continue. On the basis of its currentpipeline of loan applications and its assessment of the likelyinvestment needs of its client base, TDB is projecting total loanapprovals of T$8.5 million (US$6.1 million equivalent) duringFY1986/87 and FY1987/88. Of this amount, approximately T$3.8 million(US$2.7 million equivalent) will represent approvals for the purchase

17 There are no fisheries extension officers on the Island.2/ The slngle-channel radio link is largely used for making business

calls associated with the shipment of produce to Tongatapu forexport (e.g. bananas), or for sale in the local market.

16

of imported Items. As of 31 December 1985, TDB had US$1.4 million inforeign exchange resources available for financing such loans,leaving a foreign exchange resource gap of approximately $1.3 millionfor the FY1986/87 and FY1987/88. Since current interest rate policieshave led to a number of difficulties (see para 32), there is a need toundertake a review of these policies to assess the relative costs andbenefits of the present and alternative interest rate regimes with aview to recommending future courses of action (see para 91).

17

PART A: THE MULTIPROJECT LOAN

III. THE PROPOSED MULTIPROJECT

A. Objectives and Scope

44. The Multiproject aims at assisting the Government inundertaking a number of high-priority development projects which areexpected to be included in DP5. Each of the subprojects comprisingthe Multiproject will either by itself or in conjunction with othersubprojects support one or more of the following Governmentobjectives: (1) economic diversification and development ofmanufacturing; (ii) regional development, particularly the developmentof islands outside of Tongatapu; and (iii) development of agricultureand forestry. In this context, the considerations governing theselection of the subprojects included the following:

(i) the subproject should be accorded high priority by theGovernment and should be consistent with its objectives.

(ii) the subproject should prima facie be technical feasible,economically viable and suitable for Bank financing; and

(ii) the subproject should not require further detailed, ortime-consuming feasibility studies.

45. The subprojects selected on the above basis for inclusion inthe Multiproject are as follows:

1. Small Industries Centre (SIC) Expansion (Tongatapu)2. Small Industries Centre (SIC) Establishment (Vava'u)3. Nafanua Harbour Improvement ('Eua Island)4. Agricultural Access Roads ('Eua Island)5. Telecommunications System Upgrading ('Eua Island)6. Rural Roads Improvement CTongatapu)

46. These subprojects are expected to increase employment, toearn or save foreign exchange, and to facilitate self-sufficiency infood production; all of them are prima facie suitable for Bankfinancing. However, before final approval is given, individualappraisal reports will be prenared by the Government with theassistance of consultants to be engaged under the proposed technicalassistance to be provided by the Bank and by the AustralianDevelopment Assistance Bureau (ADAB) (see paras 91-93). The appraisalreport for each subproject will be submitted to the Bank for reviewand approval before any funds are released for the subproject. Theaubproject appraisal report will include, among other things, thefollowing: (i) a complete description of the subproject; (ii)confirmation of the technical soundness of the subproject; (iii)detailed cost estimates, showing foreign and local costs and physicaland price contingencies; (iv) designation of the ImplementingAgency and detailed implementation arrangements, including adescription of the proposed procurement procedures; (v) a detailedimplementation schedule; (vi) financial and/or economicjustification for the subproject; and (vii) an assessment of the

18

environmental impact of the subproject and proposals for minimizingany adverse environmental 1ffects during the construction andoperation of the subproject.- In the case of Subproject No. 5(Telecommunications System Upgradlig on 'Eua Island), thesubproject appraisal report will provide additional justification toshow thMt the exchange and radio equipment proposed represents themost co -effective solution.

B. Description of Subprojects

1. SICEnnsio Ta.tu

47. This subproject has two components: (i) developmentof the remaining eight-acre SIC site to provide an additional 12 to14 serviced plots; and (ii) erection of two factory sheds (2 x 286eq m), one nursery building (429 sq m), const1 uction of a combinedbonded warehouse/site office/meeting room,- and provision ofequipment. The new factory/nursery buildings will provide space forseven new enterprises on the site. Site development includes landcleartin, filling and grading of the site, demarcation of plots,provision of access roads. provision of a stormvater drain andinstallation of utilities. To simplify design, the dimensions andsize of the new sheds are to be the sat as those constructed underthe Bank's Second Multiproject Loan.- The present capacity ofutilities on Tongatapu (namely power, water, and telecommunications)ts adequate to service the expanded SIC site, and utilitiesexpenditure will be limited to expansion of distribution and supplylines. The site has Its own sewage treatment plant with adequatecapacity to service the expanded site.

48. The SIC is under the administrative control of MLCI and theday-to-dAy running of the estate is handled by an Estate Manager,who is assisted by an accountant and seven supporting staff. Thereare plans to create a new post of Maintenance Officer in FY1986/87 todeal with the maintenance and repair of buildings and utilities.

2. SIC Establishment (Vavatu)

49. This subproject includes acquisition of a thirteen-acre sitein Neiafu, development of an initial eight acres of the site toprovide 12 to 14 serviced plots, erection of two multi-purposeworkshop/factory buildings (2 x 286 sq m), and provision of a smalloffice, common wasbroom facilities, a vehicle and equipment.Selection of a suitable site will be a malor factor in the success ofthe SIC, and It was consequently agreed that leasing or making otherfinal arrangements for a suitable site (see para 81) would be a

1/ Loan Agreement, Schedule 1, paras 1 and 3 and Schedule 5, para 5.I/ One unit in a Nursery Building Is currently used as the site

office; once permanent office space has been provided, this wouldbe re-used as nursery space.

I/ Loan No. 540-TON(SF), approved in 1981.

19

condition of Bank financing of this subproject.-L Site developmentincludes land clearing, gradlng, demarcation of plots, fencing,construction of access roads and installation of utilitles. Thebuildings will be designed to minimize costs and permit flexible use.The present capacity of power and water supplies on Vava'u is adequateto serve the proposed SIC and, since supply lines run close to thesite boundary, no connection problems are anticipated. Sewage will bedisposed of by means of septic tanks serving each of theworkshop/factory buildings; this is considered the mostcost-effective solution for this item.

50. The proposed SIC will be admlnistered by MLCI, and theGovernment proposes to appoint a qualified Deputy Estate Manager todeal with the day-to-day management and operation of the site underthe general guidance of the Estate Manager on Tongatapu. TheVava'u SIC will also receive support In the form of accountingservices, etc. from the Estate Office on Tongatapu.

3. Nafanua Harbour Improvement ('Eua Island)

51. This subproject involves improvement of Nafanua Harbour;-/the detailed engineering and construction supervision for thissubproject are to be financed by Australia under parallel financingarrangements (see para 92). The subproject includes provfiding anadequate basin for maneuvering vessels, constructing a wharf andloading ramp, providing a cargo and passenger handling and storagearea, widening the harbor entrance, providing necessary navigationalbeacons, and constructing a small boat landing ramp. The harbor willbe administered by MWD within MOF.

4. Agricultural Access Roads ('Eua Island)

52. This subproject consists of construction of about 20km of agricultural access roads with a 4-i formation width and 4-mpavement. The sections of road to be constructed run along establishedrights-of-way (only two short sections still need to be surveyed) andwill open up areas of agricultural potential not currently accessibleexcept on foot or horseback. The Government has undertaken to financethe entire local cost of the roads to be constructed under theMultiproject and will ensure that MOW ass ujs responsibility formaintaining the roads to an adequate standard.-

1/ Loan Agreemnt, Schedule 3, para 5(i). A suitable site hasalready been identified in Neiafu on the outskirts of thebullt-up are (See Appendix 5).

2/ A description of existing harbor facilities is given in Appendix 4.3/I Loan Agreement, Schedule 5, para 13. Agricultural access roads

are normally constructed on a cost-sharing basis; the Governmentfinances 90 per cent of the cost and the smallholders finance theremalning 10 per cent. The maintenance of these roads is left tothe _allholders. The system does not work satisfactorily; itleads to considerable implementation delays while smallboldersare contacted and sked for their contribution, and the roadsare rarely aaintained.

20

5. Telecommunications System Upgrading ('Eua Island)

53. This subproject involves establishing a multiplex channelradio link between 'Eua Island and Nuku'alofa, together withinstallation of a 128-line automatic telephone exchange in 'Ohonua.The subproject includes provision of an automatic exchange, anexchange building, a radio and associated multiplex equipment, a smallPower supply f or periods of the day when the main supply is shutJOWU,-t a limited distribution network, cable laying, staff trainingand engineering, furnishing and installation. That part of the Loanproceeds to be allocated for financing this subproject will be relent.y the Government to TTC under a Subsidiary Loan Agreement.Execution, delivery and effectiveness of a Subsidiary Loan Agreementby the Government and TTC, containing terms and conditionssatisfactory to the Governments the Bvk and TTC, will be a conditionof Bank financing of this subproject.- It has also been agreed tatthe onlending rate will be 8 per cent per annum and that the loan willbe repaid over 15 years with a three-year grace period. The foreignexchange risk with 3espect to the repayment of the loan will be borneby the Government.-

6. Rural Roads Improvement (Tongatapu)

54. This subproject includes improvement of about 30 km of roadon Tongatapu to all-weather coral standard (6 m formation width and 6m pavement width). The road sections to be improved will be selectedfrom the Government's indicative five-year road program and theviability of improving these roads will be established under the Bankfinanced technical assistance (see paras 91-93). The roads improvedunder this subproject will be maintained by MOW as part of theirregular road maintenance program for Tongatapu.

C. Cost Estimates

55. The total cost of the Multiproject is estimated at $2.52million equivalent (inclusive of taxes and duties) of which theforeign exchange cost is $2.00 million (about 79 per cent) includingabout $22,000 for the service charge on the Bank loan duringconstruction; the local cost is $0.52 million equivalent (about 21per cent). The cost estimates for the Tongatapu SIC expansion,establishment of the new SIC on Vava'v and road works on Tongatapuand 'Eut Island, were derived from estimates prepared by MOW and wereadjusted to end-1985 prices. Since MOW's unit rates for selectedconstruction work are to be reviewed under the Bank technicalassistance (see para 91), a ten per cent allowance was made forphysical contingencies on these items. The cost of the telephoneexchange and radio equipment was based on quotations from suppliersand was likewise adjusted to end-1985 prices. The costs for NafanuaHarbour were based on an engineering reconnaisance study carried out by

I/ The maim power supply, which has plenty of spare capacity,operates from 6 am to 12 am and from 4 pm to 12 pm.

2/ Loan Agreement, Schedule 3, para 5 (iii).3/ Loan Agreement, Schedule 5, para 14.

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consultants / and financed under technical assistance provided byADAB. These cost estimates are tentative since they were preparedwithout detailed site investigations. A 15 per cent allowance hastherefore been made for physical contingencies on this item. Asummary of the cost estimates Is given in Table I (see Appendix 6 fordetailed cost estimates).

1/ Connell, Eddie, Riedel and Byrne (Australia).

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Table 1. Summary Cost Estimates of the Multiproject($'000 at end-1985 prices)

Foreign LocalExchange Currency Total

Cost Cost Cost

Base Cos0t:

1. Small IndustriesCentre Expansion 263.4 151.4 414.8

2. Small IndustriesCentre Establishment 115.0 61.0 176.0

3. Nafanua Harbour Improvement 529.6 85.3 614.9

4. Agricultural Access Roads 116.9 34.4 151.3

5. Telecommunications SystemUpgrading 248.3 9.0 257.3

6. Rural Roads Improvement 281.5 82.8 364.3

Total Base Cost 1,554.7 423.9 1,978.6

Physical Contingency 169.5 46.3 215.8-

Price Contingency 249.4 52.3 301.7k/

Service Charge on the Bank LoanDuring Construction 22.2 0 22.2

Total-' l,995.8 522.5 2,518.3

a/ Physical contingencies are 10 per cent for Subproject Nos. 1, 2,4 and 6. They are 15 per cent for Subproject No. 3, and 5 percent for Subproject No. 5.

b/ Price contingencies are based on the following price escalationfactors: foreign exchange costs, 7,0 per cent for 1986 and 1987and 7.5 per cent for 1988; local costs, 7.0 per cent for 1986,1987 and 1988.

c/ Excluding the cost of consulting services to be financed underBank advisory technical assistance and by ADAB under parallelfinancing arrangments.

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D. Financing Plan

56. The financing plan is shown in Table 2. It is proposed thatthe Bank provide a loan of $2.0 million equivalent from Its SpecialFunds resources which represents about 79 per cent of the total costof the Multiproject. The loan will finance the entire foreignexchange cost of the Multiproject, including the service charge on theBank loan during construction. To facilitate prompt disbursement ofthe loan proceeda, the Government has requested establishment of anImprest account and statement of expenditure which will be setlypunder appropriate procedures as a matter of project administration.-

Table 2: Project F*nancing Plan($'000)

Foreign LocalExchange Currency Total

._ Cost Cost Cost Per Cent

Bank Loan 2,000 - 2,000 79.4Government Financing - 520 520 20.6

Total 2,000 520 2,520 100.0

57. The borrower of the Bank loan will be the Kingdom of Tonga.The Government has assured the Bank that all funds needed to implementthe Multiproject in addition to those provided under the Bank lo10will be made available on a timely basis from its own resources.-For this purpose, the Government has already Included necessary fundsin the national budget for FY 1986/87 and has agreed to make a similarprovision in future years.

58. If after the Government or the Bank has reviewed anindividual appraisal report, it is found that a subproject is notsuitable for implementation, it will be deleted from the Multiproject.A substitute subproject may then be included in the Multiprojectpr9vided the Government and the Bank agroe that: (i) it mets theselection criteria applied in identifying the subprojects (see para44); (ii) it is appraised under the same procedures applied to theoriginal aubprojects (see para 46); and (iii) the requiredfinancing is consistent with he limits of the proposed financingavailable under the Bank loan.-

1/ Loan Agreement, Schedule 5, pars 8.2/ Loan Agreement, Section 4.02(a).3/ Loan Agreement, Schedule 1, para 2, and Schedule 5, pare 5.

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IV. PROJECT IMPLEMENTATION!'

A. Executing Agency and Project Coordination

59. The Executing Agency for the Multiproject will be MOF. Eachsubproject will be implemented by a designated Implementing Agency(see ection B below). The Secretary for Finance has been designatedas Project Coordinator and will be responsible for the overallcoordination and execution of the Project; the Goverment has agreedto consult the Bank2prior to making any changes in the position ofProject Coordinator.- The Project Coordinator will coordinate thepreparation of each subproject and present it to the Bank forapproval, and will supervise the channelling of loan proceeds to therespective Implementing Agencies. The Project Coordinator willconsult and be assisted and supported by the Central PlanningDepartment (CPD) In the coordination of the Multiproject. The ProjectCoordinator will also3pct as the liaison between the ImplementingAgencies and the Bank.-

60. To assist the Project Coordinator in carrying out hisresponsibilities, the Government has agreed to establish aProject Coordination Committee (PCC) by 31 July 1986. The ProjectCoordinator will serve as Chairman of the PCC which will also have asmembers the Deputy Secretary for Finance (as member and secretary forthe PCC), the Secretary of Labour, Commerce and Industries, theDirector of Works, the Director of Planning and the General Manager ofTTC. The PCC will meet at least once every two months and will beresponsible for the overall planning and scheduling of all subprojectactivities, for the periodic review and monitoring of theprogress (f individual/ subprojects and for progress on theNultiproject as a whole.-

61. The above arrangements are expected t: ensure more effectivecoor0ination and follow-up than would be possible If there were anumber of separate executing agencies. This arrangement. excludingthe establishment of a PCC, has been successfully used in the twoprevious Multiproject loans (see para 77). The designation of MOF asEwecvting Agency should also ensure that the Multiproject costs arekept within reasonable limits and local funds are provided promptly.MOF Is suitably staffed; it includes a Secretary, Deputy Secretaryand Assistant Secretary for Finance, an Accountant-General, anAccountant for Development Projects, an Economist, two accountants, asenior accounting officer, six accounting officers and a chief clerkwho supervises a support staff of about 34. MOF also has subtreasuryofficers stationed on 'Eua Island and in Nelafu.

_/ Section E summarizes the implementation status of previous Bankprojects.

2 Loan Agreement, Schedule 5, para 3.3/ Loan Agreement, Schedule 5, para 1.4/ Loan Agreement, Schedule 5, para 4.

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B. Implementing Agencies

62. The implementation of the individual subprojects, includingall technical, constructon and procurement activities will be done bythe following Agencies:-

(1) Ministry of Labour, Commerce and Industries:

Subproject No. 1 - Small Industries Centre Expansion(Tongatapu)

Subproject No. 2 - Small Industries Centre Establishment(Vava'u)

(il) Ministry of Works:

Subproject Nos. 3, 4 and 6 - Nafanua Harbour Improvement andAgricultural Access Roads ('Eua Island) and Rural RoadsImprovement (Tongatapu)

(iii) Tonga TelecoLmmnications Commission:

Subproject No. 5 - Telecommunications System Upgrading('Eua Island)

1. Ministry of Labour, Commerce and Industries GMLCI)

63. MLCI implemented the previous SIC subprojectssatisfactorily-' and will act as Implementing Agency for the two SICsubprojects to be financed under the Multiproject. The Secretary ofMLCI will be responsible for overall implementation of the subprojectsand for coordination with other Government ministries and agencies.The Estate Manager, who is responsible for the day-to-day operationof the existing SIC in Tongatapu, will help implement the proposed SICsubprojects. He is assisted by an accountant, two secretaries and twosupporting staff. The Estate Manager will report to the Secretary,MLCI, who will continue to be responsible for the promotional andmarketing aspects of the SIC and will also be responsible for planningan# implementing development of future SIC's throughout the country.NCI has the capacity to satisfactorily implement both the SICExpansion on Tongatapu and the SIC Establishment on Vava'u.

2. Ministry of Works (MOW)

64. MOW is responsible for the planning, design, constructionand maintenance of practically all public works in Tonga, including

1/ The Government has agreed to inform the Bank of any changes inkey personnel In these Implementing Agencies. Loan Agreement,Schedule 5, para 3.

2/ Small Industries Centre Project, Loan No. 335-TON(SF), approvedin December 1977, and the SIC expansion subprojects included inthe Multiproject Loans No. 435-TON(SP), approved in December1979, and No. 540-TON(SF), approved in November 1981.

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roads, ports, airports, and public buildings. MOW's operations alsoinclude plant and vehicle maintenance for other governmentdepartments, and operation of a concrete block manufacturing plant.MOW has been the Implementing Agency for several subprojects under theBank's earlier Multiproject loans.

65. The Ministry is headed by the Minister of Works and has fivesections in Tongatapu, covering administration, road construction andmaintenance , government stores, mechanical services, andarchitectural building services. Permanent works supervision unitshave been set up on the islands of Vava'u, Ha'apai, 'Eua andNiuatoputapu and Niuafo'ou. These sections, which operate under theDirector of Works, had an established staff level of 193 at the end of1984. In addition, four professional grade, three supervisory andtwo technical training staff were provided under external aidprograms. MOW's construction capacity was strengthened followingreceipt of construction equipment provided under EEC aid. Plant andequipment continue to be located in 'Eua and Vava'u to allow work tobe carried out on these islands.

66. MOW's Architectural Divisior., which is responsible forconstruction and maintenaqp of all Government buildings, consists ofa Governfnt Architect,- three local architects, a quantitysurveyor,- and three trainee quantity surveyors. It also includes anumber of building foremen and building tradesmen. The Roads Divisionis responsible for the construction and maintenance of the road network,including construction of agricultural and community roads. The RoadsDivision is also responsible for coral quarry production and forimplementing special projects. In recent years this has involved aconsiderable amount of work on the Queen Salote Wharf project and onforeshore protection works in Nuku'alofa. The Roads Division has onestructural engineer, three engineers trained at Lae University ofTechnology In Papue New Guinea and six overseers and foremen. NOW hasthe capacity to satisfactorily handle the improvament of NafanusHarbor on 'Eua Island, the construction of Agricultural Access Roadson 'Eua Island, and the improvement of Rural Roads on Tongatapu.

3. TonMa Telecommunications Commission (TTC)

67. TTC was established as a semi autonomous goverwnentstatutory body on 1 July 1984. Previous to that it operated as aGovernment department. TTC is responsible for the operation,maintenance and development of the domestic telecommunications systemin the country. TTC's Board consists of the Prime Minister asChairman, the Minister of Fimnace, the Secretary to Government, TTC'sGeneral Manager and three representative subscribers. TTC's GeneralManager is the former TTD Superintendent and most TTD staff andpersomnnl transferred to TTC when It was formed. The General Manageris supported by a Finance and Administration Manager, an EngineeringBranch Manager and a Traffic Officer. Further, a Training Manager,responsible for TTC's Technical Training Center, is due to beappointed to assist the General Manager.

I/ Thse posts are currently vacant.

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68. The Finance and Administration Manager is assisted by anAccountant and a Personnel Officer, and the Engineering Branch Manageris assisted by five Controllers responsible respectively for NorthernOperations, the Radio Section, Internal Plant, External Plant andthe Planning Section. At present, TTC's total staff, includingadministration, technical and service personnel, is 166. There is oneNew Zealander expert acting as the Finance and Administration Manager,and two Australian experts who act as the Engineering Branch Managerand the Radio Section Controller. The caliber of TTC's technicalstaff is continually improving. Further steps have been taken toensure that relevant upgrading courses will be available and thatTongan personnel receive the appropriate technical qualifications andmanagement1rkills to enable them to ev-ntually take over all seniorpositions.-

69. The Bank-financed Telecommunications Project [Loan No.146-TON(SF), approved in November 1973] and the telecommunicationssubproject financed under the first Multiproject Loan [Loan No.435-TON(SF), approved in December 19791 were both implemented by TTDand its performance was satisfactory.

C. Procurement

70. Procurement of all Bank-financed goods and services for theMultiproject will be carried out in accordance with the Bank'sGuidelines for Procurement, by the implementing agencies concern>under the overall coordination of the Project Coordinator.-Specifically, with the exception of minor items, procurement of goodsand services for the various subprojects will be as follows (seeAppendix 7 for a breakdown of the amount of 3Phe project to beimplemented under various procurement procedures):-

Subproject No. 1 (Expansion of SIC, Tongatapu)

1. Grading and site preparation .................... ,A2. Construction of buildings ....... e........... LCB3. Utilities . . .... .. .. ...... ......... FA

Subproject No. 2 (Establishment of SIC, Vava'u)

1. Grading and site preparation .................... FA2. Construction of buildings LCB3. Utilities ........... FA

11 An agreement has recently been signed with Telecom Australiawhich provides for technical training of TTC staff.

2/ Loan Agreement, Schedule 4, para 2, and Schedule 5, paras 1 and 2.3/ Loan Agreement, Schedule 4, paras 4(a) and 5 to 8. LCB - Local

Competitive Bidding, FA - Force Account, ICB - InternationalCompetitive Bidding, IS - International Shopping, PP - ProprietaryProcurement.

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Subproject No. 3 (Construction of Nafanua Harbour, 'Eua Island)

Improvement of the harbor ........................ ICB

Subproject No. 4 (Construction of Agricultural Access Roads, 'EuaIsland)

Road construction .0...... .A......... .... FA

Subproject No. 5 (Telecomnunications System Upgrading, 'EuaIsland)

1. Automatic exchange, radio and multiplexequipment, and training .......................... PP

2. All other equipment .......... **.*o.....*****e .. IS3. Construction of Exchange Building ................ LCB4. Laying of cable and connection of lines .......... FA

Sub-project No. 6 (Construction of Rural Roads, Tongatapu)

Road construction ........*. ............ .* .. . FA

71. The utility connections for Subproject Hos. 1 and 2 (SICExpansion, Tongatapu, and SIC Establishment, Vava'u) will beundertaken by TTC, Tonga Water Board and Tongs Electric Power Board.The cable laying for Subproject No. 5 (Telecommunications SystemUpgrading, 'Eua Island) will be undertaken by TTC. All the remainingforce account work will be undertaken by MOW. In all these cases, thesize, nature and location of the works make them unsuitable forconstruction under competitive bidding procedures. Foreigncontractors would not be interested in these jobs, while Tongancontractors are not equipped to carry out this kind of work. TTC, theWater Board, the Electric Power Board and MOW, on the other hand, dohave the necessary construction facilities and will be able toundertake the works expeditiously and at reasonable cost. About 30per cent of the base cost of the Multiproject will be carried outunder force account.

72. To ensure that the force account work on Subproject Nos. 4and 6 to be undertaken by MOW is based on a satisfactory record ofactual costs Incurred, it. has been agreed that MOW will establish anengineering charging system with respect to these subprojects which issatisfactory to the Government and the Bank prior to any disbursementsbeing made 1from the loan account to meet the cost of thesesubprojects.- The consultants to be appointed under the technicalassistance component of the Multiproject will assist MOW inimplementing this charging system. To ensure this does not lead toany implementation delays, the consultants are beitg recruited underthe Bank's advance recruitment procedures (see para 93). It Isexpected that establishment of the engineering charging system willhave been completed by September 1986.

17 Loan Agrem_nt, Schedule 3, para 5(il).

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73. The Government requested the use of LCB !or the packepes ofcivil works iuteutiied for procurement by this method in SubprojectNos. 1, 2 and 5. This method is appropriate since tihe size and natureof the work is such that foreign contractors are unlikely to beinterested in biddiog; however, local construction facllities areavailable at reasonable cost and are efficient and have adequatecapacity (see para 34). The Government will use its usual LCBprocedures, which are acceptable to the Bank, to select contractors.

74. Proprietary procurement is appropriate only for thetpecitic equipment so indicated in Subproject No. 5. In these cases,proprietary procuremeut would belp standardize uew equipment withexisting equipment, minimize maintenance problems and avoid the needto keep an excessive stock of spare parts. The amount of theM!ilLiproject to be procured on a proprietary basis amounts to justover ten per cent of the base costs. International Shopping islikewise justified for the equipment Identified for procuremnt bythis method In Subproject No.5 since the package are not large ew4hto attract suppliers under international competitive biddtingprocedures. As in past multiprojects, procurement of midor ltems,which in this case mean items costing less than US$10,000 equivalent,may be carried out by the implviueau. agencl concerned without priorapproval from the Bank.

D. Design, Construction Supervision and Other Consulting Services

75. The Government requested technical assistance to finance allforeign consulting services (see paras 91-93) other than thosefinanced by ADAB under parallel financing arrangemets. Thearrangements for provision of the remaining engineering services areas follows: (1) the demarcation of boundarles, site surveys andpreparation of contour maps for Subproject Nos. 1 and 2 (SICExpansion, Tongatapu, and SIC Establishment, Vava'u) will beundertaken by the Ministry of Lands, Survey and Natural Resourcesbefore the consultants to be appolnted under the Bank technicalassistance for preparatil o. the U Jte Master Plans (see para 93)start their fieldwork;- (ii) MOW will provide constructionsupervision for the force account work to be dome under SubprojectNos. 1 and 2 (SIC Expansion, Tongatapu, and SIC Establishbent, Vava'u);(iii) MOW will evaluate and let tenders under LCB procedures and provideconstruction supervision for the buildings to be constructed underSubproject Nos. I and 2 (SIC Expanelon, Tongatapu, and SIC Establishment,Vava'u); (iv) the necessary topographic and marine surveys needed forthe design of Subproject No. 3 (Nafanua Harbour Iprovemant, 'Eualsland) will be carried out by the Ministry of Lands, Survey andNatural Resources and HWD wore the consultants to be fInanced byADAB start their fieldwork;- (v) MOW will evaluate and let tendersunder ICB procedures for Subproject No. 3 (Nafanua Harbour Improvemmnt,'Eua Island); (vi) the Ministry of Lands, Survey and Natural Resourceswill set out the rights-of-way for all roads to be constructed underSubprojey No. 4 (Construction of Agricultural Access Roads, 'EuIsland);- and (vii) MOW will design and provide construction

1/ Technical Assistance Agreement (for Multiproject part), Schedule 3.2/ Loan Agreement, Schedule 5, para 11.3 Loan Agreement, Schedule 5, para 12.

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supervision for the force account work to be carried out underSubproject Nos. 4 and 6 (Construction of Agricultural Access Roads,'Eua Island, and Improvement of Rural Roads, Tongatapu). Theexchange building to be constructed as part of Subproject No. 5(Telecommunications System Upgrading, 'Eua Island) will be designed,and the ensuing construction will be supervised, by competent localarehitect. to be recruited by TTC.

E. Implementation Status of Previous Bank Projects

76. The Bank's first loan to Tongs was for aTelecommunicetions Project, Loan No. 146-TON(SF), approved inNovember 1973. A Project Performance Audit Report (PPAR) wascirculated to the Board in July 1982 whieh noted that although therewas an Initial ¢qlay caused by revision and curtailment of the scopeof the project,- the main physical and financial objectives of theproject were su87tantially met. The financial performance of theexecuting agency- was better than expected and there was significantorganizational improvement, particularly on the accconting side.

77. The first Multiproject loan, Loan No. 435-TON(SF), approvedin December 1979, was examined in a PPAR circalated to the Board inApril 1984. The main issues noted in tte PPAR were: (i) theMultiproject loan modality helped the developmezt of the Bank's SouthPacific DNCs, and in this case resulted in significant administrativecost savings; (ii) the project as a whole experienced a cost overrunof about 17 per cent and implementation was delayed by 18 months;(ifti) a clearer definition of the Consultants' responsibilities in theTerms of Reference, combined with more careful selection ofconsultants, mlght have reduced implementation problems; (iv) thecivil works carried out by the Ministry of Works (MOW) under forceaccount stretched its available manpower and equipment capacity andthis led to delays in construction of subprojects; and (v) theexecuting at* implementation arrangements were judged to besatisfactory.-

78. The first loan to help establish the SIC in Tongatapu, LoanNo. 335-TON(SF) approved in December 1977, was examined in a PPARcirculated to the Board in December 1984. The PPAR noted that: (i)the success of the project was attributable to comprehensive projectpreparation, provision of consulting services for implementation andoperation, and judicious administration by MLCI staff; (il) there wasa cost overrun of about 12 per cent, but this was mostly due to thehigher-than-expected cost of site development and infrastructure

1/ Due to a large cost overrun caused by an unusual escalation Inprices.

2/ The Telegraphs & Telophones Department.3/ The Ministry of Finance was nominated as Executing Agency with

the Secretary for Finance as Project Coordinator. Thetmplementing agencies for the separate subprojects were MOW,the Telegraphs & Telephones Department, MLCI, the Ministry ofHealth, and the Tonga Water Board.

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development;y (iii) implementation was delayed by 10 months due toa shortage of experienced engineers; and (iv) the Bank should continueto monitor the progress of the SIC to ensure the project achieves ano-profit no-loss financial position.

79. The main lessons learned from implement dtion of past Bankprojects in Tonga is that: (i) the multiproject lending modality isan appropriate way of supporting the Government's development program;(ii) the appointment of the Ministry of Finance as Executing Agency,together with implementing agencies for separate subprojects, hasworked successfully in previous loans; (iII) consultants play a keyrole in helping implement subprojects on time, and their effectivenessis improved if the Terms of Reference are well-drafted and theconsultants are carefully selected; and (iv) MOW has limited capacityto undertake force account work and subprojects must consequently beformulated so as not to exceed this capacity.

F. Iplemntation Schdule

80. The Multiproject as a whole vill be implemented over aperiod of nearly three years, in accordance with the implementationschedule (Appendix 8). The implementation schedules for individualsubprojects vary, depending on the particular circumstances of eachsubproject.

G. Land Acquisition

81. There are no major issues with regard to the acquisition ofland. The land required for expansion of the SIC on Tongatapu isalready leased by the Government and is in its possession. The landrequired for establishment of the SIC on Vava'u is owned by theGovernment and, although the three sites considered suitable aresubject to the rights of third parffes, the Government has alreadytaken steps to repossess one of them.- The site needed for improvingNafanua I,rbour lies in the foreshore area and is already owned by theGovernment, the Agricultural Access Roads on 'Eua Island will allfollow established rights-of-way, and the Rural Roads on Tongatapualso all follow establisted rights-of-way. The land required for thetelephone exchange on 'RuN Island is owned by the Government and isalready occupied by a wooden exchange building owned by TTC; alltelephone lines follow estabLished rights-of-way within existing roadreserves. The Government ha agreed to ensure that all lands, rightsin lands, and other rights and privileges required for the subprojectswill be acquired and3lade available on a timely basis to avoid anyimplementation delay.-

1/ The PCR consldered that alternative designs for theelectrification and sewerage components could have reduced thiscost.

2/ Leasing, or making other final definitive arrangements for asuitable site is a condition of Bank financing this Subproject.Loan Agreement, Schedule 3, para 5(i).

3/ Loan Agreement, Schedule 5, para 7.

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H. Operation and Msintena$ce

82. The Government has agreed to ensure that the equipment andfacilities provided, constructed or upgraded under the Multiprojectwill be adequately operated, waged, mintained and repaired inaccordance with sound practices.- For this purpose, the Governmentwill make available, promptly as needed -- either directly or as soleshareholder of TTC - sufficient funds and other resources requiredfor the proper oration and maintenance of the Multiproject's equipmeneand facilities.- In particular: (1) MLCI will be responsible forthe operation and maintenance of the SIC Expansion on Tongatapu andthe SIC Establishment on Vava'u; (il) HWD within MOP will beresponsible for the operation of Nafanua Harbour which is to beimproved under the Project; (iii) MOW will be responsible formaintenance of Nafanua Harbour and for all the roads on 'Eua Islandand on Tongatapu to be constructed, or improved under the Multiproject;and (iv) TTC will be responsible ¢or operation and maintenance of alltelecomunications facilities to be upgraded under the Multiproject.

83. The Government agreed that part of the technical assistancefor the Project (see para 91) will include a study of the rentalstructure of the SIC plots and buildings. The study will identifysuitable means for incieasing rents at the existing SIC on To<sgatapuand setting them at the new SIC on Vava'u so as to ensure that in thelong term rental revg?ues cover costs, particularly the cost ofbuilding construction.- It was agreed that, shortly after submissionof the consultant's draft final report on this matter, the Governmentand SIC representatives would meet with the Bank to review the reportand would jointly develop revisions to the rental scheme for theTongatapu SIC, including a phaed program for increasing rental feelevels to ensure that the SIC will operate on a no-profit no-lossbasis. The no-profit no-loss principle requires the setting of rentalfees so that tenants at the SIC pay enough to permit full 4 yffovery ofall capital costs and operating and maintenance expenses.- - The newVava'u SIC Olls, over the long term, also operate on a no-profit no-loss basis.-

1/ Loan Agreement, Sections 4.01 and 4.04.2/ Loan Agreement, Section 4.02(a). The annual incremental cost to

the Government of operating the Multiproject facilities isnegligible. The two SICs are to b( operated on a no-profit no-loss baesi (see para 83); the tar ffs for use of coastal portsare to be revised to recover costs f operation and maintenanceof Nafanua Harbour (see para 84) The telecommunicationsimprovements are expected to earn a reasonable rate of return.The agricultural access roads, on the other hand, will increaseroad maintenance costs by about $18,000 per annum, but this isexpected to be largely offset by the savings in road maintenancecosts associated with improvement of rural roads on Tongatapu.

3/ This is to ensure that potential occupants are not discouragedfrom erecting their own factory sheds.

4/ Loan Agreement, Schedule 5, para 9.5/ When the SIC in Tongatapu was first established under Loan No.

335-TON(SF), approved in December 1977, it was agreed that thebasic financial policy should be to operate on a no-profitno-loss basis.

6/ Loan Agreement, Schedule 5, para 10.

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84. The Government has also agreed to institute levies, ortariffs for use of coastal port facilities in Tonga which will be setat levels which: (i) are, by completion of the Nafanua HarbourImprovement, adequate to recover at least the cost of operation andmaintenance of Nafanua Harbour; and (ti) are, within a period to beagreed upon by the Government and the Oak, adequate to recover anagreed-upon percentage of capital costs.- In the case of roads, theGovernment indicated that the current system of user charges wasan appropriate subject for review and that rationalization of suchcharges was of importance; the 9prernment agreed to keep the Bankinformed on progress in this area.- No specific agreement was madewith TTC regarding tariffs, since they already operate on a commercialbasis and adjust their tariffs from time to tim to ensure thatrevenues cover costs.

I. Reports, Accounts and Audit

85. The Project Coordinator, assisted by the Project Managersfor the telecommunications, harbor and roads subprojects, will beresponsible for monitoring the progress of the Multiproject and willfurnish to thy, Bank quarterly progress reports on subprojectimplementation.- To facilitate post-evaluation of the Multiproject,the Project Coordinator will also submit to the Bank, within threemonths of the physical completion of the Multiproject, a reportcovering details of impl nentation and operation of each subproject,the cost of the various subprojects, and the performance 4?fobligations under, and accomplishment of the purposes, of the Loan.-

86. The Government will establish and maintain separate accountsfor: (i) all expenditures incurred under the Multiproject; and (ii)for each subproject. These accounts and related financial statements,will be audited annually in accordance with sound auditing standardsby auditors acceptable to the Bank. The unaudited accounts will befurnished to the Bank not later than six months after the end of thefinancial year to which they relate, and the audited accounts andrelated financial statements will be furnished to the BSank not laterthan UV, months after the end of the financial year to which theyrelate.-

J. Project Benefit Monitoring and Evaluation

87. In order to assess the overall impact of improving NafanuaHarbour and constructing agricultural access roads on 'Eua Island, theGovernment has agreed to establish a system for recording the volumeand type of goods shipped through the harbor, as well as the numberof passengers using it. Base line figures giving a representativeone year's traffic flow will be collected before work on the harborcommences, and similai figures will be collected immediately after Itis fully operational.- In the case of the roads to be improved on

1/ Loan Agreement, Schedule 5, para 15.2/ Loan Agreement, Schedule 5, pars 16.3/ Loan Agreement, Section 4.07(b).74/ Loan Agreement, Section 4.07(c).3/ Loan Agreement, Section 4.06(b).6/ Loan Agreement, Schedule 5, pars 17.

34

Tongatapu, the Government has agreed to conduct traffic surveys priorto improvement of all roads considered for improvement, and on eachroad improvf? under the Multiproject, promptly following suchimprovement.-

K. Considerations Regarding the Environment and Women

88. The *fxisting SIC in Tongatapu has given careful attentionto the environment. The building regulations require that developerscomply with the following two conditions: (i) no tree with a trunkdiamete. exceeding 150 mm may be removed without the prior consent ofthe Site Office; and (ii) where such trees are removed, they shall bereplaced by two other trees of a species recommended by the SiteOffice. The substance of these conditions -- namely, the protectionof mature trees -- is reflected in the Terms of Reference for theconsultants preparing the Master Plans for expansion of theTongatapu SIC and establishment of the Vava'u SIC; in the case of thenew SIC on Vava'u, the Terms of Reference also require the consultantsto pay special attention in the design of buildings to the localbuilding vernacular (see Appendix 9). In the case of Nafanua Harbourimprovement, the proposed Terms of Reference for the consultantsrequire that they plan and design the harbor facilities in a way thatminimizes adverse environmental impacts; the Terms of Reference alsorequire that they take account of an environmental impact studyprepared in connection with the earlier ADAB-financed reconnaisancestudy for the harbor (see Appendix 10). Although the agriculturalaccess roads to be constructed on 'Eua Island pass through virginbush, the only trees affected are of the small, scrub variety and theformation width is being kept to a minimum (four m) to avoidunnecessary use of agricultural land. The Terms of Reference for theconsultants preparing the roads to be improved on Tongatapu, requirethat they ensure that all necessary precautions are taken to avoidadverse environmental impacts (see Appendix 9). The telephone linesto be installed on 'Eua Island will all be buried; this is standardpractice to prevent damage by cyclones.

89. The employees working on the existing SIC in Tongatapu aremostly women, and it is expected that the two SIC subprojects willfurther increase female employment; otherwise the Multiproject hasno gender-specific implications.

L. Project Administration

90. The Bank's headquarters staff will engage and supervise thework of the consultants to be recruited under the Bank's technicalassistance and will review and approve the individual subprojectappraisal reports to ensure they are technically sound andeconomically viable. After each subproject appraisal report has beenapproved, the Bank's South Pacific Regional Office (SPRO) will beresponsible for all Project Administration matters and forpreparation of the PCR for the Multiproject. The Bank's headquartersstaff will assist SPRO on technical matters.

I/ Loan Agreement, Schedule 5, para 18.

35

V. TECHNICAL ASSISTANCE

91. Implementation of the Multiproject is being supported by twotypes of technical assistance: one financed by the Bank and the otherby ADAB under parallel financing arrangements. The Bank technicalassistance will be used to assist the Government in: (i) establishingunit rates for road construction work undertaken by MOW; (ii)preparing Master Plans for expansion of the SIC site on Tongatapu andestablishment of a new SIC site on Vava'u, including preparation ofspecifications and quantities to enable this work to be carried out ona force account basis; (iii) revising designs for the factory andnursery buildings to be erected on the SIC site on Tongatapu andpreparing specifications and bid documents to enable the buildings tobe constructed under LCB procedures; (iv) preparing designs and biddocuwAents for the workshop/factory buildings to be erected on the SICsite on Vava'u to enable the. buildings to be constructed under LCBprocedures; (v) undertaking a review of the rental fee structure ofthe existing SIC on Tongatapu and recommending a revised rental feestructure to cover both SICs; (vi) reviewing the Governntnt'sindicative five-year road development plan for Tongatapu, establishinginvestment priorities and preparing an initial package of roads forfinancing under the Multiproject; and (vii) undertaking an in-depthanalysis of the Government's interest rate policies, examiningalternative interest rate scenarios, and making recommendations forchanges in interest rate policies to make them more effective. Theoutline Terms of Reference for this techn-Ical assistance are attachedas Appendix 9. Items (i), (v), and (vi) above will make an importantcontribution to institutional strengthening of the implementingagencies.

92. The detailed engineering and construction supervision forNafanua Harbour will be financed by ADAB. The Government has agreedto ensure close collaboration between the consultants, MOW, HWDwithin MOF, and the Bank. In particular, the Government has agreed tosubmit to the Bank forj its concurrence a copy of the consultants'Terms of Reference before proposals are invited from consultants andto provide to the Bank copies of all of the consultants' reports and,within one month of completion of the final report, to schedule ajoint meeting between the Governmyt, the Consultants, ADAB and theBank to review the final report.- A copy of the outline Terms ofReference prepared by the Mission to guide preparation of the detailedTerms of Reference by the Government is attached as Appendix 10.

93. It is estimated that about 12 man-months of consultingservices in engineering costing, architectural design, costaccounting, rental policy, transport economics, and interest ratepolicies will be required to assist the Government and MOW inundertaking the tasks listed in para 91 above. The Ministry ofFinance will be Executing Agency for the technical assistance whichwill be carried out under the direction of the Secretary for Finance.

1/ Loan Agreement, Schedule 5, para 11.

36

The consultzuts for this technical assistance will be engaged inaccordance with the Bank's Guidelines on the Use of Consultants. Theconsultants are being reyauited under the Bank's dvance recruitmentprocedures (see para 72).- The total cost of the consulting servicesis estimated at $237,000, of which $221,000 is the foreign exchangecost. A detailed breakdown of the total cost is given in Appendix 11.The foreign exchange cost includes the cost of consultants'remuneration, per diem, international travel, internationalcommunications, report preparation and contingencies. The localcurroncy cost of the technical assistance Is estimated at $16,000equivalent and includes the cost of office space, secretarialfacilities, local comuunications facilities, land transport for sitevisits, and counterpart staff. It is proposed that the foreignexchange cost of the technical assistance amounting to $221,000 befinanced by the Bank as a grant. The Government has agreed to providethe local currency cost of the technical assistance. The Governmenthas also agreed to undertake preparation of boundary and topographicsurveys, and to prepare contoured O te plans for both SICs before theconsultants start their fieldwork.-

1/ Advsance Action for Recruitment of Consultants, IN. 47-86.j/ Technical Assistance Agreement (Multiproject part), Schedule 3.

37

VI. JUSTIFICATION AND BENEFlTS

A. General

94. The multiproject lending modality is designed to assist theGovernment to implement small, high-priority subprojects which aretoo small to be financed under separate Bank loans. The subprojectsselected for inclusion In this Multiproject support the Government'sobjectives of: (i) diversifying the economy and developingmanufacturing; (ii) encouraging regional development (particularlythe development of islands outside of Tongatapu); and (iii)developing agriculture and forestry. In designing the Multiproject,due attention has been paid to Government priorities, technicalfeasibility, economic viability and state of project preparation (seepara 44), and the capacity of MOW to carry out civil works by forceaccount (see para 79). The Multiproject also aims at promotinginstiturton building end self-reliance, and at encouraging the privatesector.-

95. The subprojects are located on Tongatapu, Vava'u and 'EuaIsland; these areas together contain about 88 per cent of thecountry's population. The SlCs are located in the largest two towns-- Nuku'alofa on Tongatapu with a population of about 28,000 andNeiafu on Vava'u with one of about 4,000 -- and should make animportant contribution to supporting development of industry andincreasing employment in these towns. 'Eua Island is still relativelyundeveloped, and considerable potential exists for increasingagricultural output and -- in the longer term -- for developingforestry; the subprojects located on this island should make asignificant contribution to such development.

B. Financial/Economic Evaluation

96. Full details of the cost of the subprojects and of thebenefits to be expected from them will only be available after theyhave been appraised under the technical assistance component of theProject. However, the Mission made some preliminary estimates of theeconomic internal rate of return (EIRR) for Subproject No. 3 (NafanuaHarbour Improvement, 'Eua Island) and Subproject No. 4 (Constructionof Agricultural Access Roads, 'Eua Island). The estimated EIRR for?#afanua Harbour, which has been calculated conservatively, is 10.4 percent which is considered satisfactory, and the EIRR for theagricultural access roads is estimated at 14.1 per cent which is alsoconsidered satisfactory. The methodology and assumptions used in theeconomic evaluation are set out in Appendix 12. No Separate EIRRestimates have been made for the remaining Subprojects, although inthe case of Subproject No. 6 (Rural Roads Improveient, Tongatapu), theTerms of Reference for the consultants (Appendix 9, Part A, item 5)requires them to select road sections that give an EIRR of at least 9per cent.

1/ By expanding the Tongatapu SIC, establishing the Vava'u SIC, bydoing a large amount of construction work under LCB proceduresand by using local architects in the design of the building forthe telephone exchange on 'Eua Island.

38

C. Risks

97. The major risk associated with the Multiproject is thatimplementation of subprojects may be delayed. To iiimiSse the riskassociated with acquisition of land rights for the Vava'u SIC, theGovernment has already initiated action to reposess the site. Tominimise delays during preparation of the subproject appraisalreports, technical assistance is being provided to assist theImplementing Agencies to prepare these reports. Technical Assistanceis also being provided by ADAB under parallel financing arrangeometsto facilitate implementation of Subproject Jo. 3 (Nafanua HarbourImprovement, 'Eua Island).

. 39

PART B - THE LINE OF CREDIT

III. THE PROPOSED LINE OF CREDIT

A. Objective end Scope

98. TDB is the most important source of long-term developmentfunds in Tonga. The Government expects TDB to continue to play anImportant role in the development of the Kingdom by helping to promoteand finance high-priority projects in the agriculture and industrialsectors. The primary objective of the proposed line of credit is toprovide TDB with financial resources and technical assistance to enableIt to continue fulfilling its role in promoting economic developmentactivities and to improve the level of efficiency of its operations. Inaddition, an advisory technical assistance will be provided to theGovernment for a review of its interest rate policies and to formulatepolicy recommendations promoting development of the banking sector.

99. A general credit line is envisaged for TDB, which will onlendmost of the proposed loan to small-scale enterprises.

B. The Proposed Loan

1. Loan Amount, Borrower and Executin agency

100. On the basis of TDB's additional estimated foreign currencyrequirements of US$1.3 million during FY1986-1987, it is proposed that athird Bank loan of US$1 million equivalent be extended to the Kingdom ofTonga (the Borrower) for relending to TDB (the Executing Agency) under asubsidiary loan agreement satisfactory to the Bankl/. The Loan isproposed to be made from the Special Funds resources of the Bank underthe standard terms and conditions. The Borrower will bear the foreignexchange risk2/.

2. Main Features

a. PuErose

101. TDB will use the proceeds of the proposed loan to makesubloans to fiance the foreign exchange costs of specific developmentprojects in Tonga3/. The tentative sectoral allocation of the proposedloan is: agriculture, 50 per cent; industry, 30 per cent and servicesincluding transportation and tourism, 20 per cent. The subprojectsfinanced will meet TDB's normal evaluation criteria as found in itsPolicy Statement4/. When approving subloans of $10,000 or more, TDBwill ensure that the subproject satisfies the Kingdon's laws andregulations as they relate to the preservation of the environment/.

1/ L.A. Section 3.01(b).2/ L.A. Schedule 6, para l(c).3/ L.A. Schedule 1, Part B.41 Appendix 16.3/ P.A. Schedule, para 6.

40

b. Utilization

102. The closing date for submission by TDB of applications forsubloans for approval/authorization of withdrawal will be three yearsafter the effective date of the proposed losull. The closing date forwithdrawals will be four years after the effective date of the loan2/.

c. Amortization Schedule

103. A fixed amortization schedule, as was the case in the previoustwo loans, is proposed between the Borrower and TDB. The maturityperiod for the loan to TDB will be 15 years including a grace period ofsix years3/. A flied repayment schedule with a relatively long graceperiod Is justified in view of the following factors: (i) it will allowTDB to recycle the principal repayments received from its sub-borrowersfor further leading4/, and (ii) it will strengthen TDB's resourceposition.

104. The sub-borrower's repayment terms to TDB will not exceed 15years including a grace period not exzeeding three years5/.

d. Onlendlag Rate

105. It is proposed that the borrowers' relending rate to TDB forthe proposed loan be 3 per cent per annum6/ as in the previous loans.This will give ThE an interest rate spread of 5.5 per cent based on anestimted projected average onlending rate of 8.5 per cent. TDB willconsult the Bank before effecting any changes in its onlending rates.In particular, In the event that Tonga's interest rate policy, law orregulations are amended to allow higher lending rates to be charged byTDB, the onlending rate will be reviewed and revised in consultationwith the Bank7/.

106. The lower relending rate from the borrower to TDB is needed tomaintain TDB's flasncial position. The lower rate will ensure adequateInterest spread to cover the high administrative costs incurred by TDB'sbeavy lnvolvement with small loan projects (T$1,000 and below).Furthermore, as a relatively new DFI, TDB needs to bull4 up itsprovisions and retained earnings to an adequate level. In view of theabove, the Mission believes1 that the three per cent releading rate isappropriate, although a higher relending rate should be applied in theevent that the Government's interest rate regulations are amended.

17 .. Section 2.02 c).Ti/ L.A. Section 3.07 (Il).SI L.A. Schedule 6, para 1(b).'/ P.A. Schedule, pare 4.T/ P.A. Section 2.04(b).L/ L.A. Schedule 6, para 1(a).7/ L.A. Schedule 6, para 2; and P.A. Schedule, pare 2.

41

e. Subloan Interest Rates

107. TDB's Interest rates on subloans vill be charged in accordancewith TDB's current interest rate schedule. These interest rates arel/:

(i) Top priority sectors (agrlculture, fisheries, livestock,natural resources) - 6 per cent

(ii) High priority sectors (export-oriented industries,manufacturing, raw material processing and tourism) - 8 percent

(iii) All other industrial and comercial loans - 10 per cent

108. TDB will consult the Bank prior to effecting any changes InIts interest rates2/. Furthermore, TDB will review its interest ratesimmediately following any changes in the Government' s interest rateregulations (see para 105).

f. Free Limit

109. Considering the size distribution of subloans under the secondBank loan, only one of which has been above the free limit, theprevailing free limit of $40,000 is proposed to be maintained for theproposed loan3/.

g. Max:mum Size of Subloans

110. In order to ensure a balanced distribution of subloans, TDBwill not make any subloan' In an amount exceeding $250,0004/. TDB'spolicy statement restricts its maximum commitment in any enterprlse to20 per cent of its equity. This limit amounted to about T$0.72 million($0.52 million equivalent) as of 31 December 1985.

h. Reimbursement of Expenditures

111. Reimbursement of expenditures incurred up to 120 days prior tothe receipt of a subloan application by the Bank will be allowed5/, asunder the previous two Bank loans,

i. Procurement

112. TDB will satisfy the Bank that the procurement proceduresadopted by individual sub-borrowers under the proposed loan areappropriate in the circumstances6/.

17 P.A. Schedule, para 2.2/ L.A. Schedule 6, para 2; and P.A. Schedule, para 2.3/ P.A. Section 2.02.7J P.A. Schedule, para 3.5/ P.A. Section 2.03.Ti L.A. Schedule 4. par& 9.

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j. Withdrawal

113. The second Bank loan provided for withdrawal of 75 per cent ofcost of off-the-shelf purchase of machinery and equipment as indirectforeign exchange cost, where procurement costs were $50,000 or less whenthe foreign exchange cost could not be precisely determined, and 60 percent of total contract value for building construction projects. It isproposed to maintain these percentages in the proposed projectl/.

k. Data Monitoring

114. TDB will compile relevant subproject performance data,including relevant information for completed sub-projects for which ithas provided a subloan in excess of $10,0002/.

1. Quarterly Reports

115. TDB will provide to the Bank quarterly reports giving detailsof its operations, financial position, resource position, arrears andcollection performance, and institutional developments within threemonths after the end of each quarter3/.

C. The Proposed Technical Assistance

116. The technical assistance the Bank initially extended to theGovernment to establish TDB provided basic institution-building andmanagement in its initial stages. In connection with the first Bankloan for TDB, a second technical assistance grant was provided tore-engage the consultant as Managing Director for a 20-month period. Inconnection with the second Bank loan, further technical assistance wasprovided to assist TDB in developing its economic evaluationcapabilities. While TDB's institutional aspects are generallysatisfactory and its management is entirely localized, it is consideredthat TDB requires further technical assistance to upgrade specificinstitutional aspects that would promote the increased efficiency ofTDB's operations. The Government and TDB have requested advisory andoperational technical assistance as follows: assistance with thecomputerization of TDB's accounting system and assistance in reviewingTDB's personnel management policies and procedures.

117. TDB's accounting system is at present manually operated. At31 December 1985, TDB's accounting system was handling transactions fromalmost 5,000 loan clients. For most of these loans, interest is chargedand Installments are paid on a monthly basis. Furthermore, transactionsare conducted at each of TDB's three regional offices as well as atheadquarters. As a result, a relatively large volume of transactionsmust be handled each month. The current accounting system is working at

1/ L.A. Schedule 3, pawa 7.~/ P.A. Schedule, para 5.sI P.A. Section 3.05(b).

43

capacity to maintain up-to-date accounting records, and it is notcapable of generating timely and accurate manegement reports onimportant aspects such as arrears and the performance of the variousprofit-centers. Moreover, the high volume of manual input to theaccounting system results in a degree of inaccuracy. During mid-1983,consultants funded by the Japanese International Cooperation Agency(JICA) undertook initial systems specification and systems design for acomputerized accounting and loan administration system for TDB. On thebasis of the report prepared by the JICA team, the Mission estimatedthat the total cost of purchasing, installing and implementing acomputerized accounting system for TDB would be approximately $165,000,including the purchase of computer hardware, software and equipment forapproximately $35,000, and that the time required for installing such asystem would L- zpproximately eight man-months. It is proposed that theBank provide technical assistance in the amount of $125,000 to fund theforeign exchange portion of the consulting costs component of theproject with the balance of the financing for the purchase of computerhardware, software and equipment to be arranged by TDB.

118. The Mission found that TDB's policies and procedures relatingto staff remuneration matters, staffing levels and the determination ofstaff training and development needs have been developed in an ad hocmanner. As a result, there are deficiencies in staff resources in someareas of lDB's operations and under utilized staff resources in otherareas. In particular, there is no centralized responsibility for staffrecruitment that would allow all staffing decisions to be clearly madewithin the context of pre-determined budgets, staffing requirements andstaff development plans. It is proposed that the Bank provide technicalassistance in the amount of $35,000 to fund two man-months of consultingservices to review TDB's current personnel management policies andprocedures with the objective of providing recommendations for'.provement.

119. Terms of reference for the proposed technical assistance toTDB are presented in Appendix 13. The proposed technical assistance isestimated to cost about $168,000, of which the foreign currency costsare estimated to be not more than $160,000 (see Appendix 14). It isrecommended that an amount of $160,000 be provided by the Bank on agrant basis. TDB has agreed that on its part it would meet the localcurrency costs of the technical assistance for providing secretarialservices, domestic accommodation and transport and other support. Inaddition, TDB has agreed that its Board will approve the financing ofthe computer hardware, software and equipment prior to the consultantsbeing fielded for the computerization technical assistance.

120. Separate selection will be undertaken for each of thetechnical assistance components in accordance with the Bank's Guidelineson the Use of Consultants.

44

D. Benefits and Risks

121. TDB has tabulated the socloeconomic benefits anticipated fromprojects recelving TDB loans of $10,000 or more made between 30 June1977 and 31 September 1985. These projects, which had an aggregate loanamount of T$6.7 million, were expected to generate: (1) incrementalsales value of T$ 23.9 milllon; (ii) Incremental value-added of T$ 7.9million; (iii) net foreign exchange earnings/savings of T$ 6.6 million;and (lv) additional employment for 805 people. The subloans of over$10,000 approved under the previous two Bank loans accounted for T$1.54million (23.0 per cent) of this financing, and therefore have resultedIn significant economic benefits to Tongs. As of 31 December 1985, 12.0per cent of the value of subloans approved under the Bank's loans weremade to projects in the outlying Islands, thus assisting the developmentof the poorer, remote areas. Similar types of benefits could beexpected under the proposed project.

122. The risks involved In the project are minimal. TDB is anestablished and relatively experienced development bank with goodmanagement and staff. TDB's current sound financial condition tsexpected to continue (see pare 174), and strong debt-service coverageand debt:equity ratios are projected. Thus TDB's operations and abilityto service its financial obligatiois would remain unimpaired. TDB hasalso administered two Bank loans successfully and therefore should notencounter any problems in channelling the proposed loan to the intendeduses.

123, The only possible risks associated with the Project are that:*i) if TDB's portfolio arrears position were to deteriorate, it couldjeopardize TDB's financial soundness, and (Ii) if TDB continues to havedifficulties in recruiting good quality professional staff, loanappraisal and supervision standards could decline. However, the Missionfound that recent moves initiated by TDB's maagement have resulted inan improvement in TDB's arrears situation and further improvements areexpected (see para 166). Furthermore, the proposed technical assistancefor reviewing TDB's personnel management pollcies and procedures shouldprovide a sufficient basis for TDB's management to address and overcomecurrent and potential stafftng deficiencies. A further aspect whichcould detrimentally affect the utilization of the Bank loan is thecurrent Interest rate structure in Tonga (see para 32 and 33). Thecurrent artificially low rates that have resulted from the Government'sinterest rate regulations may result in a lessening of the effect ofmarket forces in allocating the loan proceeds to worthwhile projects.The proposed loan will, howover, Include appropriate conditionalityunder which the Government will discuss the technical assistanceconsultant's final report on review of interest rate policies with theBank and will implaent agreed-upon recommendations within a tsimeframeagreeable to the Bankl/. No.other problems could be idedtified whichwould entail constraints on the successful execution of the project.

1/ L.A. Schedule 6, pars 6.

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IV. THE EXECUTING AGENCY

A. Organization and Management

1. History, Legal Framework, Share Capital andRelationship with the Government

124. Following Bank technical assistancel/, Tonga Development Bank(TDB) was established on 30 June 1977 under the Tonga Development BankAct. As of 31 December 1985, TDB's authorized capital was T$7.0million, of which T$3.46 million had been issued. The Government owns90 per cent of TDB's shares while the Bank of Tonga (BOT) owns theremaining 10 per cent.

125. The Government and TDB have a close working relationship andTDB generally conforms to the economic priorities set by the Governmentthrough the national development planning program. The Government hasgeneral control over TDB through the following provisions in the Act:i) power to appoint the Managing Director; (ii) power to appointdirectors representing the Ministries concerned in TDB's operations2/ aswell as two other Directors; (iii) the appoiiitment of the Minister ofFinance as Chairman of the Board of Directors; and (iv) the requirementthat TDB function with due regard to the general economic policies ofthe Government. At present, three directors, including the BOTrepresentative, are from the private sector.

126. The Mission considers that the TDB Act, Articles ofAssociation and Policy Statement (see para 140 and Appendix 15) areappropriate and ensure reasonable autonomy for TDB in its operations.

2. Board '; Directors, Organization and Management

127. A list of the members of TDB's Board of Directors is given inAppendix 16. The Board meets at least monthly to set policies and toapprove loans excee.'ing T$15,000. In addition, the Board requested thatbeginning November 1985 TDB's management submit detailed quarterlyreports on the status of arrears for loans of T$5,000 or more. Althoughthe Board has generally functioned adequately, the Mission found from areview of the minutes of Board meetings that decisions relating to theestablishment of staff recruitment and remuneration policies had oftenbeen deferred or made in an ad hoc manner (see para 133). Otherwise theMission considers that TDB's Board of Directors provides adequateguidance and policy direction to TDB's operations and manage_mnt.

128. The organization chart of TDB is given in Appendix 17. Withinits headquarters office, TDB has separate operating divisions foragriculture loans and industrial and commercial loans. The managers ofeach of these divisions and the officer in charge of the loan

11 TA No. 174-TON approved 22 July 1976.2/ Ministry of Finance, Ministry of Agriculture, Fisheries and

Forestry, and Mnlistry of Labor, Commerce and Industries.

46

rehabilitation section report to the Deputy Managing Director. Thethtree regional offices In 'Eua, Ha'apai and Vava'u are notdivisionalized in their operations and report to the AdministrationManager at headquarters. The Mission found that TDB's organizationalstructure i8 appropriate to its current and future needs with thefollowing qualification. There is no defined personnel managementfunction within TDB's organization. As a result there Is inadeoquatecoordination of recruitment, establishment of required staffing levels,staff training and development and staff planning. The proposedtechnical assistance discussed in para 118 Is designed to address thisinadequacy.

129. TDB's Managing Director (MD), the chief executive, overseesTDB's operations. On 1 January 1986, the incumbent MD left for twoyears' study leave to the United States. During that period, theDeputy Managing Director (DMD) is the Acting 1D, and the OperationsManager for Industries and commerce is the Acting DMD. All of TDB'smanagement are Tongans with uuiversity qualifications; all of them haveappropriate experience and have performed effectively.

130. Two manager r 'ositions that are vacant at present areFinance Manager and r ;s and Research Manager. The Finance Managerposition is a kev f , part cularly given the need for strongaccounting expert - wi u 1DB du ing the proposed computerization ofTDB's accountir 4>tsem. .DB .. - iperienced difficulties in recruitinga suitably-c -ilfied Finance Manager from within Tonga and, as aconsequence, the Australian Government has agreed to provide anexpatriate accountant under technical assistance to fill the positionfor a two-year period. At the time of the Mission, a shortlist ofcandidates had been submitted to TDB, and an appointment is expected tobe made soon. To address the long-term position, a senior member ofTDB's accounting staff is studying, with financial assistance from TDB,for an accounting degree at the University of the South Pacific (seepara 155). The Economics and Research Manager position is vacant as aresult of recent promotions within TDB. This vacancy is less criticalas TDB's economist is well-qualified and capable of handling TDB'songoing requirements for economic evaluation, monitoring of the econvaicclimate and compiling and reporting on various statistics. However, ifTDB is to become more actively involved in sector research, projectidentification and project promotion activities, an Economics andResearch Manager needs to be appointed. TDB has applied to theCommonwealth Fund for Technical Cooperation (CFTC) for technicalassistance to fill the position, although the results of thatapplication are not yet known.

131. The Government will, before making any appointment to theposition of Managing Director or Deputy Managing Director, consult theBank regarding the qualifications, experience and tenure of office ofthe candidate 11.

17 L.A.L chedule 6, para 4.

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3. Staff and Training

132. TDB's total staff increased from 52 (including 28professionals) as of 30 September 1982, to 88 (including 32professionals) as of 31 December 1985. Staff turnover levels within TDBhave been low in the past, although staff turnover has increasedrecently from 14 per cent during 1982 to 24 per cent during 1985. Mostof this turnover has been among supporting staff and only fourprofessional staff had left TDB's employ between the time of TDB'sestablishment and 31 December 1985. Most of the increase in TDB's staffresulted from increased administrative staff numbers. This increase insupporting staff numbers resulted partly from the requirement for moreaccounting staff for operating TDB's manual accounting system. However,the Mission expressed the view, and TDB's management agreed, that therapid overall increase in TDB's supporting staff numbers was difficultto justify in terms of a compensatory increase in the volume of loan-related transactions. Overstaffing has therefore been allowed todevelop In some areas of.TDB's operations.

133. On the other hand, the increase in professional staff numbersover the period since 1982 has been relatively small, and it is apparentthat some important functional areas of TDB's operation areunderstaffed. In particular, two senior loan officer positions, theposition of rehabilitation officer and two staff training officerpositions are vacant. As a result, TDB's loan appraisal and supervisioncapabilities are overtaxed atid internal staff training programs havelapsed. TDB has encountered difficulties in recruiting personnel forthese positions, partly because the remuneration levels offered do notcompare favorably with remuneration levels within the private sector inTonga, particularly within the Bank of Tonga.

134. It is apparent from TDB's staffing situation that TDB'spersonnel management policies and procedures are in urgent need ofimprovement. TDB's management fully agrees with this assessment andattaches high priority to the need for the technical assistance proposedin para 118. The results of that technical assistance and TDB's plansfor implementing the consultant's recommendations will be discussed withthe Bank within three months of the completion of the consultingservicesl/.

135. TDB's in-house staff training activities are at presentrestricted to on-the-job training. This is supplemented by attendanceof professional staff at overseas training courses organized by, amongothers, the Bank2/. Twelve staff members attended such training coursesduring 1984 and 1985. The lack of formal in-house training has resultedfrom difficulties experienced in recruiting a suitable training officer.However, CFTC has approved provision of technical assistance that willprovide a staff training expert to TDB for a two-year period. Thisappointment is expected to be made during the first half of 1986. The

17 P.A. Schedule, para 9.2/ Three Tongans attended the Bank's Training Assistance Unit courses

during 1984 and four during 1985.

48

Mission considers that the proposed CPTC assistance will Improve TDB'astaff training procedures. The Mission also found that, as a result ofthe relatively long tenure of many of TDB's professional staff, thegeneral skill levels of staff are high and satisfactory for TDB'scurrent operations. TDB will continue to give high priority to itafftraining activities, will keep the Bank infored of its staff trainingprogram on an annual basiss1/ and will continue to take all necessarymeasures to ensure that Its staff is adequately qualified2/.

B. Operations

1. Activities

136. Although TDB is empowered to carry out a full range of lendingand other support activities,3/ it has mailly been involved In providingterm loans for projects in agriculture and industry. TDB has thus farmade five equity investments. TDB will seek the Bank's prior agreementbefore establishing or acquiring any subsidiary companyl/.

137. TDB's project admlaistration capabilities have also beenutilized in the implementation of projects as follows: (i) as agent tothe New Zealand Government for the Pacific Islands IndustrialDevelopment Scheme; (ii) as the executing agency for the Artisanal FleetDevelopment Plan under which 40 fishing vessels are being financed bythe Government and the United Nations Capital Development Fund; and(iii) as the executing agency for the Bank's credit line to assistprivate vanilla growers in the development of vanilla curing facilities,on-farm facilities and extension services. TDB also acts as acommission agent for insurance services to its borrowers. TDB, asagent, does not assume any liability under the insurance policies.

138. The provision of relatively small medium-term loans to a largenumber of borrowers remain TDB's predominant activity. The appraisaland supervision of a large number of such loans is a costly undertaking,particularly in view of the need for TDB to provide loan services towidely-dispersed geographic areas. As a result, TDB's administrativecosts are high in relation to the value of its portfolio (see pare 162).The Mission considers, and TDB's management agrees, that TDB shoulddevelop avenues for widening the scope of its activities so as to makemore efficient use of its staff and other resources. As well asimproving TDB's potential profitability, a wider scope of activities(including, for example, provision of hire purchase and lease financing,and providing loans for property purchase) could result in TDB being amore efficient financial intermediary. In addition, TDB has yet todevelop a domestic funding base independent of equity contributions fromthe Government and the Bank of Tonga, and in the interest of promotingits own maturity as a financial institution, such independent fundingsources should be developed.

17 P.A. Schedule, para 8.2/ L.A. Schedule 6, para 5; and P.A. Schedule, pars 7.3/ Under the TDB Act, TDB can lend to all types of development

projects, participate in equity investments and issue guarantees.4/ P.A. Section 3.08(c) (11).

49

139. As an initial step in developing a wider and more appropriaterange of activities, TDB has agreed to adopt an operatiug strategystatement by 31 December 1986 that would also formalize a specificprofit objective for FYs 1987 through 1990. The new strategy statementwill outline the means for improving TDB's profitability, including anynecessary changes in the scope and method of Its operationsl/.

2. Policies

140. The basic document guiding TDB's operations is its PolicyStatement which remains unchanged and continues to provide satisfactoryguidance (see Appendix 15). Any substantial amendment in TDB's PolicyStatement will be effected only with the prior agreement of the Bank2/.

3. Procedures

141. TDB's operational procedures for loan processing,documentation, procurement, disbursement and supervision are generallyadequate. Loan approval limits of TDB's officers have been reviewedsince the appraisal of the second loan. The Managing Director's loanapproval limit remains. unchanged at T$15,000, the Deputy ManagingDirector's loan approval limit has been increased from T$7,500 toT$I0,000, and Operations Managers can now approve loans of up toT$5,000. The Mission considers these limits to be appropriate.

142. The only major change in TDB's approval procedures since theappraisal of the Bank's second loan has been the establishment of a loanreview committee which is comprised of the Managing Director, DeputyManaging Director, Operations Managers, Administration Manager and theEconomist. This committee reviews all loan proposals of T$15,000 ormore at an early stage of loan processing. Loan supervision procedureshave, however, been significantly Improved. In recognition of theinadequate attention given to loan supervision prior to FY1984, and inresponse to a growing arrears problem (see para 166), TDB's managementestablished a rehabilitation section to handle problem loans of T$*5,000or greater, and introduced administrative procedures that ensure thatthe required project visits are made and appropriate follow-up actionsformulated. The Mission is satisfied that TDB's loan supervisionprocedures are satisfactory, but considers that the Improved arrearsinformation that will result from a computerized accounting system willmake TDB more responsive to emerging problem situations and furtherimprove the quality of TDB's loan portfolio.

143. TDB's loan appraisal procedures benefitted significatly fromthe work of the consultant under the Bank's T.A. No. 510-TON. As aresult of this technical assistance, economic evaluation aspects of theappraisal of loans of T$10,000 or more has improved, more attention isbeing paid to marketing aspects and sector issues, and financial

17 P.A. Schedule, para 13.2/ L.A. Schedule 6, para 3; and P.A. Section 3.01(c).

50

analyses are more detailed. In addition, an adviser currently secondedto TDB for a two-year period from the New Zealand Rural Banking andFinance Corporation has introduced improvements to the appraisal ofagricultural loans. The Nission is satisfied with the quality of TDB'sloan appraisals and was particularly impressed by the improvement inloan appraisal standards that resulted from the employment during thelast three years of the current Acting Deputy Managing Director and theOperations Manager for Industries and Commerce.

4. Operational Performance

a. Overview

144. Highlights of TDB's lending during FY1981-1985 are summarizedin Table 3. A detailed analysis of approvals by sector,type ofborrower, geographic location, size and maturity of loan is provided inAppendix 18.

Table 3: §ummzy of Low and Fm 98L-1m

Pye ndig 31 Dec. 1981 1982 B 1984 1985No. Am- No. Nuxm No. Ammt ND. Awt No. hAmt

Ariculdmwe 2,728 1,261 2,965 1,707 2,233 1,300 2,544 1,967 2,488 1,880ndustry and hbs s 347 1,198 427 1,134 312 1,113 369 1,427 303 1,690Staff a/ 71 78 39 38 103 47 180 98 270 128Equity bwetzumnts 1 25 - - 1 20 1 35 - -Total 3,147 2 - 2879 W W -3 3527 3 E W 3

3,4~~~ - - -. _- - -

Amwel Gwth Rate (Z) 24.9 12.4 (13.9) 42.2 4.8

a7 trn. areovId to staff on a lUdtd basis to assist wih pKonaral axpetes.Ia mea these loim are dert-tem salazy advane to mist with day-to-dayfinaing r {drEns,but thWy als include larger-tam lams for huse andorvdcle pase.

145. Between FYs1981 and 1985, TDB's approval levels grew at anaverage annual rate of 9.6 per cent. A 13.9 per cent decline inapprovals occurred during FY1983, largely as a result of cyclone Isaacand the subsequent disruption to the economy. With an infusion of fundsby way of additional equity from the Government and credit lines fromthe Bank and the European Investment Bank during late 1983 and early1984, lending levels were able to recover strongly during FY1984.

146. TDB's equity investment operations, which commenced in 1978,have been of minor importance. As of 31 December 1985, TDB had approvedsix equity investments with a total value of T$141,000. Of these, oneinvestment of T$20,000 was not disbursed, two investments totallingT$53,500 have failed and been written-off, three investments totallingT$32,000 are in profitable operation and one investment of T$35,000 isstill In its Initial expansion program. Appendix 19 provides furtherdetails of TDB's equity investment portfolio.

51

b. Type of Borrower) Geographic Locatlon, Loan Sizeand Maturity

147. A high proportion of TDB's clients are repeat borrowers.During FY1985 only 30 per cent of TDB's loan approvals by number and 32per cent by value were mwde to new borrowers. This is partly a resultof TDB's "Aim High" lending promotion which encourages quick repaymentof loans to qualify for a subsequent loan for further investmentpurposes.

148. TDB's lending has been concentrated in the main island ofTongatapu which accounted for 73.7 per cent of approvals by value duringfiscal year 1985. The geographic spread of TDB's lending correspondswith the population spread between the various islands and also with theavailability of better infrastructure and the larger market withinTongatapu.

149. The average size of loan approved by TDB increased from T$814during FY1981 to T$1,208 partly as a result of inflation, but also as aresult of TDB's increasing emphasis on lending to commercial agricultureas opposed to subsistence agriculture projects. However, during FY19852,680 loans or 87.5 per cent of the total loans by number were forT$1,000 or less. This is a large volume of loans for a small DFI toprocess, and is the prime cause of TDB's relatively high staff costs.

150. Between FY1981 and FY1985 there was a gradual increase in theproportion of loans made with longer maturities. Despite this, 88.6 percent of the loans made by TDB during FY1985 had a maturity of less thantwo years. This reflects the small size of the loans and also thepurpose of many loans which were made to facilitate the planting andharvesting of short-term crops. However, to promote longer-termdevelopment of productive resources and also to allow TDB's interestearning portfolio to increase to a more profitable level, TDB needs toincrease the average maturity period of its loans. This is recognizedby TDB's management, and top priority has been given to theidentification of projects requiring long-term financing.

c. Sectoral Distribution

151. A detailed sectoral classification of approvals for the periodFY1981-1985 Is provided in Appendix 20. The sectoral distribution ofTDB's leandlg reflects the importance of the agriculture sector inTonga's economy, with 53.6 per cent of total approvals during the five-year period being made to agriculture projects. Financing of crops isthe dominant form of agriculture lending with 27.3 per cent of totallending for the period. This is followed by farm, plant and equipmentfinancing with 15.4 per cent of total approvals. Despite the highpriority given to the identification and promotion of industrialprojects by both TDB and the Government, only 10.1 per cent of TDB'sapprovals during the five-year period were to manufacturing projects.The small domestic market within Tonga and high transport costs forexported products have the Inevitable result that new manufacturingindustries are difficult to establish. In addition, a sbortage of

52

local entrepreneurs and technicians results in a situation in which arelatively low proportion of TDB's lending is to industrial projects.The tourism industry was the next most Important recipient of TDB'sloans, receiving 7.8 per cent of total approvals over the five-yearperiod. This reflects the steady growth of small-scale touristfacilities within Tonga.

5. Projected Operational Performance

152. The projected lending and equity investment operations of TDBfor FY1986-1990 are summarized in Table 4.

Table 4: TDB's Projected Loan and Equity Investment Approvals(T$'O0O)

Year ending 31 Dec. 1986 1987 1988 1989 1990 Total 2

Agriculture 29100 2,218 2,307 2,415 2,514 11,554 44.5Industry andbusiness 2,028 2,028 2,682 3,084 3,547 13,673 52.7

Staff 75 78 82 86 90 411 1.6Equity Investments 50 50 75 75 75 325 1.2

Total 4,253 4,678 5,146 5 660 6,266 25 963 T-1.0US$ Equivalent 3,037 34 3,673 5 4,447

153. Of TDB's total projected loan and equity approvals of T$26.0million during FY1986-1990, the agriculture sector will account for 44.5per cent, followed by the industry and business sectors (52 per cent),staff loans (1.6 per cent),: and equity investments (1.2 per cent). Theprojected approvals for 1986 are based on TDB's operational plan andpipeline of projects and will represent an increase of 15 per cent over1985. Thereafter, projected approvals are expected to increase at anannual rate of 10 per cent. These projections, vhich take into accountthe envisaged capital outlays it the country, the operationalperformance of TDB during 1985 and its existing pipeline, are consideredreasonable and realistic.

C. Accounting, Audit and Financlal Controls

154. TDB's accounts are maintained in accordance with therequirements under the TDB Act. The accounting system iS centralized atthe headquarters office, although the Vava'u office maintalis its ownloans ledger. The accounting system is msnually operated and utilizesthree NCR accounting machines. Income is reported on an accrual basis;the format of the accounting system would make it difficult for incometo be reported on a cash basis. The accounting system currently inuse has remalied basically unchanged since TDB was established and is nolonger appropriate to TD'sa requirements, given the large number of loanaccounts and the large number of transactions handled each month. In

53

particular, the system does not allow for variable interest rates to becharged, does not automatically compute penalty interest or interest tobe charged on overdue installments and arrears; such information must belaboriously extracted by anually checking all loan ledger cards. As aresult, arrears reports are often up to two months late.

155. The senior accounting officers are adequately trained and haveshown themselves capable of operating the current system in a mannerthat allows acceptable accounting information to be generated for theday-to-day operation of TDB. In addition, monthly, quarterly and annualincome accounts and balance sheets are generated In a timely manner.TDB will continue to provide the Bank with its financial projections forthe succeeding three years within six months of the completion of eachfiscal year 1/. TDB has encountered difficulties since itsestabliahuent, however, in recruiting a sufficiently experienced andqualified Finance Manager. The position was most recently filled (untilNovember 1985) by a US Peace Corps volunteer who performed herday-to-day duties adequately, but was unable to introduce neededimprovements into the accounting system and was also unable to fulfillthat part of her terms of reference that required an updated accountingprocedures manual to be prepared. As a long-term solution to fillingthis vacancy, a TDB staff member is currently at the University of theSouth Pacific studying for an accounting degree with financial supportfrom TDB. An interim Finance Manager is currently being recruited for atwo-year term under Australian Government technical assistance.

156. The need for TDP to purchase and introduce an appropriatecomputerized accounting system is urgent and Bank technical assistanceIs proposed for that purpose (see para 117).

157. TDB employs a full-time internal auditor who reports directlyto the Managing Director. He undertakes acceptable checks and preparesappropriate reports on the manner in which TDB's operating proceduresare followed and accounting transactions conducted. Appropriate actionsare taken by TDB's management to follow up on the internal auditor'srecommendations.

158. TDB confirmed that its accounts will continue to be audited byan independent private auditor acceptable to the Bank, and that a copyof the audited accounts and the auditor's report will be furnished tothe Bank within six months after the end of TDB's financial year2/. Itwas further agreed that the audit report would include a separate longform audit report containing (i) the scope of audit, and adequacy ofinternal control procedures; (ii) a quality classification of TDB's loanand equity portfolio; (iii) the auditor's opinion regarding the adequacyof TDB's balance sheet provisions; (iv) an analysis of arrears; (v) theauditor's evaluation of the adequacy of TDB's accounting systems andprocedures and of its financial management; and (vi) the auditor'sopinion as to whether the covenants of major borrowings have beencomplied with so that their maturities are not likely to be

1/ P.A. Schedule, para 10.21 P.A. Section 3.06 (a).

54

acceleratedl/. TDB will also authorize the Bank to discuss itsfinancial alfairs from time to time with TDB's independent auditors 2/.The Mission considers TDB's current audit arrangements satisfactory.

D. Financial Performance

1. Interest Rate Structure

159. The interest rates charged by TDB vary between 6 per cent and10 per cent per annum depending on the type of project being financedand the size of the loan. The lowest rates are charged on loansprovided to top-priority projects for development of the agriculture,fisheries, livestock and natural resource sectors. TDB's currentinterest rate structure (see Appendix 2) was adopted on 1 October 1984following a review of its interest rate policies conducted by theconsultant under the Bank T.A. No. 510-TON. The consultant recommendedthat concessional interest rates should continue to be charged inaccordance with sectoral prioritisE as defined under the Government'sdevelopment plans. TDB has agreed to review and revise its interestrate structure In consultation with the Bank within one month of anychanges being wade in the Goverrment's interest rate policy, law orregulations 3/.

160. Under the current interest rate structure, it is expected thatTDB will have a projected average onlending rate of 8.5 per cent perannum to its borrowers. This rate is comparable with the averagelending rate of BOT which is expected to be 9 to 9.5 per cent. Themargin provided to TDB under the proposed loan of 5.5 per cent isadequate to meet TDB's projlcted costs.

2. Past and Current Performance

161. Table 5 summarizes TDB's financial performance for FYs1981through 1985. The detailed financial statements are given in Appendixes21, 22 and 23.

1/ P.A. Section 3.0 (b).2/ P.A. Section 3.06 (c).3/ P.A. Schedule, para 2.

55

Table 5: Sumary of Financial Performance FY1981-1985(T$'0O)

Year ending 31 December 1981 1982 1983 1984 1985

Total assets 3,734 5,176 5,679 7,046 8,149Total portfolio 2,872 3,789 4,136 5,626 6,389Total long term debt 2,050 2,484 2,711 3,388 4,256Tozal equity 1,571 2,557 29848 3,237 3,618Income from loans 218 299 375 405 517Operating expenses 165 196 264 360 423Interest on borrowings 57 71 72 86 110Net income 17 34 31 22 30

Ratios:

Debt:equity a/ 1.3:1 1.0:1 0.9:1 1.0:1 1.2:1Debt-service coverage(times) 26 25 18 5.9 8.2

Return on av. equity 1.1 1.3 1.1 0.7 0.9Operating expenses toaverage total portfolio 6.9 6.0 6.7 7.5 7.0lnterest spread b/ 6.1 6.3 6.8 5.6 5.8Earnings spread c/ 7.7 7.1 8.1 7.6 8.2Current ratio dr 6.7:1 7.3;1 8.2:1 2.2:1 4.8:1

Long-term liabilities less current portion of long-term debt:total equity.

b/ Income from portfolio as a percentage of average portfolio minusInterest on borrowings as a percentage of average borrowings.

c/ Total income as a percentage of average total loans and Investmentsminus Interest and operating expenses as a percentage of averageloans and investments.

d/ Current assets:Current liabilities.

162. TDB has maintained margitally acceptable profitability duringthe period FY1981-1985 with a return on average equity varying between0.7 per cent and 1.3 per cent. This relatively low return on equity isa reflection partly of. TDB's low debt:equity ratio which has beenmaintained at close to unity and of TDB's relatively high personnelcosts. These high costs are a result of the large number of small loanshandled by TDB, but also of inadequate staffing policies whieh may haveresulted in an overstaffing situation in some areas of TDB's operation(see para 132).

163. TDB has maintained strong liquidity over the period. AlthoughTDB's debt-service coverage ratio has reduced during FYs1984 and 1985from very high earlier levels reflecting the end of grace periods onearlier borrowings, it still reflects a strong position at 8.2 times forFY1985. The debt:equity ratio has rmained well wi.this the coveinatedmaxwmum of 3:1.

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164. TDB's source and application of funds during FYs1981-1985 aresummarized in Table 6. Details of TDB's borrowings as of 31 December1985 are given in Appendix 24. During the period, loan disbursementsconstituted the bulk of the total fund requirements accounting for 87.1per cent. Debt service requirements were light (5.5 per cent),reflecting the long-term nature of TDBts borrowings with grace periodsranging from five to ten years. Internal cash generation and loancollections accounted for a relatively high 62.5 per cent of TDB'sresource requirements over the period, reflecting the relatively shortmaturity of TDB's loans.

Table 6: Summar of TDB's Sources and ApplIcation of Funds(FY 1981-1985)

(T$_'000)

Year ending 31 December 1981-1985 %

Sources of Funds:

Internal cash generation 1,047 7.2Loan collections 8,049 55.3Borrowings 2,963 20.3Share capital increase 1,929 13.3Increase in current liabilities 566 3.9Total 14,554 100.0

Application of Funds:

Loan disbursements 12*673 87.1Debt service 798 5.5Acquisition of fixed assets 917 6.3Increase in current assets 166 1.1Total 14,554 1B675

3. Portfolio Management

165. An analysis of TDB's loan collection performance and asectoral analysis of TDB's portfolio for the period PYs1981-1985 isprovided in Appendix 25. As of 31 December 1985, TDB's loan portfoliototalled T$6.3 million and accounted for 77.8 per cent of total assets.Between FYs1981 and 1985, TDB's loan portfolio increased in line withits lending operations. The share of agriculture loans by amount in thetotal portfolio increased only marginally from 37.6 per cent to 39.8 percent despite the higher proportion of approvals to the agriculturesector during the period. This is a reflection of the generallylonger-term average maturities for industrial and commercial loans.

166. TDh's loan collection performance deteriorated between FYs1981and 1983. During FY1981,, TDB achieved a good collection ratio of 78.5per cant and this had declined to 62.6 per cent by the end of FY1983.External causes of this deterioration included the effects of the

57

cyclone in 1982, a prolonged drought during 1983 and the adverse impactof worldwide economic recession since 1981. Within TDB, Inadequate loansupervision procedures that were exacerbated by the steadily increasingnumber of loans in TDB's portfolio were also an important cause of theincreasing arrears levels. TDB's management recognized this problemduring 1984 and appointed an arrears task force to develop remedialaction. This remedial action included the establishment of a loanrehabilitation section to handle larger problem loans and to maintain awatching brief over the staff's performance In meeting its loansupervision requirements. In addition, improved administrativeprocedures for loan supervision have been developed and implemented.

167. The Mission found that TDB's management has now takenappropriate action to improve loan supervision and as a result. TDB'scash collection ratio has improved to 67.2 per cent during FT1985. Thisimprovement has occurred despite a prolonged drought In Tonga during1985 that affected the performance of a large number of the projectsstupported by TDB. To encourage further improvements in TDB's collectionperformance, a covenant to the proposed loan will require TDB to furtherimprove its minimum annual cash collection ratio, calculated on arolling quarterly basis, to 70 per cent by the end of 1986 and to 75 percent by the end of 1987 and thereafter 1/.

168. A detailed analysis of TDB's arrears is provided in Appendix26. Total arrears increased from T$0.189 million as of 31 December 1981to T$0.523 million LB of 31 December 1985. At that date, 68.4 per centof arrears by value were from agriculture loans which, In addition tobeing the sector worst affected by cyclones and drought, are the mostdifficult to supervise. TDB's overall arrears ratio (the ratio ofarrears to total portfolio) has, however, improved significantly from12.57 per cent at 31 December 1983 to 8.3 per cent at 31 December 1985,mainly as a result of the improved loan supervision.

169. The category of TDB's arrears that is in most need ofattention is the hardcore arrears that are 12 months or more overdue.The arrears in this category increased from 1.3 per cent of totalportfolio value at 31 December 1981 to 5.9 per cent at 31 December 1983,and have since declined to 3.8 per cent at 31 December 1985. A highproportion of these arrears are well secured under chattels securitiesand/or meaningful personal guarantees. TDB has previously beenreluctant to enforce such securities In a businesslike manner, althougha stronger attitude has been adopted recently. The Mission feels,however, that high priority should be given to reducing the hardcorearrears which at 31 December 1985, were equivalent to 45.5 per cent oftotal arrears. Accordingly, a covenant to the proposed loan willrequire TDB to reduce the ratio of hardcore arrears to total loanportfolio value, calculated on an annual basis, to a maximum of 3.0 percent by 31 D,cember 1986, and to a maximu of 2.0 per cent by 31December 1987 and thereafter 2/. In the event that TDB fails to meetthese targets, or the minlmum annual cash collection ratios (see para167), disbursements under the proposed loan could be halted 3/.

1' P.A. Schedule, para 11 (a).2/ P.A. Schedule, pare 11 (b).31 L.A. Schedule 3, para 9; and P.A. Schedule, para 12.

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170. TDB'a provision for doubtful debts as of 31 December 1985 wasT$396,000, equivalent to 75.7 per cent of total arrears. Given thegenerally good security held by TDB over its loans and the goodrepayment ethic present within Tongan society, the Mission considersthis provision to be acceptable.

4. Projected Financial Performance and Resource Position

171. A summary of TDB's projected financial performance forFYs1986 through 1990 Is given in Table 7, and details are given inAppendixes 21, 22 and 23. The major assumptions for the projections aregiven in Appendix 27.

Table 7: Swima of Prolected Financial PerformanceFY1986-1990

Year ending 31 December 1986 1987 1988 1989 1990

Total assets 9s786 10,304 10*802 11,856 13,618Total portfolio 7,607 8,377 9,519 11,131 13,066Total long-term debts 5,788 6,164 6,405 7,056 8,059Equity 3,798 3,950 4,091 4,492 5,105Income from loans 656 746 831 954 1,116Operating expenses 505 545 576 606 667Interest on borrowings 146 170 178 194 222Net Income 38 52 41 51 63

Ratios: a/

Debt:equity 1.5:1 1.6:1 1.6:1 1.6:1 1.6:1Debt service coverage

(times) 7.4 7.9 7.2 6.0 4.8Return on averageequity 1.0 1.3 1.0 1.2 1.3

Return on equitybefore provisions 4.1 5.4 5.9 f.9 7.8

Operating expenses toaverage total portfolio 7.2 6.8 6.4 5.9 5.5Interest spread 6.6 6.7 6.7 6.6 6.6Earnings spread 8.2 8.1 8.2 8.3 8.3Current ratio 8.9:1 8.3:1 3.6:1 2.4:1 1.7:1

a/ Ratios calculated as in Tale 5.

172. TDB is projecting a continuation of marginally acceptableprofitability. Net income as a percentage of average equity is notprojected to increase significantly despite good projected portfoliogrowth and an average Interest spread of around 6.6 per cent. However,the projections reflect the requirement for TDB to commence paying

59

income tax from FY1988 1/. Under Tongan law, tax is calculated on netincome before provisions for doubtful debts. In the case of TDB, 75 percent of projected net income before tax is transferred to the provisionfor doubtful debts. As result, a high rate of tax on net profit afterprovisions Is projected. TDB's return on equity before provisions isprojected to show a more satisfactory increase from 4.1 per cent inFY1986 to 7.8 per cent in FY1990.

173. The Mission considers that TDEBs operational efficiency wouldbenefit from the commercial discipline that would follow from theadoption of a more challenging profit objective. A coveuant to theproposed loan will require that TDB adopt a new operating strategystatement prior to 31 December 1986 that incorporates such aprofitability objective for FYs1987 through 1990 and the proposed meansfor achieving it 2/.

174. TDB is projecting a continuation of its satisfactory liquidityposition with projected debt service coverage well above the covenantedminimum of 1.5 times cover 3/. TDB's financial structure is alsoprojected to remain strong and the projected debt:equity ratio remainsbelow the covenanted maximum of 3.0:1 41. The Mission considers thatTDB's policy of appropriating 75 per cent of pre-tax profit to itsprovision for doubtful debts should provide adequate protection againstpotential bad debts in forseeable circumstances. In addition, TDB'sauditors will in the future be required to provide their assessment ofthe adequacy of TDB's provisions 5/. The projections show thi.sprovision increasing to T$1,135 millia by 31 December 1990, equivalentto 8.7 per cent of total projected portfolio value.

175. The Government has given satisfactory assurances with regardto meeting TDB's local currency requirements 6/. TDB's projectedfinancing plan for the period FY1986-1990 is summarized in Table 8.

1/ TDB was awarded a ten-year tax holiday at the time of itsestablishment.

2/ P.A. Schedule, para 13.3/ P.A. Schedule, Section 3.09./I P.A. Schedule, Section 3.09.51 P.A. Section 3.06 (b).T/ L.A. Section 4.02 (b).

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Table 8: TD's FinancIEg Plan for FY1986-1990(T11000)

Year ending $1 December 1986-1990 2

Sources of Funds

Internal cash generation 2,159 9.1Loan collections 14,656 61.6Borrowings 5,538 23.3Share capital increases 1,242 5.2Increase in current liabilities 179 0.8

23,774 100.0

Application of Funds

Loan and equity disbursements 21,333 89.7Debt service 2,641 11.1Acquisition of fixed assets 380 1.6Increase in current assets 580) (2.4)

Z3,7 4 -100.

176. Total disbursements of loans and equity investments for theperiod are projected to amount to T$21.3 million, of which the foreigncurrency portion will account for about 40 per cent. TDB's total debtservice requirement will Increase significantly to 11, 1 per cent oftotal fund requiremante as a result of the ending of the grace periodson various borrowings, but will still be a relatively low proportion ofTDB's outgoings. The major sources of finance will be from internalcash generation and loan collections (70.7 per cent) followed by newborrowings (23.3 per cent). The Mission considers that TDB's financingplan is sound.

E. Implemetation of Previous Bank Loans and Teehnical Assistance

1. General

177. The details of the Bank loans and their utilization are givenin Appendixes 28 and 29. The Bank has provided for TDB from SpecialFunds, loans totalling US$2.5 million the overall utilization of whichhas been satisfactory. The first Bank loan has been fully utilized andclosed. Comitments under the second loan of US$1.0 million amounted to$0.646 million as of 31 December 1985, and It Is expected to be fullycommitted as of 31 May 1986. All disburcements under the Bank loansthus far have been on a reimbureemet basis, mainly for off-the-shalfpurcbaess. An manlysis for the two Bank loans of procureant by countryof origin Is given in Appesdix 30. By amount, the loading countrieswere Japan, Australia and New Zealand.

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2. Nature of Subloans

178. TDB has financed 1,410 subloans under the two Bank loans as of31 December 1985. By number, 91.9 per cent were approved for theagriculture sector, followed by 7.0 per cent for the service sector and1.1 per cent for the manufacturing sector. The average size of subloanunder the first loan was $1,458 and $1,543 under the second loan.Reflecting this relatively small average size of subloans, 92.4 per centof subloans under the first loan and 77.7 per cent of subloans under thesecond loan were for a term of two years or less. Subprojects financedunder the two loans were mainly located in Tongatapu and Vava'u.

3. Financial and Socioeconomic Performance of Subprojecte

179. It is difficult to assess the financial and socioeconomicperformance of subprojects financed under the loan due to the nature ofthe subprojects, a paucity of relevant data and the large number ofsmall borrowers involved. However, all apart from 13 of the 57 subloansof over T$5,000 financed under the first loan have since been repaid;this implies generally satisfactory financial performance. As of 31December 1985, 16 of the 64 subloans of over T$5,000 financed under thesecond loan were in arrears, a proportion which is generally in linewith the performance of TDB's overall portfolio.

180. The consultant employed under the Bank's T.A. No. 510-TONevaluated data on the expected socioeconomic contribution of loans ofover $10,000 provided by TDB since its establishment. The consultantfound that such loans had an aggregate amount of T$6.7 million and wereexpected to generate (i) incremental sales value of T$23.9 million, (ii)incremental value added of T$7.9 million; (iii) net foreign exchangeearnings/savings of T$6.6 million; and (iv) add!tional employment of 805people. The subloans of over $10,000 approved under the two Bank loansaccounted for 23.0 per cent of this financing and therefore haveresulted in significant economic benefits to Tonga. For the purpose ofthe proposed loan, TDB has agreed to introduce an improved projectbenefit monitoring system to allow an improved assessment of the loan'sfinancial and socioeconomic performance 1/.

4. Implementation of Technical Assistance

181. The first two technical assistance grants provided by the Bankto TDB enabled a senior development banking expert to be employed toassist the establishment of TDB and the initial management of TDB'soperations. This technical assistance made an Important contribution tothe subsequent satisfactory performance of TDB. The technicalassistance provided under the second loan was originally intended toprovide accounting as well as economic evaluation expertise tostrengthen TDB's operations. However, a US Peace Corps volunteer withappropriate qualifications became available to TDB, and the full nineman-months of the Bank's technical assistance were utilized to ImproveTDB's economic evaluation capabilities. This technical assistance wassuccessfully completed, and related changes have since been made toTDB's policies and procedures.

1/ P.A. Schedule, para 5.

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5. Lessons Learned from the Previous Bank Loans

182. The sajor recomendations of the Project Completion andProject Performance Audit Reports covering the first Bauk loan were asfollows: (1) The Bank should cosider the provision of furtherinstitution-building technical assistance to TDB following an li-depthanalysis of TDB's key constralits and potentials; (ii) TDBtsinstitutional productivity should be laproved through an improvement ofpersonnel mangemnt policies and procedures, through a widening of thescope of TDB's operations, and through a review of TDB's isetitutionalstructure; (iii) a thorough study of the causes and implications ofTDB's hardeore arrears Is necessary; and (iv) the government shouldimprove the effectiveness of Its Interest rate policies.

183. The Mission undertook its appraisal for the proposed loanwithin the context of these recommendations and ldentifled the keyconstraints to TD)B's operations as being its inadequate accountingsystem, inadequate personnel mauagement policies and procedures, and therestrictive Interest rate enviroment. Appropriate technical assistanceis proposed to help overcome these constraints. The recomendation thatthe scope of TDB's operations be reviwed and widened was addressedduring detailed discussion with the Government and TDB. A videaning ofthe scope of TDB's operations could include TDB's inolvemet in hirepurchase and lease activities and possibly the provision of homefinance. In addition, TDB could hecome lvolved In taking deposits fromthe private sector. A covenant requiring TDB to review its operatingstrategy was developed in this regard 1/. The Mission found thatappropriate analysis of TDB's arrears sltuation has been undertaken byTDB's management and appropriate corrective action taken (see paras 166an4 167).

6. Compliance with Previous Bank Loan Covenants

184. All covenants under the Bank's loans to TDB have been compliedwith (see Appendix 31).

17 P.A. Schedule, para 13.

63

VII. CONCLUSIONS AND RECOMMENDATIONS

185. The scattered nature of the Tongan island groups and thesmall size of the country's population means that development projectsare smalU and have to be designed to fit within the capacity of theImple_enting Agencies. In this context, the Project has beenfomulatted as a Multiproject and a Line of Credit to TDB. Theproposed loan of $3.0 million from the Bank's Special Funds Resources- $2.0 million to support the Multiprojece and $1.0 million toprovide the line of credit -- is considered suitable for this purpose.the Project also provides for technical assistance grants totalling$381,000 to provide consulting services to assist in implementing thesubprojects to be financed under the Multiproject, to enable theGovernment to review its interest rate policies, and to provideinstitutional strengthening to selected implementing agencies and TDB.

186. The Multiproject will support implementation of a number ofsmall, high-priority subprojects in the industrial and infrastructuresectors; the subprojects will support development of manufacturing,the Goverrment's regional development policy, and development ofagriculture. The line of credit to TDB will also generally supportdevelopment of manufacturing and agriculture. In designing thesubprojects to be financed under the Multiproject, due attention hasbeen paid to Government priorities, technical feasibility, economicviability and the state of project preparation; they have also beenformulated to ensure they are within the capacity of the implementingagencies.

187. TDB's institutional and operational aspects continue to besatisfactory although TDB's accounting system and personnel policiesand procedures are in urgent need of strengthening. Apart from thesedeficiencies, TDB has developed as a well-performing developmentfinance institution with potential for further growth and has a soundfinancial position. Covenants to the proposed loan will ensure thatTDB will continue to maintain a sound financial position and willencourage further improvement in TDB's profitability and a broadeningof its scope of activities.

188. In addition to the standard provisions and requirementsIncluded in the Bank's loan documents, specific assurances have beenreceived from the Borrower with respect to the following:

A. For the Multiproject:

(i) Each subproject will be subject to individual appraisal bythe Borrower and the financing of a subproject under the loanwill be conditional on the Bank's approval of the subproject on thebasis of the appraisal report submitted by the Borrower (Loan Agreement,Schedule 1, para 1).

(il) By agreement between the Bank and the Borrower, subprojectsmay be added to, or substituted for those subprojects listed in theAttachment to Schedule 1 of the Loan Agreement, provided that the

64

identification, preparation and implementation arrangements are carriedout in accordance with criteria acceptable to the Borrower aud theBank, and the required finap ng for the Multiproject does not exceedthe amount of the Loan (Loan Agreement, Schedule 1, paras 1 and 2).

(iii) No withdrawals will be made from the Loan Account forexpenditures incurred In carrying out work on Subproject Nos. 4 and 6(Agricultural Acess Roads, 'Eua Island, and Rural Roads Improvement,Tongatapu) until satisfactory evidence has been presented to the Bankthat an engineering charging system satisfactory to the Borrower andthe Bank will have been implemented with respect to these subprojectsby MOW [Loan Agreement, Schedule 3, para 5 (it)].

(iv) Not later than one month after the consultants to befinanced under the Bank technical assistance grant for theMultiproject have completed their final report on the study to beundertaken of the Tongatapu SIC rental structure, representatives ofthe Borrower will meet with representatives of the Bank to developnecessary revisions to the rental scheme for the Tongatapu SIC,including a phased program for increasing rental fee levels which willensure that the Tongatapu SIC will operas, on a no-profit no-lossbasis (Loan Agreement, Schedule 5, para 9).-

(v) The Borrower will institute a system of tariffs for use ofcoastal port facilities in Tonga which will set tariff levels that:(a) are, by the completion of Nafanua Harbour, adequate to recover atleast the cost of operation and maintenance of Nafanua Harbour; and(b) are, within a period of time satisfactory to the Borrower andthe Bank, adequate to recover an agreed-upon percentage of the capitalcost of the coastal ports (Loan Agreement, Schedule 5, para 15).

(vi) Within two months of the completion of the review of theGovernment's interest rate policies, the Government will discuss thereport's recommendations with the Bank and will implement agreed-uponchanges within a timeframe satisfactory to the Bank (Loan Agreament,Schedule 6, para 6).

B. For the line of credit:

189. (i) In the event that Tonga's interest rate policy, law orregulations are amended to allow higher lending rates to be charged byTDB, the onlending rate will be reviewed and revised in consultationwith the Bank (Loan Agreement, Schedule 6, para 2; Project Agreement,Schedule, para 2).

(ii) Within three months of the completion of the consultingservices funded under the Bank technical assistance for reviewingTDB's personnel management policies and procedures, the consultant'srecommendations will be discussed with the Bank (Project Agreement,Schedule, para 9).

17 A similar covenant requires the Borrower to ensure that theVava'u SIC operates on a no-profit no-loss basis.

65

(MA) As initial step in developing a wider end moreappropriate rnge of activites, TDB hs agreed to adopt en operatinstrateg by 31 December 1986 that vili formaliz a more specficprofit objective for the flimcial yars 1987-1990 (Project Agreemnt,Schedule, para 13).

(iv) To encouroge further improvemnts In TDB's collectionperfomnce, TDB will be required to meet minimum anul cashcollectlon ratio targets of 70 per cent by the end of 1986 and 75 percent by the end of 1987. Also, In order to focus loan supervilsoefforts on TDB's hardcore arrears, TDB il be required to reduce theratio of hardcore arrears to total portfolio to 3.0 per cent by theand of 1986 and to 2.0 per cent by the end of 1987J (Project AgstSchedule, para 11). Except as the Bank may otherwie agree,couitusats will be balted in the event these targets are not not(Loan Agre t, Schedule 3, pare 9; Project Agreamt, Schedule,pares 11 (a) end 12).

66

LIST OF APPENDIXES

ApRendix Page

A. Background

1 Tonga Telecomunications Commission 68

2 Interest Rates Prevailing in Tonga 69

3 Income Statement: Tongatapu SIC 70

B. The Multiproject

4 Nafanua Harbour Improvement, 'Rua Island 71

5 Small Industries Centre, Vava'u 73

6 Detailed Cost Estimates of the Multiproject 75

7 Amount of the Project to be ImplementedUnder Different Procurement Procedures 77

8 Implementation Schedule 78

9 Outline Terms of Reference for Appraisal ofSubprojects under Multiproject Loan and fora Review of Government Interest Rate Policies 79

10 Outline Terms of Reference for Development ofNafanua Harbour 87

11 Estimated Cost of Proposed Technical Assistance 90

12 Economic Evaluation of Nafanua Harbour andAgricultural Access Roads on 'Eua Island 91

C. The Line of Credit

13 Outline Terms of Reference for Proposed TechnicalAssistance to TDB 100

14 Cost Estimates for Proposed Technical Assistanceto TDB 104

15 Statement of Operating Policies 105

16 Members of Tonga Development Bank'sBoard of Directors 110

17 Organization Chart for Tonga Development Bank 111

18 Analysis of Loan and Equity Investment Approvals 112

67

Appendix Paie

19 Equity Investment Portfolio 113

20 Analysis of Approvals by Industrial Sector 114

21 Actual and Projected Income Statements 115

22 Actual and Projected Balance Sheets 116

23 Actual and Projected Cash Flow Statements 117

24 Details of Major Borrowings 118

25 Analysis of Collection Performance andSectoral Analysis of Portfolio 119

26 Analysis of Arrears 120

27 List of Major Assumptions for Financialand Operational Projections 121

28 Details of Previous Bank Loans 123

29 Analysis of Subloans Provided Underthe EarlUer Bank Loans 124

30 Procurement by Country Under Previous Bank Loans 125

31 Compliance with Covenants Underthe Earlier Bank Loans 126

68

Appendix 1TONGA TELECOMMUNICATIONS COMMISSION

Profit and Loss Statement for the Year EndinR 30 June 198-(T$)-

1985 1984REVENUE

Telephone Meter Calls 608,773 *53,852Telephone Rental 172,582 129,588Radio Telephone Calls 92,964 54,991Connection Fees and Other Parges 29,175 19,189Terminal Share & Royalties- 184,040 358,646Telegrams 88,841 79,449Miscellaneous 106,869 41,685

TOTAL REVPNUE 1,283,244 1,137,400

EXPENSES

Payroll 499,491 290,845Utilities 74,447 40,208Travelling & Transport 66,725 36,968Accommodation 10,913 60,646Subscription & Donations 21,250 14,813Repair & Maintenance 116,778 118,009Legal & Audict$g Charges 21,976 29,892Depreciation- 238,840 201,171Amortisation of Consultancy Cost 43,231 43,231Miscellaneous 42,879 67,157

TOTAL EXPENDITURE 1,136,530 902*940

Operating Pro5)t Before Abnormal Item 146,714 234,640Abnormal Item- 52,992 _ _

Operating Profit After Abnormal Item 93,722 234,640Prior Period Adjustment 1,295 -

Operating Profit Before Tax 92,427 234,640Income Tax 23,107 -

Net Profit After Tax 69,320 234,640Dividend to Government 34,660 -

Net Profit After Dlyidend Transferredto General Reserve- 34,660 -

a/ This refers to the first full year of the Commission's operationas a Public Corporation.

b/ The Commission receives a 15 per cent share of the revenue earnedfrom the international calls operated by Cable & Wireless (UK)under a franchise agreement.

c/ Calculated on the basis of historical costs.d/ Mainly writing off obsolete stock.e/ The debts of the previous Telegraphs and Telephones Department

were transferred to the Corporation as an Interest-free TreasuryLoan; no Interest charges are therefore shown in the accounts.

(Reference In text: page 10, para 24)

69

Appendix 2

INTEREST RATES PREVAILING IN TONGAas of 31 December- 1985

(T and per cent)

BANK OF TONGAPer Cent Per Annum

Under T$100,000$100,000 and-over

Deposit Interest rate.

Savings accounts 5.0 5.0

Term Deposits3 months 5.25 6.006 months 5.50 6.25

12 months 5.75 6.5024 months 6.00 6.5036 months 6.50 6.75

LendinS Rates (rates applying as from 1 July 1985)

Purpose

Housing - ordinary 8.0- Investment 10.0

Personal - general purpose 9.5- unsecured 9.5- motor vehicle 9.5

Comercial- all loan 10.0Overdrafts 10.0

TONGA DEVOPEN BAN

Top prioriy sectors

Below $2,000 6.0 flat rate$2,000 and above 6.0 reducing balance

Bigh priority sectors

Below $2,000 8.0 flat rate$2,000 and above 8.0 reducing balance

All other industrial and comercal lomn

Below $2,000 10.0 flat rate$2,000 and above 10.0 reducing balance

(Reference in text: page 12, para 32)

19789 9/80 198/81 1981/82 1982/83 198/ 19 1 6

A. Xpsmdn - 1,180 14,738 25,769 35,50 37,276 42,018 56935

0 4,375 11,822 19,208 1,660 25,369 28,716 29,163 3Z,750- - 3,121 1,367 1,766 3X26 4,516 2,800o 1am af lad 1,875 2,500 250 2,50 4,00D 4,00 Q4 4,0Q0

553 165 501 795 713 1l __

bb"toSal 6,250 14,875 25,694 23,028 31,930 36,705 38,929 40,90945 14A49 i_2_4 27_4 __10 __ 37_btl Fap MP= 192935 43.694 50,6272 59,514 63-515 060

at;qmmtfm bo (Ddtdt) (7,195) (28,01) (,) 4 (24(2006 (M (26M1) (21,795)Int a cm Dabe III 1,823111 2,611 3,491 7,711 8,518 UD, 88

a 11 m 0iit) (7.30 (30,017) C31567) (28344) (31,m) (34,757) (37939) C34,9Dt 8azvat - - - - - - - -

Cl ciMM of t ftnt Do&t Ion star In 19O8, with nI=Mk of VAUD36.., .. , .~~~~~~~~~~

71

dpenix 4Page I

NAFANUA HARBOUR IMPROV1MENT, 'EUA ISLAND

Nafanua Harbour is located on the West Coast of 'Eua Island.The coastline In this area runs in a north-northeast/south-southwestdirection. The foreshore is made up of old coral reef material andthe harbor consists of a small basin in the foreshore. The basin ispart natural and it has been extended artificlal?; the present portfacilities are located in the extension. The basin is at the mouth ofa natural watercourse which only carries water during and after heavyrain. A narrow channel through the coral connects the basin with theopen sea. A section of reef between the natural basin and theextension lies opposite the entrance channel and seriously restrictsthe maneuvering room available for vessels entering and leaving theharbor. The coastline in the area is featureless and has no bays orheadlands. The harbor entrance is consequently exposed and receivesno protection from waves, or swells from the sector betweennorth-northeast/south-southwest; this creates difficulties for vesselsentering and leaving the harbor.

The prevailing winds in the area are the southeast trades.Winds from south through east to northeast, and of strength greaterthan 10 knots, blow about 85 per cent of the time; average windstrength from this sector is about 12 knots. The area is subject tocyclonic weather from November/December to March. The coast appearsto be periodically subject to heavy swells from the north/northeast.These swells appear to be generated by east and southeast winds andare refracted and/or diffracted around the northern tip of the island.This swell, together with westerly wind waves, produce the vorstconditions at the harbor entrance.

About five times a year, the harbor is closed to shippingdue to rough sea conditions, for about two days each time. Therestricted room inside the harbor makes conditions worse when vesselsenter the thirbor with a following sea. In such cases, vessels arecompelled to reduce ahead power earlier than desirable to enable tthemto make a turning maneuver.

The vessels presently using the harbor are launchesapproximately 15-18 m in length which carry both passengers and cargo;a regular service is operated by the Shipping Corporation of Polynesiain a vessel that carries 60 passengers and five tons of cargo. Atleast four others are owned privately, or by local churches and servethe port on an irregular basis. The Shipping Corporation of Polynesiaalso operates an 18 m self-propelled barge-type vessel with a bowloading ramp; it has a cargo-carrying capacity of 27 tons. A roughestimate of present per annum cargo and passenger traffic through theport is 30,000 passengers and 7,300 tons of cargo.

The present port facilities consist of two berths and aloading/unloading ramp. One berth, approximately 30 m long, hasfailed structurally and is used only by small fishing boats. The

(Reference in text: page 14, para 40 and page 19, para 51)

72A_pendix 4Page 2

other berth io appoxiately 25 a long and io used by the launches.This berth has a siding derrick with a bhd wineb of about two tonscapacltye, but it appears to be little used. The loading romp is usedby the self-propelled barge. The harbor Is also used by several smallfishing boats and these supply fish to the local population. Theseboats moor in the natural basin, some distance from the portfacilities.

73

Appendix 5

I(LL INDUSTRIES CENTRE, VAVA'U Page 1

Selection of a Suitable Site for the Saall Industries Centre

Several sites were sugsted to the Missiong they are alllot'at!ed to the North of Neiafu and have good road access. However,since the Sall Industries Contra (SIC) i likely to be primrilyused to accomodate service industries (e.g., automotive repair.servicng electrical appliancea, servlcing and repairing of mollmschadcal equipmet, etc., it needs to be located close to thebuilt-up area In Neiafu. With this in mind, three sites were selectedfor closer lmpection as follows:

A. Situ Imediately adjacent to the town boundary

This site consists of two blocks of Goverment land with atotal area of over 13 acres. Both blocks are currently rented byprivate lindviduals. The site has road access on t% sides. Laitoneroad runs a1o" the eastern boundary and a legal road on the southernboundary connects Laitoue road to the extesion of King Street whichIs the main road leading to the airport.

The site falls gently from one corner (northwest) to theopposite corner (southeast). There are soe smll rises anddepresions, but these could be re8raded with a minimum of earthwork.The lad Is not utilind apart from one relatively small section ofcltivatio Vegetation cover consists of well-spaced trees withscrub growth beneath. Site preparation would be miniml and wouldinolve: (1) claring of trees and vegetation (ii) a mall amount ofertbworks to trim building sites and ensure good drainge; and (iii)construction of access roads. The Ministry of Works has equipment todo this work and bas a quarry for supplying coral witbin two km of thesite.

A three-phase power supily (230V phase/neutral) is availableat the soutbast cornr of the site end the circuit appears to havespare capacity. A three-phase (600V phase/neutral) supply is alsoavalab1e close to the site and the line capacity could be readilylicreased. A 50-em water main with spare capacity runs within 100 mof the suthern boundary of the site. Avallablity of water couldalso be radlly Increased from other mains in the vicinity.

B. Site on the eastern side of the road to the aport.

This site consists of four blocks of Goverment lend with atotal area of 33 acres. It gi within 800 m of the townboundary and is immediatoly east of the extension of King Streetwhich rmu north to the airport. Access Is available from there andfrom Laitone road. 'There s a samill on one of the blocks and partof the land is being cultivated.

(Reference in text: page 19, para 49)

74

&2endix 5

The site is mostly evenly graded with gentle falls; thereare some steeper areas with large changes in level (up to 15-18 m)in one corner. Vegetation cover is similar to site A. Water isavailable from the same point as in the first site and the water mainwould have to be extended--by about one km. Power is available alongthe road adjacent to the site.

C. Site on the western side of the road to fzhe airgort.

This site consists of two blocks of Government land with atotal area of 16-1/2 acres. It is on the western side of the roadleading to the airport, from which it gains access and is approximatelythe same distance from the town boundary as site B. Some of the siteis under cultivation and the topography and vegetation cover issimilar to site B. Power and water are available as for site B.

All three sites would be suitable for development of aSmall Industries Centre, but site A is considered the most suitable.

75

4Ppendix 6Page 1

DETAILED COST ESTIMATES OF THE MULTIPROJECT$ at end-1985 prices)

TOTAL

FOREIGN .LOCAL TOTAL

1. Small Industries Centre Expansion, Tongatapu

Land Clearing,Grading, Filling, 24,000 6,000 30,000Demarcation of Plots

Construction of Access Roads & 32,000 8,000 40,000Installation of Utilities

Stormnater Drain (0.25 km) 6,400 1,600 8,000Two Factory Sheds (2*286 sq a) 72,000 48,000 120,000One Nursery Building (429 sq m) 57,000 38,000 95,000Warehouse/Admin. Office/Meeting 60,000 40,000 100,000

RoomEquipment 12,000 0 12,000Supervision by MOW (2.5 2) 0 9,825 9,825

Subtotal 263,400 151,425 414,825Contingencies (102) 26,340 15,143 41,483

2. Small Industries Centre Establishment, Vava'u

Land Clearing, Grading, 8,000 2,000 10,000Demarcation of Plots aad Fencing

Construction of Access Roads 20,000 5,000 25,000and Installation of Utilities

Two Multipurpose Buildings 75,000 50,000 125,000(2*286 sq m) and an office

Vehicle and Equipment 12,000 0 12,000Supervision by MOW (2.5 2) 0 4,000 4,000

Subtotal 115,000 61,000 176,000Contingencies (10X) 11,500 6,100 17,600

3. Nafanua Harbour Development, 'Eua Island

Site Establishment 79680 7,680 15,360Drilling/Blasting 18,974 3,886 22,860Excavation,Haulage and Sorting 279,000 21,000 300,000Breakwaters 28,830 2,170 31,000Fil1 and Grading 21,260 1,600 22,860Forming Wharf 156,000 44,000 200,000Boat Ramp 17,831 5,029 22,860

Subtotal 529,574 85,366 614,940Contingencies (15%) 79,436 12,805 92,241

(Reference in text: page 21, para 55)

76

Appendix 6Page 2

DETAILED COST ESTIMATES OF THE MULTIPROJECT( at end-1985 Prices)

TOTAL

FOREIGN LOCAL TOTAL

4. Agricultural Access Roads, 'Eua Island

Clearing and Formation 31,200 7,800 39,000Supplying Coral at Site 52,880 13,220 66,100Construct Pavement 15,920 3,980 19,900Surcharge for Work on 'Eua (10%) 10,000 2,500 12,500Overheads and Supervision (10X) 6,875 6,875 13,750

Subtotal 116,875 34,375 151,250Contingencies (101) 11,688 3,438 15,125

5. Telecommunications System Upgrading, 'Rua Island

Automatic Exchange 65,000 0 65,000Exchange Building 6,000 4,000 10,000Radio and PCM Equipment 115,000 0 115,000Standby Power Supply 10,000 0 10.000Distribution Network 26,000 0 26,000Lable Laying 0 5,000 5,000Tralning 6,300 0 6,300Engineering, Furnishing & 20,000 0 20,000

Installation

Subtotal 248,300 9,000 257,300Co-,^tingencies (5%) 12,415 450 12,865

6. Rural Roads Improvement, Tongatapu

Clearing and Formation 60,480 15,120 75,600Supplying Coral at Site 162,480 40,620 203,100Construct Pavement 42,000 10,500 52,500Overheads and Supervision (101) 16,560 16,560 33,120

Subtotal 281,520 82,800 364,320Contingencies (101) 28,152 8,280 36,432

Total Base Coat 1,554,669 423,966 1,978,635Physical Contingencies 169,531 46,215 215,746Price Contingencies 249,399 52,337 301,736Interest During Construction 22,159 0 22,159

Total-/ 19522.517 2.518.2

8/ Numbers do not add up exactly due to rounding.

77

Appedix 7

AMOUNT OF THE PROJECT TO B D E NDERDIFFRN PROCURBENUT RCDIS(bse costs at end-1985 PRi5es)

ICB 614S940 31.1

LCB 450,000 22.8

Force Accou5ti/ 633,570 32.0

Proprietary Procurement 206,300 10.4

IS & Other 73,825 3.7

Total Base Cost I,978S635 100.0

a/ Incliideg DintallatIon work done by Tbga ElectrIC Por Board,Tonga Water Board and Tonsa Toleeatic&tions wlon.

(Reference in text: paeo 27, per 70)

IMPLEMENTATION SCHEDULE

OURATION (IN MONTHS

J I FlA AMJ JA I S jO iqN D JA F A JN J Aj SO NOiS JAUA J !JA 0II

1936 13? - .8S

A. SUB-PROJECTS

1. SIC EI.uFon A

-Site il DE A

2. SIC E. bNsbme IC I I- I

2 2. S C E lE{ l l l C

j Not3.mmlwm HwL~or Imuprowameram

4. Actitutal AcceRoads IM c

5. tcsmm inRtio"n System A TJI DE Cup-ag Mm L E no m o

.l R Rsmo

B. TECHNICAL ASSISTANCE

1. Ibaft TodmW AsionecC S2. ARA TcdIAovsI su_maau

2.AOAB C = = = = = = T- =~~~~I I I I I I I I

SC - otlw9 Cof_G=Ukts A - Apprail C- Cor8tvctlwn and Spply of Equipmw nFS- FidSw*fm DE O d b usslnuarn DOes i

CtS- Csuvttm Sem*Ion T/A - T.idgAwswrd of Conta

79

Appendix 9Page 1

OUTLINE TERMS OF REFERENCE

Appraisal of Subprogects Under Nultlprolect Loanand for a Review of Government Interest Rate Policies

I. Introduction

The Asian Development Bank is providing technical assistanceto assist the Government of Tonga to: (i) assist the Ministry ofWorks (MOW) to establish unit rates for road construction work carriedout on a force account basis; (ii) help prepare and implement selectedsubprojects t3 be financed under the Bank's Third Multiproject loan;and (iii) undertake a review of the Government's interest ratepolicies. The components to be included in the Multiproject havealready been tentatively identified. However, if any of thesesubprojects turns out to be unsuitable for implementation, theGovernment may delete the subproject from the Multiproject. Asubstitute subproject may then be included in the Multiprojectprovided that the Government and the Bank agree on its suitability.In the case of such substitution, the Terms of Reference for Part A ofthis technical assistance may be amended by aegotiation to includework on the substitute subproject.

A firm of consultants will be appointed to undertake thestudies and other work to be financed under the technical assistance.The consultants will report to the Secretary for Finance who willcoordinate the work of the consultants through a joint steeringcommittee comprising the Ministry of Works (MOW), the Ministry ofLabour, Commerce and Industries (MLCI) and the Central PlanningDepartment (CPD).

II. Objectives

The technical assistance will be undertaken in two Parts, asfollows:

Part A

Under Part A the consultants will:

(a) Establish unit rates for road construction work undertakenby MOW.

(b) Prepare a Master Plan for development of the new eight-acreSIC site in Ma'ufanga, Tongatapu and prepare specifications,quantities and other necessary documents for development ofthe site and coijtruction of two factory sheds and onenursery building.-

1/ MOW will prequality tenderers, let tenders and provide constructionsupervision.

(Reference in text: page 34, para 88, page 35, para 91and page 37, para 96)

80

Appendix 9Page 2

(c) Prepare a Master Plan for development of the 13-acre SICsite in Neiafu, Vava'u and prepare specifications,quantities and other necessary documents for developmentof the M/te and construction of two workshop/factorybuildings.-

(d) Review the rental fees charged at the Tongatapu SIC and makerecommendations regarding their level and structure; alsorecommend suitable rental fees for use of the Vava'u SIC.

(e) Set priorities for the Government's five-year roaddevelopment program on Tongatapu and select about 30 km ofrural roads from this program to be Improved under theProject.

Part B

Under Part B the consultants will:

(a) Assess the extent to which interest rates have been, and arecurrently used as an economic policy instrument and reviewthe effectiveness of such use.

(b) Assess the extent to which interest rate levels have beenand are currently affecting national savings, consumptionand investment levels and the efficiency with whichinvestment expenditure is allocated.

(c) Define and assess the advantages that could be gained by theGovernment's use of the interest rate as a policy instrumentfor achiev.g its objectives under the fifth developmentplan. In particular, the consultants will assess thepotential advantages of using the interest rate to achievenational saving targets and investment targets inhigh-priority sectors.

(d) Recommend appropriate policy, legislative, regulatory andadministrative measures that could be initiated by theGovernment. Such measures should promote the development offinancial markets within the Kingdom and lead to an interestrate regime which would (i) encourage resource mobilization;(ii) improve resource allocation by enabling the privatesector to respond more rapidly to market forces; (Ili)strengthen the use of the interest r'ate as a policyinstrument; (iv) enhance efficiency in financialintermediation through requiring financial institutions tomore effectively meet the diverse needs of savers andinvestors; and (v) lead to an activatiov of capital/moneymarkets.

1/ MOW will prequality tenderers, let tenders and provide constructionsupervision.

81

Apefndlx 9Page 3

III. cope of Work

Part A

1. Unit Rates for Selected Construction Work

Unit rates are required for the road construction yorkundertaken by MOW on a force account basis. The work will include,among other things, the following tasks:

(a) Review of the existing charging procedures used by MOW --particularly those for charging for plant andequipment -- together with their proposals for revising themto put them on a more commercial basis.

(b) Establishing a framework of cost headings Includingoverheads for civil works, with all materials, plant andlabor costs allocated for work under each heading(including provision of design services, constructionsupervision and general overheads).

Cc) Establishing plant bire rates for MOW plat which cover allcosts (including depreciation, based on annual revaluedreplacement costs) and costs for all other materials, plantand labor.

(d) Using the above information, the consultants will arrive atthe best estimates of the cost per km of constructinghighways, trunk roads, feeder roads, agricultural accessroads and other access roads on Tonsatapu, Vava'u and 'RuaIsland.

2. Master Plan for SIC on Tongatagu and Bid Document,o for NewFactory Sheds and Nursery Buildin&

The Master Plan will cover the eight-acre site which has notyet been developed. The new buildings to be constructed (two factorysheas and one nursery building) will be located on the existing12-acre site. The work will include, among other things, the followingtasks:

(a) Review of the Master Plan used for development of theexisting 12-acre site and development of an appropriateMaster Plan for development of the adjacent 8-acre site.The Master Plan must include access roads, utilities,sewer connections, plot boundaries and other ncessaryfacilities and be designed -- as far as possible - In away that protects and enhances the environment (e.g. bypreserving mature trees).

82

Page4

(b) Preparation of detailed drawings, specifications andquantities suitable for use by NOW which will undertake thesite development work; in the case of utilities, thedrawings and specifications should be suitable for use byTongs Electric Power Board, Tonga TelecommunicationsCommission and the Tonga Water Board which will undertakethe work.

(c) Review of the existing building designs and discussion oftheir suitability with prospective users Identified by theManager of the SIC and by MLCI. In the light of this, theconsultants will revise the designs as necessary.

(d) Preparation of bid documents for the two factory sheds andone nursery building to enable these to be constructed unCzrLocal Competitive Bidding (LCB) procedures.

3. Master Plan for SIC on Vava'u and Bid Documents forWorshop/Facor-y Buildigs-

A 13-acre site will be acquired for the new SIC on Vava'u;it is proposed to initially develop 8 acres of t4e site. Although theeight-acre site could accommodate about 12 workshop buildings, it isproposed to start by constructing two multi-purposeworkshop/factory buildings (286 sq m each), a small office and acommon washroom facility. The technical work to be undertaken willInclude, among other things, the following tasks:

(a) Preparation of a Master Plan for development of the entire13-acre site, showing access roads, utilities, sewerarrangements (by sept:'c tank), plot boundaries andother necessary facilities; the development should bedesigned to protect - and where possible - to enhance theenvironment by protecting mature trees, etc..

(b) Preparation of detailed drawings, specifications andquantities for development of the initial eight-acre sitesuitable for use by MOW which will undertake the sitedevelopment work; similar documents will be prepared forutilities; the work on the latter will be undertaken by theTonga Electric Power Board, the Tonga Water Board and TongaTelecommunications Commission.

(c) PreparLtion of detailed designs, specifications and biddocuments for the two multi-purpose workshop/factorybuildings, office and washroom facilities. The designshould pay special attention to economy, flexibility and thelocal building vernacular. The bid documents should beprepared in a way that would allow the buildings to beconstructed under LCB procedures.

83

Appendix 9Page 5

4. Review of SIC Rentals and Recommendations

When the Tongstapu SIC was first established, theGovernment's objective was that it should not be subsidized, and thatit should operate on a no-profit no-loss basis. This has not beenrealized; the sub-leases for the SIC, which may limit rent revisionsto once every five years, combined with the incidence of inflation,has meant that rental levels have risen less rapidly than expenditureand, as a result, the SIC now makes a significant loss. The purposeof this Study is to review MLCI' s rental fee policy and to makesuggestions for consideration by the Government and the Bank. Thestudy will examine the following issues:

(a) How significant are rental payments for existing users ofthe Tongatapu SIC? How do they compare with rental feesoutside this SIC? Are they an inducement to locate on thisSIC and would higher rentals be affordable?

(b) Could rentals be raised each year and still remainconsistent with the Land Act?

(c) Would it be desirable to have a two-part tariff -- onecharge for the site and another for the building -- in whichthe building rental was (i) revised each year; and (li) setat a level to recover all costs to encourage sTZ usersto erect their own factory sheds? Would such an arrangement(in the context of (b) above] require the Government towrite off some, or all of the site development costs?

(d) Would rentals be more affordable for newcomers to a SIC ifthere were a promotional rate (possibly 75 per cent of thefull rate) applicable for as long as the industry enjoyedtax-free status? Should the Government reimburse the SICconcerned directly for such promotional inducements?

(e) What relationship should rentals at the SIC on Vava'u bearto those at the SIC on Tongatapu?

(f) Finally, taking all the above into account, what rental feelevels appear to be realistic and affordabls at each SIC andover which time scale might they be introduced?

84

Appendix 9Page 6

5. Identification of Roads to be Improved on Tongatapu

This subproject involves establishing investment prioritiesfor the roads to be improved under the Government's five-year roaddevelopment plan on Tongatapu. The road improvements need to bejustified in economic terms by showing that the benefits ofimprovement (in terms of vehicle operating cost savings, net inducedagricultural production and other benefits) give an economic internalrate of return of at least nine per cent. In addition, this study isexpected to produce a simplified method of establishing improvementpriorities on roads where vehicle operating cost savings are thedominant, or only source of benefits. The work to be undertaken willInclude, among other things, the following tasks:

(a) Review of the draft five-year road development programprepared by the Government.

(b) Identification of the characteristics of the vehicle fleet,selection of a range of typical vehiclee (cars, lighttrucks, trucku and buses) and estimation or typical vehicleoperating costs.

(c) Relating these vehicle operating costs to roughness of theroad surface using the World Bank's HDM model, or theTransport and Road Research Laboratory's RTIM model.

(d) Using these vehicle operating costs, together with thetypical cost of upgrading different classes of road preparedby MOW (and updated in the light of item (1) of the Scopeof Workl, prepare charts, or tables showing vhen, in termsof average traffic volumes, each class of road justifiesupgrading to the next higher standard.

(e) Reviewing the trunk/access/feeder roads tentativelyIdentified by the Government for improvement under thefive-year road program and, using the charts/tablesdeveloped under (d) above, together with an assessment ofany induced agricultural production and other benefits,recommend investment priorities.

(f) Selection of a package of roads, totalling about 30 km. forimprovement under this Multiproject Loan.

(g) Estimating the costs of improving this package of roads andsummarize the costs, benefits and internal rate of returnfor each section of road.

(h) Checking each section of road to be improved to esteure thatall necessary precautions are taken to avoid any adverseenvironmental impact.

85

Appendix 9Page 7

Part B

Review of Government Interest Rate Policies

(a) Determination of the present structure and levels of lendingand deposit interest rates prevailing in the Kingdom and inthose overseas financial markets currently holding financialInvestments and assets of Tongan citizens, Tongan legalentities and the Government.

(b) Evaluation of the effects that interest rate levels withinthe Kingdom have had and are having on saving levels, andthe likely effect on future saving levels of alternativedeposit interest rate regimes.

(c) Evaluation of the effect that interest rate levels withinthe Kingdom have had and are having on levels of nationalconsumption and investment, and the likely effect on futurenational consumption and investment levels of alternativelending interest rate regimes.

(d) Identification and evaluation of the effect on nationalincome levels of inefficiencies in resource allocation thatmay have occurred as a result of current interest ratelevels during the period of the Fourth Development Plan. Inparticular, evaluation of the contribution of interest ratelevels to the underachievement of natiowal savings targetsand investment targets in high-priority sectors in terms ofthe effect of this underachievement on current and futurenational income levels.

(e) Definition and evaluation of the role that interest ratelevels could play as a more actively-used policy instrumentwithin the Government's overall economic policy framework.In particular, evaluation of the the likely costs andbenefits of alternative interest rate scenarios that couldbe promoted by the Government in its pursuit of economicgrowth objectives during the period of the Fifth DevelopmentPlan.

(f) Recomendation of administrative mechanism and proceduresfor establishing and setting interest rate levels withinTonga. Such mechanisms and procedures should encourage thedevelopment of financial markets and market-determinedinterest rates and should also take account of the possibleest&olisbment of a Central Bank.

(g) Development of a feasible program for the lplementation ofrecommendations.

86

Appedix 9.Page 13

IV. Consultant Services

The above consultant services will be carried out by a firmrecruited according to the Bank's Guidelines on the Use ofConsultants. The firm wili submit biodta for the consultantnominated to carry out Part B of the Terms of Reference; If the Bankconsiders the biodata unsuitable, it reserves the right to recruit anindividual consultant to undertake this work. It is envisaged thatabout 12 man-months of consultant services will be required coveringengineering costing, architectural design, cost accounting, rental feepolicy, transport economics and intere)st rate pollcy. The consultantservices are expected to start in August 1986. Part A, item (1) ofthe Scope of Work should be completed by the end of September 1986,Part A, items (2), (3), (4) and (5) and Part B by the end of December1986.

87

Appendix 10

OUTLINE TERMS OF REFERENCE FOR DEmVLOPMENT OFNAFANUA HARBOUR

I. Tntroduction

Along with agricultural and other development on 'EuaIsland, the Government proposes to construct improved facilities atNafanua Harbour. Consulting services are required for development ofthe project from site investigations and assessment of conditions,to design of suitable facilities and supervision of the ensuingconstruction. Construction of new facilities is to be financed by theBank, while the consulting services are to be financed underAustralian bilateral aid.

II. Scope of Work

The consulting services are to be provided in three phases:Phase I covers site investigations and preparation of preliminarydesigns; Phase II covers detailed engineering and, when relevant,preparation of bid documents and provision of assistance forpre-qualifying contraccors and evaluating bids; Phase III coversconstruction supervision. At the end of Phase I, a tripartite meetingwill be convened among the Government, representatives from theAustralian Development Assistance Bureau, and the Bank to consider theconsultant's preliminary recommendations. The meeting will review thealternatives proposed and will select the option to be studied infurther detail during Phase II.

The work to be undertaken by 1t9e consultants will include,among other things, the following tasks:-

Part I

(i) Assessment of hydrographic data and data on sea conditionscollected by the Harbour and Wharves Department within theMinistry of Finance.

(ii) Assembling of all available data (from the Central PlanningDepartment, the Shipping Corporation of Polynesla, etc.) oncargo and passenger movements through the port, andpreparation of forecasts of likely future traffic flows upto the year 2006, taking account of the expected economicdevelopment of 'Eua Island over this time period.

(iii) Carrying out of all necessary gootechnical investigations ofthe site, including test drillings of the rock in theharbor basin to establish, among other things, the bestmethod of excavation.

17 A preliminary engineering study prepared by Connel, Eddie, Riedel& Byrne (International) is available on request.

(Reference in text: page 34, para 88 and page 35, para 92)

88

Appendix 10Page 2

(iv) Based on the above data, preparation of preliminary designsof alternative layouts of harbor and port facilities thatmeet cargo and passenger needs at minimum cost, ensuring inthe procr?s t4at the designs minimize adverse environmentalimpacts.-

(v) Preparation of preliminary engineering designs for allnecessary structures and preparation of preliminaryestimates of construction costs for each layout; costestimates should be accurate within 20 per cent.

(vi) Evaluation, to the extent possible, of each of thealternative layouts, describing their advantages anddisadvantages in terms of: (a) service to cargo andpassengers, vessel operation and cargo handling; (b) overallcost and cost effectiveness; (c) flexibility in adapting todifferent types/volumes of cargo; and (d) their ease ofconstruction.

(vii) Recommending the best method of having the new facilitiesconatruc.ed, including: (a) letting the works as a singleconstruction contract awarded under the InternationalCompetitive Bidding (ICB) procedures of the ADB; (b) lettingthe wrorks as a single construction contract awarded underthe International Shopping (IS) procedures of the ADB; (c)dividing the works into several subcontracts to be let underICB or IS procedures; or (d) dividing the works into severalpackagas to be let as subcontracts under ICB/IS procedures,or carried out by force account by MOW.

Part It

(i) Preparation of the final designs for all structures,including wharves, wave protection structures, turningbasin, navigational aids, cargo storage areas, etc.

(ii) Preparation of engineering drawings, specifications andquantities in sufficient detail to enable the work to becarried out in the manner agreed-upon with the Bank at theend of Phase I.

17 The preliminary engineering study carried out by Connel, Eddie,Riedel & Byrne includes a short section on possibleenvironmental impacts; these should be taken into account inpreparing engineering designs.

2/ In this regard, the Bank's Guidelines for Procurement are tobe followed at all times. In particular, tender deposits,performance bonds and other conditions should be consistent withthese guidelines.

89

Appendix 10Page 3

(iiI) Where nternational Competitive Bidding proceduresY are tobe used, assisting the Ministry of Works In prequalifyingall potential contractors, preparation of evaluationcriteria for use in the bid selection of contractors,preparation of all bid documents (including General andSpecial Conditions, Specifications, Schedule of Quantities,etc.), ensuring that all necessary environueutal safeguardsidentified in the design phase are Included In thedocuments, preparation of reports on site Investigations foruse by tenderers, and assisting the Ministry of Works, asnecessary, in evaluating tenders.

Part III

(i) Providing site staff for supervision of construction andadministration of the contract. , It is expected thatselected Ministry of Works staff will be seconded to theconsultants for purposes of on-the-job training.

II1. Time Schedule

The servicern of the consultants are expected to startEpprohimately In Septeiber 1986. It is expected that Phase I will becompleted by the end of November 1986, and that Phase II will becompleted by about March 1987, The construction supervision (PhaseIII) Is expected to start approximately In September 1987 and to lastabout nine moutbs.

90

Appendix 11

ESTIMATED COST OF PROPOSED TECHNICAL ASSISTANCE(15

A. Bank Financing:

Foreign Exchange Cost:

1, Remuneration 137,0002. Internataqnal Travel 19,000°e Per Diem- 26,0004. Reports and Communication 10,0005. Contingencies (about 15 per cent) 29000

221,000

B. Government Financing:

Local Cost:

1. Office Accommodation, CounterpartServices and Facilities 7,000

2. Local Travel for Site Visits(car and domestic air fares) 4,500

3. Local Communications 2,000

4. Contingencies (about 15 per cent) 2,500

16,000

TOTAL COST (A + B) 237,000

a/ Calculated on the basis of $71.00 per day.

(Reference in text: page 36, para 93)

91

Appendix 12

ECONOMIC EVALUATION OF NAFANUA HARBOUR ANDABRICULTuRAL ACCESS ROADS ON 'EUA ISLAND

The lack of adequate harbor facilities on 'Eua Islandconstrains development of the Island's agricultural resources. Theharbor is small, has a dangerous entrance and provides no shelterduring rough weather. As a result, the only regular shipping servicesconnecting 'Eua Island to Nuku'alofa on Tongatapu are provided bysmall, old vessels; newer vessels are unwilling to risk using theharbor. The present vessels are loaded by hand; vegetables and othergoods are manhandled over the ship's rail and are then stacked ondeck. Produce is frequently damaged during the course ofloading/unloading and much of it reaches Nuku'alofa in poor condition.Apart from top quality export bananas and copra which are shipped Inboxes and bags by the Commodities Board, farmers generally accompanytheir produce to Nuku'alofa and sell it themselves in the main marketat Talamahu. The ships provide standing room only and the trip takesthree hours each way through rough seas. As a result, only the mostdetermined farmers sell their surplus produce in Nuku'alofa.

Improved harbor facilities is a prerequisite to furtherdevelopment of 'Eua Island. Provision of a safer entrance channel,with appropriate navigational beacons, a small turning basin andsheltered anchorage would make it possible to operate nawer and moresuitable vessels; they would not necessarily be larger, but theservice would probably be more frequent. Such services, particularlyif combined with equipment for loadIng/unloading produce, would resultin less wstage and spoilage, especially of fresh produce. It wouldalso enable farmers to get higher prices for their products inTalamahu market. It is conservatively estimated that less wastage andspoilage, combined with higher prices, would increase the value ofagricultural output by between 5 and 10 per cent.

Table 1 shows the amount of land currently allocated asrural tax allotments that is being cultivated. It shows the area undervarious crops, including fallow land, together with the average yieldassociated with this type of cultivation. Table 2 shows the averagereal price (1982-1986) for the major crops produced; the figures weresupplied by Central Planning Department (CPD) and, although some ofthem relate to only a few mvwNhs in each year, CPD considers themreasonaoly representative of thn year as a whole. Table 3 estimatesthe impact of an average 7.5 per cent increase in output for the majorcrop types. The calculation of net value added in the Table assumesthat Incremental (paid) labor inputs are zero, that incrementaltransport and yvrketing costs amount to about about 20 per cent ofmarket value,- and that other costs are negligible. Theseassumptions are considered to be reasonable. The EIRR for the barborimprovement is calculated in Table 4 using an economic life for the

1/ eased on a detailed study carried out by the Commodities Board:'Bua Farm Project, 1986.

(Reference in text: page 37, pars 96)

92

Appendix 12Page 2

harbor facilitles of 20 years. The costs shown in the Table includedetailed engineering and construction supervision (to be financedby ADAB under parallel financing arrangements), civil works costs(including contingencies) and operating and maintenance costs. Thebenefits, In the form of the net value added estimated in Table 3, areassumed to develop over a five-year gestation period after which theyremain constant. The resulting EIRR is 11.3 per cent which given theconservative nature of the assumptions is considered satisfactory.

The 20 km of roads proposed to be constructed on 'Eua Islalrun along one side of an estimated 256 standard-sized allotmet t-with a total land area of 855 ha. The alignments for these roads tseeMap on page (v)J were selected aver studying large-scale, coloredaerial photographs of the Island;- the roads were then located toprovide access to those areas where: (1) the bull type was kfp tobe suitable for general cultivation, or for growing coconuts;- and(ii) the photographs showed that half, or more of the area wascurrently not under cultivation. The aerial photographs showed thatland was intensively cultivated in the vicinity of existingagricultural access roads. Cultivation drops off quite sharply awayfrom these roads and gives way to scrub containing limited pockets ofland which appear to be cultivated on a shifting basis by farmers whohave no legal title to th. land. This pattern of cultivation wasconfirmed durlng the Appraisal Mission's field visit to 'Rue Island.

Since only about half the area affected by the newagricultural access roads is currently cultivated, provision ofthese roads ahould enable the other half to be cultivated as well.Table 5 estimates what effect this is likely to have on the output ofthe main crops grown on the Island. tie calculation of net valueadded in the Table makes the fo'.lowing assumptions: (i) eachaddition# allotment cultivated requires an annual labor input ofT$2,000;- (ii) transport costs amount to about 20 per cent of marketvalue; and (1ii) othex inputs (planting materials, seeds,fertillers and pesticides) amount to about 25 per cent of marketvalue.- These atsumptions are considered to be conservative. TheEIRR of the new agricultural roads is calculated in Table 6 using aneconomic life for the roads of ten years. The costs shown in theTable include construction supervision, road construction costs,routine road maintenance and periodic re-gravelling. The benefits, inthe form of the net value added estimated in Table 5, are assumed todevelop over a five-year gestation period after which they remainconstant. The resulting EIRR is 15.0 per cent which is considered tobe satisfactory.

1/ A standard allotment measures 8.25 acres (roughly 3.3 ha).2/ At a scale of about 1:3000.3/ Soils of 'Eua Island, New Zealand Soil Survey Report, 1983.41 This corresponds to two laborers who are paid T$1000 each and

are also allowed to grow their own subsistence crops on theallotment.

5/ Based on a detailed study carried out by the Commodities Board:'Eua Farm Project, 1986.

93

rndx 12Page 3

In view of the sisple nature of the above analysto of thenow agricultural access roads, and the rather conservative asumptionsused, no sensitivity analysis bas been corried out on these roads.At 15.0 per cent the EIRR Is relatively high, ad the mjor risk -'which is the possibility of delayed implementation - will have verylittle effect on the EIRR. The major risk associated with NafanuaHarbour, Is the possibility of a cost overrun. The impact of this onthe EIRR has been tested by assming that civil works costs are 15per cent higher than expected; this causes the tIRR to fall by 1.2 percent to 10.1 per cent which is still considered to be satisfactory.There are no other major risks which might adversely affect the EIR.

9~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

94

Page 4

Table 1. Area Under Ion. by Croo TvDeand AL*r ae onld. 'ea IslMad

(hectare and tone/ha/year)

Area Under Cuti~vatio~n NoBt1ad(ct } (Per Cent Of Yield

C r 0 Chetaresj!~ total alloagted) (tons/a/veaIr)

Yaw 196 6.9 10

Taro Tonga 125 4e4 10

Taro Fortuna 280 9.9 10

Tapioca 178 6.3 10

Swet Potato 45 1.6 10

Plantain 21 0.7 10

Banana 35 1.3 10

Giant Taro 5 0.2 10

Corn 1 - 2

Vegetables 6 0.2 3

Vanlla 8 0.3 1

Coconut 980 34.6 0.5

Estimted Fallow 952 33.6 -

Total 2__32_/ 100.0

a/ Basd on a survey carried out by staff of the Minstry ofAgriculture. Forestry 8 Fisheries in May 1982; the areacultivated Is not thought to have been affected by the cyclone.

b/ Taken from a report on agriculture In Tongp prepared by the Foodand Agiculture OrganizatIon.

C/ From Kindom Of Mm: Develent of 'Be Islad, U.N.Developmnt Advlsory Toms, 1953.

95

Appendix 12Page 5

Table 2. Prices of Main Agricultural ProductsTalauahu Market. Nukulalofs

(T$ per kg)

P r i c ea/1982 983k' 1984k 198S/ 98d

Product 1982 1983E 1984 19861/ 1982-1986

Yaws 0.69 1.20 1.19 0.93 0.97 1.00

Taro Tonga 0.41 0.33 0.40 0.32 0.37 0.37

Taro Fortuna 0.38 0.34 0.40 0.22 0.22 0.31

Tapioca 0.20 0.19 0.15 0.05 0.09. 0.14

Sweet Potato 0.37 0.30 0.21 0.30 0.29 0.29

Platain 0.35 0.30 0.30 0.23 0.20 0.28

Banana - - - 0.23e/ 0.23

Coconut (Copra) - - - - 0.30e/ 0.30

_i Market prices, adjusted to 1985 levels by the Consumer PriceIndex for Food items.

b/ Mean prices for January-April._/ mean price for September.dt Moan price for Jauary..1 Prices paid by the Tonga Coumodities Board for export quality

bananas and for Grade A copra.

Table 3. Fatlmted Increase In Value Added as a Pesilt of ruprwed Hstbor Faclities(T$ pere)

InfTu,e area of TrAewta1 Viel t rket Prlce Value of Cot Of NTcreasethe led in l of timil in valu

Harbr Ara ouWp 0x of o£ xhmetares) (tows/bayear) ( per Wg (W000 per year) (W$'000 per year) (T'W per yew)

Yams 196 0.75 1.00 147.0 -

Ibro T4a 125 0.75 0.37 34.7 - -

Taro Fbrba 280 0.75 0.31 65.1 - -

qbpoca" 178 0.75 0.14 18.7 - -

met Psto 45 0.75 0.29 9.8 - -

Mlantain 21 0.75 0.28 4.4 - -

snn0-n 35 0.75 0.23 6.0 _

rCoom,z (Qpra) 980 0.038 0.30 11.2 - _

btal 1,860 - - 296.9 59.4 237.5

a/ Fcm Tabe 1; uzh rcrop md fAl w groud bwe bow dtted.b Ihis asane. an in yields of 7.5 per cam due to the barbor luprovuwnt.cPans Tabl !..

I This sus thn are no Inaraemtal lbor costs, that "m;port/mmiattrg costs anxmt to 20 per cmt of inmiut value (fram 8a Oxoditts baDdPAo;t, 'Rs F ProJect, 1986) and that other ixpits are t4gligible.

97

Appendix 12Page 7

Table 4. Calculation of Internal Rate of Returnon Nafanua Harbour Improvement

(US$)

Operatita & Net IncreaseCapital MNantenance in Val? of NetCosts§/ Costs Output- Bsnefits

1986 60.0 -60.0

1987 246.2 - -246.2

1988 581.0 - - -5810C

1989 - 15.0 33.9 18.9

1990 - 15.0 67.8 52,8

1991 - 15.0 101.7 86.7

1992 - 15.0 135.6 -120.6

'-93 - 15.0 169.6 154.6

1994 - 15.0 169.6 154.6

1995 - 15.0 169.6 154.6

1996 - 15.0 169.6 154.6

1997 - 15.0 169.6 154.6

1998 - 15.0 169.6 154.6

2000 - 15.0 169.6 154.6

2001 - 15.0 169.6 154.6

2002 - 15.0 169.6 154.6

2003 - 15.0 169.6 154.6

2004 - 15.0 169.6 154.6

2005 - 15.0 169.6 154.6

2006 - 15.0 169.6 154.6

2007 - 15.0 169.6 154.6

2008 - 15.0 169.6 154.6

2009 - 15.0 169.6 154.6

a/ Including detailed engineering and construction supervision.i/ Assumes a five-year gestation period before all benefits are

realized.

KIRK e 11.3 per cent.

Mabe 5. Fatlaed bIcr e in Value as a 8siult of Now Rd (biuctimCL$ par year)

Tnhuie Area Aea fipected Fatimated. Yield Mat Pie Value of Ct Of Jit b eof the to be Qltivated Ci NeIlm& yatsd of rIead hx"runuw1 In Value

dua to Prswm a lamt=Tuts-a of ,a(bectares) of New P1ad ( ) ( per ('000 per yer) (T$'000 per year) '000 per er)

Yawu 59.0 29.5 10 1.00 295.0 - -

MarD Ibqa 37.6 18.8 10 0.37 69.6 - -

Ibro Fbrtuna 84.7 42.4 10 0.31 131.3 - -

TSpicCS 53.9 27.0 10 0.14 37.7 - -

gent potato 13.7 6.9 10 0.29 19.9 - -

Plantain 6.0 3.0 10 0.28 8.4 - -

rAnnna 11.1 5.6 10 0.23 12.8 - -

lbtal 266.0 133.2 - - 574.7 485.9 88.8

a/ Tbe 20 km of nw av icultral roads vll provide aoces to an estimgtd 256 aord-stizu atsll ts totalling 855 ba. Ihf ma inKuer each crp iscalaiated fra Table 1; a m cps, co0nat anid £fU gm-d bwe been amned.b/ Aerial ptog abs *bv that Only abt half the area affeed by the nw roads Is crratly cultivated; tbese calculatimns asmam t*it provision of

-acrm roads uvulA enoble the otber half to be cltlivated as wiLc, PFku TIble 2.

I lebor inputs are estianted to mimt to I$2000 per aflobmt. cces amnt to about 20 per cent of wmrit value, t&isl otierilpsts amt tOD dxxit a further 20 per cet of wrist value (fron the Qxmvditias BoErd Report, 'Eua FaI Projea 1986).

c 0aDf>

99

Appendix 12Page 9

Table 6. Calculation of Internal Rate of Returnon Agricultural AcCess Roads

Operating & Net IncreaseCapit,t Maintena?e in Value c NetCosts_ Costs- Output-' Benefits

1987 151.3 - -151.3

1!88 - 10.0 12.7 2.7

1989 - 10.0 25.4 15.4

1990 - 10.0 38.1 28.1

1991 - 10.0 50.8 40.8

1992 40.0 10.0 63.4 13.4

1993 - 10.0 63.4 53.4

1994 - 10.0 63.4 53.4

1995 - 10.0 63.4 53.4

1996 - 10.0 63.4 53.4

1997 - 10.0 63.4 53.4

a/ Including construction supervision.b/ Road maintenance costs are based on $500 per km, together with

$2000 per km for re-gravelling every five years.c/ Assumes a five-year gestation period before all benefits are

realized.

EIRR - 15.0 per cent.

100

pendl13

OUTLINE TERMS OF REERENCE FOR PROPOSED TECHNICAL ASSISTANCETO TONGA DEVELOPMET A -

I. Torms of Reference for the Desin, Specification andIm_lomntation of Comuterized Accountln, Loan n and

hifomation Satems for theo a Develo sent BiB

A. Obaective

The objective of the proposed tochnical assistance is toreplace TDB's current mXally-operated loan administration, accountinand operational statistics systems with fully-computerized systeme. Thetechnical assistance will utilize as a starting point the results of thestudy of TDB'e electronic d*ta processing (EDP) requireonts undertakenby the Japanese International Cooperation Agency (JICA) during 1983.

B. Scope

The proposed technical assistance will undertake all necessarytasks for the design and Implementation of an EDP system that will fullyreplace TDB's current manual sy6tems and that fully meets TDBtsmanagement information and reporting requirements. These tasks willinclude systems design, programming and modification of software,program testing, staff training, initial data input, Initial runningtests and bandover of the system in full running order. Hardware,software and ancillary equipment purchase will be undertaken by TDB'smanagement In accordance with a pre-determined workplan for thetechnical assistance project.

C. Detailed Terms of Reference

The consultants will:

1. In consultation with the Finance Manager and TDB's seniormanagement, define necessary alterations and improveents toTDB's current data processing and accounting system necessaryfor fulfilling the various functions required of these systemsby TDB's operations and management.

2. Undertake the detailed systems analysis necessary for thecomputerization process.

3. Select appropriate hardware and software that will meet thesystems' requirments. While having full regard for thetechnical requlrments of the proposed system, the selectlonprocess should facilitate the use of comparative pricingprocedures by TDB's manageent In the final selection ofequipment.

(Reference in text: page 43, para 119)

101

Appendlx 13Page 2

4. Make on-site preparations for installation of hardware, andupon arrival, install and test all equipment.

5. Install required software.

6. Undertake the detailed systems design required to integratethe software purctased into the required Input/output systems.

7. Undertake system programming and software modification asrequired.

8. Undertake necessary training of TDB staff to allow independentoperation of the new system by TDB without undue recourse tooutside expertise.

9. Input initial data to facilitate comissioning of the newsystems.

10. Following confirmation of defect-free operation of thesystems, undertake for an appropriate period parallel runningof the new systems alongside the present manual systems.

11. Handover the new systems on a fully-operational basis,including provision of detailed operating manuals.

D. Manpowr Keguirements and Time Schedule

The assistance will be provided by a team of at least twoconsultants with extensive experienco and knowledge in the areas ofaccounting, systems analysis and the implementation and operation of EDPsystoe. One member of the team should have appropriate staff trainingexperlence to enable the full development of TDB's staff capabilities tooperate the new systems. TDB's Finace Manager and the other localcounterpart who will eventually be designated as EDP Manager will makeavailable at least half of their work time during the technicalassistance project in order to provide lialson between the operation ofthe old and new system, and to assist with systems specification.During the period of the technical assistance project, the FinanceManager will prepare a detailed accountitg manual setting out the Bank'saccounting policies and procedures on the basis of the operation of thenew system. It Is esitmted that the consulting team will requireeight man-months to complete the technical saistance project.

E. Usporting

The consultants will be required to prepare for 2DB and forthe Bank:

1. An inception report within one week of the beginning of fieldwork setting out a proposed work program.

102

Appendix 13Page 3

2. A final report at the completion of the study detailing theconsulting team's achievements in terms of the original workprogram.

The consultants will also prepare other reports, as necessary,for TDB's management to enable relevant decisions to be made.

II. Terms of Reference for a Review of Tonga Development Bank'sPersonnel Management Policies

A. Objective

The objectives of the review are to provide an informed basisfor establishing personnel management policies, systems and proceduresthat will enable TDB's management to maintain closer control of staffinglevels within the context of pre-determined budgets and plans, toimprove staff development planning procedures and to overcome therecruitment problems currently being experienced.

B. Scope

The review will focus initially on the manner in which TDB'spersonnel management functions are organized, Including the place ofpersonnel management functions within TDB's organitational structure.It will then undertake an all-encompassing review of TDh's currentpersonnel recruitments staff planning, performance review, remunerationand staff development policies and procedures with the objective ofidentifying areas for improvement that would enable TDB's management toseek improved utilization of its staff resource and a reduction inoperating costs, strengthening of staff resources In area, that arecurrently deficient, a more structured approach to developing staffresources to meet TDB's current and future needs, and the development ofa well-defined career path for personnel.

C. Detailed Terms of Reference

The consultant will:

1. Define the current personnel managemnt policies andprocedures followed by TDB.

2. Within the context of the staffing procedures of Institutionssimilar to TDB, and taking into account the particularcharacteristics of TDB's operations, define a procedure formeasuring the staffing requirements of the various functionalareas of TDB's operation that will allow TDB to operateefficiently at current and projected levels of operation.

103

oppzdi 13Pass 4

3. Evaluate the effectivenees of TDI's current personnelemnt policies and procedures In match#& TDh's staff

resources to Its requirements,

4. Identify area for Improvement In ThD'a personnl mangementpolicies and procedures, and in consultation with TDB'smanagment, develop appropriate procedures for tbese ar"s.Iu developing such procedures, the cosultante's task wili beto undertake all analysis necess"ry for making recemedationsto TDE's Board of Directors regarding policy chages. Inaddition, the consultant will be required to doesgappropriate procedures that will allowe TDB to mplemetImproved persomel management system and procedures duringand at the completion of the technical assistance.

D. Manpoer RequiremenLts and Tim. Schedule

The assistance will be provided by one consultant withextensive knowledge and experience in determination of personnlmanagment policies, operation of personel m procedures andstaff development prograe. The consultant will also have extensiveexperience In the operation of development finance Instltutions and/orsimilar intitutions. TDB's Administration Manager will be required towork closely with the consultant on a counterpart basis. It isestImted that the consultant will require two na-months to completethe assignment.E. Meortjn

The consultant will be required to prepare for TDB's managementand the Bank:

1l An inceptleon report whicb sets out a proposd work programwithin one week of the begInn of field work.

2. An Interim report following completion of Items (1), (2) and(3) of the detailed terms of reference; this reprt willdetail conclusions and recoienntlons and set out a revisedwork program for completlon of the assoi t.

3. A final report at the completion of the study. A draft ofthis report wll be made available to ThD's manag t and theBaok for discussion before completio. The finl reportsbould be submitted simultaneously to TDB and th Beank withinthree mnths of the comne of work on the revie.

The consultant should be prepared to participate In atripartite meeting with representatives of teb a and TI's ama menta the eand of the as t.

104 A2pendix 14

TWA MNrN BACost a*Afor ; I~ I yve Toui 3'r A*1 t to IB

1suls of lrmm O_ eBMt &oii AEV

A. LmVoM 2!2! T cd~ost

P_Cicn 23,000 92,000Per dim a lume 4,500 17,0OO

trae 2,500 5,000as 5 000 11,000

125,000

B. Imlan u

DC 6 er ~~~~~~500 1,000Office an

secretaial 1,000 4,000500 1,000

Total (A + B) 37#000 131,000

tal X X %

Bgnk TA, 160,000 95.2 35,000 94.5 125,000 95.41B 8 000 4.8 2 000 5.5 6,000 4A

(eferece tet pe 4m 11)M

(Reference in text: page 43, para 119)

105Appendix 15Page 1

TONGA DEVLOPMENT BAIKStatemnto GEraMcfios

A. The Bank

Tonga Development Bank was established under the TongaDevelopment Bank Act 1977 as an independent statutory body. Thefunctions of the Bank are to promote the expansion of the economy ofTonga for the economic and social advancemat of the people of Tonga bygiving financial and advisory assistance In Its discretion to anyenterprise operating or about to operate In Tonga.

In carrying out its functions the Bank will be guided by thefollowing general operational, fimacial and promotlonal policies.

B. Scoe of Activities

1. The Bank will conduct its operations within the gneral frameorkof the Government's economic policies, plans and priorities.

2. Although the primary role of the Bank is to promote economicdevelopment and production In the private sector, the existence ofGovernment or other public ownership In an enterprise will notpreclude that enterprise from being assisted by the Bank.

3. The Bank will finance projects aimed at increasig production anddevelopment in the fields of agriculture including horticulture,livestock and fishing; timber extraction and reforestation;quarrying, industry, manufacture and processing of all kinds;tourism; commerce; transport and comuncation; and serviceIndustries including professions.

4. The Bank will finance both new enterprises and the expansion ormodernization of existing enterprises (the work "enterprise" asused In this Policy Statement having the same ueaning as is definedin the Tonga Development Bank Act 1977 and includes cooperativesand community activities). Particular attention will be given topromotion of the entry of new entrepreneurs into the field ofproductive endeavour and the development of managerial andentrepreneurial skills 6

5. The Bank will provide financial and other fonm of assistance inthe following ways:

(a) extending loans;(b) making equity participation;(e) guaranteeing the finance provided by other sources;(d) providing tecanicals, managerial and financial

consultancy services;(e) assisting In the identification, formulation and

promotion of new projects.

(Reference in text: page 45, para 126)

106

Appndix15Page2

6. The Bank's financial assistance will be primarill for theacquisition of fixed assets. However, the Bank may in deservingcaes also finance seasonal and short-term credit requirements inthe agricultural sector as well as working capital requirements inany sector.

C. Development Policies and Operatlin Princlles

7. It will be one of the Bank's important aims to investigate andidentlfy investment opportunities, and to promote and assist In theestablishment of enterprises of Importance to the economy.

8. In addition to the operating principles mentioned under Section 6of the Development Bank Act 1977, the Bank will also givepreference, in determining whether or not assistance is to be givento any enterprise, to enterprises which will- -

(a) use local raw materials in processing and muaufacture;(b) make use of labor intensive technologies and provide more

opportunities for employment and training of local people;(c) contribute effectively to broadening the base of local

entrepreneurship and ownersihip;(d) have a good potential for expanding exports or decreasing

Imports;(e) lower costs and improve the efficiency or standards of goods

and services;(f) lead to an increase in the incomes and living standards of

people, particularly of those at the village or grass rootslevel.

9. The Bank will carry out its operations as a development financeinstitution in accordance with sound banking and businesspractices.

10. The Bank will provide financial assistance only to those projectswhich, on the basis of its own analysis, appear to be economicallyjustified, technically feasible, financially viable andprofitable. Special attention will be given to the quality ofmanagsemnt of the enterprise and to the market prospects of theproject.

11. The Bank will eadeavour to secure its loans and gusrantees Inaccordance with sound banking practices, but in doing so the Bankwill have due regard to its functional requirement to promote theeconomy for the economic and social advancement of the people ofTonga.

12. Applicats will be required to provide a reasonable equity in theenterprise to ensure that they have an appropriate stake In theirown venture. They will also have to ensure that the totalfinancial requirement for the successful implementation of theproject will be available.

107

AMndlx 15Page 3

13. The Bank will ensure, in making its financial assistance availableto any borrower, that the financial requirement for the completionand commissioning of the project is appropriately covered,Including due allowance for possible cost overruns.

14. Normally, loans will be disbursed after the promoter has made hisown financial contribution to the project and after ensuring thatsuch disbursement is in accord with the requirements of thefinancial plan approved for the project.

15. The repayment period of a loan made by the Bank, Including a graceperiod as appropriate and needed, will be determined taklng intoaccount;

(a) the repayment capacity of the enterprise;(b) a reasonable payout to the promoter during the term of the

loan; and(c) the optimum use of the Bank's own funds In maximizing the

turnover of Its portfolio.

16. The Bank will supervise closely the use of its funds, the progressof the project financed and the performance of the enterprise, toensure that remedial action is taken promptly should circumstancesso warrant.

17. The Boak will require its borrowers to keep records and accounts inaccordance with sound and generally accepted accounting principles,and to furnish whatever Information on their operations andaccounts that it deems appropriate. The Bank will also maittainthe right to inspect the enterprises it finances, as well as theiroperations, records and books of accounts.

18. The Bank will endeavour to assist farmers and entrepreneurs withthe provision of managerial, financial, technical and otheradvisory services. It is the aim of the Bank to help its borrowerstowards the successful completion of their projects.

19. The Bank will continue to build up an effective organization anddevelop an adequate and technically qualified staff, In order tocarry out its functions efficiently and to assist its clients Inthe formulation and conduct of their projects.

20. Business secrets and other private information furnished to theBank by clients will be treated as confidential.

D. Diversification of Portfolio

21. In order to reduce the concentration of risk, the Bank will seek todiversify its portfolio by sectors of operation and by avoldingInappropriately large livestment in any one project. In view ofits developmental function, the Bank will also pursue geographicaldiversification of its portfolio.

108

Appendlx 15Page 4

22. The Bank's equity investments shall service mainly as a catalyticagent for the establishment as well as for the expansion ofenterprises. The Bank will normally dispose of such investments toTongan nationals when appropriate. The Bank's equity investmentshall not normally exceed 25 per cent of the paid In capital of theassisted enterprise.

23. The Bank will not normally commit to a single enterprise in theform of equity participation more than 10 per cent of itsunimpaired paid in 3hare Capital and Reserve Fund. The aggregateequity investment of the Bank at any time shall not exceed 25 percent of It paid in Share Capital and Reserve Fund.

24. The Bank's total comuitment in the form of loans, equity investmentand guarantees in a single project or enterprise shall not exceed;

(a) 25 per cent of the total of the Bank's unimpaired ShareCapital and Reserve Fund; and

(b) 75 per cent of the tangible assets of such enterpriseincluding the Bank's own investment.

25. In exceptional cases meriting special consideration, limits underClause 24 (b) may be exceeded provided the loan is covered byadequate additional security over assets not forming part of theproject.

26. In financing worthwhile projects requiring more than its maximumlending limits under Clause 24, the Bank may seek a syndicatedcooperation of other institutions, both domestic and foreign,limiting the Bank's liability in such cases to the ceiling referredto under such Clause.

E. Financial Guidelines

27. The Bank will review and determine from time to time the rate ofinterest and fees to be applied to Its advances in the light ofprevailing Government policy and developments in the capitalmarket, with due consideration to the costs of its own borrowings.

28. The Bank will not carry the exchange risk on its debts payable inforeign currency.

29. The Bank will not seek to take a controlling interest or managementof any enterprise in which it has invested, other than byrepresentation on the board of directors (or similar committee) Inappropriate cases. However, should it become necessary to protectits own interest, the Bank may take such action as it considersappropriate In the circumstances.

109

30. The Bank will not undertake long-term borrowing obligationso,including guarantees, that In the aggregate would exceed threetimes the total of Its unimpaired paid In Share Capltal and ReserveFund.

31. The Bank will maintain accounting records adequate to reflect ibbusiness operations In accordance with sound and geerally acceptedaccounting principles and practices.

F. Provisions and Reserves

32. The Bank shall set aside in each year at least 50 per cent of itsoperating profit In that year as a provision against bad anddoubtful debts until such tiae as the provisioons equal 10 per centof its loans, equity investments and gurantees outstanding, andwill thereafter set aside annually such amounts as are sufficientto maintain the provisions at least at that level.

33. The Bank shall set aside annually to its General Reserve the wholeof its net income during the first five year of its operation and,thereafter annually, at least 50 per cent of its net Icome untilsuch tire as its General Reserve Is equal to the asount of its paidin Share Capital.

110

Appendix 16

TONGA DEVELOPMT BANKMembers of the Board of Directors

(As of 31 December 1985)

Name Date of Appointment Occupation

1. Non. James C. Cocker 20 March 1982 Minister ofFinance

2. Baron Vaea 3 September 1984 Minister ofLabor, Commerce& Industries

3. Tomasi T. Simiki 5 August 1977 Director ofAgriculture

4, Tsutouu Nakao 28 November 1977 Businesman

5. Masao Soakai 5 August 1977 Businessman

6. Selwyn Jones 1 November 1984 Secretary ofFinance

7. Peter Jones 27 February 1985 Chief Manager,Bank of Tonga

8. Lisiate 'A. 'Akolo 19 March 1982 ManagingDirector

(Reference in text: page 45, para 127)

,-:MA JE: ;b4 ^A?K

Was~~~~s l' >t

- - rn~ 1 KLCAIS toAm GFRMU U-

[ i~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~z

1~. 1 a...1 , g1

~~, ,ha L _,m | "_*U .AW S*U -

r---~ ~ ~ ~ ~~ ~~~lfeec in- text:z --- e -5 pr 128)

112

Jauyi of 1udv 1 maa1 ppwlPTO 1981 -198

FY ailing 31 DeIuer lb. AMM No. / ut . h o. h¢mt No. h

AcorEgm to SectorAgritdture 2,728 1,261 2,956 1,707 2,233 1,300 2,544 1,967 2,488 1,880I&Ustry andl bwizm 348 1,223 427 1,134 313 1,133 370 1,462 303 1,690Staff 71 78 39 38 103 47 180 98 270 128

Accordir~ to D~e of UorOMHurTican_ rb- - 673 232 - - - - - -Nw borrowers 1,466 907 1,062 801 805 867 949 1,447 944 1,202Repeat borr 920 410 1,051 515 1,197 458 1,471 761 1,766 883Coest oaerrw 279 44 208 56 17 6 - - - -"Aim ltW" Secmd 374 489 287 598 383 535 584 972 306 1,090"Aim W1i" lhidl 87 290 114 468 145 249 - - - -"Alm Htt" Fouth 21 422 22 195 73 331 - - - -"Alm IW I Pfth - - 5 14 27 30 84 295 44 i18"Alm HWl Sixth - - - - 1 2 - - - -"Aim IiW" Seventh-t - - - - 1 2 5 17 1 5Others - - - - - - 1 35 - -

3,147 2=6 3,422 2,2W 2 2,64 T. 3=52 -3,0rT,61 9 8

Accordlrg to 2!qdcaEl locatict.TuatqxW 2,201 1,773 2,263 1,955 1,436 1,810 1,889 2,553 1,835 2,726lk'pai 231 107 228 109 331 95 216 119 313 149Vava'u 595 632 627 724 610 479 714 710 548 666Others 120 50 304 91 m 96 275 145 365 157

to"d SIzeup to $1,000 2,886 680 3,108 796 2,379 702 2,621 875 2,680 837Mhm to $2,500 111 170 156 254 146 237 233 359 214 334Tha to $5,000 - - - - 68 267 118 461 65 250hen to $10,000 127 650 131 559 32 233 86 587 64 440

Thm to$ 50,0CD 19 491 20 518 19 401 29 596 28 449Ihn to $100,000 2 121 2 105 - - 7 649 3 246MW er$100,000 2 45D 5 647 5 640 - - 7 1,142

Up to I yeaw 2,022 764 1,694 630 1,385 527 1,300 654 1,429 715Ihb to 2 year 946 516 1,404 655 1,043 595 1,352 868 1,282 774Thi to 3 years 134 480 267 540 178 588 365 1,007 288 811lhn to 5years 31 273 42 573 35 324 55 354 47 605hlntoDl0ye6rs 8 420 7 265 6 425 17 518 13 771

Oer lOgyes 5 84 8 216 1 1 4 91 2 22E ty 1s I 25 - - 1 2D 1 35 - -

,W7 TV3B TM !E TW I 3 T27 3,61- :3

(Reference in text: page 50, para 144)

113

Appendix 1¶'

I ii~~~IN

IQI~

i

Hi: 10:12 B N~~~ Ic~

4~~~a

(Reference in text: page 50, para 146)

Ta IELi T B}hiulysls of 4~provds b~y lz-trial Sector

lYe 1981 - 1965

1981 1982 1983 1984 1985 TOlAmmt Percet Amouct Perf w Nroui Amut Pe;;;;,; Alx Peru Amm ecn

Agr~icuure TI

{D Root crops, Sies, fruits* ~viand v 1t 308 12.0 422 14.7 460 18.5 1,591 45.1 1,352 36.6 4,133 27.3

Fa pl.t, toolstd e* amndegt 680 26.5 952 33.1 668 26.9 18 0.5 9 0.2 2,327 15.4

|t IYAi~lb 177 6.9 197 6.3 141 5.7 244 6.9 277 7.5 1,036 6.8,*t IIvestck 96 3.8 136 4.7 31 1.3 114 3.2 242 6.5 619 4.1

Stow 1,261 49.2 153 1,300 32 1,967 55.8 T§ 50.8 8,115 53.6 _*- - _

I=sIwtry and msImes s.

* Rewtal, viiasale trade 247 9.6 451 15.7 280 11.3 615 17.4 278 7-5 1,671 12.4v t aot" "e and bhtels 398 15.5 65 2.3 14 0.6 264 7.5 437 11.8 1,178 7.87 SsTrmport ad stoxne 200 7.8 259 9.0 273 11.0 310 8.8 165 4.5 1,207 7.9.s 1q:uinzfacter1 216 8.4 88 3.0 432 17.4 116 3.3 677 18.3 1,529 10.1

.i Otbers 162 6.3 271 9.4 134 5.4 157 4.4 133 3.6 857 5.6b Siss-*cl~~~~~122 47.7 T,5 1,13 4 X .M W7S =,462 r-45.,M -77 =4 43.8

VI

Z Staff Tinw 78 3.1 38 1.3 47 1.9 9B 2.8 1i 3.5 389 2.6

Total 2ID62 100.0 2.879 100.0 ° 1000 3.527 0 3 15.46 100.0

115

21

Actual and Projeted StatmItsFYs 1981-1990

Actual ofProjectedYear menft 31 Dsoabe 1981 1982 1983 1984 1985 1986 1987 1988 1989 90

Lierest anloa 218 299 375 405 517 656 746 831 954 1,116Tnterest an' 63 47 46 42 57 73 85 68 39 26DI)videns 2 2 2 7 3 3 3 3 4 4ote 9 22 38 79 75 72 90 91 100 118

Total Tncame 29 3i 33 W N W 1,097 1TW

P.rtx --l 104 130 158 217 265 336 357 381 406 447Odw _Midstratim eqxmm 48 52 72 100 114 115 129 138 152 169

13 14 34 43 44 54 59 57 48 51Total .1.es I 1 i ̂ M 360 W 357 B W

Provsin for d1tfu nacomts 53 69 94 65 89 115 157 124 L52 191CDst of£bormz 57 71 72 86 110 146 170 178 194 222

Total lcpues 7 336 W 511 622 766 7 W5 95-2 Iixtat 74 94 121

NetrPmfit 17 31 22 -3 38 52 1F -I _

atlos:Reitur catavr eqity M) 1.1 1.3 1.1 0.7 0.9 1.0 1.3 1.0 1.2 1.3Adm. .pwes/aw. totl

portfolio (1b 6.9 6.0 6.7 7.5 7.0 7.2 6.8 6.4 5.9 5.5Interest sd b 6.1 6.3 6.8 5.6 5.8 6.6 6.7 6.7 6.6 6.6Erg spredS 7.7 7.1 8.1 7.6 8.2 8.2 8.1 8.2 8.3 8.3

a/ UwAited.b nterest Ca lam portfolo _ erst

hAV Lam pErio v. borrwiz4cl Total i interest Am diidmd plid

Ai. him po+br + bea diasIts + eA. bonmwl%o + eqi

(Reference in text: page 54, para 161)

116

?WG WevELM 1 DM Appendix 22Acla im Peced , e ,, ,tSh

lye 1981-1990C!00oo)

Year eua 31 Doh11 98 1984 -I9W 1986 1987 1988 1989 1990

CO& h lWd Inban 3 13 421 341 338 422 203 227 255 273Short-tlln uvssunt 725 t 525 50( 950 1,300 1,300 800 400 4001amns Xoeivble vdtn an yew 1,686 1,621 1,561 2,318 2,207 3,385 3,410 3,257 3,170 3,615Accouts receivables &

Pray.}te 25 18 34 67 45 70 75 75 80 80Toti QAumt Asts T2,4 -2,613 ;T 3,2 3,540 3157 T,9 4,r 339 4,368

I 2,790 3,707 4,104 5,559 6,322 7,490 8,210 9,722 10,814 12,674Bqui t 83 82 32 67 67 117 167 242 317 392TOal Ptfolio 2,87 3,789 ;3 5,626 6,389 7,0 8;77 9.5-19 =1TT,6 tos: Ptwvlim for &uhtful

eco0 206 271 243 307 396 511 688 792 944 1,135'am -- aei,bJe wltbidone r 1 686 1 627 1,561 2,318 2,207 3,385 3,41 3,257 3 170 3,615

Total NetTkroio 9& D O, 1 3,0 3,786 MI3, 1 4W 5 ,703 7,017 8,316Find Aaets 315 672 806 819 823 898 1 017 973 934 934

Total Asse;t 3 =5,176 5 767 ; 8,4 fiB 10,802,8 13,618

L15UfmU AND YOXM=t Uei3±ltiAS

Emkwedz ef 44 42 34 125 - - - - - -Acw4te payble' 69 93 86 296 275 200 190 232 214 333Tom botrwphdus

vitbha as yew - 24 177 201 206 274 309 399 547 65Pwiali for lt1o*s - - - - - - - 74 94 121Total Ozreat L1ttiItN D !W1B M 9 79 EN3 TW

Bmeumm (AM) 1,117 1,265 1,265 1,744 2,038 2,451 2,317 2,179 2,012 1,816Qivemnm (1% 550 550 527 502 453 402 349 295 239 183Goer t (Aitulia) 250 25r 250 250 250 250 250 222 193 163hwpemi Cdc 01 3m1ty 133 133 133 1 1 133 133 133 131 127aEin Iwesuot Bu t - 286 286 534 844 1,057 995 931 811 688BUIk ofTlh - - 250 225 200 175 150 125 100 75I=D - - - - 338 1,020 1,02D 1,020 1,02D 907Pim b ordp 2 300 950 1,500 255 4,1IOTotal lorTom Liabilities 2. 2, 711 3,388 3;7 , 1 7,Mle*. Due vithin con r - 24 177 201 20 6 274 309 399 547 605Total Not 1cTGM Ud3itlas 2,S4 TM I 4,050 51 3g 6% 6,i 7;

Srha Capitl 1,527 2,478 2,738 3,105 3,456 3,598 3,698 3,M8 4,148 4,698Gl rem/arstnm

profits 44 79 110 132 162 20D 252 293 344 407Tt I1ity T3.! 2,557 T.= 3,237 3,618 3,798 T; 4,9 ; ff 31,MTotal LtablJ±das a Ity 3,734 5,176 5,679 7,046 8,149 9,786 10,3 10,802 8 13,618

Netics:WW*d.t ato bJ 1.3:1 1.0:1 0.9:#1 1.0:1 1.1:1 1.5:1 1.5:1 1.5:1 1.4:1 1.5slQEYIt ratio c/ 21.6:1 16.4:1 8.6:1 5.2:1 7.4:1 10.9:1 10.0:1 6.2:1 4.6:1 4.1:1

.1TOW;34rst Ial tiptsan l. o

Orrmt Ama (Reference in text: page 54, para 161)asrr i i.

117

243

C"1000)

Actual ,rolecteaYear 1uMh 31 Dww 11982 1 4 18 197 198i 1989 1990

Net Pzdfit (befor pwidsm) 70 103 125 86 119 153 209 239 297 375I etot - - - - - - - (74) (94) (121)N _m-cad s 13 14 34 43 44 54 59 57 48 51CoLlctim of pricpal 1,348 1,565 1,534 1,327 2,275 2,243 3,08 3,102 3,046 3,187antee an barr p 57 n 72 86 110 146 174 178 186 222h,aMUb fcr &bt euvecinT TWT75 ;7l Tom I;U T; 3,5T TI T714-Ism In pai-1n cqdal - 951 26 367 351 142 100 100 350 550

ikubm of bor g 421 435 250 788 1,069 1,438 - - - -Pzr borwI - - - - - 300 650 550 1,050 1,550increae IincutllaW.i 1ims 77 23 12D 367 2 Q) AO) 116 2 146

Total S&iree 4,88 s

hpyutof bornudvoprbn dl ad Intee: 57 71 96 263 311 352 448 487 585 769

Louis 2,166 2,487 2,137 2,783 3,038 3,411 3,798 4,169 4,583 5,047.eqty1 uest s 25 - - 35 - 50 50 75 75 75

Aoflsit uo fixasnsta 274 371 168 56 48 129 178 13 9 51bmr in maurt sonts (36) (7) 16 33 (22) 25 5 - 5 -(2e In liqd assats (502) 240 _22) (0) 572 434 (219) (476) ( 18

Debt/servIe w e (tim)l 26 25 18 5.9 8.2 7.4 7.9 7.2 6.0 4.8

v UudJted.b/ lAb fm (ef t pt ae5 pr_6

R p_Imt of bmur4 ,,: i) ~a

(Reference In texct: page 54, para. 161)

AS 4oE 31 198

DNA of h=Mt umt yet uWtmt h ntarmL Dran2dam to be Draw 1$) (fttmfJ TerM I] l.ac

sorces 1iom hmut (1$) C1*) Gri Perld (.)

A US$ 1500,00a/ 2D Dec. 1978 1,265,374 - 1,077,308 15 ( 6)- yas 3AD SDR 918,OOQ/ 6 May 1983 910,254 152,000 910,254 40 (10) years 3A D US$ 307,838./ 15 N4w. 1983 50,00D 392,000 50,000 15 ( 6) years 3U> 1K Ts 550,000./ 4 Sept. 1979 550,OOD - 452,697 15 ( 5) years 3E9C EMC I,0ob/ 23 Jan. 1980 133,217 - 133,217 40 (111) years 1-1/2A hstrall T$ 250,000./ 28 July 1980 250,000 - 250,00D 15 ( 7) years 3

t EIBI NJ eJs0,00/ 1 Sept. 1981 468,855 - 468,855 12 ( 5) years 2-1/2EIB 11 HU 700,00(b/ 14 Feb. 1984 375,177 212,823 375,177 15 ( 5) years 2-1/2 oE) ir 1$ 250,009/ 29 May 1982 250,000 - 2i0,000 10 yes e2TMD S 950,000./ 4 N4w. 1985 337,607 682,000 337,606 14 ( 4) years 3s

TUOL 4,590,483 1,438,823 4,255,114

a / Lot to iarnmmn of Tcp, rDet to M.tenut directly to T2p Dwelcpunt BL.

119 Appendix 25

TONGA DEVELOPMENT BANKAnalysis of Collection Performance and Sectoral Analysis of Portfolio

FYs 1981-1985(T$'000)

Collection of Loans

Year ending 31 December 1981 1982 1983 1984 1985

Arrears at the beginningof the period 68 189 282 516 559

Current dues during theperiod 2,699 2,768 3,060 3,644 3,861

Total dues for collection 2,767 2,957 3,342 4,160 4,420Loans rescheduled a/ 405 726 734 968 927Cash collection 2,173 1,949 2,092 2,633 2,970Arrears at the end ofthe period 189 282 516 559 523

Percentage Comparison

Cash collection/totaldues for collection 78.5 65.9 62.6 63.3 67.2

As TDB's accounting system does not explicitly record the amountof interest that is rescheduled, these figures are estimates.The Mission is satisfied with the validity of the estimationprocedure followed.

Sectoral Analysis of Loan Portfolio

Year ending 31 December 1981 1982 1983 1984 1985

Agriculture 1,050 1,509 1,640 2,403 2,515Industry and comwerce 1,792 2,311 2,552 3,142 3,719Government fund a/ 29 20 21 21 -

Staff loan 107 127 144 210 250Less: Unearned interest b/ (188) (260) (253) (217) (162)

Total 2,790 3,707 4,104 5,559

a/ Loans originally made by the Government and transferred to TDBafter TDB's establishment.

b/ Interest which is debited to loan account but not yet accrued.This relates to loans with flat interest rates.

(Reference in text: page 56, para 165)

120

Apex 26

M Dm BSANKM#g of AreFYs 1981 - 1985

(T$'OOQ)

1981 1982 1983 1984 1985As of 31 DeceuIer No. A im t No. Amoait No. Amtmt No. hiAmt No. hiAnmt

By Sector

Agriculture 313 66 410 115 777 260 947 317 1,053 358Industry and service 40 123 64 167 162 256 201 242 186 165Total 353 189 W 282 939 516 55 T29 ;523

By AlE

3- 6 rmmths 238 42 322 60 483 114 376 139 324 1136- 9 manits 59 107 69 31 239 84 201 96 241 1089-12 mxmts 9 3 27 15 71 74 181 92 202 64Over 12nmoths 9 19 29 156 89 211 351 220 445 210Legl Actin 38 18 27 20 57 33 39 21 27 28Total 353 189 474 282 939 516 1 559 1,239 523

By Area

Tcxiwaeapu 183 151 299 .03 557 386 632 393 674 343' Fix 31 3 33 4 40 7 32 7 37 5Niua - - - - - - - - 4 2H1'apai 30 6 32 22 108 39 87 15 84 13Vava'u 109 29 110 53 234 84 397 144 440 160Total 353 189 474 M 939 3I6 1,148 559 1,239 523

Total Loan Pbrtfolio 2,785 2,790 3,329 3,707 3,302 4,104 3,864 5,559 5,233 6 322Provision for bad debts 206 271- 2 - 307Provisimo for bad debts asZ of total loan portfolio 7.38 7.31 5.92 5.52 6.3

Hardce arrers a/ asZ of totalportfolio 1.3 4.7 5.9 4.3 3.8

Arrears rato (%) b/ 6.77 7.61 12.57 10.06 8.3

a/ Hardcore arrea include overdUe of more than 12 mmths plus cases under legal actim.b/ Total Arars x 100

Total loan portfolio

(Reference in text: page 57, para 168)

121

Page 1

TONGA DEVELOPMENT BANKList of Major Assumptions for Operational and Financial Projections

(FY 1986-1990)

I. Operational Projections

A. Approvals

Total loan approvals are assumed to increase at an annual rateof 15 per cent in 1986 and 10 per cent per annum to 1990. Agricultureloans are expected to increase at an average annual rate of 6 per centto 1990. Business and industry loans are assumed to increase 20 percent in 1986 and 15 per cent per annum to 1990.

B. Disbursements

Based on past experience, the following assumptions areapplied:

a) For loans, 85 per cent of the total approvals will result innet approvals, and 53 per cent will be disbursed in the sameyear. The balance of the disbursement will be made in thefollowing year, with the total disbursement representing 82per cent of the approved amount.

b) Equity investments are assumed to be disbursed in the year ofapproval.

C. Repayments

Repayment of existing loans is assumed to be on the basis ofactual amortization. For new loans, an estimated amortization scheduleis assumed as follows:

For loans For loansover T$5,000 up to T$5,000

1st year 20% 3022nd year 302 50%3rd year 19% 2024th year 10%5th year 5%

II. Financial ProJections

A. Income Statement

(i) Interest Income

(a) Loans: 8.5 per cent interest per annum on averageportfolio.

(Reference in text: page 58, para 171)

122

Appendlx 27Page 2

(b) Term Deposits: 6.5 per cent Interest per annum onaverage balances.

(ii) Other Income

(a) Letter of Credit (L/C) Guarantees: 1 per cent(b) Premiums on Collected Insurances: 10 per cent(c) Rental received from three Government Departments

occupying the top floor of the Bank's building.

(iii) Administrative Expenses

(a) Travel, administration and auditing costs willincrease by 11 per cent per annum as in 1985.

(b) Personnel costs will increase by 6 per cent perannum to 1990 as in 1985.

(iv) Cost of Borrowings

UK, ADB and Australia at 3 per cent per annum, EEC at 1.5per cent per annum, European Investment Bank at 2.5 percent per annum, BOT at 8 per cent per annum, newborrowing at 3 per cent per annum on average outstandingbalances.

(v) Application of Accumulated Profits

TDB will continue its policy of transferring at least 75per cent per annum of operating profit to provisions fordoubtful accounts with the objective of increasing thevalue of the provision figure to 10 per cent ofoutstanding loans and equity investments.

B. Cash Flow

(i) Increase in Capital

The following equity injections from TDB's shareholdershave been projected:

1986 - T$142,0001987 - T$100,0001988 - T$100,0001989 - T$350,0001990 - T$550,000

(ii) Repayments of Borrowings

As per repayment schedules in the subsidiary loanagreements. Repayments of new borrowings are assumed tobe on a similar basis as for existing loans.

123 Appendix 28

TONGA DEVELOn4EWT BANKDetails of Previous Bank Loans

As of 31 December 1985($)

Loan 376-TON(SP) Loan 624-TON(SF)

Loan Amount $1,500,000 $1,000,000Date of Approval 7 December 1978 26 April 1983Date of Effectiveness 17 January 1979 4 August 1983Closing date for submission

of subloans 17 July 1982 4 August 1986Closing date for disbursement 15 June 1983 4 August 1987Amount credited $1,445,151 $646,669Amount disbursed $1,445,151 $646,669Number of subproject financed 991 419Free limit amount $30,000 $40,000Subloan above free limitnumber 11 1amount $696,911 $43,825

(Reference in text: page 60, para 177)

124Appendix 29

TONGA DEVELOPNENT BANKAnalysis of Subloans Provided Under the Earlier Bank Loans

As of 31 December 1985($'O00)

Loan 376-TON(SF) Loan 624-TON(SF)No. Amount % No. Amount X

Secroral Distribution

Manufacturing industry 9 424.8 29.4 6 53.6 8.3Service industry 44 527.9 36.5 55 258.9 40.0Agriculture 938 492.5 34.1 358 334.2 51.7

WT 1,445.2 100.0 TI 646.7 100.0

Geographical Distribution

Tongatapu 765 1,236.3 85.6 252 603.6 93.3'Eua 23 25.1 1.7 17 5.8 0.9Ha'apai 40 66.6 4.6 40 18.7 2.9Vava'u 163 117.2 8.1 110 18.6 2.9

d91 1,445.2 100.0 19 64h6.7 10.0

Maturity

Up to 1 year 496 114.4 7.9 164 62.7 9.72 years 420 214.9 14.9 141 73.9 11.43 years 56 443.1 30.7 107 447.7 69.24 years 7 108.3 7.5 3 19.4 3.05 years 7 284.7 19.7 3 19.9 3.16 years 3 75.1 5.2 1 23.1 3.67 years 1 30.5 2.1 - - -8 years 1 174.2 12.0 - - -

Size

Up to $2.5 922 273.1 18.9 342 175.9 27.2Over $ 2.5 - 5.0 17 70.0 4.8 11 30.9 4.8Over $ 5.0 - 10.0 27 189.4 13.1 52 252.2 39.0Over $10.0 - 20.0 13 174.8 12.1 11 96.3 14.9Over $20.0 - 50.0 8 271.6 18.8 3 91.4 14.1Over $50.0 4 466.3 32.3 - - -

91 1,445.2 100.0 TI -646.7 100.0

Status of SubloansT$5,000 and above

Projects Completed 57 794.9 64 442.8- satisfactory operation T7 695.4 417.9- problems in operations 10 99.5 4 26.8Projects UnderConstruction - - 1 4.1Projects with Arrears 13 16.9 16 13.8- less than 6 months 12 16.3 4 11.9- 6-12 months 1 0.6 2 1.9

(Reference in text: page 60, para 177)

125

Appendix 30

TONGA DEVELOPMENT BANKProcurement by Country Under Previous Bank Loans

As of 31 December 1985($'000)

Loan 376-TON(SP) Loan 624-TON(SP) TotalCountry of Origin Amount % Amount x Amount X

Australia 396.4 27.4 47.5 7.3 443.9 21.2New Zealand 347.6 24.1 83.3 12.9 430.9 20.6Japan 304.3 21.1 512.7 79.3 817.0 39.1Fiji 98.7 6.8 - - 98.7 4.7United States 36.2 2.5 - - 36.2 1.7United Kingdom 30.3 2.1 0.7 0.1 31.0 1.5Other 231.7 16.0 2.5 0.4 234.2 11.2

Total 1,445.2 100.0 646.7 100.0 2,091.9 100.0

(Reference in text: page 60, para 177)

126Appendix 31Page 1

TOIA PEVEOP_T 3NComlionce wlth Coveanto Under the Erlirlank Len

Covenants URforsene to Loan a/Covenanto . Doct ^ t Statt

A. Obligation of the Exeuting gcp (TO)

1. Except as the Dank may otherwis, agree, TOD shall P.A. Section 3.01(c) Complied Withnot substantally mnd le Artles of AssocltStonor Its Policy Stateamt.

2. TDB shall furnioh to the lank all sucb reports P.A. Section 3.05(a) Complied withand informtion as the Dank ohall reasonably requeston the lo* and On the eubloans.

3. TO) sball furnich to the lbank quartorly reports P.A. Section 3.05(b) Complid Withon the executlon of the projects sad on theopetation ad Management of TOD.

4. ?VD shall furnish Its finneal statements certified P.A. Sectio 3.06 CoMplied withby Independent auditors acceptable to the lankwithin six monthe after the close of the finaenilYear.

S. Except as the lank nd T) shall otbhws" agre. P.A. Section 3.08 Complied withTDv s11 not (1) cell. le&",, transfer or other-WIse dlp"os of any of teo assets, except In theordinry course of Its buoness, or (11) establshor acquire any subsdtiay.

6. DS ohll maintain a debt/equity ratio of P.A. Section 3.09 Compiled with3:1 and a debt-vervice ratio of not le tbhn1.5 time.

7. TDB shall reviev its interost rate structure P.A. Schedule Complled wlthand subcit tho result to the Bnk for coments. Para 2

8. TDB ohall consult the Bank prior to affecting P.A. Schedule Complied withany ebange in the Interest rate. Para 2

9. tn the seiact1on of oubprojects. TOD sholl give M. L. P. Complied withprioritl s; to maller enterprieos end enterprises Pars ato be set in the Small Industries Centre.

10. TDB shall appoint an economist wlthin six momths P.A. Schedule Complled withfrot the date of loan effectiveness, and appolnt Pare 6an accountant as soon as possible.

11. TDO shall furnish to the ank Its flnancial P.A. Schedule . Complied withprojections vithin the first sly months of each Para 7:lscal year.

(Reference in text: page 62, para 184)

127

Appendix 3LPage 2

te'ference to Loan s/Covenant. Doceuanto Status

O Obligations of the Borrover (Goverrment)

. The 3orrower shall cause TDB to CaTNr Out the L.A. Section 4.01 Complied vithProject vith due diligence and efficiency and inconformity with sound adminlstrative, financial,business and development policies and practices.

2. The Borrower shall tale all action, including L.A. Section 4.02(b) complied withthe provision of funds, facilities, ervlces andother resources. which shall be nece*sary on Itspart to meet the resource requirments of TDB lnorder to enable TDB to perform Its obligation underthe Project Agreement, and shal; not take or permitany action on Its part which would interfere withthe performance of such obligations.

3. The Borrower shall furnish or tause to be furnished L.A. Section 4.01 Complled withto the ank all informatlon as the Bank shall reasonablyrequest on the loan and financial and economiccondition of longa.

4. The Borrowe shall cause TDB to review its Interest L.A. Scbedule 6 Complied vithrote strueture and submit the results of such revewv Pars 2to the Bank for coGooats.

5. The Borrower shall cause ?DB to consult the bank prior L.A. Sheodule 6 Complied withto effecting any change it the Interest rates. Pare 2

6. The Borrover shall not permit ?DB to make any L.A. Schedule 6 Complied withsubstantial amendment to its Policy Statement Pars 3without prior agreement of the Borrowerand the Bnk.

7. The Bot ower shall, prior to making any appointeant L.A. Schedule 6 Complted Withto the position of Managing Director or Deputy Par. 4Managing Director of TDB, consult the Bank regardingthe qualifications, experience and tenure of officeof the person proposed for appointment.

8. The Borrower shall take all necessary measures L.A. Schedule 6 Complled vithto ensure that TDB continues to be staffed by suitably- Pars Squalified professionals with adequate experience andtechnica: expertise.

a/ P.A. - Project Agreerent; L.A. - Loan Agreement; M.L.N. - inutes of Loan Neoptiations.