Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. P-3831-PA

REPORT AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL DEVELOPMENT ASSOCIATION

TO THE

EXECUTIVE DIRECTORS

ON A

PROPOSED CREDIT

IN AN AMOUNT OF SDR 47.0 MILLION (USt5O.O MILLION EQUIVI

TO THE

ISLAMIC REPUBLIC OF PAKISTAN

FOR A

SECOND SMALL INDUSTRIES PROJECT

May 25, 1984

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

Currency Unit = Pakistan Rupee (Rs)US$1 = Rs 13.5Rs 1 = US$ 0.0741

ACRONYMS AND ABBREVIATIONS

ABL Allied Bank of Pakistan LimitedDSI Directorate of Small IndustriesGOP Government of PakistanHBL Habib Bank LimitedIACP Investment Advisory Center of PakistanIDBP Industrial Development Bank of PakistanIIC Industrial Investment CreditMCB Muslim Commercial BankNBP National Bank of PakistanNWFP North West Frontier ProvincePBC Pakistan Banking CouncilPSIC Punjab Small 'Industries CorporationSBP State Bank of PakistanSIC Small Industries CorporationSID Small Industries DepartmentSIDB Small Industries Development BoardSIRD Small Industries Refinance DepartmentSSI Small Scale IndustriesSSI I First Small Industries Project (Cr. 1113-PAK)SSI II Proposed Second Small Industries ProjectUBL United Bank Limited

FISCAI, YEARS

Government of Pakistan : July 1-June 30Commercial Banks : January 1-December 31

FOR OFFICIAL USE ONLY

PAKISTAN

SECOND SMALL INDUSTRIES PROJECT

Credit and Project Summary

Borrower: Islamic Republic of Pakistan

Beneficiaries: Allied Bank of Pakistan Limited (ABL)Habib Bank Ltd. (HBL)Muslim Commercial Bank (MCB)National Bank of Pakistan (NBP)United Bank Limited (UBL)Industrial Development Bank of Pakistan (IDBP)Federal Ministry of IndustriesProvincial Small Industries Corporations (SIC)Pakistan Banking Council (PBC)

Amount: SDR 47.0 million (US$50.0 million equivalent)

Terms: Standard

On-Lending Terms: The Government would relend the proceeds of thecredit through the Industrial Development Bank ofPakistan (IDBP) to the five participating commercialbanks at terms which would provide a spread of4%-5.25% to the banks and an administrative fee of1.5% to IDBP, with an onlending rate of 11% to thefinal subborrowers. The Government would bear theforeign exchange risk. The participating banks wouldrepay their loans over 12 years, including a graceperiod of five years. The proceeds of the credit tobe used for technical assistance would be passed onto the executing agencies on IDA terms or, in thecase of federal ministries, as non-reimbursableallocations under the annual development budget.

Project Description: The project would provide credit to promote invest-ments in promising small scale industries (SSI) andto accelerate modernization and improve productivityof existing SSI units. To complement the creditscheme, technical assistance would be provided toSSIs through the provincial Small IndustriesCorporations and the federal Ministry of Industriesin project identification and investment promotion,project preparation and extension services, andmanagement training. Present Government policiesaugur well for continued growth in the industrialsector generally and among SSIs in particular. The

This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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main risk is thal: adverse political or externaleconomic factors could affect growth in the sectorand demand for SSI credit. The technical assistancecomponent is vulnerable to institutional weaknesses.The experience accumulated under the first Project,together with strong institution building inputsthrough training and consultancy services, shouldreduce this risk.

Estimated Costs

Local Foreign Total--- US$ million--

Lending Component 86.00 30.00 116.00Technical Assistance Components 2.36 0.92 3.28

Total 88.36 30.92 119.28 1/

Financing Plan

Local Foreign Total---------US$ million---------

IDA 19.08 30.92 50.00Participating Commercial Banks 21.54 - 21.54Sub-project Sponsors 47.00 - 47.00GOP 0.74 - 0.74

Total 88.36 30.92 119.28

Estimated Disbursements:

FY35 FY86 FY87 FY88 FY89 FY90-------------------US$ million---------

Annual 2.6 12.0 14.0 14.0 5.0 2.4Cumulative 2.6 14.6 28.6 42.6 47.6 50.0

Appraisal Report: No. 5058-PAK dated May 11, 1984

Map: IBRD 16248R

1/ Duties and taxes are negligible.

INTERNATIONAL DEVELOPMENT ASSOCIATION

REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON APROPOSED CREDIT TO THE ISLAMIC REPUBLIC OF PAKISTAN FOR A

SECOND SMALL INDUSTRIES PROJECT

1. I submit the following report and recommendation on a proposedcredit of SDR 47.0 million (US$50 million equivalent) to the IslamicRepublic of Pakistan to help finance a Second Small Industries Project.The credit would be on standard IDA terms. The proceeds of the credit tobe used for subloans would be onlent to the participating commercial banksthrough the Industrial Development Bank of Pakistan (IDBP) dt terms whichwould provide a spread of 4%-5.25% to the commercial banks, and anadministrative fee of 1.5% to IDBP, with an onlending rate of 11% to thefinal subborrowers. The commercial banks would repay their loans over 12years, including a grace period of five years. The Government would bearthe foreign exchange risk. The proceeds of the credit to be used fortechnical assistance would be transferred to the respective agencies onIDA terms or, in the case of federal ministries, as non-reimbursableallocations under the annual development budget.

PART I - THE ECONOMY 1/

2. The most recent economic report "Pakistan: Recent EconomicDevelopments" (No. 4906-PAK, dated February 24, 1984) was distributed tothe Executive Directors on March 13, 1984.

3. Economic developments during FY83 were generally favorable. GDPgrew by 5.8%, with value added in agriculture rising by 4.8% and inindustry by 8.3%. Continued stagnation in (fixed) investment, whichdeclined slightly from 13.6% of GNP in FY82 to 13.4% of GNP in FY83, wasamong the few unfavorable events. National savings, on the other hand,rose sharply from 10.9% to an estimated 14.1% of GNP. The declining trendin the rate of inflation continued; as measured by the consumer priceindex, the rate of inflation slowed from 11.5% in FY82 to 5.2% in FY83.

4. There was a dramatic turnaround in the balance of payments inFY83. The current account deficit, at US$554 million (1.8% of GNP), wasless than half the size of deficits in recent years. This outcomereflected three main factors: a resumption in the growth of exports fol-lowing a substantial decline in FY82; a slight decline in the value ofimports; and buoyant remittances from migrant workers. Exports grew by13%, nearly regaining their FY81 level. The most striking feature of theexport performance was the growth of non-traditional exports, whichincreased by over a third. The drop in imports reflected, inter alia,

1/ Parts I and II are substantially the same as Parts I and II of the President'sReport P-3808-PAK (Command Water Management Project), dated May 4, 1984.

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higher domestic production of oil and import-substitution in some keycommodities. The incipient recovery in world trade and delinking of theexchange rate from the U.S. dollar in January 1982, with its subsequentdepreciation, contributed significant:ly to the improved balance of pay-ments picture. Given the favorable outcome on the current account, normallevels of net inflows of long-term capital, and net IMF purchases,Pakistan's reserves more than doubled. At: the end of FY83, gross officialreserves stood at US$1,911 million, the equivalent of 3.5 months' ofimports of goods and non-factor services.

5. Notable progress was made in many areas during the Fifth Five-YearPlan Period (FY79-83). Real growth rates in national output (6.3%),agriculture (4.4%), industry (9.1%) and exports (9.2%), though below Plantargets, were all substantially above the rates achieved during 1970-78and very respectable compared to the performance of other LDCs over thesame period. This growth - coupled with ̀ Lncreased inflows of migrantremittances - benefited large segments of the urban and rural populationi.The output of all major crops reached record levels and self-sufficiencyin wheat and sugar was achieved. Encouraged by improved governmentpolicies, private investment in manufacturing expanded by 8% p.a. in realterms; this expansion was more than offset by the declining public invest-ment in the sector, however. The baLance of payments performance wasquite satisfactory: the current account deficit declined significantlyrelative to GDP. Government fiscal and credit policies reduced budgetdeficits and monetary expansion and inflationary pressures graduallysubsided. This progress was made despite a number of unforeseen events:(a) world recession; (b) a 30% declirLe in the external terms of tradeafter 1979; (c) the Afghan crisis, which necessitated increased outlaysfor defense and refugee assistance; and (d) a continued decline in realnet aid flows.

6. In recent years the Government has taken a number of initiativesto improve agricultural, industrial and fiscal and credit policies. Inagriculture, particular attention has been given to improving farmerincentives and input supplies. Support prices for all major crops havebeen raised so that they are ncow closer to world prices. At the sametime, steps have been taken to reduce! the fertilizer subsidy. AnAgricultural Prices Commission has been set up to make recommendations onappropriate changes in crop support and input prices on a consistent andtimely basis.

7. The Government has formulatecl and begun to implement a newagricultural policy based on the main recommendations of a UNDP study onirrigated agriculture which emphasizes the need to improve the efficiencyof the water delivery system through the rehabilitation of canals andbetter scheduling of water deliveries to the farmer, and to expand therole of the private sector. Other programs--in pesticides, seeds,agricultural credit, extension, research and farm power--have also beenstrengthened. These initiatives are still at an early stage and a

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breakthrough from the problems of low productivity at the farm level isyet to take place.

8. Major changes have also been made during the past five years ingovernment policies in the industrial sector. The policies pursued in theearly and mid-1970s of extensive nationalizations, tight restrictions onthe private sector, and rapid expansion of the public sector to spearheadindustrial investment and growth have been gradually reversed. Mostagricultural processing and some industrial units have beendenationalized; constitutional safeguards have been provided to privateindustry against further arbitrary government acquisitions; and the areasopen to the private sector have been widened. A wide range of fiscalincentives have been granted to encourage private investment and exports.These have been supplemented by a liberalization of imports which hasimproved the availability of inputs. The investment sanctioning procedurehas been streamlined. These measures have led to an improvement inprivate sector confidence and stimulated private investment, mainly insmall and medium-scale projects.

9. At the same time, the Government has embarked on the difficult andinevitably long process of reforming the public industrial sector, whichhas been plagued by low efficiency and profits. Major studies have beencompleted of the management and organization of the public sector, and theperformance of individual enterprises. In accordance with the recommenda-tions of these studies, the Board of Industrial Management (BIM) has beenabolished, the number of sector holding corporations has been reduced, andboards of directors have been established which have helped to increaseautonomy at the enterprise level. Some public sector units which havelittle prospect of improved financial performance have been closed down.These measures have helped to increase production and capacity utilizationsubstantially in the puiblic sector.

10. Fiscal performance improved significantly over the Fifth Planperiod. The overall budget deficit and government borrowing from thebanking system, which stood at 8.8% and 4.3% of GDP in the first year ofthe Plan, fell to 6.4% and 1.7%, respectively, by the final year. Reducedlevels of goveinment borrowing from banks, together with overall creditrestraint, led to lower rates of growth of the money supply and lessenedinflationary pressures; prices rose by 5% in the final year of the Plan ascompared with 8% in the first year. The improvement in fiscal performancewas, however, largely the result of expenditure restraint rather thanbetter revenue performance. Real expansion in current expenditures oneconomic and social services barely kept pace with population growth anddevelopment expenditures declined relatively to GDP. At the same time,government revenues remained constant at 16% of GDP and public savings,having risen in the first half of the Plan period from 1% to 3.8% of GNP,amounted to only 1.6% in the last year of the Plan. Greater resourcemobilization by the public sector will be critical for the implementationof the Sixth Plan.

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11. The developments in the Pakistan economy since 1977 representwelcome steps towards the solution of a set: of problems which are essen-tially structural and long term in nature. Notwithstanding theseimprovements, further wide-ranging measuresl to address the main issuesare necessary if Pakistan is to sustain itEi recently improved economicperformance over the Sixth Five-Year Plan period (FY84-88). These issueeinclude the farm-level factors affecting low productivity in agriculture;,the structure and competitiveness of the industrial sector; the need torestrain the growth of energy demand and improve the exploitation ofdomestic energy resources; the factors lying behind continued rapid growthin population; and the problems of resource mobilizations

12. Agriculture remains the economy's mainstay, accounting directlyfor roughly a third of GDP, employing about: 55% of the labor force and,directly or indirectly, providing nearly two thirds of total exports.Except in the important case of wheat, agricultural growth since themid-1970s has been the product of acreage expansion with little improve-ment in yields. Because of the high cost of extending the irrigationsystem, a switch to more intensive agriculture is essential. The achieve-ment of higher productivity will require imaproved agricultural servicesand increased efficiency of the irrigation system as well as continuedattention to producer incentives. Toward the latter part of the FifthPlan, some progress was made in reorienting expenditures towards projectsdesigned to rehabilitate and improve the operation and maintenance of theirrigation system, increase the efficiency of water use, improve qualityof research and extension, and increase the supply of complementaryagricultural inputs. These efforts will need to be accelerated during theSixth Plan period. To encourage greater agricultural yields, theGovernment must also continue to rationalize prices of agricultural out-puts and inputs. In recent years, pricing decisions have been taken in amore systematic and timely fashion based oni recommendations by the newlyformed Agricultural Prices Commission; procurement prices have beenbrought more nearly in line with international prices and subsidies forfertilizers and pesticides substantially r(educed. These efforts, too,will need to be continued during the Sixth Plan period.

13. Manufacturing contributes about 15% of GDP and during much of the1950s and 1960s provided a major stimulus to growth. After a period ofstagnation during the period 1970-77, manufacturing growth has againaccelerated. To provide a solid economic basis for continued rapidgrowth, incentives for greater private and public manufacturing enterpriseefficiency will have to be implemented. Despite some success in revivingthe private sector and improving the performance of public enterprises,much remains to be done to bring about a major restructuring of industryand place it on a competitive basis. The efficient long-term developmentof the industrial sector will require both a relaxation of governmentcontrols and rationalization of' industrial incentives. To encourageindustrial growth more in line with Pakistan's comparative advantage, the

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process of import liberalization initiated over the past few years must becontinued. In addition, the differential rates of protection given tovarious domestic products need to be substantially narrowed. To providefurther encouragement for private investment as well as to attract riskcapital, the number of administrative regulations must be reduced. Inaddition, the scope of price controls should be substantially narrowed,especially the use of cost-plus pricing which discourages improvements inefficiency and energy conservation. Further strong measures to increaseefficiency and self-financing capacity in the public sector are alsoessential. The implementation of the Public Enterprises Signaling Systemin FY84--which has set performance objectives for individual enterprisesand will provide bonus incentives for managers--should contribute towardthe achievement of these objectives.

14. Energy shortages have become a significant constraint to rapideconomic growth in Pakistan. Power and gas shortages are common and thecountry imports 90% of its petroleum needs costing over 26% of totalimports. Energy investments to improve the energy situation total over33% of public investment in the Sixth Five Year Plan. The Government'sefforts to deal with the energy situation by adjusting domestic oilprices, and by encouraging the substitution of other energy forms and theexploration and development of domestic oil resources, have met with somesuccess. Growth of petroleum consumption has been restrained by thedevelopment of hydroelectricity and natural gas resources as well as bypetroleum price adjustments. At the same time, activity in the oil sectorhas been stepped up, in some instances through joint ventures with foreignprivate companies. Nevertheless, due to a variety of technical, geologi-cal and other reasons, progress on exploration of new fields as well asthe development of existing fields has been slow and Pakistan's con-siderable potential in the oil and gas sector has yet to be realized. TheGovernment has begun to implement a number of reforms relating to suchmatters as energy planning, pricing and organization in order toaccelerate progress.

15. While it is clearly vital to sustain rapid economic growth, it isalso necessary to contain the rapid growth in population, currently run-ning at about 2.8% p.a. Family planning programs have so far had littleeffect and there have been few changes in the socio-economic environmentof a type that usually accompany declines in fertility. Rapid populationgrowth places severe burdens on government resources simply to maintaineducation and health programs at their current inadequate standards.However, without higher literacy rates, improved health facilities and areduction in child mortality, it is doubtful that population growth ratescan be much reduced. The Government has recently shown more awareness ofthis problem.

16. Policies that face the longer-term issues in both the productiveand the social sectors will take time to have an appreciable effect andwill have to be implemented in the context oi continued domestic and

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external resource constraints. National savings averaged only 12% of GNPover the Fifth Plan Period. To improve the budget and the balance ofpayments, a fundamental improvement is required in the overall savingslevels in the economy, particularly in public savings. Given the size ofthe public sector's domestic resource requirements, a comprehensivestrategy that utilizes all available instruments, including taxationpolicy, greater reliance on user charges, curtailment of open and implicitsubsidies and improved self-financing of investment by public enterprises,will be needed.

17, The Sixth Five-Year Plan, initiated on July 1, 1983, represents apragmatic overall strategy for Pakistan's continued rapid development.The Plan puts heavy stress upon improvements in economic policies as wellas on a public expenditure program. Recognizing the importance of adynamic private sector for rapid economic growth and the limitations onpublic sector resources, it calls for reduced regulations on the privatesector, increased emphasis on market incentives for greater production andefficiency and for increased participation in sectors where the Governmenthas previously played a large role. The size and composition of thepublic sector development program is appropriate. While public develop-ment expenditures would expand only as rapidly as gross domestic product,this is a realistic target given projected available resources and thedemands for improved public services. To achieve such an expansion - areversal of the declining trend experienced under the Fifth Plan - and tofinance an increasing share from domestic resources will require a majormobilization effort. The largest increases in sectoral allocations havegone to energy, agriculture and irrigation, and the social sectors. Theshift in the composition of the public; sector development program isjustified because of the threat to future growth posed by energyshortages, the need to increase agricultural yields by improvements inagricultural and irrigation/drainage services, and the past neglect of thesocial sectors.

18, The recent policy initiatives, which are to be continued duringthe Sixth Plan, have improved Pakistan's creditworthiness for commercialborrowing and for a blend of Bank and IDA borrowing. At the end of calen-dar 1982, Pakistan's external public clebt (excluding the undisbursedpipeline) stood at US$9.2 billion, of which US$4.8 billion was owed tobilateral members of the Pakistan Consortium, US$1.3 billion to OPEC andUS$1.8 billion to multilateral agencies and the balance to other bilateraland private lenders. In 1982, the Bank Group's share in Pakistan's exter-nal public indebtedness was 15.2% and in external debt service was 12.1%.According to Bank forecasts, provided recent policy improvements aresustained, Pakistan's debt service ratio (debt service divided by exportsof goods and factor and non-factor services), which was about 13.7%(including IMF charges) in FY82,, is likely to remain below 15% during the1980s, even assuming substantial commercial borrowing.

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PART II - BANK GROUP OPERATIONS IN PAKISTAN

19. The cumulative total of Bank/IDA commitments to Pakistan(exclusive of Loans and Credits or portions thereof which were disbursedin the former East Pakistan) now amounts to approximately US$2.9 billion.During its long association with Pakistan, the Bank Group has beeninvolved in almost all sectors of the economy. This has included itsinvolvement with other donors, over a 20-year period, in the major programof works to develop the water resources of the Indus Basin. Approximately30% of total Bank/IDA commitments to Pakistan have been for agricultureand irrigation; 26% for industry including import program credits; 21% fortransport, telecommunications and public utility services; 14% for energyincluding power, gas pipelines and petroleum; 4% for social programs ineducation, population and urban development; and 5% for a SAL.

20. Lending operations in Pakistan have three main objectives: first,to support the directly productive sectors of the economy; secondly, tosupport the expansion of, and to improve the institutions which areresponsible for, the principal public services supporting economic growth;and thirdly, to meet basic needs in the areas of rural and urbandevelopment.

21. In pursuit of these objectives, the Bank Group has placed specialemphasis on lending for agriculture, which is the mainstay of the Pakistaneconomy. Projects in this sector are aimed at augmenting the supply ofessential inputs, principally irrigation water, fertilizer, seeds andcredit; strengthening research, extension and other agricultural support-ing services; improving water management; reclaiming land by controllingsalinity and waterlogging; and providing essential facilities includingtubewells, livestock development and dairy processing. An importantpurpose of this lending is to assist the Government's program to increasethe productivity of available land and water resources in the Indus Basinthrough quick-yielding investments, as recommended recently in aUNDP-financed study for which the Bank was executing agency.

22. In industry, lending through DFCs and other financial inter-mediaries which has been mainly for the private sector totals US$438.5million. This includes eleven Loans/Credits for the Pakistan IndustrialCredit and Investment Corporation (PICIC), two Credits for the IndustrialDevelopment Bank of Pakistan (IDBP), one Credit for the NationalDevelopment Finance Corporation (NDFC), a Credit for Small ScaleIndustries through five commercial banks, and a Loan/Credit for industrialinvestment through five participating financial institutions including two

p commercial banks. Direct lending for industry has also included assis-tance to three large fertilizer plants and a refinery engineering loan.As of March 31, 1984, IFC had made investments in 16 Pakistan enterprisesfor a total of US$182.4 million, of which US$170.8 million was by way ofloans and US$11.6 million by equity participations (these are shown inAnnex II). About US$55.1 million of these investments remained

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outstanding. The enterprises assisted by IFC include three in the fieldof pulp and paper products, two each in textiles, food and foodprocessing, and petrochemicals, and one each in cement, steel,fertilizers, plastics, and wood processing. IFC is also a shareholder inPICIC.

23. The Bank has had a long standing involvement in the energy sector.In power, the Bank Group has assisted t:he Karachi Electric SupplyCorporation (KESC) and the Water and Power Development Authority (WAPDA)with four and three projects respectively; the sector has also beenassisted by the construction under the Indus Basin Development Program ofMangla and Tarbela Dams. In petroleum, the two Sui gas transmissioncompanies have been assisted with five projects, while the Bank group isfinancing two petroleum projects, for production and exploration, and isplaying an important role in strengthening the public Oil and GasDevelopment Corporation. An IDA credit: to support a Coal ExplorationProject was recently approved. These efforts are assisting in the effi-cient development and utilization of Pakistan's domestic energy resourcesand in establishing a policy and instit:utional framework for increasedprivate investment in the sector. In addition, IFC has made three loansin the petroleum sector.

24. The focus of Bank Group lending for transport and communicationshas shifted increasingly towards assist:ing Pakistan to better utilizeexisting capacity by improving the efficiency of operations andstrengthening the institutions responsi.ble for these services, especiallythe Karachi Port Trust, Pakistan Railways, the Telephone and TelegraphDepartment, and federal and provincial highway agencies. IDA has financedfour projects in the urban and water supply sector, three of which arecurrently being implemented. Five creclits for education, totaling US$62.5million, have assisted in upgrading primary, post-secondary and highertechnical and agricultural education, middle-level training of primaryteachers and agricultural extension agents. A first population projectwas approved in early 1983.

25. In addition to financing specific high-priority projects in keysectors of the economy, the Bank has from time to time supportedPakistan's development through program assistance. A first structuraladjustment lending operation (SAL) was approved by the Executive Directorsin June 1982. This SAL program consisted of a number of significantreforms in government development planning and in policies and programs inthe agriculture, energy and industrial sectors.

26. Annex II contains a sumMaLry statement of Bank Loans and IDA Creditsas of March 31, 1984. Credit andi loan disbursements have been generallysatisfactory. Some projects have experienced initial delays due to protractedgovernment procedures for project approval, which are being addressed, andto slowness in the procurement of goods and services. Rapid turnover of

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managerial and technical staff, in part due to migration to the Middle East,and budgetary constraints have been problems in the case of some projects.

27. A number of further projects for Bank Group financing are currentlyunder appraisal or being prepared in Pakistan. These include projects forpower tranimission and generation, direct and indirect industrial investments,oil and gas development, irrigation, agriculture and education. Pakistancontinues to have domestic resource constraints for the reasons set out inPart I. To assist the Government to finance agricultural and other high-priority projects which have a low foreign exchange component, financingof some local expenditures in specific cases is justified.

28. In addition to lending, economic and sector work provides the

basis for a continuing dialogue between the Bank Group and the Governmentof Pakistan on development strategy, and for the coordination of externalassistance within the Pakistan Consortium.

PART III - THE INDUSTRIAL SECTOR AND SMALL SCALE INDUSTRIES

Industrial Structure. Performance and Prospects

29. In FY83, industryl/ accounted for about 23% of GDP, employed 19%of the economically active population and accounted for 57% of totalexports, of which textile products accounted for 77%. Textiles and foodprocessing industries are estimated to account for more than half ofmanufacturing value added; other major sectors are engineering andchemicals. In large-scale industry, public sector enterprises (PSEs)produce about 15% of value added and constitute a substantial share of anumber of key sub-sectors (cement, fertilizers, chemicals and heavyengineering).

30. During the 1970s, the Government nationalized a large part ofindustry. The present Government, which took office in 1977, has takenseveral measures to reverse these policies, and is committed to having theprivate sector play a leading role in industrial development. In thisregard, the Government has already denationalized most agriculturalprocessing and a number of manufacturing units, introduced a constitu-tional guarantee against nationalization, widened areas open to theprivate sector, restricted public sector industrial investment to thecompletion of ongoing projects and key investments for balancing,rehabilitation and modernization, liberalized trade policy, and introduceda range of export and investment incentives. As a result these measureswhich have been supported by Bank Group sector work, the StructuralAdjustment Loan and industrial development projects, real annual growthsince 1977 has averaged 9% for industrial value added, 10% for private

1/ Including construction and mining.

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fixed industrial investment, 10% for manufactured exports, and 4% forindustrial employment, with expansion occurring in all established sub-sectors.

31. Industrial Strategy and the Sixth Five-Year Plan (SFYP). TheSixth Five-Year Plan assigns a prominernt role to industry, with realgrowth in industrial output expected to average 9% and the volume ofmanufactured exports 11% annually. The targeted sectors for highergrowth and output are engineering; products, agro-processing industries,and agricultural inputs. Exports of manufactured goods will be promoted,with particular emphasis on non-traditional, labor-intensive products.Investment will be encouraged through government policies on deregulation,simplified sanctioning procedures, rationalization of the incentivesstructure and improvements in infrastructure. Continued investor con-fidence is expected to result in an increase in the level of industrialinvestment from 4.0% to 5.3% of G,DP during t'he Plan period. In totalfigures, industrial investment for the five years is projected at Rs 83billion, of which Rs 62 billion is expected to be contributed by theprivate sector.

32. The Plan provides for a premier role for the private sector ininvestment and production; promotion of efficient import substitutionindustries; rapid growth in exports of manufactured items; continuedimprovements in the efficiency of public enterprises; and the provision ofinfrastructural facilities and services required by both private andpublic industrial enterprises. The success of the Plan, with respect toindustry, will depend largely on the Government's ability to furtheraddress the weaknesses in industrial policy, regulations, and procedures,and the rationalization of the tariff structure to provide a more uniformdegree of effective protection. The Government is aware of these issuesand it is expected that the positive steps already taken (paragraph 30)will be followed by additional similar measures.

33. Small Scale Industries (SSI) Sector. In recent years, SSIs havecontributed close to 4.7% of GDP, 27% of industrial value added, and 30%of manufactured exports. SSIs employ about two million workers in about80,000 establishments. Small firms are generally less affected byeconomic variations since they have greater flexibility with respect toproduction schedules and employment of labor: are less vulnerable andsensitive to political changes; generate a good portion of their capitalneeds from the informal capital markets; and require less infrastructuralsupport than do larger firms. During the dil'ficult years of theseventies, while output from larger firms declined, small scale industry

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continued to grow representing 20% to 30% of total industrial investmentin the seventies versus 10% to 14% in the sixties.l/

34. SSIs in Pakistan are more labor intensive and, generally, moreefficient users of capital than large scale units2/; SSIs have also provedto be more efficient producers of goods, especially for the rural markets,where quality requirements are less stringent. Compared to selected EastAsian developing countries,3/ SSIs in Pakistan are more labor intensiveand use capital more efficiently, but have a lower labor productivitysuggesting that Pakistan SSIs utilize less productive traditionaltechnology. There is substantial room for appropriate modernization toimprove labor productivity without sacrificing labor intensity and capitalproductivity.

35. The majority of SSIs are located in the provinces of Punjab and

Sind, with a smaller proportion in North West Frontier Province (NWFP) andBaluchistan. This geographic distribution reflects populationconcentrations, availability of raw materials and infrastructure, accessto markets and local entrepreneurship. Traditionally, SSI units con-centrated on processing local raw materials. Recently, expansion has beennotable in food processing, engineering products and constructionmaterials. Other key SSI activities focused on exports on the basis ofadding value to imported raw material. Agro-industries, selected textileproducts and light engineering are expected to continue to be the majorgrowth areas in the medium term.

36. SSIs in the Sixth Five-Year Plan (SFYP). Recognizing the impor-tance and potential of the Small Scale Industries sector, the SixthFive-Year Plan (1984-1988) envisages a continuing prominent role for smallindustry. The Plan envisages Rs 9.4 billion of direct private investmentin small scale industry during the five-year period. These investmentsare projected to result in 350,000 new jobs, 7.3% real annual growth insector output, and 15% p.a. growth in sector export volume. In light ofthe actual growth over the last five-years the target appears realisticand attainable. These targets are also consistent with economy-wide

1/ These figures are only indicative of trends and relativecontributions, as only limited and not very reliable data on SSIs isavailable in Pakistan.

2/ Investment cost per job is about US$1,800 compared with US$21,000- for a sample of larger private projects financed by the Pakistan

Industrial Credit and Investment Corporation. The average capital-output ratio of SSIs was 0.8 compared to between 1.0 and 1.5 for largescale industries.

3/ Philippines, Thailand, Malaysia and Singapore.

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growth objectives, SSI potential, anticipated inflation and current inteest in SSI investment as reflected in credit demand. To attain theseobjectives, the Plan places particular emphasis on (a) the expansion ofagro-processing, adding value to exportable surpluses, (b) the forwardintegration of the textile industry to produce high value articles forexport, such as ready-made garments and speciality cloth, and (c) theadoption of subcontracting arrang;ements with SSI units by the largeengineering manufacturers. There is already some success in these areasas evidenced by increasing exports of processed agricultural products andmade-up textile products. However, much more needs to be done to developprojects along these lines especially in the area of subcontracting. Astudy in subcontracting would be undertaken under the proposed project todevelop measures in this area. Overall., the SSI sector still encountersproblems in production methods, labor skills, management capacity, tech-nology modernization, product quality, and effective marketing. Increasedtechnical assistance and extension services will have to be provided bySmall Industries Corporation (SICs) and closer attention paid by the banksto identify investors and prepare projects. The proposed project isdesigned to assist the SICs and the banks in responding to theserequirements.

37. Policy Environment and Development Strategy. The Government'spolicies for industrial development do not d:Lfferentiate between large andsmall industry. Rather than protecting or subsidizing small firms, theGovernment has maintained a strategy of increasing SSIs' access to creditand technical services. SSIs are allowed to set up and operate withlittle regulation, and market signals are the main determinants of SSIinvestments and their viability. The Government's policy provides thatall SSIs be in the private sector. Subsectors with strong potential, highvalue added, and limited economies of scale are promoted--but notreserved--for SSI production. There is a push to develop SSIs in moreremote urban and rural areas, but this objective again is pursued bypromotion and provision of services, rather than through subsidization,allowing SSIs to prosper or decline with the market.

38. The promotional and technical assistance activities in support ofSSIs are a Provincial Government responsibility and are carried out by thePunjab Small Industries Corporation (PSIC), the Sind Small IndustriesCorporation (SSIC), the Small Industry Development Board (SIDB) of NWFP,and the Directorate for Small Industries (DSI) in Baluchistan.l/Traditionally, SICs focused their assistance to the sector on providingphysical facilities, developing industrial estates, building and equippingservice centers, and establishing training and production centers forhandicrafts. Insufficient attention was given to building effectiveprograms to promote viable new enterprises and to provide extension serv-

1/ The acronym SIC in this report refers to all of these agencies.

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ices to existing firms. The first SSI Project (Cr. 1113-PAK) encouraged

the SICs to develop these services through subsector studies, projectdevelopment, and practical export promotion components. The SICs willneed to continue to build their capabilities in these and other "soft-ware" aspects of SSI promotion. The technical assistance components ofthe propcsed project are designed to assist in these areas.

Industrial Finance

39. Structure of the Financial System. The financial system inPakistan consists of nationalized and foreign commercial banks, and arange of specialized financial institutions. The State Bank of Pakistan(SBP), the central bank, regulates and supports the financial system. ThePakistan Banking Council (PBC) coordinates the activities of the fivenationalized commercial banks and serves as a communications link betweenthem and the Government

40. With total assets of Rs 212 billion, or 90% of the assets of the

financial system as of June 30, 1983, and a network of around 7,000branches throughout the country, the commercial banks play a dominant rolein the financial system. In the commercial banking system, the five NCBsaccounted for about 89% of deposits, 87% of advances, 82% of commercialbank net profits. Since 1979, a number of steps have been taken toimprove the overall performance of the NCBs: branch expansion has beenlimited; uneconomic branches are being closed down; hiring of staff,except for middle level management, has been stopped; a staff performancereview and disciplinary system has been introduced; promotion is now basedmore on merit than seniority; central training institutes such as theInstitute of Bankers are being strengthened; and NCBs will be allowed tobuild up their capital to a prudent level, with the Government not requir-ing dividends for the next three years. These actions resulted in a 91%increase in NCB's profitability in FY82, with further improvementsprojected in 1983.

41. SSI Financing - Sources and Demand. The nationalized commercialbanks have principal responsibility for SSI lending activity. Annualtargets for SSI lending are set by the State Bank of Pakistan based on theGovernment's Annual Development Plan projections for SSI investments andvalue-added and divided among the five banks according to deposit volume.The targets are revised during the year in relation to actual creditdemand from SSI for investment and working capital. With the availabilityof long term resources from IDA, fixed investment loans to SSIs haveincreased. Moreover, the first SSI project reinforced the banks'capabilities in project-based term lending.

42. Investments in SSI grew from Rs 725 million in FY79 to Rs 1,337million in FY83, at an average annual rate of 17%. While this rate wasslightly lower than growth of investments in larger private industry, SSIinvestment growth compared favorably with total investments in large

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public industry which stagnated due tco contraction in investments inpublic enterprises.

43. As an indication of credit demand, for FY84, the State Bank ofPakistan's target for net additional lending to SSIs totals Rs 1.6billion, which is consistent with the Sixth Plan projections. Taking aconservative approach to Sixth EPlan projections for investment andreliance on institutional finance, the! average demand for institutionalcredit for investment by the sector will be about Rs 1.1 billion for FY85and FY86. Assuming a conservative 7% real annual rate of growth inoutput, the requirements for incremental working capital financing fromthe banks also could average Rs 1 billion annually, assuming that self-finance would constitute 50% of working capital requirements.

44. Recent levels of financing by the banking system and the pipelineof SSI projects suggest sizable immediate credit demand. Since fullcommitment of the subloan components cf the first SSI project in September1983, the five commercial banks have sanctioned 277 more subloans amount-ing to US$14.5 million equivalent. These, together with a pipeline ofabout US$20 million equivalent, provide the proposed project with theprospect for a strong start-up.

45. Islamization. In recent years, the financial sector has expandedrapidly at an average annual rate of 16%, in current values. However, itslong term development is constrained on the resource side by the low levelof domestic savings, wlhich recently has been counterbalanced by the inflowof foreign remittances from Pakistani workers abroad. On the lendingside, two important government policies are influencing the development ofthe financial sector. The first is the use of commercial banks to provideterm financing to agriculture and industry. The second factor is thatsince 1981, GOP has introduced a number of changes in the financial systemas part of its Islamization process. The objective of financialIslamization is to shift from an interest-based financial system to oneoperating on the principle of profit and loss sharing (PLS). Changes inthe financial system relevant to industrial finance include the introduc-tion of: (i) PLS working capital loans (MuEiharika); (ii) participationterm certificates (PTCs) based on the PLS principle, to replace debenturefinancing; (iii) Modaraba companies, which operate as investment funds inaccordance with Islamic tenets; and (iv) the conversion of a number ofspecialized financial institutions, including National Investment Trust,House Building Finance Corporation and Small Business Finance Corporation,to a non-interest basis of operation.

46. Since the process of Islamization is being implemented graduallyand pragmatically, it is too early to evaluate its full economic andfinancial implications. However, indications are that, on the whole,Islamization has so far had a positive impact. By not imposing restric-tions on the terms and conditions whiclh can be negotiated between lendersand borrowers using the new instruments, the Government is in effect

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freeing financial rates of return. This applies in particular to termfinancing through PTCs, and the arrangements for hire purchase and leasingcurrently under consideration. However, since there are a number ofpotential problems in the operation of a parallel interest and PLS-basedsystem, the Government will remain involved in the regulation of thefinancial system for some time and may have to continue to resort todirect intervention in financial markets to meets its macroeconomic anddevelopmental objectives.

47. The Government is committed to maintain the application of inter-est based financing where foreign funding is involved. As theIslamization process is extended and experience gained, closer analysis ofthe system may be required to see if it is necessary to adapt Bank Groupfinancing in any significant way.

48. Credit Allocation. In Pakistan, the credit allocation system isused as a tool to achieve overall monetary policy objectives. Within thecountry's total credit limits, annual targets are set for lending to thepriority productive sectors, industry and agriculture, to ensure adequatecredit availability. There is also a corresponding allocation of theoverall credit amounts to the commercial banks. However, allocations arenot made to specific industrial subsectors or to particular projects. Ananalysis of the system of credit allocation has found that while theremaining rigidities make it less than ideal, the system is administeredrelatively flexibly, revised quarterly based on actual demand for credit,and does not squeeze out the private sector. In fact, the proportion oflending to the private sector has increased yearly. While allocations donot represent a significant bottleneck at present, the system would con-tinue to be the subject of dialogue and careful monitoring, during thecourse of project implementation.

49. Interest Rates. The interest rates in Pakistan are set by theGovernment through the State Bank of Pakistan (SBP). Current rates forall industries are 11% p.a. for term loans for investments and 14% p.a.for short term working capital loans. Foreign currency term loans formedium and large industries, which are provided mainly by developmentfinance institutions, are also at 11% p.a. but a 3% p.a. foreign exchangerisk fee is charged by the Government which bears the exchange risk.Since experience has shown that the majority of subloans for smallindustries are applied to local expenditures, the Government does notapply an exchange risk fee for term loan to SSI even where the source ofthe funds are foreign. These current rates represent a positive return tocapital, given an inflation rate of 10.5% in 1982 and 6% in 1983. Theaverage inflation rate for 1984 is projected to be higher, as externalresource flows in the latter half of 1983 contributed to monetary expan-sion which translated into higher prices in the first quarter of the year(11% on an annual basis). With the Government's proposed reduction inmonetary expansion down to 13% from 26% and no visible structural infla-tionary pressures, it is likely that inflation in the medium term will

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remain below 10% and that lending rates wotuld remain positive in realterms.

Bank Group Lending Strategies

50. The Bank Group strategy for industry in Pakistan has focused oneffective transfer of financial resources to the private sector throughinstitution building of financial intermediaries, coupled with projectpromotion and subsector analyses. In addition to the first SSI project,other Bank Group operations in the industrial sector of Pakistan haveconsisted of 14 loans and credits to three development finance institu-tions for onlending to medium and large industrial projects, of which 13operations totaling US$324 million were for the private sector and one,amounting to US$30 million, for public sector projects. The recentlyapproved Industrial Investment Credit (IIC) of US$100 million equivalentfor financing of medium and large projects in the private sector will bechannelled not only through the traditional development finance institu-tions but also through two commmercial banks with a view to broadening andimproving credit channelling to industry. Work on the overall policyframework was furthered under the first Structural Adjustment Loan (SAL).Within industry the SAL focused on progress in the reform of the incentivestructure, improvements in the efficiency of the public manufacturingsector, and streamlining of investment: licensing procedures.

51. The First SSI Project (Cr. 1113-PAK). Prior to the first SSIproject, (SSI I), SSI lending was carried out jointly by Small IndustryCorporations (SICs) and the cominercia:L banks, an arrangement whichresulted in overlapping responsibilities, friction between institutions,delays in loan processing and, finally, poor loan recovery performance.Moreover, concerns with lending drew l:he SICs away from the other impor-tant functions of SSI promotion and extension. SSI I succeeded inrationalizing institutional roles by assigning the lending function com-pletely to the commercial banks and reorienting the SICs toward promotionand technical assistance. The project: assisted the commercial banks inorganizing and staffing appropriately for project-based SSI lending.About 400 branches were designated by the five banks to process IDA sub-loans and the banks, with the Industrial Development Bank of Pakistan(IDBP) as refinance and monitoring agency and the Pakistan Banking Council(PBC) as coordinator, have demonstrated their capability for SSI lendingby fully committing the $26 million subloan component of the credit morethan one year ahead of schedule. Disbursements to subprojects havereached US$21 million and full disbursement is expected by December 1984.Subloans averaging US$48,000 have been approved for 646 subprojects, withfixed cost per job of US$3,250. Major subsectors financed have beenagro-industries, light engineering, textiles and garments, and woodproducts. While most subprojects are still under implementation andsubloans have not yet matured, a random sample of subprojects alreadyoperating indicates that lending decisions being made under the scheme are

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sound, with a high quality of sponsor screening and good appraisaltechniques.

52. To reorient the SICs toward promotion and extension services,implementation of the technical assistance components was made theirresponsitility. Implementation of the technical assistance componentsother than the preparation of subproject proposals, however, has beendelayed, due to problems with civil works for the service centers, dif-ficulty in locating and hiring appropriate consultants for the exportpromotion and project promotion components, and indecision on onlendingterms by the Government for the subsector studies fund. Most of theseproblems have now been resolved and new target completion dates have beenagreed with the concerned agencies. These dates are still within theoriginal appraisal estimate of project completion.

f

PART IV - THE PROJECT

53. The proposed project, which builds on the experience and successof the first Small Industries Project (Cr. 1113-PAK), would expand creditand technical assistance to SSI's to promote investments in promisingsubsectors and accelerate modernization and increase productivity ofexisting SSI units. The proposed project would also continue to assistthe participating commercial banks in reinforcing organization and staff-ing for SSI lending.

54. The proposed project was appraised in October 1983. Negotiationswere held in Washington, D.C. from April 30 to May 4, 1984; the Pakistandelegation was led by Mr. Riyaz H. Bokhari, Secretary, Ministry ofIndustry. A Staff Appraisal Report entitled "Pakistan - Second SmallIndustries Project" (Report No. 5058-PAK, dated May 11, 1984) is beingcirculated separately to the Executive Directors. A supplementary datasheet is attached as Annex III.

Project Objectives and Scope

55. The proposed project is designed to increase SSI's contribution toindustrial employment,exports and output by providing expanded financialand technical services utilizing institutional arrangements and buildingon assistance programs developed under the SSI I. As in SSI I, thegeographic scope would be nation-wide. The proposed project includesincreased technical assistance, especially in project promotion, forBaluchistan and NWFP to help increase their share of SSI investments andcredit. All SSI subsectors would be eligible for financing on the basisof established subproject eligibility and viability criteria (paragraph69). Project profiles for selected promising subsectors, particularly innew areas of investments and for Baluchistan and NWFP, would be used toaccelerate project development in these areas. Major subsectors demandingcredit would continue to be agro-industries, light-engineering, and tex-tiles and garments. Subsector studies to be completed under SSI I would

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be used in promoting investments in new areas such as in more advancedagro-industry and engineering activities and new manufactured exports.Assistance to be provided through technical information and extensionservices and management training would stress modernization of SSIs toimprove productivity and promote growth of efficient small scaleproduction.

Proiect Description

56. The major components of the proposed project are:

(a) term loans to SSIs which meet the eligibility criteria(paragraph 69) for fixed invest:ments and permanent workingcapital through five participating commercial banks, withreview and partial refinance by IDBP using the proceeds ofthe proposed credit. Coordinat:ion of the commercial bankswould be done by the PBC; and

(b) technical assistance to the participating agencies and SSIs,which would include:

(i) training for staff of the commercial banks to improvethe quality of their SSI Loan officers, increase delega--tion of the appraisal function and build systems forcredit and project supervision;

(ii) assistance to the Baluchistan DSI and the NWFP SIDB inproject promotion;

(iii) a training program to improve SSI managementperformance;

(iv) assistance to subborrowers in project preparation; and

(v) a study on subcontracting to identify measures forexpanding subcontracting linkages between large andsmall industries.

Technical Assistance Components

57. Technical assistance for training of staff of the participatingbanks aims to enhance the banks" role in SSI financing by improving sub-project selection and appraisal and improving SSI project lendingpolicies, systems and procedures, complementing their strengths in branchnetworking and credit analysis. Training programs have been prepared byPBC and IDBP in consultation with the participating banks.

58. About 50 loan officers would be trained in project appraisal atthe Pakistan Banking Council's Development Banking Institute. Staff of

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designated branches would be trained in project supervision at the sameInstitute in a similarly organized program. The commercial banks wouldmeet all local costs. The cost of foreign lecturers would be financedout of the proceeds of the credit. Thirty executives/managers would besent on short term overseas fellowships to visit other countries withsuccessful SSI programs to study their lending policies, systems andprocedures. All foreign costs associated with this fellowship programwould be financed out of the credit.

59. The technical assistance components for SICs are designed tocontinue re-orienting the SIC programs towards private sector assistanceand to supporting elements of programs in which SICs have comparativeadvantage, i.e. investment promotion and project development, projectpreparation, and management training.

60. Technical assistance to Baluchistan (DSI) and NWFP (SIDB) would bein investment promotion and project identification and development. Thiswould involve a promotional scheme to identify project possibilities,prepare project profiles, promote investments, and attract entrepreneursto invest in these projects. In Baluchistan, an existing program would becontinued and a marketing study added, while in NWFP a unit similar tothat in Baluchistan would be established to carry out the program.Equipment, foreign and local consultancy services and staff training forthe investment promotion scheme and consultancy services for the marketingstudy would be financed out of the credit; local staff and administrativecosts would be met by SIDB and DSI.

61. To carry-out the SSI management training program, the Governmentproposes to establish an Institute for entrepreneurship under the federalMinistry of Industry. The operating costs of the proposed program for thefirst three years, including equipment and materials and the services of aforeign training advisor, would be financed under the credit. Physicalfacilities would be rented. To ensure continuity of the Institute beyondthe project period, an endowment fund of Rs 10 million would be estab-lished with contributions of Rs 1 million each from the five commercialbanks, Rs 2 million each from Baluchistan and NWFP, Rs 2 million from theGovernment and Rs 1 million from IDBP. Fifty percent of these funds wouldbe paid up in the first year of the project. The earnings from the endow-ment fund would cover the operating costs of the Institute after the threeyear period. The endowment fund and the Institute would be directed by aBoard of Trustees representing the contributors to the fund.

62. Under SSI I, it was anticipated that some prospectivesubborrowers, especially newer and smaller entrepreneurs, might havedifficulty in preparing project proposals, for both new and existingprojects, in a form required by the banks for appraisal purposes.Accordingly, a subproject preparation fund was established under SSI I toenable the SICs to undertake the function of assisting, without charge tothe user, prospective subborrowers. To date, more than 600 subborrowers

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have been assisted by this fund. Funding for subproject preparation willbe continued under the proposed project usinig the procedures and scheduleof fees established under SSI I. On request by a subborrower or a banker,,an SIC would undertake project preparation and, upon completion of thesubproject study and its acceptance by a bank, the SIC can claim 10% ofthe fee. The other 90% would be paid only uipon approval of the subproject:and subloan by the bank. As under SSI I, the subproject preparation fundwould continue to be administered by IDBP's Simall Industries RefinanceDepartment.

63. In order to develop subcontracting between large and smallindustries, a study of subcontracting in the engineering sector, to becarried out by consultants, would be financed under the proposed project.PBC would be the implementing agency.

Project Cost and Financing Plan

64. Costs of the proposed project are estimated to total about US$120million equivalent of which IDA would finance US$50 million equivalent(SDR 47.0 million) or about 40%. Norwegian co-financing in an amount ofUS$10 million equivalent is being actively sought. IDA financing wouldcover 70% of subloan amounts while the commercial banks would provide theother 30%, up from the 20% provided by commercial banks in SSI I; sponsorswould contribute, on the average, 40% of subproject cost. IDA's share infinancing a subproject would be about 40%, compared with about 50% in SSII. For the technical assistance components, IDA financing would coverequipment costs, training, subproject preparation and consultancy amount-ing to about US$2 million. The Government, SICs and the banks would fundlocal administrative and staff costs estimated at US$1.3 million.

Participating Financial Institutions

65. The five participating commercial banks would continue to beresponsible for appraisal, supervisioni, and collection of subloans underthe proposed project; they also would continue to bear the credit risks.The five banks have demonstrated capabilities for selecting sponsors andfor appraising and implementing SSI subprojects. Under SSI I, SmallIndustry Departments (SIDs) were established at the headquarters of eachbank to undertake project appraisal, and about 400 key branches weredesignated to process subloan applications by undertaking credit analysis,forwarding applications to the SIDs for appraisal, disbursing approvedsubloans, and supervising subloan accounts. Under the proposed project,appraisal would be decentralized from the bank's headquarters to circleofficesl/ where small SIDs, stafted with a credit/financial analyst and anengineer/technical person, are already being organized. The

1/ The five participating banks have about 7,000 branches which, foradministrative purposes, are grouped under zonal offices. These zonaloffices in turn are grouped under circle offices.

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financial/credit analysts of the circle SIDs are already in place andrecruitment of engineers/technical persons is being carried out. The 400designated branches would continue to undertake the same functions asunder SSI I. However, as subloans under SSI I start to mature, specialattention would be placed on organizing the systems for end-use, projectsupervision, and appropriate training for the branch staff concerned(paragraphs 57 and 58).

Refinance and Monitoring Agencies

66. The Small Industry Refinance Department (SIRD) of IDBP, which hasfunctioned effectively in subproject review, refinance, coordination andmonitoring under SSI I, would continue to undertake the same functionsunder the proposed project. SSI I proved that using the commercial banksas the "retailers" and a development bank as the "apex" has resulted in agood blend of commercial and development banking, with the commercialbanks providing geographic coverage and good credit analysis and thedevelopment bank providing orientation in project-based lending. As theSIRD is already fully organized functionally, an appropriate increase instaff is all that is required under the proposed credit. IDBP has agreedthat SIRD would recruit four professionals, one for the subproject reviewand monitoring section, two for the finance and disbursement section, andone for the research and training section. The expansion of the financeand disbursement section would allow increased attention to the end-usefunction, especially ex-post review of commercial bank disbursement andprocurement documentation. As in SSI I, PBC would assist in coordinatingtraining and reporting and in monitoring the performance of the commercialbanks.

Credit and Administrative Arrangements

67. SSI Credit Component and Training. The proposed IDA credit ofUS$50 million equivalent would be made to the Government of Pakistan onstandard terms. Under the proposed credit, US$48.15 million equivalentwould be on-lent to IDBP who would enter into a subsidiary loan agreementwith the Government. The signing of a subsidiary loan agreement, satis-factory to IDA, between the Government and IDBP would be a condition ofeffectiveness of the credit (Section 6.01(a) of the draft DevelopmentCredit Agreement). IDBP, in turn, would on-lend to the five commercialbanks, through participation agreements between IDBP and the banks,US$48.0 million for SSI subloans and US$0.15 million for training of staffof the participating banks. Signing of participation agreements andapproval and issuance of a statement of operating policies and proceduresacceptable to IDA, by at least two banks, would be a condition of effec-tiveness (Section 6.01(b) of the draft Development Credit Agreement).

68. Technical Assistance Components. The US$1.06 million of technicalassistance for the SICs would be passed on to the respective SICs on IDAterms. The US$740,000 for the management training program component and

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the US$500,000 for the study on sub-contracting would be made available tothe proposed training Institute and the PBC, respectively, as non-reimbursable allocations.

69. Subproiect Eligibility Criteria. The proposed project wouldcontinue to use eligibility criteria as a means for improving projectselection (Schedule 3, paragraph C.4, of the draft Development CreditAgreement). Experience under SSI I has shorn that appropriate eligibilitycriteria can serve as a good proxy for economic appraisal for small sub-projects (free-limit subloans) for which detailed economic analysis wouldbe impractical. For subloans above the free-limit, the commercial bankswould be required to calculate domestic resource cost as a measurement ofeconomic viability. Criteria established under SSI I would be utilizedwith some modifications. The National Credit Consultative Council hasrevised the definition of small industry from Rs 3 million to Rs 5 millionof fixed assets, excluding land and buildings. This definition, which isnow accepted by the financial sector, the Provincial Governments, and theFederal Government, will be used in the proposed project. This adjustmentreflects inflation and devaluation since the previous definition of SS-Iwas made in 1972. To avoid promoting artificial smallness, the definitionwould be considered as a before-the-loan instead of after-the-loan basisso that, under the proposed project, a small firm could use the loan tograduate to a larger scale. However, a subloan would be limited to amaximum of Rs 5 million to keep lending principally for SSI as defined.The fixed cost per job criteriorL would. be increased from Rs 60,000 to Rs100,000 in order to accommodate subloans for balancing and modernizationwhich may have low employment generation potential but are important inimproving productivity and assuring permanent workplaces. Moreover, sincemost SSIs in Pakistan are labor--intensive (paragraph 34), this criterionwould be used as a flexible guideline to be reflected in the strategystatements of the banks. The free limit would be increased fromRs 800,000 to Rs 1.5 million in recognition of appraisal quality demon-strated under SSI I, and to align with the commercial bank's internal"free-limit" structures. Based on experience under SSI I, the otheron-lending terms are considered adequate and it is proposed to retainthem, viz:

(a) subloans would be fEor the setting up of new units or forbalancing, modernization, replacement or expansion (BMRE) ofexisting units in the industrial sector, including industrialservices and agro-industries;

(b) working capital financing would be allowed only as a part ofa fixed investment subloan and only for permanent workingcapital needs;

(c) a minimum of 30% of subproject costs would be provided bythe sponsor in the form of equity; and

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(d) at least 50% of the credit would be allocated to subloansof less than Rs 1,500,000.

70. Subloans would be applied to financing plant and equipment, fac-tory buildings and permanent working capital. In order to discourageover-investment in buildings, financing of factory buildings would belimited to 15% of a subloan. Purchase of land would not be eligible forfinancing out of the proceeds of the credit.

71. Onlending Terms. IDBP would onlend US$48.15 million of theproposed credit to the participating commercial banks at the same interestrates charged to IDBP by the Government. As the refinance agent for thesubloan component, IDBP would receive a fee from the participating banksof 1.5% to cover administrative costs and the financial cost of bridge-financing. For subloans, the final lending rate by the banks to the SSIswould be 11%, which is the current rate for local currency term loans toindustry, regardless of size. As in SSI I, to provide sufficient incen-tive to the commercial banks to lend to smaller subprojects and to compen-sate for higher administrative costs and risks of SSI lending, the commer-cial banks would receive an interest spread of 5.25% for free-limit sub-loans and 4% for subloans above the free-limit. The proposed final lend-ing rate of 11% is positive in real terms and is expected to remain so inthe medium term. The inflation rate in Pakistan, which was 6% in 1983, isexpected to rise in 1984 because of monetary expansion resulting fromexternal resources flows. However, with the Government's proposed reduc-tion in monetary expansion and no visible inflationary pressures, it isprojected that inflation in the medium term wil1 remain below 10%. In Lheevent of increased inflation, the Government has agreed to review interestrates under the proposed project and to take measures to ensure thatlending rates under the proposed project would be kept positive in realterms (Section 3.05 of the draft Development Credit Agreement). Sincethe credit involves many subprojects, five participating commercial banksand IDBP, the Government has decided to waive commitment charges by allthe institutions. However, participating commercial banks would beallowed to charge commitment fees to their subborrowers according to theirnormal practice.

72. Foreign Exchange Risk. Experience under SSI I shows that onlyabout 10% of subloans were used for direct foreign exchange expenditures.Most of the subloans were applied to rupee purchase of locally manufac-tured equipment or locally available imported equipment (55%), factorybuilding construction (20%) and permanent working capital (15%). Whilelocal and foreign goods which are locally procured ultimately involveforeign costs, it is administratively very difficult to separate thesecosts for a large number of small subloans to SSIs. Both the subborrowersand the participating institutions accordingly denominate these subloansas rupee loans and the Government will therefore assume the foreignexchange risk.

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73. Repayment Terms. As in SSI I, subloan maturities would be for atleast three years and up to a maximum oE ten years, including a graceperiod of up to 24 months. Since the maximum allowable maturity of sub-loans is ten years, commercial banks would repay their loans on a fixedamortization schedule of 12 years, inclusive of a grace period of fiveyears; banks would be allowed to use recycled funds arising from shortersubloan maturities only for lending to SSIs which meet the eligibilitycriteria.

74. Refinance Arrangements and Revolving Fund. Under the proposedproject, the proportion of subloan amounts financed by the commercialbanks would be raised from 20% financed under SSI I to 30%, therebyincreasing the potential number of subprojects financed. IDA's contribu-tion would be roughly equivalent to the! direct and indirect foreignexchange requirements of the whole subsector. All subloans which areapproved by the commercial banks and stLbsequently authorized by IDA areeligible for refinance for up to 70% of subloan amounts (paragraph 64). Acommercial bank can claim refinarnce against subloan disbursements fromIDBP on a periodic (e.g. monthly) basis; by furnishing IDBP a certificationthat disbursements have been made and required procurement proceduresfollowed. Each bank would keep, in a case-by-case file, documentsevidencing disbursements and procurement of goods. These files would beopen to inspection by IDA and IDBP review missions. Under SSI I, IDBP hada line of credit of Rs 10 million from the £,tate Bank of Pakistan (SBP)which served as a revolving fund from which refinance was made to theparticipating commercial banks. The SBP line of credit would be increasedto Rs 50 million to accommodate expected refinancing needs under theproposed project. IDA would advance US$2 million equivalent from theproposed credit, once it has been declared efEective, to augment thisrevolving fund. IDBP would refinance the commercial banks from therevolving fund and, on a periodic basis, seek reimbursement from IDA.These reimbursements would be used to replenish the revolving fund.

75. Procurement. Goods and services costing US$20,000 equivalent ormore per item, or US$50,000 equivalent or more per contract, would beprocured through international shopping on the basis of at least threecompetitive quotations; for contracts of goods and services with singleitems costing less than US$20,000, or combined items costing less thanUS$50,000 equivalent, the commercial bank would ensure and certify thatthese are reasonably priced and are suitable to the requirements of sub-projects. Under existing procedures, the banks require their clients toobtain three competitive quotations for fixed investment loans. Forsubloans under the proposed project, the banks would be required to main-tain records of the method of procurement, summarizing offers and awardsper subproject. IDBP would periodically review these records which arekept in commercial bank branches. Based on IDBP reports on these reviews,IDA review missions would examine these records on a sampling basis.

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76. Disbursement. In view of the large number of subprojects and thesmall size of subloans, the normal DFC procedure of disbursing againstexpenditures of individual subprojects would be inappropriate. Thus, alldisbursements for foreign or local expenditures made by the commercialbanks would be financed equally at 70% of subloan amounts. Disbursementswould be refinanced against certified statements of expenditure for whichappropriate documentation would be retained by the commercial banks andmade available to IDBP/IDA review missions. In order to expedite paymentsto the commercial banks a revolving fund would be set up using a line ofcredit from the State Bank of Pakistan and an initial deposit from theproposed credit (paragraph 74). IDA's reimbursement would be limited toexpenditures made by a subborrower not more than 180 days prior to IDA'sreceipt of IDBP's request for reimbursement, except for those expendituresto be retroactively financed (paragraph 77). For the technical assistancecomponents, IDA would disburse 100% of expenditures for consultants andtraining; the CIF cost of imported equipment and supplies; and the ex-factory cost of local equipment and supplies. For imported equipment andsupplies which are purchased locally, IDA would disburse 75%, giving a 25%average allowance for taxes and duties. Withdrawal applications will besubmitted to IDA by the implementing agency. Disbursement of the trainingfunds for the commercial banks will be done through IDBP. The subloancomponent is expected to be committed in three years and disbursed in sixyears from the date of credit effectiveness.

77. Retroactive Financing. Despite full commitment of the proceedsunder SSI I, it was agreed with the commercial banks, IDBP and PBC thatsubloan sanctioning should continue in order not to disrupt the momentumthe project had generated. Accordingly, the commercial banks continuedprocessing subloans, subject to availability of funds, and by February 29,1984, had sanctioned 277 subloans amounting to US$14.5 million. To ensurethat investments in these subprojects are realized, retroactive financingin an amount not exceeding $5 million equivalent is proposed to meet 70%of the disbursements related to these subloans made after October 1, 1983.

Reporting, Accounts and Audits.

78. The commercial banks would submit semi-annual progress reports oncommitments, disbursements, collections and arrears under the project toIDBP who in turn would consolidate the report for transmittal to IDA. Inaddition, the banks would maintain proper accounts for subloans, includingsupporting disbursement and procurement documents, which would be auditedannually according to current practice.

79. The technical assistance implementing agencies would prepare andsubmit semi-annual progress reports direct to IDA. Accounts specific tothe components would be maintained separately and would be auditedannually according to current practice. Audit reports would be submittedto IDA no later than six months after the close of the fiscal year.

-26-

Project Benefits and Risks

80. Benefits. The SSI sector has been an important segment of thePakistan economy and is expected to continue to play a major role in thedevelopment effort under the Sixth Five-Year Plan. The proposed projectwould tie in with the Government''s secitor strategy of making investmentand working capital credit more readily available to small industries, andof providing them complementary support: through effective technicalservices. The proposed IDA credit wouLd fill a significant portion of theresource gap for SSI lending, especially for f'ixed investments, com-plementing the short-term resources of the commercial banks available forworking capital lending.

81. Application of project-based lending methodology by the commercialbanks is expected to improve project selection to ensure not only finan-cial but also economic viability of subprojects. It is anticipated thatabout 1,450 subprojects would be financed, resulting in an investment ofabout US$115 million. Differential spreads according to the size of thesubloan would continue to induce the banks to give increased attention tosmaller subborrowers. As in SSI I, it is expected that about 85% of thesubloan amounts would be for loans of below Rs 1.5 million. Directemployment generated is projectecd to be about 35,000 full time jobs, withfixed cost per job averaging about US$3,500. With the greater participa-tion of the commercial banks in financi'ng individual subprojects(paragraph 74), domestic resources mobilized for SSI lending would beincreased, thereby signalling in advance the gradual reduction of IDAparticipation.

82. The proposed project would continue the strong institution build-ing aspects of SSI I. The lending component of the project would haveimportant effects in strengthenirng the credit delivery system for SSIsthrough the commercial banks' network of branches. Capability for projectappraisal and supervision would c:ontinue to be improved not only at thebanks' headquarters but also in 45 circle offices and 400 branches. Thetechnical assistance components would build on the existing structure ofthe SICs, enhancing their comparative institutional strengths and increas-ing their interaction with, and relevance to, the private sector.Overall, the complementary, but distinct, roles of SSI lending by thecommercial banks and technical assistance by the SICs would be moreclearly delineated and operationally effected under the proposed project.

83. Increased attention given to th,e less developed areas ofBaluchistan and NWFP through more intensive project promotion activitieswould assist in achieving the Government's objective of more balanceddevelopment without resorting to distorting measures of allocation orsubsidization. The technology information and extension services com-ponents are expected to have a significant impact in modernizing SSItechnology and improving productivity. Management practices in small

-27-

industrial enterprises would be upgraded through the management trainingprogram for SSIs.

84. Risks. As is generally the case in industry, the SSI sector maysee its performance affected by present infrastructural deficiencies,which could discourage investment, affect production, or reduce marketingefficiency. The still limited capabilities of the SICs in terms of ade-quately qualified staff and logistical support may also make it difficultto extend project benefits as widely and deeply as desired. The proposedproject, through training and consultancy services, would continue toassist the SICs to become more effective in promotion and extensionservices.

85. Inasmuch as the small industry sector is almost exclusively aprivate sector activity, investment in the sector and the performance ofindividual enterprise is subject to effects from overall economic andpolitical conditions. Should these suffer important changes or adversedevelopments, the sector would naturally be affected, although to a lesserextent than large industries which require greater investment and havegreater visibility.

PART V - LEGAL INSTRUMENTS AND AUTHORITY

86. The draft Development Credit Agreement between the IslamicRepublic of Pakistan and the Association and the Recommendation of theCommittee provided for in Article V, Section 1(d) of the Articles ofAgreement are being distributed to the Executive Directors separately.The execution of a Subsidiary Loan Agreement between the Government andIDBP, and the execution of Participation Agreements between IDBP and atleast two participating commercial banks together with the approval andissuance by the Boards of such participating banks of a statement ofoperating policies and procedures, satisfactory to the Association, wouldbe additional conditions of effectiveness. Special conditions of theproject are listed in Schedule III of Annex III.

87. I am satisfied that the proposed credit would comply with theArticles of Agreement of the Association.

PART VI - RECOMMENDATION

88. I recommend that the Executive Directors approve the proposedcredit.

A. W. ClausenPresident

AttachmentsMay , 1984

-28-ANNEX I

T A BLE 3A PACE I

PAKISTAN - SOCIAL INDICATORS DATA SHEETPAKISTAN REFERENCE GROUPS (WEIGHTED AVERAGES) /a

MOST (MOST RECENT ESTIMATE) lb

/b /b RECENT LOW INCOMF MIDDLE INCCME1 96lb 1973- ESTIMATS- ASIA & PACIFIC ASIA S PACIFIC

AREA (THOUSAND SQ. KM)TOTAL 803.9 803.9 803,9AGR ICLLTURAL 2 2 8. 8 2 4 3 . 3 2533 2

GNP PER CAPITA (US$) 70.0 140.0 350,0 276.7 1028.6

ENERGY CONSM ION PER CAPITA(KILOGRAMS OF COAL EQUIVALENT) 143.0 209.0 224.0 398.4 792.8

POPULATION AD VITAL STATISTICSPOPULATION,MID-YEAR (THOUSANDS) 45851.0 60449.0 84501.0URBAN POPULATION (X OF TOTAL) 22.1 24.9 28.7 21.5 32.9

POPULATION PROJECTIONSPOPULATION IN YEAR 2000 (MILL) 148.1STATIONARY POPULATION (MILL) 410.6YEAR STATIONARY POP. REACHED 2150

POPULATION DENSITYPER SO. KM. 57.0 75.2 102.1 161.7 260.7PER SQ. KM. AGRI. LAND 200.4 248.4, 324.1 363.1 1696.5

POPULATION AGE STRUCTURE (X)0-14 YRS 43.8 46.3 46.3 36.6 39.4

15-64 YRS 51.8 50.5 50.9 59.2 57.265 AND ABOVE 4.4 3.2 2.8 4.2 3.3

POPULATION GROWTH RATE (X)TOTAL 2.3 2.8 3.0 1.9 2.3URBAN 4.6 4.0 4.3 4.0 3.9

CRUDE BIRTH RATE (PER THOUS) 51.3 47.4 45.5 29.3 31.3CRUDE DEATH RATE (PER THOUS) 24.3 19.9 15.8 10.9 9.6GROSS REPRODUCTION RATE 3.7 3.5 3.1 2.0 2.0

FAMILY PLANNINGACCEPTORS, ANNUAL (THOUS) .. 1908.1 1244.0USERS (- OF MARRIED WOMEN) .. 6.0 48.1 46.6

FOOD AM NTRITIONINDEX OF FOOD PROD. PER CAPITA(1969-71-100) 89.0 102.0 106.0 111.4 125.2

PER CAPITA SUPPLY OFCALORIES (% OF REQUIREMENTS) 88.0 97.0 106.0 98.1 114.2PROTEINS (GRAMS PER DAY) 58.0 60.0 65.0 56.7 57.9OF WHICH ANIMAL AND PLLSE 23.0 20.0 20.0/e 13.9 14.1

CHILD (AGES 1-4) DEATH RATE 25.4 21.5 17.3 12.2 7.6

HEALTHLIFE EXPECT. AT BIRTH (YEARS) 43.3 46.2 50.2 59.6 60.2INFANT MORT. RATE (PER THOUS) 161.5 143.0 123.2 96.6 68.1

ACCESS TO SAFE WATER (%POP)TOTAL . . 21.0 29.0/d 32.9 37.1URBAN 77.0 60.07W 70.8 54.8RURAL . . 4.0 I 7.0/d 22.2 26.4

ACCESS TO EXCRETA DISPOSAL(% OF POPULATION)

TOTAL .. 3.0 6.0/e 18.1 41.4URBAN .. 12.0 21.07 72.7 47.5RURAL .. .. .. 4.7 33.4

POPULATION PER PHYSICIAN 5400.0 4300.0/f 3480.0/f 3506.0 7771.9POP. PER NURSING PERSON 16960.0 10580.07o 5820.07d 4797.9 2462.6POP. PER HOSPITAL BED

TOTAL 1790.0 1860.0 1900.0/c 1100.6 1047.2URBAN 510.0 650.0 710.07 298.4 651.1RURAL 22850.0 12480.0 11860.o7N 5941.6 2591.9

ADMISSIONS PER HOSPITAL BED .. .. .. .. 27.0

HOUSINGAVERAGE SIZE OF HOUSEHOLD

TOTAL 5.4 5.3 .3. .URBAN 5.6 5.5 ..

RURAL 5.4 5.2 ..

AVERACE NO. OF PERSONS/ROOMTOTAL 3.1 2.8/RURBAN 3.1 2.77j .RURAL 3.1

2.87 .

ACCESS TO ELECT. (% OF DWELLINGS)TOTAL 17.9..URBAN .. 5

4.4/g .

RURAL .. 4.9X.j- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - --_ _ - - - - --_ - - - - - -- - - - - - - - - - - - - - - - - - --_-_ _-_ _-_- -_- -_-_ _-_ .- _- -_- -_-_ _-_ _-_- -_- -_-_ _-_ _-_- -_ _ _ _ _ _ _ _

-29-

ANNEX IT A B L E 3A PAGE 2

PAKISTAN - SOCIAL INDICATORS DATA SHEETPAKISTAN REFERENCE GROUPS (WEIGHTED AVERAGES) ia

MOST (MOST RECENT ESTIMATE) /bRECENT LOW INCOME MIDDLE INCOKE

1960-/b 1970- ESTIMATE-_ ASIA & PACIFIC ASIA & PACIFIC

EDUCATIONADJUSTED ENROLLMENT RATIOS

PRIMARY: TOTAL 30.0 40.0 57.0 96.1 101.2MALE 46.0 57.0 81.0 107.8 106.0FEMALE 13.0 22.0 30.0 82.9 97.5

SECONDARY: TOTAL 11.0 13.0 15.0 30.2 44.9MALE 18.0 20.0 22.0 37.3 50.0FEMALE 3.0 5.0 8.0 22.2 44.6

VOCATIONAL (% OF SECONDARY) 1.0 1.5 1.3/h 2.3 18.5

PUPIL-TEACHER RATIOPRIMARY 39.0 41.0 45.0 34.4 32.7SECONDARY 24.0 20.0 17.0 18.4 23.4

ADULT LITERACY RATE (%) 15.4 20.7/i 24.0 53.5 72.9

CONSUM' IONPASSENGER CARS/THOUSAND POP 1.5 2.6 4.5/c 1.6 9.7RADIO RECEIVERS/THOUSAND POP 6.0 17.1 67.0 96.8 113.7IV RECEIVERS/THOUSAND POP .. 1.6 9.7 9.9 50.1NEWSPAPER ("DAILY GENERAL

INTEREST") CIRCULATIONPER THOUSAND POPLLATION 13.2 *- 13.7 16.4 54.0

CINEMA ANNUAL ATTENDANCE/CAPITA 1.7 3.0/i 2.2 3.6 3.4

LABOR FORCETOTAL LABOR FORCE (THOUS) 14448.0 17364.0 23375.0

FEMALE (PERCENT) 8.6 9.3 10.3 33.3 33.6AGRICULTURE (PERCENT) 61.0 59.0 57.0 69.0 50.9INDUSTRY (PERCENT) 18.0 19.0 20.0 15.8 19.2

PARTICIPATION RATE (PERCENT)TOTAL 31.5 28.7 27.7 42.5 38.6MALE 55.2 50.4 47.2 54.4 50.7FEMALE 5.7 5.5 6.0 29.8 26.6

ECONOMIC DEPENDENCY RATIO 1.5 1.7 1.8 1.0 1.1

INCOff DISTRIBUTIONPERCENT OF PRIVATE INCOMERECEIVED BY

HIGHEST 5% OF HOUSEHOLDS 20.3/j 17.8 . . 16.5 22.2HIGHEST 20% OF HOUSEHOLDS 45.3/j 41.8 .. 43.5 48.0LOWEST 20% OF HOUSEHOLDS 6.4/f 8.0 .. 6.9 6.4LOWEST 40% OF HOUSEHOLDS 17.575 20.2 .. 17.5 15.5

POVERTY TARGET GROFPSESTIMATED ABSOLUTE POVERTY INCOMELEVEL (USS PER CAPITA)

URBAN .. 68.0/i 176.0 133.9 194.5RURAL .. 47.071 122.0 111.6 155.0

ESTIMATED RELATIVE POVERTY INCOMELEVEL (US$ PER CAPITA)

URBAN . . 34.0/i 88.0 .. 178.0RURAL .. 22.071 58.0 .. 164.8

ESTIMATED POP. BELOW ABSOLUTEPOVERTY INCOME LEVEL (%)

URBAN ,, 42.0/i 32.0 43.8 24.4RURAL .. 43.071 29.0 51.7 41.1

NOT AVAILABLEd . NOT APPLICABLE

N O T E S

/a The group averages for each indicator are population-weighted arithmetic means. Coverage of countries among theindicators depends on availability of data and is not uniform.

/b Unless otherwise noted, "Data for 1960 refer to any year between 1959 and 1961; "Data for 1970' between 1969 and1971; and data for "Most Recent Estimate" between 1979 and 1981.

/c 1977; /d 1976; /e 1975; ff Registered, not all practicing in the country; /g 1973; /h 1978; /i 1972; /j 1964.

May 1983

-30- ANNEX ~~~~IPage 3

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-31-ANNEX IPage 4

ECONOMIC DEVELOPMENT DATA

GROSS NATIONAL PRODUCT IN l987/83 /a ANNUAL RATE OF GROWTH (7, constant prices)

US$ billion Z 1969/70-1974/75 1975/76-1980/81 1981/82 1982/83

GNP at market prices 31.45 100.0 3.5 6.8 3.8 7.3Grcss domestic investment 4.86 15.4 -5.5 4.0 9.4 9.0Gr,33 national saving 4.43 14.1 -2.1 6.9 5.0 20.3Current account balance -0.55 -1.7Resource gap -3.18 -10.1

OUTPUT. LABOR FORCE AND PRODUCTIVITY IN 1982/83

Value Added Labor Force /b V. A. Per Worker$ Million M Million Z US$ Z

Agriculture 7,968 31 13.5 51 590 60Industry /c 6,333 24 5.4 20 1,173 120Services 11.566 45 7.6 29 1 522 156Total/Average 25,867 100 26.5 100 976 100

GOVERNMENT FINANCE

General Government Id Federal Government(Rs billion) % of GDP (Rs billion) Z of GDP1982/83 te 1982/83 1977/78-1982/83 1982/83 /e 1982/83 1977178-1982/83

Current receipts 60.1 16.3 15.8 46.8 12.7 12.4Current expenditures 57.7 15.7 14.1 45.0 12.2 10.6Current surplus 2.4 0.6 1.7 1.8 0.5 1.8Capital expenditures /f 28.2 7.7 9.3 21.5 5.8 7.4External assistance (net) 5.7 1.5 2.8 5.7 1.5 2.8

MONEY. CREDIT AND PRICES1973/74 1974/75 1975/76 1976/77 1977/78 1978/79 1979/80 1980/81 1981/82 1982/83 La

(Rs billion)

Money and quasi money 28.0 33.1 41.6 51.7 63.7 76.5 90.7 103.5 113.6 147.4Bank credit to public sector 14.4 17.5 22.7 29.5 34.3 43.1 48.1 54.1 60.1 71.6Bank credit to private sector 15.6 19.7 23.1 30.1 35.7 42.7 50.6 58.7 70.9 86.9

(percentages or index numbers)

Money and quasi money as Z of GDP 32.2 29.5 31.5 34.6 36.7 39.0 38.3 37.0 35.1 40.1Consumer price index (1969170-100) 157.8 200.0 223.3 243.9 260.7 282.5 311.8 355.0 396.0 416.5Annual percentage changes in:

Consumer price index 30.0 26.7 11.7 9.2 6.9 8.4 10.4 13.9 11.5 5.2Bank credit to public sector 21.2 29.4 28.8 16.6 25.6 11.6 12.5 11.1 19.1Bank credit to private sector 26.3 17.3 30.3 18.6 19.6 18.5 16.0 20.7 22.6

/a Provisional.Lb Projection for 1982/83. Does not include unemployed labor force./c Includes manufacturing, mining, construction and electricity and gas.d censolidated revenues and expenditures of Federal and Provincial Governments (excluding Federal-Provincial

Government transfers).|e Revised budget data./f Excluding principal repayments of loans. Capital expenditures as defined in government budget include

certain current expenditures.

-32.-

ANNEX I

Page 5

BALANCE OF PAYMENTS HERCHANDISE EXPORTS (AVERAGING 1978/79-1982/83)

1978179 1979/80 1980/81 1981/82 1982/83 US$ million %(US$ million)

Exports of goods, NFS 2,107 2,955 3,461 3,052 3,474 Rav cotton 302.3 12.4Imports of goods, NFS 4,485 5,709 6,466 6.679 6.655 Cotton yarn 210.7 8.6Resource gap (deficit - -) -2,378 -2,754 -3,005 -3,627 -3,181 Cotton cloth 252.3 10.3

Rice 401.9 16.4Interest payments -261 -285 -357 -320 -421 All otber commodities 1.277.4 52.3Workers' remittances 1,395 1,748 2,097 2,224 2,886 Total 2,444.6 100.0Other factor payments (net) 134 151 274 188 162Net transfers .. .. .. .. _Balance on current account -1,110 -1,140 -991 -1,535 -554 EXTERNAL DEBT, DECEMBER 1982

Direct foreign investment .. ..

Net MLT borrowing os$ millionDisbursements 813 1,134 956 1,102 1,301Amortization -235 -310 -516 _*492 _-389 Public debt, including guaranteed 9,178.3Sub-total 578 824 440 610 912 Non-guaranteed private debt /e

Transactions with IMF/a -14 78 315 358 413. Total outstanding and disbursed 9,178.3

Other items n.e.i. /b 238 600 546 318 331Increase in reserves (-) 308 -362 -310 249 -1,102 DEBT SERVICE RATIO FOR 1981/82 If

Gross reserves (end year)/c 386 748 1,058 809 1,911 %Official Gold (year end;

million ounces) 1.8 1.8 1.8 1.8 1.9

Fuel and Related Materials

Petroleum imports /d' 530 1,079 1,535 1,710 1,610 Public debt, including guaranteed 10.2Petroleum exports /d 61 178 126 194 77 Non-guaranteed private debt

Total 10.2

RATE OF EXCHANGE IBRD/IDA LENDING (December 1982)(US$ million)

Through May 11, 1972 From May 12, 1972-Feb. 15. 1973 IBRD IDA

US$1 - Re 4.7619 US$1 - Re 11.00 Outstanding and disbursed 339.7 1,051.0Rs I - US$0.21 Rs I - US$0.09 Vndisbursed 111.3 563,0

Outstanding including undisbursed 451.0 1,614.0,

From Feb. 16. 1973-Jan. 7. 1982 From July 1981-June 1982 Li; From July 1182-June 1983 Le

US$ I - Rs 9.90 US$l - Rs 10.55 US$1 - Rs 12.75Rs 1 - US$O.10 Re 1 * DS$0.095 Rs 1 - VS$0.078

/a Including Trust Fund./b Including net sbort-term borroving and errors and omissions./c Excluding gold reserves of about 1.8 million troy ounces.Id Crude and derivatives.le Non-guaranteed private debt service is negligible.If Ratio of actual debt service to exports of goods, non-factor services and workers' remittances; debt service does not include

short-term or IMN chargea.L Effective January 8, 1982, the rupee is being managed with reference to a weighted basket of currencies. The average

exchange rate shown is vis-a-vis 0S$ for the period shown.

April 198t

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ANNEX IIPage 1

STATUS OF BANK GROUP OPERATIONS IN PAKISTAN

A. STATEMENT OF BANK LOANS AND IDA CREDITS (as of March 31. 1984) /a

(USS million)Loan/ (Amount net of cancellations)Credit Fiscal Undis-Number Year Purpose Bank TW IDA bursed

Ninety-three loans and credits fully disbursed /b 781.4 32.0 936.1/f

620 1976 Seed Project -- 23.0 4.4630 1976 Second Lahore Water Supply -- 26.6 1.4648 1976 Irrigation & Drainage (Khairpur) -- 14.0 5.11366T 1977 Punjab Livestock Development -- 10.0 -- 4.4678 1977 Third Education -- 15.0 3.8751 1977 Hill Farming Tech. Development -- 3.0 0.6754 1978 Salinity Control & Reclamation -- 70.0 67.9755 1978 Hazara Forestry -- 1.7 1.0813 1978 Punjab Ext. & Agric. Dev. -- 12.5 5.7877 1979 Salinity Control & Recld (Mardan) -- 60.0 55.5892 1979 Primary Education -- 10.0 5.1922 1979 Sind Agricultural Extension -- 9.0 6.8968 1980 Third WAPDA Power -- 45.0 12.9974 1980 Third Highway -- 50.0 28.81019 1980 PICIC Industrial Development -- 40.0 6.01109/e 1981 Vocational Training - 25.0 19.31113/e 1981 Small Industries -- 30.0 10.51157/e 1981 Grain Storage - 32.0 24.91158/e 1981 Agricultural Research -- 24.0 16.81163/e 1981 On-Farm Water Management -- 41.0 23.41186/e 1982 Industrial Development (IDBP II) -- 30.0 16.12122 1982 Fourth Telecommunication 40.0 -- 29.22172 1982 Fertilizer Industry Rehabilitation 38.5 -- 32.92247/c 1983 Reservoir Maintenance Facilities 10.2 -- 10.02305/c 1983 Agricultural Dev. (ADBP V) 10.0 -- 10.02324/c 1983 Fifth Sui Northern Gas Pipelines 43.0 -- 43.01239/e 1982 Irrigation Systems Rehabilitation -- 40.0 34.01243/e 1982 Baluchistan Minor Irrig. & Agr. -- 14.0 12.61256/e 1982 Technical Assistance -- 7.0 5.61278/c 1982 Eleventh Railway Project -- 50.0 46.91348/c 1983 Lahore Urban Development -- 16.0 16.01350/c 1983 Population - 18.0 17.21355/c 1983 Coal Engineering -- 7.0 7.01374/c 1983 Karachi Water Supply - 25.0 25.01375/c 1983 Fourth Drainage -- 65.0 63.91380/c 1983 Agricultural Development (ADBP V) -- 47.8 39.92218 1983 Refinery Engineering Project 12.0 -- 10.22351/c 1984 Petroleum Exploration 51.5 -- 51.52374/c 1984 Second Toot Oil and Gas Development 30.0 -- 30.02380/c 1984 Industrial Investment Credit 50.0 - 50.01439/c 1984 Industrial Investment Credit -- 50.0 50.0

Total 1,066.6 42.0 1,919.0 905.3of which has been repaid 490.7 0.5 32.1

Total now outstanding 575.9 41.5 1,886.9Amount sold 23.9of which has been repaid 23.9 -- -- -- --

Total now held by Bank and IDALd 575.9 41.5 1.886.9

Total undisbursed 266.8 4.4 634.1 905.3

/a The status of the projects listed in Part A is described in a separate reporton all Bank/IDA financial projects in execution, which is updated twice yearlyand circulated to the Executive Directors on April 30 and October 31.

/b Excludes the disbursed portion of loans and credits wholly or partly for projectsin the former East Pakistan which have now been taken over by Bangladesh.

/c Not yet effective./d Prior to exchange adjustment./e IDA Credits under the 6th Replenishment denominated in SDRs. The principal

is shown in US$ equivalent at the time of negotiation. Disbursed amounts arecomputed at the market rate on dates of disbursements.

/f By using the market rate on dates of disbursements, the current principalfor Credit 1066-PAK and Credit 1255-PAK (both fully disbursed) is$42.5 and $77.5, respectively.

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ANNEX IIPage 2

B. STATEMENT OF IFC INVESTMENTS (as of March 31 1984)

Fiscal Amount In US$ MillionYear Obligor Type of Business Loan Equity Total

1958 Steel Corp of Rolled SteelPakistan Ltd. Products 0.63 -- 0.63

1959 Adamjee IndustriesLtd. Textiles 0.75 -- 0.75

1962- Gharibwal Cement1965 Industries Ltd. Cement 5.25 0.42 5.671963- PICIC Development1969- Financing -- 0.52 0.5219751965 Crescent Jute

Products Textiles 1.84 0.11 1.951965-1980- Packages Ltd. Paper Products 19.38 0.84 20.2219821967- Pakistan Paper1976 Corp Ltd. Paper 5.38 2.02 7.401969 Dawood Hercules

Chemicals Ltd. Fertilizers 1.00 2.92 3.921969 Karnaphuli Paper

Mills Ltd. Pulp and Paper 5.60 0.63 6.231979 Milkpak Ltd. Food and Focod

Processing 2.40 0.37 2.771979 Pakistan Oilfields

Ltd. and Attock Chemicals andRefinery Ltd. Petrochemicals 29.00 2.04 31.04

1980 Fauji Foundation Woven Polypropy-lene bags 1.78 -- 1.78

1980 Premier BoardMills Ltd. Particle Board 2.70 -- 2.70

1981 Habib Arkady Food and FoodProcessing 3.15 0.17 3.32

1982 Asbestos Cement 4.25 -- 4.251983 Pakistan Petroleum Chemical and

Ltd. Petrochemicals 87.71 1.56 89.27

Total Gross Commitments 170.82 11.60 182.42

Less: Cancellations, Terminations,Repayments and Sales 126.30 1.02 127.32

Total Commitments Now Held by IF'C 44.52 10.58 55.10

Undisbursed (including participants) 86.74 0.34 87.08

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ANNEX IIIPage 1 of 2

PAKISTAN

SECOND SMALL SCALE INDUSTRIES PROJECT

Supplementary Proiect Data Sheet

Section I: Timetable of Key Events

(a) Time taken to prepare the project:

5 months

(b) Agency which Prepared the project:

The Government of Pakistan and participating agencies

(c) Date of first presentation to IDA and first IDAmission to consider the proiect:

September 1983

(d) Date of departure of appraisal mission:

October 7, 1983

(e) Date of completion of negotiations:

May 4, 1984

(f) Planned date of effectiveness:

September 30, 1984

Section II: Special IDA Implementation Actions

None

Section III: Special Conditions

Government would periodically review the adequacy of the levelof lending rates for subloans under the project and as neces-sary take measures to keep such rates positive in real terms(para. 71).

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ANNEX IIIPage 2 of 2

The following would be additional conditions of effectiveness:

(i) The execution of a Subsidiary Loan Agreement between theGovernment and IDBP; and

(ii) The execution of Participation Agreements between IDBP andat least two participating commercial banks, and theapproval and issuance by the Boards of such participatingbanks of a statement of operating policies and procedures,satisfactory to the Association (para. 67).