Document of

The World Bank

FOR OFFICIAL USE ONLY

AJS 32 P-cws

Report No. 7702-CHA

STAFF APPRAISAL REPORT

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

JANUARY 9, 1991

Industry and Energy Operations DivisionChina DepartmentAsia Region

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.

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

CV--j.RNCY EQUIVALENTS(As of November 1990)

Currency utame = Renminbi (RMB)Currency urit = Yuan (Y) = 100 Fen

Y 1.00 = $0.19$1.00 = Y 5.22

FISCAL YEAR

January 1 - December 31

WEIGHTS AND MEASURES

Metric system

GLOSSARY OF ABBREVIATIONS AND ACRONYMS

BOCOM - Bank of CommunicationsCIB - China Investment BankCRS - Contract Responsibility SystemERR - Economic Rate of ReturnFRR - Financial Rate of ReturnGDP - Gross Domestic ProductGNP - Gross National ProductGOC - Government of ChinaGVIO - Gross Value of Industrial OutputICB - International Competitive BiddingICBC - Industrial and Commercial Bank of ChinaIFS - International Finance CorporationMOF - Ministry of FinanceMOFERT - Ministry of Foreign Economic Relations and TradeOEM - Original Equipment ManufacturerPBC - People's Bank of ChinaPCBC - People's Construction Bank of ChinaPCR - Project Completion ReportPFIs - Participating Financial InstitutionsPMU - Project Monitoring UnitPPY - Per Person-YearPRC - People's Republic of ChinaSFERTC - Shanghai Foreign Economic Relations and Trade CommissionSEAC - Shanghai Electrical Apparatus CorporationSECC - Shanghai Electronic Components CorporationSEPB - Shanghai Environmental Protection BureauSFIC - Shanghai Foreign Investment CommissionSIDP - Shanghai Industrial Development ProjectSIEB - Shanghai Instrumentation and Electronic Industry BureauSITCO - Shanghai Investment and Trust CorporationSMG - Shanghai Municipal GovernmentSMEIA - Shanghai Mechanical and Electrical Industries AdministrationSOE - Statement of ExpendituresSPERI - Shanghai Planning Economic Research InstituteSPPMC - Shanghai Printing and Packaging Machinery CorporationSPSIC - Shanghai Precision and Scientific Instrument CorporationTORs - Terms of Reference

FOR OFFICIAL USE ONLYCHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Loan and Project Summary

Borrower: People's Republic of China.

Beneficiaries: Shanghai Municipal Government (SMG) and the Partici-pating Financial Institutions (PFIs).l/

Amount: $150.0 million equivalent.

Terms: Twenty years, including five years' grace; standardvariable interest rate.

Onlending Terms: The proceeds of the loan would be made available bythe Borrower to the SMG on terms and conditionssatisfactory to the Bank. S.4G would onlend theentire proceeds to the five PFIs for 20 years,including five years' grace, and at a variableinterest rate equal to the Bank rate. The PFIswould in turn extend subloans to eligible enter-prises for a maximum period of 12 years including amaximum grace period of three years at a variableinterest rate equal to the Bank rate plus at least1.25 percent; subborrowers would carry the foreignexchange risks associated with the Bank's loan.

Project Description: The project would support the development of fourindustrial subsectors in Shanghai (printing machin-ery, electrical apparatus, electronic components andprecision and scientific instruments). It would aimto promote increased efficiency and competitivenessthrough: (a) technical assistance for organiza-tional restructuring in each of t1o subsectors andupgrading internal enterprise management systems;(b) financing through a credit component of techno-logical restructuring subprojects that are environ-mentally sound and based on rational product, mar-keting and organizational restructuring strategies,and sound financial and economic criteria; and(c) implementation of policy reforms at the subsec-tor level. The project will also include an insti-tutional development component consisting of policystudies on enterprise reform issues and the effectsof recent and planned policy changes in the four

1/ The PFIs are: China Investment Bank, Industrial and Commercial Bank ofChina, People's Construction Bank of China, Bank of CommunicationsShanghai Branch, and Shanghai Investment and Trust Company.

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.

- ii -

subsectors. In addition, there are preproiecttraining courses for the PFIs in subprojectappraisal.

Benefits and Risks: Subsector-wlde restructuring and implementation ofsubsector policy reforms would result in improvementof subsector efficiency, growth and exports. Sub-project eligibility criteria will ensure their eco-nomic and financial viability. The main projectrisks pertain to implementation of subsector policyand enterprise reforms, and to the timely implemen-tation of the project. However, SMG is stronglycommitted to the needed reforms, and has implementedseveral of the enterprise reforms since appraisal.During appraisal, the Bank and SK4G agreed on: thesubsector policy and enterprise reforms that wouldbe implemented in connection with the project and aframework for periodic reviews and studies in con-sultation with the Bank. In addition, legalrestructuring of the subsector corporations wouldtake place before subloans to them are approved.Arrargements for preproject training, implementationat the level of the subsector corporations, techni-cal assistance and overall project coordinationshould facilitate project implementation.

Estimated Cost: /a Local Foreign Total------------ ($ million) ----- _

Technological restructuring 131.7 155.2 266.9Training 2.6 11.7 14.3Computers 0.8 3.7 4.5Management assistance 4.1 9.7 13.8Institutional development 0.1 - 0.1

Total 139.3 30.3 319.6

Financing Plan: la

IBRD - 150.0 1'r.0PFIs, other banks and enterprises 139.2 - l.:9.2Shanghai Municipal Governme.t /b 0.1 30.3 30.4

Total 139.3 180.t 319.6

/a Tentative figures based on the initial pipeline of subprojects. Detailedfinal estimates will be prepared by thc PFIs for each subproject at thetime they are appraised. Since these are preliminary estimates, noattempt has been made to separate contingencies.

/b Includes $105,000 equivalent from the Japanese Grant Facility to financethe estimated foreign costs for the studies and some of the training.

- iii -

Estimated Disbursement: Bank FY: 1991 1992 1993 1994 1995 1996----- iiii---- ($ million) -- __-_______

Annual 5.0 17.5 40.0 42.0 29.5 16.0Cumulative 5.0 22.5 62.5 104.5 134.0 150.0

Economic Rate of Return: At least 12 percent for subprojects.

- iv -

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Table of Contents

Page No.

I. INTRODUCTION .1...................... . 1

II. THE INDUSTRIAL SECTOR IN CHINA . . . . . . . . . . . . . . . 3

A. Structure and Performance. 3B. Industrial Development Issues and Strategy . . . . . . . 3C. Bank Support for Industry. 7

III. THE INDUSTRIAL SECTOR IN SHANGHAI . . . . . . . . . . . . . . 11

A. Background .11B. Shanghai Municipality and Its Industrial Structure . . . 11C. Industrial Performance .13D. Resources and Constraints .13E. Development Strategy and Policies . . . . . . . . . . . . 15F. The Four Subsectors .19

Enterprise and Subsector Policy Reforms . . . . . . 19Subsector Restructuring . . . . . . . . . . . . . . 21

G. Bank Role and Strategy .24

IV. THE PROJECT........................ . 25

A. Project Objectives . . . . . . . . . . . . . . . . . . 25B. Project Components . . . . . . . . . . I . . . . . . . . 25

Financial Assistance Component . . . . . . . . . . . 25Technical Assistance Component . . . . . . . . . . 26Institutional Development Component . . . . . . . . 27

C. Eligibility Criteria .27D. Project Cost and Financing . . . . . . . . . . . . . . . 27E. Project Implementation Arrangements . . . . . . . . . . . 29

Role of the Shanghai Municipal Government . . . . . 29Role of the Subsector Corporations . . . . . . . . . 30Role of the Participating Financial Institutions . . 31

F. Environmental Impact .33

This report is based on the appraisal by a Bank mission, composed of DariusMans (Mission Leader), Harbaksh Sethi, Sally Zeijlon, Shanker Krishnan, AnupamKhanna, Natalie Lichtenstein, Mohan Pherwani and Edgar Su (Consultant), thatvisited China in February/March 1989 and the postappraisal by a Bank missioncomposed of Sally Zeijlon (Mission Leader), Ramaswami Venkateswaran, SwoonWeng Leong (Consultant) and Zhou Yuling that visited Shanghai in March 1990.Peer reviewers include Julio Gamba (AS5IE) and Emanuel Sharon (Consultaat).

Page No.

V. THE LOAN ...................................................... 35

A. Lending Arrangements and Terms .. 35B. Procurement ............................................... 36C. Disbursement .. 37D. Reporting and Auditing .. 37E. Benefits and Risks .. 38

VI. AGREEMENTS AND RECOMMENDATIONS .39

ANNEXES

1. The Development Strategy and Policies for Shanghai'sIndustrial Sector . . . . . . . . . . . . . . . . . . . . 41

2. Statement of Shanghai Municipal Government on the DevelopmentProgram and Strategy for SIDP Subsectors . . . . . . . . 50

3. Shanghai Electronic Components Subsector . . . . . . . . . . 554. Shanghai Precision and Scientific Instruments Subsector . . . 675. Shanghai Electrical Apparatus Subsector . . . . . . . . . . . 776. Shanghai Printing and Packaging Machinery Subsector . . . . . 887. Consulting Services Terms of Reference . . . . . . . . . . . 988. Scope of Subproject Feasibility Studies . . . . . . . . . . . 1049. Implementation Schedule of Major Activities . . . . . . . . . 10710. Key Monitoring Indicators .10811. Shanghai Investment and Trust Corporation . . . . . . . . . . 10912. The Industrial and Commercial Bank of China . . . . . . . . . 11613. The People's Construction Bank of China . . . . . . . . . . . 12214. Bank of Communications - Shanghai . . . . . . . . . . . . . . 12815. China Investment Bank .13616. Estimated Disbursements .14217. Progress Reports for the Project . . . . . . . . . . . . . . 14318. Documents Available in the Project File . . . . . . . . . . . 148

CHARTS

1. Organization Chart of Sharing Relationship of SubsectorCorporation with Various Levels of Government . . . . . . 149

2. Organization Chart of Shanghai Mechanical and ElectricalIndustries Administration . . . . . . . . . . . . . . . . 150

CHINA

SHANC,HAI INDUSTRIAL DEVELOPMENT PROJECT

I. INTRODUCTION

1.1 The ongoing economic reforms in China have decentralized much of theinvestment responsibility from the Center to the provinces. In industry, thisrequires the provinces to play a more active role in the preparation and exe-cution of development programs and strategies for individual subsectors. TheGovernment of China (GOC) has requested the Bank to assist some selected prov-inces in carrying out this task. The Tianjin Light Industry Project (Loan3022-CHA, February 1989) was the first operation to assist the development ofspecific subsectors at the provincial level. The proposed Shanghai IndustrialDevelopment Project is the second such project.

1.2 Shanghai is the largest and economically preeminent city in Chinaand has the status of a province. It has a strong industrial base which isfacing increasing competition from other provinces and has been growing muchslower than the rest of China's industry. The reasons for this include asqueeze on the availability of raw materials, comparatively outmoded manufac-turing technology in many enterprises in Shanghai, limited investibleresources after meeting its tax obligations to the Central Government, and,until two years ago, slower implementation of the government's enterprisereform program in Shanghai than in other provinces. In a significant depar-ture from past policies, Shanghai has now been designated as a major focus foreconomic deveiopment and opening to the outside world. Reform initiatives arebeing implemented and, if successful and consistent with past practice, ireexpected to be replicated elsewhere in China. While some pause in the imple-mentation of these initiatives was evident in 1989, the commitment of thenational and municipal governments to the reform effLrts in the city has beenreconfirmed and progress is again evident. Important elements of Shanghai'sindustrial strategy are to move into more technology-intensive, less pollut-ing, and less energy- and raw-material-intensive subsectors, which could becompetitive within China and in export markets, and to implement enterpriseand related economic reforms more extensively (Annex 1). The subsectors to beassisted in the proposed project are passive electronic components, precisionand scientific instruments, electrical apparatus and printing machinery.Strengthening these types of industries is consistent with Shanghai's indus-trial strategy.

1.3 During project preparation, in-depth studies of the four subsectorsin Shanghai were carried out by foreign consulting companies--Boston Consult-ing Group and Booz, Allen and Hamilton--with the assistance of local consult-ing firms. These studies and discussions between the Shanghai Municipal Gov-ernment (SMG) and the Bank have assisted the government in the preparation ofdevelopment programs and strategies for the four subsectors (Annex 2) whichare consistent with the conclusions and recommendations of the consultants'studies. They outline: (a) the subsector policy reforms needed in the sub-sectors; (b) viable product and market strategies for each subsector;(c) plans for restructuring the organization and production facilities of thesubsectors; (d) investment programs; and, (e) implementation plans.

1.4 The main objective of the proposed project is to assist SMG in theimplementation of the above-mentioned development program and strategy. Theproposed Bank loan of $150 million would support the foreign exchange needs ofthe project. It would be onlent through five participating financial in,titu-tions (PFIs) in Shanghai for technological restructuring and technical assis-tance, including consultant services for organizational restructuring, manage-ment upgrading, training and computers in the four subsectors. The subproj-ects to be financed by the PFIs will be consistent with SMG's strategies forthe four subsectors and will also meet the other eligibility criteria agreedupor. with the Bank.

- 3 -

II. THE INDUSTRIAL SECTOR IN CHINA

A. Structure and Performance

2.1 Industry is China's largest productive sector, accounting for46 percent of its gross domestic product (GDP) in 1988 and employing nearly18 percent of the country's total labor force. About 99,000 state-ownedenterprises generate 57 percent of total industrial output; the remainder isproduced by more than 1.5 million nonstate enterprises--primarily urban andrural collectives, township and village enterprises. The state enterprisesconcentrate on important raw materials, capital goods, and strategic commodi-ties such as fertilizers, although there are also state enterprises producinga wide range of light industrial and consumer goods. Nonstate enterprisesmainly produce downstream consumer products. The gross value of industrialoutput (GVIO), which amounted to Y 1,811 billion ($486.7 billion) in 1988, isshared almost equally by light and heavy industry. GVIO increased rapidlybetween 1980 and 1988, at about 13.7 percent a year in real terms. Duringthis period, light industry registered a much faster annual growth rate(14.9 percent) than did heavy industry (10.9 percent). Macroeconomic stabili-zation policies initiated in 1988 led to a reduction of the annual growth oftotal industrial output to 6.7 percent in 14.39 and an estimated 6 percent for1990.

2.2 Between the mid-1950s and mid-1970s, Chinese industry was orientedmainly toward the rapidly growing domestic market. Since then manufacturedexports have grown rapidly, especially during the 1980s. They rose fromaround $8 billion in 1980 to about $33 billion in 1988, and expanded furtherin 1989, in spite of the overall slowdown of the economy. The share ofexports in industrial output was 6.8 percent in 1988.

B. Industrial Development Issues and Strategy

2.3 Between 1949 and 1978, China's iriustrial development was guided byan inward-oriented, import substitution strategy, with emphasis on capitalaccumulation. This led to rapid growth of industrial output and employment,building up industrial skills, and development of a wide range of basic,intermediate and consumer goods industries. Nevertheless, it also resulted indeficiencies that have constrained industrial development in several respects.The most obvious deficiencies pertain to: outdated technologies (nearly80 percent of the current stock of capital equipment is obsolete and needsreplacement or technical renovation); institutional rigidities deriving inpart from quota and price controls; a distorted structure of prices; inade-quate infrastructure; and an underdeveloped financial sector. These problemsare reflected in the low productivity of labor and low efficiency of resourceuse in Chinese plants.

2.4 Emphasis on self-sufficiency at the regional level has led to afragmented national market, reduced domestic competition, and the suboptimaluse of scarce skills and resources. As a result, potential gains from econo-mies of scale are often missed. Subeconomic-sized enterprises proliferate,often in the same markets as large enterprises, and are usually financiallyprofitable due to government price controls and other support. Institutionalinflexibility, compounded by inadequate market integration, has provided

- 4 -

little incentive for industrial enterprises to improve managerial efficiencyand product quality. This incentive is further reduced by the weak budgetaryconstraint for large state-owned enterprises, which can normally expect theirlosses to be covered by the government. The low prices of energy and basicintermediates for industrial production also contribute to the inefficient useof inputs. Investments in infrastructure, particularly for transportation andtelecommunications, have lagged behind those in industry. This disparity hasin turn been a major constraint on industrial development.

2.5 Between 1979 and 1988, the Government of China (GOC) changed itsindustrial development strategy and gradually introduced reforms, afterperiods of local and regional experimentation, to strengthen market forces andimprove the incentives to industrial efficiency. The new strategy emphasizedmodernizing existing equipment, developing manufactured exports and more effi-cient light industry, and conserving material and energy resources in indus-try. The introduction of these reforms has been a cautious process, though,involving experimentation and repeated fine-tuning. The reforms implementedsince 1979 have focused mainly on five areas: (i) enterprises--strengtheningmanagement accountability; (ii) prices--expanding the role of market forcesin price determination; (iii) trade--promotion of exports to earn foreignexchange, which in turn finances imports of modern technology and equipment;(iv) financial sector--developing financial institutions and markets; and(v) investment--decentralizing responsibility and shifting its pattern toaddress key bottlenecks.

2.6 Enterprises. Enterprises have been provided with various Incentivesto enable them to operate with greater management autonomy in a more competi-tive business environment. Reforms adopted in 1984 aimed at decentralizingeconomic decision-making toward the provinces and enterprises based on greateruse of market signals. The state enterprise reforms introduced, among otherthings, a system of contract management responsibility, introduction ofgreater uniformity in tax rates for enterprise income, wage incentives forworkers, and higher profit retention. While these actions have demonstrablyincreased enterprise autonomy and resulted in improvements in enterprise per-formance, continued initiatives are needed to address the distortions thathave become evident during the incremental reform process. GOC continues toactively study and experiment with modification of the management contractingsystem, alternative forms of enterprise ownership, and the introduction ofcompany law and bankruptcy legislation. Of particular importance are currentefforts to design a shareholding system ("joint-stock ownership") suitable forChinese state-owned enterprises. Several versions of shareholding are beingintroduced experimentally in selected locations, among which Shanghai is prom-inent. These include clarification of ownership rights and exposure of enter-prises to increased competition, which are vital to further efficiency gains(para. 3.22). As part of this effort, the government has established theNational Administrative Bureau of State-Owned Property. Not only is this seenas a first step in the separation of the ownership role from the policy andregulatory functions of government agencies, but the new body also has a man-date to devise policies for asset valuation and transfer.

2.7 Prices. In 1984, reforms were adopted to enhance the role of mar-kets in determining prices and industrial output by reducing the role of man-datory planning and initiating the correction of major price distortions. Asa result of these price reforms, a two-tiered pricing system now exists: con-

trolled prices for production to meet planned output targets, and market-related prices for the growing portion of output above plan targets. TheGovernment conside.ably raised the price of major industrial inputs includingenergy. The proportion of industrial output sold at market-related prices hasincreased significantly. For example, as early as 1985 a major enterprisesurvey showed that 53 percent of output was already being sold directly in themarket, while only 20 percent of the output was determined by the state'smandatorv plan and 27 percent by the guidance plan; since then, the proportionunder planning has continued to decline. The share of industrial materialsand intermediate goods under state distribution has also fallen considerably.For example, even for steel and coal, less than 50 percent was under statedistribution in 1988, and nearly three quarters of all metal-cutting toolswere sold by state enterprises in the market. Virtually all consumer goodsare now sold in the market and the gap between state and market prices forthese categories has become quite small. The impact on enterprise behavior ofthese reforms has been significant. By late 1988, the majority of enterprises(state and nonstate) were making decisions with reference to market prices,indicating that allocative efficiency was increasing. Marginal choices areincreasingly being made at market prices because virtually all enterprisessell a portion of their products in the market and depend on market transac-tions to purchase their marginal inputs.

2.8 In 1988, further price reforms were interrupted when the Governmentreacted to rapid inflation by initiating a macroeconomic stabilization pro-gram. In its initial stages, this three-year program involved strict controlof the prices of the approximately one-fifth of commodities still within theprice control system, but did not increase controls for commodities alreadyoutside that system. The Government has stated its intention of doing awaywith dual pricing in the medium term, and adjusting controlled raw material,energy and transport prices, to reduce remaining distortions. In early 1990,and following the government's success in reestablishing macroeconomic stabil-ity, new price adjustments for cotton, and for rail and water freight trans-port were announced. The two-tiered pricing system represents a significantimprovement over the strict price control of the past. Nevertheless, remain-ing distortiors in relative prices and large gaps between controlled and mar-ket prices have a numiber of shortcomings; reduced allocative efficiency,discriminatiorn across producers and consumers, administrative complexity, andcreation of opportunities for corrupt practices. It is thus important thatthe government continues with its stated intention to continue the process ofprice reform.

2.9 Trade. As a result of the decentralization of export respor.2ibili-ties in the 1980s, several thousand Chinese enterprises now have the right totrade directly with foreign firms, and many more use trading companies asagents rather than selling exportable goods to them. There is concern thatthis rapid granting of direct export rights, especially in 1988, without suf-ficient regulation and institutional support for enterprises to adhere toquality and delivery standards, may -ave created negative impressions in over-seas markets. GOC is studying ways of addressing such problems, and expandingdirect trading more slowly, although its commitment to the "open-door" policyinitiated in 1979 has not changed. The availability of foreign exchange tononexporting enterprises has improved somewhat with the creation of the for-eign exchange adjustment centers, mainly in the coastal zone. Central manda-tory planning continues to be used to ensure imports of essential raw materi-

-6

als to fill the deficits left in the domestic economy, and lice:nsing (ratherthan tariffs) discourages some consumer goods imports. Export competitivenesshas been maintained through periodic adjustments in the exchange rate, themost recent of which occurred in November 1990 (para. 3.27).

2.10 Financial Sector. Prior to 1979, China essentially had a monobanksystem which allocated resources according to fiscal directives. Reform ofthe system was initiated in the early 1980s with the formal establishment, in1984, of the People's Bank of China (PBC) as the country's central bank, anddivestiture of its banking functions to independent specialized banks. Since1986, China's financial sector reforms have accelerated. Before then, thesystem was largely limited to four national banks, specialized along economicand sectoral lines, and financial assets mainly consisted of deposits andgovernment bonds. As a result of the reforms, the range of financial institu-tions and instruments has markedly increased. Numerous nonbank financialinstitutions (NBFIs) have been established. Financial bonds, commercialpaper, bankers acceptances, trade bills, and bond-like enterprise shares havebeen introduced. These reforms have resulted in considerable financial deep-ening, despite some setbacks in the recent period of high inflation: M2 as aproportion of C,DP increased from 37 percent in 1979 to 75 percent in 1987,before declining to 60 percent in the first half of 1989. The reforms havealso succeeded in reducing the rcle played by the budget in investment finan-cing, while substantially increasing the role of bank finance.

2.11 Notwithstanding these advances, weaknesses remain. The system isdominated by the four specialized banks. Financial institutions still needsubstantiEl institutional upgrading to function as effective intermediaries.The recent trend of increasing portfolio arrears in the banking system needsto be arrested. Regulation and supervision of the financial system requireconsiderable strengtiuening, as do the accounting and legal frameworks, andwhile recent reliance on administrative mechanisms has enabled the governmentto regain control of rapidly accelerating inflation, in the longer term, PBCshould make greater use of indirect monetary credit policy tools. In thisconnection, PBC, assisted by the Bank (para. 2.15 and 2.18), is currentlyformulating plans designed to strengthen its clearing, supervisory and regula-tory functions.

2.12 Interest rates have been adjusted several times during the pastdecade. As of August 1990, interest rates on deposits generally range from8.64 percent for one-year deposits to 13.68 percent for eight-year deposits,and from 2.16 percent for sight deposits to 6.48 percent for deposits of lessthan one year. The interest rate on individuals' time deposits of threeyears' or more duration are indexed to the rate of inflation. Lending ratesare generally 9.36 percent for working capital loans, and between 9.36 percentand 11.16 percent for fixed asset loans, depending on their maturities. How-ever, further rationalization of the structure is necessary. There is anexcessive number of different rates, and they are widely dispersed. For somecategories of loans and deposits, there is an inadequate margin with a poten-tially negative impact on bank profitability. The general level of real ratesIn the recent past was negative, but recent and projected declines in theinflation rate, coupled with the above-mentioned adjustments, have served tomitigate this problem. Although the need for a more flexible interest ratemechanism remains, the general level of real rates is now positive and isprojected to remain so.

- 7 -

2.13 Investment. The above reforms have also been accompanied by a pro-gressive reduction in the incidence of central planning and the raising ofapproval limits for provincial authorities, to three times the level they wereat in 1984. Enterprises are now empowered to embark on small-scale, technicalupdating projects without following complicated approval processes if theproject can be financed with the enterprise's own funds. Close to 30 percentof fixed investment is now financed from retained funds. The ongoing stabili-zation program has resulted in some retrenchment in this process. For exam-ple, in July 1990, the government published a list of 23 product groups forwhich central approval will be required for investment projects. This measurewas taken partly in recognition that large scales of production, necessary forsuch products, were avoided as provinces tend to favor projects whose size iswithin provincial approval limits. By reducing the implied waste, the cpntralgovernment also hopes to free up scarce resources for key debottleneckinginvestments in energy, infrastructure and raw materials. The recognition )fthis problem is a positive move, but the longer-term solution lies in a fur-ther deepening of ongoing enterprise, price and financial system reforms.

C. Bank Support for Industry

2.14 The Bank Group's industrial lending operations in China, which beganin 1982, comprise the following: (a) five loan/credit operations totaling$945.6 million to the China Investment Bank (CIB) (Loan 2226-CHA/Credit 1313-CHA, December 1982; Loan 2434-CHA/Credit 1491-CrdA, June 1984; Loan 2659-CHA/Credit 1663-CHA, March 1986; Loan 2783-CHA/Credit 1763-CHA, March 1987; andLoan 3075-0-CHA, May 1989); (b) four loans totaling $394 million (Loans 2541-CHA, May 1985; 2838-CHA, June 1986; 2958-CHA, June 1988; and 3066-CHA, May1989) for a Fertilizer Rehabilitation and Energy Saving Project, a FertilizerRationalization Project, a Phosphate Development Project, and the Hubei Phos-phate Project; (c) a $100 million loan (Loan 2784-CHA, April 1987) for theShanghai Machine Tool Project; (d) a $20 million industrial development compo-nent of the Gansu Province Project (Loan 2812-CHA and Credit 1793-CHA, April1987); (e) a loan of $127 million (Loan 2943-CHA, May 1988) for the ChinaPharmaceutical Project; (f) a loan of $154 million (Loan 3022-^HA, February1989) for the .ianjin Light Industry Project; and (g) a credit/loan of $114.3for the Rural Industrial Technology (Spark) Project (Loan 3274-CHA/Credit2186-CHA, December 1990). In addition, the Planning Support and Special Stu-dies Project (Credit 1835-CHA, June 1987) includes components for long-termplanning and strategic studies in some industrial subsectors. InternationalFinance Corporation (IFC) support, since the first operation in 1985, totals$25 million equivalent in the following projects: Guangzhou and Peugeot(Investment No. 813, FY85), China Investment Company (Investment No. 974,FY87), Shenzhen China Bicycles Co., Ltd. (Investment No. 1020, FY87), andShenzhen Crown Electronics (Investment No. 37740, FY88).

2.15 Apart from some delays in the first China Investment Bank (CIB)operation, disbursement of the CIB loans and credits generally has proceededsatisfactorily. A PCR for the first CIB project has been prepared. The PCRconcludes that the project's objectives have been fully achieved, in particu-lar, in laying a foundation for CIB, a new financial institution, to developas an autonomous and efficient intermediary in industrial finance. With con-tinued Bank support, CIB's capacity in project design, selection and appraisalhas improved significantly since its establishment. Lessons learned from theimplementation of the first project were reflected in the design of subsequent

CIB projects supported by the Bank. Recently, the quality of CIB's portfoliohas deteriorated, mainly due to the general economic downturn Chine has beenexperiencing. Strengthening of CIB's canabilities to monitor and supervisesubprojects and cope with problem loans is a priority in providing furtherBank assistance to CIB. Physical implementation of the first two fertilizerprojects is proceeding satisfactorily. After some delays in project implemen-tation due to the Government's recent austerity program and the resultingshortage of local counterpart funds, the two phosphate projects are now pro-ceeding well. Procurement is well under way for the Pharmaceuticals Project,Phosphate Development Project, Shanghai Machine Tool Project, which involvesrehabilitation and modernization of the machine tool subsector in Shanghai,and the industrial component of the Gansu Project, which involves diversifica-tion and modernization of rural industry.

2.16 The Bank Group's overall objectives in the industrial and financialsectors in China are to assist the Government to: (a) improve the policyframework for the sectors as a whole; (b) build sound institutions and prac-tices for financial intermediation, subsector planning, and project approvaland implementation; (c) promote and implement technology upgrading, plantrestructuring and rehabilitation, and energy and material conservation inselected subsectors at the provincial and national levels; and (d) promoteenterprise reform in the state sector. In the industrial sector, the BankGroup would seek to underpin further enterprise, trade, and price reformsdesigned to give market forces a greater role in stimulating efficiencyimprovements. In the financial sector, emphasis would be placed in the nearterm on strengthening and enhancing the viability of the banking system, whichmust play an increasingly important role as other economic reforms proceed,through reforms designed tc. (i) safeguard banks' financial viability,through adequate interest rate spreads and accurate reflection of their port-folio quality; (ii) improve bank management; (iii) strengthen regulation andsupervision of the financial system; and (iv) improve the bank accountingframework. Other reforms to be supported include strengthening the centralbank's ability to implement effectively monetary and credit policy withgreater use of indirect tools, developing more robust money and capital mar-kets, improving the overall level and structure of interest rates, and enhanc-ing competition in the banking system.

2.17 The Bank's pipeline and the program of economic and sector workagreed with the government reflect these objectives. Specific plans in theindustrial sector include assistance to selected major subsectors, includingchemicals, fertilizers, machinery manufacturing, electronics, and buildingmaterials, consistent with their comparative advantage and national economicpriorities. The increasing devolution of responsibilities for planning andimplementation from the center to the provinces has the potential for a sig-nificant impact on the industrial sector, provided the provincial authoritiescan effectively enunciate and carry out their new role. The anticipated pro-vincial operations, including the present project, involving subsectorrestructuring in the context of coherent provincial industrial developmentstrategies, is designed to help selected provinces articulate and implementtheir new responsibilities for industrial planning and project implementation.The Bank is also assisting the rapidly growing nonstate industrial sector.Initial support for the latter is through the Spark program (para. 2.14),which is providing technical and financial support to rural enterprises.

- 9 -

2.18 In the financial sector, specific plans include further support forCIB as well as other intermediaries designed to foster their overall institu-tional developmnent in a more competitive banking enviromnent. While theirlarge market share argues for upgrading the leading nationwide specializedbanks, the possibility of strengthening some of the newer intermediaries willalso be reviewed. Support is also planned for improving the regulatory andsupervisory activities of the central bank and other core central agencies.Financial intermediaries would also continue to help support operations withprincipally real sector objectives. Under such operations, the intermediarieswould be expected to satisfy minimum eligibility criteria, and would receivesupport for targeted institutional improvements, as is the case for the pres-ent project.

2.19 In recent years the Bank, through its economic and operational work,has sought to assist the government in defining and Implementing its programof enterprise reform. This effort has included two sector reports and opera-tions at the national and provincial level in the chemical, machine tool,textile, paper and packaging subsectors designed to promote corporate andphysical restructuring. While considerable progress has been made in increas-ing enterprise autonomy (para. 2.6), it is now apparent that further clarifi-cation of the ownership function is essential to the next stage of enterprisereform. At a recent workshop jointly organized by the Bank and the SystemReform Commission, participants agreed on the importance of several areas ofreform: separating policy and regulatory functions from the state's ownershiprole; diversifying the ownership function between state agencies; relievingstate enterprises of some of their social welfare obligations; and furthersteps to promote competition. The importance of consolidating enterprisesoperating below economic scales, which typify much of China's state sector, toenable them to compete effectively was also emphasized. Continued cooperationin the design and monitoring of the next phase of "joint-stock" experiments isanticipated, and a series of supporting operations is planned. Once the cor-porate restructuring and enterprise reform program under the proposed SIDP isfully implemented, the beneficiary enterprises would be suitable candidatesfor 'joint-stock" experiments; similarly planned operations in the cement,electronics and heavy engineering subsectors would promote the development ofdiversified ownership mechanisms at the national level.

2.20 The Bank Group's program of economic and sector work and technicalassistance in industry, trade and finance provides the basis for an activepolicy dialogue with the Government on the issues described in Section Babove. To date, studies have been completed on the state enterprise manage-ment system, enterprise reform, the electronics subsector, the financial sec-tor, external trade and capital, and industrial policies and structuralchange. Further studies and technical assistance are underway on enterprisereform and the automotive sector. Additional work is planned on other subsec-tors at the national and provincial level. This work is being carried outjointly with Chinese agencies.

2.21 In addition to the above, the Bank Group is the executing agency forUNDP technical assistance projects and has financed two technical cooperationcredits, thereby encouraging the use of technical assistance, particularly forproject preparation. EDI's large training program in China and the past lend-ing program have helped in raising investment efficiency in China by demon-strating how the Hank Group's appraisal methodology can be applied to improve

- 10 -

project selection and efficiency of project design, and by strengtheninginstitutions' project preparation and appraisal capacities.

- 11 -

III. THE INDUSTRIAL SECTOR IN SHANGHAI

A. Background

3.1 Shanghai is one of three municipalities in China with provincialstatus. The city proper is the largest in China. Shanghai led the country'sindustrial revolution in the mid-nineteenth century, and by the 1930s, thecity was East Asia's largest port and leading manufacturing, commercial andfinancial center. Until the mid-1980s, the municipality led all other prov-inces in industrial production and exports. It has been the major supplier ofmanufactured goods to the rest of China, and the largest single source offiscal revenues to the central government. In the reform decade (1979-88),however, Shanghai's economy stagnated compared to those of other coastal prov-inces. Jiangsu and Guangdong have displaced Shanghai as the top industrialproducer and top exporter, respectively. In recent years the growth rate ofoutput in Shanghai's industry, the municipality's most important sector, haslagged behind all but the poorest provinces.

3.2 One of the most important reasons for this relative stagnation isthat Shanghai's industrial structure, technology, and management have not beenable to handle the increasing competition in export markets and within Chinacaused by national economic reforms introduced since 1979. The municipality'sindustrial sector is inefficient and inflexible. It includes many activitiesthat are not well suited to the characteristics of the location: congestedtransport, lack of local raw materials, and, especially in the city, insuffi-cient space for efficient factory layouts. Investment in support services andinfrastructure has been inadequate, and their underdevelopment is an addi-tional constraint to Shanghai's industry.

3.3 The central government aims to transform Shanghai into one of thelargest industrial and trade centers on the west coast of the Pacific.Shanghai, with its strong economic and human resource base, is intended tolead China's integration into the world economy, and set an example for imple-menting industrial restructuring and policy reforms. To encourage greatercompetition among enterprises, SMG is gradually reforinr.g its economic manage-ment and has begun to shift to indirect market controls. SMG also is con-structing infrastructure within the city and in the surrounding suburbs andrural areas to facilitate industrial growth, restructuring and modernization,and encourage foreign investment.

B. Shanghai Municipality and its Industr.al Structure

3.4 Shanghai is located on the eastern fringe of the Yangtze RiverDelta. Only 748 of its total 6,340 square kilometers are classified as urban.This area comprises 12 central districts, collectively referred to as thecity, and two satellite towns. The rural and suburban areas are divided intonine counties that include 197 townships and more than 3,000 villages. Thepermanent population of Shanghai at the end of 1988 was estimated to be 12.62million, of which 7.23 million (58 percent) was urban. Over six millionpeople live in the city proper.

3.5 Shanghai is China's richest province in terms of per capita income.In 1988 its gross product amounted to Y 64.8 billion, or Y 5,145 ($1,379) per

- 12 -

capita--over four times the national average. Computed through net materialproduct, the per capita municipal income was Y 4,487 ($1,203), more than50 percent higher than that of Beijing. Shanghai's GVIO, excluding villageand rural enterprises, was Y 118.1 billion ($32 billion) in 1988, which repre-sented 8.1 percent of the national total. About 70 percent of GVIO originatedin the urban districts of the municipality. Industry accounts for 67 percentof the municipality's net material product, while agriculture accounts for4 percent and the growing service sector for 29 percent. The labor force num-bers 7.7 million, of which 12 percent is engaged in the primary sector,60 percent in the secondary sector, and 28 percent in the tertiary sector.Most of the labor force is employed in industrial activities, even in suburbanareas of the municipality.

3.6 Shanghai's industry is fragmented and highly diversified. There are12,431 enterprises in the municipality (excluding about 20,000 village andtownship enterprises): 4,318 state enterprises, 7,069 collectives, and 1,024others, including foreign joint ventures. Of the 749 independent accountingenterprises classified as large and medium in size, 11 employ more than 10,000workers, 86 employ 3,000 to 10,000, 397 employ 1,000 to 3,000, and 255 employfewer than 1,000. There are enterprises involved in virtually every indus-trial activity except mining. Light industry has the largest number of enter-prises--7,134,-representing 57 percent of the total--and a GVIO of Y 59.6billion ($16 billion) or 55 percent of the total, in constant 1980 prices.Textiles and nonelectric machinery are the most important industrial subsec-tors, accounting for 13.9 percent and 14.5 percent of GVIO in 1987, respec-tively. These subsectors are followed by iron and steel (7.7 percent), elec-tronics (7.5 percent), chemicals (6.4 percent), and electric machinery(6.3 percent). In each of these subsectors, except textiles and chemicals,the city's share of gross national output was 10 percent or more in 1988.Shanghai also held large shares of the output of chemical fibers (21.2 per-cent), and instruments (15.4 percent), among others.

3.7 State-owned enterprises dominate the municipality's industrial sec-tor. Shanghai's state-owned enterprises contribute a higher proportion ofGVIO than state-owned enterprises do in other provinces. In 1988, about68 percent of Shanghai's industrial output was generated by state enterprises,compared to 43 percent in Jiangsu and 39 percent in Zhejiang. The stateenterprises are poorly positioned to operate in competitive markets, as theirflexibility is limited by the lack of separation of regulatory, ownership andmanagement functions, overly bureaucratic systems of organization and manage-ment, and a long history of command planning. As in the rest of China, state-owned industry in Shanghai has grown more slowly than the municipality's col-lectives.

3.8 About one-quarter of Shanghai's industrial output is exported; thesales of the remainder are split evenly between Shanghai and the rest ofChina. In 1988, Shanghai exported $4.61 billion in merchandise. This repre-sented an increase of 10.8 percent over 1987. Light products and textiles arethe major exports, accounting for 62 percent of the total in 1988.

- 13 -

C. Industrial Performance

3.9 Shanghai's industrial performance has fallen off in recent years.This stagnation is evidenced by the municipality's low growth of GVIO, munici-pal zevenue collection, and productivity. Despite this stagnation, though,the efficiency of Shanghai's industry remains high compared to that of otherprovinces.

3.10 Since 1978, Shanghai's GVIO has grown at a much slower pace thanthat of its neighboring provinces. In Shanghai, growth has averaged 7.0 per-cent per annum on average, while Jiangsu, Zhejiang, Anhui and Fujian achievedgrowth rates in excess of 13 percent, the national average. The differencebetween growth rates was more marked between 1983 and 1987. During thisperiod growth of GVIO in Shanghai was 9.0 percent per annum, while thenational average was 16.5 percent (constant 1980 prices). As a result ofrelatively lagging growth, Shanghai's industrial output as a p.oportion ofnational industrial output decreased from 12.9 percent in 1978 to 7.1 percentin 1988. Similarly, exports dropped from 29.7 percent to 9.7 percent ofnational exports (measured in current US dollars).

3.11 Shanghai's municipal revenue, which is mainly collected from enter-prises, also declined as a share of the country's total between 1978 and 1988,from 17.0 percent to 10.1 percent. Except for a brief period in 1984 and1985, municipal revenue collections have fallen steadily in absolute termssince 1980. Budget revenues were Y 18.2 billion in 1985, Y 17.6 billion in1986, Y 16.5 billion in 1987, and Y 15.4 billion in 1988.

3.12 The average labor productivity of Shanghai's state-owned industry,Y 33,735 per person-year (PPY), is almost double the national average o_Y 18,056 PPY, but its rate of improvement is below the national average inalmost all subsectors. Shanghai's industry remains the most profitable amongthe provinces in China, with profit rates about 50 percent over the nationalaverage. Nevertheless, because of their booming light industry collectives,in 1988 Jiangsu and Zhejiang had output-to-capital ratios of 2.3 and 2.4,respectively, while that of Shanghai was 2.0. However, for state-owned enter-prises Shanghai has the same ratio (1.7) as the other two provinces (based on1988 current prices). The national average for all independent accountingenterprises Js 1.4, and 1.1 for state enterprises.

D. Resources and Constraints

3.13 Shanghai retains a lower percentage - its revenue collections thanany other province--23.5 percent in 1986 and 1987, and as little as 10-15 per-cent in previous years. In 1988, its collections were 10 percent of thenational total, but its budgetary expenditures were only 2.6 percent. Themunicipality's restricted budget has resulted in poor infrastructure forindustrial development. It also has had negative consequences for enterprisesin Shanghai, from which SMG collects much of its revenue. Despite Shanghai'slead position in gross profitability, the small proportion of profits retainedby enterprises in Shanghai has constrained investment. Since the 1970s, fewnew sizable factories have been built other than the giant steel (Baoshan) andpetrochemical (Jingshan) complexes managed by the central government. Thelimits on retained profits also have constrained enterprises from doing ade-quate research and development.

- 14 -

3.14 The effects of the low rates of investment in the past can be seenin the aging physical stock of capital in Shanghai. Buildings and machineryare ouatdated and ill-equipped to meet the challenges of increasing interna-tional and domestic competition. Factory sites are cramped and layouts exhi-bit histories of piecemeal additions resulting in inefficient workflow pat-terns. It is estimated that roughly two-thirds of machinery and equipmentmatches international technological levels of the 1960s or earlier. Thispartly explains the stagnation in productivity improvements (para. 3.12).

3.15 While the physical stock of capital needs improvement, Shanghai'shuman resource base is strong compared to the rest of China. The municipal-ity's relatively high labor productivity can be attributed to its unequalledbase in skilled human resources, accumulated experience in running industrialenterprises, and educational, scientific and technical infrastructure, com-pared to the rest of China. Shanghai has a relatively high proportion ofengineers and technicians on the staff of its industrial enterprises (6 per-cent compared to 4 percent nationally) and a large number of scientific andtechnical personnel in municipal research and design institutes. The 1982census showed, for example, that Shangha' had 24 university graduates and 204senior middle school (high school) graduates per 1,000 residents; in contrast,the corresponding figures for Sichuan, an interior province, were only 3 and40, respectively.

3.16 Shanghai's industrial performance has suffered from another con-straint--a shortage of land. This shortage has several aspects. One is theovercrowding and lack of space within the city itself. Second is the absenceof mechanisms to adjust land use patterns appropriately since there is nomarket for land or usufruct rights. Third is the lack of funds for buildingcostly infrastructure needed to develop new industrial sites. Fourth is therelated problem of urban transport which results in employees being unwillingto relocate to new factories outside the city. Finally, there is the problemof environmental pollution, which has surpassed acceptable limits; for exam-ple, 80 percent of the biological waste in the water originates in industrialeffluents.

3.17 Recently, the cost of raw materials has risen and reduced the prof-itability of some Shanghai enterprises because their output prices have notbeen adjusted. This sharp increase in the effective cost of raw materialsreflects the impact of the government's price reform program together with adecline in the share of plan allocations that are obtained at low, controlledprices and raw material shortages. Rising wage and energy costs have also ledto a decline in the profitability of enterprises since, reflecting the highpriotity attached by the goverimnent relating to the control of inflation,liberalization of output prices in Shanghai has proceeded slowly. Neverthe-less, output prices for the four subsectors that would be beneficiaries of theproposed operation (para. 3.34) have been largely liberalized.

- 15 -

E. Development Strategy and Policies

3.18 In contrast to its role during the earlier 1980s, Shanghai has nowbeen designated as a leading center of China's economic reform effort and, asa result, the Municipality has embsrked on a number of major initiatives.SMG's broad goal is to take full advantage of China's opening to foreign mar-kets, as well as the large and growing domestic market, by specializing in thefields of industrial production for which it is best suited. To these ends,the SMG has been gradually reforming industrial policy and providing incen-tives ior competitive behavior by industrial enterprises. In keeping withChina's incremental reform process, successful experiments are expected to bereplicated elsewhere in the country. While some pause in this process wasevident during the austerity program in 1989, the central and municipal gov-ernments' commitment to these initiatives has been reconfirmed and progress isagain evident. This section summarizes Shanghai's broad industrial develop-ment strategy and policies. SMG's detailed strategy and the related policyreforms are presented in Annex 1.

3.19 Shanghai is giving priority to those categories of industry that aremost suitable for the municipality's resource endowments and shortages: thestrong human skills and research base, and the lack of raw materials, energyand land. In consumer goods and light industry, the two goals are to increaseexports and the range of goods produced for domestic consumption. The formerwill be achieved by improving product quality, modernizing techniques of pro-duction, and reorganizing enterprises to raise efficiency and lower costs.The latter will be achieved by producing more of the higher quality goodsbeing demanded in China. In heavy industrial equipment and machinery, thegoals are to increase research and development efforts, improve productionefficiency and product quality in the electrical and mechanical industriesthrough greater product standardization, Integrate electronic and mechanicalproducts, and increase exports in these categories. For raw materials forheavy industry, the goals are to make better use of the existing complexes,develop downstream processing, and moderately increase the production of othermaterial inputs required by the priority subsectors in Shanghai.

3.20 Shanghai is implementing a number of enterprise reforms. Thesereforms are intended to revitalize the state-owned sector by making it moreresponsive to market forces. This is to be achieved by granting enterprisesgreater managerial autonomy, separating ownership from management, makingenterprises responsible for their profits and losses, reducing governmentinterference in routine enterprise affairs, and promoting new forms of groupcompany. Shanghai's experience in these reforms is serving as a nationalexample.

2.21 During 1987 and 1988, Shanghai abolished the administrative corpora-tions that formed an intermediate level of bureaucratic control between theindustrial bureaus and the enterprises. Instead, subsector corporations werecreated. These are not administrative units, but independent accounting enti-ties that are responsible for their own profits and losses. They have limiteddirect authority over the enterprises. They provide some services for theenterprises, such as sales and marketing, for fees that serve as their mainsource of income. SMG viewed the formation of these corporations as a firststep in obtaining a clearer separation of government and enterprise roles, andcarrying out a reorganization of the subsectors. The subsector restructuring

- 16 -

to be carried out under the project is an important next step in this process(para. 3.37).

3.22 One of the obstacles to industrial restructuring in Shanghai hasbeen the difficulty of transferring assets through mergers or acquisitions ofenterprises or their parts. This difficulty has resulted from the unclearownership of state assets. SMG has initiated some experiments to solve thisproblem, and is studying wider measures. Following the establishment of theNational Administrative Bureau of State-Owned Propercy at the central-govern-ment level in 1988, Shanghai set up a parallel department under the MunicipalBureau of Finance, with a mandate to devise policies for asset valuation andtransfer. The department is also playing a role in current efforts to definethe state-ownership function. SMG is experimenting with enterprise groups:some involve full mergers of state-owned enterprises in the same line of busi-ness; others resemble holding companies. Integrated companies along the linesof those in the four SIDP subsectors are being established in several moresubsectors. Finally, SMG is at the forefront of current national efforts todesign and implement a shareholding system with diversified public ownership.Several important joint-stock experiments have been initiated in the city andothers are contemplated. The corporations to be supported under the proposedproject are potential long-term candidates for such experiments once the nec-essary corporate restructuring to be supported under the project has beenachieved and the prerequisites for successful joint-stock companies estab-lished.

3.23 Since 1988, the primary instrument used to separate ownership frommanagement in Shanghai's large- and medium-sized enterprises has been thecontract responsibility system (CRS). Under the CRS, each enterprise negoti-ates and signs a contract, valid for three to five years, with the MunicipalBureau of Finance and the relevant industrial bureau. The contract alwaysspecifies how much money the enterprise should submit as revenue to the gov-ernment, and may also state goals for profit retention for investment or tech-nical development, volume of exports, and, especially for new products, theproductioD volume and quality. Once the contract is signed, it is expectedthat the managers will decide how to fulfill the enterprise obligations.While the CRS has resulted in increased enterprise autonomy, it also has somedrawbacks. For example, it allows much negotiation of eacht enterprise's obli-gations and benefits. This has resulted in lower effective profit taxes forpoorly performing enterprises and constrained the production and investmentstrategies of other enterprises.

3.24 Authority over most investment decisions has been delegated from thecentral government to SMG and Shanghai industriai bureaus. The current rulesfor enterprises with no foreign ownership fall into two categories. First.all new capital construction projects with costs under Y 30 million ($8 mil-lion) require SMG approval. Second, technical renovation projects--thoseinvolving replacement of part of a factory--require the relevant industrialbureau's approval for amounts up to Y 3 million in the case of light industryand for amounts up to Y 5 million for heavy industry. Technical renovationprojects between these amounts and Y 30 million require SMG approval. Ineither category, projects costing more than Y 30 million require central go7-ernment approval. It is expected that further steps to relax these limitswill be initiated once the current national stabilization program is success-fully brought to its conclusion.

- 17 -

3.25 During 1987 and 1988, some flexibility in setting industrial pricesin Shanghai was introduced. Jurisdiction over many prod -t prices, particu-larly for consumer goods, was transferred from central government to SMG. TheShanghai Price Bureau has in turn delegated the pricing of many goods to theenterprises. Nevertheless, it still monitors these prices regularly to ensurethat they do not deviate from guideline prices by more than 20 percent, or byan amount necessary to match quality improvements over the guideline's productdefinition. Since the stabilization program began in 1989, only smaller devi-ations have been allowed; however, further liberalization can be expected inthe medium term.

3.26 Foreign trade reform in Shanghai began in 1979 as part of thenational policy of opening the economy to the outside world. Since then, thenumber of channels for foreign ti:ade has been increased. Hitherto Shanghaihas been slow to grant direct export rights to enterprises, and this has beenidentified as a cause of poor export performance, particularly in marketswhere the international norm is custom production and contact between buyerand producer is important. However, in 1989, about half of Shanghai's export-ing enterprises switched to the agency system of exports instead of sellingtheir goods outright to a trading company as under the previous purchasingsystem for exports. Under the new agency system, trading companies export theproducts of enterprises for a fee. Some subsectors are introducing trainingschemes to improve the enterprises' ability to export and are planning phasedprograms to acquire export rights from the trade companies and other agents.

3.27 Several additional export incentives have been introduced during thelast few years. First, enterprises are now allowed to retain a share of theirforeign exchange earnings, with the share varying from as low as 8 percent forbelow-plan exports, to as much as 93 percent for direct exporters.1/ Theydo not actually hold foreign exchange, but their foreign exchange receipts areconverted into domestic currency by the Bank of China and given to the enter-prises. In addition, they receive that currency and a quota, or entitlement,to purchase a fixed amount of foreign exchange for approved imports. Second,enterprises receive rewards for exceeding their export targets, includingbonuses, larger shares of retained foreign exchange for above-target earnings,and the freedom to sell that foreign exchange at the Foreign Exchange Adjust-ment Center, where market rates have until recently been higher than the offi-cial exchange rate. As a result of these efforts, Shanghai's enterprises nowhave access to the most active foreign exchange market in China. Thirdly,China has sought to maintain export competitiveness through regular adjust-ments in the official rate, the most recent of which occurred in November1990; the official rate is now close to that prevailing in the adjustmentcenters.

3.28 At least four measures have been taken by the central and municipalgovernments to increase the number of financial instruments and institutionsin Shanghai. First, the Bank of Communications was reestablished and itsheadquarters situated in Shanghai; this step increased competition amongShanghai's financial institutions and should help to improve financial ser-vices for industrial borrowers. Second, Shanghai now has a small primary

1/ For a discussion of the foreign exchange retention mechanism see: WorldBank: China: External Trade and Capital, 1988, Chapter 2.

- 18 -

securities market; a stock exchange was opened in December 1990. Third, aninterbank money market was recently introduced. Fourth, two foreign exchangeadjustment c,nters were established in 1987; since then they have grownrapidly in volume.

3.29 SMG has modified technology policy over the last three years toencourage technology development in Shanghai's enterprises. Firms may negoti-ate that 1 percent to 2 percent of sales be retained for research and develop-ment purposes. Enterprises can now hire personnel from university andresearch institutes as consultants, and may enter into contracts for jointreFearch with these organizations. Research institutes receive financialrewards if the technology they develop is used by an enterprise. Researchinstitutes are now expected to generate their own funds. Strong client rela-tionships with enterprises are making research more relevant to enterprises'needs; however, SMG will need to monitor this closely to ensure proper diffu-sion of technology developed by research institutes to industrial enterprisesand that basic research is not neglected.

3.30 SMG also is actively encouraging foreign investment as a way tobring in sophisticated technology, gain access to export markets, and developlocal supplier industries. In June 1988, the Shanghai Foreign InvestmentCommission (SFIC) was established to provide "one-stop" approvals for foreigninvestments. Within Shanghai municipality, industrial parks also have beenestablished to provide appropriate infrastructure for foreign factories. Theredevelopment of the Pudong area of the municipality is being designed toattract foreign firms through provision of adequate modern infrastructure andsupport services for businesses and trade.

3.31 SMG also is altering industrial location and environmental protec-tion policy. The goals are to reduce congestion and pollution in the cityproper, and to facilitate the movement of enterprises to locations with ade-quate space for economic scales of production. A zoning system for new enter-prises has been introduced for the city and surrounding counties and satel-lite. The new zoning system also designates restricted locations for heavilypolluting firms. Relocation of existing factories is still difficult, how-ever, because there is no land market.

3.32 Several schemes have been introduced to facilitate labor mobility.Lifetime employment guarantees are being phased out. For example, employmentcontracts lasting one or several years have been introduced and must be usedfor all newly hired industrial workers. Some enterprises have establishedretraining programs to teach workers new techniques of production, and indus-trial bureaus are providing retraining for some senior and skilled workers.Under the Labor Bureau's guidance, enterprises are establishing job defini-tions and standards to encourage evaluation of employee performance and fairercompetition for positions.

3.33 Enterprises in Shanghai have traditionally paid their workers'(unfunded) pensions upon retirement. This placed a cost burden on olderenterprises, which typically have a lower ratio of active to retired workersthan new competitors in other provinces. The pension system also made workersreluctant to move between enterprises, since this would result in lost bene-fits. To address these problems, a new municipal pension scheme was estab-lished in 1988. The new scheme is based on employer contributions and is

- 19 -

administered by the newly formed Consolidated Retirement Pension Funds (CRPF)under tle Shanghai Labor Bureau. An unemployment mpensation scheme has alsobeen established. Under that scheme, employees involuntarily released fromindustrial jobs receive payments until jobs are found for them, or for a maxi-mum of two years.

F. The Four Subsectors

3.34 There are four subsectors included in the project: printing machin-ery, electrical apparatus, electronic components, and precision and scientificinstruments. The printing macht.nery and electrical apparatus subsectors areunder the Shanghai Mechanical and Electrical Industries Administration(SMEIA). SMEIA is the largest bureau in Shanghai and accounts for about25 percen. of the municipality's industrial output. The electronic componentsand precision and scientific instruments subsectors are under the ShanghaiInstrumentation and Electronic Industry Bureau (SIEB). Chart I shows theorganizational relationships between the subsector corporation, bureau, SMGand Central Government. Chart 2 shows the internal structure of a bureau.

3.35 These subsectors are among the priority suDsectors in SMG's develop-ment strategy (para. 3.19). Each has historically been a leader in China andoccupies a significant or dominant position in its domestic market now. Nev-ertheless, competition from new domestic producers has reduced profitabilityand, in some cases, also diminished market share. Exports also are low,despite China's potential competitiveness.

3.36 During preparation of the project, consultants (para. 1.3) carriedout extensive market research and analysis of the weaknesses, capabilities andpotential of each of the four subsectors. The consultants' reports are avail-able in the Project File. Based on this work, and that of Bank staff, enter-prise and subsector policy reforms cutting across th four subsectors havebeen agreed between the Bank and SMG. These reforms are described belowfirst. Then the agreements with respect to the subsector specific product andmarket strategies and organizational restructuring that would be supportedunder the project are briefly described for each subsector. Therefore, thissection provides a brief descriptior. of the intentions of SMG regarding thedevelopment program and strategy for the project subsectors. A translation ofthe full text of SMG's official statement on its intentions is attached asAnnex 2. Details on the subsectors and their strategies can be found inAnnexes 3 to 6.

Enterprise anid Subsector Policy Reforms

3.37 Under the project, SMG is undertaking a common set of enterprise andsubsector policy reforms across the four subsectors. These measures, whichare under the control of SMG, are intended to provide an appropriate structureand policy framework for the managerial, organizational and technical improze-ments to be implemented under the project. These improvements are intended toraise efficiency, growth and competitiveness, consistent with the broad strat-egy of Shanghai's industrial development and to provide reform models whichcan be subsequently replicated in other subsectors. The measures include:(a) the legal establishment of integrated corporations (paras. 3.38-3.40);(b) phased introduction of direct export rights for the integrated corpora-tions (para. 3.41); and (c) improved access by the subsectors to foreign

- 20 -

exchange (para. 3.42). Since appraisal, the four integrated corporations havebeen legally established. In addition, organizational changes within the cor-

porations have begun. These changes are consistent with the introduction ofdirect export rights and the subsector restructuring, which would take place

under the project.

3.38 Integrated Corporations. In 1988, each of the four subsectors com-

prised essentially all of Shanghai's factories which manufacture products inthe subsector's broad product group. However, these were independent, often

suboptimally sized factories with many overlapping products and duplicatemanufacturing processes. The subsector corporations had limited control over

the factories under them (para. 3.21), and, therefore, were unable to carry

out the needed product and manufacturing rationalization. To address this

issue, in each of the four subsectors, an integrated corporation was legally

established and a charter issued for it in May 1989. Each consists of some,but not all, of the factories that were in the subsector as of January 1989.

Each integrated corporation consists only of priority factories that have animportant role to play in implementation of viable product, market and manu-

facturing strategies. (See Annexes 2 through 6 for details on the strategies,and the lists of factories included in each integrated corporation.) In the

future, additional factories could be acquired by or merged with the inte-grated enterprise. Joint ventures with foreign firms could also be possible.

The decision to acquire or merge would be based on consideration of the tech-

nical and economic efficiency of the units to be merged and their impact on

the larger integrated corporation that would result from the union. Further-more, in each subsector, there are some factories, such as foundries, thatsupply critical inputs to the manufacturing processes in the subsector. Theywere initially included in the integrated corporation, but may become indepen-dent of the corporation later.

3.39 For each integrated corporation, financial consolidation of thesubsector corporation and constituent factories was carried out within nine

months of charter issuance. The municipal government's completion of this

process, despite the delays in the Bank's consideration of this project whichoccurred during this period, provides strong evidence of the SMG's commitmentto the restructuring program. The integrated corporation assumes all debt andtax obligations, including those under the CRS, as a single unit. Relatedchanges are being phased in over two years. At the end of that period, theintegrated corporation would become the sole legal entity, responsible for allprofits and losses. It would exercise certain rights, including export andforeign exchange retention, as a single unit. The integrated corporationwould be empowered to reallocate all resources, including employees, materials

and equipment, between factories and divisions as needed to rationalize pro-duction. After the transition period, the formerly separate factories andsubsector corporation will lose their status as independent legal entities.At negotiations, understandings were reached on appropriate transition periodsfor the subsector corporations. These enterprise reforms are reflected in thecharters, found acceptable to the Bank, and approved by SMG in May 1989. Thatapproval was required before any subloan could be made to the corporation(para. 4.8). The charters define the structure, composition, rights and obli-gations of each integrated corporation, and the means by which these may beamended in the future (see Annex 2).

- 21 -

3.40 The integrated corporations are establishing corporate headquartersthat would have the following responsibilities: setting company-wide policy;implementing the investment strategy; financial management; export develop-ment; purchase of bulk raw materials; and coordinating the divisions. Busi-ness divisions that would be profit centers, responsible for product develop-ment, production, sales and marketing, have also been defined, and staffreorganization is under way. Each diviqion involves one or more factories,which will operate as cost centers. Some of the corporations have researchinstitutes and material processing centers that will also be cost centers.SMG recognizes that complex tasks will have to be carried out in the inte-grated corporations in terms of organizational restructuring, design andimplementation of management systems, and financial and manufacturing consoli-dation. Therefore, it has been agreed that assistance of consultants to pro-vide the restructured corporations with expertise in these critical areaswould be provided under the project (para. 4.16).

3.41 Trade Rights. Under the project the integrated corporations woulduse the agency system for exporting instead of the old purchasing system(para. 3.26). A joint office of corporate staff and foreign trade companystaff will be established to handle exports. This arrangement would facili-tate both the training of corporate trade staff and direct contact between thecorporation and overseas clients. Integrated corporations would be granteddirect export rights once they have built up trained staff and demonstratedtheir ability to take responsibility for the risks associated with exporting.Annual reviews of each integrated corporation's progress in this area will becarried out to decide when-it would be appropriate to grant direct exportrights (para. 4.14).

3.42 Access to Foreign Exchange. Each integrated corporation would alsobe allowed to retain as much of its foreign exchange earnings as needed toservice the subloans received under the project and meet other operationalneeds. In addition, the corporations would be allowed to buy foreign exchangeat the Foreign Exchange Adjustment Centers should their export earnings beinadequate to meet their needs.

Subsector Restructuring

3.43 Electrical Apparatus. Before the commencement of the agreedrestructuring (paras. 3.38-3.40), Shanghai's electrical apparatus subsectorconsisted of a subsector corporation (SEAC), 28 factories, a research insti-tute and four subsidiaries of the corporation. The subsidiaries provided ser-vices--material procurement, marketing and sales, systems engineering andtechnology development--to the factories. The subsector employs over 23,000people. In 1989, its total sales were Y 703 million, and its profits were19 percent of sales. The Shanghai subsector's domestic market share was about10 percent in 1987. Exports were about $8 million in 1989. A significantshare of these exports were contactors and relays sent to European firms underbuyback agreements.

3.44 Shanghai's electrical apparatus subsector is growing more slowlythan its domestic competitors. It has failed to expand output in line withmarket demand. Ma.y of its products are outdated. The subsector's operatingefficiency is good compared to many other domestic producers, but very low byinternational standards. Compared to iniustrialized countries, manufacturing

- 22 -

costs are high, delivery times are long, and technology is outdated. Manyproducts are produced by several factories in the subsector, each operatingbelow economic scale. Overseas marketing has been weak.

3.45 Since appraisal, 21 of the 28 factories in the electrical apparatussubsector have been reorganized into an integrated corporation with five divi-sions according to product groups. This will allow consolidation of fragmen-ted facilities, and permit efficiency gains. Export marketing would be han-dled at the corporate level and domestic sales at the divisional level. Threekey strategies have been identified for the domestic market: (a) maintain andstrengthen SEAC's lead position in components and systems products throughefficiency gains and production of new-generation products; (b) build elec-tronics capabilities for applications in electrical apparatus; and,(c) strengthen marketing and sales capabilities by setting up nationwide salesand service centers and establishing a corporate brand. To increase exports,the corporation would focus on independent standard components and dependentstandard subassemblies for original equipment manufacturers (OEMs), and buildexport channels for markets in Southeast Asia and the United States.

3.46 Electronic Components. In March 1989, Shanghai's passive electroniccomponents subsector consisted of a subsector corporation, 24 factories, andone research and development institute. The subsector's share of the domesticmarket declined from 25 percent in 1983 to 7 percent in 1989 and profits as ashare of sales declined from 40 percent to 18 percent in the same period.Restructuring was considered necessary to increase the subsector's competi-tiveness through increased product specialization, larger scales of produc-tion, quality improvement and lower unit costs. Exports were Y 34 million in1989, one-quarter of China's exports of electronic components. However,export quality was low.

3.47 Following appraisal of the proposed SIDP, only eight of the 24 fac-tories and the research institute were joined to form the integrated corpora-tion. This arrangement allows the integrated corporation to focus on priorityproducts that have a strong potential to be competitive in domestic and inter-national markets. The factories are being grouped into five business units.There are three aspects of the strategy: first, for existing products withstrong market demand, technology will be upgraded and production efficiencyimproved to international standards; second, for new products such as chipcomponents and hybrid circuits, foreign technology will be acquired and pro-duction for the domestic market geared up; and tlird, marketing will beimproved and targeted on television manufacturers and foreign joint venturesin China as well as OEMs and distributors in foreign markets. In the longrun, the objective is to improve technology to the level of the leaders in theindustry.

3.48 Precision and Scientific Instruments. In March 1989, Shanghai'sprecision and scientific instruments subsector consisted of a subsector corpo-ration, 13 factories and a research institute. In 1989, it employed over9,000 people and had sales of Y 169 million. All the factories are small byinternational standards. Output grew by 5 percent a year between 1983 and1989--faster than the domestic average of 3 percent for this subsector. Nev-ertheless, its profitability has declined from 42 percent to less than 20 per-cent of sales over the same period and competition from domestic manufacturershas increased. The subsector earned $3.3 million from exports in 1989. The

- 23 -

Shanghai subsector has a wider range of products than its competitors, andneeds to focus on a smaller range of products and improve quality. Currently,its overhead costs and inventories are high, equipment utilization is low, andthe production cycle is long. Marketing and financial accounting systems arepoor.

3.49 The strategy to be adopted by Shanghai's precision and scientificinstruments subsector under the project aims to reduce unit costs and raisequality to gain a greater share of domestic and foreign markets. Six of the13 factories have now been regrouped to form a single integrated corporation.The new corporation will concentrate on seven products in three groups for thedomestic market, and two products for export. The strategy for this subsectorhas five elements: (a) improve design and quality, and integrate new technol-ogies into priority products; (b) rationalize and consolidate priority facto-ries; (c) introduce modern management practices; (d) improve marketing chan-nels; and (e) train and redeploy staff.

3.50 Printing Machinery. In March 1989, Shanghai's printing machinerysubsector consisted of a subsector corporation and 12 factories. Eight enter-prises manufactured printing and post-press machines and four manufacturedcomponents. In 1989, the subsector employed 7,000 people, and had total salesof Y 185 million. The Shanghai subsector's domestic market share was 13 per-cent in 1987. The Shanghai subsector's exports of $5.0 million in 1990 arealmost three times the exports of 1983.

3.51 Although Shanghai has been the traditional leader in printingmachinery in China, there are major challenges to Shanghai's position as aresult of shifts in domestic market demand and initiatives taken by competi-tors. The domestic market is growing at an annual rate of 10 percent andthere is excess demand for printing machines. There is also growing demandfor new products to improve the speed and quality of printing. The Shanghaisubsector has not fully kept up with this growth. In addition, the subsectoris not able to exploit fully its export potential, despite its significantcost advantage in many products. The subsector needs to upgrade product qual-ity, develop new machines, and sell through new marketing channels.

3.52 Since appraisal, the printing machinery subsector in Shanghai hasundertaken a program of reorganization, and is adopting a focused product andmarket strategy. The new integrated corporation includes a large number ofexisting factories because each has a critical role in implementing the agreedproduct, market and manufacturing strategies. However, under SIDP, therewould be substantial rationalization of production to remedy the current prod-uct duplication and excessive vertical integration. The corporation is beingorganized into three divisions based on three key product groups: largepresses, small and medium presses, and post-press equipment. For largepresses, the approach will be to gear up production of web presses based onimported technology, and to develop multicolor sheet-fed offsets, beginningwith low-speed models. In small and medium presses, the division will investin equipment for the manufacture of letter presses with the flexibility toaccommodate the anticipated shift of demand from letter presses to sheet-fedoffsets, and increase production of duplicators, which are in great demand.For the post-press division, the priority will be on upgrading quality andincreasing production. To increase export earnings, the integrated corpora-tion will seek joint production agreements with some of its curre.t technology

- 24 -

partners for sales into Western markets, and for the Southeast Asian markets,it will appoint a sales and servicing agent.

G. Bank Role and Strategy

3.53 To revitalize its economy Shanghai needs to adjust the structure andmanagement of its industrial sector (para. 3.18). The Bank is well-placed toassist SMG in formulating, implementing and financing an integrated package ofneeded policy and enterprise reform measures based on its experience withindustrial restructuring elsewhere in the world and previous economic andsector work and lending operations in China. This experience includes theindustrial restructuring projects in Hungary, Mexico, and Indonesia, pastsector work on enterprise reform in China, and the Shanghai Machine ToolProject.

3.54 Through the work already done on the proposed project, the Bank hasestablished a broad dialogue with SMG on overall industrial development strat-egy and policy in Shanghai. At the subsector level, the proposed projectwould assist in the design and implementation of specific strategies andrestructuring programs for four priority subsectors in Shanghai. Theseefforts would assist SMG in developing relevant approaches to, and experiencein, the kind of industrial restructuring that is required elsewhere in theindustrial sector, and provide models for subsequent replication in Shanghaiand the rest of China. In addition, the operation would contribute to insti-tution building in Shanghai through technical assistance to strengthen thecapability of SMG to do industrial sector planning and policy analysis in twoways: first, it would improve local consulting capability in the area ofindustrial restructuring because three major consulting firms in Shanghai haveworked closely with the foreign firms that have helped develop the subsectordevelopment programs, and local consulting firms would work on the implementa-tion of the programs also; and second, two policy studies to be done in con-junction with the project would contribute to building policy-making institu-tions in Shanghai. One of these studies, which is looking at enterprisereforms and the supporting mechanisms to be developed, such as boards ofdirectors and asset transfers, is already under way. The other study wouldmonitor the impact of policy changes on the four subsectors and suggest modi-fications if needed.

3.55 The consulting firms, with the assistance of the subsector corpora-tions and SMG (para. 1.3), have carried out in-depth studies of the four sub-sectors, which are satisfactory to the Bank and available in the Project File.These studies were financed under the Japan Grant Facility. They focus on:subsector competitiveness in domestic and foreign markets, technology andmanufacturing capabilities and trends, product and market strategies, organi-zational development strategies, investment plans and overall program imple-mentation. Annexes 3 to 6 summarize the main findings and recommendations ofthe consultants' reports. The Bank has played an active role in guiding andproviding inputs to the studies. These studies have helped form the basis fora constructive dialogue with SMG, the subsector corporations and their indus-trial bureaus, and agreement with the Bank on development strategies and pro-grams for the four subsectors, including subsector policy reforms, organiza-tional and technological restructuring, and technical assistance. The initialorganizational restructuring is underway.

- 25 -

IV. THE PROJECT

A. Project Objectives

4.1 The proposed project forms part of the Bank's overall effort tosupport the implementation of GOC's program of industrial reform. The projectwill focus on four subsectors in Shanghai which have been given priority inthe municipal government's development strategy: electronic components, pre-cision instruments, electrical apparatus and printing machinery. The projectwould assist the implementation of the Shanighai government's developmentstrategies and programs for the above subsectors. Specifically it would pro-mote increased efficiency, and greater domestic and international competitive-ness in the four subsectors through:

(a) rationalization, modernization and expansion of plants in the foursubsectors based on sound product and market strategies, upgradedtechnological and manufacturing capabilities, and clear financialand economic performance criteria;

(b) organizational restructuring and upgrading of internal enterprisemanagement systems; and,

(cl subsector policy reforms.

B. Project Components

4.2 The project will have three main components:

(a) financial assistance for technological restructuring of enterprisesin the four subsectors;

(b) technical assistance to support organizational restructuring, man-agement upgrades and project implementation, including training,computer hardware and software, and management consultancy services;and,

(c) institutional development assistanr-e for economic policy making andthe PFIs in Shanghai.

The description of the three components is as follows.

Financial Assistance Component

4.3 The project will provide financial assistance of $133.8 million outof the proposed Bank loan toward meeting the foreign currency requirements fortechnological restructuring in the four subsectors, including the costs ofproduction equipment and technology transfer. The funds would be onlentthrough the PFIs (para. 4.17). Altogether for the four subsectors, about 40subprojects for technological restructuring have been proposed for financingunder the project. In tne electronic components subsector, the investmentswould include improvements in product design and quality, capacity expansionsand manufacturing improvements for existing products such as capacitors,resistors, connectors and switches, transformers, relays and future growth

- 26 -

products such as chip components and hybrid circuits. In the precisioninstruments subsector, the investments would include improvements in productdesign and quality, capacity expansions and manufacturing improvements inthree key areas: analytical instruments--spectrophotometers and chromato-graphs; general purpose and environmental control instruments; and opticalsystem products, particularly microscopes and optical elements.

4.4 Financial assistance for technological restructuring would also beprovided to the electrical apparatus subsector. The specific areas to be sup-ported include: gearing up for volume production of new generation productsalready being manufactured under existing technology transfer agreements fromindustrialized countries (e.g., contactors): developing new systems productsbased on technology for which licensing arrangements have already been negoti-ated (e.g., AC drive converters); developing a few key new generation stand-alone products (e.g., voltage control units and leakage switches); and devel-oping some electronics products for application in electrical apparatus (e.g.,uninterruptible power supply). In the printing machinery subsector, financialassistance would be provided for increasing production of large web-presses,as well as labor-intensive subassemblies of these presses for export, and ofthe large, medium performance, multicolor sheet-fed offset machines, introduc-tion of small and medium multicolor sheet-fed offset machines and duplicators,replacing the old generation of letterpresses, mainly for the Chinese market.In addition, support would be provided for upgrading product quality andincreased output of post-press machines (e.g., cutting and binding machines).

Technical Assistance Component

4.5 The project will provide technical assistance to finance computerequipment and software, training, and consulting services. Broad outlines ofprograms in each of these areas have been established by the corriorations withthe assistance of consultants. Each corporation will submit its requests forsuch financing in the form of subloan proposals to the PFIs; these are expec-ted to total $16.2 million. The category of training includes courses formanagement and technology development, and travel abroad for acquisition offoreign technology. About $8.5 million of the loan will be used for thispurpose. During negotiations it was agreed that the Bank and SMG would reviewannually, by September 30 each year, a 12-month program for overseas trainingfinanced under the project. The requiremenits of computer equipment includingsoftware have already been specified for each corporation at an estimatedtotal cost of $2.7 million.

4.6 During appraisal, agreement was reached on the nature of consultantservices needed during project implementation. They cover services in theareas of: project management, organizational restructuring, production con-solidation, preparation of feasibility reports, management information sys-tems, financial and cost accounting, and industrial engineering and opera-tional effectiveness. About $5 million of the loan will be used to financethe necessary consultant services. Generic terms of reference (TORs) forthese services are included at Annex 7. Each of the four corporations hastailored these generic TORs to their own specific requirements and the revisedTORs have been agreed with the Bank. Local and foreign consultants will beengaged to help carry out the scope of work in the TORs. The Bank hasapproved the corporations' request to negotiate directly with the consultantswho helped develop the subsector strategies and development programs to assist

- 27 -

in carrying out the above scope of work. Appointment of all the consultantsneeded to carry out the full scope of work outlined in the TORs is a conditionof loan effectiveness.

Institutional Development Component

4.7 The project will asssist institutional development in the areas ofeconomic policy-making, project appraisal, and subsectoral restructuring.During project implementation, two interinstitutional studies will be coordi-nated by the Shanghai Planning Economic Research Institute (SPERI). Thesestudies involve monitoring the impact of policy changes on the four subsec-tors, and assessing the implementation of enterprise reforms in those subsec-tors as well as their wider applicability in Shanghai's industrial sector.Terms of reference for these two studies have been agreed with the Bank.Since March 1989, managers and project staff from the five PFIs have attendedcourses on project appraisal. In April 1991, a seminar on industrial restruc-turing will be given by the Economic Development Institute in collaborationwith the Shanghai Planning Commission, and educational institutiopq inShanghai. This course will assist industrial managers in Shanghai to analyzethe need for industrial restructuring and appropriate restructuring methods.The institutional development component is being financed by SMG; this finan-cing includes $105,000 equivalent from the Japanese Grant Facility to financethe estimated foreign costs of the studies and courses.

C. Eligibility Criteria

4.8 The Bank has reviewed subprojects in the pipeline for their appro-priateness with respect to the agreed subsector strategies (para. 3.37). Theenterprises would submit the feasibility studies of subprojects according tothe format agreed with the Bank (Annex 8). The PFIs would appraise each sub-project proposed for financing to ensure that: (a) it is sponsored by a cor-poration that has been established as an integrated enterprise, as reflectedin a charter acceptable to the Bank and approved by SMG (para. 3.38); (b) itis consistent with the subsector strategies agreed between SMG and the Bank(Annex 2); (c) the subproject and the sponsoring factory are in compliancewith environmental control guidelines (para 4.31); and, (d) the subprojectwould nermit the sponsoring corporation to maintain a satisfactory financialposition. Furthermore, all subprojects except for those for training, compu-ter equipment (including software) and consultant services, would have to haveminimum financial rates of return of 12 percent in constant prices. Subproj-ects above the free limit would also have to have an economic rate of returngreater than 12 percent in constant prices. Assurances on the above eligibil-ity criteria were obtained at negotiPtions.

D. Project Cost and Financing

4.9 The total cost of the pipeline of subprojects, including incrementalworking capital, is estimated at $320 million (based on November 1990 prices),of which $180 million (56 percent) would be in foreign exchange. Table 4.1summarizes the estimated project costs including contingencies. The estimatesare of a tentative nature as the project components are based on preliminarycost estimates of the subprojects in the pipeline. Consequently, no attempthas been made to separate contingencies. Final cost estimates for the actual

- 28 -

subprojects financed could be different since these would be prepared by the

enterprises for subproject appraisal by the PFIs.

Table 4.1: ESTIMATED PROJECT COST /a

Local Foreign Total 2 of Total------ ($ million) ------

FINANCIAL tS.SISTANCE COMPONENT

Technological RestructuringCapital Costs:

Instrumentation 8.0 27.9 35.9 11.2Electronic components 16.9 64.6 81.5 25.5Printing machinery 11.1 22.3 33.4 10.5Electrical apparatus 14.2 40.4 54.6 17.1

Subtotal 50.2 155.2 205.4 64.3

Incremental working capital /b 81.5 - 81.5 25.5

Subtotal for TechnologicalRestructuring 131.7 155.2 286.9 89.8

TECHNICAL ASSISTANCE COMPONENT

Training 2.6 11.7 14.3 4.5

Computer Hardware and Software 0.8 3.7 4.5 1.4

Consultant Services 4.1 9.7 13.8 4.3

Subtotal for TechnicalAssistance Component 7.5 25.1 32.6 10.2

INSTITUTIONAL DEVELOPMENT COMPONENT 0.1 - 0.1 -

Total Financing Required 139.3 180.3 319.6 100.0

/a Final estimates to depend on individual subproject cost estimates thatwill be prepared by the PFIs at the time of subproject appraisal. Sincethese are preliminary estimates, no attempt has been made to separatecontingencies. Project cost estimates include taxes on local costs andcustoms duties on imports. Local taxes are about 15 percent of localcosts. Foreign costs financed by the Bank would be exempt from customsduties.

/b Imports of raw materials and parts will be financed through foreignexchange earnings, for which the working capital is included in the localcost.

- 29 -

4.10 Furthermore, the pipeline may change if the PFIs' detailed analysisshows that some of the subprojects in the current pipeline are not viable andtherefore no longer eligible for financing, or if other suitable subprojectsare developed. Moreover, although the project is intended to assist the foursubsectors, the PFIs would be alluwed to use the proceeds of the loan for thisproject to finance subprojects in other industrial subsectors as agreedbetween the Bank and SMG on the basis of agreed development strategies to beprepared by the municipality; assurances to this effect were obtained at nego-tiations.

4.11 The proposed Bank loan will provide $150 million. Based on theinitial pipeline of subprojects, this would leave a foreign exchange financinggap of $30.4 million. If there is such a gap after all subprojects areappraised and firm foreign exchange estimates are known, SMG would finance it.Local currency requirements would be financed by the PFIs, other Chinese banksand the enterprises' own resources. Table 4.2 summarizes the financing planfor the project. During negotiations, assurances were obtained that SMG willmake available all funds needed for implementation of the project.

Table 4.2: ESTIMATED FINANCING PLAN(S million)

Local Foreign Total

FINANCING PLANIBRD - 150.0 150.0PFIs, other banks and enterprises 139.2 - 139.2Shanghai Municipal Government /a 0.1 30.3 30.4

Total Financing Plan 139.3 180.3 319.6

/a The Japanese Grant Facility will finance the estimated $35,000 equivalentin foreign costs for the studies, and $70,000 equivalent of the foreigncosts for training seminars.

E. Project Implementation Arrangements

4.12 Project implementation will be carried out by SMG, the subsectorcorporations and the participating financial institutions. During negotia-tions, agreement was reached on the formats and frequencies of reports to beused by each of these parties to monitor project implementation (para. 5.9).

Role of the Shanghai Municipal Government

4.13 SMG will carry out the enterprise and subsector policy reforms asoutlined in the agreed development program and strategy (Annex 2), and coordi-nate and monitor all project-related activities. For the latter, SMG hasestablished a project monitoring unit (PMU) comprised of staff from theShanghai Planning Commission, the Shanghai Bureau of Finance and the ShanghaiForeign Economic Relations ar1d Trade Commission. The unit's responsibilities

- 30 -

include: (a) monitoring technical assistance and training under the project;(b) providing advice to the subsector corporations and PFIs on Bank proceduresincluding matters related to procurement and disbursement; and (c) monitoringproject implementation and forwarding to the Bank regular reports on progressof the project. During 1989, staff of the PMU participated In seminars orga-rized by SMG and MOF covering Bank disbursement and procurement procedures andreporting requirem!nts. During negotiations, assurances were obtained fromSMG that it will maintain the PMU throughout project implementation, withcompetent staff in adequate numbers, and given functions and responsibilitiesacceptable to the Bank-

4.14 During negotiations, assurances- were obtained that SMG also wouldmaintain a Steering Committee of high-level officials to guide the work of thePMU with composition, functions and responsibilities acceptable to the Bank.In addition, this Steering Committee would annually review the progress of theproject. Moreover, the Shanghai Planning Economic Research Institute will bemonitoring the impact of the subsector policy and enterprise reforms under-taken in connection with the project and identifying any adjustments or newreforms needed. During negotiations, assurances were obtained that SMG willeach year: (a) prepare and furnish to the Bank, by April ;5 of each year, anassessment of policy and enterprise reforms in the project subsectors and(b) exchange views on these assessments with the Bank.

Role of the Subsector Corporations

4.15 Restructuring programs in each subsector will be carried out byproject implementation units (PIU) set up in each corporation. These unitswill come under the responsibility of the general manager of the corporationand be headed by a project manager. The project manager will divide the PIUinto specific task groups in ctitical restructuring areas such as organizationstructure and development, product development, management systems, and opera-tional effectiveness programs. The role of the task groups will be the devel-opment of detailed plans and execution of appropriate implementation activi-ties. Project managers will regularly report to the corporate management onprogress and any problems in project implementation. The project implementa-tion schedule is at Annex 9. Annex 10 gives the key performance indicatorsfor project implementation. One of the first tasks will be to consolidate thefinancial accounts of the new integrated corporations. During negotiationsassurance. were obtained from SMG that this would be done within nine monthsof charter issuance for each corporation. Draft consolidated statements werecompleted at that time, and were revised following discussion with the Bank.

4.16 Because of the complex nature of the subsector restructuring pro-grams, consultants will be hired to assist the PIUs in overall project manage-ment and development and implementation of plans in each functional area(para. 5.5). Terms of reference for these services have been agreed with eachcorporation (para. 4.6).

- 31 -

Role of the Participating Financial Institutions

4.17 The proceeds of the proposed loan will be onlent through five PFIs,consisting of four banks and one nonbank financial institution. The fourbanks are the Bank of Communications (BOCOM) Shanghai, China Investment Bank(CIB), Industrial and Commercial Bank of China (ICBC), and People's Construc-tion Bank of China (PCBC). The nonbank PFI is the Shanghai Investment andTrust Corporation (SITCO), a Shanghai-based financial institution. The PFIswould be responsible for the normal functions performed by financial interme-diaries. These include independent appraisal and supervision of the subproj-ects, evaluation of the borrowers' creditworthiness, coordination of procure-ment and other project implementation arrangements, disbursement of loanproceeds, and recovery of debt service obligations. In addition to onlendingBank funds in foreign exchange, the PFIs would also provide local currencyloans to finance capital costs denominated in local currency and incrementalworking capital requirements of the borrowing corporations.

4.18 Bank loans for industry in China using financial intermediaries haveso far been onlent primarily through CIB (para. 2.15). An important step forthe Bank in the financial sector in China is to esthblish relationships withother key financial institutions. This would ailow the Bank to understandbetter and assist in the evolution of financial institutions in China. Theproposed project would further this process by including BOCOM, ICBC, PCBC andSITCO as financial intermediaries for the first time under a Bank project.This project also would strengthen the capability of these PFIs to appraiseand manage medium and long-term loans. It would support moves to increase thenumber of qualified financial institutions in the area of long-term lending, afield hitherto dominated by PCBC and CIB (which is closely affiliated withPCBC).

4.19 Responsibility for project implementation would rest with theShanghai branches of the four banks and SITCO. which is based in Shanghai.The bank branches would be able to approve subprojects independently under theproposed Bank project, without having to seek further approval from their headoffices. Each of these five institutions is considered to be capable of car-rying out the project appraisal, implementation, and supervision tasksrequired under the proposed project. However, to strengthen their skillsfurther, staff from the PFIs are attending preproject training courses. Thesecourses cover project appraisal methodology as recommended by the Bank, andacquaint the PFIs with Bank procedures on procurement, disbursement, andreporting. Each institution would lend to a specific subsector, and wouldtherefore be able to develop expertise on the issues and risks faced by thatsector during the restructuring process. The financial condition and perfor-mance of these institutions have been assessed by Bank staff, and judged to besatisfactory. A summary description of each PFI, its operations, financialcondition, and performance is provided in the following paragraphs. Moredetail on each PFI's operations Ss presented in Annexes 11 through 15.

4.20 Bank of Communications. BOCOM is a universal bank with its head-quarters in Shanghai. Established in 1908 in Beijing, the bank was reconsti-tuted in 1986, at which time its headquarters were moved from Beijing toShanghai. As of December 1988, BOCOM had 8 branches and 24 subbranches inChina employing about 5,000 staff, plus a large Hong Kong branch. BOCOM's

- 32 -

total assets, including the Fong Kong branch, were Y 42 billion at the end of1987.

4.21 The Shanghai branch of BOCOM, an independent legal entity, has grownrapidly since it commenced its operations in 1986. A. the end of 1988, totalassets of the branch were Y 4.1 billion, with Y 1.0 billion in medium-termloans. The branch has aggressively recruited qualified staff from otherinstitutions, and its medium-term lending operations are handled by about 20staff members. The branch's pretax return on average assets in 1988 was highat 4.0 percent. Capitalization was strong as of end-1988, with net worthbeing 19 percent of assets. Arrears on principal payments were about 3.5 per-cent of outstanding loans as of September 1988, and all the arrears were lessthan 60 days overdue.

4.22 China Investment Bank. CIB commenced its operations in 1981 as adevelopment finance institution. While CIB is administratively under theleadership and supervision of MOF, it remains closely tied with PCBC. Itsprimary focus is financing the technical transformation needs (i.e., fixedasset investments involving modernization or rehabilitation) of small- andmedium-sized projects, particularly in the light industry sector. CIB hadtotal assets of Y 6.7 billion as of end-1988, with 56 branches and subbranchesemploying about 1,000 staff. The Bank Group's involvement with CIB has beenextensive (see para. 2.15).

4.23 Between 1985 and 1989, CIB's Shanghai branch approved 63 loanstotaling about Y 370 million equivalent, mainly in foreign exchange. Of theloans made, only two have been rescheduled during the last five years of oper-ation, and the branch reported no arrears a, of December 1989. The branchshowed a pretax return on average assets of 3.8 percent for 1989. It has 14professionals in charge of appraisal and supervision activities, and thesestaff are well trained in project appraisal methodology satisfactory to theBank.

4.24 Industrial and Commercial Bank of China. ICBC accounts for abouthalf of the deposits and loans of the entire banking system in China. It wasestablished in 1984 as a spin-off from the People's Bank of China (the centralbank). Today, 1CBC provides most of the short-term loans received by indus-trial and commercial enterprises in urban areas, and has a large share ofurban savings deposits as well. The bank had total assets of Y 562 billion atthe end of 1988. and a network of about 24,000 branches and subbranchesemploying 440,000 staff.

4.25 At the end of 1989, ICBC's Shanghai branch had total assets of Y 38billion and a staff of about 14,000. The branch's financial performance hasbeen good, with a pretax return on average assets of 2.3 percent in 1989.Although most of its loans are for short maturities, the branch has a largeportfolio of medium-term loaas for technical transformation purposes. Between1985 and 1989, the branch financed 1,788 of these projects, with cumulativecommitments of over Y 6.7 billion. The branch has a special credit unitresponsible for technical transformation loans. This unit has a staff of 17,most of whom are financial analysts and economists. The unit handling techni-cal transformation loans reported arrears of less than 1 percent of the port-folio as of December 1989; loans affected by arrears were estimated to be2.6 percent of the portfolio.

- 33 -

4.26 People's Construction Bank of China. PCBC was established in 1953and is the primary bank in China for the financing of medium- and large-sizedfixed investment projects. At the end of 1988 the bank was responsible fortotal assets of Y 342 billion, consisting of Y 165 billion of its own assetsand Y 177 billion of projects managed for the government's fixed investmentbudget. The bank has a nationwide network of more than 3,000 branches, sub-branches and savings deposit offices, with a total staff of approximately100,000. PCBC's primary business lines remain project financing and lendingto constructicn enterprises, but the bank is expanding its range of operationsconsiderably. The Bank is currently preparing a Financial Institutions Devel-opment Project, a component of which is expected to assist PCBC to achieve itsinstitutional development objectives.

4.27 At the end of 1989, PCBC's Shanghai branch employed 3,000 staff, hadtotal assets of Y 14.4 billion, and managed government investments of Y 14.8billion. Between 1985 and September 1989, the branch approved Y 6.9 billionin loans. About three-quarters of its lending is devoted to medium- and long-term project finance; the remainder comprises working capital loans. Itsstaff already is familiar with Bank project analysis procedures, since abouthalf the management staff in Shanghai have attended courses sponsored by theBank. The financial performance of the branch has been good, with a pretaxreturn on average assets of 2.3 percent in 1989. The branch's overdue princi-pal amounted to 0.7 percent of its outstanding loan portfolio as of December1989.

4.28 Shanghai Investment and Trust Company. SITCO was established by theShanghai Municipal Government as a nonbank financial institution in 1981.Today SITCO and its subsidiaries offer a wide range of corporate financialservices, including loan and equity financing. Between 1984 and 1988 SITCOapproved over 200 loans totaling $1.5 billion equivalent in foreign currencyand Y 1.1 billion in local currency. Almost all of this lending has financedtechnical transformation projects. SITCO has 30 staff members responsible forproject appraisal and supervision. Its total staff of 408 is well qualified,as both in-house and overseas training are emphasized. SITCO's pretax returnon average assets was 2.3 percent in 1989. SITCO is strongly capitalized,with a capital-to-assets ratio of 18 percent at the end of 1989. Apart fromrescheduling three loans totaling $25 million, SITCO reports no overdue prin-cipal or interest payments since it started its lending operations in 1986.

F. Environmental Impact

4.29 While Shanghai has major problems of environmental pollution, theproject subsectors are not major contributors to Shanghai's environmentalproblems. It should be noted, in particular, that the electronic componentssubsector included in the project consists only of the manufacture of passivecomponents; it does not include semiconductor manufacturing plants which areknown to be the major contributors to fluorocarbon pollution within the elec-tronics industry. However, there are some environmental issues in the projectsubsectors, such as the use of electroplating and disposal of acids andwastes. These would be addressed in the project through the arrangementssummarized below.

4.30 The Shanghai Environmental Protection Bureau (SEPB) has confirmedthat all the subsector enterprises involved in the project must comply with

- 34 -

its guidelines. SEPB would approve their renovation and expansion plans andwould periodically monitor their compliance. Moreover, as part of the invest-ment approval process in Shanghai, SEPB would routinely be involved in approv-ing all feasibility reports for subprojects under the loan, i.e., clearance bySEPB is required before any subproject can be financed by the PFIs. In par-ticular, SEPB would require that all subprojects in the subsectors to befinanced under the Bank operation include adequate expenditure for controllingenvironmental pollution. For each feasibility report, SEPB would review theenvironmental provisions to ensure that they meet China's environmental stan-dards, which are adequate for the project subsectors. It would also ensurethat the subproject's sponsoring factory is in compliance with those stan-dards.

4.31 Bank staff have determined that SEPB has the capability and staffingto monitor the environmental aspects of the project effectively. During nego-tiations, assurances were obtained that the PFIs will not approve any subproj-ect for financing until: (a) the subproject is approved by SEPB and meetsprevailing environmental guidelines; and (b) the existing operations of thesubproject's sponsor are in compliance with SEPB's environmental standards.The approach to addressing the environmental issues in the project will becomplemented by the Bank's Shanghai Sewerage Project (Loan 2794-CHA and Credit1779-CHA) which addresses industry-wide environmental issues in Shanghai. Thefocus in that project has been to install sewer interceptor and collectionsystems to reduce organic pollution loads into the most heavily polluted sec-tion of the city draining into Suzhou Creek.

- 35 -

V. THE LOAN

A. Lending Arrangements and Terms

5.1 The People's Republic of China (PRC) will borrow the proposed Bankloan of $150 million, and pass it on to SMG on terms and conditions satisfac-tory to the Bank. SMG will make available the loan proceeds to the PFIs underSubsidiary Loan Agreements with each. The initial allocation of the loanproceeds among the PFIs is based on a proration of the estimated foreign cur-rency costs of the project. This allocation is presented in Table 5.1 below.This initial allocation is subject to change during project implementation.Funds may be reallocated from one PFI to another subject to Bank approval,depending on the progress made by each PFI in committing its allocated shareof the loan proceeds.

Table 5.1: INITIAL ALLOCATION OF LOAN PROCEEDSAMONG THE PFIs

(S million)

PFI Amount

BOCOM 22.0CIB 27.8ICBC 42.0SITCO 27.0PCBC 31.2

Total 150.0

5.2 The PFIs will onlend the Bank's funds to finance eligible subproj-ects in the four subsectors (para. 4.8). The Bank will sign a Loan Agreementwith the PRC, a Project Agreement with SMG, and a Financial IntermediariesProject Agreement with the PFIs. Approval of the Loan Agreement by the PRC'sState Council and signing of the Subsidiary Loan Agreements satisfactory tothe Bank will be conditions of effectiveness of the loan.

5.3 SMG will lend the funds to the PFIs on the same terms as the Bank'sloan to the PRC. These terms include a 20-year maturity, with five years'grace, at the Bank's standard variable interest rate. For loans made by PFIs,the maximum maturity would be 12 years, including a grace period of up tothree years. The PFIs would charge their borrowers an interest rate equal tothe Bank's standard variable interest rate plus at least 1.25 percent. ThePFIs' spread is considered adequate to cover their administrative costs, risksand a reasonable profit margin. The PFIs would handle the foreign exchangerisk of the Bank's currency pool in one of two ways: (a) they would pass onto their borrowers the entire foreign exchange risk of the Bank's currencypool, or (b) the PFIs would pass on most of the foreign exchange risk througha scheme where they would lend in a three-currency basket (US Dollar, JapaneseYen and German Deutsche Mark), in order to improve the transparency and pre-

- 36 -

dictability of the final borrower's nominal debt service payments. This bas-ket would very closely track the Bank's new targeted currency pool; hence theresidual foreign exchange risk to the PFIs under this scheme would be smalland could be covered by charging their borrowers an appropriate premium. ThePFIs intend to consider this second option only for subloans made with roll-over funds (i.e., funds arising from repayments on the initial set of subloansmade by the PFIs).

5.4 The PFIs would lend Bank funds for either "investment' subloans or"technical assistance" subloans. Investment subloans would fund goods,related services and technology transfer for subprojects to be appraised bythe PFIs. The free limit for investment subloans will be $3 million. Inaddition, each PFI's first two investment subloans below the free limit wouldbe submitted to the Bank for approval. The maximum subloan size will be $20million. Any subloan above this amount will be subject to approval by theBank on an exceptional basis only, and Bank staff may directly participate inappraisal of the subproject, together with PFI staff. Based on the currentinvestment pipeline, however, no subloans above $20 million are expected.Technical assistance subloans will finance all consultants' services, computerequipment and training that are not tied to specific investment subprojects(para. 4.5). All technical assistance subloans will be presented to the Bankfor approval. The last date for submission o.' all subloan applications willbe December 31, 1993. The expected project completion date is December 31,1995, and the closing date of the loan will be June 30, 1996. During negotia-tions, assurances were obtained from PRC, SMG and the PFIs on the above lend-ing arrangements and terms.

B. Procurement

5.5 For goods and related services, individual contracts over $1 millionwill be awarded after international competitive bidding (ICB) is carried outaccording to Bank procurement guidelines. Only two or chree contracts areexpected to exceed $1 million. Local bidders would be granted the standardmargin of preference, equal to customs duties and other import taxes, or15 percent of c.i.f. cost, whichever is lower. Contracts below $1 millionwould be awarded after a comparison is made of quotations solicited from atleast three qualified suppliers from different countries. Items of a prop::i-etary nature or spare parts may be procured through direct contracting. Sinceonly a few contracts are likely to go out for ICB, no procurement table isgiven. Consultants' services during project implementation would be obtainedin accordance with the Bank's Consultants Guidelines and financed out of loanproceeds. The Bank has approved SMG's request for direct negotiations betweenthe subsector corporations and the consultants used in developing the subsec-tor strategies and development programs because the consultants have helpeddesign the strategies to be implemented during execution of the project andare competent to undertake the task. In addition, local consultants may becontracted separately for some of the tasks covered in the TORs. During nego-tiations, assurances were obtained that each corporation would engage all thenecessary consultants to carry out the work described in the terms of refer-ence (Annex 7) prior to loan effectiveness. Technology transfer, overseastraining, and study tours would be subject to approval by the Bank. TheBank's standard prior review and approval procedures (from bidding documentsthrough contract award) will be applied to all ICB contracts. All other con-tracts may be subject to post-review by the Bank, and the PFIs are to maintain

- 37 -

all the relevant documents for this review. The PFIs will be responsible forsupervising procurement by subborrowers.

C. Disbursement

5.6 Disbursement of the loan proceeds will be allowed as follows:(a) for investment subloans, 100 percent of amounts disbursed by a PFI forforeign expenditures and for local ex-factory expenditures; (b) for goodsunder technical assistance subloans, 100 percent of foreign expenditures,100 percent of local expenditures (ex-factory cost) for goods bought directlyfrom the manufacturer and 75 percent of local expenditures for other itemsprocured locally; and (c) for consultants' services and training under techni-cal assistance subloans, 100 percent of expenditures. Disbursements fortraining and study tours and for contracts of less than $200,000 each will bemade against Statements of Expenditure (SOE). In the latter case, full docu-mentation will be held by the PFIs for rev.ew by Bank supervision missions.Each PFI will provide a monthly SOE to the Bank, with a copy to be kept by thePMU.

5.7 To facilitate disbursement of project funds, Special Accounts willbe established on terms and conditions satisfactory to the Bank. A separateSpecial Account will be established for each PFI. The Bank will make a maxi-mum initial deposit in each PFI's Special Account as follows: $1.2 millionfor BOCOM, $1.5 million for CIB, $1.7 million for PCBC, $2.3 million for ICBC,and $1.5 million for SITCO. These amounts represent the estimated four-monthaverage of project expenditures to be withdrawn by each PFI from the SpecialAccount. Applications for replenishment will be submitted monthly, or whenthe amounts withdrawn are equal to 50 percent of the initial deposit, which-ever occurs first. Disbursements under the project are expected to be com-pleted by June 30, 1996. The estimated schedule of disbursements is given inAnnex 16. It is based on the disbursement profiles of loans through financialintermediaries and other industrial loans in China, as well as the Bank'sexperience with industrial restructuring projects in other countries.

5.8 Eligible expenditures incurred after March 15, 1989, up to a maximumof $5 million will be eligible for financing on a retroactive basis. Themajority of such expenditures will be for financing initial payments fortransfer of technology, the consultants' services that are immediately neededto prepare for project implementation and for travel abroad to acquire foreigntechnology.

D. Reporting and Auditing

5.9 Shanghai Municipal Government. SMG established a PMU, which willbecome fully operational under the project (see para. 4.13). One of theresponsibilities of the PMU will be to monitor project implementation andforward to the Bank regular progress reports on the project and audited proj-ect accounts. The format and frequency of these progress reports were agreedat negotiations (Annex 17). The PMU, with the assistance of the PFIs, willalso prepare a project completion report within six months after disbursementof the loan proceeds is completed.

5.10 Participating Financial Institutions. Each year the PFIs will pro-vide the following reports to the Bank, through the PMU: (a) statements of

- 38 -

loan collection ratios on Bank subloans; (b) audit reports of the accounts ofthe Shanghai branches of the four banks and of SITCO; and (c) audit reports ofproject accounts, including Special Accounts and SOEs. The accounts of SITCOand the Shanghai branches of the four banks would include an Income Statementand a Balance Sheet, with these financial statements accompanied by appropri-ate supporting schedules and explanatory notes. In particular, (a) the IncomeStatement would incorporate, or be accompanied by, a Statement of Allocationof Profits that would record the distribution of profits, and (b) the BalanceSheet would be accompanied by a Statement of Changes in Net Worth that woulddetail the reasons for the changes in net worth (capital and retained earn-ings) from one period to the next. The audit reports of the accounts of thePFIs would be carried out by auditors acceptable to the Bank. All auditedaccounts and statements will be provided to the Bank within six months afterthe end of each institution's financial ye-.r beginning with the financial yearending 1990. The PFIs will also provide the Bank, through the PMU, quarterlyreports on commitment, disbursement and procurement under each subloan.

E. Benefits and Risks

5.11 Organizational and technological restructuring and policy reformswill result in greater efficiency and competitiveness in the four subsectorsunder the project. The strategies that have been agreed with SMG are designedto improve product quality and exports. The subproject selection criteriawill ensure that investments under the project are financially and economic-ally viable and are consistent with SMG's strategy for each subsector.

5.12 The main project risks pertain to: (a) the implementation of theenterprise and policy reforms that are to be carried out at the subsectorlevel, and (b) the timely implementation of the project. However, SMG isstrongly committed to the needed reforms (para. 3.37), as reflected in thestatement of their intentions (Annex 2). In addition, agreement has beenreached on a framework for periodic reviews, and consultations with the Bank,on the subsector policy environment (para. 4.14). Regarding the second risk,specific agreements have been reached on arrangements for project implementa-tion, including training prior to the project, establishment of the PMU,implementation arrangements at the subsector corporations, and engaging con-sultants to provide management assistance to support project implementation.

- 39 -

VI. AGREEMENTS AND RECOMMENDATION

6.1 During negotiations, assurances were received on the following con-ditions of loan effectiveness:

(a) State Council to approve the Loan Agreement (para. 5.2);

(b) The Shanghai Municipal Government (SMG) and the PFIs to sign Sub-sidiary Loan Agreements satisfactory to the Bank (para. 5.2); and

(c) All subsector corporations to engage the necessary consultants(para. 5.5).

6.2 Assurances also were received from the PRC, SMG, and PFIs on thefollowing:

(a) PRC to: make loan proceeds available to SMG on terms and conditionssatisfactory to the Bank (para. 5.1);

(b) SMG to:

(i) maintain a Project Monitoring Unit throughout project implemen-tation with functions and responsibilities acceptable to theBank and with competent staff in adequate numbers to coordinateand monitor overall implementation of the project (para. 4.13);

(ii) maintain a Steering Committee that would guide the work of thePMU, and annually: prepare and furnish to the Bank by April 15of each year an assessment of policy and enterprise reforms inthe project subsectors and exchange views on these assessmentswith the Bank (para. 4.14);

(iii) ensure that financial consolidation of the new integrated cor-porations is carried out within 9 months of charter issuance(para. 4.15);

(iv) ensure the availability of funds for the implementation of theproject (para. 4.11);

(v) ensure that overseas training under technical assistance sub-projects shall be carried out in accordance with annual pro-grams acceptable to the Bank and provide to the Bank for con-currence, by September 30 in each year, the proposed trainingprogram for the following year (para. 4.5); and,

(vi) meet reporting and auditing requirements (paras. 5.9 and 5.10).

(c) Each PFI to:

(i) onlend to subborrowers on terms and conditions acceptable tothe Bank (para. 5.3);

- 40 -

(ii) ensure that all subprojects to be financed under project meetthe agreed eligibility criteria (para. 4.8);

(iii) seek Bank approval of the first two investment subloans belowthe free limit and all technical assistance subloans(para. 5.4).

(iv) meet reporting and auditing requirements (paras. 5.9 and 5.10);and

(v) be allowed to use the proceeds of the loan for this project tofinance subprojects in other industrial subsectors as agreedbetwee,. the Bank and SMG on the basis of agreed developmentstrategies to be prepared by the municipality (para. 4.10).

6.3 During negotiations, understandings were reached on appropriatetransition periods for the subsector corporations (para. 3.39). In addition,SMG's official statement of its develupment program and strategy for theproject subsectors was received during negoti&- ions and found acceptable tothe Bank (para. 3.36).

6.4 With the above conditions and assurances, the proposed project issuitable for a Bank loan of $150 million, repayable over 20 years includingfive years' grace at the Bank's standard variable interest rate, to be made tothe People's Republic of China.

ANNEX 1- 4.1 -

Page 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

The Development Strategy and Policiesfor Shanghai's Industrial Sector 1/

Strategy for Structural Change

1. The central government aims to transform Shanghai into one of thelargest economic centers on the west coast of the Pacific over the long term.Shanghai intends to specialize in the fields of industrial production forwhich it is best suited, in the context of an industrial sector that is trade-oriented and based on advanced science and technology. Shanghai's industrialdevelopment priorities are to: take advantage of China's opening to foreignmarkets by developing manufactured exports and increasing the value-added ofthose exports; phase out manufacturing activities that require large amountsof energy, raw materials, and land, and those that cause excessive environmen-tal damage, in favor of industries and services more suitable to Shanghai'sresource endowments; improve the technological level of Shanghai's industry;build appropriate supporting infrastructu:e for modern industry; andstrengthen support services for industry. Shanghai's industry will have tointroduce, update and adapt technology, accelerate product innovation,restructure and rehabilitate some enterprises, introduce new activities, andreach international standards in more product groups. This strategy forstructural change is consistent with the priorities adopted by the centralgovernment at the outset of the stabilization program, and therefore has notbeen altered as a result of that program.

2. SMG is giving priority to three categories of industry. The firstof these is consumer goods and light industry. Here there are two aims: toincrease exports, it will be necessary to improve product quality, modernizetechniques of production, and reorganize enterprises and subsectors to raiseefficiency and lower costs; and for the domestic market, it is intended toenlarge the range cf goods produced, and develop the higher quality goodsbeing demanded in China. The second priority category is heavy industrialequipment and machinery. The aims for this area are to increase research anddevelopment efforts, standardize the electrical and mechanical industries,integrate electronic and mechanical products, and increase exports in thesecategories. The third category is raw materials for heavy industry where theaims are to make better use of the output of existing complexes, develop down-stream processing and moderately increase the prod4ction of some other mate-rial inputs required for the priority subsectors.

3. In addition, efforts will be made to acquire, produce or adaptadvanced technology in such areas as microelectronics, optical fiber communi-

1/ The document was prepared by Bank staff based on extensive discussions ofShanghai's industrial strategy and policies, with all key agenciesinvolved.

- 42 - ANNEX 1Page 2

cations, bioengineering and new materials. The first goal would be to learnhow to apply techniques from these areas to traditional subsectors. For exam-ple, the combination of electronics and machinery technologies could improveproduction efficiency and product design capability in many existing enter-prises throughout the industrial sector.

4. In conjunction with these industrial priorities, expansion ofrelated services and infrastructure is important. Shanghai has a large popu-lation concentrated in and around the city and an intensive industrial base,as well as being an important commercial center. It needs pre- and post-production services, domestic and foreign trade services, tourism, finance,insurance, consulting and information services, postal services, telecommuni-cations, most types of transport, and real estate. The shortage of adequateinfrastructure and support services for industry has been a significant con-straint on Shanghai's industrial development, but the SMG has begun to addressthis problem. Shanghai has emerging opportunities to provide such servicesfor industry in other parts of China.

Industrial Policies

5. Prior to the introduction of the national stabilization program in1989, Shanghai had become a major site for the experimental introduction ofreformed industrial policies, particularly in the areas of enterprise autonomyand foreign investment. The goal of these reforms was to gradually strengthenincentives for competitive behavior by industrial enterprises and shift toindirect market controls. While some caution was evident during the initialstages of the austerity program introduced in 1989, major policy changesintroduced earlier have not been reversed, and in some areas that are impor-tant for the improvement of enterprise efficiency, further measures have beentaken. In particular, the implementation of policies rblated to the restruc-turing, and improved competitiveness in international markets, of the fourSIDP subsectors, remain a commitment of SMG and the industrial bureaus for thesubsectors. These measures are setving as examples for the municipality'sindustrial sector.

Enterprise Reform

6. Consistent with national reform priorities and progress, enterpriserefo-m has become a major area of system reform in Shanghai. The aim of thisrefo. has been to revitalize the state-owned sector by granting enterprisesgreater managerial autonomy, separating ownership (of the whole people) frommanagement, making enterprises responsible for their profits and losses,improving the business environment (especially by reducing government inter-ference in routine enterprise affairs), promoting "horizontal cooperation"among enterprises, and introducing the notion of sector management. Theseefforts have been buttressed by a variety of other reform measures such asthose effective in the area of labor, investment, planning and the materialallocation system.

7. Amon, the specific enterprise reform measures in Shanghai between1986 and 1988 was the abolition of the administrative corporations that formedan intermediate level of control between the industrial bureaus and the enter-prises. Although many such "companies" resurfaced as subsector corporations,

- 43 - ANNEX 1Page 3

the reformed legal entities are independent accounting units without, in prin-ciple, administrative means for controlling the enterprises. Instead theyprovide a variety of corporate services, such as sales and marketing, thepayments for which are their primary source of income. In addition, manycorporations are responsible for coordinating subsector production, but theirauthority over the individual enterprises, which are also independent legalaccounting entities, has been limited. The resulting ambiguity meant that ithas been difficult to comprehensively rationalize production processes andproduct lines within subsectors. This weakness is being addressed in SIDPthrough the formation of integrated enterprises, which is already underway.The integrated enterprises are now financially consolidated single legal enti-ties within which resources are becoming mobile.

8. An important instrument now being used in Shanghai to separate own-ership and management is the contract rebponsibility system (CRS). Since mid-1987, 98 percent of the roughly 1,700 large- and medium-scale industrialenterprises under the jurisdiction of the Municipal Economic Commission havecome under CRS, as have an additional 700 commercial er.terprises. Leasing,which is increasingly being used in other parts of China, has not been wide-spread in Shanghai. Only a few industrial enterprises, and less than 10 per-cent of commercial enterprises, have been leased.

9. The unclear ownership of state enterprises in China is arguably themost pressing problem facing the enterprise reform program. As an attempt toaddress this issue, the central government established the National Adminis-trative Bureau of State-Owned Property (NABSOP) in July 1988. Shanghai hasestablished a parallel Department under the Municipal Finance Bureau for thesame purpose. The Department is studying asset valuation and asset transfer,as well as the definition of the ownership function for state-owned enter-prises, and will issue policies in these fields.

10. One of the diffictulties exacerbated by unclear ownership of stateassets conrerns the transfer of assets and property rights such as throughmergers and acquisitions of enterprises or their parts. Such adjustment mech-anisms are necessary for the reorganization and rationalization of industrialstructure. Prior to 1990, there had been a few cases of mergers in Shanghai,but these mainly involved collective enterprises or were structured as manage-ment contracts. In recognition of the importance of further improvement inthis area, SMG is initiating an experiment with enterprise groups. Thisinvolves the merging of state-owned enterprises producing similar or r4latedproducts, or using the same sort of equipment, in order to facilitate theirreaching an economic scale of production. In addition, to bring integratedfinancial strength into play, the larger company resulting from the mergerwould be allowed to own portions of other related companies to form an enter-prise group. In that case, the portion not owned by the state-owned enter-prise could be owned by collectives or other enterprises. Plans to apply thisexperiment in about 20 subsectors are being formulated, with four or fivegroups to be established late in 1990. In addition, integrated enterprisesalong the lines of those in the four SIDP subsectors are being established inseveral more subsectors, in particular in the electrical and mechanical indus-tries.

- 44 - ANNEX 1Page 4

11. The Shanghai Office of Economic System Reform is also studying thepossible wider application of the joint-stock system. So far, Shanghai hasproceeded cautiously with experiments with joint stock companies. Presentlythere are only 11 enterprises that have issued stock. However, most of theshares are owned by the state, other enterprises and workers in the enter-prise, and are not widely traded.

12. On several of these enterprise reform issues, a study will be donein conjunction with SIDP. The study will be managed by the Shanghai PlanningEconomic Research Institute (SPERI) and carried out by an interagency teamheaded by SPERI and the Research Association of the Shanghai Office of Eco-nomic System Reform.

Investment Regulation

13. Authority on many investment decisions has been delegated from thecentral goverrnment to SMG and Shanghai industrial bureaus. The current rulesfall into three categories: (a) for foreign joint venture investments, up to$5 million requires only district or county government approval, and largeramounts require SMG approval; (b) for domestic enterprises, all new capitalconstruction projects, regardless of size, Liust have SMG approval; and(c) technical renovation projects (those involving some demolition ardreplacement of production facilities, but not a whole new plant) or Liachineryimports must have the approval of the relevant industrial bureau for amountsup to Y 3 million for light industry and up to Y 5 million for heavy industry,and SMG approval up to Y 30 million. For all types of domestic enterpriseinvestments, amounts over Y 30 million require central government approval.Enterprises can spend on technical renovation up to Y 50,000 (or Y 100,000 insome cases) without external approval provided they have sufficient retainedearnings to cover the outlay and require little or no new bank credit for theproject. For larger technical renovation projects, even if the enterprise hasadequate retained funds to cover the full cost, industrial bureau approvalmust be sought. In all cases, approval is more difficult to obt&in forinvestment spending not anticipated in previcusly agreed long-term plans orcontracts.

14. In concert with the general tightening of investment controls inChina under the stabilization program, some retrenchment in the liberalizationof investment controls occurred; however, these and other limits have not beenchanged in the past year and further relaxation is expected now that macrosta-bilization has been largely achieved. New central government regulations dorestrict the expansion of industrial activities that create large amounts ofpollution, or are judged excessively intensive in energy and raw material use,and require review of proposals in these fields by several government agenciesat the level of government with approval authority for the investment pro-posed. In addition, project proposals for new small factories, in productgroups for which economies of scale are important, are being reviewed by sev-eral levels of government, including the central government.

Price Policies

15. Although general guidelines for pricing policies in China are set bythe central government, few specific product prices are set centrally. These

- 45 - ANNEX 1Page 5

are typically the prices of standard products and commodities used throughoutthe country. Products with a smaller market range have prices or instructionsfor pricing issued by the municipal government. The Shanghai Price Bureau hasdelegated pricing for many products to the enterprises, but retained the prac-tice of monitoring them regularly. Often the Price Bureau sets a guidelineprice for a basic product, and allows enterprises to set their price for simi-lar products within a prescribed range of guideline price. For example, forheavy industrial products, prices must be wlthin 20 percent of the guideline,and for electrical and mechanical intermediate goods, the range is typically15-20 percent. For output beyond planned production targets, enterprises settheir prices, subject to review by the Shanghai Price Bureau (or a centralgovernment bureau if the product is under central jurisdiction).

16. Regardless of the authority required, prices usually are set tocover costs, which is a disincentive to greater efficiency and cost savings.SMG has stated that it intends in the medium run to continue gradually freeingprices within its jurisdiction from administrative control as competitionstrengthens; however, in 1989 this process was temporarily slowed as a conse-quence of the continuing efforts to reduce inflation. Price increases havebeen recently authorized for some enterprises suffering financial losses as aresult of input prices having risen more steeply than output prices during1989 and early 1990. Most products within plan targets for output volumecontinue to be free to fluctuate within prescribed ranges. Enterprises stillhave the freedom to set market prices for new products involving technologi-cal, quality or design improvements, although these prices are reviewed by theShanghai Price Bureau (or a central government bureau if the product is undercentral jurisdiction).

Trade Policy

17. Foreign trade reform began in Shanghai in 1979, as part of China'spolicy of opening to the outside world. A general thrust of this reform hasbeen the separation of the functions of government and enterprises and greaterdelegation of autfority to the enterprises. A single municipal trade depart-ment, the Shanghai Foreign Economic Relations and Trade Commission (SFERTC)was consolidated in 1984. It administers foreign trade through macroeconomicpolicies, coordination of import and export plans, approval of import andexport licenses on behalf of the .Ainistry of Foreign Economic Relations andTrade (NOFERT), and approval and allocation of import quotas.

18. The number of channels for foreign trade has been increased. Thefirst foreign trade corporations (FTCs) were established in 1980 for groups ofindustrial enterprises. Some national trading companies established special-ized local branches. Several forms of foreign trade organization have beenestablished, to encourage integration between industry, technology developmentand trade, as well as direct contact between foreign buyers and industrialenterprises. There are now 20 branches of national FTCs in Shanghai, and 115other entities with foreign trade rights. The latter group includes FTCs runby Shanghai's industrial or science and technology departments, eight largeenterprises with direct trading rights, joint ventures between FTCs and enter-prises, and two trading companies. Shanghai has established 20 export agencyoffices in major overseas markets to promote sales there. In addition, various

- 46 -ANNEX 1Page 6

specialized companies were established for advertising, export inspection,insurance, freight, transport, and other services.

19. The agency system, which is used for almost all imports, is beingapplied to exports as well. Until mid-1988, most industrial exports fromShanghai were handled by trading companies purchasing goods from the enter-prises and then selling them abroad on their own account. Under the agencysystem, the trading company handles the settlement and may facilitate the salefor a fee, but the enterprise is allowed contact with final customers andexport market conditions. By the end of 1989, approximately one-third ofShanghai's industrial exporters had been shifted to the agency system. Thisnumber includes most textile- and garment-export enterprises, as well as someenterprises that export mechanical and other products. The results of thischange have been encouraging, and the wider application of the agency systemwas undertaken in 1990. In addition, the number of firms with direct importand export rights was targeted to double from 50 to 100 during 1990.

20. During the last few years, several export incentives have beenintroduced: allowing enterprises greater retention of foreign exchange earn-ings; rewarding enterprises that fulfill their export quotas; and inst.tutingincentive payments of Y 0.02 per dollar of exports under the mandatory planand Y 0.30 for above-plan exports. The directors of FTCs have been givengreater responsibility, and their staffs and management receive bonusesrelated to export earnings. The devaluations of 1989 and November 1990 havealso helped in this regard.

21. Shanghai is considering making further trade policy changes in atleast three areas: (a) granting greater direct import rights for exportingenterprises within the municipality to ensure the availability of suitablematerials and semifinished products; (b) approving direct export rights formore large- and medium-sizvd firms; and (c) improving export incentives andtheir administration. Two important incentives are allowing firms the use oflarger portion of their foreign exchange earnings, and enabling them to buyand sell foreign exchange at market rates.

_4nancial Intermediation

22. Central and municipal government measures have increased the rangeof financial instruments and number of financial institutions in Shanghai.The Bank of Communications was reestablished with its headquarters inShanghai. This has increased the competition between Shanghai's financialinstitutions, which could contribute to better services for industrial borrow-ers. Shanghai now has a small primary securities market. An interbank moneymarket was recently introduced. Two foreign exchange adjustment centers onwhich certain enterprises may trade at free market rates were established in1987. Consideratio- is being given to expanding the scope and depth of thesemarkets; improved means of supervising and regulating them are being studied.

Foreign Investment

23. The Shanghai Municipal Government is actively encouraging foreigninvestment as a means of bringing in sophisticated technology, gaining accessto export niarkets, and developing local supplier industries. In June 1988,

ANNFX 1Page 7

the Shanghai Foreign Investment Commission (SFIC) was established to serve asthe single municipal government office that a foreign company needs to contactin order to set up and run a business in Shanghai. In 1990, SFIC was broughtinto SFERTC to strengthen SFIC's authority of other parts of the municipalgovernment. The SFIC approves foreign investment projects with total invest-ment of between $5 million and $30 million, as well as projects in the"restricted" category under $5 million, Most projects under that limit arenow approved by district and county-level government. The SFIC provides for-eign investors with administrative services and advice about the industrialpolicies, laws and regulations affecting them in Shanghai, and helps themduring project preparation and implementation. Within Shanghai Municipality,some industrial parks have already been established to provide foreign inves-tors with appropriate infrastructure for their factories. In such parks, SMGhas initiated the long-term leasing of land to foreign firms on a trial basis.A large new industrial zone is under development in the Pudong district.Infrastructure and services are being designed to attract foreign investment,and SMG has begun active promotion abroad for the scheme.

Technology Policy

24. Shanghai has drawn up a Science and Technology Development Plan forindustry. This plan sets objectives for the renovation of traditional indus-try and new industrial development. According to this plan, projects fundedby the Science and Technology Commission will ie divided into two categories:basic theoretical study and development of applied technology. The latterprojects are now decided by the Economic and Science and Technology Commis-sions jointly according to their likely industrial usefulness and economicbenefits. Research institutes receive rewards once technology they havedeveloped is used by an enterprise, and may sell technology. They may alsoreceive development funds from enterprises. For certain key projects, thegovernment will give low interest loans to support research in both the insti-tutes and enterprises. Funds availab'e for science and technology with indus-trial applications are being concentrated in priority subsectors. The Scienceand Technology Commission recently established a department of new technologydiffusion to help transfer technology from research institutes to enterprises,by setting up meetings and exhibitions, and providing specialized library,data bank and information exchange services.

25. With the exception of some large units, enterprises have not beenable to do adequate research and development themselves dup to shortages offunds and personnel. To address these problems, under the contract system,firms may now negotiate that 1 percent to 2 percent of sales be retained forresearch and development purposes. Enterprises may hire some university andresearch institute personnel as consultants, or make contractual arrangementsfor joint research. The SMG will expand these arrangements to encourage prod-uct and technology development in Shanghai's enterprises.

Location Policy

26. Many enterprises in Shanghai are crowfded in old buildings in con-gested parts of the city. This has several disadvantages. It makes it diffi-cult for raw materials to be transported to the factories, and for thefinished goods to be shipped out. Expanding or modernizing manufacturing

- 48- ANNEX 1

Page 8

facilities, to include long assembly lines and a continuous flow of goods inprogress, is difficult, since several floors of the same building or evenseveral small buildings may house different stages of a production line. Itis also difficult to keep some buildings clean, due to their open construc-tion, the air pollution from surrounding industry and traffic, or the largenumber of industrial plants relying on the same source of water for productionneeds or as a waste repository. Cleanliness is important for meeting interna-tional quality standards in many modern industries, such as pharmaceuticalsand electronics. The densely industrialized parts of the city are unpleasantand sometimes unhealthy for nearby residents.

27. In recognition of these problems, the SMG is planning the locationof factories taking into account the restructuring and expansion of the physi-cal facilities necessary for producing good quality products at competitiveprices, as well as the costs of providing appropriate space, transport access,waste treatment, and other infrastructure in different locations. A zoningsystem has been introduced for the city proper as well as surrounding countiesand satellite towns. Under this system, new enterprises will be authorized toset up factories and other facilities only in zones designated for their typeof industrial activity. The movement of existing enterprises presents diffi-culties, though, because the land market is limited and experimental, andfactories and workshops usually are moved in accordance with SMG's assignmentof new space. Also, employees cannot easily move to new locations. While theemployee of the relocating enterprise would be given a residence permit forthe new area, other working members of the family would not.

28. The zoning system also designates areas where heavily pollutingfirms may locate, but in tandem with this, SMG has a system of fines chargedto violators of the municipality's environmental code. However, the fines donot appear to be high enough to enforce compliance. Moving polluting firmsmay not resolve all the pollution problems if the new locations outside thecity are no better equipped to clean air and water or dispose of waste than isthe city.

Labor Mobility and Incentives

29. The Shanghai government recognizes that restructuring the industrialsector will involve redefining some jobs, teaching workers new skills, hiringstaff with different skills than those of current employees, moving employeesfrom firm to firm, and reducing the number of employees in some enterprises orproduction lines. Several schemes have been introduced to facilitate thisadjustment. Employment contracts have been introduced and must be used forall newly hired workers. The contracts last for one or several years and whenthey expire neither the enterprise nor the worker is obliged to renew thearrangement. Retraining programs have been established in some enterprises,to teach workers how to use new techniques of production. For some senior andskilled workers, industrial bureaus are organizing retreining. Since mostenterprises have gained responsibility for selling their output, they aretraining some of their employees for sales jobs. Under the Labor Bureau'sguidance, enterprises are establishing job definitions and standards toencourage evaluation of employees' performance and fairer competition forpositions.

- 49 - ANNEX 1Page 9

30. Until recently, the enterprises in Shanghai paid pensions to theirown workers upon their retirement. This placed a cost burden on older enter-prises, which have a lower ratio of active to retired workers than new compe-titors. In addition, workers were reluctant to move between firms since thiswould result in loss of pension benefits. To address these problems, theShanghai Labor Bureau has established the Consolidated Retirement PensionFunds (CRPF), which will pay the pensions of all retired industrial workers inShanghai. All enterprises are required to contribute an amount equal to25.5 percent of employee salaries to the pension fund, and employee pensionswill be paid by the CRPF from 1989 onward.

31. Another recently established organization under the Labor Bureau isthe Labor Services Company (LSC). The LSC pf lorms several functions thatcontribute to labor mobility. It finds jobs for contract workers when theircontracts expire and helps recent graduates search for jobs. It also keeps aregistry of unemployed people seeking jobs, and pays some compensation tothose people who were released involuntarily from their enterprises until jobsare found for them (or a maximum of two years). For peop._ who have workedmore than five years, unemployment compensation is 60-75 percent of the previ-ous salary for the first year, and 50 percent for the second. For people withless than five years work experience, unemployment compensation is 50 percentof the previous salary for one year.

- 50 - ANNEX 2Page 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Statement of Shanghai Municipal Government on theDevelopment Program and Strategy for SIDP Subsectors _/

Introduction

1. Shanghai Municipality, which has provincial status, is the spcondlargest province in China measured by industrial output value. However, inspite of its strong industrial base, Shanghai is facing increasing competitiondomestically while also being squeezed on the availability of raw materialsand energy and saddled with outmoded manufacturing technology, deterioratinginfrastructure and a scarcity of land for expansion. Even though it has lim-ited raw materials, energy and land, Shanghai has a strong base of hurnanresources and research and development compared with the rest of China.

2. Important elements of Shanghai's industrial strategy are to:(a) improve the organization and management of its industrial sector; and(b) move into higher value-added activities and subsectors which are moretechnology-intensive, and less polluting, and energy and raw material inten-sive. One of the areas within Shanghai's industrial sector that is beinggiven priority under this strategy is industrial machinery and equipment. Inthis field, the goals are to upgrade technology, improve production efficiencyand product quality in the electrical and mechanical industries throughgreater product standardization, integrate electronic and mechanical products,and increase exports. Four important subsectors in the field of industrialmachinery and equipment are electrical apparatus, electronic components, pre-cision and scientific instruments, and printing machinery. These four subsec-tors would be assisted by the proposed Shanghai Industrial Development Project(SIDP).

3. In connection with the SIDP, SMG is undertaking new initiatives forenterprise reform, policy adjustments and industrial restructuring in the foursubsectors. These measures are intended to provide an appropriate industrialstructure and policy framework for the organizational, managerial and techni-cal improvements to be implemented under SIDP. TIe goal of these improvementsis to raise e.ficiency, growth and competitivenes., consistent with Shanghai'sindustrial development strategy. The measures and achievements in these foursubsectors will serve as examples for reforms elsewhere in the industrialsector. This statement sets out SMG's intentions with respect to the enter-prise reforms, policy changes, and strategies to be implemented under SIDP.

1/ This a translation of an official statement that was issued/adopted bythe Shanghai Municipal Planning Commission on May 16, 1989.

- 51 - ANNEX 2Page 2

Enterprise Reforms

4. Enterprise reforms are needed in the four subsectors to adjust theirstructure and management mechanisms to the increasing competition they nowface. Each of the four subsectors is comprised of independent but subopti-mally sized factories with many overlapping products and duplicate manufactur-ing processes. The subsector corporations have limited control over theenterprises in the subsector and are unable to rationalize product lines andmanufacturing processes. This rationalization is necessary to improve effi-ciency, produce higher quality goods that match the demands of domestic andforeign markets, and control the costs of production.

5. To facilitate industrial restructuring and factory rationalization,SMG will implement enterprise reforms in all four subsectots. An integratedcorporation will be legally established in each of the four subsectors. Thiswill be reflected in a legal charter for the integrated corporation that willdefine its structure, composition, rights and obligations, and the means bywhich these may be amended in the future.

6. The integrated corporation. will be legal entities, responsible fortheir own profits and losses. They will be financially consolidated, andassume debt and tax obligations as single units. They will exercise certainrights, including export and foreign exchange retention, as single units.Within the corporation, all resources, including employees, materials andequipment, may be reallocated between factories and divisions by the corpora-tion's management to facilitate the needed rationalization of product linesand manufacturing processes.

7. Each integrated corporation will consist of some, but not all, ofthe factories in the subsector as of January 1989, as well as the subsectorcorporation of that date. Each integrated corporation will ini-ially includeonly those factories and support services necessary for the efficient manufac-ture of the priority product groups. Those formerly separate factories willlose their status as independent legal entities after a transition periodduring which the consolidation of the integrated corporations would be com-pleted. The financial consolidation, and consolidation of contract responsi-bility system agreements currently outstanding, will be implemented as soon aspossible.

8. Although some factories within each subsector will not initially beincluded in the integrated corporation, they will continue to operate indepen-dently within the same bureau, and the integrated corporation would maintainsupply contracts with them. In each subsector, there are some factories, suchas foundries, which supply critical components to manufacturing processes inthe subsector. They will be included in the integrated corporation at thisstage, but may become independent of corporation later. Other factories maybe acquired by or merged with the integrated corporation in the future. Thedecision to acquire or merge will be based on consideration of the technicaland economic efficiency of the factories to be merged and their impact on theintegrated corporation.

9. The internal organization of each integrated corporation willinclude a corporate headquarters, business divisions, and factories, as well

-52 - ANNEX 2

Page 3

as research institutes. The divisions and factories in each integrated corpo-ration are listed in their charters. Each integrated corporation's headquar-ters will be responsible for setting company-wide policy, implementing theinvestment strategy, managing finances, developing exports, purchasing bulkraw materials, managing research and development, and coordinating the busi-ness divisions under it. Each integrated corporation will have several busi-ness depending on need. The business divisions are based on product groupswith common technology and markets. Each business division will operate as aprofit center, responsible for product development, production, marketing andsales. Each division will include one or more factories, which will be costcenters as will the research institutes belonging to the integrated corpora-tion.

Policy Adiustments

10. Exports by the four subsectors should gradually move from the pur-chase to the agency system, then to direct exports, following relevant staterules. The integrated corporations will initially use the agency system forexporting. Under the agency system, joint office of corporate staff and for-eign trade company staff will be established. This arrangement will facili-tate both the training of corporate trade staff and direct contact between thecorporation and overseas clients. For example, corporation staff would par-ticipate directly in export transactions such as negotiations, quoting prices,etc. The goal is to allow the integrated coroorations direct export rightsonce they have built up trained staff and demonstrated their ability to takeresponsibility for financial risks associated with exporting. Annual reviewsof each integrated corporation's progress will be carried out to review theirability for direct export.

11. Each integrated corporation will be allowed to use retained foreignexchange earnings to service its foreign debt and import critical raw materi-als for its operation. In addition, the corporations will be allowed to buyforeign exchange, as available at the Foreign Exchange Adjustment Centersshould their export earnings be inadequate to cover their debt service obliga-tions and meet other needs. If they earn more foreign exchange than theyneed, they should be able to decide on their own whether or not to makeadvance repayments of subloans under the SIDP.

12. The enterprise reforms and policy changes presented above will bemonitored closely during project implementation. SMG has established aproject monitoring unit (PMU) that will coordinate and monitor all SIDP-related activities. The work of the PMU will be guided by a Steering Commit-tee to be appointed by SMG. A study under the management of the ShanghaiPlanning Economic Research Institute (SPERI) will monitor the impact of policychange on the perforimance of the subsectors, in coordination with the Bank'ssupervision of the project. These organizations will review regularly withthe Bank the implementation of enterprise reforms and policy changes. Owner-ship and management functions should be separated. The industrial bureausand other SMG agencies would play a strategic role in the corporations, butwould not participate in their day-to-day management and operations. One suchmechanism is the board of directors, which could include representatives ofthe government and have the responsibility to define corporate strategy.

- 53- ANNEX 2Page 4

Product and Market Strategies

13. Each integrated corporX 'on has adopted a focused product and marketstrategy based on priority products, i.e., those with the greatest potentialto compete successfully in domestic and foreign markets. The product andmarket strategies for each subsector are presented ir. the following para-graphs.

14. Electrical Apparatus. The product and market strategy to be adoptedby the integrated corporation is aimed at maintaining and strengthening theleader hip position in component and systems products, building up electronicscapability for application in the electrical apparatus business and strength-ening its marketing and sales capabilities by unifying the marketing function,setting up nation-wide sales and service centers and establishing a corporatebrand. The export market strategy is to focus on promising independent stan-dard components and dependent standard subcomponents. These are productgroups where low labor and overhead costs give Shanghai's products a competi-tive advantage in overseas markets.

15. Electronic Components. For electronic components, the productstrategy will focus initially on a group of priority products currently pro-duced, and facing healthy market demand with opportunity for growth and gainsthrough technological improvement. These products include capacitors, resis-tors, connectors, transformers and relays. The intention is to develop thecapability to produce these products at lower cost by enlarging the scale ofproduction and reaching international quality standards. This way both domes-tic and export sales are expected to increase. In addition to this strategyfor currently manufactured products, the integrated corporation will developnew products in the areas of chip components and hybrid circuits. To developthese products, the corporation will acquire foreign technology. It isintended to first meet the demands of the domestic market in these fields,then export later when experience has been gained. In order to ensure thedomestic market success of these products, the corporation will establislhcustomer support marketing programs focussed primarily on TV manufacturers andforeign joint ventures in China. To promote exports, the integrated corpora-tion will redesign some products to customer specifications in the switchesand connectors, and capacitors product groups. A new organization will beestablished in the corporate headquarters for direct sales to OEMS, and salesthrough distributors in foreign markets, particularly the United States. Thecorporation will also seek contractual relationships with foreign producers tobuild up future export markets.

16. Precision and Scientific Instruments. The strategy that will beadopted by this subsector's integrated corporation is to reduce unit costs andraise quality to gain a greater share of domestic and foreign markets. Thecorporation will concentrate on seven products in three groups: (i) chromato-graphs and spectrophotometers in analytical instruments; (ii) microscopes,optical elements and optical meteorological equipment in optical systems; and(iii) balances and related items in physical and general purpose environmentalinstruments. The strategy for this subsector has five elements: (i) improvedesign and quality, and integrate new technologies into priority products;(ii) rationalize and consolidate priority factories; (iii) introduce modernmanagement practices; (iv) improve marketing channels; and (v) train and rede-

-54 ANNEX 2Page 5

ploy staff. The domestic market strategy will focus on major local distribu-tors, key customers, and joint ventures companies in China. The export strat-egy will focus mainly on using OEMs for components of spectrophotoineters andoptical systems and using distributors for microscopes and general purposeinstruments.

17. Printing Machinery. The subsector falls into three product groups:large presses, small- and medium-sized presses, and post-press equipment. Forthe large presses, the strategy adopted is to increase production of webpresses and high and low-speed models of multicolor sheet-fed offsets. Formulticolor sheet-fed offsets, the first phase will be adapting advanced tech-nology from abroad to suit domestic needs. For small- and medium-sizedpresses, there will be a gradual shift in demand away from letter presses tosheet-fed offsets. For this reason, equipment purchased for letter pressproduction to meet increasing demand in the short run will be reoriented foroffset production later. Also within the small- and mediumr-sized press group,duplicators will continue to be a priority product due to their continuedstrong demand. For the post-press equipment, where Shanghai already has astrong national market position and there are good prospects for continueddemand growth, emphasis will be on increasing output and upgrading quality,enhancing capacity for developing new products, and forming economies ofscale. For promoting exports, the strategy involves different approaches toAsian and Western (European and North American) markets. For Southeast Asianmarkets, the integrated corporation will seek reputed sales and serviceagents. For Western markets, it will seek joint production agreements withthose foreign companies that already have technology transfer arrangementswith the enterprises to be included in the integrated corporation.

Conclusion

18. This above statement outlines the reforms, policies and product andmarket strategies being implemented by SMG for four subsectors--electricalapparatus, electronic components, precision and scientific instruments, andprinting machinery. SMG is seeking World Bank support under the proposed SIDPto implement these measures.

55 ANNEX 3Page 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Shanghai E'ectronic Components Subsector 1/

Background and Organization

1. China's electronic components industry originated in Shanghai in1924. At that time, the first electronic company (Ya Mei Ltd.) was set up toproduce simple communication components. Up until 1949, the industry consis-ted of 70-80 small companies employing about 1,000 people. After 1949, theindustry u,nt through three transitions in the 1950s, 1960s and late 1970s.In the 1950s, the small-scale passive components manufacturers, which by thenhad grown to about 300, were reorganized into several manufacturing factories.In 1960, these were again reorganized as eleven factories specializing incomponents for the radio industry, and later for the TV industry. In late1970s and early 1980s, collectively-owned components manufacturing factorieswere integrated into the subsector, creating a diversified structure of small,medium, and large companies. During this period the technological foundationof the subsector was strengthened with imported product and manufacturingtechnologles. In 1985, an Electronic Component Research Institute was estab-lished to serve as the center of technical development, application engineer-ing, and quality assurance for the subsector.

2. In March 1989, the electronic components subsector consisted of 24factories, of which half were state-owned, and half were collectives. Thefactories employ more than 27,000 people. Attachment 1 shows the main fea-tures of the factories. The aggregate value of the net fixed assets in 1988was Y 180 million ($49 million) and the value of sales in the same year wasY 535 million ($145 million). The subsector produces a wide variety of pas-sive components: passive devices (capacitors, resistc. s/potentiometers); elec-tromechanical (connectors, switches) and electromagnetic (inductors, trans-formers, relays) products; and acoustic assemblies (speakers, microphones).In 1989, the industry met 8 percent of the nation's demand for electroniccomponents; the domestic television industry was the dominant user. Exportsof the subsector in 1990 were approximately Y 34 million ($6.4 million), rep-resenting 8 percent of the value of component production in Shanghai.

3. The organization of the subsector at appraisal is presented inAttachment 2. Within the Shanghai Municipal Government (SMG), the ShanghaiInstrumentation and Electronics Bureau (SIEB) is responsible for overalldevelopment of the electronic components subsector. Since the mid-1980s, aprogram of enterprise reforms has been implemented gradually to separate thefunctions of regulation, ownership, and management. During 1987 and 1988, oldadministrative corporations were abolished in Shanghai. The remaining corpo-rations took on a coordination and support role without having clear .esponsi-bilities or financial authority. In line with this change, the role of the

1/ The subsector includes only passive components.

- 56 - ANNEX 3Page 2

Shanghai Electronic Component Corporation (SECC) became support to SIEB incoordinating the subsector. The factories under SIEB became self-sufficientand operated quite independently. By the end of 1988, each of the 24 facto-ries in the subsector was a single profit center, responsible for its ownbusiness functions, planning, marketing, production and finance. The facto-ries varied widely in size and capability. None was of economic size byinternational industry standards and there was a great deal of overlap inproducts and production capabilities. Furthermore, the marketing function wasseriously underdeveloped in all the factories; none had a credible exportmarket capability. There were still multiple layers of external control,unclear roles and responsibilities, and less defined accountability for thecorporation and factories vis-a-vis one another. Given these organizationalconstraints, the industry needed to be restructured to attain greater competi-tiveness.

Performance of the Subsector

4. Between 1983 and 1989, the sector in Shanghai achieved a growth ofonly 5 percert per year compared to the national output growth of 22 percentper year. The following table shows the development of major product groupsover this period.

SHANGHAI: ELECTRONIC COMPONENTS SU8SECTOR PRODUCTION(Y MliliIon)

Average annualgrowth rate

Product group 1983 1984 1986 1988 1987 1988 1989 1983-87 (X)

Resistors andPotentiometers 81.8 40.0 44.5 46.6 52.6 68.8 S0.1 8

Capacitors 70.7 89.8 90.7 89.8 89.2 77.S 78.2 6

Switches/Connector* 41.6 42.8 40.6 41.8 68.8 45.2 88.6 -1

AcousticAssemblies 48.1 44.3 40.6 41.8 62.9 65.0 66.0 4

Inductors/Transformers 8.6 4.1 4.9 26.2 19.4 18.2 18.9 26

Relays 18.4 28.4 44.0 3a.6 44.0 48.6 60.6 18

Others 116.6 78.0 77.4 81.4 10.2 189.7 108.6 -1

SECSProduction 825.7 307.0 348.8 86e.7 437.1 483.8 435.0 6

NationwideProduction 1,761.2 2,297.6 2,790.3 3,031.9 4,366.7 5,661.4 6,903.6 22

Percentageof SECSProduction 18.6 13.4 12.6 12.1 10.0 8.6 7.4

- 57 - ANNEX 3Page 3

Although the growth rate of most of the individual product groups in the table

appears to be reasonable over the period, each one lags behind national growth

for the group. No individual product within each product group dominates the

production of output. The share of the subsector in the nation's output has

declined continuously from 19 percent in 1983 to 7 percent in 1989. The sub-

sector's profitability also has declined, from 40 percent of sales in 1983 to

18 percent in 1989. The subsector has not kept pace with the market growth.

To increase the subsector's competitiveness, product specialization needs to

be increased, quality to be improved, and a better quality/price ratio to be

attained. These changes are addressed as part of the subsector restructuring.

Market Development

5. The market for electronic components in China is very large and has

grown over 20 percent per year since 1983. All the major product groups

shared in this overall high growth, except for relays. Domestic manufacturers

are the major suppliers of the domestic market. Within the domestic market

passive components are sold directly to end-users. The market is dominated by

constmer electronics, particularly the television industry which grew by about

52 percent per year between 1983 and 1987, before slowing at the end of the

decade. The rest of the market is shared by telecommunications, computers,

and other products. Imports and exports both have been low. Imports are

tightly controlled by the government: only high-technology electronic compo-

nents designated for specified user industries are permitted and very few

electronic components that might compete with domestic production are allowed.

Maximum imports ($113 million) during rhe last five years occurred in 1986

(12 percent of the total consumption). Exports amounted to only Y 105 million

($28 million) in 1987, 2 percent of domestic production. Continued rapid

growth in all major product groups is projected for the future. In addition

to products employing existing technologies, some new higher-technology prod-

ucts such as chip components and hybrid circuits will enter the market. A

temporary slowdown in growth during 1989 and 1990 resulted from government

reEcraints on consumer electronics. Nevertheless, annual growth of over

25 percent is estimated during 1987-93.

6. Although Government regulations do not allow much import competi-

tion, there is strong competition among domestic manufacturers. The Shanghai

industry lost its market leadership to Jiangsu province in the 1980s, as shown

in the following table. Shanghai now does not lead in any major product

group.

58 - ANNEX 3

Page 4

CHINA: MARKET SHARE OF DOMESTIC COMPETITORS(X)

1983 1984 1985 1986 1987 1988 1989

Shanghai 25 22 20 17 10 9 8Jiangsu 20 20 20 22 30 25 23Guangdong - 3 5 8 10 14 19Beijing 15 15 10 7 4 6 6Others 40 40 45 46 46 45 45

In almost all product groups, Jiangsu manufacturers have competed aggres-sively, outgrowing the market on selected products such as capacitors, resis-tors, transformers, and developing new products. Guangdong is another compe-titor whose market share has grown rapidly. It is following an approach simi-lar to that of Jiangsu and now has matched Shanghai in the second place.Jiangsu and Guangdong have succeeded because of their greater degree of prod-uct specialization. This is reflected in their high share of top three prod-uct groups in the total output--70 percent for Jiangsu and 90 percent forGuangdong compared to 50 percent for Shanghai. Domestic users attribute thesuccess of Jiangsu and Guangdong succest to high quality, better service,flexible technical adaptation, and competitive prices. The Shanghai subsectormust reorient itself to respond to these needs of the domestic electronicsindustry. It needs to improve product quality, focus resources on selectedproducts, develop new products and features, improve the qualitylprice ratio,and reorganize for faster growth.

7. Globally, the market for electronic components is very large but hasgrown rather slowly over the past few years. Industrialized countries consumeabout $30 billion of electronic components, and United States accounts for50 percent of this market. US consumption also leads in almost all productgroups. The large markets have a very high import propensity. Of the total$4 billion of components imported in these countries, the United States aloneimports over 50 percent. Capacitors, relays, connectors and acoustic assem-blies account for 80 percent of US imports. Developing countries have managedto penetrate the import market in these countries, especially in the UnitedStates, even with high technology products. For example, one third of USimports of electronic components comes from less developed countries (LDCs).Even the share of imports into Japan and the EEC from LDCs is increasing. Sofar, neither China nor the Shanghai subsector has any significant role inexport markets largely because of their variable quality of goods and poorservice levels. In 1987 China's exports were Y 105 million; of this Shanghaicontributed Y 26 million (25 percent). A large portion of these exports areat the very low end, for example to the toy industry. Although Shanghai'sexports rose to Y 34 million in 1990, they remained concentrated among low-endproducts. In order for the Shanghai subsector to penetrate foreign markets,it must adopt flexible market channels, supply user-oriented products, reduceproduct size, and meet required specification standards. Distributors play akey role in the export of components. Their share continues to grow rapidly

- 59 - ANNEX 3Page 5

as distributors take over service requirements from suppliers. For example,in the US the top five distributors control 50 percent of the market. Dis-tributors and end users are skeptical of China's ability to deliver productsin this competitive market. For Shanghai to penetrate export markets, it mustreorganize to become competitive in terms of quality, price, reliability, andcustomer accessibility.

Subsector Capabilities and Competitiveness

8. The Shanghai electronic components subsector manufactures a widevariety of products which can be grouped into eleven major product groups.2/The subsector is capable of supplying the full range of passive componentsexcept for the more modern chip-sized components. Although the subsectorpossesses a good market share in some major product groups, these shares havedeclined significantly as shown in the table below:

SHANGHAI: DOMESTIC MARKET SHARE OF MAJOR PRODUCT GROUPS(Z)

1983 1987 1989

Capacitors 10.5 6.0 5.5Acoustic Devices 14.8 6.8 7.3Resistors 17.8 11.3 8.9Connectors 25.3 14.4 8.2Others 39.0 14.0 12.0

The subsector's loss of competitive leadership and profitability is attributedto its high degree of product diversification, outmoded technologies and poorquality products. Furthermore, the subsector has not been able to develophigh-technology products such as chip components, hybrid circuits, sensors,and transducers, all of which are in great demand now. Therefore, there is anurgent need to upgrade and redesign potential products, rationalize productlines to achieve better concentration, and develop products with new technolo-gies. In export markets, the subsector's product technologies at the low endof the market are comparable to those of other manufacturers and its marginalsuccess in exports has been primarily the result of price competition. Thissituation will remain so for years to come, as SECC will not be able todevelop technological changes. However, in order to improve exports, SECCshould work on improving the quality of its products and making them consis-tent with international standards.

2/ These product groups consist of: capacitors, resistors/potentiometers,connectors, relays, magnetic devices, acoustic assemblies, photoelectricdevices, micro devices, electronic ceramics, crystal products, and trans-formers.

- 60- ANNEX 3Page 6

9. The subsector also suffers from a number of shortfalls in productionstructure, manufacturing technologies, production organization and managementsystems. Manufacturing problems in the 24 factories include subscale opera-tions, excessive overhead, poor facilities and layout, inefficient product/production development. Product and process overlaps occur with capacitors,connectors, switches, relays and magnetic materials. Manufacturing also ishampered by poorly maintained and outdated process equipment, a major portionof which is more than 10 years old. A new operational strategy is needed toestablish a structure conducive to high quality and low-cost production.

10. Low quality, irregular and unreliable deliveries of some criticalraw materials (such as ceramics, aluminum foil, plastics, resistant paste) isanother key issue facing subsector. An effective supply chain needs to beestablished to improve this situation. Manufacturing systems are another areaof concern. Problems in this area include inefficient production schedulinglevels, long production cycles, large buffer inventories, and poor utilizationof machines. Poor-quality control systems also contribute to higher costs. Aweak management information system does not permit accurate strategicdecision-making by the management. Training and incentive systems also needto be improved to promote better quality and stronger operating skills.

Restructuring Needs

11. Despite the constraints under which the subsector has been operating--regulatory, organizational, technological, managerial, and financial--it hasmade a number of accomplishments. It is an important part of the Chinese elec-tronic components industry, employs good technical skills, has developed asmall export capability, and is profitable. However, the subsector stillfaces many obstacles: (a) lagging growth with respect to the domestic elec-tronic components industry; (b) declining market share; (c) poor product tech-nology and quality; (d) absence of modern management systems; (e) inefficientproduction organization; (f) declining profits, a situation that restrictsfunds for future investments; and (g) low export capability. An intensiverestructuring of the subsector is needed to introduce a modern structure andsystems, upgraded and higher technology products, and modern manufacturingtechniques. These changes will allow the subsector to regain its domesticmarket share, build up sustainable exports and foreign exchange, and achievehigh levels of profitability for future investments. A comprehensive restruc-turing plan therefore has been developed for the subsector by the SIEB and thecorporation with the assistance of a reputed international consulting firm.The plan consists of changes in organizational structure, product and marketstrategy, and operational strategy.

12. Organizational Structure. Under the new organizational structure,SECC will become a fully integrated company of eight factories, which manufac-ture priority products that have strong potential to become competitive indomestic and export markets. The research and development institute also willbe integrated into the corporation. SECC was established as an integratedcompany following issuance of its charter in May 1989. Financial consolida-tion of the former subsector corporation, the eight factories, and the insti-tute was done during the nine months after that. The consolidated statementsfor 1989 are shown in Attachment 3. By June 1991, the remaining independentlegal status of the constituent factories will be phased out, so that SECC

- 61 - ANNEX 3Page 7

will be the sole legal entity, responsible for profits and losses. The formercorporation will be reorganized to manage planning, finance, personnel, andservice (particularly marketing) activities. SECC will assume all debt andtax obligations as a single unit. As part of the restructuring, some opera-tional functions currently performed by the Bureau will be transferred toSECC. A Board of Directors will be established to monitor the corporation'sperformance and set long-term objectives and policies. Within the corporationfive business profit centers will be created. These units will manufacture:capacitors/hybrid circuits; resistors/potentiometers; connectors/switches;transformers/inductors; and relays. Each business unit will have the author-ity and respoasibility to run the unit as a modern business focusing on prod-uct development, production, and marketing of products at economic scales.The remaining 16 factories will continue to operate independently under theBureau.

13. Product/Market Strategy. The product/market strategy focuses onselected products that have clear potential to be competitive in the rapidlygrowing electronic components market. A two-pronged approach is adopted:(i) product quality upgrading, capacity and manufacturing enhancement, andinstallation of new marketing mechanisms for five existing products; and(ii) development of two product groups with new technologies. The five exist-ing products have a large potential for immediate growth, both domesticallyand in exports. This determination is based on a detailed analysis of theproducts' rmarket attractiveness, competitive position, and the ability toimprove operational performance of related factories. The five products arecapacitors; resistors; connectors/switches; transformers/inductors; a.adrelays. The two products to be developed are hybrid circuits and chip compo-- nts. For the domestic market, the corporation will establish strong market-ing and sales capabilities for the seven product groups. This will be donethrough customer support programs focused primarily on TV manufacturers and byestablishing links with foreign joint ventures in China. On the export mar-ket, the corporation will design customer-specific products for switches/con-nectors and capacitors and market them for direct sales and through local andregional distributors. It will also seek to build alliances with foreignproducers to bu'ld up future export markets. The subsector's product/marketstrategy will form the basis of investment programs in each of the five busi-ness units.

14. Operational Strategy. The success of the restructured factories isclosely related to their ability to develop and manufacture products effi-ciently, at economic scale, and at internationai standards of quality, theirability to develop a strong marketing organization, and their ability tointroduce effective manufacturing systems. To achieve these objectives, thefollowing measures will be implemented under the strategy:

(a) short-term programs to improve product designs and quality, includ-ing acquisition of new product technologies in close coordinationwith the R&D institute;

(b) reorganization of production layout including installation of equip-ment for rehabilitation, replacement and expansion purposes;

(c) training of staff in production and management systems;

- 62 - ANNEX 3Page 8

(d) implementation of a basic .nanagement information system coveringproduction, quality control, personnel, financial and marketingfunctions;

(e) installation of new marketing channels in domestic and export mar-kets; and

(f) technical assistance to help the corporation and the factories planand implement the strategies.

15. Investment Plans. The investment program to support the restructur-ing of SECC is estimated as follows:

SECC: RESTRUCTURING INVESTMENT PLAN

Local Foreign Total(Y million) ($ million) ($ million)

Civil Works & Facilities 32.0 1.6 7.7Equipment 40.3 42.9 50.6Product Development & Tech. Transfer 3.8 9.3 10.0Training 5.9 4.6 5.7Technical & Management Assist. & Tools 10.8 3.5 5.6

Subtotal 92.8 61.9 79.7

Contingencies 27.9 12.3 17.6Incremental Working Capital 125.1 - 24.0

Total 245.8 74.2 121.3

The cost estimate is based on an analysis of different programs recommendedunder the subsector strategy. These programs include product development,improvement in facilities, equipment for modernization and capacity expansion,training and technical assistance. As shown in the table, about 73 percernt ofthe installed cost is for 'hardware" (equipment and facilities), and 27 per-cent is for "software" (product development, training and management systems).The high cost of 'software' indicates the changes required in current businesspractices in order for SECC to succeed in domestic and export markets.Investments in equipment and facilities alone would not be sufficient tocorrect the problems of the subsector.

16. Implementation Plans. The subsectoral restructuring plan will takeabout five years to implement, as it involves complex tasks in major areas--the policy environment, organizational structure, product and production oper-ation, and management organization and systems. Detailed implementationschedules for these tasks have been established, and are summarized inAnnex 9.

- 63 - ANNEX 3Page 9

17. Impact Analysis. As a result of the restructuring strategy, thecapacity of the major product groups is expected to double by 1995. The pro-gram will substantially increase labor productivity, reduce overheads, andincrease material efficiency. It will almost quadruple the volume of sales ofpriority products; domestic sales of these products will increase by over15 percent per year and exports will contribute 22 percent of the total sales.Passive devices such as capacitors axid resistors will make a major contribu-tion to these sales.

SECC: IMPACT ANALYSIS OF RESTRUCTURING PROGRAM

L995 as Z1989 1995 of 1989

Total Sales (S Million) 69.2 287.9 416Domestic Sales ($ Million) 66.6 223.4 335Export Sales (S Million) 2.6 64.4 2,500

Gross Margin (Z) 17.5 30.5 175Net Profit Margin (Z) 6.9 14.3 207

Labor Productivity (Index, 1987=100) 98 450 459

CHINA

SHANCHAI INOUSTRIAL DEVELOPMENT PROJECT

Shanahai Electronic Comoonents Subscetor

Malor Features of Factories in tho Subsector (1988)

Year of Not fixed Salosestablish- Nature of assets revenuo Employmnt

Name of company went company ---- (Y million) ---- (no.) Major products

Radio Factory No. 1 1960 State-owned 18.6 38.3 2,147 Resistors, capacitors, sensorsRadio Factory No. 6 1960 State-owned 12.0 42.0 2,002 CapacitorsRadio Factory No. 8 1960 State-owned 6.6 62.6 1,620 RelaysRadio Factory No. 9 1960 State-owned 8.0 66.1 2,117 Switches, connectorsRadio Factory No. 12 1960 State-owned 15.3 44.8 2,137 PotentiometersRadio Foatory No. 16 1968 State-ownod 4.6 20.6 1,033 Switches, sockotsRadio Factory No. 28 1965 State-owned 10.7 24.6 B89 InductorsTian He Capacitors Factory 1946 State-owned 8.1 37.4 2,201 CapacitorsFu Dan Capacitors Factory 1947 State-owned 13.8 40.3 1,778 Capacitorsdagnotic Material* Factory 1964 Stote-owned 8.7 19.5 1,438 Magnetic materialsFoi iJ Corporation 1960 State-owned 19.1 64.8 2,721 Acoustic assembliesZong Ye Factory 1969 Colloective 13.1 11.6 816 CapacitorsLian Yi Radio Factory 1967 Collective 2.4 9.7 983 Capacitorsagenetic Materials Factory No. 2 1968 Collective 2.4 6.6 442 Magnetic materials

Electronic Compononts Factory No. 2 1969 Collective 0.9 6. 7 449 TransformersElectronic Components Factory No. 13 1968 Collective 0.6 3.9 403 SocketsElectronic Components Factory No. 14 1974 Collective 0.3 2.1 249 Switches, SocketsElectronic Components Factory No. 16 1958 Collective 0.9 2.8 324 Fuses, socketsEloectronic Components Factory No. 21 1968 Collectivo 22.8 6.7 660 CapacitorsXiang Yang Factory 1968 Collective 2.8 11.4 818 ResistorsYu Zhou Factory 1968 Collective 2.3 9.3 538 PotentiometersHuang Pu Factory 1961 Collective 0.8 8.0 613 CapacitorsChang Zhong Faectory 1965 Collective 1.7 12.9 667 TransformorsFong Lei Factory 1969 Collective 2.1 16.9 900 Acoustic assemblies

Total 180.3 636.0 27.641

ox

- 65 - ANNEX 3Attachment 2

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Shanghai Electronic Components Subsector

Subsector Organization, January 1989

CentralGovernment Issue policy guidelines basedState on state economic considerationsCouncil

ShanghaiMunicipal Issues policy guidelines forGovernment Shanghai Municipality

Shanghai Bureaus act asInstrumentation and regulatory bodiesElectronic Industrial

Bureau

|Corporatin iShanghai ICorporation| Subsector corpora-Electonic tions (8) coordi-Components nate companies'Corporation activities

Companies 24 Companies| ompanies Companies (over200) are productionentities

ANNEX 3- 66 - Attachment 3

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Shanghai Electronic Components Corporation

Consolidated Financial Statements, December 31, 1989

A. Consolidated Income Statement

Y'OO0

Sales income 252,632Less cost of goods sold 209,753

Gross income 42,879Less administrative and selling expenses 12,645

Operating income 30,234Other income 3,852Interest and other expenses 13,926

Net income 20,160Taxes 11,714

Net income after taxes 8,446

B. Consolidated Balance Sheet

Y'OOO Y'000

Current Assets Current LiabilitiesCash and bank balance 1,756 Accounts payable 80,664Accounts receivable 68,582 Short-term borrowings 69,510Inventories 148,056 Others 339

Total Current Assets 218,394 Total Current Liab. 150,513

Fixed Assets Long-Term LiabilitiesLand, buildings, machin- Long-term debt 83,748

ery and equipment 152,164 Others -Accumulated depreciation 70,629

Total Liabilities 234,261Net Fixed Assets 81,535

EquityOther Assets 92,639 State funds 104,296

Special funds 49,483TOTAL ASSETS 392,568 Enterprise funds 4,528

Total Equity/Funds 158,307

TOTAL LIABILITIES ANDEQUITY 392,568

- 67 - ANNEX 4Page 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Shanghai Precision and Scientific Instruments Subsector

Size and Organization

1. The Shanghai Precision and Scientific Instruments Subsector (SSIS)is a very small and young subsector. Most of the factories in the subsectorwere established in the 1950s. The subsector includes 13 factories and aresearch institute which together had net fixed assets of only Y 49.7 million($13.4 million) at the end of 1988. Sales in that year were Y 155.8 ($42million) and the subsector employed 9,500 people. The factories vary widelyin size, but all are small compared to worldwide industry standards. Thelargest factory had sales of Y 30.2 million ($8.1 million) with net fixedassets of Y 13.2 million ($3.6 million) in 1988. The subsector's major prod-uct groups include analytical, optical and general purpose Instruments.liAttachment 1 summarizes the major features of each factory in this subsector.

2. The current structure of SSIS has organizational, operational andmarketing strategic constraints which result in a lack of accountability,overlapping of products and processes and inability to meet changing marketingconditions. These constraints make it imperative to change the structure ofthe subsector to attain greater efficiency and competitiveness. Structurally,at the time of appraisal, SSIS was organized in a manner similar to theShanghai Electronic Components Subsector (Attachment 2 of Annex 3). The SSISis subjected to controls from various levels--the central government, theShanghai Municipal Government, the Shanghai Instrumentation & ElectronicIndustrial Bureau (SIEB), and the Shanghai Precision Scientific InstrumentCorporation (SPSIC). Reforms in 1987 and 1988 abolished the administrativelevel of SPSIC and put the factories under the direct control of SIEB. SIEBperformed a regulatory and controlling role, making sure that the factoriesabided by policy guidelines and performance targets established by the centraland state governments. This change gave SIEB more functions with respect tothe factories, yet SIEB was not suitably equipped to carry out some of them.To make up for this, SPSIC was given a coordinating role, although it nolonger had any direct responsibilities over the factories. Each of the 13factories functioned as an "individual entity" responsible for its own plan-ning, marketing, production and finances.

Performance of the Subsector

3. The subsector's output over the past few years is shown in the fol-lowing table:

1/ These include: analytical instruments- spectrophotometers, chromato-graphs; optical instruments--microscopes, optical elements, optical mete-orological products; and general purpose instruments--balances, pollutioncontrol instruments, etc.

- 68 - ANNEX 4Page 2

SHANGHAI: SCIENTIFIC INSTRUMENTS SUBSECTOR PRODUCTION, 1983-89(Y Million)

Average AnnualGrowth (2)

1983 1984 1985 1986 1987 1988 1989 1983-89

Analytical Instruments 34 54 66 58 60 64 66 12Optical Instruments 10 10 22 10 12 33 31 21Balances 17 16 20 22 17 15 14 -3Others 49 40 22 30 41 32 33 -6

SSIS Production 110 120 130 120 130 144 144 5

Nationwide Production 440 475 500 485 480 NA 540 3

Between 1983 and 1989, production in Shanghai grew faster than in the countryoverall--5 percent per year, compared to 3 percent per year. However,Shanghai's profitability during this period has declined from 42 percent to20 percent. The growth of the subsector is based on its strong position inspectrophotometers, chromatographs, and general purpose instruments. Thesethree products contribute 50 percent of the subsector's output and 65 percentof its profit. Microscopes and balances, two important products, have 14 per-cent of the subsector's output. However, these products contribute only7 percent of the subsector's profits at present. Except for microscopes, thesubsector has a sound and reputable position in the domestic market. The sub-sector has been able to increase its market share over recent years, but itfaces continuous competition from other emerging manufacturers at the nationallevel. A well defined developmental approach is required to increase itscompetitiveness. Also, its performance in export markets must be improved.The subsector's exports are very small, accounting for 4 percent of produc-tion. In 1987, it exported instruments with a total value of Y 6.0 million($1.6 million). This represented over 40 percent of the nation's exports ofthese products. The products exported included primarily optical instrumentsand elements.

CHINA: MARKET SHARE OF DOMESTIC COMPETITORS(Z)

1983 1987 1989

Shanghai 17 22 26Jiangsu 13 15 17Beijing 9 13 16Others 61 50 41

- 69 - ANNEX 4Page 3

Market Development

4. The market for scientific instruments in China is relatively small.In 1987, domestic consumption was Y 590 million ($160 million) and growthaveraged only 2 percent per year between 1983 and 1987. Due to capacity limi-tations, local manufacturers have not been able to meet the national demand.Imports therefore have played an important part in meeting domestic demand forscientific instruments, particularly at the very high end of precision andtechnology. Imports have provided over 20 percent of the market, but over thelast few years, the authorities have restricted imports. Domestic productionof scientific instruments is dominated by analytical instruments (spectropho-tometers and chromatographs) and optical instruments (microscopes and opticalelements), but the strongest growth has occurred in balances.

CHINA: DOMESTIC PRODUCTION AND CONSUMPTION OF SCIENTIFIC INSTRUMENTS(Y Million)

Production ConsumptionAverage annual Average annualgrowth (X) growth (Z)

1983 1989 1983-89 1983 1989 1983-89

AnalyticalInstruments 180 200 2 260 270 1

OpticalInstruments 180 282 8 280 280 0

Balances 40 58 6 30 62 13Others 45 NA NA NA NA NA

Total 445 540 3 570 612 1

Scientific instruments are sold to many industries, but the leading consumeris the chemical industry, with 16 percent of market consumption. Because ofcustomer diversity, domestic sales are marketed through four national distri-butors. These distributors cover about three-fourths of the market. SSIS isthe leading competitor in the industry and has increased its market share overrecent years. In 1989, SSIS had more than 70 percent of the domestic marketin four product groups (abey refractometers, universal tool microscopes,spectrum-photometers, and conductometers) and between 50 percent and 70 per-cent in three others (gas chromatographs, pH meters, and mechanical balances).However, its main competitors, Jiangsu and Beijing, also have strengthenedtheir position in the domestic market in the 1980s, reaching 15 percent and13 percent, respectively, of the national scientific instruments market in1987 (when Shanghai's overall share was 22 percent). SSIS is specialized inanalytical instrument and balances, but is largely diversified in other prod-ucts. In contrast, its major competitors are concentrated in a few productcategories and have pursued new strategies in the market with improved prod-ucts. Over the coming years the market is expected to show slow growth of3-4 percent per year. However, a shift is expected to occur from mechanical

- 70 - ANNEX 4Page 4

to electronic balances, and towards environmental analysis instruments andoptical meteorological products. Domestically, SSIS should develop a targeteddistribution and marketing system for priority instruments. This requireseffective technical support service to selected larger user companies, foreignjoint ventures in China, and key national distributors.

5. The global market for scientific instruments in 1987 was about $5.0billion. Of this market, analytical instruments, especially chromatographsand spectrophotometers, account for nearly 50 percent. Industrialized coun-tries consume nearly 70 percent of the world's scientific instruments. TheUnited States leads, consuming 40 percent of world production. Analyticalinstruments, mainly chromatographs and spectrophotometers, constitute nearlyone-fourth of the global scientific instruments market. The manufacturing ofscientific instruments is highly concentrated in industrialized countries.For example, the top five US manufacturers control 50 percent of the domesticmarket. In Japan, the top three producers control 70 percent of the market.The European industry also is moving toward consolidation. Therefore, theability to export scientific instruments depends largely upon the accessibil-ity of these Lhree markets--US, Japan, and EEC. Imports of scientific instru-ments in these countries account for 20 percent of global market and theUnited States accounts for half of this. Imports from developing countries inthese countries are low, only 10 percent of world imports. They consist pri-marily of microscopes and optical measuring instruments, as well as elementsin the US and Japan, and analytical instruments in the EEC. In this largeglobal market, China's exports of scientific instruments are extremely low,amounting to Y 14 million ($3.8 million) in 1987. Optical instruments,including those of SSIS, are the major contributors to China's exports ofscientific instruments. Distributors and end-users in import markets areskeptical of China's ability to deliver instruments of world-class standards.In order to build up exports in these markets, SSIS must be able to meet prod-uct requirements for international design and standards, reliability, andcustomer accessibility. SSIS also must build up appropriate marketing chan-nels, using OEMs for spectrophotometers and optical elements, and using dis-tributors for microscopes and general physical instruments. In 1989, theShanghai subsector exported $3.3 million, a considerable increase over pastyears.

Subsector Capabilities and Competitiveness

6. Within the three major product categories, the Shanghai instrumentssubsector manufactures a wide range of products. For a small domestic marketthis product mix is inappropriately wide and varied. The product range needsto be concentrated and other improvements implemented such as new designs formicroscopes, better detector design and control systems for analytical instru-ments, the introduction of electronics in products, and microprocessor controlfor laboratory instruments. Competition also is affected by manufacturingorganization, processes and systems. There are numerous overlapping productsand duplication of manufacturing processes among the factories. This has ledto a low scale of production, low utilization of equipment, high capitalinvestment, excessive overhead costs, and so on. The workshops in the facto-ries are physically isolated from each other, and unsuited for modern manufac-turing. Manufacturing equipment is too outdated to adapt to changing marketspecifications; this leads to excessive downtime, high maintenance costs and

- 71 - ANNEX 4Page 5

poor product quality. Also, the management organization and systems needimprovement. Poor management of production has led to long production cycles,high inventories, and low productivity. Low-quality raw materials and parts,and their unsuitability for machining and assembly, hampers the production ofprecision instruments. Under this project, organizational steps will beintroduced for improved procurement and specification procedures. Also, thecorporation will work with suppliers to develop the latter's capability toprovide timely deliveries. Improved access to foreign exchange under theproject will allow the corporation to import critical raw materials and compo-nents, such as microprocessors and special optical glass and gratings. Also,rigorous inspection and acceptance programs for incoming materials will beestablished. Finally, the organization lacks marketing and financial account-ing systems to develop market strategies. As a result of these deficiencies,the subsecto,. faces serious cost constraints, both in domestic and interna-tional markets. The proposed development plan for the subsector addressesthese constraints.

Restructuring Need

7. The many problems facing the subsector in the area of organizationalstructure, product quality and technology, manufacturing process, and manage-ment structure and systems call for restructuring and renewal in a slowlygrowing market. The objective is to create an appropriate business environ-ment supported by appropriate policy which will make the subsector more com-petitive in domestic and export markets. The major elements of the restruc-turing strategy, the first step of which has been implemented, are summarizedbelow.

8. Organizational Structure. Under the new structure, one financialentity has been formed by uniting the subsector administrative corporation andthe factories manufacturing priority products as an integrated company, SPSIC.The integrated company was established by issuance of its charter in May 1989.Financial consolidation of the former subsector corporation and the factorieswas completed by March 1990. The consolidated statements for 1989 are shownin Attachment 2. By June 1991, the remaining independent legal status of theconstituent factories will be phased out, so that SPSIC will be a single legalentity. SIEB will evolve into a regulatory entity and become less involved inthe planning, financial, and operational activities of the corporation. Somefunctions currently performed by the Bureau will be transferred to the corpo-ration. As with the electronics subsector, the Bureau will concentrate onpolicy making. The former subsector corporation is being reorganized as acompany headquarters and will be responsible for planning, financial, person-nel, and market development functions. SPSIC will assume all debt and taxobligations as a single unit. Under the corporation three business units willbe established. These units will focus on priority products: analyticalinstruments; optical instruments and systems; physical instruments, and envi-ronmental control instruments. Existing factories associated with these busi-nesses will be consolidated under the relevant new units. This restructuringwill eliminate product/production duplication, reduce manufacturing costs,improve product quality, and strengthen marketing and sales capabilities. Thebusiness units will be responsible for product development, production, andmarketing functions. The factories grouped under the business units willoperate as cost centers. Under the plan, six out of the existing 13 factories

- 72- ANNEX 4Page 6

will be regrouped. The reorganization was agreed with the relevant authori-ties, and began in June 1989. Implementation is expected to be completed in1992.

9. Product Market Strategy. A product/market strategy for the subsec-tor has been developed based on an analysis of products currently manufacturedin the subsector, their market access, product technology, customer service,market growth and profitability. The basic principles governing this strategyare: improve quality, introduce new technology and designs, and establishappropriate marketing networks domestically and in export markets. Domesti-cally, the subsector will concentrate on seven products in three major productgroups: (a) chromatographs and spectrophotometers in analytical instruments;(b) microscopes, optical elements, and optical meteorological in optical sys-tems; and (c) balances and related items in physical instruments and generalpurpose environmental instruments. Potential products for export are opticalsystems and components of spectrophotometers. Initially these would be soldat the low end of market. However, after technical improvements, the exportmarket for complete sets of spectrophotometers, chromatographs and opticalsystems coul.d be large. The domestic marketing strategy for priority productswill focus on major local distributors, key customers, and joint venture com-panies in China. This will be achieved by developing an adequate sales/tech-nical marketing staff and reorganizing the marketing function to facilitatemarket feedback on product performance. The export marketing strategy willfocus mainly on using OEMs for spectrophotometers and optical elements andusing distributors for microscopes and general purpose instruments. Thisstrategy will establish an appropriate marketing infrastructure, initially torthe United States market, where there is a large potential for exports. Theproduct/market strategy for the subsector will govern the strategic planningof the corporation relating to its future development and resource allocation.

10. Operational Strategy. The operational strategy involves productdevelopment, production rationalization, and improvements in management prac-tices, marketing and training systems. Strategic plans have been developed ineach of these areas to promote efficient production and marketing of priorityproducts. These plans consist of: (i) implementing product development plansfor priority products to improve design and quality, and to integrate newtechnologies; (ii) rationalizing and consolidating priority production facto-ries to manufacture products at lower cost; (iii) introducing modern practicesand systems for management information, strategic planning, financial and costaccounting, production management, and marketing; (iv) setting up improvedmarketing channels in domestic and export markets; (v) training and redeploy-ing staff; and (vi) providing technical assistance to implement the subsec-tor's strategy and the proposed project.

11. Investment Plans. The total cost of implementing the restructuringplans is estimated to be $58 million. The estimate for major cost categoriesis as follows:

- 73 ANNEX 4Page 7

SPSIC: RESTRUCTURING INVESTMENT PLAN

Local Foreign Total(Y Million) (S million) ($ million)

Civil works and facilities 15.6 - 3.0Equipment 16.5 15.9 19.1Product and technology development 4.0 7.5 8.3Training 2.7 2.2 2.7Technical & management assistance 4.9 3.0 4.0

Subtotal 43.7 28.6 37.0

Contingencies 13.1 5.7 8.2Incremental working capital 68.2 - 13.1

Total 125.0 34.3 58.2

A significant part of the investment is allocated to software activities forproduct development, training, and technical and management assistance. Inorder to use the hardware equipment to best advantage, software must bestrengthened to allow for modern management practices, the development ofquality products with new technology, and marketing in an extremely competi-tive environment.

12. Implementation Plans. Detailed implementation plans have beenworked out for the major task areas: the policy environment, organizationalstructure, product and production rationalization, organizational moderniza-tion, and management systems. These plans are developed as a framework withthe flexibility to accommodate changes during the implementation process asthe need arises. Implementation is expected to take five years. Details areprovided in Annex 9.

13. Impact Analysis. Restructuring of the corporation is expected toincrease domestic and export sales, improve the corporation's profit margin,and increase labor productivity, as shown in the table below.

- 74 - ANNEX 4Page 8

SPSIC: IMPACT ANALYSIS OF RESTRUCTURING PROGRAM

1995 as 21987 1995 of 1987

Total Sales ($ million) 34.1 63.2 185Domestic Sales (million) 32.9 51.4 156Export Sales ($ million) 1.2 11.8 983Gross Margin (2 of Total Sales) 24.2 29.6 122Net Profit Margin (2 of Total Sales) 9.8 11.8 120Labor Productivity Index (1987=100) 100 400 ;00

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Shanghai Precislon Scientific Instrument Subsector

Us;or Features of -actories Jn the Subsector (1989)

Year ov Not fixed Salesestablish- Nature of assets revenue Employment

Name of company m*nt company ---- (Y million) ---- (no.) Major products

Optical Instrument Factory 1963 State-owned 12.6 32.6 2,850 Uicroscopes, optical element,measuring and analyticalinstruments

Optical Instrument Factory No.2 1943 State-owned 6.1 6.7 711 Measuring instruments

Optical Instrum_nt Fectory No.3 1958 State-owned 1.2 1.3 271 Surveying instruments

Physical Optical Instrument Factory 1966 State-owned 4.6 4.3 309 Measuring instruments

Optical Lens Factory 1958 State-owned 1.1 2.1 308 Optical lenses and *l em nts

Analytical Instrument Factory 1952 State-owned 8.4 43.5 S,203 Analytical instruments

Rex Instrument Factory 1953 State-owned 3.1 17.7 488 Electrochemical, analyticaland environmental protectionmonitoring instruments

Analytical Instrument Factory No.3 1968 State-owned 4.1 19.8 590 Analytical instruments

Electro-Optical Devices Works 1958 State-owned 3.1 12.4 407 Light sources, electrodes

Balance Manufacturing Factory 1948 State-owned 6.2 17.3 769 Precisian balances

Balance Instruments Works No.2 1953 State-owned 1.9 7.5 4SO Precision balances

Qin Fen Instrument Factory 1980 Collective 0.8 2.1 305 Microscopes

Hongyu Equipment Factory 1968 Collective 0.7 2.8 33 Environmental protection andmonitoring instruments

Optical Instrument Research Institute 1984 State-owned 2.1 - 361 Product development

Total 64.0 189.0 9.333 :D.

rt

ANNEX 4- 76 - Attachment 2

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Shanghai Precision and Scientific Instruments Corporation

Consolidated Financial Statements, December 31, 1989

A. Consolidated Income Statement

Y'000

Sales income 131,774Less cost of goods sold 100,281

Gross income 31,493Less administrative and selling expenses 9,107

Operating income 22,386Other income -Interest and other expenses 442

Net income 21,944Taxes 9,568

Net income after taxes 12,376

B. Consolidated Balance Sheet

Y'OOO Y'OOO

Current Assets Current LiabilitiesCash and bank balance 3,930 Accounts payable 26,282Accounts receivable 15,391 Short-term borrowings 41,780Inventories 76,431 Others 469

Total Current Assets 95,752 Total Current Liab. 68,531

Fixed Assets Long-Term LiabilitiesLand, buildings, machin- Long-term debt 14,620

ery and equipment 73,722 Others -Accumulated depreciation 35,046

Total Liabilities 83,151Net Fixed Assets 38,676

EquityOther Assets 22,467 State funds 56,531

Special funds 14,370TOTAL ASSETS 156,895 Enterprise funds 2,843

Total Equity/Funds 73,744

TOTAL LIABILITIES ANDEQUITY 156,895

77 ANNEX 5Page 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Shanghai Electrical Apparat - Subsector

Background and Organization

1. The Shanghai electrical apparatus industry emerged in 1919. Sincethen it has gone through many stages of development. From 1919 to 1956, theindustry included hundreds of small electrical apparatus manufacturers. In1956, the Shanghai Electric Power Facility Manufacturer Corporation was set upwhich included manufacturers of electrical apparatus as well As power genera-tion. In 1960, the Shanghai Electrical Arparatus Co. (SEAC) was set up as aseparate company specializing in the manufacture of electrical apparatus.Until 1986, this company exerted considerable influence over the production,product planning, personnel, and marketing decisions of its factories. In1987, the central government promoted the concept of each factory as an inde-pendent enterprise, and SEAC became purely a coordination entity. Despiterecent changes, strong traditional ties have been built up between the coLpo-ration and factories over the last 30 years and these ties persist even now.

2. At the beginning of 1989, SEAC was coordinating 28 factories whichoperated as independent legal entities responsible for their own performancequota, technology and product development, production schedules, marketing andsales. This subsector is the largest manufacturer of low-voltage electricalapparatus products in China, with sales of Y 703 million and 23,100 employeesin 1989. Its products have the broadest coverage of all domestic competitorsin the electrical apparatus industry and include 800 series and 3,000 varie-ties. The products can be broken down into two basic categories: (a) compo-nents: contactors, relays, circuit breakers, transformers, voltage regula-tors; and (b) systems: switchboards, drive controls, and rectification sys-tems. The Shanghai subsector maintains a 15-20 percent domestic market sharefor its key products and has enjoyed real growth of about 5 percent a yearover the last seven years. In 1989, it exported $8 million worth of electri-cal products. Attachment 1 shows the main features of the factories in thesubsector.

3. In addition to the 28 independent factories, the subsector corpora-tion oversees the Shanghai Electrical Apparatus Technology Research Instituteand four subsidiaries. The subsidiaries have been set up to facilitate mate-rial procurement, marketing and sales, systems engineering and technologydevelopment in the subsector. The SEAC headquarters corporation and its sub-sidiaries together employ about 350 people. Following its formation in 1987,the corporation provided some corporate functions, but horizontal integrationamong the factories was very limited. For enhancing the competitiveness andefficiency of the electrical apparatus subsector, changes in the current orga-nization structure were considered necessary in 1989, and the first steps in arestructuring program agreed with the Bank have been undertaken since then.

- 78- ANNEX 5Page 2

Performance of the Subsector

4. The total size of the domestic market was estimated to be Y 6 bil-lion in 1987. It had been growing by about 8 percent a year between 1980 and±985--a rate it is expected to maintain over the next decade. Low-voltageelectrical apparatus products are required for industrial, commercial, andresidential installations and are incorporated into many items of industrialequipment (e.g., machine tools). Many of these products were designed in the1960s and early 1970s and are still widely used in China today. They repre-sent the majority of sales for most factories in the electrical apparatusindustry. Since 1979, various new generation products have been introduced inthe country using the technical know-how of Western companies such as Siemens,AEG, BBC, Westinghouse. These new generation products have obvious advantagesover old generation products in terms of their function, quality, durability,manufacturing efficiency, material usage, and application efficiencies. AsChina's economy develops, it will need to produce and use a greater number ofhigher quality electrical apparatus products. At the same time, competitionamong the regions of China will continue to intensify. For example, besidesthe five original electrical apparatus bases (Shanghai, Shenyang, Beijing/Tianjin, Tianshui, and Zunyi), many collective enterprises have entered themarket. The dominant products among these new entrants are manufacturingproducts that have low entry barriers and high profitability, such as switch-boards. Furthermore, each region tends to favor local producers, so Shanghaineeds to compete aggressively in other regions. The Shanghai subsector'smarket share has been declining over the last several years. Annual saleshave grown at 5 percent a year, compared to 8 percent a year for the nationalindustry. The decline in SEAC's market share is due to its own productionconstraints, intensive competition from other regional manufacturers, andinefficient domestic marketing channels. SEAC also has been introducing newgeneration products. The company will have to find a way to apply its compe-titive advantage to regain market share and achieve a superior competitiveposition.

Market Development

5. Growth in the domestic market presents promising opportunities forthe SEAC group. Projected growth rates and SEAC sale targets for key productsare presented in the following table. These projections form the basis of theproposed product-market strategy.

- 79 - ANNEX 5Page 3

CHINA - DOMESTIC DEMAND OF KEY ELECTRICAL COMPONENTS(Y million)

National Sales SEAC Sales1987 1995 1987 1995

Contactor 260 500 35 110Relay 176 335 25 82Circuit breaker 270 648 43 128Voltage regulator 37 67 16 40Transformer 1,835 3,200 43 167Circuit board 467 833 27 75Drive control 157 392 34 104Rectifying system 94 150 27 45

Total 3,296 6,125 250 706

According to these figures, an average annual growth rate of over 8 percent isforeseen in the domest4c market. The SEAC group wishes to strengthen itsleadership position by gearing up for the much higher annual growth rate of14 percent.

6. The world market for electrical components is extremely large buthighly competitive; the US market alone exceeded $50 billion sales in 1987.SEAC has good export potential due to its competitive advantage in low laborcosts. In 1987 SEAC exported $5.4 million. However, 50 percent of itsexports consisted of storage batteries sold to the USSR and Eastern Europe inthat year. SEAC also exported contactors and relays to Brown Boveri andSiemens in Europe, as a form of payment for technology transfer under prevail-ing buy-back agreements. Both companies have expressed satisfaction with thequality of SEAC products. In 1989, exports grew to $8 million, and wereexpected to reach $10 million in 1990. Building on its presence in Europeanmarkets, SEAC should be able to capture a small portion of the global market.Here, independent standard components and dependent standard subcomponentsoffer the best chance of success. SEAC also will need to build up its exportchannels and management capabilities in primary markets, Southeast Asia, andthe US.

Subsector Capabilities and Competitiveness

7. Although the SEAC group has a good operating efficiency compared toother domestic companies, it still needs to reduce manufacturing costs andshorten manufacturing cycles. SEAC sales per employee were Y 25,000 per yearin 1987 or 79 percent higher than the domestic average. By 1989, sales peremployee had risen to Y 31,000. The profit on sales is 17 percent, and returnon assets also is very high. However, SEAC sales per employee are only5-10 percent of those of foreign firms; inventory turnover is less than25 percent that of foreign companies and lead times for delivery of "systems"

- So - ANNEX 5Page 4

products are much longer. Thus, there is a need to improve operational effi-ciencies to decrease manufacturing costs and shorten the manufacturing cycle.

8. SEAC has at present a subsidiary which supplies its requirements ofsteel, copper, aluminum and other materials. Most of the raw materials arelocally available. However, irn tha case of pressed sheet steel componentsrequired for contactor bodies and switchgear panels, cold rolled steel sheetsare imported. Likewise, silicon steels required for the manufacture of trans-former cores are also imported. No major problems with material inputs areexpected; however, to reduce scrap generated in the cutting of steels, a mate-rial processing center will be established under the project. As SEAC pro-gressively enhances its systems electronics capability for integration withits electrical apparatus, there will be need for import of certain electroniccomponents.

9. The SEAC group has a competitive advantage over other domestic com-petitors in terms of its products, production and equipment, and technicalknow-how. In order to apply this competitive advantage to impzove its posi-tion in domestic and international markets, SEAC needs organizational restruc-turing and further investments 'n both hardware and software.

10. Between 1981 and 1988, SEAC invested $50 million to introduce newgeneration products, including expenditures on technology and productionequipment. These new generation products fall into the category of growthproducts and they are expected to become the major products of the next fiveyears. Although SEAC has led domestic competitors in introducing these newgeneration products, with 34 percent of the sales in 1987 ccming from theseproducts, so far it has not been able to produce them in quantities largeenough to reduce unit costs or meet market demand.

11. SEAC's competitive advantage in system products is the greatest forprojects which are technically very complex and/or require sophisticatedequipment. However, for less complex jobs, SEAC cannot compete with collec-tive enterprises because of its long delivery cycles. If SEAC could reduceits delivery cycle by half, it could increase sales of its systems products by50 percent.

12. Shanghai electronic apparatus factories and reputed foreign compa-nies are very far apart in terms of technology and product development. Here,the SEAC group needs to focus more on technology absorption and manufacturingefficiency. The company can make advances in these areas by restructuring itsR&D organizations and making technology investment a priority. Electronics isan important technology area. As SEAC's system products use more and moreelectronics to improve control and reliability functions, the company willneed to build up its electronics capability. The focus here should be onapplications, conceptual designs, printed circuit board design and assembly.

- 81 - ANNEX 5Page 5

Restructuring Needs

13. To improve its efficiency and market pordtion, the Shanghai electri-cal apparatus subsector needed to be reorganized into an integrated corpora-tion, a step taken in May 1989 when a charter was issued. The new structurewill improve SEAC's potential to achieve: (a) competitive advantage in prod-uct lines in the low-veltage electzical apparatus industry; (b) scale econo-mies in production, marketing, product technology development, raw materialpurchasing; (c) a sound financial structure; (d) an efficient allocation ofinvestment and foreign currency; and (e) a competitive advantage in 'systems'products. In the industry worldwide, only a few major players are active ineach region because of the full coverage of products required and the econo-mies of large-scale operations. In the long term, China also will have onlyfew major manufacturers of electrical apparatus, and SEAC stands a good chanceof being one of them.

14. Organizational Structure. SEAC's corporate capability and tradi-tional linkages with the factories is facilitating its restructuring into anintegrated corporation. Financial consolidation was done by March 1990 (seeAttachment 3), and by June 1991, the remaining independent legal status of theconstituent factories will be phased out, so that SEAC, as an integrated com-pany, will be the sole legal entity, responsible for profits and losses, andhandling debt and tax obligations as a single unit. Nonetheless, considerableorganizational development and management training will be required to imple-ment the new structure. The structure will consist of regrouping some of the28 factories into five autonomous divisions and integrating the ResearchInstitute as a "cost center" within this organization. In addition, a sepa-rate division will be established to include the two fuse manufacturing facto-ries and the metal alloy plant. In the long run, this division will be sepa-rated from the corporation and function as an independent entity. The fiveproposed divisions include: (a) the Low Voltage Electrical Apparatus Compo-nents Division; (b) the Machine Tool Electric Apparatus Division; (c) theDrive Control Division; (d) the Trarsmission, Distribution and TransformerDivision; and (e) the Electronics Division. A material processing center willbe established to optimize the storage and cutting of sheet steel used in themanufacturing of electrical components and panels.

15. The profit center divisions will include only those factories whichmanufacture products and provide critical components/services which are essen-tial to SEAC's product/market strategy. The factories to be included underthe pioposed divisions are presented in Attachment 2.

16. Marketing and sales functions for international markets are beingconsolidated at the corporate level. In addition, each division will have adomestic market/sales function. The finance function at the corporate levelwill cover all the financial and accounting functions. Other corporate func-tions include strategic planning and personnel. SEAC will be treated as oneentity in dealing with external entities including the bureaus and banks.SEAC also will be given direct export and import rights, while continuing towork closely with foreign trading organizations such as CMEC. Each divisiongeneral manager will run the division as a profit center. The general managerwill be responsible for divisional product/market strategy, production plan-ning, and finances.

-82- ANNEX 5Page 6

17. SEAC will need to develop managerial capabilities both at the corpo-rate and divisional level to perform the functions expected of them. To avoiddisruptions in production, a transitional substructure will be needed. Duringthis time the 21 factories will report to SEAC directly, and the finance,marketing, personnel, and technology planning functions will be centralized atthe corporate level. The Research Institute becomes a part of SEAC rightaway. During the transition period, priority is being given to rationalizingproducts and consolidating production facilities among the factories.

18. Product/Market Strategy. The strategies are based on a joint marketstudy carried out by internationai and local consultants in consultation withthe corporation. Three product/market strategies have been identified forSEAC's domestic market. These include: (a) strengthening SEAC's leadershipposition in components and systems products; (b) building up an electronicscapability in the electrical apparatus business; and (c) strengthening SEAC'smarketing/sales capabilities. SEAC's position in components and systems willbe improved through volume production of new-generation products, improvingthe efficiency of systems assembly; developing critical new systems to main-tain leadership; 'eveloping next generation etand-alone products for importsubstitution. Marketing and sales will be strengthened by unifying the mar-keting function; setting up nationwide sales-service centers and establishinga corporate brand.

19. Before any electrical components are accepted by a market, they mustconform to national specifications. Although SEAC has met IEC standards forlow-voltage electrical apparatus products in Europe, it has to modify itsspecifications and have its products retested to meet US requirements. SEAChas a 15-20 percent cost advantage in labor and overheads which it can exploitfor generic standard products such as contactors, overload relays, and "naked"transformer coils. It also can increase sales to its licensors such as BBC.

20. SEAC's product/market strategy for exports is designed to increasesales from $5.4 million in 1987 to $14-16 million by 1995. This should beachieved by focusing on those independent standard components and dependentstandard subcomponents which offer the best chance of success. To exploitthis potential, SEAC will need to build export channels in its primary marketsin Southeast Asia and in the US.

21. Operational Strategy. If the proposed restructuring of the subsec-tor is to succeed, substantial improvements are needed along all areas whichresult in enhanced operational effectiveness. These include: materials man-agement, production planning and control, plant layout, preventive mainte-nance, industrial engineering, quality assurance, etc. There is a need fortraining in marketing, in cost analysis, and in strategic planning. Manage-ment information systems are needed for effective planning and control at thedivisional and corporate levels. Product development and technology manage-ment functions also need to be strengthened.

22. Investment Plans. The investment plan to implement the strategiesis estimated as follows:

- 83 - ANNEX 5Page 7

SEAC - RESTRUCTURING INVESTMENT PLAN

Local Foreign Total(Y Million) ($ million) ($ million)

Equipment 40.3 23.4 31.1Civil works 23.7 - 4.5Technology transfer - 10.3 10.3Training 2.8 2.0 2.5Management system 3.4 2.4 3.1Management tools - 0.7 0.7

Subtotal 70.2 38.9 52.3

Contingencies 21.0 7.8 11.8Working capital 227.4 - 43.6

Total 318.6 46.7 107.7

23. TL-e proposed investment will assist the subsector to: (a) gear upvolume production of new generation products; (b) improve the efficiency ofsystem assembly; (c) develop higo potential export products; (d) develop prof-itable electronics products; and (e) develop critical new products to maintainleadership in system business. Technical assistance programs to facilitateimplementation of the plan and subsector restructuring are included in theinvestment package. In addition, funds are included to develop export marketchannels, export management, and domestic market channels.

24. Implementation Plan. SEAC will face some very complex coordination,planning and integration problems in implementing the proposed subsector reor-ganization. In order to ensure the success of the restructuring, a detailedimplementation schedule has been established and is summarized in Annex 9.

25. Impact Analysis. Restructuring of the subsector should considerablyimprove the operational and financial targets for SEAC in 1995. as shown inthe following table.

- 84 - ANNEX 5Page 8

SEAC - IMPACT OF RESTRUCTURING

1995 as Z1989 1995 of 1989

Sales Revenue (Y Million) 710 1,100 155of whichDomestic (Y million) 672 1025 153Export ($ Million) 8.01 12.9 161

Gross Profit (D of Total Sales) 17.1 19.1 112Employees (Numbers) 23,100 19,000Productivity (Y'000/employee) 25.7 59.9 233

CHDN A

SHANCHAI DUSTRIAL DEVELOP MET PROJECT

Electrical Apparatus Sabqector

Vajor Features of Factories In the Submictor (1989)

Year of Not fixed Saloeestablish- assets revenuo Employment

Name of company aont ---- (Y million) ---- (no.) Major products

Component FactoriesShanghai Ron Min Electrical Apparatus Works 1942 14.1 68.6 1,888 Contoctors, circuit broakers, etc.Shanghai Lixin Electrical Apparatus Works 1947 6.8 29.8 1,867 SCR modium -frequoncy sorvices, etc.Shonghai Electric Apparatus Use Electronic 1976 4.2 8.8 879 Integrated circuits, photoelectric elo-Componont Works oents

Shanghai First Switchgeor Works 1949 8.4 17.1 544 Saall control panels, driving panelsShanghai Voltage Regulator Works 1987 2.1 26.8 840 Transtormrs, voltage regulatorsShanghai Machino Tool Electrical Apparatus 1981 12.8 87.0 1,242 Vigital-display dovicos, oachine toolWorks electrical components

Shanghai Second Machine Tool Electrical 1988 6.4 20.7 712 Machine tool electrical apparatus, simpleApparatus Works progrm controls

Shanghai Third Machine Tool Electrical 1960 2.6 16.0 627 Machine tool electrical componentsApparatus Works

Shanghai Electronic Material Works 1969 6.6 9.8 628 Monocrystalline siliconeShanghai Third Switchgear Works 1960 4.2 12.6 588 Low-voltage switchboards, main el e ntsShanghai Jin Shan Electrical Apparatus 1965 3.4 17.1 400 Low-voltage fuse s Factory

Shanghai Electric Ceramic Apparatus Works 1949 8.6 18.5 o6o Lou-voltage fuses, knife switchesShanghai Electric Apparotus Works 1987 6.0 28.1 1,606 Driving panols, explosion-proof switchoeShonghal Alloy Material Works 1965 11.7 86.7 1,027 Electrical alloy, carbon alloysShanghai Xin-Ho Mold Factory 1980 9.1 8.8 820 Forming dies, cold di-uShanghai Electric Ap;sratus Uso Foundry 1980 1.9 6.' 692 CastingsWorks /a

Shanghai Electric Apparatus Pross-Costing 1961 2.1 7.3 U81 Die-cesting partsWorks

Shanghai Hwa-Jian Electrical Apparatus Works 1960 2.1 65. 424 Bak.lito parts, sockets, switchesShanghai Electric Plating Factory 1956 1.7 4.8 250 Eloectroplating of parts

Systems FactorliShanghai Rectiflor Works 1946 6.4 40.4 1,619 Silicon rectifier self-control *lo_ ntsShanghai Hunyl Electrical Apparatus Works 1940 8.2 19.8 820 Silicon rectiflor "achino tool switch-

boardsShanghai Transformer Works 1d60 9.7 111.4 1,609 Transformers, load switchosShanghai Mine Us Electrical Apparatus Works 1936 3.8 18.9 6S8 Charging racks, electrical control equip- >

*ent r.Shanghai Resistance Works 1958 8.2 23.0 828 Silicon rectifier wain el_emntsShanghai Hoisting Electrical Apparatus Works 1931 4.4 23.1 1,116 Driving panels, main olements c Shanghai Electric Assembly WUrks 1912 9.3 49.9 1,373 Driving pansli, low-voltage switchboardsShanghai Electric Apparatus Use Plastic Works 1956 4.0 16.7 486 Washing machinos, plastic elementsShanghai Storago Battery Works 1986 17.8 86.2 774 Storage batteries

_ot4l 166.2 703.1 23.100

La 1983 figures.

ANNEX 5- 86 - Attachment 2

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Electrical Apparatus Subsector

Factories Included Under the New Divisions

1. Low Voltage Electrical Apparatus Division:

- Renmin Electrical Apparatus Works- Lixin Electrical Apparatus Works- Third Switchgear Works

2. Machine Tool Electrical Apparatus Division:

- Machine Tool Material Apparatus Works- No. 2 Machine Tool Electrical Apparatus Works- No. 3 Machine Tool Electrical Apparatus Works

3. Drive Control Division:

- Electrical Assembly Works- Switchgear Works- Rectifier Factory- Material Processing and Fabrication Works

4. Transmission Distribution and Transformer Division:

- Electrical Apparatus Works- Resistance Works- Transformer Works- Voltage Regulator Works- Huayi Material Apparatus Works

5. Electronic Division:

- Electrical Apparatus Use- Electronic Components- Hoisting Material Apparatus Works- Electronic Material Works

6. Infrastructural Division (Transitional):

- Jin Shan Electric Apparatus Works- Electric Ceramic Apparatus Works- Alloy Material Works

ANNEX 5- 87 - Attachment 3

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Shanghai Electrical Apparatus Corporation

Consolidated Financial Statements, December 31, 1989

A. Consolidated Income Statement

Y'000

Sales income 555,422Less cost of goods sold 396,421

Gross income 159,001Less administrative and selling expenses 21,900

Operating income 137,101Other income 10,161Interest and other expenses 38,758

Net income 108,504Taxes 60,654

Net income after taxes 47,850

B. Consolidated Balance Sheet

Y'000 Y'000

Current Assets Current LiabilitiesCash and bank balance 10,165 Accounts payable 224,321Accounts receivable 215,593 Short-term borrowings 295,997Inventories 353,386 Others -

Total Current Assets 579,144 Total Current Liab. 520,318

Fixed Assets Long-Term LiabilitiesLand, buildings, machin- Long-term debt -

ery and equipment 203,601 Others -Accumulated depreciation 79,057

Total Liabilities 520,318Net Fixed Assets 124,544

EquityOther Assets 146,672 State funds 223,981

Special funds 106,061TOTAL ASSETS 850,360 Enterprise funds -

Total EquitylFunds 330,042

TOTAL LIABILITIES ANDEQUITI 850,360

- 88 - ANNEX 6Page 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Shanghai Printing and Packaging Machinery Subsector

Background and Subsector Organization

1. The manufacture of printing machinery in Shanghai began between 1917and 1940. Since then, Shanghai factories have been the traditional leader inthe printing machinery industry in China. They have the b.oadest product lineand the largest output of any competitor in China. Before 1986/87, the 12printing machinery factories in the printing machine subsector formed part ofthe administrative companies of the Light Industry Machinery Corporation(LIMC). These administrative companies served as extensions of the industrialbureaus, the level of the government closest to the factories. In 1986, theprinting machinery units as well as the associated administrative personnelfrom LIMC were split off and organized into a separate group. This group wasfurther reorganized in September 1987 into the present Shanghai Printing andPackaging Machinery Subsector (SPPMS).

2. The subsector therefore is a relatively new entity. It consists ofa company and 12 factories, 8 of which make printing and related machines,l/and 4 of which are component factories. The salient features of SPPMS aregiven below. Attachment 1 gives the list of enterprises included in SSPMS.

SSPMS--SALIENT FEATURES, 1987

Unit 1987

Employees persons 7,028Net Fixed Assets Y mln 55.4Printing Machinery Output sets 2,401Domestic Sales Y mln 111.00of which - within She.aghai Y mln 27.10

- outside Shanghai municipality Y mln 83.90Exports Y mln 10.00Total Sales Y mln 121.00Profits before tax Y mln 38.27

3. At the beginning of 1989, SPPMS had a two-tiered structure with boththe company and the ractories as independent legal and economic entities in

1/ The printing machinery units manufacture web and sheet-fed offsetpresses, small and medium offsets, letter presses and postpress equip-ment.

- 89 - ANNEX 6Page 2

which each was responsible for its own profits and losses. The company car-ried out many of the tasks performed by the former administrative companies,such as setting production targets and plan with the bureau and the factories.The primary source of income of the company was sales of part of the facto-ries' products. Because the company was not a corporate entity, it had littleleverage over the factories. That structure did not provide the organiza-tional coordination and control needed to implement a cohesive subsectorstrategy.

Performance and Market Development

4. Attachment 2 gives the development of major product groups in thesubsector over the period 1983 to 1989. Between 1983 and 1987, outputincreased by 7.5 percent per annum, but growth accelerated in 1988 and 1989 to24 percent, bringing output to Y 185 million. Profits increased at a somewhatlower rate. Profitability lagged behind output slightly because raw materialprices increased faster than product prices. Over this period, exportsincreased from $1.7 million to $3.2 million per year.

5. The products of the printing machinery sub-sector in China are soldprimarily to the printing and packaging industry. Gross revenues in thisindustry are estimated at Y 20 billion ($5.4 billion). By comparison, therevenues of the printing industry in the US and UK in 1987 were $129 billionand $7 billion, respectively, in 1987. There are 30,000 printing factories inChina which are divided into several segments: book/magazine publishing,newspaper publishing, packaging and others. Due to the increased demand forexport packaging, this segment has grown quite rapidly--at over 16 percent perannum.

6. SSPMS houses only 8 of 59 major enterprises in China which manufac-ture printing machinery. Most of the enterprises are under the Ministry ofMachinery Electronics, and a small number are under the Publishing Bureaus.Their total output is estimated at Y 590 million in 1987. In addition, thereare a smaller number of factories producing about Y 150 million of printingequipment. Including imports, the domestic market for printing equipment isestimated at Y 800 million, with an annual growth rate of 10 percent per yearin recent years. Shanghai's share of the industry in 1987 was approximately13 percent.

7. The major product line of the qubsector fall into three productgroups: (a) large presses (web offset end large sheet offset presses);(b) small- to medium-size offsets and duplicators; and (c) postpress equipment(cutters, binders and blades). Based on current and emerging market demands,the development of these product lines projects major increases in new prod-ucts. A whole new generation of products will emerge in offset machines, forexample, to replace imports of these products on the domestic market. For thelarge presses, 100 percent of the output in 1995 will be new. For the smnall-medium presses, the offset machines will dominate over the letter presses.The anticipated growth, and the greater domestic competition in the printingmachinery industry demand clear organizational structures and aggressive prod-uct and market strategies by SPPMC.

- 90 - ANNrX 6Page 3

Subsector Capabilities and Competitiveness

8. The SSPMS group manufactures all types of printing machinery.Except for sheet-fed offsets, the corporation is strongly competitive in allthe other product groups. In web presses, Shanghai is strong in productoffering and technology. Although there are domestic competitors in Hunan andBeijing, However, Shanghai's Renmin plant has the best quality and controlsover 50 percent of the market. Renmir. has purchased technology for modern webpresses from the Rockwell-Goss Corporation. With this, it has successfullyproduced two model, and is in a position to expand its position in the market.

9. Large Offsets. The four-color offsets represent the top end of thedomestic offset market. Here, there is large unfulfilled demand estimated tobe in excess of 300 machines. The domestic market for large two-color offsetsis better established: approximately 200 units being manufactured per year.The domestic production of single-color offsets amounts to about 1,000 peryear. Competition is strong for all three types. At the high end of thefour-color market are imports from Heidelberg and other Western companies. Atthe lower end there is strong domestic competition. The Beijing People'sMachinery Factory (BPMC) has entered the market with a four-color machine offair quality. BPIMC is also producing two-color models. Shanghai Renmin hasbeen developing a ..ur-color machine based on sophisticated technology pur-chased from Koenig-Bauer, and the first prototype is expected to be completedsoon. Investment is needed for manufacturing this complex machine.

10. Small-Medium Sheet-fed Offsets. The market for medium-size (26-inchrange) two- and four-color sheet fed offset presses is still growing, andcompetition is not yet very strong. BPMC is producing a four-color model andplans to offer a two-color version, but its machines are modeled after a rela-tively low technology and are not as well designed as the Heidelberg modelsbeing developed by SSPMS. BPMC's prices are also higher than SPPMC. There-fore SSPMS has established a good foundation in this area.

11. Duplicators. The domestic market for duplLiators is substantial,and demard already exceeds supply. Shanghai produces a machine of good qual-ity, but in limited quantities. There is only one major domestic supplierwhich assembles a knock-down Japanese model, but its selling price is higherthan the Shanghai machine.

12. Letter Presses. The current market for letter presses is large.About 2,400 machines are produced each year, and domestic supply has beenincreasing recently. Large producers such as Shaanxu and Nanning manufactureclose to 1,000 presses per year. Shanghai's TY 615 letter press is the domi-nant machine in the field, and it has a market share of about 60 percent.Because of its larger scale of operation, Shanghai is more profitable than theother suppliers. However, as printing shops grow and become more quality-oriented, the demand will shift from letter presses to offsets. The demandfor letter presses therefore is likely to peak and begin to decline in themedium term.

13. Postpress Equipment. The market for postpress products is large andstable. Domestic competition is not yet strong and exists only in individual

- 91 - ANNEX 6Page 4

products. Shanghai has the broadest product range and enjoys a very strongmarket position.

14. At present, exports are limited primarily to postpress equipment forthe Southeast Asian market. The current export structure and product portfo-lio do not do not allow for large-scale penetration of the mainstream printingmachinery markets in the West. The major manufacturers in the world offer abroad range of high-quality products and after-sales service. The Shanghaisubsector is competitive only in terms of price. However, there are substan-tial attainable opportunities for Shanghai to expand its position in SoutheastAsian markets and to enter new markets es well.

15. In overseas markets, Shanghai products serve the low-price, low-quality and minimum-service segments where end-users place high importance onprice or capital cost. Typically, Shanghai's postp:ess equipment sells at50 percent less than the price of established brand,. Despite lower laborproductivities, the very low level of wages gives Shanghai a large comparativeadvantage with exports. The low-price, low-quality and minimum-service seg-ments have some export potential, but it is limited. The export strategyassumes a 10 percent per year increase in exports of products ir, this cate-gory. The major thrust in exports will be on the formation of cooperativerelationships with for?ign producers which hove established brand, channel andservice basis. For example, preliminary cost estimates indicate that Shanghaican produce web presses of Rockwell-Goss designs, at lower cost than Rockwell-Goss could produce them. This type of arrangement will allow Rockwell to usethe coproduced machine in price-sensitive market segments.

16. The strategy for Western markets will be to cooperate with foreignpartners in selecting mainstream products. Infrastructural support will beprovided by the partner's existing distribution channels and product supportnetwork. For example, shanghai is exploring with AM International to explorethe possibility of production of their duplicators for export markets, where apotential of $3 million per year exists for Shanghai. The possibility ofShanghai Renmin plant becoming a low-cost supplier of web presses to Rockwell-Goss and generate $2.75-3.0 million per year in export revenues by mid-1990s.The manufacture of labor-intensive components and subassemblies for supply toOEM assemblers or rebuilders is another opportunity being considered.

17. "Niche" market opportunities similarly exist in areas such as cut-ters and binding machines, as these items are not widely produced in the West.The main competition would come from second-hand presses. By incorporatingimported CNC controls on Shanghai pr.-:uced presses, up to $1.25 million a yearin export revenues could be generated.

18. More than $250 million worth of printing machinery is imported intoSoutheast Asia each year. This demand for printing machinery should continueto increase with the ever-growing demand for printing material and betterquality packaging. Low-end products in the region have a higher share of themarket than in the West. In order to increase sales to this region, Shanghaiwill need to preserve its low-price position and make improvements in productquality. Already established marketing channels in Hong Kong and Singaporewill need to be strengthened and cooperative relationships will have to bedeveloped with other companies that are active in the region. For example,

- 92 - ANNEX 6Page 5

Shanghai may attempt to export its four-color offset machine through theKoenig-Bauer channel for this product in Southeast Asia.

19. The basic raw materials and components for the manufacture of print-ing machinery for the domestic market are availabte from local sources. Dueto the higher degree of sophistication and automation required for the exportmarket, it will be necessary for SPPMC to import electronic controls and otherkey components. The quality of castings, particularly thin-willed casting hasbeen a problem in producing precision printing machinery. However, this isbeing addressed under the project. Also, coordination with suppliers must beenhanced to improve the quality of oil seals and ball and roller bearings.

20. Shanghai enjoys a large cost advantage in many product areas whichcould translate into a good export potential. Given certain changes in itspolicy environment, it is estimated that by 1995, the export market for largepresses could reach around $4.0 million, that for medium presses, $7.5 mil-lion, and that for postpress equipment, $7.5 million. In total these exportscould increase from $3.0 million in 1987 to $19.0 million in 1995.

Restructuring Needs

21. Tno. structure described above did not provide the coordination andcontrol needed to implement strategies necessary for resolution of the criti-cal issues which SPPMC faces for its profitable growth and development. Thecompany was not performing a corporate role, although it did mediate among thefactories in areas such as raw materials. In most other respects, the companywas simply a bureaucratic layer above the loosely affiliated factories. Thegroup recognized that its structure needed changing, and has initiated plansto make it competitive in domestic and international markets. The objectivesare to achieve: (a) greater total financial strength; (b) greater ability todevelop export; (c) improved manufacturing efficiency through productrationalization and production consolidation between operating groups; and(d) sharing of technological capability between operating groups.

22. Organizational Structure. In June 1989, an integrated corporation,SPPMS, was formed by issuance of its charter. SPPMS was financially consoli-dated by March 1990 (see Attachment 3), and by June 1991, the remaining areasof independent legal status for the constituent factories will be phased out.Three divisions are proposed under the new structure. These divisions cor-respond to the three major product groups in which the company already has astrong competitive position: (a) large presses, (b) small-medium presses, and(c) postpress equipment. SPPMS includes those factories which have a directimpact on the production and quality of the end products, as these factorieswill be crucial to realize the product-market strategy. Based on this crite-rion, 10 of the 12 factories form part of the reconstituted company. Twofactories (gear and castings manufacturing units) are not manufacturers ofprinting machines but are retained for a transitional period as they supplycritical parts to the machinery manufacturers. Within this organization, thecorporate headquarters, divisions and factories will have distinct responsi-bilities. The functional plans have been agreed between the Bank and SPPMS.

23. Product/Market Strategy. Product and market strategies have beenformulated for each of the three product groups. These strategies are based

- 93 - ANNEX 6Page 6

on extensive analysis carried out by international and local consultantsjointly with the corporation. In large web presses, production would begeared up in order to capture 50 percent of the projected market using tech-nology act ired from Rockwell-Goss. For large sheet-fed offsets, most of thetechnology investment to produce a four-color machine--the Rapida 104-- hasalready been made. In addition, a high-quality machine will be manufacturedwhich will be superior in quality and performance to that of the competition.The development of a low-speed machine based on the designs of Rapida 104 willalso be established. Investments will be made to produce around 40-50 low-speed four-color presses by 1997.

24. The target for small-medium presses is to capture up to 50 percentof the domestic offsets by 1997. This translates to a production capacity of100 two-color and 100 four-color presses by 1995. Since printing units forthe two models are the same, many components and subassembligs can be manufac-tured in common. The nf r divisional structure will facilitate cooperativeproduztion among the various factories. While production is being increased,second-generation machines incorporating market feedback will be designed anddeveloped. Based on market demand, one-color, five-color, perfecting andother models will be addeu to the product line. In the case of the letterpresses, the subsector enjoys a strong market position. However, this is amature product which may decline in the 1990s as printing shops shift to usingmore efficient medium-size offsets. Short- to medium-term investments toimprove quality and increase production therefore will be made in generalpurpose machine tools and assemblies which can be switched to produce offsetpresses as shift in demand takes place. Duplicators have been identified as ahighly attractive product with a market which could expand to more than 2,000sets per year by the mid-1990s. The corporation will gear up to produce1,000-1,200 units per year, 50 percent of which will be for export markets.

25. Shanghai enjoys a virtually unchallenged dominant position in themar?:et for postpress machines. To retain its competitive advantage, invest-ments will be made to improve quality and increase production.

26. Operational Strategy. SPPMC's manufacturing methodologies needsubstantial improvement in virtually all dimensions: manufacturing tech-niques, plant layout and group technology, machine maintenance, quality con-trol, materials management, production planning and control, etc. Similarimprovements are needed in other management functions and associated informa-tion systems: marketing, management planning and control, human resourcedevelopment, and financial and cost controls, The ambitious strategy of over-all organizational development and enhancement of operational effectivenesswill be implemented first in a model plant. The experience gained in themodel plant will be transferred to the other groups and individual factories.Printing Aachinery Works No. 1 has been selected as the model plant.

27. Investment Plan. An investment plan has been developed for thesubsector to support the product and market strategy and the proposed resttuc-turing. The total cost is estimated as follows:

- 94 - ANNEX 6Page 7

SSPMS--RESTRUCTURING INVESTMENT PLANS

Local Foreign Total(Y Million) ($ million) ($ million)

Equipment 31.1 17.9 23.8Civil Works 18.9 - 3.6Techaology Transfer ^ 0.7 0.7Training 0.4 1.0 1.1Management Systems 3.6 1.0 1.7Management Tools 0.0/a 0.4 0.4

Subtotal 54.0 21.0 31.3

Contingencies 16.2 4.2 7.3Working Capital 56.9 - 10.9

Total 127.1 25.2 49.5

/a Approximately Y 23,000.

28. A carefully drawn out implementation plan for the major activitiesof the restructuring plan has been developed and is presented in Annex 9.

29. Impact Analysis. On the implementation of the restructuring plan,the output of SPPMC will grow Y 93.4 million in 1987 to Y 390 million in 1995.The impact of the restructuring plan on major elements is presented in thefollowing table.

SPPMC--IMPACT ANALYSIS OF RESTRUCTURING PROGP'Y

1995 as Z1939 1995 of 1989

Sales revenue (Y mln) 107 310 290Export income ($ mln) 3.2 10.0 313Profit (Y mln) 22 60 273Number of employees 5,725 6,150 107

Fixed assets (Y mln) 51.9 208 401

Productivity index (1987=100) 123 320 260

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Shanghai Printing and Packaging Machinery Subsector

Major Features of Factories in the Subne^tor (1989)

Year of Net fixed Salesestablish- assets revenue Employment

Nase of company Mont ---- (Y million) ---- (no.) Major products

Ron Min Plant 1949 14.7 28.5 1,871 Web offsot and color presses

Yan An Works 1947 1.1 8.0 234 Two-color offset presses and step andrepeat machines

Printing Machinery Works No. 1 1930 11.0 48.3 747 Four-color offset and lotter presses

Printing Machinery Works h . 2 1931 6.3 6.4 404 Small offsets and ink systems for coloroffset and letter presses

Printing Machinery Works No. 3 1930 3.2 8.8 474 Fedor systems for color offset and lotterpresses, screen printing and Flexographic q

Ptinting Machinory Work" No. 4 1940 8.8 18.0 343 Cutting, creasing and stomping machines

Paper Cuttor Works 1918 4.2 14.5 516 Paper cutting blados

Book Stitching Works 1951 4.6 12.8 e68 Book sewing machines, magazine wiresti tchers,

Printing Machine Foundry 1949 2.9 6.7 347 Castings for printing machinss

Shanghai Fei Goer Whoel Works 1939 2.8 4.2 212 Gears for printing machines

qin Fen Machinery Works 1980 1.2 4.2 285 Parts and subassemblies

Blade Works 192S 7.5 34.6 861 Cutting knives for printing maehines

Total 66.2 184.8 7.068/

/a Includes 102 employees in the Compxny. >

rt

I-.

CH0MSHANW! DOUSRIAL DEVELOPMEff PROJECT

Shanachl Printing Machinery Subsoctor

Subsector Output Value(198-89)

your 1963 198I 1987 1989

Insld Outide / Sub- Inside Outside pj Sub- Inside Outside / Sub- Intide Sub-

Shanghai Shanh al Expert total Shangabt Shanghat Export total Shanfiha Shang-ai Export total Shanghal Export total

Total 2,072 8,8a8 629 9,099 2,063 7,969 510 10,632 2,7i2 8,S90 1:034 12,136 16,767 2717 18,484

Web Offxot 141 679 0 720 82 1,282 11 1,326 160 1,048 183 1,889 1,362 69 1,431

Large Offset 15 608 0 619 21 279 0 800 9 171 0 180 1,112 0 1,112

Medi mOffeut 16 167 0 188 48 177 0 223 44 176 0 220 617 6 623

Duplicator 0 0 0 0 a 0 0 8 23 71 0 94 0 0 0

LAtter Press 188 1,941 64 2,183 198 2,282 81 2,611 269 2,783 60 8,112 3,779 291 4,070

Post Pres 8l 856 269 1,160 s9 19,au 110 1,857 61 1,300 1i8 1,56W 1,299 1181 2,480

p Within China.

It0

-97 - ANNEX 6Attachment 3

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Shanghai Printing and Packaging Machinery Subsector

Consolidated Financial Statements, December 31, 1989

A. Consolidated Income Statement

Y,O0O

Sales income 100,935Less cost of goods sold 75,624

Gross income 25,311Less administrative and selling expenses 1,848

Operating income 23,463Other income 143Interest and other expenses 4,536

Net income 19,073Taxes 13,223

Net income after taxes 5,850

B. Consolidated Balance Sheet

Y'000 Y'00

Current Assets Current LiabilitiesCash and bank balance 3,J67 Accounts payable 42,658Accounts receivable 24,617 Short-term borrowings 34,709Inventories 79,087 Others 2,244

Total Current Assets 106,771 Total fiurrent Liab. 79,611

Fixed Assets Long-Term LiabilitiesLand, buildings, machin- Long-term debt 35,685ery and equipment 87,512 Others -

Accumulated depreciation 35,251Total Liabilities 115,296

Net Fixed Assets 52,261Equity

Other Assets 48.947 State funds 59,624Special funds 29,356

TOTAL ASSETS 207,979 Enterprise funds 3,703

Total Equity/Funds 92,683

TOTAL LIABILITIES ANDEQUITY 207,979

ANNEX 7- 98- Page 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Consulting Services

Terms of Reference

Introduction

1. The Shanghai Municipal Government (SMG) commissioned two reputedinternational consulting firms to prepare in conjunction with the ShanghaiPlanning Commission (SPC), the Shanghai Economic Commission (SEC), theShanghai Instrument and Electronic Bureau (SIEB) and the Shanghai Mechanicaland Electrical Bureau (SMEB) subsector specific restructuring programs for thefollowing four industrial subsectors.

(a) Shanghai Electronic Component Subsector

(b) Shanghai Precision Scientific Instrument Subsector [Subsectors (a)and (b) are under SIEB]

(c) Shanghai Electric Apparatus Subsector

(d) Shanghai Printing and Packaging Machinery Subsector [Subsectors (c)and (d) are under SMEIA].

2. The consultants, working together with each of the corporations andthe enterprises in the respective subsectors, have submitted their recommenda-tions. The proposed subsector strategies are aimed at improving the overalloperational efficiency and effectiveness of the subsectors' factories in orderto increase both domestic and international competitiveness and developdirect/indirect exports. These strategic changes need to be carried outacross the subsector corporations and factories and encompass organizationaldevelopment and structure, product/market strategies including development ofmarketing and distribution channels, appropriate management planning, controland information systems, operational effectiveness programs in the manufactur-ing and technology functions, strategic planning, etc., supported by appropri-ate policy and institutional reforms. The consultants' recommendations havebeen accepted in broad ou'tline by SMG, SPC, SEC, SIEB and SMEIA and the pro-gram is now ready for impleimentat'-r . These authorities recognize that themanagement of this implementatien project iS an extremely complex task requir-ing coordination and control of sc-eral activities and the active participa-tion and cooperation of numerous individuals within many government depart-ments and the concerned corporations/factories. SIEB and SMEIA propose toimplement this complex restructuiring project with the assistance of the con-sulting firms who were earlier involved in the preparation of the subsectorstrategies.

- 99 - ANNEX 7Page 2

Objectives

3. The objective of the proposed consultancy services is to assist thevarious authorities involved in the implementation if the restructuring pro-grams through systematic design and successful implementation of the entireprocess so as to ensure timely completion of the project activities with mini-mal disruption of current operations. The ultimate objective is the "success"of the business enterprises in these subsectors in achieving the goals andobjectives of the industrial restructuring and the design of systems for effi-cient operations. The consulting work includes bringing about sustainedchanges in employee motivation and attitudes through associated organizationaldevelopment programs. Practical and transparent incremental benefits shouldbe realized from an early stage of program implementation to provide motiva-tion for continuing efforts on the several tasks inherent in the design ofsuch a complex project. As organization structures and systems are closelyrelated and interdependent, they should be compatible and mutually reinforc-ing. To avoid any organizational dysfunctioning, these two tasks are, there-fore, being integrated and form a part of this consulting assignment.

4. The primary responsibility for the implementation of the subsectorrestructuring projects will be that of the top level Steering Committee pro-posed to be established by SMG which will be suitably assisted by an inter-agency Project Monitoring Unit which will monitor the tasks relating to thesubsector restructuring programs, prepare details of policy measures forapproval by the authorities and monitor the technical assistance component ofthe project. The subsector restructuring programs will be implemented by thesenior management project implementation committees at the corporation andfactory levels. These committees will designate project leaders who will headseveral task forces drawn from concerned senior executives of the factories.The project leaders will report periodically to their committees. The role ofthe consultants in these matters is to support the committees, project leadersand task forces in the detailed design of project implemei.tation tasks, definethe human and financial resources that are necessary, assist in selection andcomposition of task forces and in the development of work plans and activityscbedules, implementation of these detailed plans and finally, in effectiveproject monitoring and control systems, and assessment of the effectedchanges. It has been recognized that it would be overambitious and disruptiveto cover all the factories in the four subsectors simultaneously. It is,therefore, proposed to focus the changes initially in model factories in eachsubsector and based on the experience gained, to guide changes in the remain-ing factories. At the same time, a number of short-term improvements can bemade in almost all enterprises, as also certain activities with long leadtimes can be initiated which need not necessarily await the outcome of themajor exercises being carried out in the pilot projects. The consultants willalso assist in initiating and implementing such activities. An importantobjective is to transfer this expertise in project design and implementationto the management of the subsector corporations/factories to enable them toindependently continue project implementation throughout the subsectors aftercompletion of the pilot projects. Additionally, the design of factory orga-nization structures and management systems requires extensive work and foreignconsultants should utilize to the maximum extent possible, consistent with theavailability of suitable local consulting skills, the services of localChinese consulting firms. It may also be desirable to use Chinese consultants

- 100 - ANNEX 7Page 3

where possible to facilitate communication and effect economies in consultingexpenses.

Scope of Services

(a) Assistance in Project Management Design and Implementation

5. The restructuring proposals focus on a number of managerial and"software' issues (subsector organization, management systems, operationaleffectiveness, production technology, product development and technologytransfer, etc.) as well as hardware aspects. Plans for implementation of allthese multiple interdependent activities will need to be established, detailedtasks identified and scheduled as a part of the Master Project Design. |Detailed near-term implementation plans (0-12 months) will need to be drawn upto incorporate some of the implementation steps which can be initiated immedi-ately to ensure the success of the entire subsector restructuring program anithose which have long lead times but involve relatively low levels of fundingand, therefore, can also be initiated promptly. Next, the long-term compre-hensive implementation plans will have to be established. Based on the man-power resources required for project iriplementation, the consultants willadvise and assist the corporations in establishing the Project ImplementationOrganization and Monitoring Systems. Senior management will be sufficientlyinvolved in the consultancy so as to unequivocally indicate to the employeesin the subsector enterprises their total commitment and irvolvement in theimplementation of the pro,ect. The consultants will assist in the projectimplementation and monitoring process as frequently as is considered necessaryfor timely and successful completion of proiect activities.

6. Beside advice and active assistance in project management, there arecritical tasks forming an essential part of the restructuring program whichconstitute the core of this consulting assignment. The consultants will fur-ther be expected to supplement these tasks with any other aretivities that maybe crucial to the success and effectiveness of these restructuring programs.These critical design and implementation tasks relate to: (i) organizationstructure and development; (ii) marketing and sales distribution; (iii) opera-tional effectiveness programs; (iv) production technology upgrading; (v) man-agement planning control and information systems; (-'i) product development andtechnology transfer; (vii) consolidation of production and preparation offeasibility studies. The scope of work under each of these heads is brieflydescribed in the following paragraphs.

7. (i) Organizational Structure and Organization Development. Theconsultants will need to assist the corporation in developing detailed orga-nization structures at the corporate, divisional and factory levels. "Transi-tional" structures for business divisions should be designed so as to facili-tate eventual shift to the divisional concept. This work will include defin-ing roles and responsibilities, job specifications, optimum manning, and anassessment of current management personnel to fulfill the new roles.

8. It is apparent that the implementation of the recommended organiza-tion structure cannot be done without extensive training at all levels ofmanagement and operations staff. This aspect of organization development iscrucial to the success of the project. The consultants will identify the gaps

- 101 - ANNEX 7Page 4

in managerial and supervisory skill,, prioritize the training needs and assistin conducting short training seminars (up to one week) particularly for seniormanagement. Tt?y will also advise on the type, venue and cost of in-depthtraining programs of longer duration which would be necessary for developmentof the requisite managerial skills at different levels. The actual conduct ofthe long duration training courses is, however, outside the scope of thisassignment.

9. (ii) Marketing and Sales Distribution. The strengthening of themarketing organization and distribution arrangements has been identified as apriority task. Consultants will assist in developing the organization struc-ture and in establishing marketing policie6 which are in consonance with therecommended product/market strategies. They will advise on locating andestablishing adequate distribution channels, sales and services networks forthe domestic and target international markets, including likely joint venturepartners to facilitate exports.

10. (iii) Operational Effectiveness Programs. Several short-termprojects for improving operational effectiveness and aimed at improving pro-ductivity, reducing costs, enhancing quality, increasing capacity utilization,etc., have been recommended. Consultants wit' issist in design and implemen-tation of such operational effectiveness min es in the subsector factories.This will include the design and implementat. an of operational system upgradesincluding production planning and control, inventory management, preventivemaintenance, quality assurance, etc. Consultants will also review currentplans for capacity expansion through acquisition of fixed assets in light oflikely improvements which may be realized through these operational effective-ness measures.

11. (iv) Upgrading Production Technology/Manufacturing Processes.Consultants will assist in identifying gaps in production processes as cur-rently practiced and recommend/implement suitable improvements consistent withrealization of optimum manufacturing costs as related to the volume of produc-tion.

12. (v) Product Development and Technology Management. Consultantswill assist in identifying acquisition of technical expertise from appropriatesources for improving products. This also includes assistance in implementa-tion of measures aimed at improving technology absorption, in-house productdevelopment, and in ensuring that enterprises initiate steps for redesign ofkey products and acquisition of new technology.

13. (vi) Development and Design of Strategic Planning, Management andControl Systems. Based on the organization structures which are to be imple-mented, consultants will develop and design management information systems forall key management functions including corporate, divisional and factory leveloperations control, financial accounting, planning and control, cost account-ing, materials management (corporate and divisional level), business planning,market and sales system, manpower planning, performance evaluation and incen-tive systems, etc. Some of the other subsystems such as production planningand control, preventive maintenance, quality assurance, stock control, etc. asalready referred to in para. 10 as a part of operational effectiveness mea-sures are also to be included. The consultants will determine the adequacy

- 102 - ANNEX 7

Page 5

and readiness of the factories to implement these systems manually or with thehelp of computers. This will also depend on the availability of the requiredhardware and software in China. However. the design ef the systems should beXsuch as to facilitate electronic data processing and integration at a laterdate.

14. The product/market strategies recommended for the respective subsec-tors are based on the macroeconomic environment in China as foreseen today. IIt is necessary to institutionalize within the corporations the capability toresponse to macroeconomic and business environment changes which will inevita-bly take place in China and the overseas markets even during the implementa-tion of the present project. Consultants will assist in establishing theorganization needed for long term business and strategic planning in eachsubsector to build full-fledged strategic planning capability. The organiza-tion of a practical strategic planning unit at the corporate and divisionallevel should be implemented in the near term.

15. (vii) Consolidation of Production and Preparation of FeasibilityStudies. Conealtants will assist the respective corporations in the drawingup and implementation of plans for rationalization of products and consolida-tion of produztion facilities so as to optimize utilization of resourcesthrough elimination, wh_rever feasible, of the manufacture of overlappingproducts or components at more than one production facility. Such rational-ization proposals would involve relocation of physical assets and manpowerfrom a less efficient to a more efficient site.

16. Proposals for investments in projects for expansion/diversificationwill be considered only after the impact of imiplementation of the above con-solidation measures have been taken into account. Consultants will assist thesubsector corporations in the preparation of project feasibility studies.These studies would, among other things, clearly spell out the strategic fitof the proposed projects with the recommended product/market strategies, themarketing and distribution arrangemer.ts and the financial and economic viabil-ity of the project.

Progress Reports

17. Consultants will submit progress reports once every quarter, clearlydefining the progress made under various activities and including designdetails of the organization structures/management systems/operational effec-tiveness measures proposed and implemented. For day-to-day monitoring of theproject, there will be a frequent reporting system established as a part ofthe 'Project Management' design which, however, will be the responsibility ofthe respective project managers in charge of various task forces. The consul-tant's responsibilities will be to see that these project monitoring reportsare prepared by the project managers and submitted on time and to assist andadvise on remedial steps which need to be taken whenever necessary to bringthe project on course.

18. At the end of each year of the consultancy assignment, the consul-tants will prepare a summary progress report, which will indicate the adequacyand capability of the subsector corporation/division/factory in independentlycontinuing the remaining project management activities and the extent to which

- 103 - ANNEX 7

Page 6

external consulting ass.'stance is still needed. Copies of the progressreports will be submitted to the World Bank for their review and information.Consultants may also be expected to make a presentation of the progress undervarious project components at suitable intervals, when World Bank staff mayparticipate.

19. The reports will also summarize the experience and lessons learnedfro- She implementation of these subsector rescructuring programs.

Collaboration j

20. The foreign consultant should present its suggestions regarding theextent of domestic consulting firms' participation in the work. This involve-ment, however, should not affect the foreign consultant's responsibility forthe consultancy services.

-104 - ANNEX 8Page 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Scope of Subproject Feasibility Studies

1. The objective of the subsector restructuring programs is to enablethe corporations and the business divisions reporting to them to increaseinternational competitiveness and efficiency. Restructuring strategies andprograms have been prepared by the corporations working jointly with interna-tional consultants. The implementation of the proposed strategies will berealized through several factory-level subprojects. It is therefore necessarythat the subsector corporations that intend to participate in this projectclearly demonstrate through their feasibility studies that their investmentsare in pursuance of the recommended strategies accepted for implementation.The feasibility studies should include the following aspects.

Past and Current Activities of the Factory

2. Description and analysis of product groups, markets, main raw mate-rials and sources, technology, structure of distribution and sales network,and major constraints that have affected the growth of the factory. The anal-ysis should be supported by documentation on the past three years' performance(production, sales, profit, and other indicators), financial history, physicalstatistics of the factory, manpower, and so on. Financial statements of theaccounts at the factory level will be necessary for meaningful presentation ofpast performance.

Product and Market Strategies for the Business Divisions

3. Description of the product and market strategy proposed for imple-mentation by the business division in which the factory will be incorporated(after the transition period). The strategy should be supported by (a) analy-sis of current and potential competitiveness of major product groups in thedomestic and export markets;l/ (b) recommendations relating to the productgroups and markets that will form the division's focus to ensure its economicand financial viability; and (c) identification and recommendation of market-ing and distribution arrangements and practices.

Proposed Project

4. Description of the proposed subproject, including an evaluation ofproduct technology for the existing and proposed product mix focusing on:assessment of present production facilities with respect to production tech-nology, manufacturing capability, tool4ng, etc., indicating areas for upgrad-

1/ These should include market- assessment (domestic and export), marketshares as compared to domestic and foreign competitors, cost, price andquality competitiveness, etc.

- 105 - ANNEX 8Page 2

ing, replacement, improvement and proposed capacity expansion; availability ofmaterial inputs (domestic and imported), recommendations for material substi-tutions, savings, etc.; availability and sufficiency of utilities and relatedinfrastructure; examination of existing and proposed licensing and know-howacquisition; evaluation of quality control and testing facilities and need fortheir strengthening; assessment of existing and proposed product developmentand research programs as related to the proposed product mix. The projectshould also clearly spell out the rationalization and consolidation of prod-ucts and production facilities that have or will be carried out simultaneouslywith the implementation of the project.

Environmental Control Measures and Safety Engineering

5. Description of existing and proposed measures aimed at complyingwith the prevailing environmental regulations as applicable to the factoryincludit,g noise, effluents, and so on. The feasibility study should specifythe investments included for environmental control. It should enclose a cer-tification from SEPA that the proposed measures comply with SEPA's regula-tions. It should also state that the factory sponsoring the subproject is incompliance with environmental standards on its current operations. A descrip-tion of measures to implement safe working practices in the factory shouldalso be included.

Organization

6. Description of the existing factory organization structure and man-power proposed to improve operational effectiveness and efficiency. Reportingrelationships to the divisional and corporate management should be high-lighted. Organizational development measures and proposals for training ofmanagers and other employees should also be included.

Management and Systems Development

7. Analysis and recommendations to strengthen management functions:marketing (e.g., export and domestic market development, market promotio.in,sales distribution, pricing); technical (e.g., production planning and con-trol, plant maintenance systems, industrial engineering, materials managementincluding inventory control); financial (e.g., financial and cost accounting,financial planning, budgeting); specific implementation plans for short- andlong-term improvements in management information and reporting system, etc.

Strategic Planning

8. The feasibility study should also describe the institutional struc-ture which will be developed at the divisional and corporate level for strate-gic planning and the inputs that the factory will provide to facilitate suchplanning including the proposed organization for monitoring the implementationof strategic plans should be included.

Subproject and Corporate Analysis

9. A detailed analysis shall be made of proposed subproject investmentsto support the factory strategies in the above areas. Investments that

- 106 - ANNEX 8

Page 3

improve the technological capability and efficiency o. the factory and divi-sion, as well as their international and domestic competitiveness, should beconsidered. The analysis should include: (a) a market analysis (domestic andexport); (b) technical aspects, capacity and production program, nature andprice of major equipment and sources of origin, separately in local and for-eign currency for equipment, technology transfer and licensing, managementsystem and assistance, training, etc.; (c) estimation of all capital costs,civil works, physical and price contingencies, interest during construction,incremental working capital to achieve production upgrading and expandedcapacity; (d) proposed financing plan for the subproject; (e) estimation ofnew production costs of the products under the subproject compared with exist-ing and international levels, unit prices of major inputs and outputs andcomparison with international prices; (f) incremental financial and economicrates of return of the subproject (based on with and without analysis of theproposed investment) including a sensitivity analysis of subproject viability;and (g) income statement, balance sheet and cash flow forecast for the corpo-ration as a whole. Based on this evaluation, the project should demonstrateits capability to meet all the eligibility criteria that have been agreed tofor SIDP.

Project Organization and Implementation

10. A description of the main activities highlighting critical tasks,accompanied by a project implementation schedule, should be included. Theproposed organization responsible for project implementation, including thetask forces that will be set up for key areas, should be spelled out. Theprogress reporting system to be established should also be specified.

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Implementation Schedule of Major Activities

Major Activities 1989 1990 J 1991 1992 1993

Approval of charters by SMG x

Establishment of corporations x

Appointment of consultants ---------- -

Establishment of Board of Directors ------- ---

Organizational Structure

Detail plans of structure of cor-porations, divisions and plants --- -----

Implementation of structural plans -------- -----Financial consolidation of plants ----- ----

Plant Restructuring

Restructuring plans of model plant --- ---Feasiblity study of model plant -----Implementation of model plant

subproject --- ---------- ---Restructuring plans of other plants -------- -----Feasibility studies of other plants --- ----------Implementation of other subprojects ---------- ---------- --- June 95

Management, Organization and Systems

System organizational plans of cor-porations, divisions and plants ---------- ----------

Development and implementation of MIS ---------- ---------- ----------Reorganization of domestic marketing ---------- ----------Establishment of export organization . ______ -----

- 108 - ANNEX 10

CHINA

SHA14GHAI INDUSTRIAL DEVELOPMENT PROJECT

Key Monitoring Indicators

Indicators Target Dates

A. General

Loan Effectiveness March 15, 1991

B. Utilization of Credit Component

Last date for subproject submission December 31, 1993Last date for loan withdrawal June 30, 1996

C. Implementation of Project

Appointment of consultants January 1991

Enterprise Reform:

Approval of Charters May 1989Establishment of integrated corporations June 1989Financial consolidation of factories March 1990Establishment of board of directors July 1990

Organizational Structure:

Detailed plans of structure of corporation,business divisions and factories June 1991

Implementation of organizational plans June 1992

Restructuring Plans:

Restructuring plans of model plant April 1991Feasibility study of model plant June 1991Implementation of subproject in model plant June 1993Restructuring plans of other plants June 1992Feasibility studies of other plants December 1992Implementation of subprojects in other plants June 1995

Management Organization and Systems:

Overall plans for corporation, division and plants December 1991Reorganization of domestic marketing December 1991Establishment of direct export organization December 1992Development and implementation of MIS December 1993

- 109 - ANNEX 11Page 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Shanghai Investment and Trust Corporation (SITCO)

1. Institutional Aspects. SITCO was established in 1981 by theShanghai Municipal Government (SMG) as a state-owned, nonbank financial insti-tution. It Is administered by the Shanghai Municipal Commissicn of ForeignEconomic Relations and Trade and is supervised by the People's Bank of China.SITCO is governed by a Board of Directors, which consists of a Chairman, tenManaging Directors, six of whom also serve as Vice-Chairmen, and 45 Directors.The President is responsible for the day-to-day operations and management ofthe corporation. SITCO has five subsidiaries, four of which are wholly-owned,and three overseas representative offices.l/ Together with its subsidia-ries, SITCO undertakes a full range of financial services including loan andequity financing, investments, trust, foreign trade and other foreign exchangetransactions, issue of securities, consultancy, real estate, and other ser-vices related to Sino-foreign businesses. An organizational chart of SITCO isattached.

2. One of SITCO's major strengths is its highly qualified staff.Eighty percent of its 408 employees have postgraduate, university, or poly-technic degrees. The corporation plans special emphasis on regular in-houseand overseas training of its staff.

3. Lending Policies and Procedures. SITCO was founded with the objec-tive of implementing the government's policy to open up Shanghai to the out-side world. As a result, it specializes in investment and trust servicespertaining to the use of foreign capital and the importation of technology.SITCO especially promotes export-oriented and import-substituting productiveventures, as well as projects which introduce new technology. The key crite-ria used for appraising loan applications are: (a) the borrower's ability toearn foreign exchange or to substitute for imports; (b) the financial andeconomic benefits resulting from the project, as measured by rates of return;(c) the management and financial performance of the prospective borrower; and(d) the auality of the loan repayment guarantee. The financial criteria usedfocus on the cash flow generation of the borrower and project under consider-ation.

4. Foreign exchange loans below $3 million and renminbi loans belowY 10 million are approved by division managers; loans above this limit are tobe approved by the Executive Vice Presidents. All foreign exchange loans are

1/ The four wholly-owned subsidiaries are: SITCO International Trading Co.;SITCO Enterprises Co., Ltd.; SITCO International Consulting Co.; andSITCO International Tendering Co. SITCO owns 43 percent of InternationalSecurities Co., and is finalizing the negotiation of a joint venturefinance company with PCBC, Bank of Tokyo, and Societe Generale (25 per-cent share for each).

- 110 - ANNEX 11Page 2

reported to the Foreign Exchange Administration Commission. About 30 loanofficers are responsible for promotion, appraisal, and supervision of thecorporation's loan portfolio of over 200 accounts. Supervision procedurestypically consist of site visits and quarterly review of borrowers' financialstatements and project progress.

5. Operations. Between 1984 and 1988, SITCO approved over 200 loans,$1.5 billion equivalent in foreign exchange and Y 1.1 billion in local cur-rency. Light and textile industries accounted for 47 percent of the loanapprovals, while chemical, machinery, metallurgy, and electronics accountedfor 42 percent. About 95 percent of the lending was to finance modernizationand technical transformation projects. About 50 percent of the loans approvedare small to medium in size, ranging from $1 million to $3 million, and havematurities of three to five years. The bulk of the lending (95 percent) isdenominated in foreign currencies. The rest of the portfolio (5 percent)consists of short-term loans denominated in local currency; these are used toprovide limited financing for working capital.

6. Fifty-eight equity investments were made between 1984 and 1987, $8.1million in foreign exchange and Y 373 million in local currency. Sixty per-cent of these investment projects are cooperative ventures with Chinese part-ners, and 40 percent are joint ventures with foreign partners, mainly fromHong Kong and the United States. About two-thirds of these investmentsinvolve manufacturing and construction/engineering projects. The other one-third involve hotels, real estate development, and other services. SITCO'slending operations between 1984 and 1988 are shown in Table 1 of this Annex.

7. Financial Performance, Position and Resources. SITCO has been oper-ating profitably since its start-up. It was tax-exempt for the five yearsbetween 1982 and 1987, but it began paying income and other taxes in 1988. In1989, SITCO's average spread on lending operations was 3.3 percent, and thepretax return on average assets 2.3 percent. These returns are satisfactory,although they represent a decline from the returns in previous years due togreater competition and a less favorable macroeconomic environment. Adminis-trative expenses were 0.4 percent in 1989. The return on the equity portfo-lio, consisting mainly of dividends, averaged about 11 percent during 1988 and1989. SITCO's foreign currency loans are generally priced at semiannualfloating interest rates, which are based on the deposit and loan interestrates periodically quoted by the Bank of China. The corporation appears tohave more flexibility in pricing its loans and in charging penalty interest onoverdue principal payments, since PBC has not yet issued regulations on for-eign currency lending.

8. SITCO is very strongly capitalized, with a capital-to-assets ratioof 18 percent at end-1989. It is owned by SMG, whose capital contributiontotaled Y 775 million at end-1989. The corporation's financial statements areattached as Tables 2 and 3 of this Annex.

9. SITCO's foreign exchange loans are partially funded by long-termborrowings from international banks. In addition, between 1986 and 1988, thecorporation raised Yen 40 billion by floating two bond issues in the Euroyenmarket. The first issue of Yen 25 billion carries a ten-year term and a fixedinterest rate of 6.6 percent per annum. The second has a seven-year term, and

- 111 - ANNEX 11Page 3

has been swapped into US dollars at LIBOR less 0.16 percent per annum. SITCOalso has negotiated a $100 million loan from the Asian Development Bank. Inaddition, it also obtained a $20 million syndicated loan from Hong Kong in1989.

10. Quality of Loan and Equity Portfolios. SITCO has rescheduled threeloans totaling about $25 million since it started its lending operations in1986. The corporation claimed that no other overdue principal and interestpayments had been experienced as of December 1989. Most of the joint venturesin which SITCO had invested were reported to be operating satisfactorily.Since most of these ventures are in the start-up phase, however, their profit-ability and potential capital gain or 10s3 will have to be assessed in duecourse.

ANNEX 11- 112 - Table 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Shanghai Investment and Trust Corporation (SITCO)

Operations(Y million)

1984 1985 1986 1987 1988

Approvals

Local currency 1.0 19.6 90.0 83.0 900.0

Foreign currency 4.3 153.9 875.0 1,451.3 2,595.6($ mln equiv.) (1.2) (41.6) (236.5) (392.2) (786.0)

Total 5.3 173.5 965.0 1,534.3 3,495.6

Disbursements

Local currency 0.6 10.8 60.5 112.3 672.0

Foreign currency 0.4 83.0 156.1 746.4 1,745.7($ mln equiv.) (0.2) (29.7) (51.7) (200.5) (469.0)

Total 1.0 93.8 216.6 858.7 2,417.7

Outstanding Loan Portfolio

Local currency 0.5 6.9 57.2 83.0 168.8

Foreign currency 2.8 85.1 238.6 982.1 1,718.0(5 mln equiv.) (0.8) (23.0) (64.5) (263.9) (461.6)

Total 3.3 92.0 295.8 1,065.1 1,886.8

ANNEX 11- 113 - Table 2

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Shanghai Investment and Trust Corporation (SITCO)

Income Statements(Y million)

1984 1985 1986 1987 1988 1989(unaudited)

IncomeInterest income from loans 1.7 3.6 44.3 94.6 170.7 304.5Income from equity investments 57.5 50.5 44.3 60.6 62.4 29.0Commissions and other income 3.6 8.3 10.7 10.7 13.1 24.0

Total Income 62.8 62.4 99.3 165.9 246.2 357.5

ExpensesFinancial expenses 0.1 0.4 43.9 92.5 165.6 252.8Administrative and other

expenses 0.9 2.0 2.9 3.5 7.0 14.8

Total Expenses 1.0 2.4 46.8 96.0 172.6 267.6

Profit Before Tax 61.8 60.0 52.5 69.9 73.6 89.9

Income tax and other taxes /a 0.0 0.0 0.0 0.0 39.6 47.8

Net Profit 61.8 60.0 52.5 69.9 34.0 42.1

Ratios (Z)Average interest spread n.a. 7.3 15.0 7.0 3.9 3.3Administrative and otherexpenses/average assets n.a. 0.4 0.3 0.2 0.2 0.4

Return on average assets(pretax) n.a. 11.9 5.5 3.9 2.5 2.3

Return on average equity(pretax) n.a. 16.4 14.2 16.2 11.1 11.0

la SITCO was exempted from taxes during the first five years (1982-87) ofoperations.

ANNEX 11- 114 - Table 3

CHINA

SHANGHAI INDUSTRlAL DEVELOPMENT PROJECT

Shanghai Investment and Trust Corporation (SITCO)

Balance Sheetsy ;i1TfI0on)

1984 1985 1986 1987 1988 1989(unaudited)

Assets

CurrentCa-shand bank deposits 37.3 149.5 449.2 483.7 622.7 354.4Short-term loans 0.5 6.9 57.2 83.0 204.5 1,153.6Marketable securities 0.0 0.0 116.7 19±.3 279.4 279.4Other receivables 57.8 55.6 68.0 77.3 86.0 105.7

Total Current Assets 95.6 212.0 691.1 835.3 1,192.6 1,893.1

Long-TermLongterm loans 2.7 85.0 238.6 982.0 1,683.8 Z.130.3Equlty investments 289.8 300.9 313.9 403.3 '29.8 202.2Fixed assets (net) 0.7 1.1 5.6 5.7 6.5 8.7Other assets 11.2 12.2 49.6 94.4 149.1 128.9

Total Long-Term Assets 304.4 399.2 607.9 1,485.4 2,269.2 2,470.1

TOTAL ASSETS 400.0 611.2 1,299.0 2,320.7 3,461.8 4,363.2

Managed funds - assets 0.0 0.0 0.0 169.4 168.4 51.9

xiabilities and Net Worth

LiabilitiesCurrent LiabilitiesEnterprise deposits 26.7 106.9 82.0 403.3 413.7 435.5Short-term bank loans 0.0 5.3 25.3 236.3 311.7 505.7Other payables 1.8 4.4 39.6 40.3 64.5 152.0

Total Current Liabilities 28.5 116.6 146.9 679.9 789.9 1,093.2

Long-Terr LiabilitiesExternal borrowings 0.0 123.6 771.1 1,143.4 1,833.3 2,454.0Other long-term liabilities 6.6 2.7 11.2 5.8 4.8 13.5

Total Long-Term Liabilities 6.6 126.3 782.3 1,149.2 1,838.1 2,467.5

Net WorthVPat-ri7n capital 300.0 300.0 300.0 400.0 730.3 775.2Reserves and retained earnings 64.9 68.3 69.8 91.6 103.5 27.3

Total Net Worth 364.9 368.3 369.8 491.6 833.8 802.5

TOTAL LIABILITIES AND NET WORTH 400.0 611.2 1,299.0 2,320.7 3,461.8 4,363.2

Managed funds - liabilities 0.0 0.0 0.0 169.4 168.4 51.9

Supplp:ntaryOutstanding letters of credit 0.0 0.0 0.0 365.5 166.8 193.6Outstanding guarantees 6.9 32.5 70.3 189.5 240.0 189.2

Total Contingent Liabilities 6.9 32.5 70.3 555.0 406.8 382.8

RatiosCapital-to-assets (Z) 91.0 60.0 28.0 21.0 24.0 18.0

SHANGHAI INVESTEl AND TRUST CORPORATION (SITCO)Orpnlzso Chwt

(As of December IMS)

Old ofofo DO 14

= Phims OIVWOO 1)(1

Ri Mli (4 CSITO hl emimCo ()

.,k~, OdegCExlioF doNM4

vi P_|_Ob M(}

u~~h DMdb.n in8

OmUFw Ddhgih CUb (NA.) (= o ha 4s h

Told Mw__wuit A Stag 363,Ars :14

r1|X|

MX,-,

ANNEX 12116 - Page 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

The Industrial and Commercial Bank of China (ICBC)

1. Institutional Aspects. ICBC was founded in April 1984 as a spin-offof PBC's former Savings Department and the Industrial and Commercial Adminis-tration Department. It is China's largest state-owned commercial bank, withassets of Y 562 billion and capital of Y 32 billion at the end of 1988. Theoutstanding deposits and loans in 1987 represented approximately half of thedeposits and loans in China's financial sector. The bank also has the largesturban branch network, with 24,000 branches and subbranches employing 440,000people. It essentially controls the country's urban savings deposits andprovides most of the short-term industrial and commercial credit to urbanenterprises.

2. ICBC's Shanghai branch has 21 subbranches, 13 of which are locatedin the city. Eight subbranches were opened in the suburban area in 1989. TheShanghai branch has three wholly-owned subsidiaries engaging in trust, invest-ment, real estate and consultancy businesses, plus two joint ventures withlocal and foreign partners specializing in leasing activities. The branchemploys about 14,000 people. An organizational chart of the branch isattached.

3. Lending Policies and Procedures. ICBC's Shanghai branch has a spe-cial credit unit in charge of fixed asset investment loans for technicaltransformation purposes. This unit, originally established in 1979 by PBC,became part of ICBC when the latter was created in 1984. Each of the 21 sub-branches in Shanghai has a counterpart credit unit which specializes in tech-nical transformation lending operations. The Shanghai branch's TechnicalTransformation Credit Division has 17 staff members, 14 of whom are economistsor financial analysts. Two staff members have attended ccurses on projectfinancial and economic analysis that were sponsored by the Economic Develop-ment Institute (EDI) of the World Bank and local academic institutes. As thebranch does not have an in-house engineering staff, it draws on its subsidiaryconsulting unit and outside technical consultants to render opinion on thetechnical viability of large projects. The branch's approval limit for localcurrenlcy loans is Y 30 million (for petrochemical and large projects, thelimit is Y 50 million), and that for foreign exchange loans is $5 million.The head office's approval is normally required for loans above these limits.

4. Operations. ICBC's Shanghai branch primarily operates in localcurrency as its international banking business only started up in mid-1987.Between 1985 and 1989, the branch approved 1,788 projects for technical trans-formation (i.e., modernization and t.chnology upgrading). Cumulative commit-ments and disbursements amounted to over Y 6.7 billion and Y 6.0 billion,respectively, during the same period. The transportation sector received37 percent of all loans; the light industry and textile sectors, 26 percent;and the machinery and electronics sectors, 21 percent. The machinery and

- 117 -ANNEX 12Page 2

electronics sectors received approval for about 350 small loans, totalingY 1.4 billion for modernization. The average size of all loans, excluding thetransportation sector, is Y 2.8 million, and the average maturity is aboutthree years. Loans to finance construction of transportation equipment gener-ally have maturities of seven to ten years. Table 1 of this Annex shows thebranch's technical transformation lending activities by sector.

5. Financial Perfonmance, Position and Resources. Before BOCOM wasreestablished in 1987, ICBC's Shanghei branch was the sole commercial bank andprovider of short-term working capital financing to the city's enterprises.With a new competitor, BOCOM, which is aggressively promoting a full range ofwholesale and ,etail banking services, ICBC's Shanghai branch is activelyimproving its services and expanding its branch network to protect its domi-nant position. The branch was hard-hit by the inflation-led run on savingsdeposits in July and August 1988. During these two months, the branch's sav-ings deposits dropped by Y 0.2 billion (about 1.8 percent) and did not recoveruntil September 1988, after infla.ion-indexed interest rates were introducedfor three-year savings deposits.

6. The branch's profitability was satisfactory between 1985 and 1989;it had an avecage interest spread of 4.0 percent and a pretax return on aver-age assets of 2.3 percent in 1989. The branch retains about 20 percent of itsprofits and transfers the balance to the head office. It relies heavily onborrowings from PBC to fill the gap between deposits and laans. At the end of1988, about 18 percent of the branch's lending assets were funded by loansfrom PBC. Other sources of funds include financial bond issues and the inter-bank money market. In addition to its participation in this project, thebranch also is exploring alternative foreign exchange sources such as loansfrom ADB, bilateral government credits, export credits, ar, other short-termbank loans.

;7. The branch's capital ratios are not meaningful since it is a bankbranch without an independent capital base, other than the small amount itretains of its annual profit.3 (20 percent) to meet operational needs. Finan-cial statements for the period 1985 through 1988 are attached as Tables 2 and3 of this Annex.

8. Quality of Loan Portfolio. Like most other PFIs, ICBC's Shanghaibranch has not made any provision for bad loans, as there is no regulationrequiring such a provision. Nevertheless, the branch plans to start makingsome allowance for bad loans in 1988, largely because PBC has requested it towrite off long overdue loans. At the end of 1989, the arrears of the Techni-cal Transformation Credit Division were reported to be less than 1 percent oftotal outstanding principal; this compared to 1.4 percent at the end of 1987.About 2.6 percent of loans in this Division were estimated to be affected byarrears at the end of 1989.

- 118 - ANNEX 12Table 1

CEINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

The Industrial and Commercial Bank of China (ICBC) - Shanghai Branch

Operations (Technical Transformation Loans Only)(Y million)

Cumulative 1985-89 LoansNo. of Loans Loans Loans outstandingprojects approved disbursed repaid 12131/89

Light industries 370 869.40 866.11 499.94 366.17

Textiles 302 883.16 825.67 345.41 480.26

Chemical 86 396.89 394.65 153.15 241.50

Transportation 286 2,455.95 2,221.96 791.36 1,430.60

Machinery andelectronics 347 1,370.54 950.83 230.56 720.27

Others 397 694.34 692.25 288.40 403.85

Total 1,788 6,670.28 5,951.47 2,308.82 3,642.65

- 119 - ANNEX 12Table 2

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

The Industrial and Commercial Bank of China (ICBC) - Shanghai Branch

Income Statements(Y million)

1985 1986 1987 1988 1989(unaudited)

Income

Interest income from loans 1,375.0 3,492.3 4,940.8 5,129.5 7,349.7

Commissions and other income 11.4 5.7 3.2 15.2 64.4

Total Income 1,386.4 3,498.0 4,944.0 5,144.7 7,414.1

Expenses

Financial expenses 622.3 2,644.0 4,015.0 4,122.0 6,313.2

Administrative and otherexpenses 105.1 130.0 171.1 242.2 309.7

Total Expenses 727.4 2,774.0 4,186.1 4,364.2 6,622.9

Profit Before Tax 659.0 724.0 757.9 780.5 791.2

Ratios (Z)

Average interest spread n.a. 4.4 4.1 4.1 4.0

Administrative and otherexpenseslaverage assets n.a. 0.6 0.6 0.8 0.9

Return on average assets(pretax) n.a. 3.3 2.8 2.5 2.3

ANNEX 12- 120 - Table 3

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

The Industrial and Commercial Bank of China (ICBC) - Shanghai Branch

Balance Sheets(Y million)

1985 1986 1987 1988 1989(unaudited)

Assets

CurrqntCash and bank deposits 1,405.7 1,824.5 2,818.3 2,807.8 3,724.9Industrial loans 11,319.2 15,255.3 17,643.0 18,670.8 21,807.6Commercial loans 4,406.8 5,314.5 5,858.3 6,923.0 7,765.0Other loans 222.7 639.4 246.9 258.5 687.2

Total Cur.ent Assets 17,354.4 23,033.7 26,566.5 28,660.1 33,984.7

Long-TermFixed asset loans 1,277.9 2,065.6 2,759.9 3,346.4 3,698.0

TOTAL ASSETS 18,632.3 25,099.3 29,326.4 32,006.5 37,682.7

Liabilities and Net Worth

LiabilitiesCurrent LiabilitiesEnterprise deposits 5,835.6 8,795.5 9,913.7 9,822.0 9,057.4Savings deposits 3,448.8 4,316.9 5,486.1 1,273.0 1,454.0Other deposits 371.3 537.0 1,075.5 1,651.7 2,043.2

Subtotal 9,655.7 13,649.4 16,475.3 12,746.7 12,554.6

Interbank borrowings andother short-term liabilities 3,663.7 3,433.8 _.066.8 3,775.7 4,521.4

Total Current Liabilities 13,319.4 17,083.2 19,542.1 16,522.4 17,076.0

Long-Term LiabilitiesLong-term savings deposits 1,970.4 2,377.0 2,972.0 8,090.3 10,510.0Financial bonds 0.0 140.0 245.0 235.8 166.3Borrowings from People's Bankof China 2,350.0 3,974.4 4,685.0 5,125.0 7,667.0

Total Long-Term Liabilities 4,320.4 6,491.4 7,902.0 13,451.1 18,343.3

Net Worth (retained earnings) 992.5 1,524.7 1,882.3 2,033.0 2,263.4

TOTAL LIABILITIES AND NET WORTH 18,632.3 25,099.3 29,326.4 32,006.5 37,682.7

THE NNu L D O CL OF CHNA (ICC)HAGHA BRACH

Orgumn Chut (Asof p--h 11_8)

R.., " 4) a 1 _owl In r -a

(PS)

~~I Da" wLuc . H u

,~~~~~~~~~~~~~~TNi -A . . .

(34)l_ 1

b 14eu_Q_-ll_0/k_~~~~~~~~(44

. ,~~~~~~~~~~~~~I

- 122 - ANNEX 13Page 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

The People's Construction Bank of China (PCBC)

1. Institutional Aspects. PCBC was established in 1953, and since 1979has been the specialized bank responsible for the long-term financing offixed-asset investment projects. It is the largest long-term development bankin China, with assets of Y 165 billion at the end of 1988 (in addition toY 177 billion of managed funds for the state investment budget). It has anationwide network of more than 3,000 branches, subbranches and depositoffices which employ about 100,000 people. In February 1988, the bankobtained government approval to operate a full range of international bankingservices. These services include all types of foreign exchange transactionssuch as lending, deposit-taking, arranging export credits, and onlending loanfunds under bilateral government credits and from multilateral developmentbanks.

2. PCBC's Shanghai branch has 29 subbranches and 76 deposit officesthroughout the municipality which employ about 3,000 people. It also hasthree subsidiaries and four ancillary organizations. The subsidiaries are thePCBC Investment and Trust Corporation, Huayin Investment and Consulting Com-pany, and Housing Investment Company. The four ancillary organizations areengaged in real estate, investment research, tendering, and management train-ing for staff. PCBC also has close ties with CIB, to whom it has providedconsiderable staff and management support. The organizational chart of thebranch is attached.

3. Lending Policies and Procedures. PCBC's Shanghai branch generallysets the annual lending targets for its network according to the credit limitsset by SMG for fixed-asset investments. These credit limits cover capitalconstruction and technical transformation. Subbranch managers are required toabide by the annual lending targets. Although all projects require priorapproval by the Planning Commission and other government authorities, allinvestment loans are also subject to PCBC's internal review to appraise theirfinancial and economic viability.

4. About half of PCBC's management staff in Shanghai have taken courseson project analysis methodology which directly or indirectly were sponsored bythe World Bank. The project appraisal unit has a staff of about 30 experi-enced engineers, economists, and financial analysts.

5. Operations. Between 1985 ard September 1989, the branch app-ovedY 6.9 billion in loans; one-third of these loans were categorized as modern-ization or restructuring loans. About 75 percent of the branch's lendinginvolves long-term project finance; the remaining 25 percent involves working-capital loans. The average maturity of the long-term portfolio is about fiveyears. Over half of the branch's lending at the end of 1986 was concentratedin the energy and raw materials sectors. In the four subsectors addressed by

- 123 - ANNEX 13

Page 2

this project, the branch has financed 127 modernization projects amounting toY 323 million. Of this amount, Y 215 million was outstanding as of June 30,1988. Table 1 of this Annex shows the operations of the branch from 1985through September 1989.

6. The branch has been actively promoting its new foreign exchangebusiness since 1986. In 1987 and 1988 it raised $337 million to help financethe first phase of Shanghai's 300,000 tpy ethylene project. It did this byatranging several syndicated loans in which more than 40 foreign banks parti-cipated. In November 1989, the Shanghai branch raised $60 million from aconsortium of Japanese, US and Italian-banks. The branch also is expandingits business in renminbi bond issues to help clients raise long-term financingfor large industrial projects.

7. Financial Performance, Position and Resources. The profitability ofPCBC's Shanghai branch is good. Besides income from lending through its ownresources, the Shanghai branch earns commissions from managing funds entrustedby enterprises and investment funds apptopriated by the fiscal authorities.Nonetheless, like all other specialized banks, PCBC's interest spread has beensqueezed by the rising cost of deposits, as it cannot fully pass these costson to borrowers. The branch's average interest spread declined from 10.4 per-cent in 1985 to 5.5 percent in 1987 and 4.4 percent in 1989. Administrativeand other operating expenses were 0.6 percent of average total assets in 1989.The pretax return on average assets was 2.3 percent in 1989. The branchretains about 10 percent of its annual profits.

8. PCBC Shanghai has relatively stable sources of local currency funds:practically all of its deposits are wholesale enterprise accounts, which areless vulnerable to inflation-led withdrawals. The branch also has strongfunding support from its head office. The branch's financial position issatisfactory, and its financial statements from 1984 through 1989 are presen-ted in Tables 2 and 3 of this Annex.

9. Quality of Loan Portfolio. At the end of 1989, the branch reportedY 31 miillion in overdue principal. This amount represents only 0.7 percent ofits outstanding loan portfolio. Of the total overdue principal, only aboutY 900,000 was rescheduled.

- 124 - ANNEX 13Table 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

The People's Construction Bank of China (PCBC) -Shanghai Branch

Operations(Y million)

Cumulative /a1985 - 09189

ApprovalsCapital construction loans 2,591.6Modernizationlrestructuring loans 1,797.0Working capital loans 1,013.2Other loans 1,462.3

Total 6,864.1

DisbursementsCapital construction loans 2,387.9Modernization/restructuring loans 1,797.0Working capital loans 1,040.9Other loans 1,363.0

Total 6,588.8

Outstanding Loan PortfolioCapital construction loans 2,296.6Modernization/restructuring loans 1,377.0Working capital loans 257.1Other loans 921.2

Total 4,851.9

/a Detailed figures for the end of 1989 are underpreparation and are not yet available.

ANNEX 13- 125 - Table 2

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

The People's Construction Bank of China (PCBC) - Shanghai Branch

Income Statements(Y million)

1984 1985 1986 1987 1988 1989(unaudited)

IncomeInterest income from loans 101.6 194.4 286.2 573.2 757.3 ',257.3Commissions and other income 0.1 0.8 0.3 2.0 1.1 21.4

Total Income 101.7 195.2 286.5 575.2 758.4 1,278.7

ExpensesFinancial expenses 75.9 51.0 72.9 296.4 492.5 932.8Administrative and other

expenses 0.0 2.4 4.5 6.4 41.4 73.7

Total Expenses 75.9 53.4 77.4 302.8 533.9 1,006.5

Profit Before Tax 25.8 141.8 209.1 272.4 224.5 2272.2

Income tax 0.0 78.0 115.0 166.2 137.0 149.7

Net Profit 25.8 63.8 94.1 106.2 87.5 122.5

Distribution of Net ProfitTransfer to head office 25.8 50.8 85.5 95.0 78.8 111.9Reserves and retained earnings 0.0 12.9 8.4 10.8 7.0 8.5Employees' welfare fund 0.0 0.1 0.2 0.4 1.7 2.1

Total Distribution 25.8 63.8 94.1 106.2 87.5 122.5

Ratios (Z)Average interest spread n.a. 10.4 6.6 5.5 5.2 4.4Administrative and otherexpenses/average assets n.a. 0.1 0.1 0.1 0.4 0.6

Return on average assets(pretax) n.a. 3.4 3.2 3.2 2.3 2.3

ANNEX 13126 - Table 3

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

The People's Construction Bank of China (PCBC) - Shanghai Branch

Balance Sheets(Y million)

1984 1985 1986 1987 1988 1989(unaudited)

Assets

CurrentCashF and deposits with PBC 438.1 1,377.1 1,726.6 1,041.1 1,401.2 2,066.7Bank deposits 1,789.0 1,252.0 763.1 905.0 1,419.9 2,738.7Short-term loans 171.9 377.7 715.2 1,213.1 1,854.3 2,674.1Securities and investments 4.3 59.4 69.4 143.5 205.5 258.1Accounts receivable 0.1 140.1 175.9 83.8 283.9 750.6

Total Current Assets Z,403.4 3,206.3 3,450.2 3,386.5 5,159.8 8,488.2

Long-TermLong-term loans including

current maturities 420.8 2,320.5 3,754.9 6,368.7 4,241.7 5,903.8Fixed assets (net) 0.0 3.8 5.4 7.6 11.2 14.8Other assets 0.0 99.5 40.0 215.2 181.1 0.0

Total Long-Term Assets 420.8 2,4Z3.8 3,800.3 6,591.5 4,434.0 5,918.6

TOTAL ASSETS 2,824.2 5,630.1 7,250.5 9,978.0 9,593.8 14,406.8

Managed funds - assetsLoans funded by government

and trust deposits 1,783.5 4,056.4 4,078.7 4,666.4 11,305.0 14,819.4

Liabilities and Net Worth

LiabilitiesCurrent Liabilities

Enterprise depositsLocal currency 2,694.1 3,683.0 4,581.4 5,679.7 6,265.7 7,168.5Foreign currency 0.0 0.0 0.0 30.9 235.5 292.5

Other payables 73.6 207.1 119.1 126.5 49.5 800.9

Total Current Liabilities 2,767.7 3,890.1 4,700.5 5,837.1 6,550.7 8,261.9

Long-Term LiabilitiesDeposits by local banks 0.1 748.0 1,465.8 2,772.4 1,240.8 3,174.2Loans from foreign banks

(foreign currency) 0.0 0.0 0.0 112.8 575.5 1,644.4

Net WorthReserves 0.0 12.9 7.5 10.0 224.5 272.2Retained earnings 56.4 979.1 1,076.7 1,245.7 1,002.3 1,054.0

Total Net Worth 56.4 992.0 1,084.2 1,255.7 1,226.8 1,326.2

TOTAL LIABILITIES AND NETWORTH 2,824.2 5,630.1 7,250.5 9,978.0 9,593.8 14,406.8

Managed funds - liabilitiesGovernment and trust

deposits 1,783.5 4,056.4 4,078.7 4,666.4 11,305.0 14,819.4

THE PEOPLE'S CONSTRUCTION BANK OF CHINA (PCBC)SHANGHAI BRANCH

Organizatlon Chart (As ot December 1988)

PRESIDENT

Generai Office (32)

Personnel DMsion (20) Trust & Invest. Corp. - (46)

Administration DMslon (67) (697. m ~~~~~~~~~~~~~~~5 Sectoral Sub-Branches (697)

_ Education Dlvision () _ Huayin Invest & Consul. Co.

Security DMslon (16)

_ Planning DMvsIon (18) Housngnvest. Co. Speaized Sub-Branches (142)

nD (20 PCBC Tendering Corp. (33)

_ I nternati on al Bankidng Dept. (64)

_ 7 11 DltrictSubXrancbes |(274)_4Constuction Economics Dlv. (47) 1 Buildhng Dev. Corp. (43)

Financing Divislon (12)

Accoun_ing DMslcn (17) Investment Research Center (30)L . ~ County Sub-Branches (243)

-i Computer Management Div. | (25)Management School (12)

e Project Financing Div. §(31)

Auditing DivisIon l (2)

Supervision DIvision } (5)

H System Retorm Division (4) >

Total Management & Staff: 1,906

EK/W44268c

- 128 - ANNEX 14Page 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Ban!. of Communications (BOCOM) - Shanghai

1. Institutional Asr*cts. BOCOM was first established in 1908 inBeijing to provide long-term finance to the transportation rnd telecommunica-tions sectors. The bank was nationalized upon the founding of the FRC in1949, and from the 1950s to 1986 its operations in China were suspended. Tosupport China's economic reform and to improve banking and financial services,BOCOM was reestablished by the State Council in 1986 and relocated toShanghai. The bank is now classified as a nationwide comprehensive bank shar-ing similar status with other specialized banks under the supervision of thePBC. It may conduct the full range of commercial banking business in localand foreign currencies, and offer other financial services such as trusts,investments, insurance, leasing, guarantees, and issuance and trading ofsecurities. In April 1987, tbe restructured BOCOM officially opened for busi-ness.

2. BOCOM is the first bank in China since 1949 to adopt a share capttalsystem. Fifty percent of its capital is held by the PBC on behalf of thestate; the other 50 percent is held by local governments and enterprises.Private individuals may hold the bank's shares up to 10 percent of the paid-incapital in aggregate. As of December 31, 1989, the bank had Y 35.8 billion inassets and Y 3.0 billion in paid-in capital. In December 1988 it had anationwide network of eight branches and 24 subbranches.

3. The Shanghai branch began operating in October 1986, although a fullrange of services was not offered until 1987. Unlike the other banks in theproject, BOCOM's Shanghai branch is a legal entity distinct from its headoffice. The shareholders of the branch are: the central government (40 per-cent), SMG (40 percent) and local enterprises (20 percent). The branch hasseven subbranches which are independent entities with joint shareholdings heldby the state and local governments. All these subbranches are located inJiangsu and Z'ejiang. The branch also has four business offices located infour city districts. In September 1988, the branch set up a wholly-ownedsubsidiary to specialize in securities. The branch employs about 860 people.An organizational chart of the branch is attached.

4. Lending Policies and Procedures. The branch manager may approveworking-capital loans up to Y 15 million and fixed-asset investment loans andleasing accounts up to Y 5 million. For foreign exchange loans and guaran-tees, the manager's approval limit is $2 million equivalent. Equity invest-ments below Y 2 million may be approved by the manager. Above these limits.all loan and investment proposals have to be approved by a branch credit com-mittee composed of the manager, deputy manager, and department heads. Thebranch's approval limits are Y 30 million for local currency loans and $5million for foreign currercy loans. Head office approval is normally requiredfor loans above these limits.

- 129 - ANNEX 14Page 2

5. BOCOM has an appraisal staff of about 20 for its long-term lendingoperations. The branch's appraisal procedures are well defined. They consistof three main phases: (a) preliminary assessment of the prospective borrow-er's financial resources and the status of various government approvals;(b) comprehensive analysis of the borrower's operations, and the project'sfinancial and social/economic viability, including appraisal of the market,technical and production aspects; and (c) final proposal for managementapproval. An evaluation of the guarantor and/or collateral is also mandatoryin the loan appraisal process. Loan officers are responsible for the supervi-sion of their accounts. Generally, supervision is carried out by reviewingmonthly, quarterly and annual financial statements submitted by borrowers, andby making periodic visits to clients.

6. Operations. Since it began operations in 1986, the Shanghai branchof BOCOM has been growing very rapidly. Within the first year of operations,it collected Y 1.3 billion in deposits from new enterprise accounts andextended Y 1.6 billion in credits. At the end of 1989, the branch had ashort-term and long-term loan portfolio of Y 5.8 billion and deposits of Y 2.8billion. About 80 percent of the branch's lending assets are short-term, withan average maturity of 2.5 years. Textiles and light industries are the twomost active borrowing sectors; these sectors account for about 20 percent ofthe branch's total lending. Besides setting up a securities subsidiary com-pany, the branch has also invested in a dozen industrial and financial enter-prises in the city. Total equity investments registered Y 74.0 million at theend of 1989.

7. The growth of the branch's international banking business also isimpressive. Between 1987 and September 1988, the branch had approved $193million in foreign currency loans and disbursed $143 million of it. About90 percent of the foreign currency lending is medium-term, with averagematurities of three to five years. In 1988, the branch received a mandatefrom the SMG to raise $600 million. This would help finance the Huangpu RiverBridge project and several priority industrial development projects in thecity. A summary of the b-anch's operations is shown in Table 1 of this Annex.

8. Financial Performance, Position and Resources. When it was reestab-lished, BOCOM was given a three-year tax exemption by the government. TheShanghai branzh earned a profit of Y 37.9 million in its first year of opera-tion. Profits for 1989 were estimated to be ' 299 million, representing astrong return on average assets of 5.4 percent.

9. BOCOM Shanghai is one of the first banks in China since 1949 toraise capital by issuing shares to enterprises. The first share issue wasmade in early 1987; it successfully raised Y 100 million. To support furthergrowth, the branch plans to increase its capital base through a second shareissue in the same amount during the fJrst half of 1989. A modest dividend of2.5 percent on paid-in capital was paid in 1988; it amounted to Y 13.3 mil-lion. The branch plans to plou back most of its profits for growth in thenext several years. In addition to capital resources, the branch has alsomobilized local, medium-term resources by issuing financial bonds with maturi-ties of up to three years. Its capital adequacy position as of the end of1989 was strong, with a capital-to-assets ratio of 15 percent. Financial

- 130 - ANNEX 14Page 3

statements for 1987, 1988 and 1989 (unaudited) are presented In Tables 2 and 3of this Annex.

10. Quality of Loan and Equity Portfolios. The branch reported Y 107million in overdue principal at the end of September 1988; this amount repre-sented about 3.5 percent of the loans outstanding then. All of the arrearswere less than 60 days overdue, and 40 percent were 30-60 days overdue. Onlya few loan reschedulings were estimated. However, no systematic statisticshave been collected on rescheduling or on overdue interest payments

ANNEX 14- 131 - Table 1

CHINA

SHANGHAI -NDUSTRIAL DEVELOPMENT PROJECT

Bank of Communications (BOCOM) - Shanghai Branch

Operations(Y million)

9 months1987 1988 1988

Approvalsocal currencyShort-term n.a. 4,117.0 n.a.Long-term 292.0 185.0 n.a.

Subtotal n.a. 4,302.0 n.a.

Foreign currencyShort-term 11.1 74.8 n.a.Long-term 125.8 500.6 n.a.

Subtotal 136.9 575.4 n.a.

Foreign currency (S mln equiv.) (36.8) (154.7) n.a.

Total n.a. 4,877.4 n.a.

DisbursementsLocal currencyShort-term n.a. 3,705.0 n.a.Long-term 270.2 166.0 n.a.

Subtotal n.a. 3,871.0 n.a.

Foreign currencyShort-term 7.4 56.3 n.a.Long-term 88.8 376.6 n.a.

Subtotal 96.2 432.9 n.a.

Foreign currency ($ mln equiv.) (25.9) (116.4) n.a.

Total n.a. 4,303.9 n.a.

Outstanding Loan PortfolioLocal currencyShort-term 1,309.0 2,162.8 2,349.1Long-term 270.1 413.7 376.9

Subtotal 1,579.1 2,576.5 2,726.0

Foreign currencyShort-term 7.4 21.6 28.3Long-term 117.3 484.2 636.2

Subtotal 124.7 505.8 664.5

Foreign currency ($ mln equiv.) (33.5) (136.0) (178.6)

Total 1,703.8 3,082.3 3,390.5

- ANNEX 14- 132 - Table 2

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Bank of Communications (BOCOM) - Shanghai Branch

Income Statements(Y million)

1987/a 1988 1989(unaudited)

IncomeInterest income from loans 94.1 226.7 n.a.Commissions and other income 2.8 81.1 n.a.

Total Income 96.9 307.8 616.0

ExpensesFinancial expenses 34.2 79.1 n.a.Administrative and other expenses 24.8 97.3 n.a.

Total Expenses 59.0 176.4 317.0

Profit Before Tax 37.9 131.4 299.0

Income tax /b 0.0 0.0 0.0

Net Profit 37.9 131.4 299.0

Ratios (Z)Average interest spread n.a. 5.4 n.a.Administrative and other expenses/average assets n.a. 3.0 n.a.

Return on average assets n.a. 4.0 5.4Return on average equity n.a. 18.5 33.5

/a 1987 results include renminbi operations only. Foreign currency opera-tions in 1987 were small

/b BOCOM is exempted from income tax during the first three years of opera-tions.

- 133 - ANNEX 14Table 3Page 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Bank of Communications (BOCOM) - Shanghai Branch

Balance Sheets /a(Y million)

1987 _988 1989(unaudited)

Assets

CurrentCash and deposits with PBC 349.9 302.5 } 60.Bank deposits 197.0 230.8 }Short-term loans - Local currency 1,309.0 2,349.1 4246.0Short-term loans - Foreign currency 7.4 28.3 }

Subtotal 1,316.4 2,377.4 5,106.0

Other receivables 164.6 0.0 65.0

Total Current Assets 2,028.0 2,910.6 5,171.0

Long-TermLoans - Local currency 270.1 376.9 562.0Loans - Foreign currency 117.3 636.2 995.0

Subtotal including current maturities 387.5 1,013.1 1,557.0

Equity investments 8.4 36.7 74.0Fixed assets (net) 2.8 22.8 30.0Other assets 30.4 78.5 195.0

Total Long-Term Assets 429.0 1,151.0 1,856.0

TOTAL ASSETS 2,457.0 4,061.6 7,027.0

Managed Funds - AssetsLoans outstanding 218.3 1,727.8 1,736.0Other assets 114.0 386.4 740.0

Total 332.2 2,114.2 2,476.0

134 - ~~~~~ANNEX 14Table 3Page 2

1987 1988 1989(unaudited)

Liabilities and Net Worth

LiabilitiesCurrent LiabilitiesEnterprise deposits - Local currency 1,243.0 1,974.2 } 2,670.0Enterprise deposits - Foreign currency 49.6 393.8 }Savings deposits 12.0 58.7 161.0

Subtotal 1,304.6 2,426.7 2,831.0

Bank deposits 174.3 317.8 779.0Short-term bank loans - Local currency 150.0 175.5 883.0Short-term bank loans - Foreign currency 75.2 158.9 421.0

Subtotal 225.2 334.4 1,304.0

Other payables 15.3 57.9 140.0

Total COrrent Liabilities 1,719.4 3,136.8 5,054.0

Long-Term LiabilitiesFinancial bonds 40.0 21.5 9 944.0Other long-term liabilities 55.8 '27.8 }

Total Long-Term Liabilities 95.8 149.3 944.0

Net WorthPaid-in capital 603.9 623.9 624.0Reserves and retained earnings 37.9 151.6 405.0

Total Net Worth 641.8 775.6 1,029.0

TOTAL LIABILITIES AND NET WORTH 2,457.0 4,061.6 7,027.0

Managed Funds - Liabilities 332.2 2,114.2 2,476.0

RatiosCapital-to-assets (Z) 26.0 19.0 -

/a Including renminbi and foreign currency operations.

ANNEX 14Attachment 1

- 135 -

WEX 1 I -}

o~ ~ g E I I EI E X II;

|}~~~~I i.5

ANNEX 15- 136 - Page 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

China Investment Bank (CIB)

'. Institutional Aspects. CIB was established in 1981 as a state-owneddevelopment finance institution. Administratively, the bank is under theleadership and supervisory responsibility of MOF. It is closely tied to PCBC,which has provided CIB with considerable staff and management support. At theend of 1988, CIB had total assets of Y 6.7 billion. The bank has 56 branchesand subbranches nationwide, employing about 1,000 staff.

2. The Shanghai branch began in 1982 and is one of CIB's very firstbranches. It has been subject to increasing competition from the specializedbanks and new finance companies which have entered the local financial sector.The branch draws most of its managers and staff from PCBC in Shanghai andcooperates closely with it at all levels of its operations. The branch hasone main business office in Shanghai and employs 69 people. An organizationalchart of the branch is attached.

3. Lending Policies and Procedures. The branch operates in accordancewith the operational and financial policies of the head office. Loans below$3 million are approved at the branch level; loans above this limit are nor-mally approved by the head office. Its former senior economist co-authoredthe Appraisal Manual for Industrial Credit Projects, which has been widelycirculated and applied in all the specialized banks and many government agen-cies. The branch has a project appraisal and supervision staff of 14 experi-enced economists and accountants, and one engineer. As one of the oldestbranches of CIB, which has had a long relationship with the World Bank, theShanghai branch has extensive experience in project appraisal.

4. Operations. Between 1985 and September 1989, 63 loans wereapproved, consisting of $76 million in foreign currency loans and Y 90 millionin renminbi financing. Textiles and light industry are the main borrowingsectors, accounting for over half of all loans approved by the branch. Mostof the branch's loans have maturities of five to seven years. Beginning in1988, the branch has also provided limited financing for working capital.Total short-term renminbi loans disbursed in 1989 amiounted to Y 24 million.Its operations for the 1985-89 period are shown in Table 1 of this Annex.

5. Financial Performance, Position and Resources. The Shanghaibranch's pretax return on average assets was 3.8 percent in 1989. The branchtransfers all of its annual profits to the head office. Prior to 1987, thebranrh's operations were funded by the head office, free of interest expenses.From 1987 forward, the head office has been charging interest on all appropri-ated funds. As of December 1989, the branch's cost of funds from the headoffice was 7.2 percent per annum and its onlending spread was about 1.3 per-cent. The branch's average interest spread in 1989 was 3.5 percent.

- 137 - ANNEX 15Page 2

6. The branch has relied exclusively on funding from the head office.It has practically no deposit base, other than the temporary deposits placedby clients to pay for local currency expenditures incurred by projectsfinanced by the branch. Nevertheless, the branch Is exploring alternativesources of funding, both in renminbi and in foreign currency. In 1989, itobtained $12.5 million in short-term borrowing at LIBOR from a group led bythe Bank of Tokyo. Its financial position is satisfactory. Financial state-ments for the 1984-89 period are shown in Tables 2 and 3 of this Annex.

7. Quality of Loan Portfolio. Of the 63 loans approved during the lastfive years, only two loans have been rescheduled. As of December 1989, therewas no overdue principal or interest.

ANNEX 15- 138 - Table 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

China Investment Bank (CIB) - Shanghai Branch

Operations(Y million)

1985 1986 1987 1988 1989

Approvals

No. of projects approved 16 4 17 14 12

Local currency 4.8 4.7 43.8 36.5 -

Foreign currency 16.2 29.1 108.0 64.0 74.4($ min equiv.) (5.8) (7.8) (29.0) (17.3) (15.8)

Total 21.0 33.8 151.8 100.5 74.4

Disbursements

Local currency 25.5 30.2 43.9 43.8 23.5

Foreign currency 17.1 21.2 71.0 97.4 114.5($ mln equiv.) (6.1) (5.7) (19.1) (26.3) (24.3)

Total 42.6 51.4 114.9 141.2 138.0

Outstanding Loan Portfolio

Local currency 25.4 29.3 119.1 156.5 166.4

Foreign currency 14.6 8.9 80.7 169.2 Z91.5($ mln equiv.) (5.2) (2.4) (21.7) (45.6) (61.9)

Total 40.0 38.2 199.8 325.7 457.9

ANNEX 15- 139 - Table 2

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

China Investment Bank (CIB) - Shanghai Branch

Income Statements(Y million)

1984 1985 1986 1987 1988 1989(unaudited)

IncomeInterest income from loans 0.2 2.8 7.9 13.4 25.5 58.5Commissions and other income 0.0 0.0 0.0 0.4 2.1 9.0

Total Income 0.2 2.8 7.9 13.8 27.6 67.5

ExpensesFinancial expenses 0.0 0.1 1.7 9.7 17.6 43.0Administrative and otherexpenses 0.1 0.2 0.6 1.0 1.6 2.1

Total Expenses 0.1 0.3 2.3 10.7 19.2 45.1

Profit Before Tax 0.1 2.5 5.6 3.1 8.4 22.4

Income tax /a 0.0 0.0 0.0 0.0 4.6 12.3

Net Profit (transferred 0.1 2.5 5.6 3.1 3.8 10.1to head office)

Ratios (Z)Average interest spread n.a. n.a. n.a. 2.8 2.8 3.6Administrative and otherexpenses/average assets n.a. 0.4 0.6 0.5 0.4 0.4

Return on average assets(pretax) n.a. 5.1 5.7 1.6 2.3 3.8

(a CIB was exempted from income tax during the first five years (1983-87) ofoperations.

ANNEX 15- 140 - Table 3

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

China Investment Bank (CIB) - Shanghai Branch

Balance Sheets(Y million)

1984 1985 1986 1987 1988 1989(unaudited)

AssetsCurrent

Cash and bank deposits 19.4 26.1 31.0 27.4 31.6 86.9Short-term loans (local currency) 0.0 0.0 0.0 0.0 52.7 124.3Other receivables 0.0 0.0 0.0 0.3 35.0 50.9

Total Current Assets 19.4 26.1 31.0 27.7 119.3 262.1

Long-TermLoans (foreign currency) 5.0 47.2 91.9 245.9 326.2 459.0Fixed assets (net) 0.0 0.1 0.1 0.1 0.2 0.5Other assets 0.0 0.1 0.1 0.0 0.0 0.6

Total Long-Term Assets 5.0 47.4 92.1 246.0 326.4 460.1

TOTAL ASSETS 24.4 73.5 123.1 273.7 445.7 722.2

Liabilities and Net WorthLiabilities

Current LiabilitiesEnterprise deposits 0.0 0.3 5.3 41.2 41.3 134.3Other payables 0.0 10.7 3.9 8.8 36.6 98.1

Total Current Liabilities 0.0 11.0 9.2 50.0 77.9 232.4

Long-Term LiabilitiesLoans from head office 24.4 60.0 108.3 220.5 359.1 466.0

Net WorthReserves 0.0 0.0 0.0 0.2 0.3 1.4Net pr, tt for the year (payable

to the nead office) 0.1 2.5 5.6 3.0 8.4 22.4

Total Net Worth 0.1 2.5 5.6 3.2 8.7 23.8

TOTAL LIABILITIES AND NET WORTH 24.5 73.5 123.1 273.7 445.7 722.2

SupplementaryOutstanding letters of credit and

guarantees 0.0 0.0 0.0 0.0 25.0 19.6

ANNEX 15- 141 - Attachment 1

C INVESTMENT BA (CIB)SHANH BRANCH

Organlkbn ChWt (As of Decembe1r N)

Pido (1) P ,dd (1)

A{-uft (1) A== D '" L

_ .- ~ ~(1) _M DMQ,(1

- 142 - ANNEX 16

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Estimated Disbursements($ million)

Period Amount Cumulative

FY91 July-December 3.0/a 3.0January-June 2.0 5.0

FY92 July-December 7.5 12.5January-June 10.0 22.5

FY93 July-December 20.0 42.5January-June 20.0 62.5

FY94 July-December 24.0 e6.5January-June 18.0 1)4.5

FY95 July-December 16.0 120.5January-June 13.5 134.0

FY96 July-December 13.0 147.0January-June 3.0 150.0

/a This amount includes an estimated $2.0 million to be tranasferred to theSpecial Accounts.

1I.~~~~~) ~ANNEX 17- 143 _Page 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Progress Reports for the Project

Introduction

1. The Shanghai Municipal Government (SMG) recognizes the importance ofthe project to the successful restructuring of the four subsectors under theproject. To this end, SMG will take all necessary steps to improve the effi-ciency and competitiveness of the four subsectors. In particular, SMG willestablish a Project Monitoring Unit (PMU) to monitor the progress of theproject in reaching its objectives. In addition, the PMU will forward to theBank regular reports on the progress of the project. Progress of the projectshould be judged by the:

(a) progress of technical assistance under the project;

(b) success of the training program under the project;

(c) progress of management development vis-a-vis agreed benchmarks;

(d) progress of utilization of loan proceeds for the project; and

(e) impact of the above measures and investments on the financial per-formance of the corporations.

2. First, this note outlines the format and frequency of the progressreports in each of these areas that are to be prepared by the PMU. Thereports will help to: monitor progress of the project and identify any stepsneeded to facilitate project implementation.

Technical Assistance

3. As per the agreed terms G.^ reference for their assignments, consul-tants will prepare progress reports every quarter defining the progress madein each of the seven areas covered in their terms of reference, i.e.:

(a) organizational structure and development;

(b) marketing and sales distribution;

(c) operational effectiveness;

(d) upgrading manufacturing technology

(e) product development and technology management;

(f) development of strategic planning, management and control system;and

- 144 - ANNEX 17Page 2

(g) conso.'.idation of production and preparation of feasibility reports.

The PKU should regularly review these reports and ensure that these reportsare forwarded to the Bank each quarter.

Training Program

4. Every 12 months, the PMU should prepare a report on the trainingbeing supported under the project, including a list for each corporation, thepersons involved, countrieb visited, purpose and duration of the visits,training costs, and description of the specific training involved.

Progress of Management Development

5. Attachment 1 sets out the key dates pertaining to management devel-opment under the project. Every six months, the PMU should report on thestatus of each indicator including any remarks on reasons for the deviation ofthe actual from target dates.

Loan Utilization

6. Attachment 2 provides a format for monitoring utilization of loanproceeds of the project. These reports would be prepared every quarter byeach participating financial institution (PFI). The PMU should regularlyreview these reports and ensure that they are forwarded to the Bank.

Impact Analysis

7. Each year the subsector corporations should prepare the attachedtable (Attachment 3) on various quantitative measures of its operational per-formance for the current year as compared to the previous three years. ThePMU should regularly review thetla reports and ensure that they are forwardedto the Bank. Each PFI will also submit the following reports through the PMUto the Bank: (a) semiannual reports on progress of all subprojects underimplementation, providing information on project cost, time schedule anddegree of project completion, production, sales, exports, and profits; andcomparing these with the projections in the appraisal reports (with properadjustment for inflation to ensure comparability); (b) annual reports on allcompleted projects, during the first three years following project completion,providing information on production, sales, exports and profits; and comparingthese with the projections in the appraisal reports (with proper adjustmentfor inflation to ensure comparability).

- 145 - ANNEX 17Attachment 1

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Key Dates Pertaining to Management Development

Enterprise Reform:

Approval of Charters April 1989Establishment of integrated corporations June 1989Est,iblishment of board of directors July 1990Financial consolidation of factories December 1990

Organizational Structure:

Detailed plans of structure of corporation,business divisions and factories June 1991

Implementation of organizational plans June 1992

Restructuring Pians:Restructuring plans of model plant April 1991Feasibility study of model plant June 1991Restructuring plans of other plants June 1992Implementation of subproject in model plant June 1993Feasibility studies of other plants December 1992Implementation of subprojects in other plants June 1995

Management Organization and Systems:

Overall plans for corporation, division and plants December 1991Reorganization of domestic marketing December 1991Establishment of direct export organization December 1992Development and Implementation of MIS December 1993

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Quarterly Summary of Utilization of Loan Proceeds

For Quarter Ending: PFI:

(1) Utilization of Funds

World Bank funds Other funds World Bank funds Other funds World Bank funds Other funds

(S'OOO equivalent) (Y'OOO) (S'OOO equivalent) (Y'OOO) (3000 equivalent) (Y'O0O)

Co.mitment

Disbursement

Repayment

(2) Procurement Durinq This Quarter (Usinq World Bank Funds Only)

Procurement Suppliers from whomItem. procured and supDlier Cost Subprolect no. method quotes and bids were obtained

ox

M1-AD -Jrt

- 1471 -ANNEX 17Attachment 3

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Operational Performance Indicators

CorporationYear

One year Two years Currentbe -re before year

Sales Revenue (Y million)of which:

DomesticIn ShanghaiElsewhere in China

List domestic sales in each ofthe top 3 provinces

Exports ($ million)List export sales by country ofdistination

Market Share Within ChinaList share in each of the main productgroups

Gross Profit

Net Profit

Rate of Return on Net Fixed Assets

Employment

Productivity (output in Y'OOO/employee)

- 148 - ANNEX 18

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Documents Available in the Project File

A-1 Final Report, Booz, Allen & Hamilton on the Shanghai Electronic Compo-nents Subsector, 1989

A-2 Final Report, Booz, Allen & Hamilton on the Shanghai Precision and Scien-tific Instrument Subsector, 1989

A-3 Final Report, Boston Consulting Group on the Shanghai Printing MachinerySubsector, 1989

A-4 Final Report, Boston Consulting Group on the Shanghai Electrical Appara-tus Subsector, 1989

A-5 Revised Charters (in Chinese) for the integrated corporations that werepresented at negotiations

A-6 Official Shanghai Municipal Government Statement on Development Strate-gies and Policies in the SIDP Subsectors

A-7 Documentation on the four subsectors provided by the related corporationsand bureaus

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

Organization Chart of Sharing Relationship of

Subsector Corporation With Various Levels of Government

SIAI1 GO=

as~~~~~~~~n'I I l l l l l l~~~~~~~~~~~~~~~~~~~~~~~~~hi GDW IWUL

_ F1U Cf ~~~~~~~~~~~~~~~~~SIA II t I mmstC

_ _

hbsincybasr~~ ~~~~~~ - --

2660IMMUS o]ktn K1 c-u

,itSmS suss u*"t S. £uuS *I

1I

CHINA

SHANGHAI INDUSTRIAL DEVELOPMENT PROJECT

OrEanization Chart of

Shanghai Mechanical & Electrical industries Administration (SMEIA)

I S Ih c M i T'Fl C*rpreatloa (STC)3. Shage IFaetaeuu Corporatioin (SFC). s. hangha Searig Crpratla (OC)4. Shanghai Hydre"lic A Fheatic C _anemt Cerpewetian (SICC)-S Sheghal Iht l6matry Machinry C a-y (SLIK)-. ShanaIE1 tctic MachTasty (Greup) Cerp*rettie (UM)7. C=lireSeep of Shangha (COS)

-C Sega_l Electric _prau (G0u) C-r rtlee (5t1C)-. Shnga _ ri tiagW md Pachaglag Mucl_tiy Cerpertian (5PC)

-1S. Shghl Gant. bI Mac ley oaIato Cer.rtie (SOMC)-11. Shanghai Y lre S Vacuum Iqulymant Cepsaratiorn (SYEC)

Planning & Development Dept. too (hanghai at1ra Cmcl" Maciey C l CMC)

Construction 1 Equipment Dept. Vice Director a - i _ngi1mD1 _e1 En1_ bela (NEW)1. SeolDe E88Wok(1M

Education Dept. -. t shoagh ifavy Mmc lery Plat (SW)S. Shanghai Machi Tee$ borks (Sill

Production Dept. 4. Shanghai Cutting Teol Works (SCnW)S.Shanghai Cable Works (SCI

Import & Export Dept. -. Shnghai Pang Pe Mbchiery Verba_ Viee Director -t. bShangha Do La" Msachinery Vara

Supplement * Sales Dept. -. sh.r ohai C wra r Factory (SCF)Director S~~. ShnhiPaOe MachineryGarabea(1 )

Ceating & Forging Dept. of ISS.r Shanghi bidi Ele cr oel niobel (S E03Dept. ~~~~~~~~~~~~~SMEXA Ii. Shnhisloeer betas (SW5

Financing Dept. -it Shan eai Pop br11e (nS

Labour Dept. - BVice Director .ller -brea (SUM)

Credit Dept. IS. _a 1Gha ti1* Aeh _s v (S WI?. Shanghi Mi Jimn Machiner Plant

Research & Technical Dept. _ I-S. agI Csnatructin =chlewwr beri (saC)_Vice DIrector _ -l. _hnga Matail1rgica 1 Miin Mactin de Manufactre (Sd)

Quality Supervision Dept. -- 9. _hau Ihg Cr _ Caa vlat zrqe *c (SCC V1. Shanghai ed-G4esd Panel Machieory Fatory (SUPW)

Enterprises Ad.intration Dept. IChmical Machbie MarIa (SS)Policyo Dept. Vice Director D . t I w

Policy Dept. _ # --14. _ a.i Electrical 11 Macnoery 1apir Generl MaIa (SElG)

1. ShIng1a 1 Itlitsu ft SaclsN1a 1 E lectrici tengi_ e1 f (lIKE)2. Shanghi Electra tsn eso"eeh _ et1tet" (SEl)S. hna IttA tf Macntin B dlding Teclmelegy (SlUT)4. = Mac4 _ al Ed _ lectrical Technlqe Inftnetlen Srvile (511M)

Sh a iaMMacinery 0Inetitte" (1CMI)