Document of

The World Bank

FOR OMCIAL USE ONLY

Reat No. P-4199-PAK

REPORT AND RECOMMENDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

AND THE INTERNATIONAL DEVELOPMENT ASSOCIATION

TO THE

EXECUTIVE DIRECTORS

ON A

PROPOSED LOAN

IN AN AMOUNT EQUIVALENT TO USt148.0 MILLION

AND A

PROPOSED CREDIT

IN AN AMOUNT EQUIVALENT TO SDR 2.0 MILLION(US$2.0 MILLION EQUIVALENT)

TO THE ISLAMIC REPUBLIC OF PAKISTAN

FOR A

SECOND INDUSTRIAL INVESTMENT CREDIT PROJECT

December 10, 1985

T hB d4 wo as reSddYkd dhtla fc *d msy be wed by recipients dy in the peforn=coc oft dir oEgic dti IZfie so"SomX wayu not odmwkse be dwidsed widdont World EBk uShonzafon.

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CURRENCY EQUIVALENTS

Currency Unit = Pakistan Rupees (Rs)US$1.00 = Rs 15.7Rs 1.00 = US$0.06

FISCAL YEAR

July 1 - June 30

ABBREVIATIONS

ADB - Asian Development BankBEL - Banker's Equity LimitedDFI - Development Finance InstitutionCOP - Government of PakistanHBL - Habib Bank Limited

ICP - Investment Corporation of PakistanIDBP - Industrial Development Bank of PakistanTIC - Industrial Investment CreditMCB - Muslim Commercial BankNBP - National Bank of PakistanNCB - Nationalized Commercial BankNOFC - National Development Finance CorporationPBC' - Pakistan Banking CouncilPICIC - Pakistan Industrial Credit and Investment CorporationrFI - Participating Financial InstitutionSBP - State Bank of PakistanSLA - Subsidiary Loan AgreementUBL - United Bank Limited

.

FOR OFFICUIL USE ONLYPAKISTAN

SECOND INDUSTRIAL INVESTMENT CREDIT PROJECT

LOAN, CREDIT, AND PROJECT SUMKARY

Borrower: Islamic Republic of Pakistan (GOP)

Beneficiaries: Habib Bank Limited (HBL)Industrial Development Bank of Pakistan (IDBP)MusLim Commercial Bank (MCB)National Bank of Pakistan (NBP)National Development Finance Corporation (NDFC)Pakistan Industrial Credit and Investment

Corporation (PICIC) andUnited Bank Limited (UBL)Pakistan Banking Council (PBC)Karachi and Lahore Stock Exchanges

Amount: Loan: US$148 million equivalent.Credit: SDR2.0 million (US$2.0 million equivalent).

Terms: Loan: Twenty years, including five years of grace, at thestandard variable interest rate.

Credit: Standard IDA terms.

Relending Terms: The Government would relend the proceeds of the loanto PICIC and IDBP at 1OZ and to the other par-ticipating financial institutions (PFIs) at 1lZp.a. The final lending rate from the PFIs to thesubborrowers (most of whom would be privateenterprises) would be 14% p.a. IDBP, PICIC, andNDFC would repay their loans over 15 years,including three years' grace. The nationalizedcommercial banks would repay their loans on thebasis of a composite amortization schedule oftheir subloans. The Government would bear theforeign exchange and interest rate risks. Itwould pass the credit proceeds to PFIs, PBC, andthe Stock Exchanges as a grant to finance techni-cal assistance.

* Project The project would support the Government's efforts to pro-Description: mote private industrial investment and would help the GOP

strengthen the financial markets. It would: (a)assist in development of a more efficient capitalmarket so as to increase the sources of equityfinance for industry; (b) stimulate further com-petition among PFIs; (c) ensure a steady flow ofterm finance to private industry; and (d) continuethe institution building programs of the PFIs.The project would stimulate private savings andfinance 40 to 45 subprojects, which would beexpected to create about 30,000 new jobs. The

Thidocument ha a resticted distribution and may be used by reipients only in hie performance oftheir ofricial duties. Its contenst may not otherwise be discosed without World Bank authorization.

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major project risk is that economic conditions,and hence investor confidence, would be hurt bypolitical and/or economic uncertainties and insuf-ficient Government action to maintain the pace ofstructuraL adjustment. Recent GOP policy measuressuggest that the Government is comitted to afurther expansion of the role of the privatesector in the economy.

Estimated Cost:

(US$ millions)Item Local Foreign Total

Subproject Investments 150 148 298Technical Assistance - 2 2

150 1S0 300

Financing Plan: (USS millions)Local Foreign Total

IBRD - 148 148IDA - 2 2Sponsors' Contributions 70 - 70PFIs 80 - 80

Total 150 150 300

Estimted (USS millions)Disbursements: IBRD/IDA FY87 M8 FY89 FY90 FY91 FY92 FY93

Annual 22.5 22.5 30.0 37.5 15.0 15.0 7.5Cumulative 22.5 45.0 75.0 112.5 127.5 142.5 150.0

x 15.0 30.0 50.0 75.0 85.0 95.0 100.0

Rate of Return: n.a.

Appraisal Report: No. 5823-PAR, dated December 6, 1985.

Map: IBRD 1624 8B

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENTINTERNATIONAL DEVELOPMENT ASSOCIATION

REPORT AND RECOMMENDATION OF THE PRESIDENT TO TbE EXECUTIVEDIRECTORS ON A PROPOSED LOAN AND CREDIT TO THE ISLAMIC REPUBLICOF PAKISTAN FOR A SECOND INDUSTRIAL INVESTMENT CREDIT PROJECT

v 1. I submit the following report and recommendation on a proposedloan for the equivalent of US$148 million and a proposed credit of SDR 2.0million (US$2.0 million equivalent) to the IsLamic Republic of Pakistanto help finance a Second Industrial Investment Credit Project. The loanwould have a term of 20 years, including five years of grace, at thestandard variable interest rate; the credit would be on standard IDAterms. The proceeds of the Loan would be relent to PICIC and IDBP at 10%p.a. and to the other participating financial institutions (PFIs) at 11%p.a. The final lending rate from the PFIs to the subborrowers would be14Z p.a. IDBP, PICIC, and NDFC would repay their loans over 15 years,including three years' grace. The nationalized commercial banks wouldrepay their loans on the basis of a composite amortization schedule oftheir subloans. The Government would bear the foreign exchange and inter-est rate risks. The Government would pass the credit proceeds to thePFIs, Pakistan Banking Council, and the Stock Exchanges as a grant tofinance technical assistance.

PART I - THE ECONOMY

2. The most recent economic report, "Pakistan: Recent EconomicDevelopments and Structural Adjustment" (No. 5347-PAK, dated March 20,1985), was distributed to the Executive Directors on April 4, 1985.

3. The steadily improving performance of recent years was interruptedin FY84 owing to an unexpected downturn in agriculture and migrant remit-tances and to the carryover of inflationary pressures from FY83. GDPgrowth slowed to 3.5Z as a result of a 6.2% fall in agriculture valueadded caused by adverse weather and pest attacks. Manufacturing grew by8.3% and services by 6.2%. Fixed investment rose by 6.5%, while privateinvestment increased by 11.52. National savings fell to 12.1% of GNP as aresult of a drop in private savings. At the same time, public savingsremained low because of reduced federal and provincial budget surpluses.Excess liquidity from FY83 (generated largely by foreign exchangeinflows), increases in world prices, and reduced agricultural outputcontributed to inflation, which reached upwards of 9Z, as against 5.2X inFY83. Budgetary policies continued to be prudent. Current revenuesincreased by 20%, largely through improved tax administration, but currentexpenditures also increased because of higher allocations for economic andsocial services. Considering the economic importance of agriculture, thecreditable growth achieved in FY84 suggests that Pakistan's underlyingeconomic structure is quite resilient, partly as a result of recentGovernment efforts to begin removing structural imbalances in the economy.

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4. The balance of payments deteriorated in PY84 relative to themarked improvement in FY83. The current account deficit stood at US$1bi'lion, which was almost double that in FY83. Stagnant ezports and lowerremittances were the main contributing factors. With cotton and yarnexports greatly reduced owing to the poor cotton crop, exports rose byonly 1.6Z, while imports increased by 6.9Z. Furthermore, remittancesdeclined for the first time in FY84, falling by 5.1. According to recentprojections, net migration is expected to decline and thus remittanceswill be lower over the medium term. As a result of the higher currentdeficit and low net capital flows, the reserve drawdown reached US$113million. Gross official goLd and foreign exchange reserves were US$2.4billion at the end of FY84, which was equivalent to 3.8 months of importsof goods and services.

5. Since 1980, the-Government has moved gradually to eliminate inter-est rates from the economy and has announced that the process will becompleted by July 1985. All transactions will be based on new financingmodes consistent with Islamic principles. Existing interest-based commit-ments will be honored and transactions with foreign governments and finan-cial institutions will not be affected. At this stage, it is difficult todetermine with any certainty the potential costs of Islamization.Undoubtedly, there will be some costs in converting the system, butwhether long-run efficiency will be affected will depend on how the systemis applied. To date, the Government has proceeded cautiously and,although fullv comitted to the elimination of interest rates, it hasstressed that new financing modes will be appLied flexibly and develop-ments monitored closely.

6. The slowdown in economic growth in FY84 marked a departure fromthe improved performance achieved during the Fifth Plan period (FY79-83).Growth in national output (6.5Z), agriculture (4.2Z), manufacturing(10.41), exports (11Z), and private investment (6.7Z), though below Plantargets, was well above the rates achieved during FY7O-78 and veryrespectable compared with the growth rates of other developing countries.Growth during this period--coupled with increased remittances-benefitedlarge segments of the population. Performance improved despite a numberof adverse factors: (a) a world recession; (b) a 30Z decline in the exter-nal terms of trade after 1979; and (c) the Afghanistan crisis with itsattendant expenditures for increased defense and refugee assistance.

7. Fiscal performance and the balance of payments improved sig-nificantly during the Fifth Plan. The overall budget deficit andGovernment bank borrowing, which in FY79 stood at 8.8Z and 4.3Z of GDPrespectively, fell to 6.4Z and 1.7Z by FY83. As the levels of Governmentborrowing from banks dropped and overall credit expansion was restrained,the growth of the money supply slowed down and inflationary pressureslessened; inflation dropped from 8Z to 5Z by the end of the Plan period.The improved fiscal performance was largely the result of expenditure

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restraint rather than better revenue performance. Real expansion incurrent expenditures on economic and social services barely kept pace withpopulation growth, and development expenditures declined relative to GDP.Government revenues remained constant at 16S of CDP, and public savings,having risen in the first half of the Plan period from 1Z to 3.8Z of GNP,dropped to 1.6Z by FY83. Assisted by remittances, but also strong exportgrowth, the current account deficit fell from 5Z of GNP to 2X by the endof the Plan Period. Gross reserves increased from 3.5 to 4.5 months ofimports of goods and services.

8. In addition to improving economic management through fiscal andmonetary policies, the Government took measures to improve performance inthe commodity-producing sectors. In agriculture, all major crops reachedrecord output levels, with wheat and sugar achieving self-sufficiency.Subsidies on pesticides were virtually eliminated, while fertilizer priceswere raised to reduce the subsidy burden. Crop procurement prices wereadjusted to bring them closer to world prices. Provincial allocations foroperations and maintenance in irrigation were increased, along with watercharges. Encouraged by improved policies and incentives, private manufac-turing investment grew by 10.9% per annum. Areas open to the privatesector were widened, most agricultural processing units weredenationalized, and sanctioning limits increased. A flexible exchangerate policy adopted in 1982 was instrumental in stimulating manufacturedexports, while import liberalization increased the availability of rawmaterials and capital goods. In energy, measures were taken to acceleratethe development of domestic resources, rationalize prices, and improvepolicy formulation and energy planning capabilities.

9. The deveLopments in Pakistan's economy since FY78 represent wel-come steps toward the solution of problems that are essentially structuraland long-term in nature. Nevertheless, further wide-ranging measures mustbe introduced to address structural issues. Pakistan's long-term growthprospects depend on two such issues: (a) the need to increase the leveland efficiency of public investment; and (b) the need to encourage exportexpansion and efficient import substitution. If Pakistan is to sustainhigh economic growth, it must make major infrastructure investments,upgrade existing facilities, and strengthen its neglected social base.The last has farztd badly as a result of resource constraints, as isreflected in Pakistan's social indicators, which lag seriously behindthose of other developing countries at comparable levels of development.It will not be possible to increase public investment and recurrentallocations without a major domestic resource mobilization effort.Although Pakistan should give priority to reforming indirect taxationthrough a broad-based sales tax, it should also rely more on user charges,should curtail subsidies, and increase self-financing by publicenterprises. Civen the more constrained outlook for official assistanceand the likelihood of lower remittance flows, sustained improvements inboth export expanision and efficient import substitution will be necessaryto support high growth with sustainable external capital requirements. If

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trade performance is to be improved, structural adjustment must be con-tinued and strengthened in the key sectors of agriculture, industry, andenergy. Both agriculture and industry have considerable potential forincreased exports and some degree of efficient import substitution. Inenergy, the accelerated development of Pakistan's under-exploited resour-ces can contribute considerably to the reduction of energy imports.

10. In agriculture. high growth has been largely the result ofincreased acreage; yet average yields remain low by world standards and bythose of progressive farmers within Pakistan. Before agricultural produc-tivity and diversification can be increased, institutional support must bestrengthened, appropriate pricing policies must be put in place, and thecore investment program identified and implemented. More effectiveinstitutional support should be sought through improvements in the qualityand quantity of services to farmers. In particular, strengthening theseed program requires more efficient seed multiplication anddissemination, increased efficiency in public sector plants, and a greaterrole for the private sector. The delivery of agricultural credit alsoneeds to be improved to ensure that it actually reaches small farmers andtenants, whose credit needs are greatest. Furthermore, marketing costsneed to be reduced and research and extension services strengthened.Agricultural pricing policies should create appropriate incentives tofarmers, while minimizing subsidies. Multicrop approaches to pricingshould complement the single-crop, cost-of-production approach currentlyused. Finally, a core investment program in agriculture and water isneeded to reduce the possibility of distortions in investment priorities.Low cost programs that yield quick returns should be emphasized along withcritical infrastructure investments that raise farm productivity. Greateremphasis on the complementarity of investment programs, especially betweenagriculture and water, would ensure that priority is accorded to programsthat increase agricultural productivity rather than merely augment thesupply of physical infrastructure.

11. If Pakistan is to increase and diversify its manufactured exportbase and encourage efficient import substitution, industrial incentivesmust be rationalized to reduce both the level and dispersion of effectiveprotection rates. The objective here is to increase the efficiency of theindustrial sector by exposing protected producers to greater foreigncompetition and to reduce the anti-export bias inherent in the presentincentives. In addition, the Government should reform the regulationsaffecting investment sanctioning and cost-plus pricing. It should limitsanctioning to a few cases of strategic importance, leaving most invest-ment decisions to the private sector, which is better able to assessinvestment opportunities. Cost-plus pricing arrangements, which provideinsufficient incentives to minimize costs or allocate capital efficiency,should be replaced by market-oriented approaches, which better reflectsupply/demand conditions and provide adequate incentives for reinvestmentand operational efficiency.

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12. tssues that need to be addressed in the energy mactor pertain tothree broad areas: (a) investment and development; (b) pricing; (c)institutional strengthening. To date, the Government's power generationprogram, as well as other investments in the sector, have not been basedon a long-term least-cost development plan. Given the likelihood ofdomestic resource constraints and persistent power shortages, theGovernment should ensure that future investments conform to such a planand that a core investment program is insulated from uncertaintiesinherent in the budgeting process. The present gas producer pricingformula for new discoveries should be adjusted to provide adequate incen-tives to attract private sector exploration. Because consumer gas priceswere kept artificially low to encourage the substitution of gas forimported oil, relative prices have become distorted and the use of gasuneconomic. The Government's policy is to increase gas prices until theyreach two-thirds of fuel oil parity by FY88; thus since 1982, priceincreases have averaged 15X per annum in dollar terms. The Governmentneeds to meet its FY88 objective and move to full parity as soon there-after as possible. Electricity tariffs, which are currently below thelong-run marginal cost, should be adjusted to reflect this cost, not onlyto ensure the efficient use of electricity and encourage energyconservation, but also to mobilize the substantial additional fundsrequired by the power investment program. Finally, the Government shouldconsider increasing the autonomy of public enterprises in the energysector to improve their efficiency and should continue to strengthenenergy planning and policy coordination.

13. The Sixth Five-Year Plan (FY83-88) articulates a pragmaticstrategy for Pakistan's continued rapid development that includes anexpanded role for the private sector, increased public developmentexpenditures, and increased allocations for energy, agriculture,irrigation, and the social sectors. Although the size and composition ofthe Plan are appropriate, development expenditures during the first twoyears of the Plan have been 9% lower than the amounts projected because ofinsufficient domestic resources. Although this would not appear overlylarge, the way in which sectoral shortfalls have been distributed con-tradicts Plan priorities. Education, energy, health, and agriculture havereceived considerably lower allocations than called for in the Plan.Furthermore, without a predefined core investment program, there is atendency to distribute shortfalls evenly over a large number of projectswithin a sector; thus too many projects have been initiated, and projects

* that should receive priority are underfunded. To address this issue, theGovernment has re-introduced a Three-Year Priority Investment ProgramCFY86-88). The Government has emphasized that the adoption of a rolling

- medi=m-term program does not mean that plan strategies and priorities arebeing revised, or that shortfalls are considered inevitable. The programwill merely identify sectoral core investment programs to be givenpriority in annual plans. If priority investments, especially in keyareas, could be protected, the public investment program would become moreeffective and its priorities would be sharpened.

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14. Despite a temporary setback in FY84, the improved performance andpolicy framework of the Fifth Plan, which the Government intends to con-tinue during the Sixth Plan, have improved Pakistan's creditworthiness fora blend of Bank and IDA borrowing and commercial borrowing. At the end of1983, Pakistan's external public debt (excluding the undisbursed pipeline)stood at US$9.8 billion, of which US$4.7 billion was owed to bilateralmembers of the Pakistan consortium, US$1.3 billion to OPEC, US$2 billionto multilateral agencies, and the baLance to other bilateral and privatelenders. At the same time, the Bank Group's share in Pakistan's externalpublic indebtedness was 15.3%, and in external debt service it was 7.0Z.According to Bank projections, if recent policy improvements are sustainedand structural issues addressed, Pakistan's debt service will remain below15% during the remainder of the 1980s, even with somewhat higher levels ofcommercial borrowing.

PART II - BANK GROUP OPERATIONS IN PAKISTAN

15. As of September 30, 1985, the cumulative total of Bank/IDA commit-ments to Pakistan (exclusive of Loans and Credits or portions thereof thatwere disbursed in the former East Pakistan) amounted to approximatelyUS$3.7 billion, and IFC's investments totalled $193.5 million. (Annex IIcontains a summary Statement of Bank loans, IDA credits, and IFCinvestments.)

16. During its long association with Pakistan, the Bank Group has beeninvolved in most sectors of the -economy. For example, it has participatedwith other donors, over a 20-year period, in a major program of works todevelop the water resources of the Indus Basin. Approximately 30Z oftotal Bank/IDA commitments to Pakistan have been for agriculture andirrigation; 28% for industry, including import program credits; 18% fortransport, telecommunications, and public utility services; 14Z forenergy, including power, gas pipelines, and petroleum; 5% for socialprograms in education, population, and urban development; and 5% forstructural adjustment lending and technical assistance.

17. Currently, the Bank's assistance strategy is to support theGovernment of Pakistan's efforts to formulate and implement policy relormsin three sectors-energy, industry, and agriculture--which shape thestructural adjustment of the economy. To ensure that the gains fromadjustment are susta5ned in the long term and shared more broadly, thestrategy also includes investments in physical infrastructure and thesocial sectors (education, population, etc.) that have been neglected inPakistan's development efforts. If this strategy is to succeed, the fullrange of traditional instruments of Bank support must be flexiblydeployed--from sector work and active policy dialogue, to policy- andproject-based lending, technical assistance and aid coordination. TheBank Group's lending program comprises two components, the larger of whichsupports specific high-priority investments in productive sectors and

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physicaL and social infrastructure. The smaller but nonetheless strategiccomponent focuses on policy reforms in the key sectors of agriculture,industry, and energy and relie, heavily on high-quality economic andsector work. The program includes a series of technical assistancecredits to finance studies and formulate action programs for policyreform. The experience with the first of these has been extremelypositive. in addition, through its annual Country Economic Memorandum,the Bank Group tries to foster greater understanding on the part ofConsortium members of the Government's structural adjustment program andaid requirements. This effort, coupled with increased cofinancing, shouldenhance the policy relevance and effectiveness of other official aid andhelp attract additional resources to Pakistan irom nonconcessionalsources.

18. Historically, the Bank Group has placed special emphasis on lend-ing for agriculture, which is the mainstay of Pakistan's economy. TheBank and the Government have agreed that the main objective of theagricultural strategy and, consequently, lending to the sector should beto increase agricultural productivity through improvements in theefficiency of the irrigation system and supporting agricultural services.Among the issues being addressed are: the balance between short-gestationprojects and projects with a longer-term focus, rationalization of inputand output prices, marketingg, improvements in operation and maintenance,cost recovery, and a wider role for the private sector. Projects in thesector have ranged from irrigation/drainage to agricultural inputs,research, and extension and have included institution-building components.Overall, progress in agriculture has been satisfactory.

19. In industry, the strategy has two complementary aspects: tostrengthen and broaden the structural adjustment in Pakistan's industrialsector and to support the Government's efforts to revitalize the privatesector through industrial financing. The industrial reform program hasbeen designed to improve the competitiveness of the sector with a view topromoting export expansion and import substitution. Issues beingaddressed include trade and industrial incentives, dereguLation,efficiency of public enterprises, pricing decontrol, and improvements inthe credit delivery system and capital markets. Lines of credit extendedto development finance institutions and other financial intermediarieshave been mainly for the private sector. Direct lending for industry hasalso included assistance to three large fertilizer plants and a refineryengineering loan. IFC's investments in 16 Pakistan enterprises were byway of loans (US$182 million) and equity participation (US$11.3 million);these are shown in Annex II. Although individual operations havegenerally achieved their objectives, the agenda for overall industrialreform remains formidable.

20. As a result of the progress under the Structural Adjustment Loan(SAL) in 1981/82 and the Energy Sector Loan in 1985, our lending programin energy is expanding rapidly. The overall objective here is to expand

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the domestic supply from all energy subsectors and simultaneously increasethe efficiency of energy use through appropriate pricing, conservation,and other methods of managing demand. No less central have been theefforts to strengthen key institutions in the sector. In power, the Bankhas helped both the Karachi Electric Supply Corporation and the Water andPower Development Authority to finance their power generation and trans-mission programs. The construction of the Mangla and Tarbela dams underthe Indus Basin Development Program, in which the Bank played a leadershiprole, has also assisted in achieving the objectives of the sectorstrategy. In oil and gas, the Bank has financed a sound exploration anddevelopment program and has assisted in developing the extensive gastransmission system. Smaller efforts, involving mainly engineeringstudies and technical assistance, have been undertaken to support coalexploration, energy audits, and oil refining. Despite much progress,however, the Bank will need to continue participating in institutionbuilding and help the Govertment mobilize adequate funds for energyinvestments through tariffs, co-financing, and greater private seccorparticipation.

21. Bank Group lending for transport and communications has focusedboth on new capital investments and on improving the efficiency of exist-ing assets. Efforts have also been made to strengthen the institutionsresponsible for these services, especially the Karachi Port Trust,Pakistan Railways, the Telephone and Telegraph Department and federal andprovincial highway agencies. However, inadequate transport infrastructureis now considersd to be critical constraint to overall growth, in largemeasure because infrastructure stock has run down. Thus, the balancebetween new investments and the efficient operation and maintenance ofexisting investments needs greater attention.

22. With an overall literacy rate of only 24%, a population growthrate of about 3.1%, and rapid urbanization, Pakistan faces an equallyformidable development agenda in the social sectors. The Bank has sup -ported the Government's programs in education through five creditsdesigned to upgrade primary, post-secondary, and higher technical. andagricultural education as well as middle-level training of primaryteachers and agricultural extension agents. The focus has been and willcontinue to be on the lower end of the education spectrum (primary,technical, and nonformal education). A first population project designedto expand the demand for population control services was approved in FY83.Furthermore, the Bank has financed four projects in the urban and watersupply sector. Besides providing urban services, these operations aredesigned to improve local resource mobilization and cost recovery; plan-ning and efficiency of resource utilization; and urban management, espe-cially at the provincial and municipal levels.

23. In addition to the above, policy-based lending was pursued throughthe SAL and an Energy Sector Loan mentioned in para. 20. The SAL programintroduced a number o'. significant reforms in govermaent development

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planning and in policies and programs in the agriculture, energy, andindustrial sectors; by the time the loan was fully disbursed at the end ofFY83, significant progress had been achieved in the above areas. The ESLsupports the Government reform program for the energy sector and assistsin the implementation of a core investment program for the sector.Continuing support for the structural adjustment process is envisionedunder other sector loans in the next few years.

24. In general, disbursements have been satisfactory. Some projectshave experienced initial delays owing to protracted government proceduresfor project approval (but these problems are now being addressed), and theprocurement of goods and services. Rapid turnover of managerial andtechnical staff, partly due to migration to the Middle East and partly tobudgetary constraints, has also been a problem in some projects.

25. A number of operations are currently being prepared or appraised.These include projects for power transmission, generation, andconservation; oil and gas exploration and development; coal development;lines of credit for industrial financing for the private sector, and forindustrial subsector restructuring, balancing, and modernization;irrigation/drainage, and agricultural inputs and services; highway con-struction and maintenance; primary and informal education; urban develop-ment and water supply. Sector loans that would support further structuraladjustment in industry and agriculture are being discussed with theGovernment. Where successful, such loans would provide a policy umbrellafor projects in those sectors. To help the Government finance agricul-tural and other high-priority projects having low foreign exchangecomponent, the Bank Group is financing some local expenditures on a case-by-case basis.

26. Economic and sector work provides the basis for the continuingdialogue between the Bank Group and the Government of Pakistan on develop-ment strategy, the sector and project lending strategy and operations, andthe coordination of external assistance within the Pakistan Consortium.The work program emphasizes resource mobilization, structural adjustmentin the three key sectors, and the development of the physical and socialinfrastructure.

PART III - THE INDUSTRIAL AND FINANCIAL SECTORS

27. Industrial Structure and Performance. Pakistan has a fairlydiversified industrial base. In FY84, manufacturing accounted for 18% ofGDP, employed 13Z of the economically active population, and accounted for71% of total exports, of which more than half were cotton manufactures.Textiles and food processing account for more than half of manufacturingvalue added; other major sectors are engineering, cement, and chemicals.In large-scale industry, public sector enterprises produce about 15% ofvalue added and constitute a significant part of a number of keyindustries. During the 1970s, the GOP nationalized a large part of

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industry. Since taking office in 1977, the present Government hasreversed these policies by assigning the private sector the leading rolein industrial development, denationalizing most agricultural processingand a few industrial units, opening up areas for private investment, andreducing public industrial investment. As a result of these measures andother incentives, the performance of the industrial sector has improvedconsiderably. During FY78-FY84, real annual growth averaged 10.8% formanufacturing value added, 13.5% for private fixed industrial investment,4% for industrial employment. and 11.8% for manufactured exports.

28. Industrial Strategy and Issues. In July 1984, the Covernmentissued a new Industrial Policy Statement (IPS) restating the Government'scommitment to a mixed economy in which the private sector is the engine ofgrowth and the public sector acts as investor of last resort. The IPSemphasized the need to rationalize the tariff structure, maintain anappropriate exchange rate so as to improve resource allocation andstrengthen the competitiveness of Pakistan's industries, and furtherderegulation of the sector. The IPS also reiterated the Government'scommitment to improve the efficiency of the pubLic enterprises throughfurther development of a Signalling System to monitor performance andreward management accordingly. In May 1985, the GOP announced fulldecontrol of cement pricing, and it raised the sanctioning limits forindustrial investments. At the same time, Commissions on Deregulation andDisinvestment were established to make recommendations on further reformsto be included in the FY87 budget. The GOP also announced in May that itplanned to sell Rs 2 billion in shares of public corporations during FY86.

29. Although the recovery of the industrial sector has beenimpressive, sustained growth will depend on improvements in a number ofareas: incentives, government controls, infrastructure, publicenterprises, and the capital market. The tariff structure requiresmodification to provide a more uniform level of effective protection andreduce the import substitution bias. Although some liberalization ofregulations has taken place in recent years, industry continues to behampered by relatively cumbersome government controls on investmentdecisions, imports, access to foreign exchange, company formation,pricing, and labor relations. Industries affected by price controls(including fertilizer and most public enterprises) operate under cost-plusarrangements which discourage operational efficiency and optimal invest-ment location. Infrastructure deficiencies, especially energy, are amajor cause of project delays and impose substantial costs on industrialefficiency. In recent years, the GOP has delegated greater decision-making authority to the holding corporations of public enterprises andincreased salaries and performance incentives. While these measures haveled to improved performance, they need to be complemented by relaxation ofprice controls and increased autonomy at the enterprise level. At thesame time, the GOP should consider further divestiture of the enterpriseswhich are not strategically important. Finally, to sustain high rates of

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industrial growth, there is a need to expand the access of private inves-tors to equity finance from non-bank sources.

30. Structure of the Financial System. The financial system consistsof nationalized and foreign commercial banks, two stock exchanges, and arange of specialized financial institutions. The State Bank of Pakistan(SBP), the central bank, regulates and directs the financial system.Within overall policies set by the GOP and SBP, the Pakistan BankingCounciL (PBC) oversees and coordinates the activities of the nationalizedcomercial banks (NCBs) and fulfills many of the functions previouslydischarged by NCB shareholders. The Ministry of Finance monitors theoperations of the other financial institutions.

31. With total assets of about Rs 250 billion, or 80% of the assets ofthe financial system at end-FY84, and a network of 7,000 branches, commer-cial banks play a dominant role in Pakistan's financial system. The fiveNCBs together accounted for about 94% of deposits, 901 of advances, and87% of commercial banks' net profits. Since 1979 a number of steps havebeen taken by the GOP and PBC to improve the overall performance of NCBs.While these actions have led to a substantial increase in profitability,che absolute profitability levels remain relatively low and vary con-siderably among NCBs. Low profits are caused mainly by relatively highreserve requirements; a large network of high cost branches in ruralareas; non-payment of interest on loans to the public sector; and generaloverstaffing due to strong labor unions. Following appraisal of theproposed project, the Government announced a number of new measures toimprove the performance of the NCBs including the granting of greateroperational autonomy, establishment of a performance and profitabilitymonitoring system with specific performance targets for each NCB, andintroduction of incentives for management and staff based on after-taxfinancial profitability.

32. Sources of Industrial Finance. A number of specialized financialinstitutions provide industrial finance. The Pakistan Industrial Creditand Investment Corporation (PICIC), the only financial institution withprivate ownership, makes foreign exchange loans to medium- and large-scaleindustry while the Industrial Development Bank of Pakistan (IDBP) lends tosmall- and medium-scale manufacturing unitr. The National DevelopmentFinance Corporation (NDFC) provides term financing and working capital tothe public and private industrial sectors. A Regional Development FinanceCorporation was set up in FY84 as a subsidiary of NDFC to finance projectsin less developed areas. Jointly with the Rafiq Habib Group, NDFC hasestablished a leasing company with financial and technical assistance fromIFC. Three joint venture companies were established in 1982 to provideloans and venture capital to industry. The Small Business FinanceCorporation provides short- and long-term loans to small scale industriesand businesses. The Investment Corporation of Pakistan (ICP) arrangesindustrial financing through consortia of NCBs, underwrites equity issues,and operates a number of mutual funds. The National Investment Trust

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operates mutual funds and unit trust savings schemes. Banker's EquityLtd. (BEL), which was originally set up to promote Islamic instruments,especially equity finance, provides capital to private industry by under-writing equity issues and arranging consortia finance participation fromNCBs. The Equity Participation Fund provides direct equity support tosmall-scale projects mainly in underdeveloped areas.

33. Notable changes in the industrial financing system during the lastdecade have been the creation of a number of non-bank financialinstitutions, the decline in the relative importance of establisheddevelopment finance institutions (DFIs), and the emergence of the NCBs asa major force in term lending. Initially, PICIC and IDBP were the maininstitutions providing term financing for private industrial development.However, in 1982, NDFC was allowed to diversify its activities to includelending to the large- and medium-scale private sector. Among the DFIs,NDFC is now the largest industrial lending institution in Pakistan. Otherinstitutions such as BEL, ICP, and the three joint venture companies havealso increased their role in term financing for private industry.Historically, the NCBs were reluctant to engage in industrial term lendingdespite the imposition by SBP of mandatory targets from FY79-81. SinceFY82, the improved investment climate and freeing of interest rates,combined with allocations by SBP specifically for industrial investment,have caused term lending by NCBs to increase dramatically. This processwas encouraged under the first Industrial Investment Credit (IIC) projectby permitting Habib Bank Ltd. (HBL) to draw upon the credit funds andproviding technical assistance to HBL and United Bank Ltd. (UBL) toupgrade their term lending skills. As a result of these changes, the DFIsfound themselves faced with competition, yet unable to provide theirtraditional term loan clients with a full range of financial services.Under the first IIC project, the GOP took a number of measures to ration-alize regulations affecting DFIs and permit them to mobilize local resour-ces and make working capital ioans. These measures have led to increasedcompetition among DFIs, an improved financial base especially for PICICand IDBP, and the provision of more comprehensive financial packages toprivate investors. As a result, tihe efficiency of the industrial creditdelivery system has improved considerably.

34. Islamization. Following a four-year transition period, since July1985, Pakistan's entire domestic financial system and all transactionshave been based on new financing modes consistent with Islamic principles.While foreign loans can continue to be relent with interest, no interestcan be charged on domestic transactions. New or proposed financing arran-gements relevant to industrial finance include: (a) Mark-Ups--where afinancial institution purchases plant andlor equipment and "resells" it tothe entrepreneur at a margin over the original purchase price, with pay-ment made on an installment basis; (b) Term Finance Certificate{TFCs)-similar to bonds with a risk premium; (c) Musharika-designed tomec working capital needs, in which profits are shared according to apre-agreed formula; (d) Modaraba company-operater as an investment fund

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.In accordance with Islamic tenets and Ce) hire-purchase and leasing. Inpractice, most short- and long-term financing is expected to be accordingto mark-up.

35. While it is too early to evaluate the impact of Islamisation onthe financial system and industrial finance, initial indications are that,on the whole, Islamization is having a positive effect. By not imposingrestrictions on the terms and conditions which can be negotiated betweenlenders and borrowers, the GOP has effectively freed financial rates ofreturn. This applies in particular to term financing under TFCs and thearrangements for hire-purchase and leasing. In contrast with term lendingat 11 in the past, TFCs are expected to carry effective rates of 14X-15Xp.a. to reflect a risk factor. At these rates, they should provide con-siderable incentive for financial institutions to engage in lending forfixed industrial investment. In addition, the introduction of new financ-ing mechanisms such as hire-purchase, leasing and Modarabas has increasedthe range of financing options available and created a stronger role forthe private sector in financial intermediation. Modarabas, in particular,offer the opportunity for project sponsors to raise funds directly fromthe public. Islamization, with its emphasis on equity or quasi-equityforms of financing investment, should also lead to a deepening of thecapital market.

36. Interest Rates. Before the fulL conversion to Islaumization,Pakistan's interest rate structure was characterized by a crossing ofrates. Since deposit rates rose while lending rates fell with maturity,the interest rate structure provided a clear incentive for banks to favorshort-term lending. Under Islamization, with rates of return on TFCs at141-15% and on mark-ups at 10-20%, the imbalance in the interest struc-ture has been corrected. OveralL, long-term rates of return of about141-151 are considered a realistic indicator of the cost of capital inPakistan. With inflation rates expected to remain below 1OZ, rates ofreturn should be substantially positive. However, if rates of return wereto become negative, it would be possible within the parameters establishedby SBP for the commercial banks to set higher rates for term lending andup to 20% for working capital loans.

37. Credit Allocation. The growth and distribution of domestic creditin Pakistan is governed by a centralized allocation system. SBP isresponsible for determining and managing the Annual Credit Plan in closeconsultation with the GOP. The Credit Plan determines the overall levelof credit and its distribution, effectively setting maximum volumes oflending for each bank and financial institution. Overall ceilings aredisaggregated by economic sector and between the private and publicsectors. This detailed system of credit allocation preempts somewhat theintermediating and allocative functions of the financial system. However,in practice the system is implemented with considerable flexibility andSBP permits financial institutions to trade ceilings.

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38. Credit allocation to the private sector is determined after takinginto account the COP's borrowing requirements and the overall money supplygrowth target. Through tight fiscal policies, the GOP has so far suc-ceeded in preventing its domestic bank borrowing from crowding out privatecredit. However, unless the GOP undertakes a major domestic resourcemobilization ef'ort, attainment of this objective could become increas-ingly difficult. During FY85, the GOP's domestic bank borrowing wassubstantially higher than projected in the Credit Plan. To minimize theadverse effects on the private sector of increased GOP borrowing require-ments and to sustain recent high industrial growth rates, there is a needto widen the sources and methods of financing private sector industrialinvestment. Strengthening the stock market, improving incentives forequity financing, and encouraging the development of secondary marketsto enhance the liquidity of long-term and equity financing would con-siderably widen the presently restrictive Pattern of industrial finance.One of the main objectives of the proposed project is to assist the GOPin developing a more efficient capital market and secondary markets forsecurities and Islamic instruments.

39. The Capital Market. After a promising start in the late 1950s,the capital market ceased to be a major source of industrial finance,stagnating from the late 1960s to the end of the 1970s. As a result ofthe improved economic climate and government measures to encourage theprivate sector, the stock market has revived somewhat since 1982 withincreased turnover and share values. Nevertheless, it remains only amarginal source of funds for industrial investment. Although Pakistan hasmore than 10,000 private companies, only 353 are listed on the Karachistock exchange, and active markets exist in only about 30. In the courseof preparation for the proposed project, the Bank Group discussed with theGOP measures to expand the stock market and generally strengthen thecapital markets in Pakistan. The Government's reaction has been positive,and it announced a number of important measures in the FY86 Budget. Theseinclude: (i) a reduction in the corporate tax for listed companies fro50% to 402 (privately held companies are taxed at 55%); (ii) income taxexemption on dividends paid by listed companies; (iii) a decision to allowprivate investment companies (local or foreign owned) to perform allbanking functions except deposit taking; and (iv) introduction ofGovernment bearer bonds in foreign and local currency to attract "blackmoney" and mobilize additional resources. The tax concessions and theincrease in the supply of shares should have a positive impact on thestock market. Bearer bonds, which can be traded in the stock exchange,and new private sector investment companies should also expand the rangeof Einancing sources for the corporate sector in Pakistan.

40. While the recent Government announcements are expected tofacilitate equity mobilization, they need to be complemented by measuresto encourage a smoother functioning of the stock exchanges, promote moremarket-oriented corporate finance services in the pricing and distributionof securities, and develop a market for short-term corporate paper. The

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Bank discussed with the GOP a number of additional policies which shouldbe considered in order to improve the efficiency and expand the range ofcapital markets in Pakiatan. These include: ti) permitting companies toissue bearer shares of common stock to attract "black money";(ii) deregulation of underwriting activities; (iii) introduction of marketpricing for new share issues; (iv) introduction of short-term corporatecomuercial paper; and tv) licensing of private comuercial banking. TheGovernment has referred these proposals to the recently establishedDeregulation Commission, and there are good prospects that some or all ofthese measures will be implemented in the near future. The GOP has alsoendorsed the stock market's request to IFC for technical assistance tomodernize its operations which will be financed from the technical assis-tance component of the first IIC project.

41. Bank Group Lending Strategy. The Bank's strategy in theindustrial sector is to address the issues described in para. 29 through aparallel program of sector and project lending. A proposed ExportDevelopment Loan, while focusing on exports, would also encourage furtheraction to deregulate investment and pricing, increase public enterpriseefficiency, and rationalize trade incentives. This operation would laythe foundation for possible future Bank support for a broad program oftariff reform. The policy-based lending will be re-enforced by projectloans to critical subsectors including those dominated by publicenterprises, such as cement and engineering, where there are goodprospects for improvements in efficiency and increased private sectorinvolvement. The main thrust, however, of the Bank's project lending inindustry will be to support the GOP's efforts to revitalize the privatesector through the provision oE industrial finance. Toward this end,future industrial investment credits, including the proposed project, willfocus on financial issues. The Bank and IFC will work closely together,as they did in preparation and appraisal of the proposed project, toassist the GOP in divestiture of public enterprises and in strengtheningthe capital markets.

42. From 1957 until 1983, the Bank Group made separate loans to thethree DFIs (IDBP, NDFC, and PICIC). The rationale for dealing with themindividually was their clearly defined roles in different market segments(para. 32); and institution building was an important objective of eachoperation. The OED report on Loan 177-PAK to IDBP (SECM79-494) concludedthat the credit component of the project had been effective, financing 65private sector subprojects with an ex ante economic rate of return of16X-50%. The report also noted the impact on IDBP of the political andeconomic disruptions of the 1970s which had resulted in wide-scale defaultby IDBP's subborrowers. It called for greater efforts by the GOP and theBank to address the operational and financial difficulties besetting IDBP.The OED report on Loan 590-PAR (SECM78-537) to PICIC and the projectcompletion reports on Loan 961-PAK and Loan 1326-PAl noted the beneficialimpact of the credit components which had financed about 60 private sectorsubprojects with ex ante economic rates of return ranging from 10-40%.

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These reports also focussed on the financial problems of PICIC, whichsuffered from the same disruptions of the 1970s as IDBP, and pointed tothe need for greater diversification. The reports also emphasized theneed for further institutional upgrading of PICIC. Through the combinedefforts of the GOP, the Bank, the Asian Development Bank (ADB), and thenew management of the institutions, IDBP and PICIC have shown steadyimprovement in recent years. Nevertheless, all parties concerned agreethat further efforts, particularly to improve the quality of IDBP's andPICIC's portfolios, are still needed. NDFC was less affected by thepolitical and economic difficulties of the 1970s, and performed well underCredit 546-PAK, financing 22 subprojects with an ex ante economic rate ofreturn of 15Z-50X. Subsequently, NDFC has branched out into privatesector financing and emerged as the largest and most profitable DFI.

43. As a result of these developments, as well as the growth of termlending by commercial banks and the creation of new DFIs (para. 33), theclient base for all the financial institutions began to overlap. Giventhese changes and the decline in the share of industrial financing by theDFIs, in 1983 the Bank Group adopted a new lending strategy of focusing onthe system of industrial financing as a whole. A principle objective ofthe strategy was to better position the Bank Group to discuss generalfinancial sector issues with the GOP, influence the roles and performanceof major institutions, and at the same time, continue to assist the GOP instrengthening DFIs through technical assistance progrems. The BankGroup's first Industrial Investment Credit (IIC) project was the vehicleto implement the strategy.

44. The first IIC project expanded the Bank's involvement in thefinancial system by using both DFIs and commercial banks as financialintermediaries for term lending to medium- and large-scale industries.Initially, three DFIs (IDBP, NDFC and PICIC) and one NCB (HBL) wereeligible to participate in the project. A second commercial bank (UBL)became eligible in late November 1984 after all the credit funds had beencommitted. Project implementation has been satisfactory. The loan/creditwas fully committed one year ahead of the original schedule. The sectoraldistribution of subloan approvals was: textiles (25%), food and alliedindustries (22Z), sugar (19%), paper products (11%), engineeringindustries (11X), cable manufacture (8%), and other manufactures (4Z).Increased competition and a larger number of efficient outlets havebenefited private investors by reducing the project processing time andwieening the range of financial services available to investors from asingLe financial institution. Because of the competitive pressure andmore stringent eligibility criteria, the PFIs have also been forced tobecome more efficient and market r iented; competition between DFIs hasdeveloped rapidly in some areas. Overall, there have been continuedimprovements in the financial performance of all the DFIs, especiallyPICIC and IDBP, and new regulations have given the DFIs greater freedom tomobilize funds and make working capital loans. This more flexible,client-oriented approach has even been extended to the small-scale

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industries projects, where IDBP acts as refinancing agent for funds chan-neled through the commercial banks.

PART IV - THE PROJECT

45. The proposed project was identified in August 1984 and appraisedin July 1985. Negotiations were held in Washington, D.C. from October 30,1985 to November 5, 1985; the Pakistan Delegation was led by Mr. SadiqSayeed Khan, Additional Secretary, Ministry of Finance, A Staff AppraisalReport entitled "Second Industrial Investment Credit Project" (Report No.5823-PAK, dated December 6, 1985) is being circulated separately to theExecutive Directors. A supplementary data sheet is attached as Annex III.

Project Objectives and Scope

46. The Second IIC project would support the Government's efforts topromote private industrial investment and would help the GOP strengthenthe financial markets. Specific objectives would be to: (a) assist theGOP in development of a more efficient capital market in order to increasethe sources of equity finance for industry; (b) stimulate further competi-tion among the participating financial institutions (PFIs) as a means ofimproving the financial services offered to investors; (c) ensure a steadyflow of term finance to private industry by increasing the number ofoutlets and range of services offered; and (d) continue the institutionbuilding programs of the PFIs.

47. The project would provide: (a) a line of credit to enable the PFIsto finance the foreign exchange requirements of investment projects ofprimariLy private medium and large enterprises; and (b) technical assis-tance to strengthen the PFIs and the Stock Exchanges. The project is animportant element in the Bank's strategy for the industrial sector as setout in para. 41. Many of the recently announced policy reforms affectingthe capital market and banking system were encouraged by interactionbetween Bank staff and GOP and PFI officials during supervision of IlC Iand preparation and appraisal of the proposed IIC II. This dialogue wouldbe expected to continue in the course of execution of the proposed projectand to be complemented by activity in connection with other possiblepolicy based lending operations.

Financing Plan

48. Total funding requirements for fixed private investment in medium-and large-scale industries from FY86-88 are estimated at US$1.3 billion,including a foreign exchange requirement of about US$600 million. Theproposed project size of US$300 million represents the estimated require-ments of some 40-45 subprojects out of a total of about 100 projectsidentified by the PFIs which are expected to be approved for financing bythem during FY86-88. The proposed IERD loan of US$148 million wouldfinance all the foreign costs or about 50% of the total costs of the 40-45

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subprojects. In addition, an IDA credit of SDR 2.0 million (US$2.0 mil-lion equivalent) would finance the technical assistance. The remainingrequirements would be met by a minimum of 23Z, or US$70 million, from theproject sponsors, and the balance from the PFIs' own resources. The Bankwould lend to the Government for relending to the PFIs, who would beexpected to commit all the loan funds by December 31, 1988. The ADB isexpected to make a paraLlel line of credit of US$150 million to helpfinance the remaining projects in the PFI pipelines. The ADB also made aparallel line of credit in connection with IIC I, although its loan wasnot available to NCBs. The Bank and ADB have worked closely togetherduring supervision of IIC I and appraisal of IIC II to ensure a consistentapproach to policy reforms and loan conditionality; and ADB has decided toinclude the NCBs under its loan for the proposed project. Finally,limited foreign financing is also available to the PFIs from exportcredits, commercial borrowings, and GOP reserves.

Participating Financial Institutions (PFIs)

49. Three DFIs (IDBP, NDFC, and PICIC) and three NCBs (fBL, MuslimCommercial Bank (MCB), and UBL) would be eligible initially to participatein the proposed project upon fulfillment of the conditions for access toloan proceeds. These include (a) adoption by the PFI Board of a Statementof Strategy and Operating Policies satisfactory to the Bank; (b) for NBP(para. 51), establishment of a project section at its head office;(c) introduction of a staff training program satisfactory to the Bank;(d) for IDBP and PICIC, commencement of an Organization/Strategy Study;(e) achievement of collection targets agreed with the Bank; (f) for theDFIs, achievement of, and maintenance of, a debt/equity ratio and debtservice coverage ratio, satisfactory to the Bank; and (g) execution of aSubsidiary Loan Agreement (SLA) with the GOP, satisfactory to the Bank.The collection targets (and, for each DFI, financial covenants) for eachPFI were agreed upon during negotiations. An institution's eligibility toparticipate in the project would be withdrawn if the PFI had not signed aSLA within six months of signing of the IBRD loan agreement with the GOP.Execution of at least two SLAs, including cne with an NCB and one with aDFI, would be a condition of loan effectiveness. This would be expected tooccur promptly after ican siguing since one NCB and one DFI have alreadymet all the conditions of access the loan proceeds except for signing theSLA. Once their SLAs were executed, all the PFIs would have access to thefunds for relending on a first-come, first-served basis and would beresponsible for appraising the projects and supervising procurement inaccordance with Bank standards.

50. The Participating DFIs. Of the three DFIs (IDBP, NDFC, and PICIC)which are expected to participate in the project, IDBP and PICIC formerlyexperienced considerable operational and financial difficulties (para. 42)caused in part by the loss of assets in East Pakistan, sharp devaluationof the rupee in 1972, and the general economic and political conditionsduring the seventies. The impact of these disturbances was seen in sig-

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nificant arrears and portfolio deterioration. Since 1981, combined actionby the GOP, the DFIs, the Bank, and ADB have resulted in continuingimprovement in the quality of IDBP's and PICIC's portfolios and improvedfinancial performance which has offset in part the poor financial perfor-mance in the 1970s. Recent Bank reviews of the operational and financialperformance of the DFIs indicate that the level of arrears in IDBP'sportfolio has fallen from Rs 1.8 bilLion (FY81), or 50% of the portfolio,to Rs 0.9 billion (FY85), or 21% of the portfolio. Through the improvedcollections, IDBP's profits after taxes have increased from Rs-5 million(FY81) to Rs 45 million (FY85). However, IDBP had difficulty meeting itsFY85 recovery targets as a result of problems experienced by textilecompanies whose production was hurt by shortages of power and raw cotton.PICIC has experienced similar improvement. Arrears have fallen from Rs1.6 billion (FY81), or 50% of the portfolio, to Rs 1.1 billion (FY84), or35X of the portfolio. Net profits after taxes have increased from Rs 38million (FY80) to Rs 12 million (FY84). NDFC's performance issatisfactory. Arrears account for only 7% of its portfolio and netprofits have increased from Rs 88 million (FY80) to Rs 188 million (FY84).While NDFC continues to perform well, it may have overextended itself, asindicated by a marked increase in the ratio of administrative expenses toloan portfolio. To ensure that the DFIs continue to improve theirperformance, it has been agreed that they would endeavor to collect atleast 75% of current dues, increase their overall collections by 15%-20Xcoupounded annually, and reduce the level of loans with arrears to about20% of the total portfolio. Additionally, the DFIs would be required tomaintain satisfactory debt/equity ratios, debt service coverage ratios,and specific rate3 of return on assets and equity. While NDFC is a rela-tively strong institution, there is concern about the significant increasein administrative expenses. This concern is shared by NDFC's managementwhich would implement an expense control review system satisfactory to theBank before the Bank would approve the SLA between the GOP and NDFC.

51. The Participating NCBs. While all six NCBs have term lendingoperations, HBL, UBL, and MCB account for the bulk of term lending toindustry. Their industrial credit divisions are well staffed to prepareterm loan proposals for financing and consortia lending, and they havetaken a number of steps to train staff and expand their industrial projectappraisal capabilities. Collection rates under the two Bank Groupfinanced Small Industries Projects (Credit 1113-PAK and Loan 2380/Credit1439-PAK), in which the NCBs are participating, is satisfactory. HEBL andUBL qualified to participate under IIC I, but the latter qualified afterall the Bank Group's funds had been committed. MCB is now expected toqualify as a PFI. The participating NCBs would be required to continuetraining staff in p:oject appraisal, using funds provided under the tech-nical assistance component of the project. The PBC, which already hastaken measures to upgrade the capabilities of the NCBs, would be respon-sible for coordinating the training programs. The National Bank ofPakistan (NBP), another large NCB, would be eligible initially for techni-cal assistance funds only. One year after loan effectiveness, the

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Government and the Bank would jointly determine NBP's eligibility tobecome a PFI.

Technical Assistance

52. The IDA credit component of SDR 2.0 million (US$2.0 millionequivalent) would finance consultants services and overseas training tostrengthen the institutional capabilities of the PFIs and improve theefficiency of the banking system and che operations of the capital market.The credit funds would supplement equivalent expenditures by the PFIs tomeet the costs of local training programs and sectoral studies. The GOPwould allocate part of the technical assistance funds to the PBC foractivities to improve the efficiency of the banking system. The Karachiand Lahore Stock Exchanges would also have access to the technical assis-tance funds to finance the implementation of the findings of theconsultants' review due in early 1986. Details of the technical assis-tance program were discussed and generally agreed upon duringnegotiations. Based on these discussions, the GOP would ensure that byMarch 31, 1986, the DFIs, PBC, and the Stock Exchanges jointly provide IDAwith a program, satisfactory to IDA, for the use of consultants and over-seas training. For all technical assistance subprojects, the Bank wouldapprove the terms of reference, the selection of consultants, and theirterms of appointment.

Credit and Administrative Arrangements

53. ReLending Rates. The PFIs would relend the loan funds to thesubborrowers at 14Z p.a. which, given that inflation is expected to remainunder 10Z in the medium term, is positive in real terms. The proposedfinal relending rate is also consistent with market rates of about 14Z-15Zbeing charged following the liberalization of term lending rates broughtabout by Islamization (para. 36). The Government and the Bank wouldreview the relending rates from the GOP to the PFIs and the subloan ratesperiodically to ensure that they were maintained at mutually satisfactorylevels. The first review of interest rates would be held six months afterloan effectiveness, and subsequent reviews would be held annually. Thefactors to be considered in determining the appropriate level wouldinclude: (a) the trend of inflation and the need to ensure that the lend-ing rates remained positive in real terms; (b) prevailing borrowing andlending rates in Pakistan; (c) the adequacy of the spread for (i) theGovernment to cover the foreign exchange and interest rate risks; and (ii)the PFIs to cover their costs in making the subloans; and (d) the rate ofcommitment and disbursement of subloans. The pronosed IBRD loan to theGOP would be relent at 10% to PICIC and IDBP (who pay income taxes) and at11% to the other PFIs (who do not pay an income tax), giving them spreadsof 4Z and 3%, respectively. In accordance with the GOP's general policy,the Government would bear the foreign exchange and interest rate risks.The GOP policy of accepting the exchange risk on all foreign credit itonlends to financial intermediaries was adopted in 1980 to avoid a repeat

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of the situation which occurred in 1972 following the large devaluation.At that time, innumerable subborrowers defaulted, jeopardizing the sur-vival of the DFIs. Moreover, in view of Pakistan's strict foreignexchange controls and the absence of a Long-term forward market to coverexchange risks, it would not be practical to pass on the foreign exchangerisk to the PFIs or final borrowers.

54. SubLoan Approval. The minimum and maximum subloan size would beUS$500,000 and US$6.0 million, respectively, with exceptions on a case-by-case basis. Based on experience under the first IIC project, most of thesubloans would be expected to be US$3.0 million or higher. A free limitfor subloans up to US$2.0 million would be permitted for the DFIs andHabib Bank up to a combined aggregate of US$40.0 million. All subloansmade by UBL and MCB, as well as all those over US$2.0 million by any PFI,would require prior Bank approval. Subprojects would be required to havean expected economic rate of return of at least 15% and would also beevaluated on the basis of their expected financial rate of return, domes-tic resource cost, capital/job cost ratio, and foreign exchange earningsand/or savings. All industrial subsectors would be eligible for financingunder the project except for the sugar industry where only balancing,modernization, and replacement (BMR) for existing mills would beconsidered. Although the proposed project is designed to promote privatesector investment, an exception would be made to enable NDFC to submitsubloan requests up to a total of US$10.0 million for public sectorprojects involving BMR. Sector distribution of subprojects would beexpected to follow the pattern established under the first IIC project(para. 44), but with less emphasis on textiles and food processing.

55. Amortization Schedule. The NCBs would repay the COP on the basisof a composite amortization schedule of their subloans. The DFIs wouldrepay over a fixed term of 15 years including three years' grace. Anumber of steps have been taken under the first IIC, and further steps areplanned under this project, to permit the DFIs to generate localresources. Until this process is complete, extended use of the repaymentsunder the subloans financed by the IBRD funds would augment their localcurrency resources and enable them to provide working capital finance totheir clients. Repayment schedules for the subborrowers would be based onthe projected income and cash flow requirements of the individualenterprises as determined at appraisal, but normally would not exceed tenyears including the grace period.

56. Procurement and Disbursement. Bank staff have reviewed theprocurement procedures of all the PFIs and have found them generallysatisfactory. As under the first IIC project, limited internationalbidding procedures would be required for individual contracts above US$2.0million. Project sponsors would be required to advertise in the localpress and seek bids from a list of potential suppliers broad enough toassure competitive prices. Sponsors would be required to notify embassiesand trade representatives of Bank member countries and Switzerland repre-

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sented in Pakistan; however, they would not be required to advertise ininternational publications. The PFIs would be required to confirm withthe actual supplier the price, quancity, and other details of theprocurement. For smaller contracts, PFIs would employ their existingprocurement procedures which generally conform to the Bank's standardpractices. In most cases, machinery and equipment would be procured byobtaining at least three competitive quotations from established sources.The PFIs would be expected to maintain records of the method of procure-ment and to monitor the use of subloans through reguLar supervisionactivities. SeLection and employment of consultants would be in accord-ance with the Bank's guidelines.

57. The loan proceeds would be disbursed under eligible subloansagainst 100l of the foreign exchange costs of goods and services and 60Xof local expenditures for the costs of imported equipment bought off theshelf, corresponding to the estimated foreign exchange content of theseitems. Full documentation of expenditures would be submitted to the Bank.For the technical assistance component, the credit proceeds would bedisbursed at the rate of 100% for consultants' services and overseastraining.

58. Reporting, Accounts and Auditing. The PFIs would be required tosubmit (a) quarterly progress reports and (b) audited financial statementsat least six months after the end of each fiscal year. In addition, theDFIs would be required to submit long form audited reports within sixmonths of the end of the fiscal year.

Project Benefits and Risks

59. Benefits. The project would support the GOP's efforts to maintainthe growth of private industrial investment, develop capital markets, andtransform development finance institutions from purely term lendingactivities into more dynamic financial institutions. The Bank Group'sdialogue with the Government in connection with the proposed project hasalready and would be expected to continue to open up new avenues forindustrial investment by the private sector and release the pressure onthe banking system. It should also stimulate private savings, both byrequiring a minimum sponsor's equity contribution to complement eachsubloan and by strengthening the capital markets. The project wouldfinance about 40-45 subprojects involving total project costs of US$300million. Based on the average investment cost per job of about US$20,000,an additional 30,000 new direct jobs would be created. The averageeconomic and financial rates of return of the subprojects to be financedunder the project are estimated at 15X. The proposed project0would alsoallow the Bank to maintain a strategic position in the financial systemwhich in turn would enable the Bank to help the GOP address broader finan-cial and banking sector issues such as the efficiency of the bankingsystem. The proposed project would also broaden the Bank's institution

-23-

building assistance to cover the comercial banks and the Karachi andLahore Stock Exchanges, as well as the DFIs.

60. Risks. While the DFIs have had many years of project appraisalezperience, the NCBs have only recently embarked on term lending opera-tions based on project viability as distinct from collateral support.Thus, there is a risk that UBL and MCB would be slower than expected inmoving from collateral to appraisal-based lending and that their par-ticipation in the project would be Limited. This risk would be reducedby the evident desire of the management of these institutions to establisheffective term lending policies, procedures, and appraisal capabilities.While IDBP and PICIC have shown steady improvement in recent years, theirfuture viability is sensitive to continued growth in their operations andto credit discipline In the entire financial sector. Further success inimproving IDBP and PICIC's operational and financial performance willrequire strong commitment by GOP and the management o' both institutions.Recent Government public statements suggest that the commitment will beforthcoming. There is a broader risk that political and economic uncer-tainties will inhibit investment. While this is a continuing problem inPakistan, investors have generally been reassured by the Government'spolicy direction in recent years. Finally, there is the overall risk thatPakistan's economy, inc'luding the industrial sector, will suffer fromexternal factors and inadeqLate structural adjustment. The record of theGovernment thus far in liberalizing the economy and the general calibre ofeconomic policy making suggests that senior GOP officials fully appreciatethe need for further concerted action. Through combined use of economicand sector work and both project and policy lending operations, the Bankseeks to re-enforce this determination on the part of the Government.

PART V - RECOMMENDATION

61. I am satisfied that the proposed loan and credit would comply withthe Articles of Agreement of the Bank and the Association and recommendthat the Executive Directors approve the proposed loan and credit.

A. W. ClausenPresident

AttachmentsDecember 10, 1985

-24-

PlAttUAN - SOCIAl. zcI CBca S wL

CHOST Wu3 wrm& ) .L_.lwo& 197zo& =Tdb Lm 1303 NNcZ 13

AM CIU u I. ut)TOrAL U3 613.9 #03.*

CRIJCULZtAL 227.s 243.3 233.0 .

Q PU Aim ClsS) .. .. 390.0 Z74.3 _0114

(KILOGAMU or oIL MIIlVALzU) 93.0 139.0 179.0 __ 285.7 5%*.

FOAIW A IXTAL ff41r14POPuLATION.NID-YEAR (TOOSAMS) 43851.0 0449.0 49729.0URUli POILAItaOF (C UT mIlL) zz.1 24.9 29.1 123 35.9

POPIIUTION PRECIIOISPOPULATION to mmA ZO0 (MaLL) 133.1S?ATIU1IAU! ?OPUtIATZO (NWLL) 330.0PUormAzom maizigru 1.9

POPULATIOII DauXT.PER 50. IN. 57.0 75.2 111.4 173.8 36.9PEr SQ. IK. AGc1. LOAN 201.5 248.4 34.4 353.3 1"1.2

POPLAETIN ACt SrRUCTU S()0-14 SRS 43.4 46.2 43.7 36.3 36.2

15-44 3S5 51.6 50.5 33.2 D9.4 5J.765 AN AIM 4.3 3.1 2.9 4.3 3.5

POPULATIUON GIITN RATE (O)TOTAL 2.3 2.6 3.0 2. .URJA 4.6 4.0 4.4 4.1 4.1

CRUDE BaT RZ CPU TOMS) 48. 446.6 42.0 27. 30.1CRUDE DEATH RATE (PER TOU) 23.5 19.4 14.9 10.2 9.4CROSS MDlOITICTION RT 3.4 3.4 2a 1.7 1.9

VANITY PLAMIEWIAC ,PTS. AUl. (T2O0S) .. 190.1 1244.0 .c

SDS t2 of MARRID Vw) .. 6.0 /d 14.3 49.4 5

100w AM wZEZINDOC POF VWROD. PER CArIC1969-71-100) 49.0 102.0 107.0 11UJ 124.4

PER CAPU SILY OFCAURS CZ ODF MQUESNTS) 77.0 95.0 104.0 106.3 U15.7PIOT1XL3S (CGUM PE VAT) S3.o Sl.0 61.0 60.1 60.3OF WIICH N IDA AID PULSE 23.o 22.0 20.0 / 14.4 14.1

CMILD (AGZS 1-4) WAT RAEn 24.9 21.1 16.0 7.3 7.2

LE ElPT. AT BIRTH (TEARS) 43.1 *6.0 50.2 60.5 60.3IWAr MM. IATE (PERt TOS) 161.5 143.0 119.0 49.2 ".9

ACCESS To SAM WATER (111)TDAL .. 21.o 34.3 44.2 44.uURBAN .. 77.0 72.0 77.2 574RUAL .. 4.0 20.0 34.6 ,7.1

ACCZSS TO EUCRE DISPOSAL(C Or POPULATION)

TWAL .. 3.0 13.1 7.5 50.1UN .. 12.0 42.0 26.8 32.9RURAL .. .. 2.0 5.5 ".7

POPULATN PM PSICIAN 540.0 4300.0 /t 3480.0 331S.0 7731.7POP. PER NURSING PERSON 38110.0 10530.0 7F 5820.04 4490.7 244.5POP. PM HOSPTAL DMm

TOTAL 1790.0 1660.0 1560.0 /c 1039.2 1112.1URA 510.0 650.0 7io.o 7e 299.1 631.4RURAL 2250.0 1248O.0 11640.0 7 4025B.2 2394.

AD-ISSIONS PER HOSPL U .M . .. t3.3 41.1

ND-AVERAGE SIZE OF WUSEC0LD

TOTL 5.4 5.3 6.1 IcURBAN 5.6 5.5 6.4 Ic.RIURAL 5.4 5.2 6.0 7..

AVERAGZ 10. Or PEHUS/R00TOUL 3.1 2.8 /nURIAN * 3.1 2.7 71RURAL 3.1 2.8 7T;

PERCETAE OF D=LLINGS 111 EC.TOAL .. 17.9h ...ORBN .. 54.4 7T .AEtRAL .. .97r

-25-Annex 1

tUtI S8 - SOeSAL SIMUM MMAM D^SXTUARINSNOS (NORs RECET SITISx)

RCE ,, LOW I1 11100D1.126ol!! ir-oMX ggT&K AgIA U PAC* ecC ASIA I PACIFIC

ADJUITEN EUMLUT SAZIO?ZMAYR TOTAL 30.0 40.0 44.0 92.6 100.7

KAU4 48.0 37.0 37.0 105.3 106.4nALE 13.0 22.0 31.0 79.3 97.2

SECONDARY: TOTAL 11.0 13.0 14.0 31.3 47.8HALE 18.0 20.0 20.0 40.8 50.6FEmALE 3.0 3.0 8.0 21.9 44.8

VOCLtIOIAL (I OF SECoMat) 1.0 1.5 1.7 3.2 18.4

PUPlL-TEANER RATIOP&Ulm 39.0 41.0 36.0 38.0 30.4SECONDUAt 24.0 20.0 18.0 17.4 22.2

PASSEIUEU CARU/TROIIUAND POP 1.3 2.6 3.4 A 0.9 10.1IDIO CZCZv/THOIURAD POP 6.0 17.1 74.t 129.5 172.9TV ItCRIVEKI/TIOUSAND pop .. 1.6 11.5 19.8 58.5NmsAW S ("DLY GI RAL

DINS ") ZRCOULATIONEZ TRODEAIID POPULATION 13.2 *- 19.4 25.7 65.3

CUIM ANAL ATIDDAMCB/CPITA 1.7 3.0 / 2.2 Ic 6.0 3.4

TOTAL LAsO m (TSII) 1"44.0 17384.0 25325.0FEtME (PERCENT) 8.6 9.3 10.6 33.2 33.6ARICULTURE (PERCENT) 61.0 59.0 57.0 69.6 52.2INDSTRY (PERCNT) 16.0 19.0 20.0 15.3 17.9

PATXTCIPATION RAn CPECNT)TOML 31.5 28.7 28.2 41.9 38.9MALI 55.2 50.4 48.3 53.6 30.813111. 5.7 5.5 6.3 29.1 26.8

-ComIC DUZNDEZNC RATIO 1.5 1.7 1.7 1.0 1.1

D3 DXII SIPERCENT OF PRIVAT INCOMERECEIVED by

EXCE1SSt S or HOIISEOLDS 20.3 jk 17.8ZIOnST 202 OF UoIuOLDS 45.3 3'.8 .. .. U.0LOWST 201 OF HOSEIIOLDS 6.4 8.0 .. .. 6.4LOWST 40s ofl HOUSEotDS 17.5 20.2 .. *. 15.5

ESTIMATED ABSOLUT PMOVERTY IIC011LIV.L CUU P CAIPZA)

3AlM .. 68.0 t 17i.O jc 133.9RURAL .. *7.0 122.0 k 111.6 151.9

ESTXIAMA URATIVE POVT INLEVEL CUJS PM CAPITA)

URaN . .. 34.0 4 88.0 c .. 177.9XURAL .. 22.07i 58.0 61.7 164.7

ESTIMATED POP. BELOW ABSOLJTEPOVERT INCOM LEVEL (Z)

URBAN .. 42.C Lt 32.0 43.8 23.5RURAL .. 43.0 E 29.0 51.7 37.8

.NOT AVA IABLNOT APPLICABLE

NOTSS

L The roup nro for "ch indeator are population-weigbed arLttlmtic man. Covarag of countrie._oug the Indicatorn depends on availab-llty of data and La not Uform.

Dbolaoe othe.vise noted. 'Data for 1960" refer to any year between 1959 and 1961; 'Dar& for 1970" between1969 *nd 1971; mad data for "Naa Recant Eatleate betwan 1981 and 1983.

/c 1979; /d 19U8; /a 1977; /f If regoterd. not alL practising in thu country; ,L 1980; /h 1973;

JUNE, 1985

-26- Annex 1Page 3

DEINrIMoNS OFSOCaL INDICAlCESNont Althoum) thicd dat airhaw from momsemaflyjudgel the ee authoritative and rliacbe itsbould iso obe noted that they may not be imeraaaonallycmpcuab becmu of the la or mardiad delluitiona ad cumcps usd by diffeent countries in collecting the dataL The d ai nonetbek, usemul modermbe oren ormagude. indiate trends, and cbartz cert mAjor didlln betwen countmmc reiensc goups am (I) the ,se counlay gmp of the subiea cruntry and (2)-a-countay group with newbat higher avcrae inoernc than th country

oupftheuwbjacuntzy (cpt for -High IncomeOil Esporeegroop _ me eMiddle Incom Nh Aricnd Middle aischode bmuseofsmeooc astiet In th et pomp data the avempa aim populion weighed arithmutic mne ror each Indibcar nd shown only when mnjruily

ofrdecountilis in a gu bhs dua for that inctor, Since tbecoveaofcountrie m_gte indiotordepndson theavailbility ofdata and is not uniform,caion must be caened in relating avenge ofone indicar to another. These averas are only useful in compaing the value ofone indicaor at a time amongthe contry an nc proup

AREA (thousand sq.km.) Crade Bir Rate (per thensaud)-Nunber oflive births in the year

Total-Total surface area comprising land area and inland waters; per thousand or mid-year population: 1960. 1970. and 1923 data.1960. 1970 and 1983 data. Craud Death JRte (per aussnd)-Number ordeaths in the year

Agrarsl-Estim ate of agicltural area used temporarily or per thousand of mid-year population; 1960. 1970. and 1923 data.permanendy for crops. pasturcs. market and kitchen gardens or to Gras Repdaetima Rate-Avcragc number of daughters a womanlie fallow. 1960. 1970 and 1982 data, will bear in her normal reproductive peiod if she experiences

present age-specific fertility rates; usually five-year avrags endingGNP PER CAPITA (USSGNP per capita esimates at current in 1960. 1970, and 1983.market pices. calulatd by s-me convesion method as World Puwy fAuirtg-Accpsen, Asal (thanessds 4 -Annual num-Bank Atdas (198 143 basis); 1963 datl ber of acceptors orbirth-control devices underauspicesof national

ENERGY CONSUMPTION PER CAPITA-Annual appat aily planning program.consumption of commercial primary energy (coal and lignite, dy PfiUmrrU (Fprcet e d -Thebpeen-petroleum. natural gas and hydro-. nuclear and geothermal ele- tage of married women of child-bearing age who are practicing ortiicity) in kilograms of oil equivalent per capita; 1960. 1970. and whom husbands are pracicing any form of contraception. Women1982 data or child-bearing agc are generally women aged 15-49. although for

some countries contraceptive usge is measured for other agePOPULAlION AND VrTAL STATLSTICS groups.

To.a Poplaion. Mi-Y)ew (thamsds 4 -As of July 1; 1960. 1970. FOOD AND NUTRMONand 1983 data.

Uirlx ofq Fee qfdP tdme PeC u nptar (1969-71 - 10)-Index ofperUrban tp.atim (per of satr)-Ratio of urban to total capita annual production of all food conunodities. Producionpopulation: dirfrent defiitons of urban areas may affect compar- exlcudes animal feed and seed for agricttuure Food commodhiesability of data among countries; 1960. 1970. and 1983 data- indude primary commodities (eg. sugaran instead of sugar)

pufliea 'R-jr.- which are edible and contain nutrients (eg. coffee and tea arePopulation in year 2000-The projection of population for 2000, cduded); they comprise cereals, root crops. pulse oil seedsmade for each economy separately. Starting with information on vegetables fruits. nuts. sugarcane and sugar bees livestock. andtotal population by age and sex, ertility rates, mortality rates, and lvestock products. Aggregate production of each country is basedintenational miigration in the base year 1980. these parameters on national average producer price weights; 196145. 1970. andwere projected at five-year intervals on the basis of genealized 1982 data.assumptions until thc population became stationary. P- Cap" s Rpefc.brl s (Percent o_freqarmseu)-Comput-Stationary poprdauion-ls one in which age- and sex-specific mor- ed from calorie equivalent of net food supplies available in countrytality rates have not changed over a long period. wbile age-specific per capita per day. Available supplies comprie domestic produc-fertility rates have simultaneously remained at replaement level tion, imports less exports. and changes in stock Net supplies(ne rcproduction rate= 1). In sucb a population, the birth rate is exclude animal feed. secds for use in agriculture quantiies used inconstant and equal to the death rate, the age structure is also food processing. and losses in distribution. Requirements wereconstant, and the growth rate is zero. The stationary population estimated by FAO based on physiologial needs for normal activitysize was estimated on the basis of the projected characteristics of and health considering environmental temperature. body weights.the population in the year 2000. and the rate of dedine of fertility age and sex distribution of population. and alowing 10 pent forrate to replacement level. waste at household level; 1961. 1970 and 1982 data.Population Momentum-Is the tendency for population growth to Per Capita SWy e rfPrw (gr p- day-Protein content ofcontinue beyond the time that replacement-level fertility has been per capita net supply of food per day. Net supply of food is definedachieved; that is, even after the net reproduction rate has reached as above. Requirements for all countries establshed by USDAunity. The momentum of a population in the year t is neasured as provide for minimum allowances of 60 grams of total protein pera ratio of the ultimate stationary population to the population in day and 20 grams of animal and pulse protein, of which IO gramsthe year t, given the assumption that fertility remains at repl- should be animal protein. These standards.are lower than those orment lvel from year r onward, 1985 data. 75 gams of total protein and 23 grams of animal protein as an

P.opwatb Dedsty average for the world, proposed by FAO in the Third World FoodPer sqkm.-Mid-year population per square kilometer (100 hec- Supply; 1961. 1970 and 1982 data.tans) of total area 1960. 1970. and 1983 data. Per Capita frea Spirpy lio Amiua and PIlwe-Protein supplyPer sqkm. agricultural lad-Computed as abovc for agricultural offood derived from animals and pulses in grams per day. 1961-65.land only. 1960. 1970. and 1982 data. 1970 and 1977 data.

Popuabti Age Sienna (percent)-Cbildren (0-14 years). work- ClN (ages 1-4) Death Rate (per thosiad)-Number of deaths ofing age (15-64 years), and retired (65 years and over) as percentage children aged 1-4 years per thousand children in the same ageof mid-year population; 1960. 1970. and 19S3 data. group in a given year. For most developing countries data derived

Pbpalaioa Greowth Rat (perceat)-Anal-Annual growth rates of from life tablesk 1960. 1970 and 1983 data.total mid-year population for 1950-60. 1960-70. and 1970483I HEALTH

Pop.lad. Growth Rat (percat)-arban-Annual growth rates Life Expectancy ar Birrt (years)-Number of years a newbornof urban population for 1950.60. 1960-70. and 1970-83 data. infant would live if prevailing patterns of mortality for all people

-27- Annex 1Page 4

at th tim orof Its birh wr to say them thougbout Its lfe; AV&aaAev Ratio - primary, and secmdrv-Totl studnt en.1960 1970 and 1913 daa. I t o in p and eondary lie vdivde by numbe ofJ411 lltp 1 (Pw _Nu nb or of Infants who die tUdwu in the correspooding levels.beform mching one yar of ap per thusn live birt In a givenyar, 1960, 1970 and 1913 datL CONSUMPTIONAcc or P* (pwa of pF" iE) 0Wh% d Piar Cws (per ahmmd jPaUe.uj-Penrger crs com-vwnl-Nunber of people (totaL urba and runal) nable prim motor cars eting l1 than eight persons; excludes ambul-

O- to sae wae upply Oinclude tiated rfae watm or ance. hae and milituy vehicle.untreated but uncontaminated water such a that from,pratected ed. Receivrs (pee *heasmudpopularm)-All type Or rceIvem

bole rinp and snitary wd1) u p it_ of their apec- for rdio broadast to general public per thousad of popultion-tin populatons. In an orban area a piblic fountain or stndpoSt excludce un-licend receiver in countries and In yes whenlocated not nm- tha 2D0 mnm from a ho. many be d registrtion of adio eu was in effet data for recet yea m-yas bng witIn reasonabe ac of that house In ruer not hr comprbl si most countre *aUboed licensing.reasonable mm w=Wd imply that the huewife or membe ofr thehoushold do not have to spend a dispoporonate part of the day TVAReeuivrs (perd isuuidjisuintles)-TV reer for broadcutin fetchig the famly's water needs. to goenl public per thousaid populaton: exclus unced TVAca to Exse.m Diwed (pnwe of AVpIpIsth-..eee xrk recevers in countneS and in yea when rgistrtion of TV st wumud tu-Number of people (toutl, urbn, and rul) served by in effectcu:rets disposal a pectae of their respective populations. -uVFYe Cke (F.l theesadpopulki.eD-Shows the aver-

Ecet diposl may include the oollcn and disposal, with or ap circulation of 'daily gneal intest newpapr." defined as awithout tretument, of human excreta and waite-watr by water- peiodical publicaion devoted primaily to ecording geeral nwwborne sysm or the use of pit priv itsnd simibk imtwns. It is consdered to be 'daily" ifit appean at lat four tinmue a week

-epsissi.upw P sidu.-*bpulation divided by number of prc. Clase Aasl At_Asmd_cr per Co& per Yew-Baed on thetisng phy qualifed frtom a medical scool at university level. number of ckt sold durng the ye. including admiss to?qsm per Nwdq P 4 Ip atmh divded by number of dnve-in ciemas and mobile units.practn mal and female graduate nure, aismnt nurs, LUOII FOtCEpraccl nurss and nusing auxilre.

~a per ~d DudtamI, wam, d wd-ftsplatin Tetal Labor Are (tosiambds-Economicifly active persns. in-(totaL, urban. and rual) divide by their repective number of ihopital beds avasible in public and private, generwi and students, etc.. covering population of al aM. Dention inhospitals and bLtitk 0. Hopibs ase various countries ar not comparable; 196I, 1970 and 1983 data.permanently staffed by at klt one physicia E i n pr F k (percmt-Female labor fore as pcentge Or totl laborWding prindcpally Cmt care are nt included Rural hot fo°ehower, include health and medical centers not permnently staffed Ariewhwe (percear)-Labor forc in fannng, foretry, huntigby a physia (but by a mdical asistant, nurse, midwife. etc.) and fishing as peetag of total labor force; 1960, 1970 and 1980which offer in-patent accommodation and provide a lmited rnge data.of Mel facilities. l]aay (parentr)-Labor force in mining, constrution. manu-A_JII.w per lsApi Bid-Total number of admissions to or fauring and eectricty, water and gs as percenta of total labordischrg from hospitals divided by the number of bes force; 1960. 1970 and 1980 data.

P dp. Rat (perea-tjsea m_le, andfJinp-s,aticipationHOUSING or activity rates ae computed as totaL mal, and feale bor foreAp e q Shte of Ifmehd (Pmy per ho_d-.uia w1aM, as percentages or total male and feml populionr at as

dnnal-A houmhold consis of a gsoup of individual who she respectively; 1960. 1970. and 1983 data. Thes are basd on [WO'sliving quarten and their main mels. A boader or odgr may or pricipation refiecnage- sct of the populto andmay not be indcuded in the household for staical purpose long time trend. A few estmates are from national sourcesAvra ANmebr of Pua pff Rem--aes& uras ad rural- Ece_mot Depeadeacy Rado-Ratio of population under 15. andAverag number of persons per room in all urban. and rural 65 and over. to the working age population (those aed 15-64).occupied conentu3nal dwellings, respectiely. DweUings excludenon-permanent structures and unoccupied parts. INCOME DISTRIBUrIONPecmeqof ejD-4 with Eerkyp-eeal whbian. -d rural- Percemwe of Twr D4osabk laew ( in eah Conventional dweUlins with electricity in living quarters as pecn- Accruing to percentile groups or housholds rnked by total house-tage of totaL urban. and rural dwllings respetively. hold income.

EDUCATION POVERTY TARGET GROUPSA4us&d Fuihwen Rlein The foUowing estinates are very approximate measures of povatyPmrpy .sdaool - road. male md feala-Gross toL|. mal ad kvels and should be interpted with considerable caution.female enrollment of all ags at the prnmary level as pentgs of Esimated Abselar Poeryt lacew Lad (USS per eVvea-sphanrespective pnmary shool-ag populations. Wbile many countri and rwra-Absolute poverty income level is that income levelconsider primry school age to be 6-11 years, others do not. The below which a minimal nutritionally adequate diet plus essentialdilerences in country pracces in the ages and duration of school non-food requiremnts is not affordable.are reflctd in the ratis diven For some countries with universal Esimted Re.* P,verty lwuce Leve (USS per capim -arb_education, gros enrollmnent may exced 100 percent sinCe Mn ad rual-Rural relative poverty income kvel is one-third ofpupils are bdow or above the countrys stndaird pnmary-school average per capita personal income of the country. Urban level isag derived from the rural klvel with adjustment for higher cost ofSecouday scheol - totaal e mak d femf e-Computed as above; living in urban areas.sonday education require at least four years of approved pri- E. ued erAlrim Beow Ahsolwe Povrty lne Lld (per-mary instcion provides general, vocational, or teacher trainig carvr-wm aid rra-. Percent of population (urban and ruralisrmctions for pupils usually of 12 to 17 years of age: corrspond- who are 'absolute poor. ecme cours are generaly excluded.Vwcadoa firohmeui (percEt of ecradivy)-Vccational institu- Comparative Analysis and Data Divisionbtns incdude tecncal industaL or other program which operate Economic Analysis and Projections Departmentindependenty or a departmcnts of secondary institutions. June 1985

-25-

CUP PR C IA 1982: 1380 LI

CROSS AISONAL nOnCT 1N 19311U lb LkLA 8 (1Q . cestt e rmcil

0S 3illies I 1291Z/7-1974175 19517S/J-l990/81 1981/82 I182193 19l3/84

GNP at u.rket prices 33.68 100.0 3.5 7.1 4.3 7.4 4.2Gross domestic investment 5.23 15.5 -5.5 4.1 10.5 9.6 3.4Cross ntinal saving 4.20 12.5 -2.1 6.7 6.9 24.9 4.5Currst account balance -1.00 -3.0

Exports of goodu. m 3.44 10.2 -3.5 7.3 -5.6 27.5 -3.2Imports of goods. UPS 7.06 21.0 -7.1 5.5 0.7 1.1 22.0

OnnUT, LABOR FORE AmNPRODUCUTI IN 1983)84

- Value Added Leahr Fmrce le T. A. Per WoerlrS Nillian - iQII_ L a i

AgricuLture 6.652 24 14.1 51 472 47Imdustry LA e.09 29 5.2 19 1.557 155Servieas _1931 47 Aal -a Jaia 1

Total/Average 27,679 100 27.6 100 1003 100

GOVERMET nUsAC

Central Government to Federal Goverment(R. billiol of ro? (Rs bitli) S of CoP

939 L -19831* 4 1978179-1931n4 1z314 Lf ItM 4 197Z7D-19B3Z/M4

Current receipto 73.2 17.4 16.6 5S.2 13.9 12.4Curret expenditures MAI M 235 62A I. 'Current surplus -7.2 -1.7 -6.3 -4.6 -1.1 -0.4Capital expeditures Lt 34.2 3.1 9.4 34.2 7.0 8.0External aaeietance (net) 6.0 1.4 2.1 6.0 1.4 2.1

NOUE. CREDIT ANID PRICES

1974175 1975176 1976177 19m7s7 1978/79 19791tlO 1980181 19B1/82 1982183 195318 Lk-. (Rs billion)

Mone nd qusi moy Li 33.1 41.6 51.7 63.7 76.5 90.7 103.5 113.6 146.0 162.5_en credit to public sector 21.2 28.1 36.6 43.5 54.9 61.8 70.9 79.7 95.5 105.6enk credit to private sector 16.0 17.8 23.0 26.5 30.9 36.9 41.9 51.3 62.8 77.8

- (percentages or index _ere)

Mouy and quaai money aS Z of CDP 29.5 31.5 34.6 36.7 39.0 38.3 37.0 35.1 40.1 38.7Consumer price index (1969170-100) 211.3 229.4 256.7 277.0 295.6 331.9 375.4 403.9 418.1 462.0

Jama percentage chages in:Cosumer price index 23.6 8.6 11.9 7.9 6.7 12.3 13.1 7.6 3.5 10.5Denk credit to public sector .. 32.5 30.2 18.8 26.2 12.6 14.7 12.4 19.8 10.6Dek credit to private sector .. 11.2 29.2 15.2 16.6 19.4 13.5 22.4 22.4 23.9

/a Baed on Vorld Benk Atlas metbodology ad calculated at e avrage of 1930-82 prices ad eacbhage rates. All otbercouversiona to dollars in this table are at the average ezcebne rate preailing during the period covered.

It Prvisial.fe Projection for 1933/84. Does not include unemployed labor force.Id Includes m facturing. mining, construction end electricity and ga.LI Cmoeolidated revenee end axpaditures of Federal ad Provincial Covermenta (excluding Pederal-Provincial Covernment

transfers).t Revised budget data.

La Excluding principal repayments of foreign loas. Capital expeditures as defined in government budget includecertain current expenitures also.Proviional.

Li Monetary statiatics of Pakistan have been fully adjusted for demonetized notes. devalustion nd revaluation of therupee. etc. as from June 30. 1975. Data for 1974/75 from State lek sources are not strictly comrable with DQeati_etes for earlier years.

Not applicable.not ailable.

Marcb 1985

n -

, port of sodm, El 2.355 32.1 3,05232414 3.433 UV 1t03 32153 11.4%oerts of goeds, "I .J0l JiM. Lii7 L311 -2.15 am" 214.7 3.1Someree mp CiafiuLt Is-) -2 74 -2. 0 7I u1I 0 3 loth *l2111 10.6

lao 417.3 15.3tereegt papemata -283 -357 -45 -4I 477 All etbw eamr itie 1A . -MA

Vurse' rdittesee 174 2,097 2,224 2,.37 2,737 Total 23651.4 100.0Othmer fauter P te Crn) 131 274 321 135 353Net trafere -, ..

lalafe 0n crrent accout -,l140 -391 -1,323 -11 -I,DO

Direct foreign 1e_t .. .. . . .let 36. borrowing Zil1it

Di.b.r at 1,134 95e 1,102 1,301 I,248Amortization _.. -.. n .. .. M ... Public debt. IcludIg gpara.teed 9,890.46ub-total 24 440 610 915 679 Wou-gareateed priwate debt La.

Treemactione with 11W La 78 315 353 412 -I Total eutstmdim ad dLabureed 9,390.4

otbhr itcom u.e.L. / 600 54 318 283 1421a.ms. in :same C- -342 -310 249 -I,102 180 Nr 33L31CR 3!o N 11,3I4 a

Greoss Efeee -(rn Year) Ll 744 1,053 609 1,911 1,7321

petroleum Imports Lj 1,079 1,535 1,710 1,610 1.t423 Public debt, Including guaranteed 15.6petroleum aports Lj 173 126 194 77 40 Nos-garnteed private debt

Total 15.6

SATE SI ESCRaNCU ruunhIDi~~~~~~~~~~~~~sSSs LMNCX tCUe..be 103) (1,3 milliem

*dwau.h U.w 11. 1072 ire. Me. 12. 1972-lab. 15 1973 Zm cIi

3I8 - Is 4.7619 =13 - Is 11.00 Outstandivg ed dLebereed 350.7 1,1".7Re 1 - U130.21 an I - 1380.0 UfdLabur.ed ML& 617.2

Outstanding lncluding dibureed 547.7 1,761.9

Pro.Fob. 153. l97jM& j Z Pr a. l-hIe 1932 a ir. hu. 1092-3... 1983 ro. July 1 2131-%At 1934 JL

13I - R .9.0 81 38 Is - 10.55 S1 -1 n 12.75 u13 a a 13.50to 1 - W30.10 Rs 1- U380.095 Re 1I . 1 00.078 i I VS$0.074

IL Including Trumt ,md.a IncLuding net ehort-term borrowing and error. ed omiecions.LI eincldin Sold reeree of about 1.8 nillio tray *ones.

Crude nd derivetiue.I b-grasteed private debt mrvice is ngligible.

Raetlo of eatual debt ceriee to epor of goods, factor ed non-factor esrvices; debt oerice Includes IW ebarges.Z ffectlve January 6. 1932, e rupe. Lu to be neged vlth refereoce to a weighted basket of currecies. no averageexchane rete shoew La vies--vis U36 for the peri bebon.

Not vralable.

Nareb 1985

-30-

PAMe TX

STATUS 01 WO CROUP OPERA7TIOII IN PAKISTAN

A. STLTIEONT o0 SAWK LOANS AND IDA CREDITS (ea of Santgeber 31. 1985) Ie

(tS$ million)Loan/ (Aamout nut of cancellations)Credit Fiscal Uediu-Number Year zinnia hu aI ID bureud

Ninety-eight loane and credite fully diaburued Lk 781.4 32.0 1.001.61L

648 1976 Irrigation & Drainage (Khairpur) - 14.0 2.71366T 1977 Penjab Livestock Developmnet - 10.0 - 2.8754 1978 Salinity Coentrol & Reclamation - 70.0 66.6313 1978 Punjab Ext. £ Agric. Dev. - 12.5 3.7877 1979 Salinity Control & Recl. (erdsn) - 60.0 49.4892 1979 Primary Education - 10.0 3.5922 1979 Sind Agricultural Eztenaion - 9.0 4.296B 1980 Third WMADA Power - 45.0 3.5974 1980 Third Rigbway - 50.0 11.91019 1980 PICIC Induatrial Development - 40.0 3.31109L/ 1981 Vocational Training - 25.0 7.81113II 1981 Snail Induatries - 30.0 0.31157L/ 1981 Grain Storage - 32.0 15.81158fr 1981 Agricultural Reaearch - 24.0 15.011631± 1981 On-F m Water ana gement - 41.0 12.21186/e 1982 lIduatrial Development (IDBP fl) - 30.0 3.02122 1982 Fourth Telecomunication 40.0 - 11.92172 1982 Fertilizer Industry Rehabilitation 38.5 - 20.32247 1983 Rseervoir Maintenance Facilitima 10.2 - 10.02305 1983 Agricultural Dev. (ADBP V) 10.0 - 5.42324 1983 Fifto Sui Northern Gas Pipelinee 43.0 - 39.91239/e 1982 Irrigation Sy. me Rehabilitation - 40.0 23.71243/e 1982 Beluchistan Minor Irrig. & Agr. - 14.0 10.91256Lg 1982 Technical Amnimtance - 7.0 2.91278re 1982 Eleventh Railway Project - 50.0 36.01348/e 1983 Labore Urban Development - 16.0 14.91350/e 1983 Population - 18.0 14.3L355/e 1983 Coal Engineering - 7.0 6.21374/e 1983 Karachi Water Supply - 25.0 2D.41375L± 1983 Fourth Drainage - 65.0 62.013O0k 1983 Agricultural Development (ADSP V) - 47.8 14.21218 1983 Refinery Engineering Project 12.0 - 8.82351 1984 Petroleum Exploration 51.5 - 41.42374 1984 Second Toot OiL and Gas Development 30.0 - 22.82380 1984 Industrial Inveatment Credit 50.0 - 44.71439k 1994 Induatrial Ineatment Credit - 50.0 44.514611t 1984 Integrated Hilt Farming Developm et - 21.0 21.31480±e 1984 Second Technical Assiatance 7.0 6.81487 1984 Comead Vater Management 46.5 46.01499 1984 Secoad SBall Induatries - 50.0 41.11532 1985 Left BDak Outfall Drsin - Stage I - 150.0 156.41533 1985 Baluchistan Agricultural Extenaion - 8.3 8.72499 1985 Fourth RAODA Power 100.0 - 100.016021± 1985 Second Primary Education - 52.5 52.516031c 1985 Second On-Fa m ater Management - 34.5 34.52552 1985 Energy Sector Loan 178.0 - 178.02553 1985 Petroleun Reaources Joint Venture 55.0 - 55.02556fc 1985 Fiftb lAPDA Power 100J 0 _lA 100I 0

Total 1,499.6 42.0 2,202.9 1.461.2of which has been repaid 5CI.1 4.6 4j3 a

Total now outeanding 998.5 37.4 2.158.6Ano t sold 29.9

of which has been repaid 29.9 -Total now held by Bank and IDA4/ 998,5 37.4 23158J 6 0

Total undisbureed 638.2 2.7 82023 1.461.2

/a The status of the projecta liated in Part A is deacribed in a *eparate reporta- all Bank/IDA financial projects in ezecution, which is updated tvice yearlyad circulated to the Executive Directors on April 30 and October 31.

lb Excludes the disbuared portion of lomn and credita wbolly or partly for projectain the former Est Pakistan which bave n been taken over by Dangladsb.

Ic Not yet effective.Id Prior to exchange adjut ent./e IDA Credita under the 6th Replenishment denominated in SDR. The principal

is shown in US$ equivslent at the tine of negotiatio. Diebursed _ounrs arecomputed at the exchange rate applicable on the transaction datee. Undisbursedamounta are valued at the exchange rate applicable on the date of thidstateent.

Lf By using the arket rate -n dates of diabursemnto. the current principalfor Credit 1066-PAZ and Credit 1255-PAM (both fully diabureed) iL$42.5 and $77.5. respectively.

-31-

ANNEX IIPage 2

B. STATEMN OF IFC INVESTINTS (as of September 30. 1985)

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

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

1959 Adamjee ludustriesLtd. Textiles 0.75 - 0.75

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

Products Textiles 1.84 0.11 1.951965-1980- Packages Ltd. Paper Products 19.25 0.84 20.0919821967- Pakistan Paper1976 Corp Ltd. Paper 5.38 2.02 7.401969 Davood Hercules

Chemicals Ltd. Fertilizers 1.00 2.92 3.921979 Milkpak Ltd. Food and Food

Processing 2.40 0.36 2.761979 Pakistan Oilfields

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

1980 Fauji Foundation Woven Polyropy-lene bags 1.78 - 1.78

1980 Premier BoardMills Ltd. Particle Board 2.70 - 2.70

1981 Habib Arkady Food and FoodProcessing 3.15 0.16 3.31

1982 Asbestos Cement 4.02 - 4.021983 Pakistan Petroleum Chemical and

Ltd. Petrochemicals 100.89 1.56 102.451985 National Dev. Money and

Leasing Corp. Capital Market. 4.13 0.37 4.50

Total Gross Commitments 182.17 11.32 193.49

Less: Cancellations, Terminations,Repayments and Sales 133.05 0.38 133.U

Total Commitments Now Held by IFC 49.12 10.94 60.06

Undisbursed (including participants) 38.28 0.51 38.79

-32-

ANNEX IIIPage 1 of 2

PAKISTAN

SECOND INDUSTRIAL INVESTMENT CREDIT PROJECT

SUPPLEMENTARY PROJECT DATA SHEET

Section I: Timetable of Key Events

(a) Time taken by the Borrower to prepare the project

Twelve months

(b) Agency which prepared the project

PFIs and GOP

(c) Date of first presentation to the Bank and date of

first mission to consider the project

August 1984

(d) Date of departure of appraisal mission

July 1985

Ce) Date of completion of negotiations

November 5, 1985

(f) Planned date of effectiveness

April 1986

Section II: Special Bank Implementation Action

None

Section III: Special Conditions

(a) Each PFI to fulfill specified conditions, includingexecution of SLA with COP, to obtain access to loanproceeds (para. 49);

-33-

ANNEX IIIPage 2 of 2

(b) Execution of SLA between GOP and two PFIs, includingone NCB and one DPI (condition of effectiveness, para.49);

(c) Detailed technical assistance program to be provided toIDA by March 31, 1986 (para. 52); and

(d) GOP and Bank to review relending rates periodically toensure that they are maintained at mutually satisfac-tory levels (para. 53).

IBRD 16248R64. ,2 U. S. S. R. MAY lU

! X-- 5g7 HINA

PAKISTAN ..- Hip NATIONAL CAPITAL 's. _ ns CITIES AND TOWNS

NATIONAL ROADS .

PRIMARY AND SECONDARY ROADS , Q.RAILWAYS S! K*-- -

4+ AIRPORTS - Chwwd A.~s, ft o Cd

- - PROVINCIAL BOUNDARIES-- INTERNATIONAL BOUNDARIES

RIVERS

3 I-2-

ISLAMIC REPUBLIC OF | - .

IRAN .! 3qV 400

v~~~~~~~~~~~h LIMB 1 tal

2d~~ -N e d -

eN rIL 7METERS/ ~~~~~~~~bMbM~~~~~W ..N N-IN-U

or 'v 0e-fta, Of

.Nle'b WNUI

64 6W 7?T