Document of

The World Bank

Report No: 22509-PAK

PROJECT APPRAISAL DOCUMENT

ONA

PROPOSED CREDIT

IN THE AMOUNT OF SDR 239.5 MILLION

(US$300 MILLION EQUIVALENT)

TO THE

ISLAMIC REPUBLIC OF PAKISTAN

FOR A

BANKING SECTOR RESTRUCTURING AND PRIVATIZATION PROJECT

October 1, 2001

Finance and Private Sector Development UnitSouth Asia Region

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CURRENCY EQUIVALENTS

(Exchange Rate Effective August 2001)

Currency Unit = Pakistani Rupees (Rs)Rs 1.00 = US$0.0154

US$1.00 = Rs 65.00

FISCAL YEARJuly I -- June 30

ABBREVIATIONS AND ACRONYMS

ABL Allied Banking LimitedADB Asian Development BankBSAL Banking Sector Adjustnent LoanCAS Country Assistance StrategyCIRC Corporate and Industrial Restructuring CorporationDFI Development Finance InstitutionFA Financial AdvisorFCD Foreign Currency DepositFSDIP Financial Sector Deepening and Intermediation ProjectGOP Goverrnent of PakistanHBL Habib Bank LimitedMCB Muslim Commercial BankMOF Ministry of FinanceNBP National Bank of PakistanNCB Nationalized Commercial BankNDFC National Development Finance CorporationNSS National Savings SchemesPC Privatization CommissionSBP State Bank of PakistanUBL United Bank Limnited

Vice President: Mieko NishimizuCountry Manager/Director: John W. Wall

Sector Manager/Director: Marilou Jane D. UyTeam and Task Leader: Joseph Del Mar Pernia

PAKISTANBANKING SECTOR RESTRUCTURING AND PRIVATIZATION PROJECT

CONTENTS

A. Project Development Objective Page

1. Project development objective 22. Key performance indicators 2

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 22. Main sector issues and Government strategy 33. Sector issues to be addressed by the project and strategic choices 5

C. Project Description Summary

1. Project components 62. Key policy and institutional reforms supported by the project 83. Benefits and target population 84. Institutional and implementation arrangements 9

D. Project Rationale

1. Project alternatives considered and reasons for rejection 92. Major related projects financed by the Bank and other development agencies 103. Lessons learned and reflected in the project design 104. Indications of borrower conmuitment and ownership 115. Value added of Bank support in this project 11

E. Summary Project Analysis

1. Economic 122. Financial 123. Technical 124. Institutional 135. Environmental 136. Social 137. Safeguard Policies 14

F. Sustainability and Risks

1. Sustainability 15

2. Critical risks 153. Possible controversial aspects 16

G. Main Conditions

1. Effectiveness Condition 162. Other 16

H. Readiness for Implementation 18

I. Compliance with Bank Policies 18

Annexes

Annex 1: Project Design Summary 19Annex 2: Detailed Project Description 21Annex 3: Estimated Project Costs 24Annex 4: Cost Benefit Analysis Summary, or Cost-Effectiveness Analysis Summary 25Annex 5: Financial Summary for Revenue-Earning Project Entities, or Financial Summary 33Annex 6: Procurement and Disbursement Arrangements 34Annex 7: Project Processing Schedule 40Annex 8: Documents in the Project File 41Annex 9: Statement of Loans and Credits 42Annex 10: Country at a Glance 45

MAP(S)

PAKISTANBanking Sector Restructuring and Privatization Project

Project Appraisal Document

South Asia Regional OfficeFinance and Private Sector Development Unit

Date: October 1, 2001 Team Leader: Joseph Del Mar PemiaCountry Manager/Director: John W. Wall Sector Manager/Director: Marilou Jane D. UyProject ID: P055292 Sector(s): FS - Financial Sector DevelopmentLending Instrument: Specific Investmnent Loan (SIL) Theme(s):

Poverty Targeted Intervention: N

Program Financing Data[ 1 Loan [X] Credit [ Grant [ ] Guarantee 1 Other:

For Loans/Credits/Others:Amount (US$m): $300.00

Proposed Terms (IDA): Standard CreditGrace period (years): 10 Years to maturity: 35Commitment fee: 0.5% Service charge: 0.75%Financing Plan (US$m): Source Local Foreign TotalBORROWER 240.00 0.00 240.00IDA 300.00 0.00 300.00Total: 540.00 0.00 540.00

Borrower: GOPResponsible agency: MOF, SBP, PCMinistry of FinanceAddress: PAK Secretariat, IslamabadContact Person: Dr. Waqar Masood, Additional Secretary FinanceTel: 92-51-9206367 Fax: Email:

Other Agency(ies):State Bank of PakistanAddress: Central Directorate, I.T. Chundrigar Road, KarachiContact Person: R.A. Chughtai, Deputy GovernorTel: 92-21-9212455 Fax: Email:Privatization CommissionAddress: 5-A, Constitution Avenue, IslamabadContact Person: Ahmed Waqar, Additional SecretaryTel: 92-51-9203881 Fax: Email:

Estimated disbursements (Bank FY/US$m):FY 2002 2003 2004

Annual 150.00 100.00 50.00Cumulative 150.00 250.00 300.00

Project implementation period: 3 yearsExpected effectiveness date: 12/01/2001 Expected closing date: 12/31/2004

OCSP*DFl F. M- -rCh2000

A. Project Development Objective

1. Project development objective: (see Annex 1)

The objective of the project is to help Pakistan continue implementation of its banking reform programstarted in 1997 and supported by the Banking Sector Adjustment Loan (BSAL), aimed at achieving acompetitive private banking system that operates under a strong regulatory framework, is supported by aneffective banking court system, and intermediates resources independently of vested interests and inresponse to price signals. The project would focus on further restructuring of the Nationalized CommercialBanks (NCB) to improve their prospects for sale to qualified strategic investors, and completing theprivatization of the partially privatized banks. It would promote the expansion of the healthy part of thesystem by liberalizing bank branching, while contracting the sickly part, including the amalgamation of thelargest development finance institution (DFI) into one of the NCBs. It would deepen the banking market byreducing the taxation on financial intermediation and the cost of loan recovery by facilitating foreclosure onloan collaterals.

2. Key performance indicators: (see Annex 1)

3 Reduction of the cost/income ratio of the NCBs to 0.65* Rationalization of the branch network of the NCBs by reducing the number of branches by 40

percent* Staff rationalization in the NCBs by reducing the headcount by 50 percent3 Amalgamation of National Development Finance Corporation (NDFC) into National Bank of

Pakistan (NBP)* Bona fide attempt at fully divesting the government's remaining shareholding in Muslim

Commercial Bank (MCB) at market pricesv Sale of the governments 49% shareholding in Allied Bank Limited (ABL) to a qualified strategic

investor3 Substantial progress in the sale of United Bank Limited (UBL)3 Substantial progress in preparing Habib Bank Limited (HBL) for sale* Initial progress in preparing National Bank of Pakistan for saleo Liberalization of bank branching policyo Revision of the tax policy for the banking sector and initial reduction in the level of taxation* Amendment to the Loan Recovery Act of 1997 to facilitate foreclosure on loan collaterals* Reform of the National Savings Schemes (NSS)* Reform of the Foreign Currency Deposit Scheme

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex I)Document number: 22219 Date of latest CAS discussion: 06/12/01

The over-arching objective of the Pakistan program is to reduce poverty through investing in people,raising productivity, and promoting sustainable economic growth. This is to be attained by achievingmacroeconomic stability, improving resource allocation, enhancing human development, nurturing acompetitive environment for private investment and promoting better governance.

Recent cross-country empirical research by the Bank has shown that sound and efficient financialintermediation leads to higher growth, by as much as an increment of 2 percent annually. A healthier andmore efficient banking system would contribute greatly to the achievement of poverty reduction in Pakistan

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by improving the country's prospects for growth, enhancing its capacity to deal with volatility, mitigatingthe risk of financial crises, and improving the poor's access to financial services.

By improving corporate governance in the NCBs, completing the privatization of partially privatizedbanks, and amalgamating the largest insolvent and illiquid development finance institution into one of theNCBs, which together account for two-thirds of the banking system, the proposed project would help toachieve macroeconomic stability through reduced quasi-fiscal deficits created by past bad lending andloss-making by these institutions; improve credit allocation as lending decisions become more marketdriven; and increase the private sector's access to credit as these institutions are professionalized.

2. Main sector issues and Government strategy:

In late 1996, Pakistan's banking system was on the verge of a crisis. Non-performing loans had reachedalarming proportions. Liquidity problems had begun to emerge as disintermediation spread and bankinglosses mounted. Most cases of loan defaults remained unresolved in an ineffective court system. Thesewere manifestations of deep-seated problems, rooted in a failure of govemance and lack of financialdiscipline. Political interference had vitiated the financial intermediation function of the banking systemand borrowers expected not to repay loans they took, especially from the NCBs and DFIs. The NCBs andDFIs were major sources of bad loans, accounting for 90 percent of the bad loans in the entire system, andwere the main loss-makers. Overstaffing and over-branching and undue interference by labor unions inbank personnel and operations resulted in large operating losses. Poor disclosure standards abettedcorruption by window-dressing the true picture of banks. The authorities realized that, while thesedeep-rooted problems would take time to resolve, immediate measures were needed to arrest thedeterioration and prevent a banking crisis, especially in face of a difficult external position. In early 1997,the central bank and the Ministry of Finance designed and started to implement what they called a"home-grown" banking reform program.

Pakistan's 1997 banking reforms aimed to strengthen the sources of govemance and financial discipline forthe banking sector, namely bank regulators, markets, the courts and bank owners, by enhancing theauthority and the ability of the central bank to supervise banks and enforce regulations, promoting marketdiscipline, improving the legal and judicial processes for enforcing financial contracts, and initiatingcorporate govemance reforms in the NCBs and DFIs. Under the program, the banking authoritiesimplemented major short-term measures that were designed to arrest the flow of bad loans, curtailloss-making, and conserve the assets of the NCBs and the DFIs. Prudential regulations and financialdisclosure standards were to brought to intemational levels to increase transparency. Market distortionswere reduced to increase the efficiency of financial intermediation. Legal and judicial processes werestrengthened to enable a more effective enforcement of financial contracts. Corporate governance wasimproved by appointing professionals to the management and boards of the NCBs and DFIs, and insulatingthe process of appointing and removing management from political interference through an amendment inthe law. Improvement in corporate govemance was to be sustained through a well-structured privatizationwhereby the NCBs and DFIs would be sold to reputable strategic investors who possess the integrity,capital, banking expertise, management and technology to run these institutions prudently and efficiently.These reform measures were not only critically needed to stop the hemorrhage. They were also needed tolay the basis for the implementation of a medium-term program that would deal with the stock of bad loans,install good governance through a comprehensive privatization program, strengthen banking supervision,and build the capacity of the legal and judicial system for loan recovery.

In February 2000, at the request of the central bank, a Bank mission reviewed the results of the reformprogram (Financial Sector Update, May 2000). Compared with the situation at the end of 1996, the

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banking sector had improved by most benchmarks by the end of 1999. Cash recovery in the three-yearperiod totaled Rs 70 billion, or a third of the stock of loan defaults. The NCBs stemmed operating lossesby reducing staff by 30% and closing 500 loss-making branches. The new banking court system processed22,000 out of 52,000 loan default cases at an unprecedented rate. The level of non-performing loansstarted to stabilize due to better quality new loans and intensified loan recovery and work-out of problemloans. These measures helped the banking system achieve improvements in capital adequacy, asset quality,efficiency and profitability. These improvements were found despite the fact that disclosure standards in1998 and 1999 were much more stringent than those of 1996, improved disclosure being part and parcel ofthe reform program itself.

However, the reform program was not completed. As the crisis eased and financial institutions began toheal, the reform process substantially slowed down and, in several respects, stalled. In mid- 1999,interference in the banking system through new centrally-mandated credit programs increased. Loanrecovery slowed down, except for the dramatic gains as a result of the accountability campaign that wasstarted in October 1999 by the military government. Loan collateral foreclosure and bankruptcyprocedures were not further strengthened as planned. Market reforms to reduce segmentation were notpursued completely. Most importantly, bank privatization did not materialized as planned due, on the onehand, to weak market conditions, the country's deteriorating foreign investment climate and lack ofsustained efforts, and, on the other, the distressed conditions of the banks with high cost structures anddepleted balance sheets.

In September 2000, a Bank mission was requested by the Finance Minister to help revive implementationof the 1997 reform program, focusing on bank privatization as the next critical set of steps in the process.Two parallel timelines for bank restructuring and privatization were constructed, proposing further costrestructuring to improve the banks' prospects for sale while working on the sale transactions themselves.The current government believes that the best way to insulate the financial intermediation function frompolitical interference is to privatize all NCBs, and reduce the number of DFIs, privatize them, if possible,or close them. The plan is to privatize HBL and UBL within the tenure of the current government and totake major steps towards preparing NBP for privatization. DFIs are to be reduced to three (catering tosmall industry, housing finance and small agriculture) with the biggest one, NDFC, to be amalgamated intoNational Bank.

To improve loan recovery and facilitate bank privatization, the government also established an assetmanagement agency, the Corporate and Industrial Restructuring Corporation (CIRC), which will helprestructure the balance sheets of the NCBs and DFIs by assuming from them all private sectornon-performing loans over Rs. 10 million, starting with those that already have court orders for execution.With special legal powers, the CIRC is expected to be more successful in liquidating and disposing ofassets than the banks. (Similar powers will be given to the banks through a further amendment of the lawto institutionalize this reform.) Since the CIRC will not replace the loans they take over from the banks andDFIs with government bonds until these institutions are privatized or after three years, whichever is sooner,this process will not result in a premature recapitalization.

Although substantial capital increases were earlier provided to HBL and UBL by the central bank inresponse to demands by foreign regulators in countries where these banks continue to operate branches, thecapital position of these two banks remains weak. The 1997 restructuring substantially improved thebusiness efficiency of the NCBs by cutting staff and branches but their cost to income ratios remainuntenable. Market soundings have indicated that quality acquirers would be reluctant to take on thesubstantial commitment of management time, as well as the political and social risks of executing thesubstantial further restructuring necessary to bring the operating structure of the NCBs closer to

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international norms. Moreover, the significant cost of these restructurings, especially when added to thecost of balance sheet restructuring, is beyond the capacity of any domestic financial institution. This partlyexplains why attempts to find buyers for HBL and UBL have to date not come to fruition. It is, therefore,now the government's plan to restructure the NCBs further to improve their prospects for sale. While therestructuring process is implemented, efforts to find buyers will continue in parallel. The sale process willallow for risk sharing mechanisms between the prospective buyer and the government along the lines ofthose used for the sale of distressed financial institutions in other countries. Together with an improvingforeign investment climate, an expected economic turn-around, a more determined sales effort andassistance by top-notch financial advisors, this approach to bank privatization is expected to yield theoutcomes that so far have been elusive.

3. Sector issues to be addressed by the project and strategic choices:

Although the proposed project focuses on the bank restructuring and privatization, it is accompanied byother policy reforms that facilitate bank restructuring and privatization and substantially extend the 1997reform program. The key policy reforms needed are:

1. Liberalization of bank branching policy - Past central bank policy required the NCBs to establish twobranches in unbanked areas for every branch established in a banked area. No NCB was allowed to close abranch in an unbanked area without central bank approval. Although closing of branches in banked areaswas liberal, NCBs preferred to sit on their banked area branch licenses instead of surrendering them as theybecame a source of econornic rent in the policy environment. Private and foreign banks were also requiredto apply for a license for each branch opening, including ATMs. Foreign banks were usually allowed only4 branches. These policies have been partly responsible for the domination by the NCBs in branching andthe virtual oligopoly in low-cost deposit mobilization, even after private banks were allowed to open morethan 10 years ago.

In general, the policy reform allows banks to open or close branches on the basis of commercial reasons.In "banked" areas, the closing of bank branches is already liberal. With regard to branch opening, theamended policy requires a bank to present to the central bank an annual branch expansion plan forapproval. Actual branch openings in accordance with the approved annual plan would require only anotification to the central bank on an ex-post basis. In "unbanked" areas, the recommendations of theinter-bank committee which proposed a sharing of the "tax" of maintaining bank branches among the fivelargest banks appear to be an acceptable interim solution until more efficient alternative institutionalarrangements for providing financial services to the rural areas are found. At privatization, closing of bankbranches in unbanked areas would be agreed with the new owners as part of the sales negotiation. Theexpected outcome of this reform would be a reduction of the branch network of the NCBs, which in itselfwould facilitate their privatization, and an increase in the network of private and foreign banks, leading to amore competitive market structure even before privatization.

2. Revision of tax policy and administration to reduce the taxation of the financial sector in line with therest of the economy - At 58% of net profits, the corporate income tax rate is higher for financial institutionsthan for non-financial companies, which are taxed at 35%. Until recently, the tax authorities did not allowbanks to deduct their loan loss provisions from income for tax purposes. Now, the government has allowedthe deduction of future loan loss provisions, although losses accrued as a result of previous provisions arenot deductible. Financial institutions are also subject to a 30% withholding tax on income fromgovernment securities which take a few years to refund, a 2% turnover tax, and a 5% interest-free cashreserve requirement. All these explicit and implicit taxes raise the effective tax rate of a bank to between75% and 80%.

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The reform consists of an initial reduction in the income tax rate from 58% to 50%, on a path toward theultimate target of 35%. Loan loss provisions that are certified by the central bank are now tax deductible.Interest in suspense will not be taxable. The withholding tax would be reduced. And, banks will beallowed to estimate the advance turnover tax and pay on that basis provided that if the estimate is less than80% of the actual tax liability a penalty would be imposed. These reforms will facilitate privatization,attract needed capital to the sector and encourage banks to expand lending activities to the middle market.

3. Ordinance amending the Loan Recovery Act of 1997 to facilitate the foreclosure of loan collaterals -The legal and judicial reforms implemented in the past three years have facilitated financial contract disputeresolution but only up to the handing down of court judgments. Implementation of court judgments is stillineffective partly due to remaining weaknesses in the law and, especially, with its implementation. The lawwould be further strengthened by enabling financial institutions to foreclose on collateral without theintervention of the courts. Implementation of this law could be facilitated by providing financialinstitutions with the required resources of the state to implement out-of-court foreclosure. At the sametime, implementation of court judgments would also be facilitated by providing the courts with adequateresources to effect loan recovery through the courts.

4. Reform of the National Savings Schemes - The National Savings Schemes (NSS) had causedlarge-scale financial disintermediation by paying very high returns that were tax-exempt, and had grown tohalf the size of the banking system in five years. Reform of these schemes aims to integrate them with thefinancial market by reducing the rates, removing the tax advantage and benchmarking their rates tocomparable government securities. The government has agreed to these reforns and has startedimplementing them. So far, it has disallowed institutional investors from investing in the schemes, reducedthe rate, removed the tax advantage, and issued long-dated government bonds which will serve asbenchmarks for NSS rates in future.

5. Discontinuance of the new Foreign Currency Deposit (FCD) scheme to avoid a repeat of the 1998foreign currency deposit crisis - In an attempt to raise BOP financing, banks were required to surrender tothe central bank foreign currency deposits that they raised but could not invest domestically in matchedassets. This new scheme quickly generated over US$550 million in FCDs putting the central bank at risk,similar to the risk it bore under the previous foreign currency deposit scheme. It was agreed that banksshould raise only the foreign currency deposits that they can prudently lend or invest locally andinternationally, and not be encouraged to bring them in to place with the central bank for purposes of BOPfinancing. In April 2001, the central bank removed the restriction that banks must place with it the foreigncurrency deposits that they cannot invest locally, resulting in the withdrawal of all FCDs deposited with thecentral bank.

C. Project Description Summary

1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed costbreakdown):

To achieve its objectives, the project would consist of the following components:

a) Restructuring Components* Branch rationalization of the NCBs* Staff rationalization of the NCBs* Amalgamation of NDFC into National Bank

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b) Privatization Components* Bona fide attempt at fully divesting the government's remaining shareholding in Muslim

Commercial Bank at market prices* Sale of the government's 49% share ownership in Allied Bank to a qualified strategic investor* Substantial progress in the sale of United Bank* Substantial progress in preparing Habib Bank for sale* Initial progress in preparing National Bank for sale

C) Policy Components* Liberalization of bank branching policy* Revision of the tax policy for the banking sector and initial reduction in the level of taxation* Amendment to the Loan Recovery Act of 1997 to facilitate the foreclosure of loan collaterals* Reform of the National Savings Schemes* Reform of the Foreign Currency Deposit Scheme

IDA Financing. The major cost of the project will come from the restructuring components. These are thecost of the voluntary separation payments for the 50% reduction in the headcount of NCB staff (25,600 outof 50,300). The staff of NDFC (800) would also be given separation payments as required by law. IDAfunds would help to finance these costs.

Government Financing. There will be some real-estate related costs, mainly settlement of long term leaseagreements, due to branch closures. The other major cost item would be the cost of amalgamating NDFCinto National Bank. This will entail a fiscal cost as NDFC deposits are moved to National Bank. In viewof the condition of NDFC's loan and investment portfolio, National Bank can only be partially compensatedby good NDFC assets. The shortfall would be covered by a combination of cash, and short and long-termgovernment securities that match the duration of the deposit liabilities. It is expected that the retaildepositors of NDFC would be fully covered while institutional depositors might be required to share in thelosses brought to light by NDFC's amalgamation. The cost of this component emanates from therecognition of quasi fiscal costs embedded in NDFC. The return on this investment would come from theavoidance of future losses which would otherwise continue to be incurred if NDFC were not amalgamatedinto National Bank.

Indicative Bank- % ofComponent Sector Costs % of financing Bank-

(US$M) Total (US$M) financingNCB and NDFC Staff Rationalization 437.00 80.9 300.00 100.0NCB Branch Closures 3.00 0.6 0.00 0.0NDFC Amalgamation 100.00 18.5 0.00 0.0

Total Project Costs 540.00 100.0 300.00 100.0

Front-end fee 0.00 0.0 0.00 0.0Total Financing Required 540.00 100.0 300.00 100.0

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2. Key policy and institutional reforms supported by the project:

* Cost restructuring of the NCBs to achieve a cost/income ratio of 0.65* Branch rationalization of the NCBs* Staff rationalization of the NCBs* Amalgamation of National Development Finance Corporation into National Bank* Bona fide attempt at fully divesting the government's remaining shareholding in Muslim

Commercial Bank at market prices* Sale of the government's 49% shareholding in Allied Bank Limited to a qualified strategic investor* Substantial progress in privatizing United Bank and in preparing Habib Bank for sale* Initial progress in preparing National Bank for sale* Liberalization of the bank branching policy to improve the health of the NCBs, encourage the

expansion of private and foreign banks and promote a more competitive market structure* Reform of the tax policy and regime for the banking sector to remove the discrimination against the

sector vis-a-vis the rest of the economy* Further reform of the loan collateral foreclosure procedures to facilitate loan recovery* Integration of the National Savings Schemes with the financial market* Discontinuance of the Foreign Currency Deposit scheme of the central bank

3. Benefits and target population:

The vision is for a sound banking sector providing efficient financial intermediation for the economy. Thebenefits of such a banking system would redound directly to savers through safer deposits and higherretums and to bonafide private sector borrowers through improved credit access, as the banks areprivatized and the default culture is eliminated.

The restructuring of the NCBs will facilitate their privatization but will not be assured by it. Still, thegains from restructuring will be preserved in the resulting restructuring of the banking market through thesubstantial downsizing of the state-owned banks, the amalgamation of NDFC, and the expected expansionof private banks through the liberalization of bank branching policy. The resulting market structure wouldbe healthier and more efficient, and the scope for corruption greatly reduced.

With regard to the NCBs themselves, the staff and branch rationalization program would bring down theircost/income ratios from the current 0.92 for HBL, 0.74 for UBL and 0.71 for NBP to 0.68, 0.69 and 0.60,respectively, after Phase 1, and further down to 0.65, 0.65 and 0.55 after Phase II, bring them closer to theintemational benchmark of 0.50 (Annex 4B). The reduction in the branch network and cost structurewould enable them to afford the technology needed to upgrade their current low-value operations, improvethe quality of financial services, and move along the productivity curve of intemational banks whichtypically spend 60% on technology and 40% on staff. The reduction in branches would also lead toorganizational transformation, with fewer layers, reduced head office bureaucracy, stronger controls andimproved intemal communications.

Finally, the cost of restructuring is justified by the project's internal cash flow of savings, with a paybackperiod of 3.5 years (Annex 4A).

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4. Institutional and implementation arrangements:

The restructuring measures will be coordinated by the State Bank of Pakistan and the Ministry of Finance.The three NCBs will be responsible for the design and implementation of their respective restructuringplans. The Privatization Commission (PC) will be responsible for implementing the required steps forbringing the three banks to the point of sale and for identifying bona fide strategic investors in parallel withthe restructuring exercise. The PC will be assisted by leading financial advisors in implementing individualsale transactions. The PC will coordinate the selection process with the State Bank of Pakistan, the bankregulator and supervisor, to ensure that the process would result in the selection of qualified buyers whohave the required integrity, capital, banking expertise, technology, and management. The State Bank willbe responsible for clearing potential buyers and their proposed management teams in accordance withestablished selection criteria and banking regulations. The PC would also be responsible in divesting theremaining government shares in Muslim Commercial Bank. The PC and/or the State Bank will beresponsible for re-privatizing Allied Bank Limited in a manner that would resolve its governance problem.The State Bank will be responsible for amalgamating NDFC into National Bank in an orderly manner. TheMinistry of Finance and State Bank will be the implementing agencies for the restructuring and other policyreforms supported by the proposed project.

D. Project Rationale

1. Project alternatives considered and reasons for rejection:

There were two design options. The first option was to do a single-tranche adjustment operation similar tothe Banking Sector Adjustment Loan (BSAL). Bank financial assistance would be provided only uponcompletion of the restructuring program, the implementation of other policy measures, and theamalgamation of NDFC. The other option was to do an investment project where Bank financial assistancewould be provided to reimburse the cost of the program while it is being implemented. The first option wasdiscarded principally because the proposed project, especially the closure of branches, is expected to takeabout 2 to 3 years to implement. An adjustment loan approach would have required that bridge financingbe provided by the State Bank of Pakistan to cover the cost of the program until Bank funding is disbursed.Such bridge-financing was not envisioned in the current monetary program agreed with the IMF, and wasconsidered to be difficult to accommodate, considering its size. An investment project would preclude theneed for bridge financing, as Bank funding would be provided through Statement of Expendituresprocedures. It would also allow for closer monitoring of the restructuring program while it is beingimplemented, as well as the privatization steps being implemented by the Privatization Commission throughstandard Bank supervision.

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2. Major related projects financed by the Bank and/or other development agencies (completed,ongoing and planned).

. [ Latest SupervisionSector Issue Project (PSR) Ratings

(Bank-financed projects only)Implementation Development

Bank-financed Progress (IP) Objective (DO)

Overall banking sector distress; weak Banking Sector Adjustment HS HSbanking regulation and supervision; Loan (closed 03/31/98)financial market segmentation;ineffective banking court systemWeak bank supervision department in Financial Sector Deepening and S Sthe central bank and lack of Intermediation Project (closingprivatization expertise in the 12/31/01)Privatization CommissionOther development agenciesUnderdeveloped capital markets; weak ADB - Capital Marketsregulatory framework for capital Development Program Loanmarkets; poor performance ofstate-owned mutual funds;Overall banking sector distress; weak OECF - Cofinancing of BSALbanking regulation and supervision;financial market segmnentation;ineffective banking court system

IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory)

3. Lessons learned and reflected in the project design:

1. Financial Sector Deepening and Intermediation Project - This financial intermediation operationproviding a credit line to private financial institutions and for private investments was used as aninstrument to require the government and the central bank to implement policy reforms. The only leverageavailable was a threat of suspension. The financial incentive (to the private sector) and the conditions (forthe public sector) were incongruent. Moreover, since the credit line was not attractive, and the funds didnot disburse, the threat of suspension was moot. The proposed operation, like BSAL, directly links thefinancial incentive to the conditionality. (In the end, FSDIP was drastically restructured as a technicalassistance project, assisting the central bank in strengthening its regulatory and supervisory role, and theprivatization cominission in executing bank privatization.)

2. The financial restructuring of bad banks should not be undertaken unless there is a definite change ofgovernance, otherwise good money would be thrown after bad. Under the proposed project, while thegovernment will give a commitment to potential buyers that the financial restructuring of the NCBs andDFIs would be undertaken, actual financial restructuring would be implemented only at the point of sale,after a qualified buyer has been selected.

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3. Privatization has many objectives (some conflicting), such as revenue generation, reduced economicactivity by the state, private sector development, greater efficiency. In view of the root causes of thebanking distress in Pakistan, the primordial objective, under which other objectives would subsume, is toachieve improved corporate governance by selling the NCBs and DFIs to the most qualified privateinvestors.

4. Selling distressed banks is more akin to transferring liabilities than selling assets. To attract qualityacquirers it is necessary to undertake cost restructuring and provide risk-sharing mechanisms to reduce thepolitical, social and financial risks associated with such transactions, but leaving balance sheetrestructuring to the point of sale, and business restructuring to the new owners.

4. Indications of borrower commitment and ownership:

Before the arrival of the preparation mission, the Ministry of Finance, the State Bank of Pakistan and thethree NCBs had met and agreed on the objectives, general approach, and extent of the proposedrestructuring program. During the mission, the NCBs presented the details of their plans and indicated atimetable for implementation. After the mission, the plans, as discussed with the mission, were presented tothe Cabinet for approval. Subsequently, a meeting chaired by the Chief Executive and attended by theNinisters of Finance, Privatization, Labor, and the Interior (to facilitate a smooth implementation of staffdownsizing and branch closures) and the Governor of the central bank endorsed the plan forimplementation. The Chief Executive instructed the Ministers to proceed with both the restructuringprogram and the policy changes agreed with the Bank admonishing them that he wanted the NCBsprivatized before the end of the current government to preempt the possible return of the looting of banksby vested interests in a political government.

The appraisal mission found that project implementation had already begun. All three NCBs had finalizedtheir branch closure plans in Phase I numbering 855 branches, with HBL and UBL already implementingtheir plans. UBL had already started and was halfway done with its staff rationalization scheme. HBLannounced its scheme during the appraisal mission. The reform of the National Saving Scheme and theForeign Currency Deposit Scheme as well as liberalization of bank branching have already been carriedout.

5. Value added of Bank support in this project:

BSAL was critical in the successful implementation of difficult reform measures needed to arrest thedeterioration of the banking system. By bringing in professional management into the NCBs, enhancing thecentral bank's autonomy and authority, promoting greater market integration and strengthening the bankingcourt system, BSAL provided some safeguard against a continuation of political interference in the bankingsector. Privatization was supposed to sustain the reform, but efforts to privatize the NCBs have not yetsucceeded for the reasons cited above. Feedback from prospective buyers and other market playersindicate that these banks are still out of line in terms of their staffing and branch networks in relation totheir asset size. The proposed further restructuring of the NCBs is seen as a necessary condition to theirprivatization to reputable investors, and achieving permanent corporate governance reform in Pakistan'sbanking system. The government believes that the Bank, which helped lay the basis for the current bankingreform program, is best placed to help bring it to fruition, and has asked for Bank assistance.

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E. Summary Project Analysis (Detailed assessments are in the project file, see Alnex 8)

1. Economic (see Annex 4):* Cost benefit NPV=US$ million; ERR = % (see Annex 4)O Cost effectivenessO Other (specify)Ideally, the cost of the staff and branch rationalization program of the NCBs should be considered arecognition of sunk cost and be expensed in the same year that they are incurred. However, the NCBscannot afford this approach which would further de-capitalize them. As a second best approach, theprogram is being justified as an investment project that is expected to produce a stream of cost savings. Assuch, the economic justification of the investment is highly sensitive to: (a) the economic life of theinvestment, i.e., how many years of cost savings are counted, and (b) the "residual value" of the investment,which conceptually would be the price premium that the private investors would pay for the banks as aresult of their having been restructured prior to privatization. (See Annex 4A)

2. Financial (see Annex 4 and Annex 5):NPV=US$ million; FRR= % (see Annex 4)Based on both the experience of the 1997 restructuring and projections for the proposed restructuringprogram, the payback period for an investment project of this kind is about 3.5 years. This seems to be along time when compared with the ideal, i.e. a recognition of sunk cost and, therefore, an expense ratherthan an investment, and in relation to the bank privatization timeline of 18 months, but is acceptable as apayback period for an investment project. (See Annex 4A)

When completed, the staff and branch rationalization program of the NCBs would bring down theircost/income ratios from the current 0.92 for HBL, 0.74 for UJBL and 0.71 for NBP to 0.68, 0.69 and 0.60,respectively, after Phase I and further down to 0.65, 0.65 and 0.55 after Phase II, bringing them closer tothe international benchmark of 0.50 (Annex 4B).

Fiscal Impact:

The severance package consists of the payment of benefits already earned by staff (2/3) and an additionalcash payment as an incentive to leave (1/3). Thus, much of the severance costs are sunk but unfunded orquasi fiscal costs embedded in the NCBs, amounting to about US$200 million. Only the cash paymentamounting to about US$140 million is new fiscal cost. With regard to NDFC, all costs are sunk. There isa shortfall or a negative networth amounting to about US$370 million, of which US$ 100 million isunfunded. The balance of US$270 million is funded by liabilities to the government and the central bankwhich would have to be wriitten-off. All told the fiscal impact would be US$340 million from theseverance payments (of which US$140 million is new) and US$370 million for the amalgamation ofNDFC, or a total of US$7 10 million or about 1.2% of GDP.

3. Technical:To maximize the benefit of the staff rationalization program, the program should be mandatory and shouldtarget separating the less productive staff. The Pakistanis have determined that a mandatory programwould not be feasible in view of the expected legal challenges to such a program. However, some targetingcan be achieved even in a voluntary program. This is done by outsourcing all non-core staff (e.g., guards,drivers, etc), and complementing the voluntary scheme with leave with pay but without benefits especiallyfor executive staff. These and other targeted approaches will be tried.

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4. Institutional:The institutional arrangements for project design and implementation have already been set-up, asdescribed above. There is strong management and institutional capacity to implement. The proposedproject is, therefore, expected to be implemented quickly, with the staff rationalization program in one year,and the branch rationalization plan in 2 to 3 years. The privatization timeline, however, would take longerin view of its dependence on market response.

4.1 Executing agencies:

None. Division of labor has been agreed among the Ministry of Finance, the State Bank of Pakistan, thePrivatization Commission and the NCBs.

4.2 Project management:

None. The management teams in the NCBs were professionalized in 1997 and are capable of implementingthe proposed restructuring program.

4.3 Procurement issues:

None

4.4 Financial management issues:

None. Since the 1997 reform, the accounting and auditing standards of the banking sector have beenupgraded to intemational norms.

The financial management systems of the implementing agencies are adequate to properly account for andreport on the project expenditures. The key project financial management-related risk is that thedisbursements of funds for the project relate to actual severance payments made in accordance withapproved policies. Mitigating measures taken on this risk are extensive, and concem the flow of funds, theprocedures for verifying severance payments, the quality of intemal audit, and the financial reporting andextemal auditing arrangements. These measures are described in Annex 6.

5. Environmental: Environmental Category: C (Not Required)5.1 Summarize the steps undertaken for environmental assessment and EMP preparation (includingconsultation and disclosure) and the significant issues and their treatment emerging from this analysis.

None

5.2 What are the main features of the EMP and are they adequate?

Not Applicable

5.3 For Category A and B projects, timeline and status of EA:Date of receipt of final draft:

Not Applicable5.4 How have stakeholders been consulted at the stage of (a) environmental screening and (b) draft EAreport on the environmental impacts and proposed environment management plan? Describe mechanismsof consultation that were used and which groups were consulted?

Not Applicable

5.5 What mechanisms have been established to monitor and evaluate the impact of the project on theenvironment? Do the indicators reflect the objectives and results of the EMP?

Not Applicable

6. Social:

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6.1 Summarize key social issues relevant to the project objectives, and specify the project's socialdevelopment outcomes.

Since it is a voluntary separation scheme, the severance package to be provided is relatively generous,minimizing untoward hardship for those who leave the banks' employment. All accrued pension, leave andmedical benefits will be paid out. The cash incentive will equal to I month total pay (or 3 months basicpay) per year of service. Since the staff and branch rationalization program is being carried outnationwide, no ethnic group or specific geographic location have been targeted and would be seriouslyaffected by the project.

6.2 Participatory Approach: How are key stakeholders participating in the project?

As in the 1997 program, staff representatives, officer associations, and, to the extent possible, the laborunions have been consulted to ensure a smooth implementation of the program.

6.3 How does the project involve consultations or collaboration with NGOs or other civil societyorganizations?

Consultations with staff representatives, officer associations, and labor unions of the banks.

6.4 What institutional arrangements have been provided to ensure the project achieves its socialdevelopment outcomes?

The human resource departments of the banks are responsible for program implementation.

6.5 How will the project monitor performance in terns of social development outcomes?

The human resource departments of the banks will establish a monitoring system that will track thefortunes of staff that leave the banks to assess the social impact of this large-scale reduction in staff andbranches, and gain valuable lessons from this experience.

7. Safeguard Policies:7.1 Do any of the following safeguard policies apply to the project?

Policy ApplicabilityEnvironmental Assessment (OP 4.01, BP 4.01, GP 4.01) 0 Yes 0 NoNatural habitats (OP 4.04, BP 4.04, GP 4.04) 0 Yes 0 NoForestry (OP 4.36, GP 4.36) 0 Yes 0 NoPest Management (OP 4.09) 0 Yes * NoCultural Property (OPN 11.03) 0 Yes 0 NoIndigenous Peoples (OD 4.20) 0 Yes 0 NoInvoluntary Resettlement (OD 4.30) 0 Yes 0 NoSafety of Dams (OP 4.37, BP 4.37) 0 Yes 0 NoProjects in International Waters (OP 7.50, BP 7.50, GP 7.50) 0 Yes 0 NoProjects in Disputed Areas (OP 7.60, BP 7.60, GP 7.60) 0 Yes 0 No

7.2 Describe provisions made by the project to ensure compliance with applicable safeguard policies.

Not Applicable

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F. Sustainability and Risks

1. Sustainability:

The most critical factor for sustainability is that the banks are acquired by quality investors who canprovide the required corporate governance. Other key factors are improvements in bank regulation andsupervision, a process which is continuing in the State Bank of Pakistan; a more competitive marketstructure, partly to be promoted by the liberalization of bank branching, an effective banking court system,partly to be strengthened by allowing out-of-court foreclosure of collaterals and the parallel efforts of theCorporate and Industrial Restructuring Corporation, and further improvement in disclosure standards toinstill market discipline.

2. Critical Risks (reflecting the failure of critical assumptions found in the fourth column of Annex 1):

Risk Risk Rating Risk Mitigation MeasureFrom Outputs to ObjectiveMacroeconomic stability H Close consultation with IMF teamSuccessful privatization H Banks are being restructured to improve their

prospects for sale; technical assistance is beingprovided to the Privatization Commission toemploy top-notch financial advisors

Competitive banking sector H Dependent on successful privatization of the 5largest banks; mitigation measures as above.

From Components to OutputsFiscal cost of program affordable H Banking reform considered priority at the

highest levels and will be accommodated in thefiscal program through reordering of priorities;

Sufficient acceptance of voluntary H Adequate preparation by banks, includingretrenchment scheme by bank employees consultations with the labor unions; attractive

package; experience in 1997 guiding design ofthe current scheme.

Court cases filed by retrenched staff H Banks have sought the advise of legal expertsand were advised that the best way to avoidlegal suits would be to make the schemevoluntary.

Adequate response from qualified H Announcement by the government of bankinvestors privatization policy; clear-cut criteria for

pre-qualification; transparent terms andconditions of sale; restructuring program isfocused on cost reduction to increase thefranchise value of the NCBs; balance sheetrestructuring will be undertaken by thegovernment prior to privatization; top-notchfinancial advisors being provided; risk-sharingmechanisms between the government and buyerswill be provided.

Islamic banking policy clarified H A high-level government commission ispreparing recommendations vis-a-vis thesupreme court's decision on Islamic banking; in

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view of progress made but more time needed toimplement Islamic banking, the court hasdecided at the request of the government topostpone implementation to July 2002.

Adequate market appetite for MCB shares H The government is committed to divest all itsand government approval process: shareholding in MCB, as evidenced by its goodThree bidders for a total of 14 million faith offer to sell all its shares at market price.shares (out of the government's holding of40 million shares) have offered bids atwhat was the market price of Rs 26 pershare; as required, the bids had to beapproved by the central bank, theprivatization commission and the cabinet;all three approvals have been given but inthe meantime the market price haddecreased to Rs. 23

Overall Risk Rating H

Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N(Negligible or Low Risk)

3. Possible Controversial Aspects:

None.

G. Main Credit Conditions

1. Effectiveness Condition

The standard condition for credit effectiveness is the submission of a legal opinion confirming that theDevelopment Credit Agreement has been duly authorized or ratified by the Borrower and is legally bindingupon GOP. There are no other conditions for credit effectiveness.

2. Other [classify according to covenant types used in the Legal Agreements.]

Board Conditions

* Legal instrument for amalgamation of NDFC into National Bank in place and transfer of NDFCdeposits to National Bank completed

* Bona fide attempt at fully divesting the government's remaining shareholding in MuslimCommercial Bank at market prices

* Decision on a satisfactory privatization route for Allied Bank that resolves its govemance problemreached and substantial progress in implementing this decision

* Revised tax policy and initial reduction of the tax on the banking sector announced* Ordinance to facilitate the foreclosure of loan collaterals promulgated* Circular to liberalize bank branching policy issued* Reform of the National Savings Schemes* Reform of the Foreign Currency Deposit Scheme

Disbursement Conditions

* The whole credit of US$300 million will be disbursed as reimbursement of eligible severance

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payments paid out to NCB and NDFC staff.* The US$100 million notionally allocated to the NDFC reform would be available for disbursement

upon effectiveness of the Credit since the legal instrument for amalgamating NDFC into NationalBank would have been in place and NDFC deposits would have been transferred to National Bank,these two actions being conditions of Board presentation.

* Disbursement of the US$200 million notionally allocated to the NCB restructuring componentswill be made not only on the basis of progress made in NCB staff reduction but also in branchclosures. The first US$100 million equivalent would be available for disbursement when 600 NCBbranches or 1/3 would have been closed; the next US$50 million, when 1,200 branches or 2/3would have been closed; and the final US$50 million, when 1,800 branches or 3/3 would have beenclosed. However, when an NCB is privatized, its branch closure program would cease (branchclosure being a means to facilitate bank privatization and further branch closure becoming theprerogative of the new owners), and the overall branch closure target of 1,800 branches would beaccordingly adjusted.

Retroactive Financing. Following the approval of a Standby Arrangement for Pakistan by the IMF,Pakistan presented to the Bank a structural reform program in support of a request for exceptional IDAfinancing. In view of the strength of the prograrn and the government's commitment to it as evidencedby advanced implementation of key components, the Region proposed a package of assistance forPakistan to the Operations Committee consisting of a Structural Adjustment Credit (Board approval-June 12, 2001) and the proposed project, supported by a CAS Update (Board discussion - June 12,2001). The country assistance continued to espouse the strategy of supporting strong reforms with aseries of one-tranche adjustment operations - with all required actions taken up-front - that started withthe 1997 Banking Sector Adjustment Loan and was followed by the 1999 SAL.

In line with this strategy, the proposed project was conceived to be a single-tranche adjustmentoperation whereby Bank assistance would be provided on basis of actions already taken rather than onpromises still to be kept. In this case, the Bank's financial assistance was to be provided only uponcompletion of the restructuring program of the Nationalized Commercial Banks (consisting of staff andbranch downsizing), the implementation of agreed policy measures, and the amalgamation the NationalDevelopment Finance Corporation into National Bank of Pakistan. As such, the Bank advised thegovermment to proceed with project implementation along agreed lines, the results of which would thenbe assessed, and if found satisfactory, would be the basis for the presentation of the proposed project tothe Bank's Board.

In the course of project preparation, the adjustment lending approach was modified because a keycomponent of the project, namely branch closures, could take 2 to 3 years to complete. In such a case,the adjustment lending approach would have required that bridge-financing be provided by the centralbank over the required timeframe to cover the cost of the program until IDA funding is disbursed.Such bridge-financing was not envisioned in the current monetary program agreed with the Fund, andwas considered difficult to accomodate considering its size. The conversion to an investment operationwas cleared with the Managing Director. Nevertheless, the Bank advised the government to proceedwith project implementation along the agreed lines to demonstrate its commitment to reforms. Becauseit was convinced of the benefits of the program, the government proceeded to implement the projectstarting in January 2001.

By project appraisal in June 2001, United Bank was halfway done with its staff downsizing programand Habib Bank announced and started its own program. United Bank and Habib Bank were alsoimplementing their Phase I branch closure programs. The appraisal mission, therefore, also conducted

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a supervision of the project, assessed how project implementation was proceeding and was satisfiedthat the project was being implemented according to prior agreements with the government, asdescribed above. A review of the disbursement documentation being used by the banks in makingseverance payments showed that the banks have satisfactory documentation for purposes of Bankreimbursement and external audits. By negotiations, 7,500 staff had been separated from United Bank(4,500) and Habib Bank (3,000), and 605 branches had been closed (United Bank - 356; Habib Bank-249). By the planned Board presentation in September 2001, it is expected that United Bank andHabib Bank would have completed their staff and Phase I branch rationalization programs, whileNational Bank would be halfway done with its staff rationalization program.

In view of the advanced stage of achievement of project objectives and the commitment to reforms thatproject implementation to date has demonstrated, retroactive financing would be allowed for eligibleexpenditures incurred since January 1, 2001, up to an amount equivalent to US$100 million, or half ofthe amount expected to be incurred by the government and the banks for the proposed project by Boardpresentation.

H. Readiness for Implementation

O 1. a) The engineering design documents for the first year's activities are complete and ready for the startof project implementation.

0 1. b) Not applicable.

OI 2. The procurement documents for the first year's activities are complete and ready for the start ofproject implementation.

O 3. The Project Implementation Plan has been appraised and found to be realistic and of satisfactoryquality.

O 4. The following items are lacking and are discussed under loan conditions (Section G):

The credit will help finance the cost of restructuring the NCBs and amalgamating NDFC into NationalBank. IDA funds, however, will finance only severance payments for NCB staff who are separated fromservice and NDFC staff who lose their jobs, with the government and NCBs financing the cost ofamalgamating NDFC and real estate-related costs in closing NCB branches, respectively. Therefore, thereare no procurements to be made under the project.

1. Compliance with Bank Policies

1 1. This project complies with all applicable Bank policies.O 2. The following exceptions to Bank policies are recommended for approval. The project complies with

all other applicable Bank policies.

Jos h Del Mar Pemia Marilou Jane D. Uy W. WallTeam Leader Sector ManagerlDirector Co try Manager/Director

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Annex 1: Project Design SummaryPAKISTAN: Banking Sector Restructuring and Privatization Project

Key PerformanceHierarchy of Objectives Indicators Monitoring & Evaluation Critical Assumptions

Sector-related CAS Goal: Sector Indicators: Sector/ country reports: (from Goal to Bank Mission)Macroeconomic stability Reduced quasi fiscal deficits Financial Sector Update, May Implementation of IMF

in banking 2000 programMonthly banking sectormonitoring report

Improved resource allocation Banking sector responding to Successful privatizationthrough improved governance price signals, not vested

interest

Competitive private sector Greater credit access by Privatization of 5 largestprivate sector banks leads to true

competition among them

Project Development Outcome I Impact Project reports: (from Objective to Goal)Objective: Indicators:To improve corporate Reduction of the cost/income NCBs management accounts Fiscal cost included in agreedgovernance through ratio of the NCBs to 0.65; reflecting reduction in cost to macroframeworkprivatization of the NCBs to income ratios.qualified strategic investors,and complete privatization of Rationalization of branch Bank supervisionpartially privatized banks. network of NCBs by reducing

no. of branches by 40 percent;

To improve market structure Staff retrenchment in the Bank supervision and Sufficient acceptance ofby reducing the state-owned NCBs to reduce headcount by statement of expenditures voluntary retrenchmentsegment of the banking 50 percent; review program by bank employeessystem.

Outsourcing of non-core Bank supervisionactivities of the NCBs

Sale negotiations commenced Invitations for bids for sale of Macroeconomy, foreignwith pre-qualified strategic HBL, UBL and ABL investment climate and legalbuyer(s) for HBL and UBL. published. (shariah) environment

conducive to attractingPrivatization timeline agreed Contracts with FAs qualified strategic investors;and Financial Advisor Adequate number of qualifiedretained for NBP. investors interested in

acquiring NCBs.Amalgamation of NDFC into Government notificationNational Bank. dissolving the NDFC Act.

Full divestment of MCB and Transfer of MCB shares as SECP approval for ABL blocksale of 49 percent government recorded by company sale as a public offering;shares in ABL to a qualified registrar. adequate market appetite forstrategic investor. MCB shares.

To sustain and deepen the Bank branching policy State Bank of Pakistanbanking reforms started in liberalized Circular

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1997Announcement of revised tax Policy and budgetpolicy and regime for banking pronouncementssystem

Ordinance amending the Loan Copy of ordinanceRecovery Act of 1997promulgated

Reformn of National Savings Policy pronouncements,Schemes reduction in interest rates and

removal of tax advantage

Discontinuance of the Foreign State Bank CircularCurrency Deposit Scheme

Output from each Output Indicators: Project reports: (from Outputs to Objective)Component:NCBs reduced in size and Cost/income ratio of 0.65; NCB progress reports; NCB Adequate acceptance ofmarket share and more staff reduced by 50 percent; annual audited reports; Bank voluntary retrenchmentefficient branches reduced by 40 supervision reports; program by bank staff

percent

NDFC amalgamated into NDFC Act revoked; deposits MOF, SBP and CIRC Consensus on treatment ofNational Bank and assets transferred to progress reports; Bank retail and wholesale deposits;

National Bank; bad assets supervision reports Agreement of creditorstransferred to CIRC;satisfactory resolution ofenergy fund (LTCF)

Project Components I Inputs: (budget for each Project reports: (from Components toSub-components: component) Outputs)NCB and NDFC Staff $437 million NCB progress reports same as aboveRationalization

NCB Branch Rationalization $3 million NCB progress reports same as above

NDFC Amalgamation $100 million MOF, SBP, CIRC progress same as abovereports

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Annex 2: Detailed Project Description

PAKISTAN: Banking Sector Restructuring and Privatization Project

The proposed project supports implementation of the government's banking sector reform program byhelping to: (a) restructure the NCBs to facilitate their privatization; (b) complete the privatization of thepartially privatized banks; (c) amalgamate NDFC into National Bank; (d) promote the growth of soundprivate banks and a reduction in the market share of the NCBs by liberalizing bank branching, therebyimproving the structure of the banking market; (e) rationalize the taxation of the banking sector in line withthe rest of the economy; (f) improve loan recovery by facilitating the foreclosure of collaterals; (g) reducemarket segmentation by integrating the National Savings Schemes with the financial market and phasingout the subsidized export finance scheme; and (h) pre-empting a repeat of the foreign currency depositcrisis by discontinuing the foreign currency deposit scheme of the central bank.

By Component:

Project Component I - US$437.00 millionNCB Staff Rationalization -To achieve an interim target of a 0.65 cost/income ratio, the three NCBs willreduce staff by 25,600 or 50%, namely 10,900 from HBL, 7,300 from UBL and 7,400 from NBP. Thiswill be done through a voluntary separation scheme whereby staff who wish to leave would be providedwith a severance package consisting of cash compensation calculated on the basis of one month pay peryear of service plus the commutation of all annual leave, pensions and medical benefits. The cashcomponent would account for about 1/3, while the commutation of accrued benefits 2/3, of the package.To achieve some targeting of staff departures, the voluntary scheme will be complemented by theoutsourcing of non-core staff and leave with pay but without benefits for those in executive levels. IDAwill finance about 2/3 of the estimated cost of US$437 million equivalent.

Project Component 2 - US$3.00 millionNCB Branch Rationalization - To assure a structural and virtually irreversible reform, staff rationalizationwill be accompanied by a proportional reduction of bank branches from 4,500 to 2700, or by 1800, namely600 in HBL, 650 in UBL and 550 in NBP. The cost of this component would come mainly from thesettlement of long-term leases on rented space, amounting to about $3 million equivalent. NCB funds willfinance this cost as part of counterpart funding.

Project Component 3 - US$ 100.00 millionNDFC Amalgamation - The amalgamation of NDFC into National Bank will entail two types of costs.The first is the severance payment to NDFC staff (800) who will lose their jobs. IDA funds can also beused to finance this cost, estimated to be about US$ 10 million equivalent, within the overall credit amount,i.e. IDA disbursement can be against eligible severance payments made to NCB staff only or both NCBand NDFC staff. The other cost emanates from the recognition of quasi fiscal costs embedded in NDFC'sbalance sheet. NDFC's deposits would have to be moved to National Bank, but in view of the condition ofNDFC's loan and investment portfolio, National Bank can only be compensated partially by good NDFCassets. The shortfall would have to be covered by a combination of cash and short and long-tenngovernment securities that match the duration of the deposit liabilities being transferred. It is expected thatretail depositors would be fully covered while institutional investors might have to share in the lossesbrought to light by the NDFC's amalgamation into National Bank. CIRC will be responsible for disposingof NDFC's bad assets and distributing the proceeds to claimants according to seniority of claims.Government funds will finance this cost as part of counterpart funding. Although the present value of theloss could be as high as $ 100 million equivalent, only the cash portion and the debt service on thegovernment securities used to compensate National Bank for the shortfall in NDFC assets need to be

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budgeted annually.

Project Component 4 - US$0.01 millionCompletion of Privatization of MCB and ABL - As part of the proposed project, the government will sellits remaining shareholding in MCB and ABL. In the case of MCB, the government's remaining 17%shareholding will be divested either through the stock market where MCB shares are already listed or toIFC. In the case of ABL, there are problems with the financial condition and internal governance of thebank. The bank is probably operating with a negative networth. The defacto ownership of the bank'sshares, which are supposed to be held by employees, is not established. The government plans to sell its49% shareholding as a block to an institution or a group of investors who qualified to take over the bank'smanagement, but it is constrained by the original terms of sale of this bank to its employees which requirethat the government's remaining share must be sold in a public offering. Considering the severe deficienciesin the financial condition and governance of this bank, the sale of the government's share must result in thetransfer of control of the bank to such other private party that is deemed fit to owned and manage this bank.The cost of this component would depend on the level of insolvency of ABL. This cost will be financed bythe government implied in the price the bank would fetch for the government's remaining shareholding.

Project Component 5 - US$0.01 millionOther Policy Measures - Other policy measures being supported by the project include the following:

1. Liberalization of bank branching policy - Past central bank policy required the NCBs to establish twobranches in unbanked areas for every branch established in a banked area. No NCB was allowed to close abranch in an unbanked area without central bank approval. Although closing of branches in banked areaswas liberal, NCBs preferred to sit on their banked area branch licenses instead of surrendering them as theybecarne an economic rent in the policy environment. Private and foreign banks were also required to applyfor a license for each branch opening, including ATMs. Foreign banks were usually allowed only 4branches. These policies have been partly responsible for the domination by the NCBs in branching and anoligopoly in low-cost deposit mobilization, even after private banks were allowed to open more than 10years ago.

In general, the policy reform allows banks to open or close branches on the basis of commercial reasons.In "banked" areas, the closing of bank branches is already liberal. With regard to branch opening, theamended policy requires a bank to present to the central bank an annual branch expansion plan forapproval. Actual branch openings in accordance with the approved annual plan would require only anotification to the central bank on an ex-post basis. In "unbanked" areas, the recommendations of theinter-bank committee which proposed a sharing of the "tax" of maintaining bank branches among the fivelargest banks appear to be an acceptable interim solution until more efficient alternative institutionalarrangements for providing financial services to the rural areas are found. At privatization, closing of bankbranches in unbanked areas would be agreed with the new owners as part of the sales negotiation. Theexpected outcome of this reform would be a reduction of the branch network of the NCBs, which in itselfwould facilitate their privatization, and an increase in the network of private and foreign banks, leading to amore competitive market structure even before privatization.

2. Revision of tax policy and administration to reduce the taxation of the financial sector in line with therest of the economy - At 58% of net profits, the corporate income tax rate is higher for financial institutionsthan for non-financial companies, which are taxed at 35%. Until recently, the tax authorities did not allowbanks to deduct their loan loss provisions from income for tax purposes. Now, the government has allowedthe deduction of future loan loss provisions, although losses accrued as a result of previous provisions arenot deductible. Financial institutions are also subject to a 30% withholding tax on income from

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government securities which take a few years to refund, a 2% turnover tax, and a 5% interest-free cashreserve requirement. All these explicit and implicit taxes raise the effective tax rate of a bank to between75% and 80%.

The reform consists of an initial reduction in the income tax rate with a path toward the ultimate target of35%. Loan loss provisions that are certified by the central bank are now tax deductible. Interest insuspense will not be taxable. The withholding tax would be reduced. And, banks will be allowed toestimate the advance turnover tax and pay on that basis provided that if the estimate is less than 80% of theactual tax liability a penalty would be imposed. These reforms will facilitate privatization, attract neededcapital to the sector and encourage banks to expand lending activities to the middle market.

3. Ordinance amending the Loan Recovery Act of 1997 to facilitate the foreclosure of loan collaterals -The legal and judicial reforms implemented in the past three years have facilitated financial contract disputeresolution but only up to the handing down of court judgments. Implementation of court judgments is stillineffective partly due to remaining weaknesses in the law and, especially, with its implementation. The lawwould be further strengthened by enabling financial institutions to foreclose on collateral without theintervention of the courts. Implementation of this law could be facilitated by providing financialinstitutions with the required resources of the state to implement out-of-court foreclosure. At the sametime, implementation of court judgments would also be facilitated by providing the courts with adequateresources to effect loan recovery through the courts.

4. Reform of the National Savings Schemes - The National Savings Schemes (NSS) had causedlarge-scale financial disintermediation by paying very high returns that were tax-exempt, and had grown tohalf the size of the banking system in five years. Reform of these schemes aims to integrate them with thefinancial market by reducing the rates, removing the tax advantage and benchmarking their rates tocomparable government securities. The government has agreed to these reforms and has startedimplementing them. So far, it has disallowed institutional investors from investing in the schemes, reducedthe rate, removed the tax advantage, and issued long-dated government bonds which will serve asbenchmarks for NSS rates in future.

5. Discontinuance of the new Foreign Currency Deposit (FCD) scheme to avoid a repeat of the 1998foreign currency deposit crisis - In an attempt to raise BOP financing, banks were required to surrender tothe central bank foreign currency deposits that they raised but could not invest domestically in matchedassets. This new scheme quickly generated over US$550 million in FCDs putting the central bank at risk,similar to the risk it bore under the previous foreign currency deposit scheme. It was agreed that banksshould raise only the foreign currency deposits that they can prudently lend or invest locally andinternationally, and not be encouraged to bring them in to place with the central bank for purposes of BOPfinancing. In April 2001, the central bank removed the restriction that banks must place with it the foreigncurrency deposits that they cannot invest locally, resulting in a reduction in the amounts deposited with thecentral bank to US$20 million.

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Annex 3: Estimated Project Costs

PAKISTAN: Banking Sector Restructuring and Privatization Project

Local Foreign TotalProject Cost By Component US $million US $million US $million

NCB Staff Rationalization 437.00 0.00 437.00NCB Branch Closures 3.00 0.00 3.00NDFC Amalgamation 100.00 0.00 100.00Completion of MCB and ABL Privatization 0.00 0.00 0.00Other Policy Measures 0.00 0.00 0.00Total Baseline Cost 540.00 0.00 540.00Physical Contingencies 0.00 0.00 0.00Price Contingencies 0.00 0.00 0.00

Total Project Costs 540.00 0.00 540.00Total Financing Required 540.00 0.00 540.00

Identifiable taxes and duties are O(US$m) and the total projectcost, netoftaxes, is 540 (US$m). Therefore, the project cost sharing ratio is 55.56%. oftotalproject cost net of taxes.

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Annex 4: Cost Benefit Analysis SummaryPAKISTAN: Banking Sector Restructuring and Privatization Project

ANNEX 4.A: Restructuring Program Projected Cash Flows

NCB CONSOLIDATED CASH FLOWS

Assumptions Staff Loans: 10,513Admin cost growth: 8% Staff Loan Ammortization Yrs: 10Present To Be Closed Total Closed Remaining Branches after Phase I

Branches: Banked Un-banked Banked Un-banked Banked Un-banked

Urban 1481 30 521 0 521 0 0

Rural 729 837 0 334 334 0 0

Totall 3254 1191 521 334 855: .7~ 857Employees:

No. of Empl. Cost of GHS Retirement Benefits Total Cost Cost Employee

Executives 1,126 1,219 2,475 3,695 3.28

Officers 8,815 3,676 8,714 12,389 1.41Clerical 5,031 1,157 2,542 3,699 0.74

Non-Clerical 10,663 2,328 5,510 7,838 0.74

Total 25j635 8380 19,241- 27,621 - LOPresent no. of totalemployees 50,343No. employees postretrenchment 25,686

Outflows: 2001 2002 2003 2004 2005 2006 2007VHS cost (27,621)

Adjustment to above (286)Cost of outsourcing (379) (775) (837) (904) (976) (1,054) (1,139)Cost of New Hires (232) (499) (652) (704) (760) (821) (887)Outplacement &Training (247) 0 0 0 0 0 0

Cost of branchclosure- (202) 0 0 0 0 0 0

Sub Total (28,966) (t,274) (1,489) (1,608) -(1-73) (1$76) (2,026)Inflows:Salary savings ofretrenched staff 2,975 6,701 7,237 7,816 8,441 9,117 9,846

StaffLoans Principal 10,513 (1,051) (1,051) (1,051) (1,051) (1,051) (1,051)Cost Staff LoansSubsidy 404 809 728 647 566 485 404Admin cost savingbranch closure 178 385 415 449 485 523 565

Sub Total 14,070 6,843 7,329 7,860 8,441 9,074 9,764Net Cash Flows (14896) .5,569 5,840 6j252 .6J0G , .79B 7,739Payback - no. ofvears: 3.53 IRR: -16% 9% 22% 30% 35%

Required Residualfor IRR of 15% 11,561.76 15,866.28 9,680.98 2,273.90 (6,580.84) (17,146.40)

- 25 -

NATIONAL BANK OF PAKISTAN

As-pdo-Wage growth: 8% Admin costs 80% StaffLoans: 2,580 Loan subsidy: 6%

Loss of rural Loans (Rs, NO: O Staff Loan AnlwriztionYrs: 10

Presernt Planned Closwe Total Closed Remainng Branches afterPhas I

Branches: Baied Un-bned Banked Un-barked B l Un-banked

Urban 671 20 150 0 150

Riaal 367 346 0 100 100

Emnployees:Retirement

No. of Empi. Cost of GHS Benefits Total Cost Cost/ Employee

Executives 171 286 405 690 4.04

Officers 3,784 1,784 3,766 5,549 1.47

Clerical 1,246 290 715 1,005 0.81

Non-Clerical 2,229 519 1,636 2,155 097

0 . § < W 9 S S - .i9

2001 2002 2003 2004 2005 2006 2007

Present no. of totalemployees 15,147Curient Daily Waged 3,800New Hires 250No. of employees postretrenchment 7,967 7,967 7,967Outsource positions postrerfenchment 1,100

Outflows:VHS cost of 7,430employees (9,399)Cost of outsourcing (40) (43) (46) (50) (54) (58) (63) (68)

CostofNewHires (90) (97) (105) (113) (122) (132) (143) (154)

Cost of branch closure - (75)

4$:; K. O: . ( 140) (151) (163) (176) (190) (206) (222)

Innfows:Salary savings ofretrenched staff 1,050 2,268 2,449 2,645 2,857 3,086 3,332 3,599

Staff Loans Principal 2,580 (258) (258) (258) (258) (258) (258) (258)

Cost StaffLoans Subsidy 77 155 139 124 108 93 77 77

Admin cost saving branchesclosed 50 108 117 126 136 147 159 171

Sub Total 3 757 2,73 2447 2637 843 3067 3,311 3,590

IRR -16% 90/0 22% 300/o 35% 38%

Required Residual for IRROf 15% 6,912.86 5,047.26 2,762.80 (18.80) (3,388.80) (7,453.48) (12,352.00)

-26 -

HABIB BANK LIMITED

AssmdnsWagegrowth: 8% Admincostsgrow8% Staff Loans: 6,018 Loansubsidy 8%

Loss ofruralwans (Rs. M): 492 Staff Loan Ammort Yrs: 10Present Planned Closure Total Closed Remaining Branches after Phase I

Urban 810 10 159 159

Rural 362 491 90 90

J-, 4M.A. !49 1.k3 411Employees:

No. of Empl. Cost ofGHS RetirentBenefit Total Cost Cost/Empk4Yee

Executives 544 927 1,138 2,065 3.80

Officers 2,601 1,754 2,624 4,378 1.68

Clerical 2,309 529 1,143 1,671 0.72

Non-Clerical 5,419 1,362 2,612 3,975 0.73

.ta . - 3- . .,. 45072 p . * 12,64

2001 2002 2003 2004 2005 2006 2007Prsent no. of totalemnployees 21,847

New Hires 400 400 400No. of employees postretrnchment 11,374 11,774 12,174Outsouce positions postretrnchment 4,000

Outflows:VHS cost of 10,873employees (12,088)

Costofoutsourcing (144) (311) (336) (363) (392) (423) (457)

Cost ofNew Hires (52) (209) (338) (365) (394) (426) (460)

Cost of branch closu - (74)Si*Toh . . . *.-(520) (674) (728) (786) (849) (917)

Inflows:Salary savings ofretrenchedstaff 1,298 2804 3029 3271 3532 3815 4120

Staff Loans Principal 6,018 (602) (602) (602) (602) (602) (602)

Cost StaffLoans Subsidy 241 481 433 385 337 289 241Admin cost savingbranchescdosed 53 114 123 133 143 155 167

SubTotal 7,610 2,797 2,983 3,187 3,411 3,657 3,926

Paybad >.6t-# 3.50 IRR: -2% 22% 35% 42% 46%Required Residual for

IRRof 15% 8,599.69 6,166.78 3,309.17 (52.69) (4,011.56) (8,675.49)

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UNITED BANK LIMITED

Assumptions Wage growth year 1: 30% Wage growth subsequent yrs : 8%Admin costs gi8% Staff Loans: 1915 Loan subsidy: 9%

Loss of rural Loans (Rs. M): 0 Staff Loan Ammortiz Yrs: 10Present Planned Closure Total Closed Remain. Branches after Phase I

Branches: Banked Un-banked Banked Un-banked Banked Un-bankedUrban 212 212Rural 144 144

)~~~~~it';mffl SO M 0 ;(dt tWg344 ^t-<.Ii -.i %]R 1110000; 00 0i4063t 80 io:Employees:

RetirementNo. of Empl. Cost of GHS Benefits Total Cost Cost/Employee

Executives 411 7 933 940 2.29Officers 2,430 138 2,324 2,462 1.01Clerical 1,476 339 685 1,024 0.69

Non-Clerical 3,015 446 1,262 1,708 0.57

MI . I I20 4 VI 0 84

2001 2002 2003 2004 2005 2006 2007Present no. of totalemployees 13,349Present no.outsourced positions 1,680New Hires 328New outsourcedpositions 2,897No. of employeespost retrenchment 6,345 6,345 6,345Outsource positionspost retrenchment 4,208

Outflows:VHS cost of 7,332employees (6,133)Adjustment to above (286)Cost ofoutsourcing (195) (421) (455) (491) (531) (573) (619)Cost of New Hires (90) (193) (209) (225) (244) (263) (2S4)Outplacement &Training (247)Cost of branchclosure - (53);;Sub1-t4 l ( 5 7*5 5 o>04i) (615) (664) (717) (774) (836) (903)Inflows:Salary savings ofretrenched staff 627 1629 1759 1900 2052 2216 2393

StaffLoansPrincipal 1,915 (192) (192) (192) (192) (192) (192)Cost Staff LoansSubsidy 86 172 155 138 121 103 86Admin cost savingbranches closed 76 163 176 190 205 222 240Sub Total 2,703 1,773 1,899 2,037 2,187 2,350 2,528

yeasw .. .tWi §:> S 4.09IRR -31% -7% 7% 16% 21%Required Residualfor IRR of 15% 5,510.91 4,652.25 3,609.02 2,345.39 819.51 (1,017.43)

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ANNEX 4.B: Actual and Projected Cost - Income Ratios of the NCBs

NATIONAL BANK OF PAKISTAN

Prior to Restructuring Post Restructuring - Phase I Post Restructuring - Phase 2(as at Dec. 31, 2000)

Staff Staff Staff Staffretnc'dtretire hiredloutsd Total Staff retnc'dtretire hired/outsd Total Staff

Total Perm Staff 15,147 7,430 250 7,680 1,000 250 6,930Executives 547 170 - 170 - 0 170Officers 7,779 3,784 250 4,034 1,000 250 3,284Clcrical 4,592 1,247 - 1,247 0 1,247Non-clerical 2,229 2,229 - 2,229 - 0 2,229Contract hire 4,000 4,000 - 4,000 0 4,000Outsourced - - 1,100 1,100 - 0 1,100TOTAL 19,147 11,430 1,350 12,780 1,000 250 12,030

Total staff costs 5,491,813 3,954,269 3,881,769

Saving from staffretnch'd/refd (1,647,544) (100,000)Costs of staffhired/outs'd 260,000 37,500Saving from staffloans (150,000) (10,000)

Other operatingexpenses 2,516,807 2,416,807 2,316,807Provisions andother costs 1,162,623 1,162,623 1,162,623Savings from

branch closures (100,000) (100,000)Total operatingexpenses 9,171,243 7,533,699 7,361,199

Total branches 1,408 1,158 908No. of branchesclosed 250 250Deposits of closedbranches 11,000,000 11,000,000Expected depositloss 6,600,000 6,600,000

Total Deposits 316,493,342 309,893,342 303,293,342Cost of deposits 20,898,938 20,762,853.91 19,714,067.23

Income loss fromdeposits (264,000) (264,000)Loss in otherincome (75,000) (75,000)Interest income 29,677,937 29,413,937 29,149,937Operating & otherincome 4,054,506 3.979,506 3,904,506

Total Income 12,833,505 12,630,589 13,340,376

Cost/Income Ratio 0.71 0.60 0.55

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HABIB BANK LIMITED

Prior to Restructuring Post Restructuring - Phase 1 Post Restructuring - Phase 2(as at Dec. 31, 2000)

Staff Staff Staff Staffretnc'dlretire hired/outsd Total Staff retne'd/retired hired/outsd Total Staff

Total No.Perm. Staff 21,847 10,873 400 11,374 1,921 400 9,853

Executives 1,444 544 - 900 - 0 900

Officers 9,802 2,601 400 7,601 1,219 400 6,782

Clerical 5,182 2,309 - 2,873 702 0 2,171

Non-clerical 5,419 5,419 -- - 0

Contract hire O- - - - 0Outsourced - - 4,000 4,000 - 0 4,000

TOTAL 21,847 10,873 4,400 15,374 1,921 400 13,853

Total staff costs 8,345,614 5,580,366 4,939,943Savings fr. staff

retnch'd/refd (2,596,400) (458,716)Costs of staff

hired/outs'd 312,640 (96,640)

Saving from staff loans (481,488) (85,067)Operating & otherexpenses 3,725,917 3,565,468 3,339,294

Provisions/other costs 1,370,735 1,370,735 1,370,735Savings from branch

closures (160,449) (226,174)

Total operatingexpenses 13,442,266 10,516,569 9,649,972

Total branches 1,680 1,431 1,080

No. of branches closed 249 351Deposits of closedbranches 8,823,000 12,437,334

Expected deposit loss 3,529,200 4,974,934

Total Deposits 266,000,000 262,470,800 257,495,866

Cost of deposits 17,385,761 15,748,248 15,449,751.98Income loss fromdeposits (647,100) (895,488)

Loss in other income (68,850) (98,504)

Interest income 25,407,135 24,760,035 23,864,547Operating & otherincome 6,564,341 6,495,491 6,396,987

Total Income 14,585,715 15,507,278 14,811,782

Cost/Income Ratio 0.92 0.68 0.65

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UNITED BANK LIMITED

Prior to Restructuring Post Restructuring - Phase 1 Post Restructuring - Phase 2(as at Dec. 31, 2000)

Staff Staff Staffretnc'd/retire hired/outsd Total Staff retnc'd/retire Total Staff

Total Perm. Staff 13,125 8,151 328 5,302 1,068 4,234Executives 763 540 252 475 0 475Officers 7,368 2,923 76 4,521 1034 3,487Clerical 1,608 1,491 - 117 0 117Non-clerical 3,386 3,197 - 189 34 155Contract hire 224 - - 224 0 224Outsourced 1,680 369 2,897 4,208 290 3,918TOTAL 15,029 8,520 3,225 9,734 1,358 8,376

Total staff costs 3,325,610 3,305,624 3,041,624Saving from staffretnch'd/retd (1,274,000) (233,000)

Costs of staff hired/outs'd 569,000

Saving from staff loans (172,000) (31,000)

Operating & otherexpenses 1,833,520 1,682,520 1,582,520

Provisions & other costs 120,539 120,539 120,539Savings from branchclosures (151,000) (100,000)

Total operating expenses 5,279,669 5,108,683 4,744,683

Total No.branches 1,368 1,012 722No. branches closed 356 290Deposits of closedbranches 10,613,000 10,976,000Expected deposit loss 3,842,000 6,358,000

Total Deposits 128,679,245 124,837,245 118,479,245Cost of deposits 6,740,868 6,241,862.25 5,923,962.25

Income loss from deposits (202,000) (297,000)Loss in other income (67,000) (98,000)Interest income 10,416,460 10,214,460 9,917,460

Operating & other income 3,497,037 3,430,037 3,332,037

Total Income 7,172,629 7,402,635 7,325,535

CostlIncome Ratio 0.74 0.69 0.65

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Summary of Benefits and Costs:

Main Assumptions:

Sensitivity analysis / Switching values of critical items:

- 32 -

Annex 5: Financial Summary

PAKISTAN: Banking Sector Restructuring and Privatization Project

Years Ending

Year1 I Year 2 Year 3 Year 4 Year 5 Year 6 | Year 7Total FinancingRequiredProject CostsInvestment Costs 390.0 100.0 50.0 0.0 0.0 0.0 0.0Recurrent Costs 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Total Project Costs 390.0 100.0 50.0 0.0 0.0 0.0 0.0.Total Financing 390.0 100.0 50.0 0.0 0.0 0.0 0.0

FinancingIBRDIIDA 150.0 100.0 50.0 0.0 0.0 0.0 0.0Government 137.0 0.0 0.0 0.0 0.0 0.0 0.0

Central 0.0 0.0 0.0 0.0 0.0 0.0 0.0Provincial 0.0 0.0 0.0 0.0 0.0 0.0 0.0

Co-financiers 0.0 0.0 0.0 0.0 0.0 0.0 0.0User Fees/Beneficiaries 0.0 0.0 0.0 0.0 0.0 0.0 0.0Others 103.0 0.0 0.0 0.0 0.0 0.0 0.0

Total Project Financing 390.0 100.0 50.0 0.0 0.0 0.0 0.0Main assumptions:

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Annex 6: Procurement and Disbursement Arrangements

PAKISTAN: Banking Sector Restructuring and Privatization Project

Procurement

Not Applicable

Procurement methods (Table A)

Table A: Project Costs by Procurement Arrangements(US$ million equivalent)

Procurement MethodL2

Expenditure Category ICB NCB Other N.B.F. Total Cost1. Works 0.00 0.00 0.00 0.00 0.00

(0.00) (0.00) (0.00) (0.00) (0.00)2. Goods 0.00 0.00 0.00 0.00 0.00

(0.00) (0.00) (0.00) (0.00) (0.00)3. Services 0.00 0.00 0.00 0.00 0.00

(0.00) (0.00) (0.00) (0.00) (0.00)4. Miscellaneous 0.00 0.00 0.00 0.00 0.00

(0.00) (0.00) (0.00) (0.00) (0.00)Total 0.00 0.00 0.00 0.00 0.00

(0.00) (0.00) (0.00) (0.00) (0.00)

Figures in parenthesis are the amounts to be financed by the IDA Credit. All costs include contingencies.

Includes civil works and goods to be procured through national shopping, consulting services, services ofcontracted staff of the project management office, training, technical assistance services, and incrementaloperating costs related to (i) managing the project, and (ii) re-lending project funds to local governmentunits.

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Not ApplicableTable Al: Consultant Selection Arrangements (optional)

(US$ million equivalent)

Selection MethodConsultant Services

Expenditure Category QCBS QBS SFB LCS CQ Other N.B.F. Total CostA. Firms 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

(0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00)B. Individuals 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

(0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00)Total 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00

(0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00)1\ Including contingencies

Note: QCBS = Quality- and Cost-Based SelectionQBS = Quality-based SelectionSFB = Selection under a Fixed BudgetLCS = Least-Cost SelectionCQ = Selection Based on Consultants' QualificationsOther = Selection of individual consultants (per Section V of Consultants Guidelines),Commercial Practices, etc.

N.B.F. = Not Bank-financedFigures in parenthesis are the amounts to be financed by the Bank Credit.

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Prior review thresholds (Table B)

Not ApplicableTable B: Thresholds for Procurement Methods and Prior Review

: Contract-Value Contracts Subject toThreshold Procurement Prior Review

Expenditure Category US$ thousainds) Method (US$ millions)1. Works

2. Goods

3. Services4. Miscellaneous5. Miscellaneous6. Miscellaneous

Total value of contracts subject to prior review:

Overall Procurement Risk Assessment

Frequency of procurement supervision mussions proposed: One every months (includes specialprocurement supervision for post-review/audits)

Thresholds generally differ by country and project. Consult OD 11.04 "Review of ProcurementDocumentation" and contact the Regional Procurement Adviser for guidance.

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Disbursement

Allocation of credit proceeds (Table C)

Table C: Allocation of Credit Proceeds

Expenditure Category Amount in US$milhlon Financing PercentageSeverance payments 300.00 100

0.000.00

Total Project Costs 300.00

Total 300.00 _

Use of statements of expenditures (SOEs):

The Credit will finance severance payments to staff who leave the NCBs and NDFC, up to a maximum of$300 million equivalent.

Financial Management Risk Assessment: The financial management systems of the implementingagencies are adequate to properly account for and report on the project expenditures. The key financialmanagement-related risk is that the disbursements of funds for the project relate to actual severancepayments made in accordance with approved policies. Mitigating measures taken on this risk are extensive,and concern the flow of funds, the procedures for verifying severance payments, the quality of internalaudit, and the financial reporting and extemal auditing arrangements.

Flow offunds: IDA funds will be financing the "non-funded" portion of severance payments given to theNCB and NDFC staff, as reimbursement of actual payments made, subject to branch closure targets andNDFC conditions being met.

The US$100 million notionally allocated to the NDFC reform would be made available for disbursementupon effectiveness of the Credit since the NDFC conditions (the legal instrument for amalgamating NDFCinto National Bank is in place and NDFC deposits have been transferred to National Bank) would havebeen met, these two actions being conditions of Board presentation.

Disbursement of the US$200 million notionally allocated to the NCB restructuring components would bemade not only on the basis of progress made in NCB staff reduction but also in branch closures. The firstUS$100 million equivalent would be made available for disbursement when 600 NCB branches or 1/3would have been closed; the next US$50 million, when 1,200 branches or 2/3 would have been closed; andthe final US$50 million, when 1,800 branches or 3/3 would have been closed. However, when an NCB isprivatized, its branch closure program would cease (branch closure being a means to facilitate bankprivatization and further branch closure becoming the prerogative of the new owners), and the overallbranch closure target of 1,800 branches would be accordingly adjusted.

The NCBs and NDFC would pay from their own sources the "funded" portion of severance payments andget reimbursed the "non-funded" portion from SBP. SBP would then have the non-funded portionreimbursed from IDA. IDA funds will be disbursed to reimburse the actual severance payments made,

- 37 -

upon receipt of SOEs in a format agreed (attached to the minutes of negotiations).

Ministry of Finance would authorize SBP to incur expenditure in respect of GoP's share in the project cost.SBP would make the payments and charge to the head of account advised by the MoF. SBP's AccountsDepartment would keep details of expenditure incurred. The project Coordinator would be responsible forconsolidating the expenditure under various heads/financiers.

Severance payment procedure/control in NCBs and NDFC: Payroll and compensation arecomputerized/controlled at the region level. Human resource departments of NCBs/NDFC would preparestatement of claims in respect of severance payments based on the computerized payroll and compensationsystem that the three NCBs/NDFC have in place. The statements would be pre-audited by the respectiveinternal audit departments of the NCBs/NDFC before payment by the accounts department. Heads ofhuman resource, internal audit and accounts departments would sign off the statements. Payments would beeither made through crossed cheques or credit to beneficiaries' accounts. The NCBs/NDFC would keepsupporting documents for subsequent verification by SBP's inspection teams and Bank supervisionmissions. These statements would be submitted to the Project Coordinator of the project in SBP. TheProject Coordinator would have the services of the International Organizations' Accounts Section in theAccounts Department to conduct check before payment. These payments would also be subject to pre-auditby Audit Division of the Accounts Department as well as post-audited by Audit Department of SBP. TheBanking Inspection Department of SBP would also test-check these payments as part of their normalon-site inspection of NCBs/NDFC whereas the Banking Supervision Departrnent would carry out theoff-site supervision. Terms of reference of external auditors of NCBs/NDFC would be expanded to includeaudit of severance payments. As per Prudential Regulations, SBP is empowered to recover improperpayments and also to levy penalties. Hence SBP would be able to recover any irregular paymentshighlighted by the Banking Inspection Department or the external auditors.

Capacity of internal audit departments in NCBs/NDFC/SBP: The three NCBs/NDFC have internalaudit departments that report to the Board of Directors. In all cases the departments comprise a mixture ofprofessionals (chartered accountants, cost & management accountants and MBAs) who have richexperience in the banking sector and in EDP auditing. Staff in the Audit Department of SBP is well trainedin bank audit. Banking Supervision Department comprises of one inspection department (for on-siteinspection) each for bank and non-bank (DFIs) audit. It also has a supervision department that hasdivisional heads who are supported by professional accountants and MBAs for off-site regulatorysupervision.

Financial Reporting and External Auditing: Audited entity financial statements, accompanied by theauditors' management letters, for the NCBs will be required within six months of the close of financialyear. In addition SBP would provide quarterly project management reports within 45 days of the end ofeach quarter (agreedfornat attached to the minutes of negotiations):

* Summary of Sources & Uses of Funds* Output Monitoring Report

The following annual audited financial statements, accompanied by the auditor's management letter, wouldbe provided for the project within six months of the close of each financial year:

* Summary of Sources & Uses of Funds* SOE Withdrawal Schedule

The project audit report will include opinions on the financial statements, and on whether the SOEssubmitted, together with the procedures and internal controls involved in their preparation, can be relied up

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on to support the related withdrawals. Formats of project annual and quarterly reports, and the form ofauditors' opinion in respect of Entity, Project/SOE have been agreed.

The ARCS requirements will therefore be:* Entity financial statement audits for the three NCBs* Project/SOE financial statement audit - SBP

External Auditors: SBP has categorized firms of chartered accountants in three categories (A, B & C).NCBs/DFIs are mandated to appoint external auditors from these categories based on the value of totalassets and number of branches. Auditors are appointed by the shareholders for a term of three years. UBL,NBP, HBL and NDFC have appointed joint auditors. SBP's Central Board appoints auditors affiliatedwith the "Big Five" international accounting/auditing firms for a term of five years. Acceptability of theauditors in each case has been confirmed at negotiations.

PMR-Based Disbursements: Because of the nature of the project, PMR-based disbursements are notconsidered appropriate.

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Annex 7: Project Processing Schedule

PAKISTAN: Banking Sector Restructuring and Privatization Project

Project Schedule Planned ActualTime taken to prepare the project (months) 4 6First Bank mission (identification) 02/01/2001 02/01/2001Appraisal mission departure 04/01/2001 05/26/2001Negotiations 08/01/2001 07/19/2001Planned Date of Effectiveness 12/01/2001

Prepared by:

Preparation assistance:

Bank staff who worked on the project included:

Name SpecialityJoseph Pernia Financial Sector Specialist

Mudassir Khan Financial Sector SpecialistChristopher Juan Costain Financial Sector Specialist

Esen Ulgenerk Financial Sector Specialist

Rune Barneus Banking SpecialistKishor Uprety Counsel

Hasan Saqib Financial Management Specialist

Ahsan Ali Procurement Specialist

Mary Agnes Evidente Program Assistant

-40 -

Annex 8: Documents in the Project File*PAKISTAN: Banking Sector Restructuring and Privatization Project

A. Project Implementation Plan

Borrower Project Implementation Plan

B. Bank Staff Assessments

I . Bank Privatization Mission Supplementary Aide Memoire, June 20002. Technical Assistance Mission Aide Memoire, September 20003. Preparation Mission Aide Memoire, February 20014. Technical Mission Aide Memoire, April 20015. Appraisal Mission Aide Memoire, June 2001

C. Other

I . Operating and Financial Ratios of NCBs2. CIRC Ordinance, September 28, 20003. National Bank of Pakistan Action Plan4. National Bank of Pakistan, Annual Report 19995. National Bank of Pakistan Corporate Restructuring, Feb. 2, 20016. National Bank of Pakistan VHS Scheme 2001, June 2, 20017. Draft Confidential Information Memorandum presented to the Privatization Comnrnissiorn, March 19998. Habib Bank Limited Staff and Branch Rationalization Plans (11 vols)9. Paper on Restructuring of Commercial Banking within UBL, September 1, 2000

10. Bank Restructuring Plan by UBL, January 1, 200111. United Bank Restructuring, January 2001 (2 vols)12. United Bank Limited Audit Report (External), May 12, 200113. United Bank Limited Company Profile, June 200114. Options Towards Resolving Tax Issues in Banking, June 200115. Letters to Minister of Finance (2)16. Implementation Completion Report #18684: Pakistan - Banking Sector Adjustment Loan, Dec. 10,

199817. Pakistan - Financial Sector Update #20218-PAK, May 31, 200018. Pakistan - Country Assistance Strategy - Progress Report, December 28, 199819. Pakistan - Periodic Economic Report, January-March 200020. Banking Sector Monthly Update*Including electronic files

-41 -

Annex 9: Statement of Loans and Credits

PAKISTAN: Banking Sector Restructuring and Privatization Project

Difference between expectedand actual

Original Amount in USS Millions disbursements'

Project ID FY Purpose IBRO IDA Carnel. Undisb. Orig Frm RevdP071092 2001 NWFP ON-FARM WATER MANAGEMENT PROJECT 0.00 21.35 0.00 20.80 0.00 0.00

P056213 2001 TRADE & TRANSPORT 0.00 3.00 0.00 1.88 -1.00 0.00

P049791 1999 POVERTY ALLEVIATION FUND 0.00 90.00 0.00 69.91 3.40 0.00

P037835 1998 SOCIAL ACTION PRG II 0.00 250.00 0.00 54.17 -5.87 0.00

P037834 1998 NORTHERN EDUCATION 0.00 22.80 0.09 16.85 15.18 0.00

P010500 1998 NATIONAL DRAINAGE PR 0.00 285.00 0.24 176.64 107.10 0.00

P010501 1997 PVT SECTOR GROUND WA 0.00 56.00 25.34 9.39 40.47 2.80

P036015 1997 IMPR FIN REP & AUDIT 0.00 28.80 0.00 19.45 19.64 0.00

P039281 1996 GHAZI BAROTHA HYDROP 350.00 0.00 0.00 80.35 72.90 35.33

P010478 1996 NWFP COMMUNITY INFRA 0.00 21.50 0.00 8.94 12.48 12.36

P010482 1996 BALOCHISTAN COMMUNITY IRRIGATION & AGRI. 0.00 26.70 0.00 4.80 7.09 6.19

P034101 1996 TELECOMREG&PRIVAT 35.00 0.00 10.00 8.40 18.40 8.40

P010481 1995 PUNJAB FOREST SECTOR DEV. 0.00 24.90 5.46 4.30 12.09 2.57

P010470 1995 FIN SECTOR DEEPENING & INTEGRATION 216.00 0.00 188.03 16.53 204.36 13.92

Total: 601.00 830.05 229.17 49Z39 506.23 81.57

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PAKISTANSTATEMENT OF IFC's

Held and Disbursed PortfolioMay-2001

In Millions US Dollars

Committed DisbursedIFC IFC

FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic

1995 ABAMCO 0.00 0.29 0.00 0.00 0.00 0.29 0.00 0.001995 AES Lal Pir 35.20 9.50 0.00 0.00 35.20 9.50 0.00 0.001996 AES Pak Gen 17.43 9.50 0.00 34.88 17.43 9.50 0.00 34.881996 Atlas Inv Bank 3.44 0.00 0.00 0.00 3.44 0.00 0.00 0.001994 Atlas Lease 3.60 0.21 0.00 0.00 3.60 0.21 0.00 0.001998 BRRIL 0.00 0.24 0.00 0.00 0.00 0.24 0.00 0.001991/94/95 BRRIM 0.00 0.00 5.00 0.00 0.00 0.00 5.00 0.001995 BSJS Fund 0.00 0.50 0.00 0.00 0.00 0.50 0.00 0.001995 Bank of Khyber 1.13 0.00 0.00 0.00 1.13 0.00 0.00 0.001993 CDCPL 0.00 0.16 0.00 0.00 0.00 0.16 0.00 0.001993/97 Crescent Greenwd 0.00 2.00 0.00 0.00 0.00 2.00 0.00 0.001996 Crescent IBank 9.00 0.00 0.00 0.00 9.00 0.00 0.00 0.001994/95/96 D.G. Khan 0.00 0.51 0.00 0.00 0.00 0.51 0.00 0.001998 Engro Asahi 14.25 0.00 0.00 0.00 8.00 0.00 0.00 0.001991/95/97 Engro Chemical 7.07 0.00 0.00 6.00 7.07 0.00 0.00 6.001996 Engro Paktank 8.74 0.00 0.00 3.64 8.74 0.00 0.00 3.641990/91/96 FPB 1.92 0.00 0.00 0.00 1.92 0.00 0.00 0.001993 Fauji Cement 22.40 5.00 0.00 17.50 22.40 5.00 0.00 17.501995 First Crescent 0.00 0.00 5.00 0.00 0.00 0.00 5.00 0.001994/96 First Leasing 0.00 0.69 0.00 0.00 0.00 0.69 0.00 0.001995 First UDL 0.00 0.00 10.00 0.00 0.00 0.00 10.00 0.001996 Gul Ahmed 22.95 4.10 0.00 26.38 22.95 4.10 0.00 26.381988 Hala Spinning 3.80 0.00 0.00 0.00 3.80 0.00 0.00 0.001991/95 IHFL 0.00 0.40 0.00 0.00 0.00 0.40 0.00 0.001992/96 JSCL 0.00 0.27 0.00 0.00 0.00 0.27 0.00 0.001995 Kohinoor 20.00 6.30 0.00 24.40 20.00 6.30 0.00 24.401994/95/97 Maple Leaf 0.00 0.52 0.00 0.00 0.00 0.52 0.00 0.001985/92 Mari Gas 2.86 0.00 0.00 0.00 2.86 0.00 0.00 0.001993 Muslim Comm Bank 2.34 0.00 0.00 0.00 2.34 0.00 0.00 0.001984/94 NDLC 4.22 1.25 0.00 0.00 4.22 1.25 0.00 0.001994 Orix Finance 0.00 0.58 0.00 0.00 0.00 0.58 0.00 0.001994 Orix Leasing 4.22 1.25 0.00 0.00 4.22 1.25 0.00 0.001994 PACRA 0.00 0.15 0.00 0.00 0.00 0.10 0.00 0.001994 PI&CL 2.19 0.00 0.00 0.00 2.19 0.00 0.00 0.001991/94/95 PILCO 0.00 0.54 0.00 0.00 0.00 0.54 0.00 0.001983/84/94 PPL 1.12 0.00 0.00 0.19 1.12 0.00 0.00 0.191965/80/82/87/91/94/9 Packages 9.07 2.50 0.00 1.25 9.07 2.50 0.00 1.255 Pakistan Service 5.00 3.00 0.00 0.00 5.00 3.00 0.00 0.001993 Pakistan Unit Tr 0.00 1.48 0.00 0.00 0.00 1.48 0.00 0.001995 Prudential 0.00 0.40 0.00 0.00 0.00 0.40 0.00 0.001991 RUPAFIL 1.20 0.00 0.31 0.00 1.20 0.00 0.31 0.001992 Regent Knitwear 6.38 0.00 0.00 2.80 6.38 0.00 0.00 2.801994 Rupafab 5.50 0.00 0.00 0.00 5.50 0.00 0.00 0.001995 Sarah Textiles 0.00 0.20 0.00 0.00 0.00 0.20 0.00 0.001993/96

Total Portfolio: 255.03 51.54 20.31 192.04 243.81 51.49 20.31 I,

-43 -

Approvals Pending Conimitment

FY Approval Company Loan Equity Quasi Partic

Total Pending Commitment: 0.00 0.00 0.00 0.00

-44 -

Annex 10: Country at a Glance

PAKISTAN: Banking Sector Restructuring and Privatization Project

POVERTY and SOCIAL South Low-Pakistan Asia income Development diamond*

1999PoDulation, mid-year (millions) 134.8 1.329 2,417 Life expectancyGNP per capita (Atlas mefhod, USS) 450 440 410GNP (Atlas method, US$ billions) 60.8 581 988

Average annual growth, 1993-99

Population (%) 2.4 1.9 1.9 1 Labor force (%i 2.9 2.3 2.3 GNP Gross

cpe primaryMost recent estimate (latest year available, 1993-99) pita enrollment

Povertv (I% of Population below national poverty line) ..Urban Population (% of total population) 36 28 31Life expectancy at birth (vears) 62 62 60Infant mortalitv (oer 1,000 live births) 91 75 77Child malnutrition (I% of chitdren under 5) 38 51 43 Access to safe waterAccess to improved water source (% of population) 60 77 64Illiteracv (% of population age 15+) 55 46 39Gross orimarv enrollment (% of school-age populalion) 74 100 96 -P kistan

Male 101 110 102 Low-income groupFemale 45 90 86

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1979 1989 1998 1999Economic ratios'

GDP (US$ billions) 19.7 40.2 62.2 58 2

Gross domestic investment/GDP 17.9 18.9 17.7 15.0 TradeExDorts of aoods and services/GDP 10.7 13.9 16.1 15.2Gross domestic savings/GDP 5.8 11.0 13.2 10.1Gross nationai savinas/GDP 13.7 15.6 15.0 11.2

Current account balance/GDP -4.2 -3.4 -2.7 -3.8 Domestic Je nInterest Davments/GDP 1.1 1.1 1.3 1.8 InvestmentTotal debt/GDP 45.3 45.7 51.8 53.6 S avinsTotal debt service/exports 18.5 24.2 23.6 27.4Present value of debt/GDP .. .. 41.1Present value of debt/exports .. .. 220.1

Indebtedness1979-89 1989-99 1998 1999 1999-03

(average annual qrowth)GDP 6.7 3.9 2.6 2.7 5.1 PPkistanGNP per caDita 3.8 1.5 -1.4 0.3 2.9 Low-income groupExports of qoods and services 9.2 2.9 -5.7 -2.4 6.9

STRUCTURE of the ECONOMY1979 1989 1998 1999 Growth of investment and GDP (%)

(% of GDP) 20

AQriculture 30.4 26.9 27.3 27.2Industrv 23.6 23.9 23.8 23.5 20

Manufacturing 15.4 16.6 15.8 15.6 0Services 46.0 49.2 48.9 49.4 -10

Private consumption 83.8 72.2 75.5 78.4 -20 General qovernment consumDtion 10.4 16.8 11.3 11.5 - e GPImoorts of goods and services 22.8 21.7 20.6 20.1

1979-89 1989-99 1998 1999 Growth of exports and imports (%)(averagqe annual qrowth)Aqriculture 4.6 4.4 4.5 1.9 20

lndustrv 7.3 4.3 6.1 2.5Manufacturinq 7.9 4.0 6.9 4.2 10

Services 7.2 4.5 1.6 4.1

Private consumption 4.2 5.0 0.1 6.3 0 |General oovernment consumDtion 10.5 0.4 6.8 -5.1Gross domestic investment 6.5 2.2 9.8 -11.8 -10Imports of ooods and services 1.7 3.4 -5.6 -6.2 -Exports Dmports

Gross national product 6.6 4.0 1.0 2.8

Note: 1999 data are preliminary estimates.

The diamonds show four kev indicators in the country (in bold) compared with its income-group average. If data are missinq, the diamond willbe incomplete.

- 45 -

Pakistan

PRICES and GOVERNMENT FINANCE1979 1989 1998 1999 Inflation (%)

Domestic prices 5(% change) 15Consumer prices .. .. 7.8 5.77 Implicit GDP deflator 6.6 8.6 7.5 6.0

Government finance(% of GDP, includes current grants)Current revenue .. 18.1 16.3 16.3 94 95 9s 97 98Current budget balance .. -1.8 -4.2 -2.6 - GDP deflator cPiOverall surplus/deficit .. -7.7 -7.7 -6.1

TRADE1979 1989 1998 1999 Export and import levels (USS mill.)

(US$ millions)

Total exports (fob) ,, 4,634 8,433 7,527 15,000Cotton .. 930 126 2 200Rice .. 304 562 533 .2,000Manufactures .. 3,312 4,866 4,538 9,0.0

Total imports (ci) .. 7,851 10,456 10,888 8 __Food .. .. 1,685 1,622 3_0 _Fuel and energy .. 1,006 1,750 1,458 -Capital goods .. .. 2,288 3,027 o

93 94 9s 98 97 98 99Export price index (1995=100) .. 51 94 90Import price index (1995=100) .. 45 91 102 H Exports * ImportsTerms of trade (1995=100) .. 112 104 88

*ALANCE of PAYMENTS1979 1989 1998 1999 Current account balance to GDP (%)

(USS millions)Exports of goods and services 2,107 5,577 10,017 8,838 0Imports of goods and services 4,485 8,736 12,819 11,6888Resource balance -2,378 -3,159 -2,802 -2,850 -2

Net income -233 -875 -2,330 -1,808Net current transfers 1,790 2,687 3,430 2,471 -4

Current account balance -820 -1,347 -1,702 -2,187 -s

Financing items (net) 515 1,347 1,554 3,441Changes in net reserves 305 0 148 -1,254

Memo:Reserves includinq qold (US$ millions) .. 1,237 1,464 2,228Conversion rate (DEC, local/US$) 9.9 19.2 43.0 50.1

EXTERNAL DEBT and RESOURCE FLOWS1979 1989 1998 1999

(US$ millions) Composrtion of 1999 debt (USS mill.)Total debt outstanding and disbursed 8,919 18,348 32,229 31,176

IBRD 339 1,428 3,262 3,175IDA 751 1,915 3,732 3,857 G 1.390 A: 3,175

Total debt service 658 1,841 2,743 2,743 F: 3,028IBRD 57 147 381 400 L: 3,857IDA 9 30 70 81

Composition of net resource flows c: 1,519Official grants 146 381 175 194Official creditors 561 931 891 1,642 E: 10.680 _ _Private creditors 23 -12 306 -316Foreign direct investment 58 210 500 428 D 7,527Portfolio equity .. .. .. 28

World Bank programCommitments 139 746 250 808 A - IBRD E - BilateralDisbursements 105 471 606 683 B - IDA D - Other multilateral F - PrivatePrincipal repayments 27 82 243 264 C- IMF G - Short-termNetflows 79 389 363 419Interest payments 39 95 208 217Net transfers 39 294 155 202

Development Economics _

- 46 -

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